To date, chemical production by cooperatives has involved the manufacture of basic chemicals used as raw materials for fertilizers. Cooperatives already sell organic chemical compounds such as agricultural pharmaceuticals, insecticides, and herbicides, and the next logical step will be manufacture of such products by cooperatives.

The recent annual report of another cooperative-a separate corporation closely connected with the Mississippi cooperative already referred to spells out an aim for the future of haviing "as completely an integrated plant as possible." In the chemical industry the term “integrated" means one company making all the intermediate products needed for the end-use item. One of the materials to be manufactured in a plant operated by the closely connected cooperative is sulfuric acid-the basic industrial chemical. It has been indicated that only a fraction of this sulfuric acid production will be used by the latter. Thus, it appears that much of the acid will be for sale on the open chemical market in competition with the product of taxpaying companies.

The chemical industry believes in the competitive way of American business, and it has grown and prospered in such an atmosphere. And they believe that the cooperatives' advantage in expansion through the use of tax-free earnings is unfair.

Unless present tax laws and regulations are changed to correct these inequalities, it seems likely that in the future many corporations will become cooperatives in order to gain the advantage of tax exemption. As this increasingly occurs, it will decrease the Federal revenue.

TAXATION OF COMPENSATION

1. Section 402 (b) of the Internal Revenue Code of 1954 provides that an employer's contribution to a nonqualified employee's trust is taxable to the employee in the year of contribution if the employee's beneficial interest is nonforfeitable at the time the contribution is made. Section 403 (b) provides for a similar rule where an annuity is purchased. Where no trust or annuity is involved but an employer promises to pay earned compensation in future years, there is considerable confusion and doubt as to the time when such compensation is taxable to the employee. The Internal Revenue Service has consistently refused to issue any rulings with respect to the taxation of compensation in this situation. This administrative policy is probably based on some feeling that the so-called "economic benefit" or "cash equivalent" theory that was adopted by the courts in cases involving the purchase of paid-up retirement annuity contracts for employees could be carried over to other types of compensation arrangements. See Renton K. Brodie (1 T. C. 275 (1942)) and Morse v. Commissioner (202 F. 2d 69 (2d Cir. 1953)).

An example of the operation of sections 402 (b) and 403 (b) and the possible extension of the "economic benefit" theory to nontrusteed arrangements points up the gross inequity in the law which needs correction. Company A spends $20,000 to buy a retirement annuity for a key employee. In addition, as consideration for past services, it promises to pay $1,000 a year for 10 years after retirement. The employee has no rights under either the annuity policy or the deferred-compensation agreement prior to his retirement and his rights are nonassignable. In the year the annuity was purchased, the employee would be required to include the cost of the annuity in taxable income under section 403 (b). The Internal Revenue Service might also assert that the commuted value of the present right to receive $10,000 in the future was taxable in the year such right became nonforfeitable. Thus, an employee, through no action of his own, would be placed in a situation where he would have to include over $30,000. in taxable income even though he could in no way reduce any part of it to possession so as to help him pay the tax.

The inequity in such a situation is manifest. Of course, where the employee had some control over the method of compensation adopted by the company, the ordinary rules of constructive receipt to tax him at the time when he could have received income but for his own decision not to accept it at that time would apply. This rule should certainly be retained in the law and the proposal submitted below would not change that rule. However, such arrangements serve valid business reasons and often trusts or annuities are used to guarantee promised benefits to employees. In other cases, companies desire to pay future benefits out of current income and the law recognizes that where the employees' rights are nonforfeitable a tax deduction is allowable.

It is our opinion that the law should be amended by eliminating the present provisions of subsection (b) of sections 402 and 403, and substituting therefor suitable language to make it clear that employees would in no event be taxed on compensation payable to them prior to the year in which it is actually received or becomes available for their unqualified use.

A substantially similar recommendation to that proposed herein was incorporated in section 401 (c) of H. R. 8300 as passed by the House of Representatives. It was eliminated without specific comment by the Senate.

2. The Internal Revenue Code of 1954 and a corresponding provision of the 1939 code have been interpreted to prevent an employer from deducting at any time an amount which is transferred to a trust or otherwise funded unless each individual employee's rights to such amount are nonforfeitable at the time the employer makes the transfer (Treas. Regs., sec. 1.404 (a)–12).

This means that an employer who places an amount in trust for an employee, which amount must be paid if the employee performs satisfactorily for a period of time, can claim no deduction for compensation paid at any time. Such arrangements are most desirable in cases where employees need assurance that they will be paid at the end of a term of employment. This is a gross inequity which makes no sense whatsoever and must be based on the technical interpretation that amounts are not deductible at the time of transfer of funds to trust since they have not been paid to designated employees as compensation and such amounts are not deductible at the time the trust distributes to the employee because at that time the trust and not the employer has made the payment.

It is recommended that section 403 (a) (5) of the 1954 Internal Revenue Code be amended to make it clear that an employer is entitled to deduct compensation at the time it is paid to the employee whether or not it is transferred by a trust or other intermediary.

3. Many employers provide in their tax qualified employee pension and annuity plans that employees may elect to take a reduced benefit for life with a continuing annuity to be paid to his wife if she survives him. The Internal Revenue Service has ruled that at the time a man makes such election he has made a taxable gift to his wife. On the other hand, section 2039 (c) of the Internal Revenue Code of 1954 specifically exempts annuities and other payments made under tax-qualified plans from the Federal estate tax.

Since the gift and estate taxes should be correlated in order to prevent harsh results and in order to further the legislative policy of encouraging the adoption of tax-qualified plans, this difference in application of the two taxes should be eliminated. Joint and survivor provisions in qualified plans are often adopted solely at the behest of employees.

It is recommended that the Internal Revenue Code gift tax provisions be amended to make it clear that no taxable gift is involved where an employee elects a survivor annuity or other payment under a tax qualified employee's trust, as provided for by section 57 of House Resolution 8381.

The CHAIRMAN. Mr. Keogh will inquire.

Mr. KEOGH. Mr. Crichley, do I understand that your recommendation with respect to the tax on cooperatives would be that the regular corporate rate would be imposed on that form of doing business prior to the declaration of any dividends that were actually paid out?

Mr. CRICHLEY. We do not advocate any specific legislation on any specific tax provision except that there be a tax on the cooperatives to eliminate the inequity which now exists and which leaves all the funds untaxed.

Mr. KEOGH. What do you mean by your statement on page 4?

In addition to concepts of fairness and equity, the taxation of cooperatives on the same basis as regular business corporations would add substantial sums to the Federal revenue.

Am I not justified in assuming that you mean that they would be on the same basis as regular corporations?

Mr. CRICHLEY. Yes; it is fair to assume that.

The CHAIRMAN. Are there any further questions?

If not, we thank you for your appearance and the information given the committee.

Our next witness is Mr. Lincoln Arnold.

Mr. Arnold, as the committee members will recall, you worked with us for many years. For the purpose of the record, will you identify yourself by giving your name, address, and the capacity in which you

appear.

STATEMENT OF LINCOLN ARNOLD, CHAIRMAN, TAX COMMITTEE, AMERICAN MINING CONGRESS

Mr. ARNOLD. I am Lincoln Arnold, an attorney of Washington, D. C. I appear before you as chairman of the tax committee of the American Mining Congress.

Last September the American Mining Congress, at its convention in Salt Lake City, adopted a declaration or policy on Federal income taxation, as well as on other subjects.

I have attached to my statement, for your consideration and for insertion in the record, the portion of the declaration adopted at Salt Lake City dealing with taxation.

In my statement today I will not discuss, or attempt even to mention, every amendment of importance which the mining industry believes should be made to the Internal Revenue Code.

Instead, I shall limit myself to those amendments which I believe, in the light of the current fiscal picture, this committee and the Congress can, and should, approve at this session of the Congress.

Exploration expenses: One of the most important problems facing the mining industry today is the tax treatment of exploration expenditures. Section 615 of the 1954 code permits the taxpayer to deduct in the year of expenditure, or to defer and deduct as the ores benefited thereby are produced, expenditures

paid or incurred during the taxable year for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, and paid or incurred before the beginning of the development stage of the mine or deposit.

A similar provision was first enacted in the Revenue Act of 1951. Unfortunately, certain limitations are imposed which will deny the deduction in many meritorious cases.

Section 615 by its terms is limited to the exploration expenditures in the amount of $100,000 per year, but, more harmfully, it is limited to 4 taxable years per taxpayer.

In other words, if the taxpayer has deducted any exploration expenditures, even though only a nominal amount, in 4 different taxable years, he is no longer permitted to deduct future expenditures of this type.

Since this provision has already been in the law for a period of 7 years, and since most taxpayers engaged in the mining business have exploration activities in every year, the net result is that the great majority of taxpayers in the mining industry today are not permitted to deduct exploration expenditures as such.

Exploration for minerals has not kept pace with the need for new discoveries. For one thing, the expense of exploration for minerals has increased tremendously.

In the early stages of this Nation's development, minerals were discovered primarily by the lone prospector who found an outcropping.

Today, however, most of the outcroppings have long since been found and the modern explorer needs more than a mule, a pick, and a shovel, Even after we have obtained the best available geological knowledge we frequently must spend thousands, even millions, of dollars to locate those mineral deposits which are to be found below the surface of the earth. In the vast majority of cases the money spent for exploration does not uncover a profitable ore body.

The discovery of new mineral deposits is vital to the maintenance and expansion of our high standard of living and the preservation of our Nation's leadership in the world. The necessity of removing the existing tax roadblocks to needed expenditures for exploration was emphasized by the President's Materials Policy Commission, the socalled Paley Commission, when it issued its report in June 1952, entitled "Resources for Freedom."

I would like to quote briefly from that report since the President's commission strongly recommended that exploration expenditures for minerals-other than oil and gas-should be fully deductible for income tax purposes:

The changing pattern of the materials we use has thrown the minerals, particularly our mineral deficits, into sharp focus. Year after year, the industry of the United States has consumed more and more mineral stuffs, chiefly as fuels to provide energy and as raw materials to shape into the manifold products that our expanding economy demands. The quantities used in 1950, huge in comparison with those of 1925, are small when set against the probable requirements of 1975. * * *

In the field of public policy the greatest emphasis should be placed upon encouraging exploration for minerals. ***

The Commission believes strongly that exploration and development costs for minerals should be fully expensible for tax purposes because of the direct incentive this arrangement gives for capital to take risks in highly uncertain fields. The Commission therefore recommends

"That the present limitations applicable to minerals other than oil and gas on the amount of permitted expensing of exploration costs be removed."

Through the operation of the tax laws, the United States Government, the State governments, and the local taxing bodies have an extremely high interest in the successful discovery of mineral deposits. This interest can be increased without the expenditure of public funds-merely by removal of the limitations on deduction of exploration expenditures.

The increased exploration which will result will redound to the benefit of the national revenue, the State and local government revenues, the peacetime standard of living, the level of employment, the ability of this Nation to defend itself, and the maintenance of a healthy mining industry.

The American Mining Congress, on behalf of the entire mining industry, urges you to repeal in their entirety the existing limitations on deduction of exploration expenditures.

Transportation from mine to treatment plant:

Section 613 (c) (2) of the 1954 code provides that mining includesso much of the transportation of ores or minerals (whether or not by common carrier) from the point of extraction from the ground to the plants or mills in which the ordinary treatment processes are applied thereto as is not in excess of 50 miles unless the Secertary or his delegate finds that the physical and other requirements are such that the ore or mineral must be transported a greater distance to such plants or mills.

Modern mining is increasingly dealing with low-grade ores and other ores hitherto considered inaccessible, which must be handled in treatment plants which in many cases will be more than 50 miles from the mine.

The location of treatment plants is dictated by a variety of considerations, including such items as water supply, power supply, labor supply, and availability of transportation.

Because of these factors it is becoming ever more difficult to locate the treatment plants near the mine.

Accordingly, the distance allowable without securing Treasury consent should be extended.

It is urged that section 613 (c) (2) be amended by substituting "100 miles" for "50 miles."

Determination of "the property": Section 614 of the 1954 code was intended to give a better definition of the term "property" for the purpose of computing depletion and to provide reasonable election to treat all or parts of the separate interests within an "operating unit" as a single property.

It does this appropriately in many cases, but its provisions are too rigid to deal fairly with the many different and complex situations which arise in the mining industry.

The American Mining Congress recommends that the statute, in order to provide the necessary flexibility, be amended so as to permit the following in the case of mining:

1. A mine can be treated as a separate property even though it may be only part of a single deposit in one tract of land.

2. More than one aggregation of properties can be made within an operating unit.

3. "Operating unit" shall be deemed to mean any two or more properties which may conveniently and economically be operated together as a single unit, and the taxpayer's determination of what constitutes an operating unit shall be presumed to be correct unless it is clearly unreasonable; and

4. The election to make an aggregation can be deferred until the first year in which development expenditures are made.

Mr. Chairman, section 32 of H. R. 8381, already reported out by this committee, does not provide the certainty and flexibility needed under section 614 by the mining industry. If we can be of any assistance to Mr. Stam and his staff in working out the statutory amendment, we will be very happy to work with him.

Facilities to abate water and air pollution: Every State has enacted legislation regulating in some degree the matter of stream and other water pollution. In addition to specific State laws on this subject, many of the States have obligated themselves by interstate compacts to establish and enforce standards directed toward the abatement of water pollution.

In addition, the Federal Government exercises some control with respect to interstate waters.

Facilities installed by a taxpayer for the abatement of water pollution usually have no useful value for any other purpose. They do not aid in the production of income. Recovery of the cost of such facilities through depreciation deductions is extremely slow because of the long life of such facilities.