*181 Decision will be entered under Rule 50.
1. Petitioner quarried a limestone which could have been used either in the production of hydrated hydraulic lime or for agricultural purposes. However, because of the existence of other limestone in the agricultural market chemically better suited to the farmers' needs, petitioner could not sell its quarried stone in that market. Petitioner's stone was therefore subjected to certain treatment processes in order to produce hydrated hydraulic lime, a product of which petitioner was the only known producer during the years in issue. Held, hydrated hydraulic lime was the first commercially marketable mineral product arrived at in petitioner's operations, and all the processes utilized in its production were ordinary treatment processes, thereby entitling petitioner to include the total gross income therefrom in its basis for percentage depletion.
2. Petitioner sold hydrated hydraulic lime in both a pure and an admixed state. The sales of the pure product were made at the minimum price of $ 19.20 per ton, and the sales of the admixed product at a price in excess thereof. Held, petitioner properly computed gross income from the property*182 by multiplying the total tonnage of hydrated hydraulic lime sold, whether in a pure or an admixed state, by $ 19.20, and adding thereto the income realized from the sale of waste material.
*447 This proceeding involves deficiencies in income and excess profits taxes for the years 1951 and 1952 of $ 34,706.31 and $ 37,884.09, respectively.
The issues to be decided are: (1) Whether hydrated hydraulic lime was the first commercially marketable product mined by petitioner within the meaning of section 114 (b) (4), for purposes of computing allowable depletion based on the gross income from such product; and (2) the amount of gross income realized by petitioner from the sale of such product.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein by this reference.
At all times material hereto, petitioner, a Virginia corporation organized to engage in the production of stone products, maintained its principal office and place of business at Riverton, Virginia. It kept its books*183 and filed its income and excess profits tax returns on an accrual basis. Its returns for the years 1951 and 1952 were filed with the former collector of internal revenue and the director of internal revenue, respectively, for the district of Virginia.
During the years in issue, petitioner owned and operated quarries in two limestone formations at Riverton, Virginia. The stone taken from one of these formations was used in concrete work, road work, and for agricultural purposes. The stone taken from the other formation was processed by petitioner to produce hydrated hydraulic *448 lime. Hydrated hydraulic lime is a cementitious lime which is used in construction work and one which will harden under water. It is a recognized product in the building industry, and both the United States Government and the American Society for Testing Materials recognize such product. In the construction specifications for certain Government buildings, petitioner's product has, in the past, been mentioned by name.
The only mineral deposit involved in this proceeding is the limestone deposit from which petitioner quarried stone to produce hydrated hydraulic lime. That deposit contained an amount*184 of argillaceous limestone of the Athens geological formation, which is a mineral but not an ore.
In general, limestone in its quarried state has many uses. However, the mineral composition of the particular stone is usually determinative of the use to which it can be put. Due to the chemical characteristics of the limestone quarried by petitioner from the deposit in issue, it could have been used only as an agricultural limestone and in the production of hydrated hydraulic lime.
While it may have been possible to use petitioner's limestone in its quarried state for agricultural purposes, petitioner could not, and did not, sell it in this market because of an abundance of other limestone in the area which was chemically more suited to the farmers' needs.
Petitioner, in order to produce hydrated hydraulic lime, subjected the limestone it quarried from the deposit herein involved to the following treatment processes:
(a) Quarrying and preliminary crushing. The stone was quarried, trucked to a crusher, and broken into pieces weighing up to 30 pounds. It then proceeded into a revolving screen having holes 1.25 inches in diameter, and any stone which dropped through those holes *185 was discarded on a waste dump. Petitioner realized $ 7,960.25 in 1951 and $ 9,318.37 in 1952 from sales of material from that dump. The sales price of such waste material averaged 81 cents per ton in 1951 and 88 cents per ton in 1952. The cost of all of the stone brought to that point averaged $ 1.34 per ton in 1951 and $ 1.39 per ton in 1952.
(b) Burning. The remaining stone was then hauled to a kiln where it was burned. After being discharged from the kiln the burned stone was placed in storage bins.
(c) Crushing and grinding. The burned stone was drawn from storage as it was needed and was then crushed and ground until 90 per cent thereof passed through a fine mesh.
(d) Hydration. The material was then mixed with water and a small amount of sulphuric acid and passed on to a hydrator to complete *449 the absorption of water. After hydration, the material was placed in storage again, where it was cured for further soundness.
(e) Final grinding and packaging. After the curing was complete, the material was carried through two tube mills for further grinding. Before final grinding, most of the material was mixed with additives. The resulting mixture contained*186 approximately 83 per cent hydrated hydraulic lime and 17 per cent cement, waterproofing, and other plasticizing agents, the purpose of which was to give greater strength as a cementitious product to the pure hydrated hydraulic lime. It was then given its final grinding and packaged for sale under the name of "Flamingo for Masonry Mortar" (hereinafter referred to as the admixed product). A small amount of the material was ground through the tube mills without the additives, and was packaged and sold under the name of "Flamingo Hydraulic Lime for Concrete" (hereinafter referred to as the pure product).
Petitioner sold 48,874 tons of hydrated hydraulic lime in 1951, and 46,160 tons in 1952. Most of those sales were of the lime in the form of the admixed product, and were made at a price in excess of $ 19.20 a ton. The remaining sales were of the lime in the form of the pure product and were made at a minimum price of $ 19.20 a ton.
During the years in issue, petitioner was the only known producer of hydrated hydraulic lime in the United States, although others had produced it in prior years. The production methods utilized by petitioner in producing hydrated hydraulic lime were *187 substantially similar to those employed by other former producers of the product.
The pure product was used in the manufacture of concrete. Due to advances attained in the manufacture of portland cement, one of the main constituents of concrete, the necessity of using the pure product in the latter's production was sharply curtailed. Consequently, during the years in issue, there was a small market for that product and petitioner made comparatively few sales of hydrated hydraulic lime in that form.
Petitioner realized total gross receipts from the sales of all its Flamingo products of $ 1,259,332.40 in 1951, and $ 1,196,541.36 in 1952.
The following table shows, for the years in issue, the cost of production at the various processing stages of petitioner's products:
| Direct costs | ||
| Processes | 1951 | 1952 |
| Quarrying and preliminary crushing | $ 123,475.39 | $ 97,997.03 |
| Burning | 132,504.42 | 119,326.53 |
| Crushing and grinding | 20,382.91 | 34,668.49 |
| Hydrating | 69,892.26 | 89,682.15 |
| Packing (mined product only) | 1 129,136.85 | 2 124,813.64 |
| Total processes | $ 475,391.83 | $ 466,487.84 |
| Direct costs | ||
| Admixtures | 1951 | 1952 |
| Cost of purchased materials | $ 244,760.55 | $ 223,054.77 |
| Cost of packing | 1 27,112.03 | 2 24,732.73 |
| Total admixtures | $ 271,872.58 | $ 247,787.50 |
| Total all Flamingo products | $ 747,264.41 | $ 714,275.34 |
*450 On its returns, petitioner claimed it was entitled to percentage depletion for the years 1951 and 1952, based on (1) an amount computed by multiplying the total number of tons of pure hydrated hydraulic lime sold in either the pure or the admixed state by $ 19.20, the minimum price per ton received for the pure product during the years in issue, plus (2) the amount realized from the sale of waste material.
Thus, for 1951, petitioner claimed a percentage depletion allowance of $ 47,317.05, based on 5 per cent of $ 946,341.05. This latter figure was the sum of $ 938,380.80 realized from the sale of 48,874 tons of hydrated hydraulic lime at $ 19.20 per ton, plus $ 7,960.25 realized from the sale of waste material. For 1952 1 it claimed percentage depletion of $ 44,773.80*189 computed by taking 5 per cent of $ 895,475.90. Again, this latter figure was the sum of $ 886,387.20 realized from the sale of 46,160 tons of hydrated hydraulic lime at $ 19.20 per ton, plus $ 9,088.70 realized from the sale of waste material.
The respondent determined that only the initial treatment processes of quarrying and preliminary crushing of the stone constituted mining operations. Consequently, he limited petitioner's percentage depletion basis to the gross income derived from such processes plus the income realized from the sale of quarry screenings. In computing that gross income, he allocated total sales receipts*190 between the mining operations and the operations he determined were manufacturing on the basis of the ratio which the cost of each such operation bore to total production costs.
Thus, for 1951, he determined petitioner realized gross sales of $ 1,259,332.40, that it expended $ 123,475.39 on the quarrying and preliminary crushing processes, and that its total production costs were $ 745,357.91. He then attributed to the initial treatment processes of *451 quarrying and preliminary crushing that proportion of the total sales income as represented by the ratio which $ 123,475.39 bears to $ 745,357.91. For 1952, he determined gross sales of $ 1,196,323.49 were realized, $ 102,975.68 expended on the initial treatment processes, and that total production costs of $ 714,275.34 were incurred. He then attributed to the quarrying and preliminary crushing processes that proportion of the total sales income as represented by the ratio which $ 102,975.68 bears to $ 714,275.34. Against such computation of gross income from the quarrying and preliminary crushing processes and the gross income actually received from the sale of quarry screenings respondent applied the statutory percentage*191 depletion allowance of 5 per cent for limestone, determining an allowable deduction of $ 10,829.01 for 1951, and $ 9,088.91 for 1952. 2
The first commercially marketable product produced by petitioner from the limestone here in issue was hydrated hydraulic lime in its pure state. The processes of original quarrying, preliminary crushing, burning, grinding, final grinding, and packaging which petitioner applied to its limestone to arrive at that product were ordinary treatment processes normally applied by mine owners to obtain the commercially marketable product.
OPINION.
Section 114 (b) (4) (A) of the 1939 Code 3 provides that the allowance for depletion*192 in the case of stone shall be "5 per centum * * * of the gross income from the property during the taxable year * * *." Subparagraph (B) defines gross income from *452 the property as "the gross income from mining * * *," and includes within the term mining "not merely the extraction of the ores or minerals from the ground but also the ordinary treatment processes normally applied by mine owners or operators in order to obtain the commercially marketable mineral product or products * * *." In Black Mountain Corporation, 21 T. C. 746 (1954), we agreed that the Commissioner, in his regulations, had properly interpreted the phrase "commercially marketable mineral product" to mean the "first commercially marketable mineral product."
*193 The primary issue before us is whether crushed limestone, or pure hydrated hydraulic lime, was the "first commercially marketable mineral product" arrived at in petitioner's production operations.
Petitioner contends that hydrated hydraulic lime was the first commercially marketable product which it produced since no market existed for its limestone until it reached that state. The respondent, on the other hand, argues that the limestone here in issue could have been used in its crushed state for agricultural purposes and that crushed limestone and not hydrated hydraulic lime was therefore the first marketable product which the petitioner produced. He, accordingly, contends that petitioner's depletion allowance must be limited to 5 per cent of the theoretical gross income derived from the sale of crushed stone plus the amount realized from the sale of quarry screenings.
We found as a fact that even though petitioner's crushed limestone could have been used for agricultural purposes, it could not and did not sell the limestone in that state because of its inferior chemical composition and that hydrated hydraulic lime was, therefore, the first commercially marketable mineral product*194 which it produced. We think "commercially marketable" means that there is commerce or trade in a mineral product and that there is an established market in which such product is sold. Here there was neither so far as this particular crushed limestone was concerned. But, even in the face of those facts, the respondent argues that because the crushed stone which the petitioner produced could have been used for agricultural purposes, it must compute its allowable depletion on the theoretical gross income supposedly derived from the sale of the crushed stone. It seems to us that the effect of that argument is to read the words "commercially marketable" out of the statute.
As the Court of Appeals said in United States v. Cherokee Brick & Tile Co., 218 F. 2d 424, 425 (C. A. 5, 1955):
The statutory language is clear and unambiguous, which is that gross income from mining must include the income from ordinary treatment processes which must be applied to the ore or mineral in order to obtain the commercially marketable mineral product, that is, the first product which is marketable in commerce. *453 There is no provision in the statute for excluding*195 any process before such a marketable product is reached. * * *
See also United States v. Merry Brothers Brick & Tile Co., 242 F. 2d 708 (C. A. 5, 1957); United States v. Sapulpa Brick & Tile Corporation, 239 F. 2d 694 (C. A. 10, 1956); Townsend v. Hitchcock Corporation, 232 F. 2d 444 (C. A. 4, 1956); and American Gilsonite Co., 28 T. C. 194 (1957).
We therefore conclude that the gross income which petitioner derived from the sale of hydrated hydraulic lime plus the income from the sale of quarry screenings is the proper basis for computing its allowable percentage depletion.
The second issue presented for our consideration is the proper method of computing the depletion base. Had all of petitioner's sales been of pure hydrated hydraulic lime, the issue would not exist. Gross income from the property could then have been equated to gross receipts. However, such was not the case. As the record reveals, sales of the product were made in both a pure and a mixed state. Therefore, we must arrive at a figure which most clearly reflects gross income*196 from the pure product, excluding therefrom the costs and proportionate profits attributable to those processes utilized thereafter to produce the mixed product. At best, any figure will be only an approximation since the bulk of petitioner's sales were of the mixed product.
The Code provides that the basis against which the statutory depletion percentage is to be applied is the "gross income from the property." The regulations 4 state:
if the product is * * * processed * * * before sale, "gross income from the property" means the representative market or field price (as of the date of sale) of a mineral product of like kind and grade as beneficiated by the ordinary treatment processes actually applied, * * *. If there is no such representative market or field price (as of the date of sale), then there shall be used in lieu thereof the representative market or field price of the first marketable product resulting from any process or processes * * * minus the costs and proportionate profits attributable to the * * * processes beyond the ordinary treatment processes. If the taxpayer establishes to the satisfaction of the Commissioner that another method of computation, *197 other than the computation of profits proportionate to costs, clearly reflects the gross income from the property, then such gross income shall be computed by the use of such other method. [Emphasis supplied.]
Petitioner contends that $ 19.20 per ton, the minimum price received by it for hydrated hydraulic lime in its pure state during the years in issue, was the representative market price for that product. It computes its gross income from the property by multiplying the *454 total tonnage of that product sold in each year, whether in a pure or mixed state, by $ 19.20, and adds to that figure the amounts realized from the sale of quarry screenings.
Respondent challenges that method. He contends that petitioner has failed to establish that $ 19.20 was the representative market price per ton for pure hydrated hydraulic lime during the years in issue. He argues *198 that while $ 19.20 might represent the market price per ton for that small portion of petitioner's total production of hydrated hydraulic lime which was sold in the pure state, it cannot be said to represent the market price for the much greater quantity of that product which was sold in the admixed state. Therefore, he argues, there being no representative market price for "a mineral product of like kind and grade as beneficiated by the ordinary treatment processes actually applied," gross income from the property must be determined on the basis of the market price "of the first marketable product resulting from any process or processes," here the admixed product, "minus the costs and proportionate profits attributable to the * * * processes beyond the ordinary treatment processes."
Accordingly, respondent would apply to petitioner's gross sales, the ratio which the cost of the ordinary treatment processes bears to the entire cost of production. This, he contends, eliminates the costs and proportionate profits attributable to those processes beyond the ordinary treatment processes, as provided by the regulations. He bases his computation on the assumption that petitioner's production*199 costs were proportionate to its profits.
In 1951 petitioner expended $ 475,391.83 on ordinary treatment processes, or approximately 64 per cent of its total production costs of $ 747,264.41. In 1952 petitioner expended $ 466,487.84 on the ordinary treatment processes, or approximately 65 per cent of its total production costs for that year of $ 714,275.34. Respondent would compute gross income from the property at 64 per cent of petitioner's gross sales for 1951, and 65 per cent of its gross sales for 1952, plus any income resulting from the sales of quarry screenings in the respective years.
This is a peculiar case in that petitioner is the hydrated hydraulic lime industry. Few sales of the pure product were made because hydrated hydraulic lime, unmixed with additives, was no longer used to any large extent in the manufacture of concrete. In effect, the pure product and the admixed product were products which competed with one another. Presumably, had petitioner not produced the admixed product, it could have sold its total hydrated hydraulic lime production in the pure state; but, because it produced a better product by adding cement, waterproofing, and other plasticizing agents, *200 which gave greater strength to the pure lime, that product was more salable *455 and was the one demanded in the construction industry. It is unreasonable to assume, as respondent's computation does, that petitioner could add those commercial components and realize anywhere near as great a markup on their resale as it could realize on its own product -- the pure hydrated hydraulic lime -- since no further processing of the lime was done when the cement and other plasticizers were added, except for a final grinding of the admixed product.
On this record, we believe petitioner's method of computing the depletion basis to be the proper one. The regulations state that, in the case of a product processed before sale, gross income from the property is to be computed on the basis of the representative market price of a mineral product of like kind as subjected to similar treatment processes. Petitioner has shown that those sales of the pure product which were made were at a minimum price of $ 19.20 a ton. Inasmuch as no further processing was done after the product reached its pure state, other than the addition of the additives, we conclude that $ 19.20 a ton represents the fair*201 market price for petitioner's pure hydrated hydraulic lime, and that petitioner's computation based on that figure is acceptable.
Decision will be entered under Rule 50.
Footnotes
1. Packing costs of $ 156,248.88 apportioned between mined product and admixtures on basis of average cost per ton on 59,135 tons, consisting of 48,874 tons of mined product and 10,261 tons of admixtures.↩
2. Packing costs of $ 149,546.37 apportioned between mined product and admixtures on basis of average cost per ton on 55,307 tons consisting of 46,160 tons of mined product and 9,147 tons of admixtures.↩
1. Petitioner erroneously computed its claim for 1952 at $ 44,773.80. It should have claimed an allowance of $ 44,779.52 based on 5 per cent of $ 895,590.37, the sum of $ 886,272 realized from the sale of 46,160 tons of hydrated hydraulic lime at $ 19.20 per ton, plus $ 9,318.37 realized from the sale of waste. The parties stipulated that $ 9,318.37 was realized from the sale of waste in 1952.↩
2. The parties stipulated that total production costs of $ 747,264.41 were incurred in 1951; that gross sales of $ 1,196,541.36 were realized in 1952; and that $ 97,997.03 was expended on the initial treatment processes in 1952. Inconsistencies between these figures and those appearing in respondent's determination have been resolved in favor of that stipulation.↩
3. SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
(b) Basis for Depletion. --
* * * *
(4) Percentage depletion for coal and metal mines and for certain other mines and natural mineral deposits. --
(A) In General. -- The allowance for depletion under section 23 (m) in the case of the following mines and other natural deposits shall be --
(i) in the case of * * * stone * * * 5 per centum,
* * * *
of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance under section 23 (m) be less than it would be if computed without reference to this paragraph.
(B) Definition of Gross Income From Property. -- As used in this paragraph the term "gross income from the property" means the gross income from mining. The term "mining" as used herein shall be considered to include not merely the extraction of the ores or minerals from the ground but also the ordinary treatment processes normally applied by mine owners or operators in order to obtain the commercially marketable mineral product or products, * * *↩
4. For the year 1951, Regulations 111, section 29.23 (m)-1 (f↩) apply; and for the year 1952, Regulations 118, section 39.23 (m)-1 (e) (3) apply.