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COURT DECISIONS CITED

Since 1951 there have been several Tax Court and circuit court decisions which, in effect, have held that, under existing law, a patronage distribution to a patron by a cooperative in noncash form is taxable to the patron currently only at its fair market value. Thus, revolving fund certificates, with no due date but which an association has been redeeming regularly at the face amount, under the court's doctrine well might be held to have no current taxable value to the patron. In fact, it might be held to have no taxable value to the patron until redeemed in cash. Obviously, these recent court decisions, which the Government has not seen fit in any instance to seek to take to the United States Supreme Court, if extended across the board, would point up an area of taxable income to somebody in which a tax would not currently be imposed.

That is the problem to which Treasury Secretary Humphrey's letter to the chairman of the House Ways and Means Committee on July 26, 1955, was directed and that is one important problem which the delegate body of the council should carefully consider.

The Treasury's letter, aside from the withholding tax proposal, did little more than state the problem. If offered no specific or satisfactory solution for the real problem of what is taxable income to the cooperative and what is taxable income to the patron.

SEVERAL DANGER SIGNALS There are several danger signals that stand out for farmer cooperatives and their members in the present status of this problem.

Some of the extremists who would like to subject farmer cooperatives to double taxation at both the cooperative and patron level still are active and occasionally make themselves heard, but they should know by now that their cause is lost. So the major aim now that we have to face is the effort to impose a corporate tax generally on cooperatives where the rate is higher and where it is easier for the Treasury to collect.

The heart of the Treasury's suggestions is : "It could be provided that cooperatives could take deductions in computing their taxable income only for (a) cash distributions and (b) noncash allocations issued in such form or under such circumstances as would make them currently taxable to the patron-members receiving them, and (c) the amount deductible by the cooperative itself should not exceed the amount so currently taxable to patronmembers."

Unless Congress spells out clearly just what is to be regarded as taxable income to the cooperative and what is to be regarded as taxable income to the patron, we very likely will find the Treasury moving, to the extent it can legally do so, in the direction of subjecting the cooperative to ever-increasing corporate taxes. It is quite clear under the Treasury's recommendation and recent court decisions that unless Congress does spell out clearly the extent to which noncash allocations shall be taxable to the patron-members then the Treasury will likely try to move in the direction of permitting the cooperative to deduct cash distributions only in computing taxable income.

SPECIAL COMMITTEE NAMED

Recognizing the complexity of some of the problems created by these recent court decisions, I appointed some months ago a special committee composed of 6 representatives of council members, including the 2 vice presidents, to work with me in trying to analyze the problem and develop for you some guidelines to assist the members of the council in reaching a sound policy position with respect to this problem.

We have had two meetings and a number of conferences on behalf of the committee with professional tax people in the council, in Congress, and in the administration. The other members of our committee are here today and will have an opportunity to express any individual views they may desire to supplement the committee report.

CONCLUSIONS LISTED

Our conclusions are as follows:

1. The general intent of the 1951 act, contemplating that the income or margins resulting from farmer cooperative operations should be subjected to a single tax, is sound in principle.

2. Recent court decisions have raised doubt as to the taxable value of any noncash patronage distribution until settled by litigation in individual cases.

3. The enactment of legislation to fill the gap in the 1951 act by providing for the current taxability to patrons of distributions in noncash form at face amount would be in the interest of farmers and farmer cooperatives and would be in furtherance of established contractual relationships between farmers and their cooperatives. It is believed that such legislation carefully drawn would stand an excellent chance of being upheld in the courts.

4. Any such legislation should clearly provide that the Treasury shall not follow a dual policy of taxing farmers in the same year on distributions in certifcate or other noncash form and also on cash received in such year in redemption of certificates previously issued.

5. The proposal for a withholding tax to be applied to patronage refunds should, we believe, be firmly opposed.

POLICY SUGGESTED

Our committee believes the following suggested policy resolution represents the soundest, fairest, and most equitable course for the council to follow. We are reading it to you today so you can be thinking about it. The resolution will be considered by the resolutions committee an delegate body in the regular course of this session.

(The proposed resolution read by the chairman at this point subsequently was unanimously adopted as a statement of policy by the delegate body. It appears in full in the statements of policy appearing elsewhere in this publication.)

M. J. BRIGGS, Chairman.
HARRY J. BEERNINK
STANLEY H. BENHAM
D. W. BROOKS
A. J. MCFADDEN
MARVIN H. WALKER
W. G. WYSOR

1

COOPERATIVE TAX POLICY The clear intention of the Congress in 1951 in the changes made in the tax treatment of farmer cooperatives was that the savings resulting from the operation of such organizations should be subject to a single tax. A number of court decisions since 1951 tend to prevent the carrying out of the above intent.

Therefore, the National Council of Farmer Cooperatives states its support of the following policies and principles :

1. Farmer cooperatives are owned and controlled by farmers and operate on a cost of doing business basis for the primary purpose of providing essential services and increasing the income of their farmer members and patrons. Under such operations and purposes, the savings resulting therefrom which the cooperative distributes to the patron under an obligation and agreement to do so represents income to the patron. Such amounts are, and should be, excludible or deductible by the cooperative, and the right of members and patrons to receive such refunds as income, whether in cash or noncash form, and to invest such amounts in their cooperatives either directly or by setoff, should be recognized.

The council supports the tax status of farmer cooperatives under existing law and shall seek clarification of the 1951 act as to the taxable status of patrons with regard to distributions made to them by their cooperatives in line with the intent of Congress in the passage of that act.

2. The council is opposed to the application of a withholding tax to patronage refunds and reaffirms the principles of its resolution adopted at the 1951 annual meeting to effect that:

A withholding tax on patronage refunds is unnecessary and unsound. It would unduly burden cooperatives in both cost and manpower in deducting, recording, reporting, and remitting such taxes without materially increasing net revenue collections. Because the tax withheld has no relation to the rate of taxes owed by the recipient, many recipients would be entitled to tax refunds, and the cost in money and manpower of internal revenue administration would be unneces

1 This policy resolution was unanimously adopted by the delegate body of the National Council of Farmer Cooperatives in annual meeting, January 19, 1956.

sarily and substantially increased. Furthermore, a withholding tax would confuse, rather than clarify, the taxable status of such refunds.

3. The council seeks legislation which would eliminate the double taxation to patrons and members which occurs when the Treasury seeks to impose in the same year a tax both on cash payments in redemption of prior issues of noncash patronage distributions, and also on current distributions in noncash form.

4. The executive committee is given the authority to implement the above policies during the coming year in a manner deemed best designed to accomplish these expressed objectives.

Mr. BEERNINK. The subject was again reviewed at the 1957 annual meeting of the council, resulting in the passage of the following resolution:

TAXATION OF FARMER COOPERATIVES The national council directs and authorizes the executive committee to develop and effectuate ways, means, and methods deemed best for the implementation of the basic principles of the council's cooperative tax policy, recognizing that the long-term interests of the farmer and his cooperative are identical and inseparable.

The significant basic principles of the council's cooperative tax policy are found in this paragraph from the 1956 resolution:

Farmer cooperatives are owned and controlled by farmers and operate on a cost of doing business basis for the primary purpose of providing essential services and increasing the income of their farmer members and patrons. Under such operations and purposes, the savings resulting therefrom which the cooperative distributes to the patron under an obligation and agreement to do so represents income to the patron. Such amounts are, and should be, excludable or deductible by the cooperative, and the right of members and patrons to receive such refunds as income, whether in cash or noncash form, and to invest such amounts in their cooperatives, either directly or by setoff, should be recognized.

We regard the above principles as the magna carta for the operation of farmer cooperatives, and in defense of them, farmers cooperatives and their members throughout the country are united.

How do these principles operate in a typical case?

A marketing cooperative in a year served 300 farmers in marketing 3 million boxes of their apples. At the end of the year, after deducting for all expenses, including initial payments to the farmer, there were net margins of $750,000 to be distributed. This would represent 25 cents per box. Farmer Jones' refund would be $2,500 on the 10,000 boxes he marketed through the co-op.

Under this agreement with the co-op he authorized it to retain 70 percent of his refund in the capital of the co-op, and he was entitled to receive 30 percent of his refund in cash. Hence, Farmer Jones receives $750 in cash and a revolving fund credit for $1,750. Under present law, the courts would say that only the $750 cash is taxable income to Farmer Jones in the current year. The courts would hold that the revolving fund credit for $1,750 does not constitute taxable income to Farmer Jones for the current year if it has no present fair market value. Such is the decision, notwithstanding the fact that Farmer Jones would have received the $1,750 in cash except for his agreement to invest it in his cooperative.

In this simple illustration, at the end of the year there is $2,500 in the hands of the cooperative that belongs to Farmer Jones. It belongs to him because he voluntarily contracted with the cooperative to turn over his apples to it to be marketed under an agreement which required the cooperative to return to him all the net proceeds of sale from his apples and all other apples marketed, on a patronage basis. But Farmer Jones and all the other patrons, in order to furnish or enable the cooperative to obtain the capital needed to finance its operations, authorized the cooperative to retain as capital 70 percent of their patronage refunds. This 70 percent of Farmer Jones' patronage refund, amounting to $1,750, is just as much his income as if it had physically been paid to him and he, in turn, had endorsed the check and turned it back to the cooperative.

Of course, if there was not a valid legal agreement in effect between the cooperative and Farmer Jones, imposing upon the cooperative an enforcible obligation to make an accounting to Jones and authorizing the cooperative to retain 70 percent of his patronage refund income as capital, then the status of the $1,750 as current taxable income to Farmer Jones would properly be subject to question. If the $1,750 revolving fund credit were something which the cooperative voluntarily issued to Jones, the cooperative would have been subject to corporation income tax on the full $1,750 and, in addition, Jones would have been subject to personal income tax on the fair market value of the $1,750 credit.

CLARIFICATION OF PRESENT LAW

Pursuant to the policy adopted by the council delegate body in 1956, representatives of the council and other national cooperative groups, with the knowledge and approval of the late esteemed chairman of your committee, Mr. Cooper, and the present chairman, Mr. Mills, who was then chairman of your Subcommittee on Internal Revenue Taxation, held several conferences with Mr. Colin Stam, Chief of Staff of the Joint Committee on Internal Revenue Taxation and his staff during the first 6 months of 1956 in an effort to develop statutory language to carry out the indicated intent of Congress in 1951 to levy a single tax at either the cooperative or patron level on the margins resulting from the cooperative's operations.

In the decided cases to date, there has been no problem as to the tax status of farmer cooperatives. The law is well settled on this point. The difficulty has arisen from court decisions holding not to be taxable income to the patron noncash refunds which under longstanding Treasury policy has been regarded as taxable income to the patrons.

Council representatives worked with Mr. Stam and his staff during the first 6 months of 1956, but the statutory draft of language which would carry out the apparent intent of Congress in 1951 could not be progressed in time for it to be considered by your committee before adjournment of Congress in 1956.

Briefly, the draft worked on would have given statutory recognition to the right of farmers to enter into any lawful contract or agreement with their cooperative that they desired and, in effect, would provide that an agreement by the patron for a part or all of his patronage refund income to be retained by the cooperative and evidenced to him in some noncash form would not change the status of such amounts as current income to the patron. The draft would have insured the imposition of a single tax on all margins arising from a farmer cooperative's operations.

As president of the National Council of Farmer Cooperatives, I extend to your committee a continuance of our full cooperation. Our officials and staff will be glad to cooperate with you, your staff and the joint committee staff in any way you may desire to develop statutory language that is legally sound and substantively fair to carry out the single tax policy objective on which, I believe, there is substantial agreement on the part of your committee and the industry.

RELATION OF FARMERS TO THEIR COOPERATIVES

I want to refer next to the allegation made from time to time that farmer cooperatives and their management are trying to shift to their farmer-patrons the burden of income taxes which the cooperatives should pay. This, of course, is an obvious attempt on the part of those who want to handle the farmer's business for their own profit, both in marketing his products and in furnishing him with farm supplies, to drive a wedge between the cooperatives on the one hand and their member-patrons on the other. It is an attempt to apply the old technique of divide and conquer.

I would be among the first to admit that there may be some disgruntled members or patrons of farmer cooperatives in this country, just as there are disgruntled and dissatisfied stockholders or customers of other corporations. It would be a miracle if every member or patron of any business was entirely happy with its entire program. But those members or patrons of cooperatives who do not like the way

the cooperative operates and cannot bring about a change usually move on and do business elsewhere. Cooperatives are voluntary organizations, and there is nothing compulsory about membership in or dealing with any cooperative.

Loyalty of farmers to their cooperatives and satisfaction with their operations are not matters of hearsay or guesswork. The real test is whether farmers by experience believe it is better for their pocketbooks to patronize their cooperatives and handle their business through them, or to handle their business through other channels. The available statistics show that an increasing number of farmers are patronizing their cooperatives.

When should the farmer-patron pay the tax on noncash patronage allocations?

My testimony thus far has been directed to the basic contractual principles underlying the organization and operations of farmerowned and farmer-controlled cooperatives. Recognition of these principles is essential to determine the amount of the margins arising from the cooperative's operations that is taxable income to its patrons. Once establishing the fact as to the amount of taxability and to whom, there remains the separate question as to the time when, as a matter of congressional policy, taxable income of the patron arising from patronage refunds which he invests in his cooperative should be reported in his gross income and the tax thereon be paid.

It should be made clear that although it has been the Treasury policy for many years, at least as far back as the early 1940's, for noncash patronage allocations to be regarded as taxable income to the patron in the years of allocation, the requisite contractual elements being present, not until 1948 did the Internal Revenue Service include instructions with the individual income tax return, form 1040, to put farmers generally on notice that noncash patronage allocations should be reported in their gross income for the year in which the allocation was made. As a result, many farmers, particularly those on a cash basis of reporting, for a long period reported their noncash patron

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