Appeal from the United States District Court for the District of New Jersey (D.C. Civil Action No. 99-cv-02451) District Judge: Honorable Joseph H. Rodriguez
Before: Scirica, Chief Judge, Rendell and Ambro, Circuit Judges
The opinion of the court was delivered by: Ambro, Circuit Judge
This appeal involves a dispute between a taxpayer and the Internal Revenue Service about the proper time to recognize income and losses. The taxpayer maintains that it was not required to recognize the proceeds from the sale of goods as income in the year it received those proceeds because the funds were subject to a governmental blocking order and, under the Claim of Right Doctrine, it did not have unfettered discretion as to the funds. It also seeks to deduct the manufacturing costs of other goods in a year prior to that in which it sold those goods, reasoning that the Iraqi Sanctions Regulation then in place — which prohibited the taxpayer from selling those goods — either was in effect a confiscation or deprived the goods of any market value. The District Court held in favor of the Government as to both claims. We affirm.
In 1989, taxpayer Inductotherm Industries, Inc. ("Inductotherm"), through its subsidiary Consarc,*fn1 contracted with Iraq to manufacture three vacuum furnaces. One furnace ("Furnace A") is an Induction Skull Melting Furnace. The other two ("Furnaces B and C") are Electron Beam Furnaces — a technology that later became disfavored and apparently is no longer in widespread use today. Iraq represented that the furnaces would be used to manufacture prosthetics for veterans of the Iran-Iraq war. It later came to light that Iraq instead intended to use the furnaces in its nuclear weapons program. Inductotherm was unaware of Iraq's true intentions.
As the three furnaces were about to be exported to Iraq, it invaded Kuwait. In response, on August 2, 1990, President George H.W. Bush entered an Executive Order — the Iraqi Sanctions Regulation — blocking all property in which Iraq had an interest. As applied to Inductotherm, the Executive Order precluded the sale or transfer of the three furnaces without the permission of the Office of Foreign Assets Control ("OFAC"). Moreover, all funds in which Inductotherm had an interest due to the Iraqi contract were blocked pursuant to the Executive Order unless OFAC issued a license unblocking them. See 31 C.F.R. § 575.201, et seq. At the time, those funds in which Iraq potentially had an interest included a $6.4 million letter of credit ("LC") and Iraq's $1.1 million deposit for the three furnaces. Moreover, because Inductotherm had received this $1.1 million deposit, OFAC took the position that Iraq had a property interest in all three furnaces and thus they were blocked property.
To mitigate its losses, Inductotherm attempted to find new buyers for the furnaces. It sold Furnace A to Mitsubishi in its 1991 tax year for approximately $1.8 million.*fn2 Rather than place the sale proceeds in a blocked account, Inductotherm commingled them with other corporate funds. It was unable to sell Furnaces B and C in that year. Eventually, however, Inductotherm sold the furnaces in 1997 to Reading Alloys for what Inductotherm alleges was less than its production and carrying costs.
When the Government learned of the Mitsubishi sale, it directed Inductotherm to block the sale proceeds. On June 17, 1991, during Inductotherm's 1992 tax year, the Government confirmed those instructions by issuing a "Directive License," which specifically applied the Executive Order to Inductotherm. Inductotherm disputed, inter alia, the applicability of the Executive Order to the sale proceeds, and protracted litigation ensued in the United States District Court for the District of Columbia and then in the UNITED STATES COURT OF APPEALS for the District of Columbia Circuit. Ultimately, the D.C. Circuit held that the furnaces, and the proceeds therefrom, were blocked property but could be released if Inductotherm placed the $1.1 million deposit in a blocked account — a procedure clearly contemplated in the Executive Order. Consarc Corp. v. United States Treasury Dep't Office of Foreign Assets Control, 71 F.3d 909 (D.C. Cir. 1995).
Meanwhile, when filing its tax returns, Inductotherm did not record the 1991 Furnace A sale proceeds as taxable income in 1991, reasoning that, as a result of the Executive Order and the Directive License, it did not have unfettered discretion to dispose of the proceeds. It urges that, under the Claim of Right Doctrine (discussed in Section II below), if a taxpayer does not have unfettered discretion with respect to funds, those funds need not be recognized as income. The IRS disputed Inductotherm's reasoning and assessed a tax deficiency. Inductotherm paid the back taxes on Furnace A as the IRS required and filed suit in the United States District Court for the District of New Jersey to recover the alleged overpayment. The Court held against Inductotherm on this issue, granting summary judgment in favor of the Government.
In its 1991 and 1992 tax years, Inductotherm took deductions on account of the production costs of Furnaces B and C, despite the fact that it did not sell them until 1997. Inductotherm argued that, while normally costs may be deducted only in the year that an item is sold, see United States v. Catto, 384 U.S. 102, 109 (1966), in its case an exception should apply: as a result of the Executive Order, the furnaces, in effect, were no longer Inductotherm's property and indeed were confiscated from it. The IRS disallowed this deduction. Again, Inductotherm paid the required tax deficiency and filed suit to recover. The District Court granted summary judgment in favor of the IRS on this claim as well.
Inductotherm appeals both ...