                              T.C. Memo. 2018-152



                        UNITED STATES TAX COURT



 MITSUBISHI CEMENT CORPORATION & SUBSIDIARIES, A DELAWARE
                  CORPORATION, Petitioner v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent*



      Docket No. 7161-16.                        Filed September 13, 2018.



      Paul W. Jones, for petitioner.

      Michael W. Tan and Aely K. Ullrich, for respondent.



  SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION


      COHEN, Judge: In our prior opinion in this case, Mitsubishi Cement Corp.

& Subs. v. Commissioner (Mitsubishi I), T.C. Memo. 2017-160, we decided two



      *
      This opinion supplements our previously filed opinion Mitsubishi Cement
Corp. & Subs. v. Commissioner, T.C. Memo. 2017-160.
                                         -2-

[*2] issues regarding the determination of petitioner’s allowable depletion

deductions for 2011 and 2012. We held that petitioner must apply a percentage

depletion rate of 14% and that it may not include the costs of certain purchased

minerals as mining costs in calculating gross income from mining under the

proportionate profits method, as provided in section 1.613-4(d)(4), Income Tax

Regs. After we issued Mitsubishi I, trial was held to decide the remaining issue,

which is the correct determination of petitioner’s gross sales for the purpose of the

proportionate profits method. Unless otherwise indicated, all section references

are to the Internal Revenue Code in effect for the years in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

                               FINDINGS OF FACT

      The background facts on which we relied in Mitsubishi I were fully

stipulated. Those facts are for the most part relevant to the issue we address in this

opinion, and we incorporate certain of them verbatim from Mitsubishi I. The

parties filed a supplemental stipulation of facts, and the additional stipulated facts

are incorporated in our findings by this reference. We also find facts based upon

the evidence presented at trial.
                                        -3-

[*3] Petitioner’s principal place of business was Nevada when it filed the

petition. Its largest shareholder is Mitsubishi Materials Corp. (MMC) in Japan.

MMC owns 67% of petitioner.

      Petitioner’s primary business activity is the production of finished cement at

its Cushenberry Cement Plant (Cushenberry) near Victorville, California.

Petitioner mines calcium carbonates at Cushenberry, and it purchases other

minerals from third parties. It mixes the mined calcium carbonates with the

purchased minerals to produce finished cement. Generally petitioner sells the

cement to customers that combine it with gravel, sand, and water to produce

ready-mix concrete. The market in which it sells cement includes the southern tip

of Nevada and southern California, with the largest portion of its sales occurring

in or around Los Angeles, California.

      Petitioner produces only Portland cement. It produces several types of

Portland cement, each of which has a different chemical composition and may be

used for a different purpose. Specifically, petitioner produces and sells Type II/V

cement, Type III “light” cement, block cement, plastic cement, and premium oil

well cement. Each type of cement that petitioner sells to customers is certified to

meet industry standards set by the American Society for Testing and Materials
                                        -4-

[*4] (ASTM). Cement producers use ASTM standards to certify that their

products meet the grade and quality specifications for specific types of cement.

      During the years in issue most of petitioner’s sales were to the subsidiaries

of MCC Development Corp. (MCCD). MMC owns 70% of MCCD, and

petitioner’s president, Kimball McCloud, is also president of MCCD. MCCD

owns 100% of each of three subsidiaries: Robertson’s Ready Mix (Robertson’s

R/M), Nevada Ready Mix (Nevada R/M), and Service Rock Products (Service

Rock) (collectively, MCCD subsidiaries). During the years in issue MCCD also

owned a 30% interest in Superior Ready Mix (Superior). In addition to its sales to

MCCD subsidiaries, petitioner made sales to Superior, and it made sales to a

number of purchasers in which MCCD held no interest (collectively, with

Superior, noncontrolled purchasers).

      During the years in issue petitioner sold Type II/V cement and Type III

cement to MCCD subsidiaries. It did not sell plastic, block, or premium oil well

cement to MCCD subsidiaries. The following table reflects petitioner’s actual

gross sales for 2011.
                                       -5-

[*5]                              Type II/V cement


            Purchaser                 Tons              Price      Price per ton


       Robertson’s R/M              960,581          $51,871,371    $54.00
       Nevada R/M                    26,897            1,828,993      68.00
       Service Rock                  35,364            2,404,759      68.00
       Noncontrolled purchasers     225,370           14,738,512      65.40
         Total                    1,248,212           70,843,635


                                  Type III cement


            Purchaser                 Tons              Price      Price per ton


       Robertson’s R/M               3,710            $356,159       $96.00
       Noncontrolled purchasers     41,671           4,018,851         96.44
        Totals                      45,381           4,375,010


                                   Block cement


            Purchaser                 Tons              Price      Price per ton


       Noncontrolled purchasers      44,630          $3,666,416      $82.15
        Totals                       44,630           3,666,416


                                   Plastic cement


            Purchaser                 Tons              Price      Price per ton


       Noncontrolled purchasers      4,194            $274,215       $65.38
        Totals                       4,194             274,215
                                           -6-

[*6]                              Premium oil well cement


            Purchaser                    Tons                  Price     Price per ton


       Noncontrolled purchasers         11,664              $1,166,366    $100.00
        Totals                          11,664               1,166,366

The following table reflects petitioner’s actual gross sales for 2012.

                                     Type II/V cement


            Purchaser                    Tons                  Price     Price per ton


       Robertson’s R/M                1,059,403         $57,207,755       $54.00
       Nevada R/M                        46,346              2,981,442      64.33
       Service Rock                      61,739              3,975,128      64.39
       Noncontrolled purchasers         245,902             15,625,665      63.54
        Totals                        1,413,390             79,789,990


                                      Type III cement


            Purchaser                    Tons                  Price     Price per ton


       Robertson’s R/M                    4,332             $415,878       $96.00
       Noncontrolled purchasers         44,771              4,383,377        97.91
        Totals                          49,103              4,799,255
                                           -7-

[*7]                                   Block cement


            Purchaser                    Tons                  Price      Price per ton


       Noncontrolled purchasers         47,039              $3,949,581       $83.96
        Totals                          47,039               3,949,581


                                      Plastic cement


            Purchaser                    Tons                  Price      Price per ton


       Noncontrolled purchasers          6,672              $454,878         $68.18
        Totals                           6,672               454,878


                                  Premium oil well cement


            Purchaser                    Tons                  Price      Price per ton


       Noncontrolled purchasers         12,681              $1,268,076      $100.00
        Totals                          12,681               1,268,076


       Petitioner prepares an annual letter that it sends to all of its customers to

notify them of the prices that it intends to charge for cement for that year.

Customers are able to contact petitioner’s sales representatives to negotiate a

lower price for their individual purchases. Generally, petitioner’s prices for sales

vary from customer to customer.
                                          -8-

[*8] MCCD subsidiaries receive petitioner’s annual pricing letters, and their

managers may contact petitioner if they believe that the prices set are too high.

However, McCloud controls the final decision regarding the prices that MCCD

subsidiaries pay for their purchases.

      On petitioner’s income tax returns for the years in issue it claimed

deductions for depletion pursuant to section 611 in connection with its mining of

calcium carbonates. It determined its depletion deductions using percentage

depletion described in section 613 and the regulations thereunder. For purposes of

percentage depletion, petitioner calculated its gross income from mining using the

proportionate profits method. For both years in issue petitioner applied the

proportionate profits method using its actual gross sales of finished cement, which

were $80,325,643 for 2011 and $90,261,779 for 2012.

                                        OPINION

I.    Percentage Depletion and Proportionate Profits Method

      Section 611 provides that there shall be allowed as a deduction “a

reasonable allowance for depletion”. Generally the deduction is calculated as a

percentage of “the gross income from the property”. Sec. 613(a). “Gross income

from the property” in petitioner’s case means “gross income from mining”. Sec.
                                         -9-

[*9] 613(c)(1). The amount of the depletion deduction under section 613(a) can

be expressed by the following formula:

           Gross Income From Mining × Percentage Depletion Rate =
                            Depletion Deduction

      Section 613(b) provides the percentage depletion rates for specific classes

of minerals. The statutory percentage depletion rate for calcium carbonates is

14%. Sec. 613(b)(7); see Mitsubishi I, at *8-*9. The other component of

percentage depletion, gross income from mining, is determined according to the

regulations. See sec. 1.613-4, Income Tax Regs.

      A taxpayer who conducts both mining and nonmining activities with respect

to a given mineral (as in the manufacture of finished products) must make an

allocation between gross income from the mining activity and gross income from

the nonmining activity. The percentage depletion rate is applied only to the gross

income from mining. Id. para. (a); see United States v. Cannelton Sewer Pipe Co.,

364 U.S. 76, 86-87 (1960). Under the general rule that applies in such a case,

gross income from the mining activity is computed on the basis of a representative

market or field price for the mineral being processed. Sec. 1.613-4(c), Income Tax

Regs. Where a representative market or field price for a particular mineral cannot

be ascertained, the proportionate profits method of computing gross income from
                                        - 10 -

[*10] mining shall be used unless permission to use an alternative method of

computation is obtained from the Commissioner. Id. para. (d); see Commissioner

v. Portland Cement of Utah, 450 U.S. 156, 160-161 (1981).

      “The objective of the ‘proportionate profits’ method of computation is to

ascertain gross income from mining by applying the principle that each dollar of

the total costs paid or incurred to produce, sell, and transport the first marketable

product * * * earns the same percentage of profit.” Sec. 1.613-4(d)(4), Income

Tax Regs. Under the proportionate profits method, a fraction, which is the ratio of

the taxpayer’s mining costs to its total mining and nonmining costs, is applied to

the taxpayer’s gross sales of the first marketable product, and the product

therefrom is treated as the taxpayer’s gross income from mining. Sec. 1.613-

4(d)(4)(ii), Income Tax Regs. The regulations provide the following formula:

      [Mining Costs/Total Costs] × Gross Sales = Gross Income From Mining

Id.

      Petitioner’s first marketable product is finished cement. In Mitsubishi I we

considered which of petitioner’s costs for the production of cement could be

treated as mining costs for the purpose of applying the proportionate profits

formula. The issue that we consider in this opinion is the correct determination of

petitioner’s gross sales.
                                       - 11 -

[*11] II.    Determination of Gross Sales

      A.     Section 1.613-4(d)(4)(v), Income Tax Regs.

      Section 1.613-4(d)(4)(v), Income Tax Regs., provides the following in

relevant part with respect to the determination of a taxpayer’s gross sales under the

proportionate profits method:

             (a) * * * [T]he term “gross sales (actual or constructive)”
      means the total of the taxpayer’s actual competitive sales to others of
      the first marketable product or group of products, plus the taxpayer’s
      constructive sales of the first marketable product or group of products
      used or retained for use in his own subsequent operations, subject to
      the adjustments required by paragraph (e) of this section. See (b) of
      this subdivision in the case of actual sales between members of
      controlled groups and in the case of constructive sales. * * *

            (b) * * * In the case of * * * sales between members of a
      controlled group, and in the case of constructive sales, the prices for
      such sales shall be determined by use of the principles set forth in
      paragraph (c) of this section, subject to the adjustments required by
      paragraph (e) of this section. * * * [Emphasis added.]

The parties agree that petitioner and the MCCD subsidiaries are members of a

“controlled group” as that term is used in the regulations. See sec. 1.613-4(j),

Income Tax Regs. (definition of controlled group). Therefore, the prices for sales

between them should be determined “by use of the principles set forth in” section

1.613-4(c), Income Tax Regs., for determining the representative market or field

prices for depletable minerals. Generally, the representative market or field price
                                         - 12 -

[*12] is “the dollar figure or amount which most nearly represents the approximate

price at which the taxpayer, in light of market conditions, could have sold * * *

[the mineral or finished product at issue]”. Sec. 1.613-4(c)(1), Income Tax Regs.

      B.     Representative Market Prices

      Generally the regulations direct that a miner-manufacturer such as petitioner

determine gross sales used in the proportionate profits method by treating its sales

of first marketable product to fellow members of a controlled group as if those

sales were made at a representative market price. Petitioner did not do this for the

years in issue. On its income tax returns it did not attempt to determine market

prices for the types of cement that it sold or to apply such prices to the sales that it

made to MCCD subsidiaries. Instead, for each year petitioner used its actual gross

sales, $80,325,643 for 2011 and $90,261,779 for 2012, in computing gross income

from mining.

      Petitioner now contends that it should be allowed to increase gross sales for

the purpose of the proportionate profits method by applying the average prices per

ton that noncontrolled purchasers paid for its finished cement to its sales to

MCCD subsidiaries. On the basis of that proposed application, it contends that we

should determine that its gross sales were $91,116,567 and $100,293,026 for the

years in issue, respectively. An increase in petitioner’s gross sales under the
                                        - 13 -

[*13] proportionate profits method would increase its gross income from mining

and would, accordingly, increase the amount of its allowable depletion deduction

for each year in issue.

      Petitioner failed to apply the regulations in its original tax filings, and now

it contends that we should apply the regulations to redetermine its gross sales and

allow increased deductions. We agree that under the regulations petitioner’s gross

sales to MCCD subsidiaries should have been determined using representative

market prices; specifically, it should have determined and applied market prices

for Type II/V cement and Type III cement, which are the two types that it sold to

MCCD subsidiaries. However, petitioner bears the burden of establishing gross

sales which are greater than those that it first reported and used in computing its

deductions and which respondent accepted when petitioner filed the original

returns.

      Statements on tax returns are admissions that must be overcome by cogent

proof. See Estate of Hall v. Commissioner, 92 T.C. 312, 337-338 (1989).

Generally the taxpayer bears the burden of proof with respect to any claimed

deduction, INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992), and this

burden includes establishing the correct amount of the deduction, Clapp v.

Commissioner, 321 F.2d 12, 14 (9th Cir. 1963), aff’g 36 T.C. 905 (1961); see also
                                        - 14 -

[*14] sec. 6001; sec. 1.6001-1(a), Income Tax Regs. To meet its burden of proof

for the deductions at issue petitioner must prove the representative market prices

for its sales to members of the controlled group.

      Petitioner contends that we should adopt the weighted averages of the prices

of its own sales to noncontrolled purchasers during the years in issue as the

representative market prices for Type II/V and Type III cements. The regulations

provide that representative market prices are to be ascertained “on the basis of an

analysis of actual competitive sales by the taxpayer or others”. Sec. 1.613-4(c)(1),

Income Tax Regs. “The taxpayer’s own actual sales * * * shall be taken into

account when establishing market or field prices, provided that those sales are

determined to be representative.” Id.

      Petitioner offered evidence intending to show that its average prices for

sales to noncontrolled purchasers represented the market prices for the years in

issue. Petitioner’s vice president and corporate controller testified about the extent

of petitioner’s geographical market and the nature of its sales to noncontrolled

purchasers. He testified that petitioner faces many competitors in the southern

California market that sell Type II/V and Type III cements meeting the same

ASTM standards as petitioner’s products. He testified that petitioner’s prices for
                                         - 15 -

[*15] sales to noncontrolled purchasers are negotiated and that the purchasers are

able to buy cement from other producers.

      The testimony of petitioner’s witness indicates that its sales to

noncontrolled purchasers during the years in issue were competitive and

negotiated, as opposed to controlled, transactions. However, to rely on

petitioner’s own sales as a basis for determining market price, we would need to

determine also that those sales were “representative” as compared to sales by other

producers in the relevant market. See id. At trial petitioner provided three

exhibits which report certain aggregated pricing data for cement sales in the

United States for the years in issue: (1) the United States Geological Survey’s

Mineral Yearbook for Cement for each of the years in issue (USGS yearbooks);

(2) excerpts from newsletters published by the Engineering News-Record (ENR

newsletters); and (3) a screenshot from Statista, an online statistics portal (Statista

web page).

      Section 1.613-4(c)(3), Income Tax Regs., provides that in the determining a

representative market price for the taxpayer’s ore or mineral, “consideration shall

be given only to prices of ores or minerals of like kind and grade as the taxpayer’s

* * * and with which, under commercially accepted standards, the taxpayer’s ore

or mineral would be considered to be in competition”. An ore or mineral will be
                                         - 16 -

[*16] considered to be of like kind and grade “if, in common commercial practice,

it is sufficiently similar in chemical, mineralogical, or physical characteristics to

the taxpayer’s ore or mineral that it is used, or is commercially suitable for use, for

essentially the same purposes as the uses to which the taxpayer’s ore or mineral is

put.” Sec. 1.613-4(c)(2), Income Tax Regs. Generally, whether an ore or mineral

is of like kind and grade will be determined “by reference to industrial or

commercial specifications”. Id.

      Petitioner’s witness testified that each of the different types of Portland

cement has a unique chemical composition and each is suited to a particular job or

use. Each type meets its own set of ASTM standards, which are the industry

standards for cement grade and quality. We conclude on the basis of the evidence

presented that the various types are not interchangeable in commercial practice.

The evidence also shows that the prices charged for the different types vary

considerably.

      None of the three exhibits listed above provides information for sales that

are directly comparable to, and would be useful in analyzing the competitive

market for, the sales at issue. The USGS yearbooks provide the averages of the

sale prices for all types of Portland cement sold in California and do not

disaggregate and provide data for sales of Type II/V cement or Type III cement
                                        - 17 -

[*17] specifically. The ENR newsletters provide the average sale prices for Type I

cement; Type I is a type of Portland cement that petitioner does not sell. The

Statista web page provides the averages of the sale prices for all Portland cements

and masonry cement, which petitioner also does not sell. Like the USGS

yearbooks, the Statista web page provides no data on the sale prices for the

different types of Portland cement. Each of the exhibits analyzes sales data and

incorporates or reports prices for finished products which are not of the “like kind

and grade” of the Type II/V and Type III cements that petitioner sold to

noncontrolled purchasers and MCCD subsidiaries.

      At trial petitioner’s counsel acknowledged that the data in the exhibits could

not be used directly to determine a market price for the two types of cement at

issue. He argued that the pricing data is relevant “to show that the price [i.e., the

average of petitioner’s own sales] * * * is representative in a comparative way”.

On brief petitioner contends that “[w]hen compared with the data [in the exhibits]

* * * [petitioner’s prices] are very reasonable”.

      We cannot speculate on the reasonableness of petitioner’s proposed market

prices in the light of the limited data provided. We reject the contention that the

information in the exhibits is relevant “in a comparative way” to determining

representative market prices for the sales at issue. Petitioner has the burden of
                                          - 18 -

[*18] proving those amounts. We are not experts in cement composition and sales

practices, and petitioner has not provided information for us to engage in an

analysis of the market prices for Type II/V cement or Type III cement as compared

to the prices for other cements.

      Petitioner failed to establish that its own sales to noncontrolled purchasers

were representative of Type II/V and Type III cement sales in petitioner’s market

for the years in issue. Because we are unable to determine that the sales were

representative, we will not take them into account in determining representative

market prices. See sec. 1.613-4(c)(2), Income Tax Regs. Petitioner has not met its

burden of proving representative market prices for the types of cement that it sold

to MCCD subsidiaries. We agree with respondent that petitioner must use the

gross sales amounts that it originally reported, i.e., its actual gross sales, to

compute gross income from mining under the proportionate profits method.

      C.     Applicability of Section 1.613-4(e), Income Tax Regs.

      Even if we held that petitioner had proven representative market prices for

the cement sales at issue, we conclude that any increases to petitioner’s gross sales

for the purpose of the proportionate profits method would be offset by adjustments

required under the regulations. Section 1.613-4(d)(4)(v), Income Tax Regs.,

provides that in all cases the determination of gross sales is “subject to the
                                         - 19 -

[*19] adjustments required by paragraph (e) of this section.” Section 1.613-

4(e)(1), Income Tax Regs., provides that “[i]f a taxpayer computes gross income

from mining under the provisions of paragraph (d) * * * discounts actually

allowed (if not otherwise taken into account) shall be subtracted from the gross

sales (actual or constructive), and shall not be considered a cost, of the first

marketable product or group of products.”

      Petitioner contends that it does not give discounts to purchasers and that no

adjustments to gross sales for the years in issue would be warranted under section

1.613-4(e), Income Tax Regs. However, the parties’ stipulations establish that one

of the MCCD subsidiaries, Robertson’s R/M, paid average prices per ton for Type

II/V cement that were substantially lower than the average prices that

noncontrolled purchasers paid. Most of petitioner’s gross sales of Type II/V

cement for each of the years in issue were sales to Robertson’s R/M. Robertson’s

R/M also paid less on average for its purchases of Type III cement than did

noncontrolled purchasers.

      Regardless of whether petitioner labels the price differences “discounts”,

Robertson’s R/M paid less than the prices that petitioner would have us accept as

the representative market prices. Section 1.613-4(e)(1), Income Tax Regs.,

provides that “[t]he provisions of this subparagraph shall apply to arrangements
                                        - 20 -

[*20] which have the same effect as trade or cash discounts, regardless of the form

of the arrangements.” Although the arrangement between petitioner and

Robertson’s R/M may not have been structured or regarded by the parties as a

sales discount, the effect was the same. If we adopted petitioner’s proposed

market prices and applied them to the sales to MCCD subsidiaries, the regulations

would require that the recomputed gross sales amounts be reduced to reflect the

actual, below-market prices that Robertson’s R/M paid for its purchases.

III.   Conclusion

       Petitioner argues that the reason that the regulations require a taxpayer to

use representative market prices to determine gross sales for sales to members of a

controlled group is to prevent the taxpayer from manipulating the prices of

controlled sales and increasing its gross income from mining (and the amount of

its depletion deduction). It argues that respondent’s position in this case, that

petitioner must use its actual gross sales to compute gross income from mining, is

“short-sighted” because in future cases “the petitioner could inflate its ‘actual

sales’ * * * and take a higher depletion deduction than the regulations clearly

intend.” Putting aside that petitioner bears the burden of proof with respect to the

issue of representative market prices (and has failed to meet that burden), its
                                         - 21 -

[*21] argument ignores the manner in which the regulations serve the regulatory

objective in cases such as this one.

      The regulatory requirement that gross sales to members of a controlled

group be reduced to reflect representative market prices prevents the taxpayer

from claiming an inflated amount of gross income from mining. Simultaneously,

the regulations do not allow the taxpayer to increase gross sales by relying on

representative market prices where, as here, it has chosen to give members of the

controlled group substantial discounts on its finished products. In either

circumstance the regulations operate to prevent the taxpayer from artificially

increasing gross sales and the amount of the depletion deduction. Gross sales for

the purpose of the proportionate profits method may be adjusted downwards under

the regulations, but they may never be adjusted upwards. This result comports

with the purpose of the regulations as petitioner interprets it.

      Petitioner did not establish representative market prices for its sales to

MCCD subsidiaries, and even if it had, we conclude that under applicable

regulations petitioner would have been required to reduce gross sales for purposes

of calculating gross income from mining to reflect the discounted prices paid for a

substantial portion of those sales. In any event, petitioner’s gross sales under the

proportionate profits method should not be increased.
                                        - 22 -

[*22] Petitioner has not shown that it is entitled to greater depletion deductions

than those that respondent would allow on the basis of the stipulations and our

holdings in Mitsubishi I. To allow for computations to be submitted in the light of

our holdings herein and in the prior opinion,


                                                 Decision will be entered

                                           under Rule 155.
