At most of these some, if not a majority, of the members want some improvement in service. In recent years, since the coming of combines and a series of good crops, the big demand has been for more elevator space. A lot of grain is harvested while it is damp, or even wet. It will spoil in a farmer's bin unless he is prepared to move it repeatedly so as to dry it out.

Farmers know that you can do the same job cheaper and better in a big local or terminal elevator run mostly by machinery, supervised by an expert.

So, instead of accepting their patronage credit in cash, they have often voted-and it is usually unanimously-to have patronage issued in stock or certificates of indebtedness. Sometimes interest is paid on this money which is, in effect, lent to the cooperative.

Farmers feel that it is fair to do it this way because the amount each farmer lends to his cooperative is in proportion to the use each makes of the cooperative.

Now, whether the farmer gets his patronage credit in cash, in stock, or a certificate of indebtedness, or by credit to an allocated reserve, he must put this credit in his personal income tax return for the year in which it is paid to him, and at its full face value. It is part of his profit on the year's business.

It was not entirely clear to him for some years because internal revenue collectors interpreted the matter differently. It is clear now, entirely clear, since the issuance on April 13, 1950, by Mr. E. I. McLarney, Deputy Commissioner of the Income Tax Unit, Bureau of Internal Revenue, of Income Tax Information Release No. 2, entitled "Patronage Dividends," as follows:

The earnings (savings) of farmers' cooperative marketing and purchasing associations, distributable to their patrons on the basis of the amount or value of produce furnished by them to the cooperatives or the value of supplies and equipment purchased by them from the cooperatives, generally are distributed to the patrons as patronage dividends in the form of cash or in one or more of the following forms:

Capital stock of the cooperative;

Revolving-fund certificates;

Retain certificates;

Certificates of indebtedness;

Letters of advice as to net amount retained.

For Federal income-tax purposes, the amounts which are includible in the gross income of the patrons to whom such distributions are made are not restricted to amounts distributed in cash. Distributions by cooperatives in the form of capital stock, or in any form other than cash, should be included in the gross income of the patrons to the same extent that such distributions would be included if paid in cash. This rule is applicable to patrons who file their Federal income-tax returns on the basis of cash receipts and disbursements as well as those who file their returns on the accrual basis.

I might here answer a question that was asked by a member of the committee this morning. This ruling was secured largely as the result of the efforts of the farmers' cooperatives. There was a good deal of confusion among farmers as to what should be included in income, and what should not. This ruling settled it.

All of the cooperative organizations that I am familiar with immediately published the ruling, so that I am sure the farmers up in the Northwest anyway, know what they have to pay a tax on, what they have to include in their income-tax returns.

I believe farmers as a group are very conscientious in making out their income-tax returns. At the annual meetings I attend in the

principal grain-producing areas, I find that they are eager to get the facts and that they want to do the right thing in making an accurate report of income and in paying the tax due to the Government.

It is true that cooperatives through loyal membership, good management, and expert salesmanship have introduced tremendous competition into the handling of grain. The farmer has profited greatly through this system of doing business at cost instead of paying out a big margin for the service. The consumer has also benefited because quality has been improved and standardized and the flow of grain to market is more orderly.

It has been obvious for some time that it is the competition which farmers have introduced through their cooperatives that has caused complaints.

If the opposition to cooperatives confined themselves to complaints, it would not be too serious. Actually, however, they have libeled cooperatives, accusing them of being "IV-F dodgers," and even of being communistic, when the truth is that cooperatives are a self-help device promoted and approved by American farmers-the ablest group of farmers in any country of the world, and the most independent. More than a million American farmers market grain cooperatively through 2,500 local associations and 20 regional, federated cooperatives.

If these farmers can increase their net returns, their profits, through marketing through their own agencies, they will be better able to pay the higher taxes which are inevitable under the present emergency. They will not be able to do that if the marketing machinery which they have so laboriously built is destroyed to satisfy their competitors. That would mean a return to the days when the grain farmer was voiceless in the market place, when margins were high and often unreasonable.

Now, Mr. Chairman, I had to get ready for this hearing on very short notice. Some time ago I wrote an article for the Duke University School of Law, which was published in their symposium issued in the summer of 1948. That article is written in objective fashion. I should like very much to simply file it and make it a part of the statement I am making to you today.

The CHAIRMAN. Is it a duplication of what you have said?

Mr. RUMBLE. No, sir; it is not.

The CHAIRMAN. How much is there of it?

Mr. RUMBLE. About 11 pages.

The CHAIRMAN. Without objection, it is so ordered, and you may file it as part of your statement.

Mr. MASON. Mr. Chairman, since that article which you have consented to put in the record is a part of the symposium of Duke University, it seems to me that the argument on the other side that is in that symposium should also be a part of the record as a comparison between his argument and the other.

The CHAIRMAN. If there is a request, we will do that.

Mr. MASON. There is an argument on the other side of the question? Mr. RUMBLE. Yes, there is.

Mr. MASON. Then I ask that the argument on the other side of the question also be included in the record.

The CHAIRMAN. Without objection, that will be done at this point.

(The articles referred to follow :)

COOPERATIVES AND INCOME TAXES

(By Wilfrid E. Rumble*),

Cooperative associations are subject to every real- and personal-property tax and almost every other type of tax, in the same way and to the same extent as ordinary private business corporations. It is in respect to income taxes_that their treatment is different. It is to that point that this article is addressed.

In order fairly to judge the point of view of cooperatives as to their incometax status, an understanding of the general nature of cooperatives in necessary. The cooperative corporation is essentially a group of individuals or corporations, or both, organized into corporate form for the purpose of acting collectively in the marketing of their products or the acquisition of their supplies. Almost every State in the Union has statutes expressly providing for the organization of cooperative corporations, and Congress has provided for the organization in the District of Columbia of cooperative associations of consumers. Most of these laws were originally enacted principally to insure to groups of farmers the right to act collectively without violating State antitrust statutes. Congress assured to cooperatives the same immunity from Federal antitrust statutes by enactment of the Capper-Volstead Act in 1922. Neither State nor Federal law grants such immunity to cooperatives in their ordinary commercial transactions and dealings.

A cooperative may be organized under the ordinary business corporation statutes of most States. The Federal Farm Board, acting under the advice of Stanley Reed, then its general counsel, now a Justice of the Supreme Court of the United States, organized its great cooperative marketing and warehousing corporations under the general corporation statutes of Delaware. There are, of course, some advantages in organization under the usual cooperative statutes, but there are also definite restrictions and disadvantages. The Minnesota General Cooperative Act is fairly typical. Cooperative associations organized under these statutes differ from business corporations in several important respects, among which are the following:

1. There is a limit on the amount of voting stock a member may own, a common limitation being "not more than one-twentieth of the stock outstanding"; 2. Dividends on capital stock may not exceed a stated rate, such as 6 percent per annum, and are not cumulative;

3. Each member has 1 vote only, regardless of the number of shares of stock he owns; and

4. All earnings or savings remaining after payment of expenses of operation, dividends on capital stock, and provision for required reserves must be distributed.

There are in general two types of cooperative association: One engages in marketing or selling the products of property of its members and patrons (customers), and is commonly known as a marketing cooperative. Practically all cooperatives of this type are owned and controlled by farmers, and market only farm products. The other engages in purchasing or buying supplies and goods for its members and patrons, and is commonly known as a purchasing cooperative. Despite the growth in recent years of urban purchasing cooperatives, it is still true that many of the purchasing cooperatives are principally owned and controlled by farmers. Urban cooperatives of this type are frequently referred to as consumer cooperatives. Some farmer-owned cooperatives engage in both marketing and purchasing activities. The principal purpose of any cooperative association is to sell, buy, or furnish products, merchandise, or services, as the case may be, for its patrons at cost. In order further to reduce costs to their patrons, some marketing cooperatives engaged in the first processing, warehousing, and transporting of farm products, and some purchasing cooperatives, for the same purpose and also in order to secure necessary supplies, engage in manufacturing operations and own and operate oil wells, refineries, fertilizer plants, and feed-processing plants.

Member of the Minnesota bar and of the firm of Doherty. Rumble, Butler, and Mitchell, St. Paul, Minn.; counsel for several cooperative associations. 'District of Columbia Cooperative Association Act, Public Law 642, 76th Cong., 3d sess., ch. 397, approved June 19, 1940. 242 Stat. 388, 7 U. S. C.. sec. 291 (1940).

Minn. Stat. Ann. (1945) secs. 308.05 to 308.18.

Cooperative associations vary in their actual methods of operation. Generally, however, the marketing cooperative agrees to market all the agricultural products of the type handled by it produced and delivered to it by its patrons, and to pay to each patron the entire marketing proceeds after deduction of expenses. When a patron delivers products to the cooperative for sale the amount to which he will finally be entitled cannot be known so the cooperative pays to the patron a substantial part of the estimated sales price. At the end of the year when the products have been sold and the costs determined, the cooperative distributes the remainder of the proceeds to its patrons in proportion to the products marketed for them. This distribution is called a patronage refund, but in reality it is further payment of the sales price. In addition to their selling, processing. warehousing, and other activities incident to the marketing of products to the best possible advantage, most farmers' marketing cooperatives employ laboratory and other experts for the purpose of improving the quality of their patrons products, increasing efficiency in production, and informing members of current developments in production methods, types of product, and equipment.

A purchasing cooperative agrees to buy and deliver to its patrons farm supplies and other goods at cost. Since the actual cost of each purchase cannot be determined in advance, the cooperative usually charges and collects from the patron an amount more than sufficient to cover the expected cost price plus estimated operating expense. At the end of the accounting period the actual cost of goods purchased plus cost of operation is determined, and any excess amount collected from the patrons is returned to them in proportion to their purchases. The amount so returned to the patrons is a true patronage refund.

*

In American Shook Box Export Association v. Commissioner,' the court said: "In order to be a true cooperative, however, the decisions emphasize that there must be a legal obligation on the part of the association to return to the members en a patronage basis, all funds received in excess of the cost of goods sold. Such an obligation may arise from the association's articles of incorporation, its bylaws, or some other contract."5

I would define a true cooperative as one which is legally obligated, by written agreement or by appropriate provisions of its articles of incorporation or bylaws or by the statute under which it is organized (1) to distribute to its members or patrons, or both, in proportion to their patronage, all of its income in excess of its costs of operation, except such as it is authorized to pay in limited dividends upon capital stock and to place in statutory or other necessary reserves, and (2) to allocate or credit all reserves (except consumable reserves) to the patrons who contributed to them, upon the same patronage basis. It is this type of true cooperative to which I refer when using the term "cooperative."

Cooperative associations are organized either on a capital stock or on a membership basis. In the capital-stock cooperatives exclusive voting control is in the common or membership stock and all eligible patrons must acquire at least one share, which may be paid for upon an ordinary subscription basis or by the application of patronage refunds. In most membership cooperatives the patron, if eligible, is required to pay for a membership (usually the fee is nominal) when he first patronizes the cooperative.

Cooperatives need capital, as do private business corporations. Indeed, some marketing cooperatives need more capital than private business corporations with which they may be in competition, because of their obligation to accept all products tendered by their members, regardless of market conditions. Such cooperatives cannot buy when market conditions are favorable and refuse to buy at other times. Carrying of large inventories and consequent unusual exposure are inevitable during certain periods and seasons.

Cooperatives generally finance themselves through the issuance of preference stock, bonds, notes, certificates of indebtedness, and bank borrowings, and the use of revolving and other reserves. A large part of the securities of cooperatives is sold to members and patrons in the usual fashion, except that sales are direct from the cooperative to the individual purchaser. It is practically impossible for a cooperative to offer a security which is attractive to the ordinary investor. be cause of the usual provisions of State statutes limiting dividends upon capital stock, prohibiting payment of cumulative dividends, requiring that control of the corporation shall always be in members (producer-members in farmer cooperatives), limiting the class from which directors and officers may be chosen,

and other less important restrictions. Thus cooperatives are practically compelled to secure their capital from their own patrons and members. The result is that this capital has been secured to a considerable extent from the reinvestment in capital securities of the cooperative by patrons of their share of the receipts of the cooperative. All the State statutes require cooperatives to distribute net income (after dividends on capital stock and after small required reserves) to patrons annually or oftener, and most of them expressly permit distributions to be made in capital securities. It is principally the methods used by cooperatives, to finance their activities which give rise to the present bitter attacks upon the income-tax treatment accorded cooperatives by Congress, the Treasury Department, and the courts.

Since 1916 the Internal Revenue Code has provided an exemption for farmer cooperatives fulfilling certain stated conditions. The Internal Revenue Code contains no other provisions specifically applicable to cooperatives, so that for income tax purposes there are only two classes of cooperatives, one class consisting of those wholly exempt from the payment of income taxes, and the other of those which are not exempt and which are subject to the same rules, regulations, and laws as private business corporations. Orderly treatment requires separate consideration of each class.

EXEMPT COOPERATIVE ASSOCIATIONS

The exemption provisions applicable to cooperative associations appear in section 101 (12) and (13) of the Internal Revenue Code. Section 101 (13) is not particularly important here. Section 101 (12) is set forth in a footnote." The statute, in different form, was first enacted in 1916 and has been amended on several occasions, but it has been in substantially the present form since 1926.8

It will be observed that the statute offers to certain farmer cooperatives a conditional right to be exempted from the income tax. There are approximately 10,500 farmer cooperatives. Roughly, half of them have been granted exemption. In order to qualify for exemption under this section a marketing association must limit its marketing operations to the marketing of the agricultural products of its members and patrons, pay to its patrons the proceeds of its sales less the necessary operating expenses on the basis of the products furnished by them, and limit its marketing of nonmembers' products to an amount not exceeding the products marketed for its members. A purchasing association must limit its operations so that the volume of goods purchased for nonmembers will not exceed the volume of goods bought for members, and so that purchases for those who are neither members nor producers will not exceed 15 percent of total pur-. chases. An association of either kind must be both organized and operated on a cooperative basis. All receipts in excess of actual cost must be turned back to patrons on a patronage basis. There may be no discrimination between members and nonmembers. Records must be kept in a manner that will disclose the interest of every patron in any patronage margins. If the cooperative has

653 Stat. 876, 26 U. S. C., sec. 101 (12), (13) (1940).

"Farmers', fruit growers', or like associations organized and operated on a cooperative basis (a) for the purpose of marketing the products of members or other producers, and turning back to them the proceeds of sales, less the necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them, or (b) for the purpose of purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses. Exemption shall not be denied any such association because it has capital stock, if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued, and if substantially all such stock (other than nonvoting preferred stock, the owners of which are not entitled or permitted to participate, directly or indirectly, in the profits of the association, upon dissolution or otherwise, beyond the fixed dividends) is owned by producers who market their products or purchase their supplies and equipment through the association; nor shall exemption be denied any such association because there is accumulated and maintained by it a reserve required by State law or a reasonable reserve for any necessary purpose. Such an association may market the products of nonmembers in an amount the value of which does not exceed the value of the supplies and equipment purchased for members; provided the value of the purchases made for persons who are neither members nor producers does not exceed 15 percent of the value of all its purchases. Business done for the United States or any of its agencies shall be disregarded in determining the right to exemption under this paragraph." Id. sec. 101 (12).

Revenue Act of 1921, sec. 231 (11); Revenue Act of 1926, sec. 231 (12); Revenue Act of 1928, sec. 231. The Revenue Act of 1928 added what is sec. 101 (13) of the present Revenue Act. See also U. S. Treas. Reg. 111, sec. 29.101 (12), (13), (1943). 79120-51-pt. 247