ment centered on the right to deduct, from current premiums received, dividends paid during the year based in part on excess premiums but more on the fact that as the Court said (pp. 533, 534) :

Premiums paid-not in the tax year but perhaps a generation earlier-have earned so much for the cooperators that the company is able to pay not only the agreed amount by also additional sums called dividends.

The Court did, however, and I think this is the importance of the case insofar as the question under consideration is concerned, endorse the principle of another section of the same statute applied to mutual fire and marine insurance companies, and which provided for the exclusion from income of premium deposits returned to policyholders, saying in language entirely apt for the operations of the typical cooperative (252 U.S. at 533):

But in respect to the service performed fire and marine companies differ fundamentally, as above pointed out, from legal reserve life companies. The thing for which a fire or marine insurance premium is paid is protection, which ceases at the end of the term. If after the end of the term a part of the premium is returned to the policyholder, it is not returned as something purchased with the premium but as a part of the premium which was not required to pay for the protection; that is, the expense was less than estimated.

It is significant that Eisner v. Macomber was decided during the same term and only a few weeks earlier; yet it is not referred to in the opinion.

The case is authority for my position.

Net margins are not taxable, because of the way in which the true cooperative does business. The ordnary business corporation can do business in the same way, also, and if it does is not taxable on its net margins.

Income is not produced by this transaction: A marketing organization buys goods from the farmer-producer, and agrees at that time that after resale of the same goods any margin left over after costs of doing business will be paid over to the producer.

Nor is income produced by this transaction: A purchasing or manufacturing organization undertakes to buy or manufacture goods and resell them to its customers. Included in the undertaking is a promise that if the initial sales price includes more than the organization's total costs, the margin or excess will be returned to the customers.

In both cases the costs cannot be determined until the end of the year, so the margins cannot be returned to the producer or customer until that time. They are, nevertheless, not the property or the "income" of the organization.

I have used the word "organization" here to emphasize that it need not be a cooperative corporation. There are many cases in which private business corporations were involved in which the propositions above stated were upheld.

13

One of the leading cases establishing that point is Uniform Printing and Supply Company v. Commissioner 18 The company was an Illinois corporation whose stockholders were insurance companies, and for whom it engaged in its principal occupation of printing insurance forms. The bylaws required distribution to the stockholders of the net amount in excess of cost, in proportion to the gross amount of

13 88 F.2d 75 (C.A. 7, 1937), reversing 33 B.T.A. 1073.

business done for each stockholder. The court stated the question as follows:

Both the Commissioner and the Board found the so-called refund was a dividend. The precise and only question before us is the soundness of this finding or conclusion. Perhaps it would be better to call it a mixed finding of fact and conclusion of law. If the payment of this sum is a dividend, it should have been included in petitioner's taxable income for 1930. If it was a refund or rebate to customer, it was not part of petitioner's taxable income, for the sum should have been included in the stockholders' taxable income.

After stating its reluctance to differ with the Board of Tax Appeals, the court said:

Had the taxpayer given a customer (whether stockholder or outsider) a discount promptly after filling the order, no one would call it a dividend. If a rebate were given promptly upon the customer's business reaching a certain volume, the same conclusion as to its character would follow. To make cost estimates and adjust them at or near the end of each year, returning the excess payment to the customer, should not change the reasoning which leads to this conclusion. Nor should the fact that the customer is a stockholder materially affect the result.

All

To the same effect are Paducah and Illinois Railroad Company,14 involving a railroad bridge company whose stock was owned by and services performed for three railroads which operated trains over the bridge and which made rebates of toll charges at the end of the year, Mobile Delivery Co.,15 Cooperative Power Plant, 16 In re General Film Corporation," and Broadcast Measurement Bureau, Inc." of these cases except the last involved corporations formed under the ordinary business laws of the various States. All of them involve to some degree the fact that there was an obligation existing at the time of the transaction to pay over the net margin at the end of the year, which made it not the income of the corporation. It is the absence of such obligation which usually accounts for a contrary holding, as in Druggists Supply Corp.19 and Cleveland Shopping News Co. v. Routzahn.20 Other decisions to the same effect involving cooperatives are cited in a footnote.2

21

A leading case involving a cooperative is San Joaquin Valley Poultry Producers Association v. Commissioner.22 The association there was incorporated under the agricultural cooperative association laws of California. The Court of Appeals for the Ninth Circuit held that the bylaws of the association made all net proceeds of the association beyond its expenses the property of the patrons, and that therefore none of them could be included in the gross income of the cooperative. To the same effect are Midland Cooperative Wholesale v. Commissioner,23 Home Builders Shipping Association v. Commissioner,24

14 2 B.T.A. 1001.

15 8 B.T.A. 1224.

16 41 B.T.A. 1143.

17 274 F. 903 (C.A. 2, 1926).

18 16 T.C. No. 122 (1951).

19 8 T.C. 1343 (1947).

20 89 F. 2d 902 (C.A.) 6, 1937; and see U.S. v. Pacific Wholesalers Assn., 338 U.S. 689, holding that net savings paid to members of the association on a patronage basis were not profits of the association.

21 Farmers Union Co-op. Co. v. Commissioner, 90 F. 2d 488 (C.A. 8, 1937); Juneau Dairies, Inc., 44 B.T.A. 759 (1941); Fountain City Co-op. Creamery Assn. v. Commissioner, 172 F. 2d 666 (C.A.) 7, 1949).

22 136 F. 2d 382.

23 44 B.T.A. 824.

24 8 B.T.A. 903.

United Cooperatives v. Commissioner,25 and Farmers Cooperative Co. v. Birmingham.26 The reasoning upon which those cases is based is stated in an article by Randolph Paul, former General Counsel of the Treasury, as follows: 27

The administrative practice has been to exclude patronage dividends from a cooperative organization's income even where the organization is not exempted from tax. This is the correct view in the case of true cooperatives, not because these patronage dividends are deductible expenses, as is sometimes contended, but because they are amounts to which the cooperative has no claim and takes as agent only. The marketing cooperative is only a conduit through which flows income from the purchaser to the farmer. The conduit retains nothing but its own expenses, including depreciation reserves, and has, accordingly, no taxable income.

It should be noted that this has been the view of the Treasury Department itself during a long course of rulings on the subject. In I.T. 1499,28 the Department said, in part:

In

This office has consistently held that, under the Treasury decision and articles of the regulations referred to (art. 75, regulations 33 (T.D.) 2737), cooperative associations, even though not exempt from taxation, may deduct from gross income for the years 1917, 1918, 1919, and 1920 the amounts returned to their patrons, whether members or nonmembers, upon the basis of the purchases or sales, or both, made by or for them. This is upon the theory that a cooperative association is organized for the purpose of furnishing its patrons goods at cost or obtaining the highest market price for the produce furnished by them. the case of purchases, instead of allowing a discount at the time of purchase, the full price is collected and the discount is allowed by way of rebate. In the case of sales of produce furnished by patrons, the refunds based upon the quantity of produce furnished are in reality only part payment of the produce furnished. If the association is organized in accordance with the laws governing farmers' and other cooperative associations in the State in which it operates and if its constitution or bylaws provides for refunds or rebates to its patrons, whether members or nonmembers, upon the basis of goods, purchased or produce furnished, or if it actually conducts its business upon such basis, the refunds or rebates so made may be deducted by the association in computing net income under the Revenue Acts of 1917 and 1918. * * * [Emphasis added.]

And in GCM 17895,29 the Department said:

*** So-called patronage dividends have long been recognized by the Bureau to be rebates on purchases made in the case of a cooperative purchasing organization, or an additional cost of goods sold in case of a cooperative marketing organization, when paid with respect to purchases made by, or sales made on account of, the distributees. For purposes of administration of the Federal income-tax laws, such distributions have been treated as deductions in determining the taxable net income of the distributing cooperative organization. Such distributions, however, when made pursuant to a prior agreement between the cooperative organization and its patrons are more properly to be treated as exclusions from gross income of the cooperative organization (I.T. 1499; S.M. 2595; G.C.M. 12393). It follows, therefore, that such patronage dividends, rebates, or refund due patrons of a cooperative organization are not profits of the cooperative organization notwithstanding the amount due such patrons cannot be determined until after the closing of the books of the cooperative organization for a particular taxable period. [Emphasis added.]

All of the foregoing cases conclude that amounts which the cooperative is obligated to turn over to the patron are not income to the cooperative. This is consistent with the judicial definitions of the word

25 4 T.C. 93.

28 86 F. Supp. 201 (D.C. Iowa, 1949). This case contains an interesting discussion of various matters related to this problem and is well-worth reading.

27 29 Minnesota Law Review, pp. 343, 369.

28 C.B. I-2, pp. 189-191.

29 C.B. 1937-1, p. 56.

"income" as used in the 16th amendment in Eisner v. Macomber, supra, and Commissioner v. Wilcox, supra. In the latter case the Supreme Court said:

For present purposes, however, it is enough to note that a taxable gain is conditioned upon (1) the presence of a claim of right to the alleged gain and (2) the absence of a definite, unconditioned obligation to repay or return that which would otherwise constitute a gain. [Emphasis added.]

The result must be that if amounts do not meet those tests they cannot be taxed under the 16th amendment, which permits only the taxing of "income." Cooperatives' margins do not meet those tests and are not "income" because they are held, not under claim of right by the cooperative, but instead under acknowledgment of the superior right of the patrons, and they are held subject to a definite, unconditional obligation to repay or return them to the patrons.

U.S. Supreme Court cases holding that income assigned in advance of receipt by a parent to a subsidiary or a subsidiary to a parent or by one member of a family to another was nevertheless income of the assignor are not authority against my position.30

Of these cases, Lucas v. Earl, the Horst case, the Harmon case, and the Tower and Lusthaus cases all involve efforts by one member of a family to get a portion of what would otherwise come to him, as income, into some other member of the family. The husband or father either made a contract without consideration, gave away interest coupons before they matured, or entered into a partnership to which the wife or children contributed nothing substantial. In each case the Court said that the income is nevertheless taxable to the person who really earned it. Those cases are not applicable to cooperatives.

The Moline Properties and National Carbide cases are of a different kind and involve corporations and their stockholders. In each the corporation was arguing that income (or gain) received by it was not its income for tax purposes. In both cases the Court rejected the contention. The two cases are somewhat different as to detail, and neither is applicable to the cooperative situation, as shown below.

In the Moline Properties case an individual held all of the stock of a corporation which his creditors had caused him to set up. The corporation held title to real estate and engaged in little activity beyond the bare holding of title. When some of the real estate was sold, the corporation asserted that the capital gain should not be taxed to it, but to its sole stockholder. The Court rejected that contention and said the corporate entity could not be ignored. It also said that there was no evidence that the corporation received the gain as agent for the stockholder, and that therefore the income was that of the corporation.

In the National Carbide case (and similarly in the Fontana Power case) a subsidiary agreed to pay its parent all of its "profits" above a fixed amount. The subsidiary then contended that all amounts so paid over to the parent were not income to it, because when they were

30 Lucas v. Earl, 281 U.S. 111 (1930); Helvering v. Horst, 311 U.S. 112 (1940); Moline Properties v. Commissioner, 319 U.S. 436 (1943); Commissioner v. Harmon, 323 U.S. 44 (1940); Commissioner v. Tower, 327 U.S. 280 (1946); Commissioner v. Lusthaus, 327 U.S. 293 (1946); National Carbide Corp. v. Commissioner, 336 U.S. 422 (1949). See also Fontana Power Co. v. Commissioner, 127 F. 2d 193 (C.A. 9, 1942).

received they were subject to the obligation to pay them over. The argument is superficially like ours here, but on second look it will be seen that it is really more the argument of the assignors of income in the Lucas v. Earl line of cases. The subsidiary knew it was going to receive income, so it assigned it in advance to its parent, without consideration. That is not the cooperatives' case. The subsidiary in National Carbide made profits from dealings with outsiders and then turned those profits over to its parent, which had nothing to do with the transactions out of which the profits grew. In the cooperative situation, the cooperative makes sales to or for its patrons and then refunds to them the amount by which it has overcharged them or has underpaid them, in the first instance. Those distributions of net margins were part of the original transactions. They went back to the original customer, not on up to a parent corporation. That this distinction is sound is demonstrated by another decision of the same court which decided the Railway Express case.31 All these cases involve attempts ot assign income over which the assignor has “command." They do not come to grips with the situation of cooperatives, who engage in conditional transactions as a result of which there is no income. At the time of the transaction there exists the obligation to distribute net margins to the patron in proportion to his patronage, including the transaction in question. See Uniform Printing & Supply Co. v. Commissioner 32

33

The same reasoning was used in Midland Cooperative Wholesale v. Ickes, in holding that the cooperative could not handle coal under the Bituminous Coal Act's licensing provisions because by its method of operation it would amount to "price cutting." The Court said in part.

The patronage dividend is as much a part of the transaction as the price itself. If petitioner did not distribute patronage dividends or hold out they would do so-as under Minnesota law and its bylaws it must-there would doubtless be no sales of coal by it. Petitioner admits this. It is its promise and obligation to pay patronage dividends on this coal business that provides the incentive for the purchase of coal from petitioner, and it is not denied that petitioner's purchases of coal are purchases in interstate commerce.

The payment of such dividend has the effect of decreasing the sale price below the established prices. It thus has an effect upon the price structure which sets the price for most of the bituminous coal production, all of which moves in or has been held directly to affect interstate commerce. * * *

Those advocating harsher tax treatment for cooperatives have referred to the long existing rule that an association or trust doing business in a corporate way may be taxed as a corporation.34 That proposition is apparently brought in to support the argument that calling cooperatives agents, partners, or trustees does not prevent taxing them as corporations.

Those cases are not really applicable, but I have no quarrel with the proposition that nonexempt cooperatives are taxable insofar as they have income. The question is whether their net margins are income.

31 In re General Film Corporation, 274 F. 903 (C.A. 2, 1921).

32 88 F. 2d 75 (C.A. 7, 1937), at p. 76.

33 125 F. 2d 618, 635 (C.A. 8, 1942).

Burk-Weggoner Oil Assn. v. Hopkins, 269 U.S. 110 (1923); Morrisey v. Commissioner, 296 U.S. 344 (1935).