dubious as a matter of law, but in fact cannot be supported by the Supreme Court of the United States without upsetting most fundamental constitutional principles in the income tax field. The question presented by the Secretary's proposal is whether an individual shareholder or member of a widely held domestic corporation, not controlled by such individual, can be constitutionally taxed on undistributed profits of the corporation. That this is precisely the legal problem presented by the Secretary's proposal is fully recognized in exhibit VII of the Secretary's statement of May 3; exhibit VII being the detailed discussion of the tax recommendation regarding cooperatives. On page 10 of exhibit VII as released to the press, it is stated that the Secretary's proposal involves the considerations presented by the question whether it is constitutional to tax stockholders of a corporation on their shares of undistributed profits of a corporation. The statement goes on to say that The courts have held such a tax constitutional. Therefore *** they would uphold the proposal, With all due respect to the Treasury's legal staff, this is a fundamentally inaccurate representation, in this context, of the Supreme Court decisions on the subject. We feel obliged to point out this basic legal error to the committee so that it will not formulate legislation in this field under a misconception of the legal difficulties surrounding any such proposal. In fact, the courts have never held such a tax constitutional. Indeed, they have held exactly the reverse. The Secretary's exhibit VII, on page 11 as released to the press, continues with a brief exposition of the decided cases. The first decision cited is the landmark case of Eisner v. Macomber, 252 U.S. 180 (1920). This decision held the direct opposite of the Secretary's proposal. The court there held that a stock dividend, that is, a dividend in stock, did not represent a distribution of profits to a shareholder and therefore was not income to him in the constitutional sense. These were dividend shares, moreover, of the Standard Oil Co. of California; and they had a readily realizable value upon established stock exchanges far more tangible than any uncollectible book credit of a cooperative. Nevertheless, the court said that the stock dividend represented a mere bookkeeping credit of surplus earnings to the shareholder's capital interest in the corporation, and did not distribute any such earnings to him. This is precisely the case when a cooperative patron is credited on the cooperative's books with a share of undistributed earnings. The language used by the Supreme Court is so remarkably descriptive of the situation of the cooperative patron that it merits a brief quotation, and I quote from Justice Pitney's opinion in Eisner v. Macomber. The essential and controlling fact is that the stockholder has received nothing out of the company's assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have resulted from employment of his money * * * still remain *** subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and not to form, he has received nothing that answers the definition of "income" within the meaning of the 16th amendment * * No statement from the Supreme Court could more clearly show that earnings merely allocated on its books by a cooperative corporation are not income of its shareholders or members within the taxing power of Congress. The Secretary's exposition of this matter in exhibit VII admits that the case of Eisner v. Macomber "casts doubt" on his proposal, as he puts it, which seems to us a remarkable understatement, but hazards a guess that the Supreme Court would view the matter differently today. This prediction is said to be based on subsequent decisions which indicate clearly that this would be the result. But the decisions cited hardly bear this out. They consist of but three essentially irrelevant cases: (1) First is Heiner v. Mellon, 304 U.S. 271 (1938), decided nearly 25 years ago and dealing not with a corporation at all, but with a partnership. It has always been recognized that partners are taxable upon partnership income, whether or not distributed. (2) The second is Helvering v. National Grocery Co., 304 U.S. 282 (1938), also decided nearly 25 years ago, which involved not the stockholder's liability at all, but the corporation's liability for the surtax on improperly accumulated surplus. The Court, in suggesting by way of dictum that Congress might have instead taxed the improperly accumulated earnings to the corporation's single stockholder, pointed out that the shareholder there involved was the sole owner of the business, which means that he had complete control of the corporate earnings at all times. This certainly is no precedent for taxing one of a thousand patrons of a cooperative on his share of accumulated earnings needed in the business, properly accumulated, and entirely beyond the reach of the patron even though he may want them badly. (3) The third and last decision cited by the Secretary was decided not by the Supreme Court but by the second circuit 18 years ago Eder v. Commissioner, 138 F. 2d 27 (2d Cir. 1943). This decision upheld the special penalty tax on the income of foreign personal holding companies, attributing such income ratably to its American shareholders. But this, by definition, is also a case of taxing a mere handful of persons, to whom the earnings of their corporation are fully available at will, on such earnings in order to prevent tax avoidance by cloaking income in foreign corporations. The Secretary also failed to mention that the courts have refused to do even this in cases where the earnings are not in fact accessible to the shareholders. Alvord v. Commissioner, 277 F. 2d 713 (4th Cir. 1960). It seems to us that these decisions which were cited by the Secretary in support of the proposition that the Supreme Court would now tax members on cooperative allocations are a far cry from holdingas represented in the Secretary's statement-that Congress may constitutionally tax shareholders generally on undistributed corporate earnings; or that they provide any basis for believing that the Supreme Court would overrule Eisner v. Macomber today. The Secretary's prediction also overlooks, much too freely in our opinion, the fact that Eisner v. Macomber has been cited by the Supreme Court and other courts more than 750 times, indeed, on scores of occasions subsequent to all three cases relied upon by the Secretary to support his belief that Eisner v. Macomber has lost its vitality as a judicial precedent. Beyond that, it is transparently plain that the doctrine of Eisner v. Macomber, requiring a receipt of true economic substance-something more than a mere book allocation-before taxable income arises, is basic to our entire income tax structure and to literally thousands of tax decisions on the books in an endless variety of situations. Nothing could create more havoc in the tax field than summarily to abandon this doctrine. We are sure that the committee is aware that Congress has no power whatsoever to enlarge the concept of "taxable income" as defined by the courts and as used in the 16th amendment. Congress may narrow the definition, and tax less than it might have; but cannot expand the term beyond its meaning as used in the amendment to the Constitution authorizing the income tax. Moreover, we do not feel it is a proper approach to the cooperative tax problem to plunge the Treasury and millions of cooperative patrons into a battle of constitutional law which would leave the situation for a period of years fully as confused as it presently is; and almost certainly result in an invalidation of the statute and the necessity of once more facing up to the task of achieving a sound and equitable legislative solution. The Secretary's approach is simply not a constructive approach. The testing of law school theories on the reach of constitutional doctrine had better be confined to law school debate, at least until some much more urgent policy considerations appear than are involved here. It is fallacious, too, to suggest that the injection of the withholding mechanism of collecting the asserted tax liability in some way improves its chance of constitutional survival. The imposition of a withholding tax does not decide in any degree the question whether the person for whose account the tax is remitted to the Treasury, actually owes the tax. If he does not owe it, the withheld tax must be refunded; and the mere fact that it has been collected will not establish liability for it. The most mileage that can be gotten out of the withholding feature is that it may be tantamount to a 20-percent cash distribution since the economic benefit of the withheld tax is available to the patron as a credit or refund in respect to his overall income tax liability. As such, the withheld tax probably should be taxed to the patron as income. But this does not solve to any extent the question of his tax liability on margins allocated, but not actually distributed. The Secretary did not suggest that these legal difficulties could be overcome by having the patron consent in advance to the retention of the earnings by the cooperative as additional capital credited to his account. We take it from this that he recognizes the clear fact that this question has already been squarely decided in the negative by the courts, as anyone who carefully reads Long Poultry Farms, Inc. v. Commissioner, 249 F. 2d 726 (1957), will readily see. It would add nothing to enact a statute along such lines, for the court there found as a matter of fundamental law that no income is created by such a consent, simply because it is totally unrealistic to suppose that, absent the consent, the earnings in question would, in fact, have been handed over to the patron for his separate use. This, said the court, would "exalt fiction and ignore reality." There is, perhaps, one way that the legal difficulties which permeate the Secretary's proposal might be cured. This would be to tax the patron only if he is, in fact, receiving cash distributions; or if he, in good faith and without contrary pressures, is given the right, after the earnings have arisen, to take them in cash if he so chooses. The latter, would make him taxable in the absence of a real distribution. This is the least that must be inserted in the Secretary's proposal to make it feasible, viewed simply as a legal matter. But we repeat, as we have so often said in hearings on this question, that we do not understand the great urge to transfer the tax burden from the cooperative, which has produced and in fact is enjoying the income, to the backs of the patrons who have as yet received nothing—even if an ingenious device can be found to do this successfully as a matter of law. Someone should speak here for the millions of Americans who would thus be asked to pay taxes without receiving income—a novel and, we think, dangerous policy to introduce into the tax system. It is a policy which can only breed contempt for the self-assessing principle of our income tax, and would doubtless stir up a great deal of thoroughly justified resentment over the enactment of such a statute. This is to say nothing of the resentment of thousands of medium and small business proprietors who are struggling against cooperative competition and who would in no way be assisted by the Secretary's proposal. We still believe that our own solution to this whole problem, analyzed in detail at pages 130 to 142 of the record of the hearings of this committee on February 2, 1960, is equitable, sound, and simple. This is to attach the tax where the income in fact is. not some place else. To the extent that a cooperative retains its earnings it should be taxable on them. To the extent it actually distributes its earnings, excuse it from tax on the ground that to this extent it is in fact functioning like a cooperative; but in such case the patron, who has then, and only then, received a real distribution, should bear the tax. We note with considerable interest that the Under Secretary of Agriculture, Mr. Charles S. Murphy, in his testimony before the committee on May 8, 1961, apparently supported this very solution of the problem. He visualized three situations, and the proper tax results, with respect to the distribution of margins to patrons, as follows: (1) That no part of the net margins be distributed to them, which would mean that the cooperative would then have to pay the full tax; or (2) That some part of the margins be distributed and some part retained, which would mean that part of the tax would be paid by the cooperative and part would be paid by the members; or (3) That the entire net margins be distributed, which would mean that the entire tax would be paid by the members. This is precisely where we think the committee should come out in its solution of this problem; but in doing so it should not accept any ill-concealed fiction that mere book allocations are real distributions. Thank you very much. I appreciate the opportunity of appearing and your courtesy in letting me substitute for Mr. Bryson. While I cannot pretend to be as well versed in this subject as he is, if there are any questions from the committee, I would be happy to attempt to answer them. (Letters and organization list referred to follow.) ASSOCIATIONS AND PROFESSIONAL GROUPS ENDORSING THE STATEMENT OF American Association of Small Business. American Industrial Bankers Association. Civic Association of America. Farm Equipment Wholesalers Association. Material Handling Equipment Distributors Association. National Appliance and Radio-Television Dealers Association. National Association of Refrigerated Warehouses, Inc. National Association of Wholesalers. Air Conditioning & Refrigeration Wholesalers. Hobby Industry Association of America. Laundry & Cleaners Allied Trades Association. National-American Wholesale Lumber Association. National Association of Electrical Distributors. National Association of Musical Merchandise Wholesalers. National Building Material Distributors Association. National Candy Wholesalers Association, Inc. National Electronic Distributors Association. National Food Distributors Association. National Frozen Food Association, Inc. National Paper Trade Association, Inc. National Wholesale Druggists Association. National Wholesale Furniture Association. Northamerican Heating & Airconditioning Wholesalers. Optical Wholesalers National Association. Sporting Goods Jobbers Association, Toy Wholesalers' Association of America. Wallcovering Wholesalers Association. Wholesale Stationers Association. National Pickle Packers Association. National Retail Farm Equipment Association (represents 33 State and regional associations). National Retail Furniture Association. National Retail Hardware Association. Alabama Retail Hardware Association. |