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. Pp.
367 U. S.
304-313.
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.
367 U. S.
313-315.
274 F.2d 129 reversed.
278 F.2d 148 affirmed.
Page 367 U. S. 304
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 the Excess
Profits Tax Act of 1950, 64 Stat. 1137. The Act, which is intended
to tax at high rates unusually high profits earned during the
Korean War, imposes a tax on profits in excess of an amount deemed
to represent the taxpayer's normal profits. [
Footnote 1] Recognizing, however, that some
profits otherwise subject to tax under this scheme might stem from
causes other than the inflated wartime economy, Congress enacted §
456. This section grants relief in certain cases of "abnormal
income" as defined in § 456(a) [
Footnote 2] by allocating some of this income
Page 367 U. S. 305
to years other than those 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 definition of
"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, extending over 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 research extending 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 were new products, and not merely improvements on
preexisting 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 then claimed a
refund. On denial of its claim, taxpayer filed a complaint in the
District Court for the Northern District of Illinois. The District
Court dismissed the complaint, but the Court of Appeals for the
Seventh Circuit reversed. It held that "discovery" might include
the preparation of new products, and that the case must be remanded
for a trial
Page 367 U. S. 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 a
photograph in 60 seconds, and the "Polaroid 3-D Synthetic
Polarizer," a device incorporated in the "viewers" through which
audiences watched the three dimensional motion pictures in vogue
some years ago. These inventions, each the product of more than 12
months' research, are novel, according to taxpayer, and each has
been patented. The Polaroid Land 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 engaged primarily
in manufacturing and selling such optical products as polarizing
sunglasses, visors and camera filters. In its returns for 1951
through 1953, taxpayer utilized the provisions of § 456 in
computing its tax on income from the sales of its photographic
equipment and 3-D polarizers. The Commissioner determined that §
456 was not applicable, and the Tax Court upheld his determination
of a deficiency. The Court of Appeals for the First Circuit
affirmed, holding that taxpayer's inventions were not
"discoveries," and its income from their sale not "abnormal
income." 278 F.2d 148.
We grant certiorari in each case to resolve the conflict between
the decisions of the First and Seventh Circuits. 364 U.S. 812,
813.
I
For present purposes, we accept, as did the First Circuit,
taxpayers' assertions of the novelty of their products. But we also
agree with that court that taxpayers' inventions are not
"discoveries" as that word is used in § 456(a)(2)(B), and that
income from sales of the new
Page 367 U. S. 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 of meaning. Here,
however, it does not stand alone, but gathers meaning from the
words around it. These words strongly suggest 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 is difficult to conceive of any other industry
to which they all apply. Certainly the development and manufacturer
of drugs and cameras are not such industries. The maxim
noscitur a sociis, that a word is known by the company it
keeps, while not an inescapable rule, is often wisely applied where
a word is capable of many meanings in order to avoid the giving of
unintended breadth to the Acts of Congress.
See, e.g., Neal v.
Clark, 95 U. S. 704,
95 U. S.
708-709. The application of the maxim 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 becomes unmistakably 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 of patents, 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 First Circuit,
"If there is a big hole in the fence for the big cat, need there be
a small hole for the small one?" The statute admits a reasonable
construction which gives effect to all of its provisions. In these
circumstances, we will not adopt a strained reading
Page 367 U. S. 308
which renders one part a mere redundancy.
See, e.g., United
States v. Menasche, 348 U. S. 528,
348 U. S.
538-539.
Taxpayers assert that it is the "ordinary meaning" of
"discovery" which must govern. We find ample evidence, both on the
face of the statute and, as we shall show, in its legislative
history, that a technical usage was intended. But, even if we were
without such evidence, we should find it difficult to believe that
Congress intended to apply the layman's meaning of "discovery" to
describe the products of research. To do so would lead to the
necessity of drawing a line between things found and things made,
for, in ordinary present-day usage, things revealed are
discoveries, but new fabrications are inventions. [
Footnote 3] It would appear senseless for
Congress to adopt this usage, to provide relief for income from
discoveries, and yet make no provision for income from inventions.
Perhaps, in the patent law, "discovery" has the uncommonly wide
meaning taxpayers suggest, but the fields of patents and taxation
are each lores unto themselves, and the usage in the patent law
(which is by no means entirely in taxpayers' favor) [
Footnote 4] is unpersuasive here. All the
evidence is
Page 367 U. S. 309
to the effect that Congress did not intend to introduce the
difficult distinction between inventions and 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 of mineral deposits. In the
Revenue Act of 1918, enacting one of the earliest excess profits
tax laws, a limit was placed on the excess profits tax on income
from
"a bona fide sale of mines, oil or gas wells, or any interest
therein, where the principal value of the property has been
demonstrated by prospecting or exploration and discovery work done
by the taxpayer."
Revenue Act of 1918, § 337, 40 Stat. 1096. [
Footnote 5] An identical limitation was imposed on
the income tax levied under that Act, [
Footnote 6] and the same usage of "discovery" obtained in
the allowance of depletion deductions. [
Footnote 7] The limitation on the income tax on the
proceeds of the sale of mineral deposits was reenacted without
significant change in the Revenue Acts of 1921, 1924, 1926, 1928,
1932, 1936 and 1938. [
Footnote
8] It remains in the income tax provisions of the Internal
Revenue Code of 1939 as § 105, and has been carried forward as §
632 of the 1954 Code. In each reenactment "discovery"
Page 367 U. S. 310
is linked with "exploration" and "prospecting," and, in each,
the word is restrictively applied to extractive industries. A
correspondingly narrow use of "discovery" has continued since 1918
in the depletion allowance sections, [
Footnote 9] and appears in § 114(b)(2) of the 1939 Code.
In the more than 30 years preceding the enactment of the section
here at issue, during which time "discovery" was used and re-used
in successive taxing statutes, the word developed 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 any transformation 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 12 months."
This was the first time specific provision was made for income
from invention, relief in cases of such income having previously
been obtainable, if at all, only under the "general relief"
provisions of the earlier Acts. [
Footnote 10] It is
Page 367 U. S. 311
instructive that the formula "exploration, discovery, or
prospecting" was not considered broad enough to cover invention,
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 Acts, and which it continued to have in the income tax
provisions of the then-current code. [
Footnote 11]
The relief provisions of the Excess Profits Tax Act of 1950,
which we here construe, were modeled in part on § 721 of 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 relief in 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 not encompass 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. Taxpayer 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 is within 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
Page 367 U. S. 312
deliberately to deny relief for it, and to limit relief in cases
of research and development to that provided in subparagraph
(C).
The relief provisions of the World War II Act had been intended
to provide "flexible rules," [
Footnote 12] and their application had often been an
uncertain affair. In administering § 721, the Commissioner often
faced the difficult task of separating income which was the product
of "research, or development" from that resulting merely from
improved management or sales efforts. The difficulty of distinction
led the Tax Court to hold that the distinction must be made "by
exercising common sense and judgment," and that "[i]t is entirely
possible that the allocation made by one person would never match
that made by another."
Ramsey Accessories Mfg. Corp. v.
Commissioner, 10 T.C. 482, 489. Congress, in 1950, recognized
the delay and uncertainty caused by the element of administrative
discretion in this and other [
Footnote 13] sections, and set about drafting an excess
profits tax law on the principle that "subjective judgments . . .
should be avoided in the new 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 certain other types of
income, particularly that resulting from the sale of tangible
property arising out of research and development which extended
over a period of more than 12 months. This provision
Page 367 U. S. 313
in the old law 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 a large degree of administrative discretion of the
type required by the general relief clause of the World War II law
(sec. 722), and because the need for a reallocation 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 eligible for
relief. They say, however, that not all income from research and
development was excluded. That which comes from inventions not
merely patentable, but also sufficiently revolutionary to be called
"genuine discoveries," is still within the protection of § 456. We
find it impossible to believe that an amendment designed to
eliminate uncertainty and administrative discretion would introduce
into the law -- without a congressional word of warning or
explanation -- a distinction as vague, as dependent upon nuances of
scientific opinion, and as unprecedented as that urged by
taxpayers.
II
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 meets certain 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,
Page 367 U. S. 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 enacting § 456 to cut
down not only the amount of administrative discretion which had
prevailed under the predecessor section, but also the scope of
available relief, the power of the Secretary to extend relief far
beyond the four corners of the statute may be doubted. [
Footnote 14] It is sufficient to
note that, unlike its predecessor (which made relief available for
all "abnormal income," whether or not specified in a particular
class), [
Footnote 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 create administrative
classifications embracing all such income. And even if the sentence
relied on gives the Secretary power to expand the classes of
abnormal income somewhat beyond the four enumerated in the statute,
he has clearly not done so here. The regulations [
Footnote 16] specifically provide that
Page 367 U. S. 315
"Income from the sale of tangible property arising out of
research and development which extended over a period of more than
12 months is not included in the list of abnormal types of income
to which section 456 is applicable, and such income may not
constitute a class of income for purposes of that section."
This specific exclusion is clearly in furtherance of the purpose
of Congress in deleting "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 otherwise applies.
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 the Court of Appeals
for the First Circuit affirmed.
It is so ordered.
* Together with No. 169,
Polaroid Corporation v.
Commissioner of Internal Revenue, certiorari to the United
States Court of Appeals for the First Circuit, argued March 21-22,
1961.
[
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 for the taxpayer to derive income of such class,
or, if the taxpayer normally derives income of such class but the
amount 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 the taxpayer was not in existence for four
previous taxable years, the taxable years during which the taxpayer
was in existence."
"(2) Separate classes of income. -- Each of the following
subparagraphs shall be held to describe a separate 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 developed over a period of more
than 12 months; or"
"(D) Income includible in gross income for the taxable year
rather than for a different taxable year 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 one which 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 inventions than discoveries.
Webster's New International Dictionary, Unabridged (2d ed.) p. 745,
makes this distinction:
"One DISCOVERS what existed before, but had remained unknown;
one INVENTS by forming combinations which are either entirely new
or which attain their end by means unknown before, as Columbus
discovered America; Newton
discovered 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 the exclusive Right to
their . . . Discoveries." While the terms "discover" and
"discovery" are used throughout the patent statutes, 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 of matter . . . may obtain a
patent therefor. . . ."
And see Dolbear v. American Bell Telephone Co. (Telephone
Cases), 126 U. S. 1,
126 U. S.
532-533.
[
Footnote 5]
This section was reenacted 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
materially disproportionate to the cost, the depletion allowance
shall be based upon the fair market value of the property at the
date of the discovery. . . ."
[
Footnote 8]
Revenue Act of 1921, § 211(b), 42 Stat. 237; Revenue Act of
1924, § 211(b), 43 Stat. 267; Revenue Act of 1926, § 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 of 1932, § 114(b)(2), 47 Stat. 202;
Revenue Act of 1934, § 114(b)(2), 48 Stat. 710; Revenue Act of
1936, § 114(b)(2), 49 Stat. 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 relief in any case in which
"the tax . . . would, owing to abnormal conditions affecting the
capital or income of the corporation, work upon the corporation an
exceptional hardship. . . ."
Section 721 of the World War II law classified specific types of
abnormal income for purposes of computing the tax, and, while it
provided relief for all abnormal income of whatever class, was not
considered a "general relief" section.
[
Footnote 11]
I.R.C. of 1939, §§ 105, 114(b)(2), 114(b)(2). It was expressly
provided by § 728 of the World War II excess profits tax statute,
54 Stat. 989, that the words used in that statute should have the
same meaning as when used in the income tax 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, 56 Stat. 914, 57 Stat. 56,
601, 58 Stat. 55, provided for adjustments in the computation of
base period income if the taxpayer established, among other things,
"what would be a fair and just amount representing normal earnings"
during the base period.
[
Footnote 14]
In fact, the Committee reports state that "Adjustments . . .
[under § 456] are limited to income arising out of" 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.
[
Footnote 15]
Excess Profits Tax Act of 1940, § 721, 54 Stat. 986, as amended,
55 Stat. 21. Section 721(a)(1) defines "abnormal income" as "income
of any class includible in the gross income of the taxpayer. . .
."
[
Footnote 16]
Treas.Reg. 130, § 40.456-2(b) (1951), as amended, T.D. 6026,
1953-2 Cum.Bull. 235:
"Other income, not within a class described in subparagraphs
(A)-(D) of section 456(a)(2), to which section 456 is applicable
may be grouped by the taxpayer, subject to approval by the
Commissioner on the examination of the taxpayer's return, in such
classes similar to those specified in subparagraphs (A)-(D) of
section 456(a)(2) as are reasonable in a business of the type which
the taxpayer conducts, and as are appropriate in the light of the
taxpayer's business experience and accounting practice. Income from
the sale of tangible property arising out of research and
development which extended over a period of more than 12 months is
not included in the list of abnormal types of income to which
section 456 is applicable, and such income may not constitute a
class of income for purposes of that section. However, section 456
is applicable to such income if the income is otherwise properly
includible within a class of income to which such section is
applicable for example, the class described in section
456(a)(2)(D)."