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Your committee realizes, of course, that taxable cooperatives are subject to precisely the same income tax laws as other taxable corporations. There is no statutory provision which expressly refers to cooperatives as such, or to their net margins as such, or which grants any taxable cooperative any special privilege with respect to excluding or deducting its net margins from its gross income when computing its taxable income and its income tax liability. Nevertheless, neither the Treasury nor the courts has consistently and expressly adhered to any specific constitutional or statutory basis or legal reason why taxable cooperatives have been permitted to exclude or deduct part or all of their net margins from their gross incomes, and the Treasury repeatedly has attempted to treat cooperatives as a special and separate classification of corporate taxpayers. In fairness to the courts and the Treasury, it should be recognized that they, like most of the public, probably have been influenced to some extent by a superabundance of misinformation in the past 15 years from people who either don't know or deem it financially advantageous not to learn. Nevertheless, those two factors, failure to assert consistently the statutory basis and the legal as well as factual reason for excluding net margins, have been major factors in creating the confusion currently fogging the subject of cooperatives and income taxes. That confusion can best be dispelled by your committee or Congress making it plain (1) that there is a statutory basis for excluding net margins from the gross income of a taxable cooperative, (2) why and to what extent they may be so excluded in a proper case, and (3) that the same basis and reason apply equally to any and all other kinds of taxable corporations.

The fundamental reason why any taxpayer is entitled to exclude the net margins from its gross income, for the purpose of computing its taxable income and income tax liability, is the fact (in cases where and to the extent that it is a fact) that the net margins constitute debts which the taxpayer owes to its patrons rather than income which the cooperative owns. It is about as elementary and fundamental as one can get to point out that, in any bookkeeping system, accounts must be classified as either assets, or liabilities (debts) or capital, or income, or expenses. Debts (liabilities) and income are two different words, and they refer to two different things. The income tax law levies no tax on any taxpayer's debts. Rather, section 11 imposes a tax on a corporation's "taxable income.” Section 63 defines "taxable income” as meaning "gross income, minus the deductions allowed by this chapter, **** Section 61 defines "gross income" as meaning "all income from whatever source derived, * **." [Italic inserted.] It is a fact that debts are not income. Consequently, debts are properly excludable from income. Therefore, if and to the extent that the net margins of any cooperative association (or of any other taxpayer) constitute debts which the taxpayer owes to its patrons rather than income which it owns, the net margins are excludable from its gross income. And there is a very specific statutory basis for so excluding them.

Whether any particular receipts constitute income to the taxpayer or debts which he owes must be determined by the circumstances which existed at the time of the taxpayer's receipt of the amount in question. Thus it has been established that if and to the extent that a cooperative association (or any other taxpayer) receives money subject to a then existing and legally enforceable obligation to pay over such money to its patrons, that money constitutes a debt which the taxpayer owes to its patrons (rather than income to the taxpayer) and, being a debt rather than income, it properly is excludable from the taxpayer's gross income.

On the other hand, if and to the extent that a taxpayer receives such money free from any such obligation so that the taxpayer may legally retain the money for its own account, the money constitutes income and must be included in the taxpayer's gross income when computing its taxable income and its income tax liability. That is true regardless of whether or not the taxpayer subsequently does pay over such money to its patrons. That is for the reason that the determination whether the money received constituted income or not, and the attendant determination whether or not the money must be included or may be excluded from gross income, must be made as of the time when the taxpayer received the money and by the circumstances under which he received it. Those determinations do not depend upon the taxpayer's subsequent disposition of the money. Once money is received as income, it must be included in the taxpayer's gross income. The only way by which the taxpayer subsequently can get that money out of his income is by disbursing it or incurring an obligation to disburse it for a purpose which makes it deductible from gross income. However, deductions are statutory; and it has been held that there is no statutory deduction for patronage payments. Consequently, it has been held that patronage payments which were voluntarily paid by a cooperative association to its patrons, that is, payments which resulted from the exercise of discretion by its board of directors (rather than from the performance of an enforcible obligation which existed at the time of the association's receipt of the money) are neither excludable from its gross income because they constituted income (rather than debts) when received nor deductible from its gross income when subsequently and voluntarily paid because the statute grants no deduction for such discretionary payments.

Consequently, numerous cooperatives, whose patronage contracts did not constitute a preexisting obligation to pay the patronage pay, ments which the association subsequently did pay, have been required to pay income tax on patronage payments which they actually paid to their patrons, and in actual cash. Numerous other cooperatives have been required to pay income tax deficiency assessments with respect to patronage payments which they actually paid to their patrons for the reason that only part of such payments was pursuant to a preexisting obligation to pay and the balance was a discretionary distribution of income upon which the association was liable for tax.

There now is no disagreement among informed people concerning the excludability of net margins if and to the extent that a cooperative received them subject to a preexisting obligation to pay them to its patrons. Nor is there now any serious question concerning the reason why such margins are excludable from gross income or the specific statutory basis for such exclusion. However, confusion persists in the application of the above rule in computing the amount which is excludable in specific cases. That confusion results from two principal causes. First, the Treasury persists in conjuring up special rules to apply to taxable cooperatives and their net margins and patronage payments; second, "obligation" is a weasel word.

One example of the first category of reasons why confusion persists is the Treasury's superimposed condition precedent to the excludability of net margins that taxable cooperatives must not only apportion the net margins among their patrons, but must also notify each patron of the amount so apportioned to him.

Prior to 1951, the word, “allocate,” in connection with cooperatives' net margins, uniformly connoted to apportion on the books of the association.” That word had never meant both (1) "to apportion on the books of the association” and also (2) “to notify each patron of the dollar amount so apportioned to him." As a matter of fact, prior to 1951, neither exempt nor taxable cooperatives had ever been subject to any compulsion to notify any patrons of any amounts apportioned to them.

In 1951 Congress enacted what is now section 522 of the 1954 code. Section 522 plainly has no application to taxable cooperatives, but that section does provide that exempt cooperatives shall take into account their patronage payments with respect to their patrons' patronage “in the same manner as in the case of a (taxable) cooperative ***" Section 522 also requires that exempt cooperatives shall notify each patron of the dollar amount of his patronage payment.

The Treasury then promulgated regulations under the new section (now 522) and defined "allocation" as meaning both apportionment and notice. Such definition was at war with every English-language dictionary then extant, as well as with the uniformly settled meaning of that word as theretofore applied to the net margins of cooperatives. What's worse, the Treasury then, without any statutory authority and notwithstanding the plain fact that taxable cooperatives are subject to precisely the same income-tax laws as other corporations, then insisted that taxable cooperatives must, as a condition precedent to excluding their net margins from gross income, "allocate" them to their patrons in the Treasury's Pickwickian sense of that word, that is, by not only apportioning the net margins on the books of the association, but also by notifying each patron of the dollar amount so apportioned to him. Today there are numerous cases pending in which the Treasury proposes to disallow the exclusion of apportioned net margins of taxable cooperatives on the ground that the cooperative had not also notified each patron. Congress required such notice of exempt cooperatives, but it has not required such notice by any kind of a taxable corporation. Nevertheless, the Treasury presumed to classify taxable cooperatives in a separate category from other taxable corporations and to impose on the cooperatives a burden which it does not impose on other taxable corporations. It thus has created a distinction (and confusion) where there was none in the law.

As another example of the Treasury's separate classification of taxable cooperatives where there is none in the law, we point out the Treasury's position that patronage payments to member patrons are not excludable to the extent that they include net margins which resulted from the patronage of member patrons. That ruling stemmed from a prior ruling that Iowa cooperatives, under a State law which prohibited the payment of patronage payments to nonmember patrons,

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were not eligible for exemption under the section (now 521) which granted exemption to only those farmers' cooperatives which marketed the products of “members and other producers” and turned back the net proceeds to "them." Quite obviously, those Iowa cooperatives were returning the net proceeds to the patrons who were "members," but they were not returning any net proceeds to the nonmember patrons who were "other producers.” In other words, the subject

“ associations were not operating as "true cooperatives" with respect to the nonmember patrons, and their payments to the member patrons were not "true patronaged dividends to the extent that they included net margins which had resulted from the patronage of the nonmember patrons. We have no quarrel with that ruling under the exemption statute.

However, the Treasury then ruled that a taxable cooperative could not exclude from its gross income its patronage payments to member patrons if and to the extent that such payments included net margins which resulted from business transacted with nonmember-patrons. The reason assigned for the latter ruling was that to that extent the payments were not “true patronage dividends.” So what? The first case involved the exemption statute which required associations to operate cooperatively in order to qualify under it, but the second case did not involve either the same or any other statute involving "true cooperatives" or "true patronage dividends.” The second case, rather, involved only a taxable corporation, and there certainly never was any statutory requirement that any taxable corporation had to establish either that it was a “true cooperative" or that its debts were “true patronage dividends" in order to exclude its debts from its gross income. . In fairness, it must be noted that neither the Treasury nor the courts nor even the cooperatives and their patrons 20 years ago had any clearcut understanding of why and to what extent the net margins were excludible from gross income. In fact, they were referred to as deductions from gross income as often as they were referred to as exclusions.

Since about 1943, however, a series of cases and rulings has made it clear that the reason why a cooperative (or any other taxpayer) may exclude net margins from gross income in a proper case is that they are debts rather than income. Thus, the reason for the exclusion has nothing whatever to do with any questions of whether or not the excluded margins are “true patronage dividends." The only material inquiry is whether they are income or debts. Nevertheless, the Treasury recently asserted that patronage payments which include net margins which resulted from handling grain for the Commodity Credit Corporation are not "true patronage dividends" and, therefore, are not excludable from gross income. In fact, the Treasury sold that contention to the Tax Court only last year. The Treasury and the Tax Court both started from the false major premise that only “true patronage dividends” are excludable from gross income; the fact is that all debts are excludable from gross income and that even “true patronage dividends" are not excludable from gross income unless they also are debts. They then added the true minor premise that the margins which resulted from handling CCC grain but which were paid to other patrons are not "true patronage dividends.” They thus produced the completely plausible, but ut

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terly false, conclusion that the payments were not excludable from gross income.

There is, in 1959, no excuse for the Treasury arguing, in the Tax Court or anyplace else, as it ruled in 1938 that only “true patronage dividends" are excludable from gross income. In the case of a taxable corporation, it is immaterial whether its payments are patronage dividends of any kind; rather, the test is whether it received the money in question as income or debt.

Nor is the end of that error in sight. Numerous revenue agents are now asserting that if and to the extent that net margins result from the marketing of one product but are paid to patrons who delivered a different product, such payments are not “true patronage dividends” and, therefore (?), cannot be excluded from gross income. That may not make much difference to the large cooperatives which can afford to maintain as accurate cost accounting records as anyone, but it can well nigh ruin the small, local country cooperatives with which we are familiar. If some revenue agent can figure out some way to calculate that corn produced more net margin than the cooperative's accountant computed and less on soybeans than the accountant computed and, therefore (?), part of the patronage payments with respect to soybeans were not “true patronage dividends” so that the association is liable for additional tax notwithstanding the fact that the money (whether it resulted from corn or soybeans) has long since been paid, reasonably and in good faith, to the soybean patrons, there just is no point at which such chicanery can logically stop. Another revenue agent may compute that å bushel of corn received on one day produced a few pennies more than a bushel received on the next day. Still another agent may reduce the whole process to perfectly patent absurdity by figuring out some basis for arguing that in order to pay a “true patronage dividend,” the association must separately calculate the refund rate on each separate kernel of corn or drop of milk. Ridiculous as it may sound, the fact is that that is the kind of argument on which the Treasury today is collecting income taxes from many country, cooperatives. The whole disgusting process and the resulting confusion stem from the Treasury's argument in the Government grain cases that patronage payments are not excludable unless and only to the extent that they are “true patronage dividends.” In this day and age, the Treasury knows better and it only stirs up confusion and worse by departing from the correct basis for such exclusions—that is, section 61—and determining, under rules which apply to any other kind of a taxpayer, whether a particular amount of money constituted income or debt when received by the taxpayer.

The other principal source of continuing confusion in relation to the application of income taxes to cooperative associations stems from the word "obligation,” in the oft repeated statement that net margins are excludable from gross income only if and to the extent that they are received by the taxpayer subject to a pre-existing, mandatory obligation to allocate them to its patrons. It is not practicable to outline in this statement the long and tortuous route which the cooperatives, Treasury, and courts have traveled in arriving at the now settled rule of exclusion above stated. For example, however, one of the favorite explanations of why net margins were excludable from

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