2003 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

12-8-2003

Inductotherm Ind Inc v. USA

Precedential or Non-Precedential: Precedential

Docket No. 02-4292

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PRECEDENTIAL

Filed December 8, 2003

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 02-4292

INDUCTOTHERM INDUSTRIES, INC.

Appellant

v.

UNITED STATES OF AMERICA

Appeal from the United States District Court

for the District of New Jersey

(D.C. Civil Action No. 99-cv-02451)

District Judge: Honorable Joseph H. Rodriguez

Argued July 31, 2003

Before: SCIRICA, Chief Judge, RENDELL

and AMBRO, Circuit Judges

(Opinion filed: December 8, 2003)

Ronald L. Glick, Esquire (Argued)

Stevens & Lee

1415 Route 70 East

Suite 506

Cherry Hill, NJ 08034

Attorney for Appellant
Eileen J. O’Connor

Assistant Attorney General

Gilbert S. Rothenberg, Esquire

Francesca Ugolini, Esquire (Argued)

Department of Justice

Tax Division

Post Office Box 502

Washington, D.C. 20044

Attorneys for Appellee

OPINION OF THE COURT

AMBRO, Circuit Judge: 

This appeal involves a dispute between a taxpayer and

the Internal Revenue Service about the proper time to

recognize income and losses. The taxpayer maintains that

it was not required to recognize the proceeds from the sale

of goods as income in the year it received those proceeds

because the funds were subject to a governmental blocking

order and, under the Claim of Right Doctrine, it did not

have unfettered discretion as to the funds. It also seeks to

deduct the manufacturing costs of other goods in a year

prior to that in which it sold those goods, reasoning that

the Iraqi Sanctions Regulation then in place — which

prohibited the taxpayer from selling those goods — either

was in effect a confiscation or deprived the goods of any

market value. The District Court held in favor of the

Government as to both claims. We affirm.

I. Background

In 1989, taxpayer Inductotherm Industries, Inc.

(“Inductotherm”), through its subsidiary Consarc,1

contracted with Iraq to manufacture three vacuum

furnaces. One furnace (“Furnace A”) is an Induction Skull

Melting Furnace. The other two (“Furnaces B and C”) are

Electron Beam Furnaces — a technology that later became

1. For convenience, we refer to Inductotherm and Consarc throughout

this opinion simply as Inductotherm. 

2
disfavored and apparently is no longer in widespread use

today. Iraq represented that the furnaces would be used to

manufacture prosthetics for veterans of the Iran-Iraq war.

It later came to light that Iraq instead intended to use the

furnaces in its nuclear weapons program. Inductotherm

was unaware of Iraq’s true intentions. 

As the three furnaces were about to be exported to Iraq,

it invaded Kuwait. In response, on August 2, 1990,

President George H.W. Bush entered an Executive Order —

the Iraqi Sanctions Regulation — blocking all property in

which Iraq had an interest. As applied to Inductotherm, the

Executive Order precluded the sale or transfer of the three

furnaces without the permission of the Office of Foreign

Assets Control (“OFAC”). Moreover, all funds in which

Inductotherm had an interest due to the Iraqi contract were

blocked pursuant to the Executive Order unless OFAC

issued a license unblocking them. See 31 C.F.R. § 575.201,

et seq. At the time, those funds in which Iraq potentially

had an interest included a $6.4 million letter of credit (“LC”)

and Iraq’s $1.1 million deposit for the three furnaces.

Moreover, because Inductotherm had received this $1.1

million deposit, OFAC took the position that Iraq had a

property interest in all three furnaces and thus they were

blocked property. 

To mitigate its losses, Inductotherm attempted to find

new buyers for the furnaces. It sold Furnace A to

Mitsubishi in its 1991 tax year for approximately $1.8

million.2 Rather than place the sale proceeds in a blocked

account, Inductotherm commingled them with other

corporate funds. It was unable to sell Furnaces B and C in

that year. Eventually, however, Inductotherm sold the

furnaces in 1997 to Reading Alloys for what Inductotherm

alleges was less than its production and carrying costs. 

When the Government learned of the Mitsubishi sale, it

directed Inductotherm to block the sale proceeds. On June

17, 1991, during Inductotherm’s 1992 tax year, the

Government confirmed those instructions by issuing a

“Directive License,” which specifically applied the Executive

Order to Inductotherm. Inductotherm disputed, inter alia,

2. Inductotherm’s tax year ends on April 30. 

3
the applicability of the Executive Order to the sale

proceeds, and protracted litigation ensued in the United

States District Court for the District of Columbia and then

in the United States Court of Appeals for the District of

Columbia Circuit. Ultimately, the D.C. Circuit held that the

furnaces, and the proceeds therefrom, were blocked

property but could be released if Inductotherm placed the

$1.1 million deposit in a blocked account — a procedure

clearly contemplated in the Executive Order. Consarc Corp.

v. United States Treasury Dep’t Office of Foreign Assets

Control, 71 F.3d 909 (D.C. Cir. 1995). 

Meanwhile, when filing its tax returns, Inductotherm did

not record the 1991 Furnace A sale proceeds as taxable

income in 1991, reasoning that, as a result of the Executive

Order and the Directive License, it did not have unfettered

discretion to dispose of the proceeds. It urges that, under

the Claim of Right Doctrine (discussed in Section II below),

if a taxpayer does not have unfettered discretion with

respect to funds, those funds need not be recognized as

income. The IRS disputed Inductotherm’s reasoning and

assessed a tax deficiency. Inductotherm paid the back taxes

on Furnace A as the IRS required and filed suit in the

United States District Court for the District of New Jersey

to recover the alleged overpayment. The Court held against

Inductotherm on this issue, granting summary judgment in

favor of the Government. 

In its 1991 and 1992 tax years, Inductotherm took

deductions on account of the production costs of Furnaces

B and C, despite the fact that it did not sell them until

1997. Inductotherm argued that, while normally costs may

be deducted only in the year that an item is sold, see

United States v. Catto, 384 U.S. 102, 109 (1966), in its case

an exception should apply: as a result of the Executive

Order, the furnaces, in effect, were no longer

Inductotherm’s property and indeed were confiscated from

it. The IRS disallowed this deduction. Again, Inductotherm

paid the required tax deficiency and filed suit to recover.

The District Court granted summary judgment in favor of

the IRS on this claim as well. 

4
Inductotherm appeals both rulings.3

II. Discussion

A. Furnace A

Inductotherm argues that it was not required to treat the

sale proceeds for Furnace A as income in 1991 under the

Claim of Right Doctrine. That Doctrine, set out in North

American Oil Consolidated v. Burnet, 286 U.S. 417 (1932),

holds that funds received by a taxpayer will be considered

income if (1) “a taxpayer receives earnings under a claim of

right” and (2) “without restriction as to its disposition,”

“even though it may still be claimed that [the taxpayer] is

not entitled to retain the money, and even though [the

taxpayer] may still be adjudged liable to restore its

equivalent.” Id. at 424. 

Here, Inductotherm has conceded that it received the

Furnace A proceeds under a “claim of right,” i.e., it

acknowledged its entitlement to the proceeds. However, it

disputes that it held the Furnace A proceeds without

restriction as to disposition in 1991. Inductotherm reasons

that the Executive Order, issued during its 1991 tax year,

required it to place the funds in a blocked account (which,

however, it did not do) and thus restricted its discretion as

to those funds in 1991. Inductotherm relies principally on

a line of cases holding that public utilities were not

required to recognize as income customers’ deposits,

prepayments, or “overrecoveries,” which those utilities

clearly were obligated to return, despite the fact that the

utilities commingled the funds (as Inductotherm did). See,

e.g., Commissioner v. Indianapolis Power & Light Co., 493

U.S. 203 (1990) (customer deposits made to assure prompt

payment of future bills not income; even though funds

commingled with general funds, deposits represent merely

loans because customers are entitled to demand return of

funds under specified circumstances); Mutual Tel. Co. v.

3. The District Court had jurisdiction under 28 U.S.C. § 1331. We

exercise jurisdiction pursuant to 28 U.S.C. § 1291. Because the issues in

this appeal are questions of law, our review is plenary. Epstein Family

P’ship v. Kmart Corp., 13 F.3d 762, 765-66 (3d Cir. 1994). 

5
United States, 204 F.2d 160, 161 (9th Cir. 1953) (monies

utility held in reserve at the direction of the Public Utilities

Commission were not income because “it cannot be said

that the receipts came into the possession of [the utility]

subject to its ‘unfettered command’ and that it was free to

enjoy the receipts at its option”); Florida Progress Corp. v.

Commissioner, 114 T.C. 587, 599 (T.C. 2000) (“Because the

time and method of refunding overrecoveries is controlled

by [agencies] rather than by Florida Power, [it] does not

have complete dominion over the overrecoveries and is not

required to recognize them as income when received.”);

Houston Indus. Inc. & Subs. v. United States, 32 Fed. Cl.

202, 210 (Fed. Cl. 1994) (“overrecoveries” for fuel costs are

not income because “[e]very dollar of overrecovery must

eventually be repaid.”). 

The Government argues that these utility cases are not

analogous because the first prong of the Claim of Right

Doctrine was not satisfied: the utilities did not claim that

they were entitled to the funds for their own benefit.

Rather, they conceded at all times that they held the funds

in a fiduciary capacity or, at least, with a clear obligation to

return the funds. Moreover, as to the second prong, the

utilities’ discretion with respect to the funds was at all

times limited by extensive regulatory oversight by state

administrative agencies. The Government directs our

attention instead to James v. United States, 366 U.S. 213

(1961), which held that money embezzled must be included

in income, even though it likely would have to be disgorged

in the future. Just as Inductotherm argues that its

commingling of the Furnace A proceeds is not dispositive

under the utility cases, the Government cites James for the

proposition that Inducotherm’s legal duty to block the

proceeds under the Executive Order is likewise not

dispositive. In James, it was clear that the embezzler had

no right to the funds at issue. Nonetheless, because the

embezzler treated the funds as his own during the relevant

tax year, he was required to recognize those funds as

income. 

We agree with the Government. As already noted,

Inductotherm’s concession (no doubt correct) that it

asserted title to the proceeds of Furnace A’s sale in 1991

answers the first prong of the Claim of Right Doctrine. 

6
As to the Doctrine’s second prong (no disposition

restriction on the sale proceeds), Inductotherm, having

commingled the funds instead of blocking them, placed

itself in a position of complete dominion over those funds

(at least during the 1991 tax year). In this context, the

Executive Order was “a potential or dormant restriction . . .

which depends on the future application of rules of law to

present facts [and therefore was] not a ‘restriction on use’

within the meaning of North American Oil v. Burnet.” Healy

v. Commissioner, 345 U.S. 278, 284 (1953). The

Government was entitled to prosecute Inductotherm for

failure to comply with the Executive Order. However, as

with any regulation or criminal law, the Government had

the discretion not to pursue Inductotherm’s Executive

Order violation. Thus, Inductotherm’s control over the

Furnace A proceeds was analogous to that of the embezzler

in James.4 See also Continental Illinois Corp. v.

Commissioner, 998 F.2d 513 (7th Cir. 1993) (because

bank’s obligation to refund interest paid over a known

percentage is contingent on the fulfillment of conditions by

the debtor, and thus the obligation is uncertain, bank must

treat interest as income in year received). 

That Inductotherm was required after the conclusion of

the 1991 tax year to block the Furnace A proceeds is in no

way relevant to the analysis. There are numerous cases in

which a taxpayer treated funds as its own in one year, only

to find that it was required to disgorge them in a later year.

In all these cases, courts required the taxpayer to recognize

the funds as income in the year received, notwithstanding

the later disgorgement. See, e.g., Healy, 345 U.S. 278

(salary a taxpayer earned in one year from a closed

corporation in which he was an officer and stockholder,

which had to be returned to the company in a subsequent

year because it was excessive compensation, was income in

the year the salary was earned); Wentworth v.

Commissioner, 510 F.2d 883 (6th Cir. 1975) (taxpayer

whose stock was illegally redeemed was required to

recognize proceeds from redemption in year he received

4. While we do not suggest that Inductotherm’s behavior was criminally

culpable (as was that of the taxpayer in James), its position for tax

purposes is legally indistinguishable. 

7
them, despite later duty to return proceeds); United States

v. Lesoine, 203 F.2d 123 (9th Cir. 1953) (taxpayer properly

included dividend as income in the year it was received,

even though it was later determined that dividend had to be

repaid to corporation because there was insufficient

surplus for payment); Saunders v. Commissioner, 101 F.2d

407 (10th Cir. 1939) (sums taxpayers received from the sale

of corporation’s capital stock were income, although

taxpayers returned money to corporation on advice of

counsel, who said that taxpayers were not entitled to

receive funds). 

In this context, the Claim of Right Doctrine does not

shield the Furnace A proceeds from being income in 1991.

B. Furnaces B and C

Inductotherm sold Furnaces B and C in 1997. However,

it sought to deduct production costs of those furnaces in its

1991 and 1992 tax years. In the District Court,

Inductotherm claimed that the Executive Order was in

effect a confiscation that deprived it of its property rights in

those two furnaces and thus, under § 165(a) of the Internal

Revenue Code,5 it was entitled to deduct the costs of the

furnaces when the Executive Order went into effect. 

26 C.F.R. § 1.165-1 sets out a two-prong test for

determining whether a taxpayer may recognize a loss under

§ 165(a) in a given year. There must be: (1) a closed and

completed transaction fixed by identifiable events and (2)

no reasonable prospect of recovery. Inductotherm contends

that the promulgation of the Executive Order was a closed

and completed transaction with respect to Furnaces B and

C, and in 1991 and 1992 there was no reasonable prospect

that it would recover the furnaces. 

This argument fails. First, other courts have held, as a

matter of law, that a blocking order is not a closed and

completed transaction because it is merely a temporary

restriction on the use of property. See, e.g., Tran qui Than

v. Regan, 658 F.2d 1296, 1301 (9th Cir. 1981) (“The

5. 26 U.S.C. § 165(a) provides that “[t]here shall be allowed as a

deduction any loss sustained during the taxable year and not

compensated for by insurance or otherwise.” 

8
blocking of the assets . . . does not affect the interest, right

or title to them which [the taxpayer] may possess. The

blocking action merely suspends indefinitely the right to

transfer those funds.”) (internal citation omitted); Nielsen v.

Sec’y of the Treas., 424 F.2d 833, 843-44 (D.C. Cir. 1970)

(“The blocking of accounts is generally recognized as

different from taking, though raising a problem of taking ‘if

continued indefinitely.’ ”). Moreover, we note that a taxpayer

may not recognize a loss unless it has exhausted its

remedies to reduce its loss. Investors Diversified Servs., Inc.

v. Commissioner, 325 F.2d 341, 350 (8th Cir. 1963). In this

case, Inductotherm could have sought a license from OFAC

to unblock Furnaces B and C. See 31 C.F.R. §§ 575.202(c),

575.203(c). Yet it did not do so. 

On appeal, Inductotherm sets out what it acknowledges

is a new theory for deducting the costs of Furnaces B and

C in 1991 and 1992. It argues that, because electron-beam

furnaces such as Furnaces B and C used a disfavored

technology, the Executive Order’s promulgation deprived it

of the only available market for the furnaces — Iraq, leaving

the furnaces with little or no resale value. In this context,

Inductotherm contends that it was entitled to recognize a

loss under 26 C.F.R. § 1.471-2, which directs companies to

value their inventory at the lower of cost or market value

and allows write-downs based on declines in inventory

value (e.g., for obsolescence).6

Ironically, Inductotherm expressly disclaimed reliance on

this theory before the District Court. In response to an

interrogatory from the Government, Inductotherm stated,

“Plaintiff claims the deductions taken in fiscal years 1991

and 1992 because of the lack of control over the assets as

a result of the freeze on the assets as issued by President

Bush, not because there was an actual loss of value to the

actual assets.” The response went on explicitly to state,

“Plaintiffs do not assert that the deductions were taken

pursuant to Section 471.” 

In light of Inductotherm’s express disclaimer in the

District Court, we decline to entertain this new argument

6. Regulation § 1.471-2 complements § 471 of the IRC, which sets out

the general rule for valuing inventories. 

9
on appeal.7

 Moreover, considering this argument would

require calculating the decline in market values of Furnaces

B and C that the Executive Order caused. Yet Inductotherm

has failed to enter into the record any data that would

enable us (or the District Court on remand) to perform this

inquiry.8 Having failed to meet its burden, we decline to give

Inductotherm a second turn at bat.9

* * * * * * * * * * *

Under the Claim of Right Doctrine, Inductotherm was

required to recognize proceeds from the sale of Furnace A

in the year it received those proceeds, 1991. Moreover,

Inductotherm did not adequately prove its entitlement to

deduct costs associated with Furnaces B and C in 1991

and 1992. We therefore affirm the District Court’s grant of

summary judgment in favor of the Government. 

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

7. Inductotherm also makes essentially the same argument under IRC

§ 165, contending that because of the Executive Order Furnaces B and

C were unsaleable on the open market and therefore it was permissible

to recognize their decline in value in 1991 and 1992. Because

Inductotherm’s response to the Government’s interrogatory stated that it

did not claim “an actual loss of value to the actual assets,” which is the

factual underpinning of this new § 165 argument, we deem this

argument waived on appeal as well. 

8. Inductotherm argues that it provided this information in its position

letter to the IRS, attached to the complaint. However, the position letter

contains no “evidence” as such, but rather Inductotherm’s arguments

that the end-of-year value of Furnaces B and C was $0 because the

Executive Order deprived them of any market value. These assertions,

without more, do not provide a basis for a court to calculate Furnaces

B and C’s decline in value. 

9. While we will consider arguments raised for the first time on appeal

“where a gross miscarriage of justice would occur,” Kahn v. United

States, 753 F.2d 1208, 1222 n.8 (3d Cir. 1985), this is not such a case.

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