Earl Warren: No. 151 John T. Jarecki, former collector of Internal Revenue, et al., Petitioners, versus G.D. Searle & Company. Mr. Barnett.
Wayne G. Barnett: Mr. Chief Justice, may it please the Court. This case and the Polaroid case which follows it, arise under the Excess Profits Tax Act of 1950, that's the so called Korean War excess profits tax. The taxpayer is a corporation engaged in the development, manufacture and sale of ethical drugs. During the years 1946 to 1949, before the excess profits tax years, the taxpayer developed two new chemical compounds, one of which proved to be effective in the treatment of peptic ulcers and was sold under the trade name of, “Banthine”. The other was proved effective in the prevention and treatment of motion sickness and was sold under the name, “Dramamine”. In 19 -- during the years 1950 to 1953, which are the excess profits tax years, the taxpayer realized very substantial amounts of income from the manufacture and sale of these two products. It included that income in the computation of its excess profits tax for those years. Later, however, they filed claims for refund, claiming that a part of that income in sale of those two products was entitled to relief in part from the excess profits tax under Section 456 of the Internal Revenue Code of 1939. At the outset, I like to explain briefly what Section 456 really is. Section 456 is one of a wide variety of provisions ultimately designed to provide a more equitable measure of the income that should be subjected to the special war time rate imposed by the excess profits tax. Its particular profits is income which is realized during the excess profits tax years, but in fact is attributable to events or work done in prior years. The clearest example might be income which was fully earned before the war, but was subject to litigation which was not resolved until after the excess profits tax was enacted. And I think there is good reason not to subject that income to the full burden of the excess profits tax, simply because it wasn't really realized until that time.
Charles E. Whittaker: (Inaudible)
Wayne G. Barnett: Yes. I will come to the precise definition. I'm -- at this point I was just suggesting the -- the general purpose of the provision. There are three requirements to qualify for relief. I'm speaking again in broad terms. The first is you must have an eligible kind of income, income, an eligible class of income, income which is of a kind to which the section applied. The second requirement is that it must -- that class, the eligible class of income, must be abnormal in amounts, which is defined to mean in excess of 115% of the average income of that same class for the four previous years. Now, at this point, I think I can clarify Mr. Justice Whittaker's problem. The statute in the definition of abnormal income first speaks of income which is abnormal in kind, income that is not normal for the taxpayer to receive and then speaks of income which is normal to receive, but which is abnormal in amount. Now practically, it is only the abnormality in amount that is important because any income that is not normal to receive will also be abnormal in amount. Such -- the -- the only real quantitative -- the only test that the abnormality test imposed is the quantitative test, but if you have income that is an eligible kind and which meets the quantitative test, then you have what is called abnormal income and the excess of that over the 115% average for the four or five years, less allocable deductions is the -- is called the net abnormal -- the net abnormal income. Now you're not automatically entitled to relief for the net abnormal income. The third step is that you must show that that income or part of it is in fact attributable to other years. Now, if you satisfy all three of those tests, eligibility in kind, abnormality in amount and attributability to other years, then the relief that you get is that you reallocate the net abnormal income to the years to which it is attributable. Now the significant part of the relief is the income that you reallocate to pre-excess profit tax years to prewar years, because any income that you cast back to those years, escapes the excess profits tax entirely. Now, the problem here isn't all that complicated. The problem in this case is concerned only with the threshold question, only with the question of the eligibility of the income, whether the income derived from the sale of these patented products, Dramamine and Banthine, which I omitted to say were patented, is income of the kind, which is eligible to qualify under the section. Now eligibility is controlled by paragraph (1) and (2) of Section 456 (a) and all of my discussion will be about those two paragraphs and that is the one part --
Earl Warren: Can I ask this, thus if -- if the respondent gets over that first question, does he win?
Wayne G. Barnett: No, no. This case --
Earl Warren: I thought you said, we were only --
Wayne G. Barnett: Yes.
Earl Warren: -- interested --
Wayne G. Barnett: The only question presented in this Court at this time is the question of eligibility.
Earl Warren: Yes.
Wayne G. Barnett: The other questions will still be in the case, but I -- I will find it later.
Earl Warren: But so far as this proceeding is concerned.
Wayne G. Barnett: Yes, in -- in the posture we're in, in this Court --
Earl Warren: You prevail --
Wayne G. Barnett: If we prevailed on that, we'd have to go back for trial in the other issues.
Earl Warren: Yes, yes.
Wayne G. Barnett: But the only question is --
Earl Warren: Yes, I understand.
Wayne G. Barnett: That is governed by paragraphs (1) and (2) of 456 (a), which is set forth at pages 24 and 25 of the appendix to our main brief, our big brief. Now, paragraph (1) defines abnormal income as meaning income of any class described in paragraph (2). That's the -- those are the eligible class of income, income of any class described in paragraph (2), so that the only eligible classes of income are those described in paragraph (2). Paragraph (2), then lists four classes of income which are specifically described. The one under which our taxpayer here claims to qualify is subparagraph (B), which includes income resulting from exploration, discovery or prospecting. And his argument is that discovery as used there includes invention and therefore, its income derived from the sale of its invented products, Banthine and Dramamine, is income resulting from discovery i.e. the discovery of those two products. Now I should add that there is an alternative argument which is made by the taxpayer here based on the last sentence of -- of paragraph (2). That argument is made at greater length by Polaroid and in following case and I propose to deal with that primarily in that case and here, I would like to concentrate on the discovery argument. The District Court entered summary judgment -- this is in a suit for refund by the taxpayer. The total claim of refund, involve about 4.5 million dollars in tax. Only three of the four years were actually covered by the suit. The District Court granted summary judgment for the Government on the ground that discovery as used in subparagraph (B), does not include inventions. The Court of Appeals for the Seventh Circuit reversed, holding that discovery was not used in the particular limited sense and could include inventions and remanded the case for trial to decide whether Dramamine and Banthine were actually discoveries though. Now, subsequently, the Court of Appeals for the First Circuit in the Polaroid case expressly disagreed with the Seventh Circuit and First Circuit held the discovery was limited to the finding of mineral deposits and did not include inventions and it was to resolve that conflict that the cases were brought here. Turning to the interpretation of subparagraph (B), what discovery there means, I would like -- I would like to concede at the outset that inventions are in common usage very often referred to as discoveries. I'm not sure that it conforms with -- with the best use of the term. I think the dictionary would support me that the best use of the term is to include finding things that previously exists, as distinguished from creating something new. I don't want to quibble about that, how (Inaudible)
Potter Stewart: Use the constitutional (Inaudible), doesn't it?
Wayne G. Barnett: Yes. The Constitution also described --
Potter Stewart: Did -- did you?
Wayne G. Barnett: Yes, it is indeed. I think Webster's in fact, does distinguish between discovery and invention. I -- I'm not relying on that distinction in any event. I am prepared that the -- that customarily, very commonly, the inventions are called discoveries. I would like to point out that so is virtually everything else in common usage and if you gave discovery the meaning in its broadest sense as -- as used, it would mean that virtually, all income results from discovery. For example, not only does an inventor discover a new product, but a manufacturer discovers a new source of supply, he discovers a way to cut cost, he discovers a new market, he discovers the value of advertising. In short, in common parlance, discovery really includes any new acquisition of knowledge and I -- I think it's clear that you can't read it in this statute in that broad sense. Now, in fact taxpayers here, although that they state their argument as the common ordinary meaning versus a strict technical meaning, in fact they recognize that you -- the word has to be limited because although they start there, they end up trying to suggest that discovery really includes only basic inventions and doesn't include minor inventions, which certainly is not in accord with common usage. So they also recognize that, we have to give the term here some -- some limited meaning and the question really is which limited meaning. The Government's position is that discovery as used here in this statute is used in the well-defined and special sense in which it is used in mining. Namely, this is one of the definitions included in the dictionary. The original finding of a part of the vain or load, it has a fine requisite in valid location of a mining company. So it's in the special use of discovery in the -- in industry that we contend is meaning here. Now, I think I can prove -- I hope to prove simply from the face of the statutes, in the face of Section 456, that the term is used in that sense and does not include inventions. Now first, our point to the subparagraph (B), which says income from exploration, discovery or prospecting, now, those three words are all words which have a special meaning in mining. It is mining that is the common denominator among those three words. The only -- the only way you can explain putting those three words together is the relationship to mining. And if we assume that there's any cohesion within this single class of income, I think it has to be explained in terms of the relation to mineral products. By the way, when I say mining, I'm including oil and gas, and the extracting industry. The second evidence I think, is the -- if one interpreted discovery in -- in subparagraph (B) to include inventions, subparagraph (C), would be superfluous. Subparagraph (C) defines is another and separate class of income, income from the sale of patent, formulae or processes. Now, if income from the use of an invention or patent -- patents formulae and processes are ultimately all inventions and if income from the use of them in manufacturing the product were included in class B as income form discovery, a fortiori income from the sale of the invention itself would be included in class B as income from discovery and there would be nothing left for class C, subparagraph (C) to do. That -- that's the rhetorical question asked by Judge Aldrich in -- in the Polaroid case, but if there is a big hole and it tends for the big cat, need there be a small hole for the small one? Now third is that from the express inclusion as an eligible class, but income from the sale of inventions, it can be inferred that Congress intended to exclude income from the use of inventions. That is nothing more than the inclusio unius, etcetera. The -- and there is a -- a fourth consideration which drawn from the face statute of the homogeneity of the classes within themselves. The importance of the classes is that you apply the quantitative test to each class separately, the 115% of the average test. Now that means that all the items of income included within a particular class in the taxable year in order to decide whether their abnormal in amount, you compare them with all the items of income included -- belonging to that same class in prior years, even on the maybe different items of income. Now, that comparison makes sense only if the items within a single class have something in common that -- that this homogeneity within the class. Now, the inference I asked you to draw from that is this. If Congress intended to make eligible income from the use of a patent, it would surely have included that income in the class with income from the sale of the patent (i.e. class C) and not in the class which the taxpayer contends was income from the sale of oil wells and goldmines, which is class B. So from the face of the statute, I think that there are -- there is a great deal of evidence that discovery was here used in the -- in the mining sense. Going beyond the statute, there's confirmation in -- elsewhere in the Internal Revenue Code itself, which where a discovery is used in provisions expressly limited to the mining industry, we set forth two of them in page 1 of our appendix Sections 105 and 114 (b) (2). I will mention here only Section 105, because I think that is really the more important one. That limits the income tax on gain from the sale of mineral properties if, but only if, the value of those properties was established, “By prospecting or exploration or discovery-work done by the taxpayer”. Now that provision dates back to 1918. It's been in the statute ever since then, with one very brief exception during the 1930s. Though now, it's limited to gas and oil properties, it originally applied to all mineral properties. The significance of that I'm -- don't like too much of it, but the significance is that those three words used together in combination, have been used together in companies for a long time in the patent statutes themselves, to refer to the mining industry. Now that confirms that that is the common denominator and that is what explains the use of those three words together described as the single class of income. Finally, what I think is really the most conclusive proof is the legislative history of -- of this particular provision itself. Section 456 present here, was taken directly and in large part, verbatim from Section 721 of the Excess Profits Tax Act that was in effect during World War II and the only significant change in the paragraph (2) in two provisions was in the description of the classes of income now covered by subparagraphs (B) and (C).
John M. Harlan II: Is 721 pointed in your brief?
Wayne G. Barnett: Yes, it is. But, I -- I think I can make the comparison easier for you if you will look at our reply brief at pages 10 and 11, there I -- I've set out the provision side by side as they appeared in the World War II law and the -- and the Korean War law at page 10 and 11 of the Government's reply brief which, is in numbers 151 and 159. The -- you will see the first provision quoted is the provision that appeared in the World War II law as class C. That included as knowledge per class of income, income resulting from exploration, discovery, prospecting, research or development of tangible property, patents, formulae or processes. That provision expressly included the very kind of income that is involved in this case, income resulting from research and development of tangible property and also it included income resulting from patents by use as well as by sale. So the income involved here would -- was expressly included in the World War II law. Now, the changes and as I say, this is the only significant change made in this paragraph of the two provisions, that class was broken down into two classes which found -- which are now classes B and C and part of it was omitted. I was -- the two classes taken from its former single class are B, income resulting from exploration, discovery or prospecting and C, income from the sale of -- of patents, formulae, or processes. The omissions are the important thing. What was omitted was -- was the phrase research or -- research or development of tangible property and in addition, income resulting from patents, formulae and processes was limited to income resulting from the sale of the patent itself, not the use of the patent. Now, it seems to us that if that departure was purposeful and necessarily very purpose was to exclude the kind of income involved here. And the Committee Reports -- the Committee Reports expressly say that that was the purpose. The House Reports which was repeated verbatim by the Senate is set forth the next page of our reply brief on page 12 and you will see that after stating that the World War II law had -- may -- included as eligible -- eligible class of income, income resulting from the sale of tangible property arising out of research and development. The report notes that that provision was a potential loophole of major dimensions. And that it was being omitted from the classes of income for which this relief was available because there appeared to be no means of restricting such an adjustment to truly meritorious cases without undesirably broad degree of administrative discretion. My -- my point is simply that that -- this is the very kind of income that was specifically included in the World War II law and just as specifically deleted from the Korean War law. And I don't know how Congress could've made any plainer without expressly stating the negative its purpose not to provide relief for this kind of income.
Hugo L. Black: Was this explained in the report?
Wayne G. Barnett: That was the report I was just (Voice Overlap) quoting from at page 12.
Hugo L. Black: Yes.
Wayne G. Barnett: That is the House Report as quoted from the House Report, the Senate Report is identical. It was taken verbatim from the House Report. Now, the taxpayer --
Hugo L. Black: So that does not --
Wayne G. Barnett: I'm sorry.
Hugo L. Black: Was there any explanation of the reason either on the report or the --
Wayne G. Barnett: No more -- no more than -- than the statement that this provision, the provision including research and development income was a potential loophole of major dimensions, because there appeared to be no means of restricting such an adjustment to truly meritorious cases other than by the introduction of an unduly broad amount of administrative discretion. It's with the administrative necessity and I will in a minute explain what the administrative difficulties were that explains this reference to the need for administrative discretion, if you're going to have that kind of provision. The -- the taxpayer here says that interpreting discovery to include truly basic inventions which they claim there is this, when I -- I don't mean to deny that, this is up on summary judgment and we accept their characterization. This is a very important invention. They say that if you include very important inventions within discovery, you don't have the administrative difficulties that Congress was worried about and I would like to point out what those administrate difficulties were.
Charles E. Whittaker: I don't understand you there --
Wayne G. Barnett: Yes.
Charles E. Whittaker: -- that should distinguish between that research patent (Inaudible) that are important over those that are less important?
Wayne G. Barnett: As I understand their argument, they do not argue that discovery includes all inventions. I think they can speak with themselves, as I understand their argument, they would limit it to basic inventions or important inventions. I'm not -- I don't want to commit to that position. The -- the kind of difficulty that you had under the Section 721 of the World War II law as applied to inventions and patents, which were eligible for relief was this. The relief applied only to the income resulting from the research and development or from the patent. Now, if the owner of the patent licensed others to use the patent and got only royalty income, the problem was -- was easy. All of his royalties resulted from the patent. But if he used the patent himself, manufactured the item, sold the item and the income you got was simply sales income, how could you decide how much of his sales income was attributable to the value of the patent and how much was simply an ordinary manufacturing profit attributable to -- to a fair return on his capital and his investment in plant and equipment to his sales program and labor and all the other factors that go into the production of income. Well, there was simply no way to do it. The -- the regulations made it clear, you have to make that segregation. The -- the manufacture -- manufacturing and selling it -- a product that he developed, who wanted relief had to segregate what part of that sales income was due to the invention and what part was due to manufacturing general demand capital, etcetera. The only place that the regulations suggested how you might do it was the case where you also licensed others you could use that royalty as a measure or the sort of constructive royalty and charge that part of his income to the patent and -- and that rest elsewhere.
John M. Harlan II: Did the treasury recommendation of any kind play a part in the change that was made in 456?
Wayne G. Barnett: I have no knowledge of that. I -- I'm sure the treasury was involved in the drafting of whole statute, but I don't know of any specific recommendations about this provision. You -- you can see the difficulties that are -- were encountered and one must pursue them I don't think we need to. We cite a group of cases in our brief at pages 47 and 48 applying the old provision. I was just -- the Ramsey Accessories case is probably the leading case, these other factors are called in the -- 721 bar, the -- the Ramsey factors from the name of that case. Now the taxpayer says, he doesn't have that problem here because it's a basic invention. Well, how does he allocate his sales income between the value of the patent and his ordinary manufacturing profit? He doesn't say in his brief, but if you look at the record at pages 10 and 11 of the record, you'll find out how he did it in his claim for refund. You will see that he had gross profit and I think, in 1951, the year 1951 was one of the years.
Potter Stewart: That's not the right page.
Speaker: 8 or 9?
Wayne G. Barnett: 8 or 9 -- yes, 8, 9. See at gross profit from the sale of those two items at $10,700,000. How much of that gross profit from the sale of those two items is attributable to manufacturing and the other factors of production and how much to the value of the patent, the royalty element? The answer, the reason why it's simple to do is that the taxpayer attributes all of the income to the patents. Every cent of the income is due to the patents and as he computes it, the net income by the way was about $8,000,000 out of this $10,000,000, as he computes it, although he had $8,000,000 net profit from these two products, he didn't earn a dime on his capital invested in the manufacturing, on his advertising activities, on his sales and promotional activities, during 1951. All of the $8,000,000 he says was earned actually back in 1946 and 1949 and he just broke even in 1951. Now, obviously that is not all income, which is attributable to the development of this item. No doubt that it -- some of it is, we don't deny that and that depends on how good a patent is and how great -- how much the monopoly that is -- is given by the patent is worth, but certainly, they at least also made ordinary manufacturing profit. I suggest the failure of a taxpayer to be able to suggest how you breakdown your sales income between the patent and the manufacturing and other activities, simply confirms the wisdom of Congress. And this is the administrative problem that caused them to delete that class of income in taking out a provision which would've required that kind of breakdown and I think ultimately there's no basis for construing the discovery provision in subparagraph (B) to recreate those problems. Thank you.
Earl Warren: Mr. Cummings.
Walter J. Cummings, Jr.: May it please the Court? There are two questions involved in Searle's case. First is whether the District Court erroneously granted the Government's motion for summary judgment, instead of letting Searle prove that its Dramamine and Banthine were discoveries within the meaning of the statute. The second question equally important which I also ought to be able to cover, is an alternative one namely whether the District Court erroneously granted the Government's summary -- motion for summary judgment, instead of letting Searle prove that the income from these two drugs could probably be classified under the last sentence or on the clause of the statue and the regulations in question. Under Rule 42 (b), to answer the question that Chief Justice put to Mr. Barnett, the remaining issues by court order have been held in abeyance, such issues as involving competition of amount of abnormal income, the years of attribution and so forth. The facts are largely in dispute as the Government conceded in the District Court but some of them are disclosed by the error record that's before this Court. As to the facts established by this record, the record shows that Searle is seeking to recover part of the excess profits taxes that it had paid in 1950 through 1952, on income from the discovery of these drugs. Dramamine is, of course, the famous anti-seasick or motion sickness remedy, whereas Banthine, is an equally sensational remedy for the treatment of peptic ulcers, normally rendering surgery obsolete in such cases. Searle advised the District Court that it intended to prove that unlike all it's other products, both these drugs were breakthrough discoveries, involving new compositions of matter and that their effect on the human body constituted an unprecedented approach to the treatment of motion sickness and peptic ulcers. Searle intended to show that the contemporary medical literature of other publications termed these two drugs discoveries for they were not mere improvements on existing drugs. Their large sales and widespread in the -- imitations were further indicia that both of these were genuine or breakthrough discoveries. But in the alternative, Searle intended to prove at the trial that it was reasonable and appropriate within the meaning of the treasury regulations, to classify the income from these drugs under the omnibus last sentence of the statute, even if it should not qualify under subparagraph (B) in the discovery provision. The Court of Appeals held that the word “discovery” as used in the statute does confine to natural resources. During the three years in question, Searle's excess in income tax payments totaled about 19 million, of which the complaint seeks to recover about three and a half million. But the judgment below did not determine that Searle was entitled to recover any part of this amount and in fact under the complicated computations that Mr. Barnett had adverted to, the District Court might conclude that the plaintiff indeed was not entitled to recover the entire amount or any of it. In this connection, the Court will be interested to note that only modest recoveries were allowed under the equivalent provisions of the World War II Act. This Korean War excess profits tax act, which was repealed in 1953, accords special treatment to income resulting from discovery and other classes of income, if it -- it falls within the definition section of the Act and the definition applies to income, abnormal in kind or abnormal at amount. Searle's incoming question, it contends is abnormal in amount. As its principal ground on the District Court, the Government's motion for summary judgment claimed that discovery does not include products prepared through research and development. The motion did not at all mention Searle's alternative claim or relief under the last sentence of the statute. As to both of these grounds and in the teeth of the regulation, the District Court held that the plaintiff's income was not entitled a relief merely because it arose from research and development. Our first point is that the ordinary meaning of discovery would include these drugs. Amphetamine sulfate was so termed by the Third Circuit in the Smith, Kline and French case recently and the salts for the treatment of anemia is so described by the Eighth Circuit throughout its Preon opinion. Interestingly enough at the famous (Inaudible) hearings, the investigation of the drug industry last year, important breakthrough drugs like these, were referred to as discoveries.
John M. Harlan II: Not in the context of the statute?
Walter J. Cummings, Jr.: No, the particular statute was not however, in the context of the statute and the very hearings on the statute, two other drugs were mentioned Mr. Justice Harlan, they were Aureomycin and ACTH. The Tax Court also used the term discovery on a non-mineral sense, when it was dealing with the equivalent provisions of the World War II had. In two cases that I found and preparing for the day and are not in our brief. In the W.P. Davis case in 5 B.T.A. 1195, the court referred the plaintiff's hosiery machine as a discovery and in Steel or Bronze Piston Ring Corporation in 13 B.T.A. 636, the court referred at the plaintiff's piston rings as a discovery, so the relief -- so that the word was used in a non-mineral sense by the Tax Court itself in administering the earlier provisions. The term is of course applied to really new drugs by common usage and there was so applied in the medical literature and the other newspaper articles dealing with these two drugs. Learned articles on such other drugs as insulin and penicillin referred to them as discoveries and as even Mr. Justice Brennan and Mr. Justice Stewart noted, the Constitution of course, uses the term discovery in a non-mineral sense.
Felix Frankfurter: Mr. Cummings --
Walter J. Cummings, Jr.: Yes.
Felix Frankfurter: And before that literacy is defined in the Oxford Dictionary, this may shed some light on the constitutional use of discoveries.
Walter J. Cummings, Jr.: Yes.
Felix Frankfurter: According to the Oxford Dictionary, discovery is a -- technical American, United States mining term. The first quotation they give is in 1802. It may well be that in course of time with those quixotisms and oddities by which words change their meaning and --
Walter J. Cummings, Jr.: Yes.
Felix Frankfurter: -- and their color without being disloyal to each other, themselves. It may well be that discovery in the -- in the constitutional draft of the 1787, at its generalized meaning of the disclosure of something new and that in America, even if they're not in England, discovery does have a technical application to the-- the processes of mining.
Walter J. Cummings, Jr.: Well, that is one of the definitions of course, but it does not the colon --
Felix Frankfurter: No, no, no.
Walter J. Cummings, Jr.: -- that (Voice Overlap)
Felix Frankfurter: But -- but I mean that may shed light on why that in 1787 discovery it may've had this generalized meaning and not yet received. I don't suppose there was so much mining going on except surface scratching in 1787 in United States.
Walter J. Cummings, Jr.: Well the whole point of a difference between discovery and invention was explored by Judge Cranch back in 1841 in the Camper case which I don't think we cite it, it's an early federal case, but in that, he concluded that at least as far as the Constitution and the patent laws go, that the words are used synonymously.
Felix Frankfurter: Yes, I know. Timeless picture were --
Walter J. Cummings, Jr.: I know. Even the treasure department apparently recognizes that drugs can come within the subparagraph for it has settled the claim involving an antibiotic in one of Searle's competitors. And then as this very record show the Internal Revenue examining officer in this case conceded that at least Dramamine constituted a discovery within the ordinary meaning of the term. Searle is of course not claiming that every patented drug is a discovery, but only that the rare pioneer or breakthrough drugs constitute discoveries. The same is true with Polaroid and its --
John M. Harlan II: Why -- why draw that distinction?
Walter J. Cummings, Jr.: Because we don't think that the statute was meant to apply to mere improvements -- mere improvements, which just grow out of research and development. They're not really truly discoveries their mere improvements are never referred to as discoveries.
John M. Harlan II: You mean it would apply under your view, the all product patents?
Walter J. Cummings, Jr.: We're not claiming that the word discovery applies to all product and --
John M. Harlan II: And draw distinction even there, as to the magnitude or significance of the invention.
Walter J. Cummings, Jr.: That's correct.
John M. Harlan II: And I was wondering what the basis -- what the reason for drawing that --
Walter J. Cummings, Jr.: Well I think, it's the same on -- it grows out of the patent law actually as was discussed by Chief Justice Taft in his Idaho process case. He said that the Court had differing attitudes toward genuine discoveries and slight improvements. In other words, they've often had to draw the line between genuine discoveries and mere improvements. You wouldn't have anything really abnormal, if it was a mere improvement. It couldn't possibly qualify. It would just be research and development.
Earl Warren: But any basic patent is a discovery?
Walter J. Cummings, Jr.: A pioneer patent, yes not an improvement patent. It would have to be something startling as Mr. Isaac Barnett will doubtless tell you about this Polaroid camera when his case is reached. That we weren't given an opportunity to prove that these two drugs were of that magnitude, that's what we would like to -- enable to do in the District Court. In the -- in administering the same provision under the World War II Act, the Tax Court seemed to reflect the same distinction between genuine discoveries or mere improvements. In the Ideal McCulloch case, which is mentioned in our brief, where the taxpayer was denied relief, where it had merely improved its vacuum tubes. Our point is that discovery should be given its ordinary meaning here, because Congress in our opinion has not specified any other meaning. One such example of this rule, in this Court is the Avery versus Commissioner in 292 U.S., where you were confronted with the meaning for the word, received. And the Court said Congress hadn't shown any other meaning that should be given to receive, so it was given its normal meaning and dividends were held received in the year in which they actually were received. The legislative history, which is to be discussed by Mr. Isaac Barnett for Polaroid, also shows that Congress intended no restrictive meaning. Because of time annotations, I won't be able to go into the legislative history except to state that in fact the only link between Section 456 and natural resources in the 1950 congressional debates or hearings or Committee Reports, was one remark by a representative of the mining industry quoted at page 70 of the Government's brief. The brief significantly omits the next sentence which in effect states, “We, the mining industry probably won't need Section 456 for ourselves, but it is a good idea for other industries.” The Government has collected a great many statutes in its principal brief and appendix to show that discovery has a narrow mineral meaning here, but unlike the headings and text of all those statutes, neither Section 456 nor Section 721 its precursor, contains any heading or text showing their applicability was confined to the natural resources industry. The same was really true on analysis we believe, for the internal content of this statute. The language used in subparagraph (B) is exploration, discovery or prospecting, or any combination of the foregoing. Each word then is given an independent significance, whereas the Government urges that discovery is covered only when in combination with exploration and prospecting in mining operations. In other words, when Congress intended to limit discovery to no resources, it has always so specified and we've given many examples and so as Polaroid in its brief. The main ground for the contrary opinion by the First Circuit was the application of the maxim noscitur a sociis. Well in accordance with many text writers on the subject of statutory construction such as Sutherland, this Court has often refused to apply the maxim. In the Russell Company case for example in 261 U.S. that company argued that the word, “contract” in a statute, had to be limited to private contracts because of it's word association, with the word, requisition. Well, the Court included Government contracts. And likewise in the Stockholms Enskilda Bank case in 293 U. S., the taxpayer argued that the word, “obligations” must because of its word, association be confined to notes and bonds. Again, this Court refused to consider the adjacent words. As in both those cases then, the noscitur maxim should not be found to restrict the ordinary meaning of discovery, specially since the application of Section 456 to a discovery of this type, does inform that the basic purpose of Congress to give relief to have normal income which is attributable in part to prior years. To our knowledge, the noscitur maxim has never been used to defeat the purpose of the statute and the Government has cited no cases in support of applying the maxim here. The only case cited by the First Circuit in favor of applying the maxim here was an 1877 case, in which its application was in accord with the basic purpose of the statute, but here the basic purpose of the statute would not be so satisfied. If you aren't going to apply the noscitur maxim, you have to look anyway at the phrase as it was immediately derived in Section 721 of the World War II Act. That's where this phrase directly came from. And there it is defined as covering both income resulting from exploration, discovery, prospecting, research or development of tangible property, patents, formulae or processes or any combination of the foregoing. So that applying the maxim, in the setting shows that discovery was not used only in the mineral sense.
John M. Harlan II: I thought they eliminated the -- they eliminated which you gave comfort out of under the old 721?
Walter J. Cummings, Jr.: Yes, but you have to see where the phrase was derived from. It was derived there and it's obvious that upon -- applying the maxim there, it could've been used in the mineral sense and just cutting out those other words, then suddenly turns, it changed the meaning of discovery. Exploration is not confined to natural resources either. Its common meaning is to seek for or after or to examine and in the Keystone Brass Works, the Tax Court referred to Keystone's exploration in developing new bushings. In other words, the term was there used in a non-mineral sense, in the sense of preliminary investigation. The Government and the District Court relies specially on the elimination of the words research and development from Section 721. And the proposed regulation provided for no relief whatever, if research and development were involved, that is true. But that regulation was abandoned after protest in favor of the present regulation which takes the exact opposite position and states that Section 456 is applicable to research and development income if the income is otherwise properly includable within the class of income to which the section is applicable, thus, of course, including discovery income or income under the Omnibus. Congress has nowhere stated the products arising out of research and development cannot constitute discoveries and the regulation is finally adopted, so permits. In other words, there is nothing to show that the removal of the words, research and development, was meant to confine the discovery language to the mining industry. Speaking of loopholes as Mr. Barnett did a few minutes ago, researchers of course, have wider concept in discovery and although the World War II Act's inclusion of those phrases supposedly threatened to create a loophole no such problem is presented by genuine discovery, which is a rare phenomenon. Even under Section 721, recoveries were modest so that any loophole was at best potential. In the light of the experience of the cases under the World War II Act, the Government's claim is unwarranted that millions of dollars would be jeopardized by affirming the holding below. After all the statute of limitations has expired, this particular statute was repealed in 1953, and the regulations themselves have very rigorous test so that there are ample safeguards for any so-called rate on the treasury. As to discoveries, we think there need to be no administrative difficulties for income from the new product can be specifically identified and segregated as it was here. Consequently, the reasons for eliminating research and development do not exist with respect to a discovery. The petitioners claim that discovery must not be interpreted and include patentable discoveries, but fear of overlapping subparagraph (C), but this assumes that the two paragraphs are mutually exclusive, they were not. The draftsmen understood that income might be quoting the draftsmen, classified and more than one of such paragraph -- subparagraphs. The language of the statute itself so states, in which case, the income is supposed to be classified under the one which the taxpayer irrevocably elects. In construing the statute, of course, the purpose of the statute looms very large and the main object of this statute was the tax benefits attributed to the large military budget and the wartime economy. Neither those factors were involved with respect to Searle's or Polaroid's products. Section 456 was enacted to give relief whereas here, the profits are not attributable to military spending or the wartime economy. As the Tax Court stated in the Ramsey Accessories case, Congress wanted these relief provisions to be applied sympathetically. The House Report which was approved by the Senate Finance Committee so states, the House Report 146, the Report states, “Equitable considerations demand that every reasonable be -- precaution be taken to prevent unfair application of the tax in abnormal cases.” The weight of the burden imposed carries with it at the commensurate need for restricting its application to the cases for which it was designed. Years of effort go into a discovery and its competitive advantage that will last on the short time and therefore, it's certainly within the spirit of Section 456 to afford relief here. The discovery of minerals and the like was no more deserving of relief legislation than the discovery of vital importance to the health of millions of persons. And there is no intention on it at all of Congress to confine subparagraph (B) to the mining industry. The mining industry was already well taken care of in many other provisions of the Code including certain sections of this very statute. The essence of Section 456 is to recognize the unfairness of bunching for heavy taxation in one year discovery income which is in fact, attributable to several years. Congress intended that abnormal income from discovery, if it can be shown to be attributable to other years, should be taxed accordingly. All Searle wants is an opportunity to prove that income, in fact, was attributable to other years and it's consequently entitled to relief under Section 456.
Hugo L. Black: As I understand the section, no such question was presented by cannons of the law.
Walter J. Cummings, Jr.: That's correct, Your Honor. In order to arrive at a solution of this problem, the District Court's order simplified it and said he would only pass on whether this could fit within subparagraph (B), the discovery provision or within the Omnibus Clause which I'm now about to discuss. Our second point and then it is an equally important point is that Searle's and Polaroid's income in the alternative, constituted a special class of abnormal income under the last sentence of the statute. That's a very short sentence. It appears at the middle of page 3 of our brief, the blue brief and states only, “The classification of income of any class not described in subparagraphs (A) to (D), inclusive, shall be subject to regulations prescribed by the Secretary.” One has to turn to the House Report on the World War II statute to see what the reason was for including an Omnibus Clause. And the same House Report Number 146 that I read from a few minutes ago gives the reason. It is stated there that “Experience with excess profits taxes both in the U.S. and abroad, has demonstrated conclusively that relief in abnormal cases cannot be predicated on specific instances foreseeable at anytime. The unusual cases that are certain to arise are so diverse in character and unpredictable that relief provisions couched in other than general and flexible terms are certain to prove inadequate and that is why this catchall clause or Omnibus Clause was inserted. The report goes on to state that existing law provides for adjustment with respect to six specific classes and the instant statute was reduced to four, received during the taxable year subject to the excess profits tax. These specific items were allowed to be spread over the years to which they're actually attributable. Your Committee feels that the relief afforded by this provision should not be limited to these specific items, but should be available also with respect to any item of abnormal income as such income is defined in the bill. And then little later, enter the -- detailed discussions of the bill, they go on to the same effect to say that since the types of abnormal income cannot be predicted in advance, you can only grant adequate relief by extending the scope of this section and that's why this last sentence was added.
John M. Harlan II: Would that -- would that mean that the -- that the Commissioner or the Secretary has got the right to enlarge the --
Walter J. Cummings, Jr.: He has never done so, Mr. Justice Harlan, instead by regulations. He's given that right to the taxpayers since 1944. He said to the taxpayer may group income in such other classes, but they have to be similar classes. They have to be reasonable and appropriate. In other words, the regulation sets up -- sets up three standards. A taxpayer under this Omnibus Clause is permitted the group income in similar classes, as those specified in paragraphs (A) to (D) as are reasonable and appropriate and that is shown at the regulation at the bottom of page 3 of our brief. “Similar” of course, does not mean identical or this Omnibus Clause would become entirely meaningless. Again, one has to resort to a dictionary definition and “similar” according to Webster means, somewhat alike. Certainly, a discovery of a new product is similar or somewhat alike to the discovery even of a new mine, except that the type of business is different. In other words, the class of income from newly discovered products is certainly similar to, if not identical with the class of discovery mentioned in subparagraph (B).
John M. Harlan II: Has the Commissioner allowed the deductions for categories other than those specified in the statute?
Walter J. Cummings, Jr.: The tax -- yes the Tax Court at least, has. The Commissioner in our case is not giving us the reason that research and development were involved, but as you can see from the last sentence of that regulation though that was an erroneous reason because --
John M. Harlan II: What are some -- what are examples -- do you cite cases in your brief where under that provision there had been allowances?
Walter J. Cummings, Jr.: In the Premier Products case, not in our brief, again, I found it preparing for today, 2 B.T.A. 445, the catchall is applied to insurance proceeds. And then in several other cases after that, such as the WB Knight case, which is in our brief in 6 B.T.A. 519, the court pointed out that the statute applies to not only the lettered classes but also to the omnibus or the catchall class. “Similar,” under the regulation in the setting, means that if a taxpayer classifies separately a readily identifiable segment of income, differing from its other products and attributed to -- attributable to prior years, such a class would be similar to the classes specified and should qualify for relief, if the other test of the statute and the regulation is satisfied. Yet, the District Court by its summary judgment would not permit Searle to meet the three tests established in the regulation. So it should not have been cut off by summary judgment from showing that it was reasonable and appropriate for it to group its income from Dramamine and Banthine in a separate class. Of all Searle's drugs, these were the only two that were completely new in concept and successfully performed in options and not previously performed by earlier pharmaceutical products. None of the other drugs marketed by Searle was truly new. In fact, this was recognized by the Government itself in 1955 when it rejected Searle's claim for refund of World War II excess profits taxes, because at that time, Searle had no new products as it's shown at pages 29 to 38 of the record. At the trial, Searle would also to show that the income from these two drugs was attributable to prior years under Section 456 (b) and was abnormal in amount between the requirements of Section 456 (a) (1). Thus, it would be entirely immaterial whether these drugs were produced as abnormal or routine part of Searle's business, which was the only test used by the Commissioner. Instead it's enough if it's abnormal in amount. What does the Government say about the Omnibus Clause? In its reply brief, it makes three points. First of all, it states that it was inadvertently left in the statute. Well that is not true, because the legislative history in 1950 shows that the House conferees insisted that it be put back in the statute after the Senate left it out. The staff reported the joint Committee on Internal Revenue's taxation in 1950, acknowledged that the Omnibus Clause give relief to a fifth class, namely, quoting five, “Income of other classes permitted under regulations prescribed by the Secretary.” Senator George made a similar statement on the senate floor, but this gave the Secretary of the Treasury the authority to prescribe classifications in addition to those prescribed in the bill. In other words, it could have been inadvertent. The Government also claims that the sentence can have no operative effect because the definition section, Section 456 (a) (1), is confined to income described in paragraph (2). Well that gives a very narrow meaning to the word, described. Instead described applies not only to the four classes specified in subparagraph (2) but also, of course, to the omnibus classification. That's part of subparagraph (2) as well. If you gave the narrow meaning to describe that the Government gives to it, the catchall or Omnibus Clause would have no effect at all, despite the fact that the House put it back for the very same reasons that was put in the World War II Act, namely, that would have been unfair without it. Finally, the Government claims that the last sentence of the regulation under this Omnibus Clause means that income involving research is excluded unless it qualifies under one of the four classes listed, namely, A, B, C, or D, but the regulation does not so state at all. The last sentence of the regulation applies to any class of income to which the principle of Section 456 and I'm quoting the statute of the regulation, “Is applicable”. In other words, the last sentence, the regulation applies to any class A through D or one selected by the taxpayer pursuant to the last sentence of 456 (a) (2) in the regulations. The reason for eliminating relief to research and development income also does not extend the income within the meaning of the last sentence for income is not entitled to relief under that sentence unless the three tests of the regulations are met. In other words, you have to show that it's similar, reasonable and appropriate. Also you have to show that the income is attributable to prior years under Section 456 (b). Thus, is it foolish to assert that if we prevail income abnormal in amount would automatically and suddenly qualified for relief, instead the attribution test at 456 (b) has to be met, the three tests of the regulation under the Omnibus Clause have to be met and many other requirements of the very rigorous regulations would still have to be satisfied. The District Court's holding that income attributable with recent surge has ipso facto excluded under Section 456, was certainly erroneous and in conclusion, the judgment of the Court of Appeals should be affirmed and Searle should be given an opportunity to prove that Dramamine and Banthine were discoveries within subparagraph (B) or if they were not, that the income was within the omnibus sentence, the last sentence of the section and the regulations there under.
John M. Harlan II: Was the Commissioner -- has construed his regulation, does not cover in your situation an effect, is that it?
Walter J. Cummings, Jr.: The only reason given, Mr. Justice Harlan in denying our claim was that if the drugs were produced as a normal or routine part of Searle's business, but that is patently wrong because as I stated earlier, the -- and as Mr. Barnett stated earlier, the definition section, Section 456 (a) (1) applies to income whether it is abnormal in kind or abnormal in amount. Our income was abnormal in amount. So the reason given for not committing the catchall clause to apply just was an invalid reason.
Charles E. Whittaker: How would it be abnormal either in the kind or amount if it is just routine with you?
Walter J. Cummings, Jr.: Because the -- whether it's abnormal in kind doesn't matter, but it satisfies the second test of the statute which is quoting from page 2. “If the taxpayer normally derives income of such class, but the amount of such income of such class includable in the gross income taxable year is an excess of 115% per annum.” We can satisfy that test, Mr. Justice Whittaker and would like to do so in the District Court. Our complaint sets out mathematically why we can meet the abnormal in amount test. Thank you.
Earl Warren: Number 169, Polaroid Corporation, Petitioner, versus Commissioner of Internal Revenue. Mr. Barnett.
Isaac M. Barnett: My secretary tells me that no matter how this case is decided, Mr. Barnett will win. The issue in this case is whether Polaroid's income from this -- from two scientific discoveries is entitled to relief as abnormal income under Section 456 (a) (2) of the Korean War excess profits tax laws. The Tax Court and the Court of Appeals for the First Circuit, while acknowledging that these discoveries were revolutionary discoveries held that no scientific discovery can qualify for relief under Section 456 and decided against Polaroid. Our contentions are similar to those advanced in the Searle case. First that Polaroid's income from its scientific discoveries falls squarely within the class of income described in 456 (a) (2) (B) as income resulting from discovery; 456 (a) (2) (B) as -- as was explained in the prior argument, reads income resulting from exploration, discovery or prospecting or any combination of the foregoing extending over a period of 12 months. Secondly, if it does not, if it's not entitled to come under (B), that such income was entitled to classification under the last sentence of 456 (a) (2), which provides for additional classifications by the Secretary. And to get that again before Your Honors, that last sentence reads, “The classification of income of any class not described in subparagraphs (A) to (D) inclusive, shall be subject to regulations prescribed by the Secretary.” We contend further that a proper interpretation of the treasury regulations issued to implement this last sentence that under such an interpretation, Polaroid's income qualified for relief. Now the two scientific discoveries that were involved in this case, are the Polaroid Land Process and the Polaroid 3-D Synthetic Polarizer. The Polaroid Land Process consisting of the Polaroid Land camera and film is a photographic system in which by one step dry processing, the developing and printing of the picture take place simultaneously within the camera, enabling the user to obtain a finished dry positive print directly from the camera within 60 seconds. Prior to the conception of the process, no photographic process existed whereby the picture was taken, the negative developed and a positive print obtained directly from the camera by a one-step dry process. The 3-D Synthetic Polarizer is the light polarizing material incorporated in the viewers, used by the audience in the viewing of three dimensional motion pictures to create the illusion of three dimensions and the exhibition of three dimensional motion pictures, could not have been undertaken without it. That the -- our case differs with the Searle case in that, we already have had the trial. The findings of fact of the Tax Court establish that these discoveries were revolutionary scientific discoveries creating new odds and that the incoming question resulted solely and entirely from the discoveries. We differ from the Searle case in another respect. We have a stipulation in our case, in which the Government and Polaroid have agreed in the event that this case is decided favorably to Polaroid, upon the amounts of net abnormal income arising from the discoveries and upon the portions thereof to be attributed to prior years. So in answer to your question, Mr. Chief Justice, if we should win here, we do not have to go back. We have a -- findings of fact on -- on the facts that we have revolutionary basic discoveries and we also have a stipulation with respect to the mathematical answers under Section 456.
Hugo L. Black: Is your argument also that there would have to be a finding of facts in each case to see if it happened to a revolutionary?
Isaac M. Barnett: Your Honor, I -- I think that the way this is construed under 456, I think Mr. -- you, yourself, Your Honor in the recent -- in your recent Convertible Top case, where there's an indication that the word, discoveries couldn't report to the type of patent that was involved there. I think that you'll find it in the patent laws, there is a distinction -- in the cases involving patented inventions, there is a distinction between a basic patent which advances the odd substantially and one which maybe entitled a patent, but it's merely an insignificant improvement. Now the court below seems to think there would be a large administrative problem connected with determining which is significant and which isn't. It might be a question, but -- and it can't very easily be answered in the abstract, but again, it seems to me that once you hear the facts with respect to any particular invention, you know whether it's significant or not. And in our case, despite the fact that we -- they've decided against us, both the Tax Court and the Court of Appeals said they were revolutionary inventions. They thought --
Felix Frankfurter: May I refer (Inaudible) that it is -- the answer is easy. If it isn't -- if it isn't significant, it is non-invention.
Isaac M. Barnett: That --
Felix Frankfurter: And it can't be -- if it's an invention, it must be significant.
Isaac M. Barnett: Well, I just want to say, Your Honor, that it seemed to me that the problem might --
Felix Frankfurter: These are opinions that convey that property.
Isaac M. Barnett: It might be, for example like was before you in an entirely different field in the (Inaudible) case. You can't state in the abstract, but once you see the facts, you know whether what the answer is one way or the other. A revolutionary invention creates tremendous surprise and you find through the lay literature, through the scientific literatures, also lots of indications as to whether it is recognized as revolutionary or not.
Felix Frankfurter: This statute is still in force, upon with all facts of deterrent patentability at the same time.
Isaac M. Barnett: I think Your Honor would have to determine as to -- there would -- there would have to be a determination as to whether there is a significant invention involved in the -- in the process or the -- or the product.
Felix Frankfurter: They're not using the significant and more dramatic phrase of flash of genius, are they?
Isaac M. Barnett: Well, yes, a flash of genius Your Honor, but there could be different flashes of genius. [Laughter] And that -- my - my namesake in making this argument has so paneled principal argument that has been made by the Government in his brief so far which had -- has been the basic argument that before these words, exploration discovery of prospecting were used in Section 721 (a) to (c) of the Second World War Act from which our Section, 456 (a) (2) (B) is derived, the words have become in the Internal Revenue laws, words of odd applicable only to natural resources. That's their basic argument and we think that's based on an improper analysis of the legislative history. And in view of the time involved, I'd like to confine most of my argument of that legislative history. In support of it -- of its contention, the Government has called attention to two statutory provisions. Both are resonating in the Revenue Act of 1918. Section 337, which established a ceiling on the rate of tax in the case of, “this is from the statute,” “A bona fide sale of a mine, oil or gas well, that's right in the statute,” the principle value of which has been demonstrated by prospecting or exploration and discovery work and the other section to which they refer is Section 234 (a) (9) of the 1918 Act, which in providing for a depletion allowance stated in the case of mines, oil or gas wells discovered after March 1, 1913, the allowance was to be based on the value at the date of the discovery.
Earl Warren: We'll recess now.