F I L E D
                                                                   United States Court of Appeals
                                                                           Tenth Circuit
                     UNITED STATES COURT OF APPEALS
                                                                           FEB 20 2002
                            FOR THE TENTH CIRCUIT
                                                                      PATRICK FISHER
                                                                                Clerk

    MID-DEL THERAPEUTIC
    CENTER, INC.; D. RICHARD
    ISHMAEL, M.D., PC,

                Petitioners-Appellants,

    v.                                                   No. 01-9000
                                                 (T.C. Nos. 9060-97, 9270-97)
    COMMISSIONER OF INTERNAL                         (Petition for Review)
    REVENUE,

                Respondent-Appellee.


                            ORDER AND JUDGMENT            *




Before LUCERO , PORFILIO , and ANDERSON , Circuit Judges.



         After examining the briefs and appellate record, this panel has determined

unanimously to grant the parties’ request for a decision on the briefs without oral

argument. See Fed. R. App. P. 34(f); 10th Cir. R. 34.1(G). The case is therefore

ordered submitted without oral argument.




*
      This order and judgment is not binding precedent, except under the
doctrines of law of the case, res judicata, and collateral estoppel. The court
generally disfavors the citation of orders and judgments; nevertheless, an order
and judgment may be cited under the terms and conditions of 10th Cir. R. 36.3.
       Petitioners Mid-Del Therapeutic Center, Inc. (Mid-Del) and D. Richard

Ishmael, M.D., PC (PC), appeal the Tax Court’s denial of litigation costs after

successfully contesting the Commissioner of the Internal Revenue Service’s

(Commissioner) deficiency determinations in docket numbers 9060-97 and

9270-97. Because we conclude the Tax Court did not abuse its discretion in

determining that the position of the government at trial was substantially      justified,

we affirm.

                                             I.

       The facts surrounding this dispute are well known to the parties and

described at length in both the Tax Court’s Memorandum Findings of Fact and

Opinion filed April 11, 2000, and its Memorandum Opinion filed December 19,

2000. Dr. Ishmael owns both Mid-Del and PC, which operate medical clinics

that purchase and use chemotherapy drugs to treat patients with cancer and

other serious illnesses. Until 1983, both Mid-Del and PC used the cash method

of accounting for tax purposes, reporting the drugs used in patient treatments

as supplies and not inventory. That year, Mid-Del switched to the accrual

method for its tax purposes.   1
                                   After being audited that year, Mid-Del was


1
       Previously, Mid-Del had used the cash method of accounting for tax
purposes, but the accrual method in its bookkeeping. Under the cash method of
accounting, all items of gross income and expenditures for expenses are included
in income or deducted in the taxable year in which they are actually received or
                                                                      (continued...)

                                            -2-
required to return to use of the cash method and to pay a tax deficiency

of $12,485.

      On April 23, 1997, the Commissioner determined that Mid-Del and PC

were both required to use the accrual method of accounting in order to

clearly reflect their income, and issued tax deficiencies of $140,025 for

Mid-Del and $211,979 for PC.   2
                                   Mid-Del and PC separately petitioned the

Tax Court, and the cases were consolidated for trial.




1
 (...continued)
made. Under the accrual method, income and deductions are included in the
taxable year when (1) all of the events have occurred that fix the right to receive
income or pay liability and the amount can be determined with reasonable
accuracy; and (2) for, expenses, economic performance must have occurred during
the taxable year. See Jacob Mertens, Jr., 2 Mertens Law of Federal Income
Taxation § 12A (2001).
2
      Section 446 of the Internal Revenue Code states:

      (a) General Rule.– Taxable income shall be computed under the
      method of accounting on the basis of which the taxpayer regularly
      computes his income in keeping his books.
      (b) Exceptions.– If no method of accounting has been regularly used
      by the taxpayer, or if the method used does not clearly reflect
      income, the computation of taxable income shall be made under such
      method as, in the opinion of the Secretary, does clearly reflect
      income.

26 U.S.C. § 446(a), (b).

                                          -3-
      The primary arguments at that trial were summarized by the Tax Court

as follows:

      By regulation, the Secretary has determined that inventories are
      necessary in every case in which the production, purchase, or sale of
      merchandise is an income-producing factor in the taxpayer’s
      business. See sec. 1.471-1, Income Tax Regs. Unless otherwise
      authorized by the Commissioner, a taxpayer who is required to
      maintain inventories must use an accrual method of accounting with
      regard to purchases and sales of inventory. . . .

             [The Commissioner] argues that the drugs at issue in
      this case are merchandise, the purchase and sale of which are
      income-producing factors in [Mid-Del and PC’s] businesses, and,
      therefore, [Mid-Del and PC] are required to use the accrual method
      of accounting to report their taxable income. [Mid-Del and PC] take
      exception to [the Commissioner’s] characterization of the drugs,
      countering that the drugs are supplies used in the course of treating
      patients, with the result that, under their view, the regulations
      requiring the use of the accrual method are inapplicable.

R. Vol. I, Doc. 30 (T.C. Memo. 2000-130) at 18-19 (further citations omitted).

      After the cases were tried, but before the opinion was issued, the Tax Court

issued an opinion that decided “for the first time whether the furnishing of

pharmaceuticals by a medical treatment facility as an integral, indispensable, and

inseparable part of the rendering of medical services is the sale of ‘merchandise’

for purposes of section 1.471-1, Income Tax Regs.”    Osteopathic Med. Oncology

& Hematology, P.C. v. Comm’r,     

, 380 (1999). In that case, the court

held that the drugs at issue were not merchandise, and that the taxpayer, which

specialized in treating cancer through chemotherapy, properly used the cash


                                          -4-
method to expense the cost of its drugs and to report income. In the present case,

the Tax Court relied heavily on its decision in   Osteopathic Med. and found, for

the same reasons, that the drugs used by Mid-Del and PC were not merchandise

and that, therefore, they were not required to maintain inventories or use the

accrual method of accounting. The court found for Mid-Del and PC, and the

tax assessments were ultimately abated.

       Mid-Del and PC subsequently filed for litigation costs pursuant to

26 U.S.C. § 7430. The Tax Court denied that motion, finding the Commissioner’s

position at trial, although unsuccessful, was substantially justified. This appeal

followed.

                                            II.

       We review the Tax Court’s denial of litigation costs for an abuse of

discretion.   Barford v. Comm’r, 

, 786 (7th Cir. 1999);    see also Pate

v. United States, 

, 459 (10th Cir. 1993) (applying same standard to

district court applying § 7430). In applying this deferential standard, we are

reminded by the Supreme Court “that a request for attorney’s fees should not

result in a second major litigation.”    Pierce v. Underwood,   

, 563

(1988) (quotation omitted). Section 7430 states in pertinent part that “[i]n

any . . . court proceeding which is brought by or against the United States in

connection with the determination, collection, or refund of any tax, interest or


                                            -5-
penalty under [the Internal Revenue Code], the prevailing party may be

awarded . . . reasonable litigation costs incurred in connection with such court

proceeding.” 26 U.S.C. § 7430(a)(2). A prevailing party is one who has

substantially prevailed in the amount in controversy or has substantially prevailed

with respect to the most significant issue or set of issues presented. 26 U.S.C.

§ 7430(c)(4)(A). If the United States can establish that its litigating position was

substantially justified, the petitioners will not qualify as prevailing parties.           

Here, the parties agree that Mid-Del and PC substantially

prevailed, and dispute only whether the government’s position was substantially

justified.

       The term “substantially justified” means “justified to a degree that could

satisfy a reasonable person” or having a “reasonable basis both in law and fact.”

(quotation omitted). In determining whether the position

of the United States was substantially justified, “the court must look at all the

facts and circumstances as well as relevant legal precedent.”          Anthony v. United

States, 

, 674 (10th Cir. 1993). The fact that the government loses

the underlying litigation is not dispositive of the determination that its position

was reasonable. Rather, “it remains a factor for our consideration.”               

also

n.2 (“a position can be justified even though it is not

correct, and we believe it can be substantially (     i.e., for the most part) justified if


                                               -6-
a reasonable person could think it correct, that is, if it has a reasonable basis in

law and fact”).

      Applying this test, we conclude the Tax Court did not abuse its discretion

in finding the Commissioner was substantially justified in his litigation position.

As that court noted, the Commissioner, relying on existing circuit and Tax Court

precedent, argued reasonably that the drugs purchased and used by Mid-Del and

PC were merchandise and an income-producing part of their business based on

several factors tending to show that the drugs were no different from other

tangible items held out for sale. It was only after the Tax Court issued

Osteopathic Med., that it was clear that chemotherapy and other drugs, when used

in the course of treating patients under certain circumstances, were inseparable

and subordinate to the overall medical service such that they could not be

considered held out for sale as merchandise. That opinion was one of first

impression and became final only days before the Mid-Del-PC opinion was

handed down. The facts as they were at the time of litigation, along with the

applicable legal precedent as well as the discretionary authority traditionally

granted the Commissioner, were sufficient for the Tax Court to conclude that the

government’s position was justified to a degree that would satisfy a reasonable

person.




                                           -7-
                                                 III.

       On appeal, Mid-Del and PC present several arguments urging this court to

find that the Tax Court abused its discretion in making its conclusion. However,

we find these arguments to be unpersuasive. First, they argue that in order to

decide whether the government’s litigation position was substantially justified,

the Tax Court must review the substantive merits of the case. Taken to an

extreme, this argument presumes that a determination that the government

would fail on the merits would necessarily lead to an award of litigation costs,

a presumption that we have already explained is incorrect.        See, e.g., Anthony ,

987 F.2d at 674; Graham v. United States (In re Graham),          

, 1139

(10th Cir. 1992) (“[N]ot every losing party will have been substantially

unjustified in its litigation position.”).   3
                                                 Nevertheless, Mid-Del and PC argue


3
       Related to this argument is Mid-Del and PC’s claim, argued more forcefully
in their motion for award of litigation costs before the Tax Court, that a finding
that the Commissioner abused his discretion or acted arbitrarily, capriciously, or
without sound basis in fact or law, necessarily leads to an award of litigation
costs. This claim can be alluring because a court’s finding that the government’s
position was arbitrary and capricious may appear, at least on the surface, to be at
odds with its subsequent determination that the government’s position was
substantially justified. The opposite conclusion, however, is implicit in our cases
cited previously (noting that the outcome in the underlying litigation is not
dispositive of the question of litigation costs), and explicit in other cases in which
reviewing courts use an abuse of discretion or similar standard to determine the
merits of an issue but which, nonetheless, find that determination is not per se
unreasonable. See, e.g., Fed. Election Comm’n v. Rose,     

, 1089
(D.C. Cir. 1986) (explaining agency position may be substantially justified even
                                                                         (continued...)

                                                 -8-
that other substantive arguments, which were not addressed in the first opinion

as being unnecessary in light of the Tax Court’s favorable decision on the

drugs-as-merchandise issue, demonstrate that the Commissioner was not

substantially justified in his litigating position. However, in its memorandum

opinion, the Tax Court again found that the relevant facts and circumstances,

coupled with the Commissioner’s legal theory and reliance upon applicable legal

precedent, demonstrated substantial justification for his litigation position. Given

our narrow standard of review, and after reading the record, we are persuaded that

the Tax Court did not abuse its discretion in making this determination.

      Second, Mid-Del and PC argue that their notice of deficiency was based on

inaccurate accruable income computations that substantially overstated their

deficiency, and claim that these errors further demonstrate that the

Commissioner’s litigation position was unjustified. Again, this argument

attempts to collapse Congress’ distinction between the legal standard for litigation

cost evaluations and the applicable standard to the underlying merits of their

claim. We decline to ignore that distinction.



3
 (...continued)
if the action taken by the agency is deemed to be arbitrary and capricious);
Abernathy v. Clarke, 

, 239 (4th Cir. 1988) (rejecting argument that
agency action reversed as arbitrary and capricious is, by definition, not
substantially justified under 28 U.S.C. § 2412); Nalle v. Comm’r, 

,
194 (5th Cir. 1995) (rejecting the same argument under 26 U.S.C. § 7430).

                                         -9-
      Finally, because Mid-Del was told in 1993 to return to the cash method of

accounting, Mid-Del and PC now argue that we should invoke the doctrine of

equitable estoppel to find that the Commissioner was barred from subsequently

requiring them to switch to the accrual method. As noted by the Tax Court, the

weight of authority on this issue favors the government.     See Auto. Club of Mich.

v. Comm’r, 

, 183 (1957) (“The doctrine of equitable estoppel is not

a bar to the correction by the Commissioner of a mistake of law.”);       see also Ezo

Prods. Co. v. Comm’r, 

, 391 (1961);      Thomas v. Comm’r, 

,

224-27 (1989). The government concedes that it made an error in 1993, and we

understand the obvious distress that particular error has caused Mid-Del and PC

over the years. However, we will not disturb the Tax Court’s ultimate finding in

this case that the Commissioner’s litigating position was substantially justified.

      This court has carefully reviewed the remainder of Mid-Del and PC’s

arguments on appeal and finds them to be without merit. The judgment of the

Tax Court is AFFIRMED.


                                                       Entered for the Court


                                                       John C. Porfilio
                                                       Circuit Judge




                                           -10-