it is doing in this instance is comparable to the patronage refund practices of cooperatives."

"Any business can operate as a cooperative, if it chooses to do so, and receive the same tax treatment," according to a spokesman for Farmers Union Central Exchange. He further says, "No business pays an income tax on a refund to its customers, whether it's a co-op or another kind of business."

Farmers do pay an income tax on refunds if they are paid in cash. According to Representative Mason, it is likely that an attempt will be made to have farmers pay Federal income tax on refunds payable at a future date. Representative Mason states that co-ops are apparently willing to have Congress pass such a law since it might head off the bill to have co-ops pay the 52 percent income tax. This proposal to tax farmers on refunds would be similar to a bill passed in 1951, but would be in such a form that it would not be made invalid by the courts as was the 1951 law.

Representative Mason stated in a recent letter to Chemical Processing that he could not tell when the Ways and Means Committee will give attention to H.R. 3550, the Tax Equalization Act of 1961. However, other sources in Washington indicate that it is likely the committee will consider it when the administration makes recommendations for closing loopholes in our tax laws.

It has been estimated that passage of this bill would provide several hundred million dollars revenue per year. This is a strong point in favor of its passage, considering the efforts being made to decrease the Federal budget deficit expected this year.

COOPERATIVES WILL EXPAND WHATEVER HAPPENS

If H.R. 3550 is enacted during this session of Congress, it will not be as easy for cooperatives to expand their chemical processing operations as it has been in the past 10 years. Even if the bill does become law, however, it is likely that the cooperatives will continue to expand on a major scale into the chemical processing field. They have a firm established base from which to work now, and plans for further chemical expansion will not be altered.

Mr. CURTIS. Mr. Chairman, I wonder if it would be appropriate, and I would like to request, that this full article be put in the record following your statement. It is of that nature, is it not?

Mr. PUTZELL. Yes, sir.

The CHAIRMAN. Without objection, it will appear in the record at that point.

Any further questions of the witness?

If not, Mr. Putzell, we thank you, sir, again.

Mr. PUTZELL. Thank you, sir.

The CHAIRMAN. Mr. Lauterbach and Mr. Lynn. Mr. Lynn, will you present the statement?

Mr. LYNN. No, sir, Mr. Chairman, Mr. Lauterbach, our general counsel will make the statement.

The CHAIRMAN. Mr. Lauterbach, you are the general counsel of the American Farm Bureau Federation. Will you give us your full name and address and also identify Mr. Lynn?

STATEMENTS OF ALLEN LAUTERBACH, GENERAL COUNSEL, AND JOHN C. LYNN, LEGISLATIVE DIRECTOR, AMERICAN FARM BUREAU FEDERATION

Mr. LAUTERBACH. All right, sir. My name is Allen Lauterbach, general counsel of the American Farm Bureau Federation. Our general offices are in Chicago at the Merchandise Mart. We have our legislative office here in Washington. Mr. Lynn, who is accompanying me, or I am accompanying him, I think I should put it, is the legislative director of the American Farm Bureau.

The CHAIRMAN. Mr. Lauterbach, whichever way it is, I am sure both of you are in good company and you are recognized, sir. Mr. LAUTERBACH. Thank you, sir. We have a prepared statement here which I believe the members of the committee have.

We appreciate the opportunity to appear before this committee relative to the question of the tax status of farmer cooperatives. Anyone familiar with the history of Farm Bureau will know that from the time of its organization in 1919, Farm Bureau has supported agricultural cooperatives as "a vital part of our competitive enterprise system." A majority of our 1,600,792 members are also members of farmer cooperatives.

We believe that the basic aim of agricultural cooperatives is to enable farmers to compete effectively in the sale of their products and in the purchase of supplies and services. At our most recent annual meeting the voting delegates of our member State Farm Bureaus stated:

We support the growth of farmer cooperatives to provide business units large enough to compete effectively at regional and national levels with other enterprises. We support establishment and operation of bona fide farmers' marketing and purchasing cooperatives and associations wherever an economic need for them exists.

The delegates urged

*** directors and other members of cooperatives to make certain that their associations are soundly and adequately financed, well managed, and forward looking enough to meet the challenges of changing economic conditions.

Our concern for strengthening the financial structure of farmer cooperatives is not unrelated to the question now before this committee. We must be sure that the tax treatment afforded to cooperatives will not in the long run be detrimental to their best interests through weakening their financial strength or ability to meet the challenge of changing economic conditions.

The following policy resolution adopted by the voting delegates of the member State Farm Bureaus at our most recent annual meeting will be of interest to this committee:

We continue to oppose aggressively any efforts to tax cooperatives on savings which are returned to the member patrons in such a form as to be taxable in their hands. We support the principles that:

(1) All net savings and income of farmer cooperatives should be subject to a single Federal income tax, to be paid either by the cooperative or by the patron, as earned.

(2) For such portion of the income of a cooperative association as is paid in cash, the association shall be allowed a deduction from its gross income and the member receiving such cash shall include such amount in his gross income.

(3) Deduction shall be allowed the cooperative association for such portion of its net savings and income as is not paid in cash, and for which it issues to the member a written instrument advising him of the amount of his allotted share of the income not paid in cash, if (a) the written instrument is of such legal quality that all members receiving it will be under a legal obligation to include the face amount thereof as gross income on their tax returns and (b) the cooperative association will certify to the Internal Revenue Service that its written instrument is of such legal quality.

(4) Any remaining income of any cooperative association not previously accounted for above shall be subject to the corporate income tax. We recommend that the Internal Revenue regulations and, if necessary, the Internal Revenue Code be amended to provide that nonexempt cooperatives receive the same treatment as exempt cooperatives with respect to the time in

which allocations of patronage dividends and notifications to the patron must be made following the close of this fiscal year.

We oppose the application of a withholding tax to the dividends of corporations, including cooperatives.

This policy resolution is identical to the one that was presented to this committee last year. At that time Mr. Shuman, president of this organization, offered a detailed statement in support of this policy resolution and also answered questions of members of the committee. Our 1960 testimony before this committee may be found on page 334 of those hearings.

At this point we would like to comment briefly upon the following recommendation of President Kennedy in his message to Congress on April 20, 1961:

I recommend that the law be clarified so that all earnings are taxable to either the cooperatives or to their patrons, assessing the patron on the earnings that are allocated to him as patronage dividends or refunds in scrip or cash. The withholding principle * * * should also be applied to patronage dividends or refunds to that the average patron receiving scrip will, in effect, be given the cash to pay his tax on his patronage dividend or refund.

We support that portion of the President's recommendation which proposes that

*the law be clarified so that all earnings are taxable to either the cooperatives or to their patrons * * *.

We cannot agree with that portion of the President's recommendation that would require the patron to pay a tax on scrip if the term "scrip" is to be interpreted as broadly as indicated by Secretary Dillon in his testimony to this committee on May 3, 1961.

Also, we oppose the application of a withholding tax on patronage dividends of cooperatives. We believe such an approach is unworkable. Furthermore, implementation of our recommendations would make withholding, in our opinion unnecessary.

Under our policy resolution, we recommend that as a condition for patronage dividends to be deductible by the cooperative, it shall be established that the written instrument evidencing such patronage dividend is of such legal quality that all members receiving it will be under a legal obligation to include the face amount thereof as gross income on their tax returns. In short, such scrip or written instrument shall give the member-patron such dominion or control over the funds as to meet the test of income taxability.

The real question at issue is whether or not the scrip referred to in President Kennedy's proposal, as interpreted by Secretary Dillon, will constitute taxable income to the patron.

Under the 16th amendment, Congress has the power

to lay and collect taxes on incomes, from whatever source derived *

The principle has long been recognized by the courts that what is not in fact income cannot be made income by legislative action, or by regulations of the legislative branch. This is an important sentence in our presentation.

Secretary Dillon in his testimony before this committee on May 3, 1961, pointed out that

several court decisions have nullified the intent of the 1951 legislation and have held that a patron does not realize income on scrip having no market value.

For example, in the Carpenter case (1955) the U.S. Court of

70510 0-61—pt. 3- -26

Appeals for the Fifth Circuit held that the revolving fund certificates under consideration in that case did not constitute income to the patron. The court states:

It is fundamental in income taxation that before a cash basis taxpayer may be charged with the receipt of income he must receive cash or property having a fair market value, or such cash or property must be unqualifiedly subject to his demand (219 Fed. 2d 635).

In the Long Poultry Farms case (1957) the U.S. Court of Appeals for the Fourth Circuit commented as follows:

It is argued that under implied agreement arising out of the provisions of the bylaws taxpayer in effect received in cash the amount of the credit and reinvested it in the revolving fund of the cooperative; but this is simply to exalt fiction and ignore reality.

To require the inclusion in income of contingent credits, such as are here involved, would be to require the patrons of cooperatives to pay tax upon income which they have not received, over which they have been given no control and which they may never receive. Apart from the question of constitutionality of such a requirement, which would be a serious one, it is safe assumption that Congress never intended to impose upon the patrons of cooperatives the hardship and burden which the taxability of these contingent credits would involve (249 Fed. 2d 726).

The Court of Appeals in the Ninth Circuit has held similarly Caswell's Estate v. Commissioner, 211 Fed. 2d, 693 (1954). Moe v. Earle, 226 Fed. 2d 583 (1955)).

Secretary Dillon in his testimony before this committee indicated that the court cases which refused to accept the "immediate reinvestment theory" can be overcome if Congress makes it clear

that the patron is now required by statute to include both cash and scrip allocations in income.

The Secretary reasoned that the patron, being cognizant of such amendments to the law, will have consented to this method of taxation at the time he enters into transactions with the cooperative. We doubt whether the courts will sustain this view.

In this connection, it is respect fully urged that the committee consider the most recent statement of the U.S. Supreme Court of what constitutes taxable income. In the case of Eugene C. James v. United States (No. 53, May 15, 1961) the Court held:

The starting point in all cases dealing with the question of the scope of what is included in "gross income" begins with the basic premise that the purpose of Congress was "to use the full measure of its taxing power" (Helvering v. Clifford, 390 U.S. 331, 334). And the Court has given a liberal construction to the broad phraseology of the "gross income" definition statutes in recognition of the intention of Congress to tax all gains except those specifically exempted (Commissioner v. Jacobson, 33y U.S. 28, 49; Helvering v. Stockholms Enskilda Bank, 293 U.S. 84, 87-91). The language of section 22(a) of the 1939 Code, "gains or profits and income derived from any source whatever." and the more simplified language of section 61(a) of the 1954 Code, “all income from whatever source derived," has been held to encompass all "acces sions to wealth, clearly realized, and over which the taxpayers have complete dominion" (Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431). A gain "constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it” (Rutkin v. United States, supra, at p. 137).

This, we would like to point out is an opinion of the Supreme Court last week and has been given since Secretary Dillon's appearance before this committee.

It is important to note that the Supreme Court continues to place emphasis on certain basic criteria for determining taxable incomenamely, the income must be

clearly realized, and over which the taxpayers have complete dominion. its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it.

This is a clear-cut statement by the Court. We respectfully submit that any "scrip" issued by a cooperative must satisfy these standards. to constitute taxable income to the patron.

In our opinion, patrons and members of the cooperatives will resist-and resent-efforts to pass along to them a tax liability which is not clearly their responsibility and which may place them in jeopardy of prosecution for failure to report such "scrip" as income.

On the other hand, farmers will welcome a clarification of the tax laws which will enable their cooperatives to develop a sound program for handling patronage dividends that will be in the best interests of the cooperative and the patrons.

We wish to emphasize again that such programs must adhere to the funndamental principle that a patron shall not be required to pay a tax on “scrip" if it is not of such legal quality that all members receiving it will be under a legal obligation to include the face. amount thereof as gross income on their tax returns.

We believe that the committee will be on the strongest ground if it develops legislation based upon what the courts have construed to be taxable income. It will not be in the best interests of cooperatives or their members to subject them to another long period of litigation.

Our policy resolution recommends that as a condition for deductibility, the cooperative association shall certify to the Internal Revenue Service that its written instrument is of such "legal quality."

The purpose of this requirement is to place the burden of proof in this regard on the cooperative rather than on the individual patron. It should be borne in mind that in many instances patronage dividends are small in amount. It would be impractical for the recipient to make any real legal test of whether the "scrip" is legally taxable. Since the cooperative is operating in the best interest of its members, it can-as one taxpayer-more appropriately establish the legal quality of such noncash payments.

Earlier in this statement, we commented briefly on the President's recommendation to apply a withholding tax to patronage dividends, both cash and scrip. As will be noted from the reading of our resolution, "We oppose the application of a withholding tax to the dividends of corporations, including cooperatives." This has been a policy position of the Farm Bureau for many years.

The withholding of taxes on patronage dividends, including written instruments or scrip, is not comparable to the withholding of tax on salaries and wages. The withholding on salaries and wages, modified by the number of exemptions, permits the withholding to be adjusted somewhat in line with the probable tax liability of the taxpayer. Of course, this is impractical with respect to patronage dividends, as it is also with respect to corporate dividends. In the case of cooperatives, these payments are generally small in amount and likewise are a small percentage of the taxpayer's gross income.