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JARECKI v. G. D. SEARLE & CO., 367 U.S. 303 (1961)
367 U.S. 303
JARECKI, FORMER COLLECTOR OF INTERNAL REVENUE, ET AL. v. G. D. SEARLE & CO.
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SEVENTH CIRCUIT.
Argued March 21, 1961.
Decided June 12, 1961. *
[ Footnote * ] Together with No. 169, Polaroid Corporation v. Commissioner of Internal Revenue, certiorari to theUnited States Court of Appeals for the First Circuit, argued March 21-22, 1961.
1. Development of new products is not "discovery" within the meaning of 456 (a) (2) (B) of the Internal Revenue Code
of 1939, as amended; and income resulting from the manufacture and sale of certain patented drugs, cameras, camera
equipment and stereo products resulting from inventions is not included within the statutory definition of "abnormal
income," in 456 (a), so as to qualify for Korean War excess profits tax relief under the Excess Profits Tax Act of 1950.
2. Such income is not made eligible for Korean War excess profits tax relief by the concluding sentence of paragraph (2)
of 456 (a), which provides that, "The classification of income of any class not described in subparagraphs (A) to (D),
inclusive, shall be subject to regulations prescribed by the Secretary." Pp. 313-315.
Wayne G. Barnett argued the cause for petitioners in No. 151 and for respondent in No. 169. With him on the briefswere former Solicitor General Rankin, Solicitor General Cox, Assistant Attorneys General Rice and Oberdorfer, ActingAssistant Attorneys General Sellers and Heffron, Harry Marselli and Norman H. Wolfe.
Isaac M. Barnett argued the cause for petitioner in No. 169. With him on the brief was David Saperstein.
Walter J. Cummings, Jr. argued the cause for respondent in No. 151. With him on the brief was Edwin C. Austin. [367 mhtml:file://C:\CMU\LawCourse2007\readings\Interpretation\JareckiVSearle.mht JARECKI v. G. D. SEARLE & CO., 367 U.S. 303 (1961) MR. CHIEF JUSTICE WARREN delivered the opinion of the Court.
These cases present problems in the interpretation of 456 (a) of the Internal Revenue Code of 1939, a section of theExcess Profits Tax Act of 1950, 64 Stat. 1137. The Act, which is intended to tax at high rates unusually high profitsearned during the Korean War, imposes a tax on profits in excess of an amount deemed to represent the taxpayer'snormal profits. 1 Recognizing, however, that some profits otherwise subject to tax under this scheme might stem fromcauses other than the inflated wartime economy, Congress enacted 456. This section grants relief in certain cases of"abnormal income" as defined in 456 (a) 2 by allocating some of this income [367 U.S. 303, 305] to years other thanthose in which it was received for purposes of computing the tax.
The dispute in these cases is whether income from the sales of certain new products falls within the statutory definitionof "abnormal income." Taxpayers claim that the income from the sales of their products is income resulting from"discovery." They claim it is therefore "abnormal income" within the class defined by 456 (a) (2) (B) as "Income resulting from exploration, discovery, or prospecting, or any combination of the foregoing, extendingover a period of more than 12 months." Taxpayer in No. 151 is a corporation engaged in the manufacture and marketing of drugs. As a result of researchextending for more than 12 months, it produced two new drugs, "Banthine," used in the treatment of peptic ulcers, and"Dramamine," for relief from motion sickness. Taxpayer received patents on both drugs, and it asserts that both werenew products and not merely improvements on pre-existing compounds. Taxpayer received income from the sale of"Banthine" and "Dramamine" in the years 1950 through 1952. It paid its tax without claiming relief under 456, and thenclaimed a refund. On denial of its claim, taxpayer filed a complaint in the District Court for the Northern District ofIllinois. The District Court dismissed the complaint, but the Court of Appeals for the Seventh Circuit reversed. It heldthat "discovery" might include the preparation of new products and that the case must be remanded for a trial [367 U.S.
303, 306] on the issue of whether taxpayer's drugs "were actually discoveries." 274 F.2d 129, 131.
Taxpayer in No. 169 is the inventor and producer of the "Polaroid Land Process," a camera and film which produce aphotograph in 60 seconds, and the "Polaroid 3-D Synthetic Polarizer," a device incorporated in the "viewers" throughwhich audiences watched the three dimensional motion pictures in vogue some years ago. These inventions, each theproduct of more than 12 months' research, are novel, according to taxpayer, and each has been patented. The PolaroidLand equipment was the subject of 238 patents by the end of 1958, and taxpayer characterizes this invention as"revolutionary." Its production was a new departure in the business of taxpayer, which had hitherto been engagedprimarily in manufacturing and selling such optical products as polarizing sunglasses, visors and camera filters. In itsreturns for 1951 through 1953 taxpayer utilized the provisions of 456 in computing its tax on income from the sales ofits photographic equipment and 3-D polarizers. The Commissioner determined that 456 was not applicable, and the TaxCourt upheld his determination of a deficiency. The Court of Appeals for the First Circuit affirmed, holding thattaxpayer's inventions were not "discoveries" and its income from their sale not "abnormal income." 278 F.2d 148.
We granted certiorari in each case to resolve the conflict between the decisions of the First and Seventh Circuits. 364U.S. 812, 813 .
For present purposes we accept, as did the First Circuit, taxpayers' assertions of the novelty of their products. But wealso agree with that court that taxpayers' inventions are not "discoveries" as that word is used in 456 (a) (2) (B) and thatincome from sales of the new [367 U.S. 303, 307] products may not receive the special treatment provided by 456.
We look first to the face of the statute. "Discovery" is a word usable in many contexts and with various shades ofmeaning. Here, however, it does not stand alone, but gathers meaning from the words around it. These words stronglysuggest that a precise and narrow application was intended in 456. The three words in conjunction, "exploration,""discovery" and "prospecting," all describe income-producing activity in the oil and gas and mining industries, but it isdifficult to conceive of any other industry to which they all apply. Certainly the development and manufacture of drugsand cameras are not such industries. The maxim noscitur a sociis, that a word is known by the company it keeps, whilenot an inescapable rule, is often wisely applied where a word is capable of many meanings in order to avoid the giving mhtml:file://C:\CMU\LawCourse2007\readings\Interpretation\JareckiVSearle.mht JARECKI v. G. D. SEARLE & CO., 367 U.S. 303 (1961) of unintended breadth to the Acts of Congress. See, e. g., Neal v. Clark, 95 U.S. 704, 708 -709. The application of themaxim here leads to the conclusion that "discovery" in 456 means only the discovery of mineral resources.
When we examine further the construction of 456 (a) (2) and compare subparagraphs (B) and (C), it becomesunmistakably clear that "discovery" was not meant to include the development of patentable products. If "discovery"were so wide in scope, there would be no need for the provision in subparagraph (C) for "Income from the sale ofpatents, formulae, or processes." All of this income, under taxpayers' reading of "discovery," would also be income"resulting from . . . discovery" within subparagraph (B). To borrow the homely metaphor of Judge Aldrich in the FirstCircuit, "If there is a big hole in the fence for the big cat, need there be a small hole for the small one?" The statuteadmits a reasonable construction which gives effect to all of its provisions. In these circumstances we will not adopt astrained reading [367 U.S. 303, 308] which renders one part a mere redundancy. See e. g., United States v. Menasche, 348U.S. 528, 538 -539.
Taxpayers assert that it is the "ordinary meaning" of "discovery" which must govern. We find ample evidence both onthe face of the statute and, as we shall show, in its legislative history that a technical usage was intended. But even ifwe were without such evidence we should find it difficult to believe that Congress intended to apply the layman'smeaning of "discovery" to describe the products of research. To do so would lead to the necessity of drawing a linebetween things found and things made, for in ordinary present-day usage things revealed are discoveries, but newfabrications are inventions. 3 It would appear senseless for Congress to adopt this usage, to provide relief for incomefrom discoveries and yet make no provision for income from inventions. Perhaps in the patent law "discovery" has theuncommonly wide meaning taxpayers suggest, but the fields of patents and taxation are each lores unto themselves, andthe usage in the patent law (which is by no means entirely in taxpayers' favor) 4 is unpersuasive here. All the evidenceis [367 U.S. 303, 309] to the effect that Congress did not intend to introduce the difficult distinction between inventionsand discoveries into the excess profits tax law.
The relevant legislative history fortifies the conclusions to which the words of the statute lead us. The word "discovery"has been used for many years in the tax laws, and has always been used with the limited meaning of the finding ofmineral deposits. In the Revenue Act of 1918, enacting one of the earliest excess profits tax laws, a limit was placed onthe excess profits tax on income from "a bona fide sale of mines, oil or gas wells, or any interest therein, where theprincipal value of the property has been demonstrated by prospecting or exploration and discovery work done by thetaxpayer." Revenue Act of 1918, 337, 40 Stat. 1096. 5 An identical limitation was imposed on the income tax leviedunder that Act, 6 and the same usage of "discovery" obtained in the allowance of depletion deductions. 7 The limitationon the income tax on the proceeds of the sale of mineral deposits was re-enacted without significant change in theRevenue Acts of 1921, 1924, 1926, 1928, 1932, 1936 and 1938. 8 It remains in the income tax provisions of theInternal Revenue Code of 1939 as 105 and has been carried forward as 632 of the 1954 Code. In each re-enactment"discovery" [367 U.S. 303, 310] is linked with "exploration" and "prospecting," and in each the word is restrictivelyapplied to extractive industries. A correspondingly narrow use of "discovery" has continued since 1918 in the depletionallowance sections 9 and appears in 114 (b) (2) of the 1939 Code. In the more than 30 years preceding the enactment ofthe section here at issue, during which time "discovery" was used and re-used in successive taxing statutes, the worddeveloped into a term of art of precise and limited meaning.
The Excess Profits Tax Act of 1940, 54 Stat. 975, made specific mention of more types of "abnormal income"qualifying for relief than did the earlier excess profits tax statutes, but there is no indication that it worked anytransformation in the meaning of "discovery." Section 721, 54 Stat. 986, as amended, 55 Stat. 21, classified six types of"abnormal income." Among them was the following, at 721 (a) (2) (C): "Income resulting from exploration, discovery, prospecting, research, or development of tangible property,patents, formulae, or processes, or any combination of the foregoing, extending over a period of more than 12months." This was the first time specific provision was made for income from invention, relief in cases of such income havingpreviously been obtainable, if at all, only under the "general relief" provisions of the earlier Acts. 10 It is [367 U.S. 303,311] instructive that the formula "exploration, discovery, or prospecting" was not considered broad enough to coverinvention and that the words "research" and "development" were added to cover that source of income. Plainly,"discovery" retained in the World War II excess profits Act the limited meaning which it had had in the previous Actsand which it continued to have in the income tax provisions of the then-current code. 11 The relief provisions of the Excess Profits Tax Act of 1950, which we here construe, were modeled in part on 721 of mhtml:file://C:\CMU\LawCourse2007\readings\Interpretation\JareckiVSearle.mht JARECKI v. G. D. SEARLE & CO., 367 U.S. 303 (1961) the World War II Act, but were different in significant respects. In the classifications of income in the new 456,Congress gave separate treatment to income from discovery of minerals and income from invention. It provided reliefin subparagraph (B) for "Income resulting from exploration, discovery, or prospecting," but provided in subparagraph(C) only for "Income from the sale of patents, formulae, or processes." (Emphasis added.) Subparagraph (C) does notencompass all income from inventions. It does not cover income from the sale of products made under a new patent,the sort of income at issue here. Taxpayers assert that the income from their inventions is, realistically speaking, as"abnormal" in their businesses as the discovery of a new mine would be in the business of a prospector. Their income iswithin the spirit of 456, they say, and should be held to be within the letter of subparagraph (B). It is clear, however,that Congress, while it may have recognized the abnormal nature of this sort of income, chose [367 U.S. 303, 312]deliberately to deny relief for it and to limit relief in cases of research and development to that provided insubparagraph (C).
The relief provisions of the World War II Act had been intended to provide "flexible rules," 12 and their applicationhad often been an uncertain affair. In administering 721 the Commissioner often faced the difficult task of separatingincome which was the product of "research, or development" from that resulting merely from improved management orsales efforts. The difficulty of distinction led the Tax Court to hold that the distinction must be made "by exercisingcommon sense and judgment," and that "It is entirely possible that the allocation made by one person would nevermatch that made by another." Ramsey Accessories Mfg. Corp. v. Commissioner, 10 T. C. 482, 489. Congress in 1950recognized the delay and uncertainty caused by the element of administrative discretion in this and other 13 sectionsand set about drafting an excess profits tax law on the principle that "subjective judgments . . . should be avoided in thenew law." H. R. Rep. No. 3142, 81st Cong., 2d Sess. 20. This principle was expressly followed in the drafting of 456.
The Senate Committee reported on 456 as follows: "The equivalent provision in the World War II law (sec. 721) also permitted adjustments with reference to certainother types of income, particularly that resulting from the sale of tangible property arising out of research anddevelopment which extended over a period of more than 12 months. This provision [367 U.S. 303, 313] in the oldlaw was a potential loophole of major dimensions. Because there appeared to be no means of restricting such anadjustment to truly meritorious cases other than by the introduction of a large degree of administrative discretionof the type required by the general relief clause of the World War II law (sec. 722), and because the need for areallocation of such income seemed to be materially less than for the other classes of income described above,the bill omits this item from the list of abnormal types of income for which a reallocation can be made." S. Rep.
No. 2679, 81st Cong., 2d Sess. 14.
The House Committee Report was virtually identical. H. R. Rep. No. 3142, 81st Cong., 2d Sess. 13.
Taxpayers recognize, as they must, that Congress intended its change in language to limit the kinds of income eligiblefor relief. They say, however, that not all income from research and development was excluded. That which comesfrom inventions not merely patentable but also sufficiently revolutionary to be called "genuine discoveries" is stillwithin the protection of 456. We find it impossible to believe that an amendment designed to eliminate uncertainly andadministrative discretion would introduce into the law - without a congressional word of warning or explanation - adistinction as vague, as dependent upon nuances of scientific opinion, and as unprecedented as that urged by taxpayers.
Taxpayers have another argument, which the First Circuit rejected and which the Seventh Circuit did not reach.
Paragraph (1) of 456 (a) defines "abnormal income" as "income of any class described in paragraph (2)" which meetscertain requirements. Paragraph (2) lists four classes of income and provides in its concluding sentence: "The classification of income of any class not described in subparagraphs (A) to (D), inclusive, [367 U.S. 303, 314]shall be subject to regulations prescribed by the Secretary." Taxpayers argue that even if the income here at issue was not provided for under any of the subparagraphs of paragraph(2), it is nevertheless included within this final sentence and is hence eligible for relief.
We need not decide the precise effect of the sentence relied on. In light of the clear purpose of Congress in enacting456 to cut down not only the amount of administrative discretion which had prevailed under the predecessor section butalso the scope of available relief, the power of the Secretary to extend relief far beyond the four corners of the statute mhtml:file://C:\CMU\LawCourse2007\readings\Interpretation\JareckiVSearle.mht JARECKI v. G. D. SEARLE & CO., 367 U.S. 303 (1961) may be doubted. 14 It is sufficient to note that, unlike its predecessor (which made relief available for all "abnormalincome," whether or not specified in a particular class), 15 456 applies only to those classes specified in 456 (a) (2).
Section 456 does not apply in terms to all abnormal income and contains no indication that the Secretary should createadministrative classifications embracing all such income. And even if the sentence relied on gives the Secretary powerto expand the classes of abnormal income somewhat beyond the four enumerated in the statute, he has clearly not doneso here. The regulations 16 specifically provide that [367 U.S. 303, 315] "Income from the sale of tangible propertyarising out of research and development which extended over a period of more than 12 months is not included in thelist of abnormal types of income to which section 456 is applicable, and such income may not constitute a class ofincome for purposes of that section." This specific exclusion is clearly in furtherance of the purpose of Congress indeleting "research" and "development" income from its classification of abnormal income. The Commissioner,effecting the will of Congress, has barred relief for the type of income here at issue.
The last sentence of the regulation, on which taxpayers also rely, does not aid them. It provides merely that "research"and "development" income is eligible for relief if it is properly includible in a class of income to which 456 otherwiseapplies. As we have held, however, taxpayers' income does not fall within any such class.
Therefore, the judgment of the Court of Appeals for the Seventh Circuit must be reversed and the judgment of theCourt of Appeals for the First Circuit affirmed.
[ Footnote 1 ] See H. R. Rep. No. 3142, 81st Cong., 2d Sess. 2; S. Rep. No. 2679, 81st Cong., 2d Sess. 2.
[ Footnote 2 ] Section 456 (a) provides in part: "(a) DEFINITIONS. - For the purposes of this section - "(1) ABNORMAL INCOME. - The term `abnormal income' means income of any class described in paragraph(2) includible in the gross income of the taxpayer for any taxable year under this subchapter if it is abnormal forthe taxpayer to derive income of such class, or, if the taxpayer normally derives income of such class but theamount of such income of such class includible in the gross income of the taxable year is in excess of 115 percentum of the average amount of the gross income of the same class for the four previous taxable years, or, if thetaxpayer was not in existence for four previous taxable years, the taxable years during which the taxpayer was inexistence.
"(2) SEPARATE CLASSES OF INCOME. - Each of the following subparagraphs shall be held to describe aseparate class of income: "(A) Income arising out of a claim, award, judgment, or decree, or interest on any of the foregoing; or "(B) Income resulting from exploration, discovery, or prospecting, or any combination of the foregoing,extending over a period of more than 12 months; or "(C) Income from the sale of patents, formulae, or processes, or any combination of the foregoing, developedover a period of more than 12 months; or "(D) Income includible in gross income for the taxable year rather [367 U.S. 303, 305] than for a different taxableyear by reason of a change in the taxpayer's method of accounting.
"All the income which is classifiable in more than one of such subparagraphs shall be classified under the onewhich the taxpayer irrevocably elects. The classification of income of any class not described in subparagraphs(A) to (D), inclusive, shall be subject to regulations prescribed by the Secretary." [ Footnote 3 ] In lay terms, Polaroid's photographic equipment and Searle's drugs are probably better called inventionsthan discoveries. Webster's New International Dictionary, Unabridged (2d ed.) p. 745, makes this distinction: "One mhtml:file://C:\CMU\LawCourse2007\readings\Interpretation\JareckiVSearle.mht JARECKI v. G. D. SEARLE & CO., 367 U.S. 303 (1961) DISCOVERS what existed before, but had remained unknown; one INVENTS by forming combinations which areeither entirely new, or which attain their end by means unknown before; as, Columbus discovered America; Newtondiscovered the law of gravitation; Edison invented the phonograph . . . ." [ Footnote 4 ] The United States Constitution, Art. I, 8, cl. 8 gives Congress the power to secure to "Inventors theexclusive Right to their . . . Discoveries." While the terms "discover" and "discovery" are used throughout the patentstatutes, they seem generally to appear with "invent" and "invention" as if the terms have separate meanings. See, e. g.,35 U.S.C. 101: "Whoever invents or discovers any new and useful process, machine, manufacture, or composition ofmatter . . . may obtain a patent therefor . . . ." And see Dolbear v. American Bell Telephone Co. (Telephone Cases), 126U.S. 1, 532 -533.
[ Footnote 5 ] This section was re-enacted by the Revenue Act of 1921, 337, 42 Stat. 277.
[ Footnote 6 ] Revenue Act of 1918, 211 (b), 40 Stat. 1064.
[ Footnote 7 ] Revenue Act of 1918, 214 (a) (10), 234 (a) (9), 40 Stat. 1067, 1078, providing "That in the case of mines,oil and gas wells, discovered by the taxpayer . . . where the fair market value of the property is materiallydisproportionate to the cost, the depletion allowance shall be based upon the fair market value of the property at thedate of discovery . . . ." [ Footnote 8 ] Revenue Act of 1921, 211 (b), 42 Stat. 237; Revenue Act of 1924, 211 (b), 43 Stat. 267; Revenue Act of1926, 211 (b), 44 Stat. 23; Revenue Act of 1928, 102 (a), 45 Stat. 812; Revenue Act of 1932, 102 (a), 47 Stat. 192;Revenue Act of 1936, 105, 49 Stat. 1678; Revenue Act of 1938, 105, 52 Stat. 484.
[ Footnote 9 ] Revenue Act of 1921, 214 (a) (10), 234 (a) (9), 42 Stat. 241, 256; Revenue Act of 1924, 204 (c), 43 Stat.
260; Revenue Act of 1926, 204 (c) (1), 44 Stat. 16; Revenue Act of 1928, 114 (b) (2), 45 Stat. 821; Revenue Act of1932, 114 (b) (2), 47 Stat. 202; Revenue Act of 1934, 114 (b) (2), 48 Stat. 710; Revenue Act of 1936, 114 (b) (2), 49Stat. 1686; Revenue Act of 1938, 114 (b) (2), 52 Stat. 495.
[ Footnote 10 ] Section 327 (d) of the Revenue Act of 1918, 40 Stat. 1093, gave the Commissioner power to grant reliefin any case in which "the tax . . . would, owing to abnormal conditions affecting the capital or income of thecorporation, work upon the corporation an exceptional [367 U.S. 303, 311] hardship . . . ." Section 721 of the World WarII law classified specific types of abnormal income for purposes of computing the tax, and, while it provided relief forall abnormal income of whatever class, was not considered a "general relief" section.
[ Footnote 11 ] I. R. C. of 1939, 105, 114 (b) (2). It was expressly provided by 728 of the World War II excess profitstax statute, 54 Stat. 989, that the words used in that statute should have the same meaning as when used in the incometax chapter of the Code.
[ Footnote 12 ] H. R. Rep. No. 146, 77th Cong., 1st Sess. 2.
[ Footnote 13 ] The "general relief" section of the World War II Act, 722, 54 Stat. 986, as amended, 55 Stat. 23, 701, 56Stat. 914, 57 Stat. 56, 601, 58 Stat. 55, provided for adjustments in the computation of base period income if thetaxpayer established, among other things, "what would be a fair and just amount representing normal earnings" duringthe base period.
[ Footnote 14 ] In fact, the Committee reports state that "Adjustments . . . [under 456] are limited to income arising outof" the four classes specified in subparagraphs (A) through (D). H. R. Rep. No. 3142, 81st Cong., 2d Sess. 13; S. Rep.
No. 2679, 81st Cong., 2d Sess. 14.
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