So the committee is faced with what one might term following the safe rule of present regulations in taxing patrons and following an unsafe rule. I find myself in agreement with many of the things said and points made by the Farm Bureau spokesmen with respect to taxing patrons on no market value scrip and I shall omit some of the things I intended to say in view of that testimony. I shall point out a couple of considerations.

First, the word "insure" in the Secretary's statement cannot be ignored. The one loophole in issue, "patronage scrip," is proposed to be dealt with. This scrip is presently taxable, as I pointed out, to no one when it has no fair market value. If it has a fair market value, but less than face amount, the difference is taxable to no one. That is the rule under the existing regulations. You cannot "insure" that the patron can be taxed in these cases. But you can insure that the cooperative can be taxed where the patron is not taxed.

This approach would be a safe method of achieving the purpose of the 1951 law and the general recommendation of the President for speedy legislation, as it would conform to the court decisions and would at the same time insure that either the cooperative or patron would be liable currently for tax on all cooperative earnings.

It would also afford a sound basis for putting into effect the President's proposed withholding tax. Withholding would be limited to amounts which must be taken into account in computing his taxable income by the per on whose funds are withheld.

Another safe approach-that of recognizing patronage allocations for tax purposes only when paid in cash, would likewise be a legally safe and administratively simpler approach than the market-value rule presently applied by the Internal Revenue Service in taxing patrons.

There is no question but that Congress can limit items which shall be deductible in taxing the cooperative. Of course, Congress can relieve the patron of the tax liability on any type of noncash item until it is sold by the recipient or redeemed by the issuing cooperative.

A most unsafe approach, as has already been tried and abandoned, is to again attempt to tax the patron on receipt of cooperative corporation scrip regardless of its market value, or even its lack of any market value, just as if its face amount in cash had been received by the patron. This would be an attempt to do by statute what had been for many years prescribed by regulations of such long standing that they had achieved the force and effect of statute, but which had to be abandoned.

To comply with the circuit court of appeal's decisions holding that receipt of no market value scrip was not receipt of income, it is my belief that no such statute could any more make income out of what is not income than did the regulations themselves. The proposal, to attempt to do this by statute, is subject to grave question.

The Secretary has indicated that it would be fair to insure the revenues and carry out the 1951 intention that all cooperative earnings be taxed, if you specifically limit co-op tax escape by issuing scrip to the extent the patron is actually liable for tax on its receipt.

The Secretary did indicate that he thought his plan was preferable, which is an opinion to which he is entitled. But we think that the tax provision that I am going to refer to in a moment is an appropriate

safeguard to his plan if it is determined by this committee that his plan be accepted and an attempt made to tax the farmer on amounts that he does not have and cannot demand.

Now, the risk I have referred to, if the courts do end up applying the market value rule again, despite a statutory attempt to tax patrons on a face value basis is zero if the cooperative sees to it that its scrip is worth par when issued. No cooperative which did this by providing the necessary certainty of payment and return for the use of funds would suffer in the event the courts stand by their marketvalue rule.

May I remark that several of the devices that the Farm Bureau spokesman mentioned would insure that the cooperative would not get in trouble. For example, if there is a short redemption period, the court would likely hold that the paper that he got is worth substantially the amount that he could get it redeemed for. If the patron is offered the alternative of cash or scrip, he can be taxed on the cash. The risk, otherwise, we believe, will depend on the market value, if any, of the scrip at the time issued to the patron. If the market value when the scrip is issued is 80 percent of the face amount and the patron is taxable only on this 80 percent, the cooperative should be taxed on the other 20 percent-that is the risk that it has deliberately assumed. If the cooperative is willing to gamble that courts will sustain taxing the farmer on receipt of no market value scrip, such as that I shall shortly describe, it should assume the risk of paying on the entire face value of the scrip if the courts stand by their decisions and hold that the patron is not taxable on receipt of such scrip.

Let us consider one example of the officially recommended scrip. Presently a co-op acting under bylaws officially suggested by the U.S. Department of Agriculture can retain its earnings tax free by notifying patrons that amounts, based on their respective volumes of patronage have been set up on its books, as their contributions to its capital. They may be sent a certificate. A recommended form is found on page 327 of Farmer Cooperative Service Bulletin 10, January 1958, U.S. Department of Agriculture.

This recommended certificate states that the person namedhas furnished $

ditions:

to the association as capital, subject to the following con

(1) This and other revolving-fund certificates of the same series are retireable in the sole discretion of the board of directors.

(2) The amount stated in this certificate shall bear no interest.

(3) The certificate is transferable only on the books of the association. (4) This and other certificates shall be junior and subordinate to all other debts * * upon the winding up liquidation * * * all certificates shall be retired in the order provided in the by-laws and shall be paid in full or on a prorata basis without priority..

The suggested bylaws are found on page 324 of the Bulletin 10 and provide that on dissolution, after payment of all debts

Holders * of preferred stock shall first be paid *** Holders of shares of common stock shall next be paid *** Holders of credits in the revolving fund shall then paid.

Certificate holders are truly low men on this fiscal totem pole.

It is obvious why the suggestion is made (page 228 of Bulletin 10):

Whether blue sky laws of a given State are applicable to revolving fund or other like certificates is a question which should be inquired into in any instance.

As stated on the same page of USDA Bulletin:

Courts have not infrequently been perplexed as to the character of particular forms of certificates which were before them, primarily because of their hybrid character and their ambiguous provisions ***

I have never heard a co-op spokesman assert that receipt of one of these certificates is the same as receipt of its face amount in income. Nor do the co-op bylaws state this.

Instead, in various ways they try to spell out a fantasy that the patron has in effect received cash in the face amount of the certificate, or book entry, and has then invested it in the capital of the co-op, receiving the certificate or notice of the book entry as evidence of this investment.

In my opinion the risk is very grave that courts will still refuse to tax a patron on the face value of items of this kind. If the committee decides that cooperatives want this attempted by statute, and that certainly might not include a great many of them, to preserve their present tax deductions, the next question is whether the cooperatives are willing to underwrite this grave risk, and thus insure carrying out the intent of the 1951 law that all cooperative earnings be taxed currently to the cooperative or to the farmer.

In framing statutory provisions respecting tax treatment of scripdefined to include letters of advice, revolving fund certificates, et cetera-we suggest that the basic rule laid down should be when and to what extent the patron is to be taxed on receipt of the scrip. That is the focal point. That is the place of beginning.

The provision as to tax deductibility, if any, of scrip by the co-op, should be defined to permit such deductibility only if, and to the extent the patron is actually liable to tax on the scrip's receipt.

If, as the Secretary suggests, you are to attempt to tax the patron on receipt of scrip on the basis of its face amount, the provision should be specific as to what happens if the courts refuse to follow this statutory provision. So we recommend you should also provide in substance that:

If it is hereafter determined by, or as a result of, court actions, that receipt of scrip need not be taken into account in its face amount in computing the patron's taxes, such scrip shall be taken into account by such patrons only to the extent of its fair market value, if any, at the time of receipt.

The provision respecting the deduction of scrip in computing the taxable income of cooperatives would then state that the cooperative could deduct only such amounts, if any, for currently issued scrip, as must be taken into account by recipients of such scrip in computing their taxable income.

Might I point out in conclusion, the importance of this type of provision?

In the first place, there is a basic unfairness in the face value rule. The U.S. Government issues two kinds of scrip, or shall we say bonds. One is sold at or near face amount. The other, the E-bonds, are sold at 75 percent of face amount. Both are equally safe. The E-bond is payable in face amount in seven years and nine months. It has several added attractions which co-op scrip lacks. Co-op scrip of the kind I have described, has no fixed date of payment, no interest, and the very minimum kind of safety of principal. It could not be issued and

sold on the open market for anything like the 75 percent of face amount that E-bonds are sold for.

As the Secretary stated, the redemption period averages 9 or 10 years. If a co-op could purchase E-bonds and distribute them, the market value rule would apply to its tax, under the existing and, I am certain, under the proposed regulations. To permit under the proposed law deduction of its own no-market-value paper at par is contrary to economic sanity.

It is not even fair to the cooperative corporations that seek to issue paper which, like some Government bonds, can be issued and sold at par. These cooperatives expect to pay the going market rate for the use of the funds thus issued.

Any cooperative that is willing to assume that proper responsibility for acquiring capital can have a real value of par. The market value rule would not affect them. The risk of the market value rule being low or zero when it is undertaken by cooperatives that insist on retaining earnings tax free by issuing questionable paper, should be backed up by specific statutory provision seeing to it that they do, in fact, take that responsibility.

The CHAIRMAN. Professor Reed and Mr. Calhoun, we appreciate your discussion of this matter. We appreciate your coming to the committee.

Are there any questions of these gentlemen?

If not, we thank both of you.

Mr. REED. Thank you very much.

The CHAIRMAN. Our next witness at 2 o'clock this afternoon will be Mr. Brinkley.

Without objection, the committee will recess until 2 o'clock.

(Whereupon, at 12:40 p.m., the committee recessed, to reconvene at 2 p.m., the same day.)

AFTERNOON SESSION

The CHAIRMAN. The committee will please be in order.

Our first witness this afternoon is a friend and acquaintance of many, many years, Mr. Brinkley.

Mr. Brinkley, will you please come to the witness table and, for purposes of this record only because we know you quite well, identify yourself by giving us your name, address, and the capacity in which you appear.

STATEMENT OF HOMER L. BRINKLEY, EXECUTIVE VICE PRESIDENT, ACCOMPANIED BY L. JAMES HARMANSON, JR., GENERAL COUNSEL, NATIONAL COUNCIL OF FARMER COOPERATIVES, WASHINGTON, D.C.

Mr. BRINKLEY. Thank you, Mr. Chairman. I would like to ask first for the privilege of being accompanied by our general counsel, Mr. L. James Harmanson, Jr.

For the record, my name is Homer L. Brinkley, and I am executive vice president of the National Council of Farmer Cooperatives, 1616 H Street NW., Washington, D.C.

I appreciate the opportunity of presenting to your committee today the policy position of the Council and our views with respect to

the recommendations in the President's tax message, as supplemented by the Treasury Department's statement presented to your committee on May 3, 1961, pertaining to the tax treatment of farmer cooperatives and their patrons.

The CHAIRMAN. Mr. Brinkley, we appreciate having you and your chief counsel, both of whom we have known for a number of years. We welcome you and you are recognized.

Mr. BRINKLEY. Thank you, sir. My close association with the practical operations of farmer cooperatives extend over a period of more than 30 years, first as general manager of the American Rice Growers Cooperative Association, Lake Charles, La., and since 1952 in my present position. So I do not appear before your committee as a stranger to the problems and competitive factors attending the cooperative tax question.

For the information primarily of the newer members of the committee I would like to state that the Council is a national organization composed of 122 direct member organizations, all of which are farmerowned and farmer-controlled cooperative marketing and purchasing associations. Considering all of the separate local, county, State or regional cooperatives affiliated with these direct members, about 5,000 separate cooperative associations are represented in the Council membership serving approximately 2.75 million farmer memberships.

COUNCIL POSITION

We support that part of the President's recommendation that contemplates clarification or change in existing law to provide that the net earnings resulting from the business operations of a cooperative shall be subject to a single income tax; that the legal responsibility for the payment of the tax shall be upon the cooperative with respect to that portion of the net earnings, if any, which the cooperative is not under a legal obligation to distribute to its members, or other patrons, on a patronage basis; and that the legal responsibility for the payment of the tax, if any is owed, shall be upon the member, or other patron, with respect to that portion of the net earnings which the cooperative is under a legal obligation to distribute to its members, or other patrons, on a patronage basis. This latter responsibility under our policy and under the President's proposal, is not affected when the distribution is made in noncash form pursuant to provisions of the articles of incorporation, bylaws or separate agreements under which the member, or other patron, has agreed to invest a part or all of such patronage distributions, which we shall refer to as "patronage refunds," and which would in the absence of such provisions or agreements be paid in cash, in the capital of the association.

The general tenor of this part of the proposal is in accord with the principles and practices on which farmer cooperatives are organized and operate and represents adoption of the principles and recommendations advocated in testimony before your committee by the then presidents of the Council at the last two hearings on this subject on January 27, 1958, and February 2, 1960.

I would like to further supplement that statement with this interjection to comment briefly, as a nonlawyer, on the constitutional aspect of the Treasury's proposal which no doubt has given some members of this committ concern in the past.