49 T.C. 488">*488 The Renegotiation Board determined that the petitioner realized excess profits of $ 250,000 in the calendar year 1957 from its contract with the Atomic Energy Commission to process yttrium oxide for that agency. The petitioner challenges the Board's determination that the particular contract involved was not exempt from renegotiation. The parties have stipulated that if this Court determines that the contract was not exempt from renegotiation, then it may enter an order determining that petitioner realized excess profits in the amount of $ 250,000 in 1957. If the contract is exempt from renegotiation, it is then stipulated that the petitioner realized no excessive profits in 1957.

FINDINGS OF FACT

All of the facts having been stipulated, they are so found.

Petitioner, Michigan Chemical Corp., is a Michigan corporation organized in 1935 with its principal place of business in St. Louis, Mo. Prior to 1956 petitioner's sole business activity was the manufacture of chemicals, including bromines, calcium products, magnesium compounds, and agricultural chemicals. In the summer of 1955, petitioner 49 T.C. 488">*489 became interested in the separation of rare1968 U.S. Tax Ct. LEXIS 178">*180 earths, such as yttrium, by use of the ion-exchange process, and shortly thereafter erected a pilot plant to study this separation process. Late in 1955 scientific nuclear research groups discovered that the metal yttrium possessed certain unusual nuclear properties which might make it desirable as a reactor material.

The metallurgy involved to convert an ore which contains yttrium into high purity yttrium oxide involves a three-step procedure. First, the ore is beneficiated, that is, it is separated from a large portion of the worthless materials with which it is associated. The rare earth material obtained by beneficiation is then "cracked," that is, dissolved in acid at elevated temperatures to dissolve the rare earth elements. The result of the cracking process is a concentrate which will contain between 60-percent and 75-percent yttrium oxide. (It is this material that is meant whenever the word "concentrate" appears in this opinion.) The final step is to convert the concentrate to high-purity yttrium oxide. It is at this stage that the ion-exchange process with which petitioner was experimenting is used. The basic process is essentially one of passing a solution of yttrium-group1968 U.S. Tax Ct. LEXIS 178">*181 rare earth chlorides or nitrates into a column containing an ion-exchange resin, the net effect of which is to separate out the yttrium ion in a solid state with extreme purity, which ion is then precipitated out of solution with oxalic acid, and filtered, dried, and calcined to produce yttrium oxide of up to 99.9-percent purity.

On May 10, 1956, the Atomic Energy Commission (the AEC) entered into a contract with petitioner under which petitioner was to process yttrium oxide of 99.9-percent purity from concentrates containing certain rare earth oxides and yttrium oxide. Petitioner was to be paid $ 79 per pound for yttrium oxide meeting the contract specifications. The relevant provisions of this contract provided as follows:

PURPOSE -- It is the purpose of this contract to provide for the supply to the Commission by the Contractor [i.e., the petitioner] of * * * [yttrium oxide] in accordance with the terms of this agreement.

* * * *

ARTICLE I -- SCOPE OF WORK

* * * *

2. * * * the Contractor will furnish or cause to be furnished all facilities, equipment, raw materials, supplies and services necessary to deliver to the Commission the * * * [yttrium oxide] herein specified.

3. 1968 U.S. Tax Ct. LEXIS 178">*182 The Government [acting through the AEC] shall furnish the Contractor with "concentrates", * * * in quantities necessary for the production of the * * * [yttrium oxide] to be produced and delivered by the Contractor under this agreement. * * *

* * * *

ARTICLE III * * * RESIDUES * * *

* * * *

49 T.C. 488">*490 2. Residues

In the course of producing * * * [yttrium oxide] under this contract, certain residues * * * will also be produced. * * * Title to the residues shall be in the Government * * *

* * * *

APPENDIX A

* * * *

Section 4 -- * * * Title to in-process and inventory concentrates so furnished shall remain in the Government. * * *

An amended contract between the parties dated December 3, 1956, greatly increased the amount of 99.9-percent pure yttrium oxide to be supplied by petitioner, provided for the production of 99-percent pure yttrium oxide under the agreement, added an article to the contract providing for prospective price redetermination, and established the petitioner's right to itself furnish the concentrate for the production of the yttrium oxide.

A supplemental agreement between the parties dated June 18, 1957, provided the terms and conditions under which the petitioner1968 U.S. Tax Ct. LEXIS 178">*183 would furnish part of the concentrates or feed material for the production of the yttrium oxide under the contract. It provided in relevant part:

1. c. (2) * * * The parties shall negotiate an appropriate adjustment in the price of * * * [yttrium oxide] to be paid to the Contractor for * * * [yttrium oxide] produced from such Contractor-furnished feed materials. * * *

* * * *

APPENDIX A * * *

Section 8 --

* * * The Government * * * has agreed to the furnishing of above described feed materials [i.e., certain concentrates petitioner was to obtain from the Mallinckrodt Chemical Company] by the Contractor, and the parties mutually agree that the price of any * * * [yttrium oxide] produced from such Contractor-owned feed material shall be increased by $ 12.00 per pound.

On September 22, 1960, the Renegotiation Board (the Board) determined that yttrium ores, concentrates, and oxides are exempt from raw materials under section 106(a)(3) of the Renegotiation Act of 1951 so that contracts for their production or processing are exempt from renegotiation, and included such materials in the list contained in Renegotiation Board Regulations section 1453.2(b)(3).

In 1957 petitioner had sales 1968 U.S. Tax Ct. LEXIS 178">*184 of $ 2,440,041 and a profit of $ 904,457, or 36.9 percent of sales, from its processing of yttrium oxide from concentrates furnished by the AEC. On August 17, 1961, the Board issued an order determining excessive profits, wherein it determined that as a result of its renegotiation petitioner had realized excessive profits during the year ended December 31, 1957, in the amount of $ 250,000 from its contract with AEC. In light of its earlier conclusion that yttrium oxide was an exempt raw material, the Board removed $ 64,655 49 T.C. 488">*491 from renegotiable sales and removed related costs and expenses with respect to yttrium oxide produced by petitioner under its contract with the AEC as to which petitioner had furnished the concentrates under the modifications to that contract. Sales for 1957 do not include the value of the AEC-furnished concentrates since they were not carried on petitioner's books as sales or cost of sales.

OPINION

The sole issue for determination in this case is whether petitioners contract with the AEC to provide yttrium oxide to that agency, such oxide to be derived from a raw material supplied by the AEC, is entitled to exemption under section 106(a)(3) of the Renegotiation1968 U.S. Tax Ct. LEXIS 178">*185 Act of 1951, as amended. ¹ The resolution of this issue hinges on the interpretation of the language "contract * * * for the product of a mine" as it is used in section 106(a)(3).

Briefly stated, the facts that gave rise to this litigation are as follows: Petitioner is a manufacturer of chemicals. In 1956, petitioner entered into a contract with the AEC under which petitioner was to process yttrium oxide from certain concentrates supplied by the AEC. ² In 1957 petitioner had receipts of $ 2,440,041 and a profit of $ 904,457 under the above contract. Subsequently, in 1961, the Renegotiation1968 U.S. Tax Ct. LEXIS 178">*186 Board determined that $ 250,000 of this profit represented "excessive profits" as that term is defined in the Renegotiation Act of 1951. It is this action of the Board that petitioner is challenging in this proceeding.

Petitioner's argument is that since the Board itself has decided that yttrium oxide is an exempt raw material, ³ their contract with the 49 T.C. 488">*492 AEC is a contract for an exempt raw material which is exempted from renegotiation under section 106(a)(3), and that any attempt by the Board to read in the requirement1968 U.S. Tax Ct. LEXIS 178">*187 of a "sale" is unwarranted. Respondent, on the other hand, citing the legislative history of the section and a case decided by this Court, argues, that a "sale" of the exempt raw material is a prerequisite to the exemption contained in section 106(a)(3). We agree with respondent.

Respondent relies, in part, on Morgan Construction Co. v. Secretary of War, 11 T.C. 764">11 T.C. 764 (1948). This was a case concerning the applicability of the cost allowance provision of the Renegotiation Act of1968 U.S. Tax Ct. LEXIS 178">*188 1943. ⁴ The rationale of this provision is that since producers whose processing of raw material does not bring the raw material beyond the first form or state suitable for industrial use are exempt from renegotiation, an integrated producer who processes a raw material to and beyond such first form or state should be allowed a cost allowance substantially equivalent to the amount which would have been realized by him if he had sold such production in its first form or state. As stated by the Court, the purpose of the cost allowance provision,

was to place producers of mineral products who processed, refined or treated such products to and beyond the first form or state suitable for industrial use in a position comparable to producers who sold their products at the exempt stage. * * * [Emphasis added.]

The Court then went on to hold that in order to be eligible for a cost allowance the producer must have a property interest in the mineral product that it could have sold at the exempt stage. The instant case, in effect, now presents the issue of whether in order to be eligible for the statutory exemption, the producer must have a property interest in the mineral1968 U.S. Tax Ct. LEXIS 178">*189 product that it could have sold at the exempt stage.

We are of the opinion that the decision of this Court in the Morgan case logically requires that such a property interest be held to be necessary in order that a producer be eligible for the exemption under section 106(a)(3) of the Renegotiation Act of 1951. This is evidenced by the incongruous1968 U.S. Tax Ct. LEXIS 178">*190 result if we decide in the present case that no property interest in the mineral is required in order to qualify for the exemption. To so hold would mean that this Court, in attempting to maintain the equality of treatment which Congress intended between the integrated producer and the producer who does not process beyond 49 T.C. 488">*493 the first state, has, instead, created a difference in treatment between the two. The present case can be used to illustrate this result.

If we decide that the producer does not need a property interest in the mineral that could be sold at the exempt stage in order to be eligible for exemption, it follows that the contract for yttrium oxide in this case is exempt from renegotiation. If, however, petitioner in this case processed or treated the yttrium oxide one step further, so that it no longer was an exempt raw material enumerated in the Renegotiation Board Regulations, then on the authority of the Morgan case, the petitioner would not be entitled to a cost allowance. But the purpose of the cost allowance was to put the integrated producer in a position comparable to the producer who claimed the exemption at the first form or state, where the 1968 U.S. Tax Ct. LEXIS 178">*191 only difference between the two was that the integrated producer took the raw material to and beyond the first state. Thus, since we have previously decided that a property interest is required in order to be eligible for cost allowance, the same property interest should be required in order to be eligible for the exemption.

Our conclusion drawn inferentially from the Morgan case is substantiated by certain language used by this Court therein and by the Senate committee that considered the Renegotiation Act of 1951. In Morgan, this Court, in discussing the cost allowance described producers eligible for the exemption as "producers who sold their products at the exempt state." (Emphasis added.) The Senate report on the Renegotiation Act of 1951 expressed the same idea in the following language: "In order to place an integrated producer * * * on a parity with a producer who sells at the last exempted form or state * * * [a cost allowance will be allowed]." (Emphasis added.) ⁵ Thus, both this Court and the Senate assumed that the producer who qualified for the exemption could sell the exempt raw material, i.e., that it had a salable property interest therein.

1968 U.S. Tax Ct. LEXIS 178">*192 Our result is further substantiated by the legislative history of the raw materials exemption. The various congressional reports and hearings on both the Renegotiation Acts of 1942 and 1951 ⁶ indicate that the following various considerations were involved in the adoption of the raw materials exemption: The depleting- and vanishing-asset aspect of mining operations; the fact that renegotiation might hamper exploratory and development activities which might endanger 49 T.C. 488">*494 future supplies of raw materials; that renegotiation might discourage the flow of venture capital into mining operations; and that it would be difficult to segregate profits for renegotiation purposes which would not constitute a return of capital to the Government. It is clear that none of these considerations have any application to the situation where the party contracting with the Government merely performs a processing operation on a raw material which the Government furnishes to it, and in which it has no property interest, and we do not think Congress intended the raw materials exemption to apply to such a situation.

1968 U.S. Tax Ct. LEXIS 178">*193 We therefore hold that in order to be eligible for the statutory exemption under section 106(a)(3), the contractor must have a salable property interest in the mineral product at the exempt stage.

The question remaining for decision is whether the petitioner in the instant case had the requisite property interest in the yttrium oxide it processed for the Government. It is our opinion that it did not have such a property interest.

In order for the petitioner to have had a property interest in the yttrium oxide, there must have been at some point a transfer of title, from the Government to it, to the concentrate from which the yttrium oxide was processed. However, we find no evidence of such a transfer in the contract between the parties, but rather, an express provision retaining title to both in-process and inventory concentrates in the Government. And this express provision, we think also negates the application in this case of any legal theory, such as the doctrine of specification, ⁷ which might operate, in the absence of any intent by the parties, to shift title to the concentrates to the petitioner. Here, the parties have specifically agreed that title to the concentrate1968 U.S. Tax Ct. LEXIS 178">*194 while it is being processed will remain in the Government, so that it is impossible to maintain that the title shifted during the processing to the petitioner by means of any such property law doctrine. Furthermore, even if the contract did not contain the express provision regarding title to the concentrates, we do not think the change brought about by petitioner's processing operation is of such a character as to fall within the ambit of the doctrine of specification. ⁸ So far as the record 49 T.C. 488">*495 shows, the finished product was the same as the concentrates in name, character, solidity, and every other physical attribute which distinguishes one from the other with the exception of purity.

1968 U.S. Tax Ct. LEXIS 178">*195 It is our conclusion that the petitioner merely performed a processing operation on a raw material furnished by the AEC and at no time had a property interest in that raw material that it could sell. ⁹ Accordingly, we hold that petitioner was not entitled to the exemption provided under section 106(a)(3), and that therefore petitioner realized excessive profits in the year 1957 in the amount of $ 250,000.

1968 U.S. Tax Ct. LEXIS 178">*196 An order will be entered in accordance herewith.