Jarecki v. G. D. Searle & Co.

Background

A drug maker and a camera company each developed new, patented products after more than a year of research and then reported income from selling those products. The drug company paid tax and later sought a refund under a tax rule that lets some unusually large profits be spread across years. The camera company tried to treat its instant-photo equipment sales the same way on its returns. Lower courts disagreed, creating a split between two federal appeals courts.

Reasoning

The central question was whether sales of new products count as “discovery” under the tax statute’s clause about income from “exploration, discovery, or prospecting.” The Court looked at the words around “discovery,” the statute’s separate clause for patents and formulae, and decades of prior tax laws and committee reports. Those materials show that Congress and earlier tax statutes used “discovery” in a narrow, technical sense tied to finding mineral deposits, not to making new products. Congress also rejected broad relief for research-and-development income when it rewrote the law. The Treasury regulations similarly exclude income from sales of tangible products developed by research. The Court therefore held such sales income is not the kind of “discovery” that receives special reallocation treatment.

Real world impact

As a result, companies that earn large profits from newly invented, patented products cannot classify those sales as “discovery” income to obtain abnormal-income reallocation under §456. The decision affirms the appeals court that denied such relief and reverses the appeals court that allowed a trial on that theory. The Commissioner’s regulation excluding this income is consistent with the Court’s reading and bars the tax relief the taxpayers sought.