ward to seeing you. We hope that this will be the last time we need your service. We hope we can get it resolved. Mr. RUMBLE. So do I. May I ask, Mr. Chairman, whether or not my statement, the statement submitted in 1959, and the statement submitted at the last hearing, including the memorandum I submitted on the legal question, will be available to the committee? The CHAIRMAN. Yes, it will be. It will not be necessary to make it a part of this hearing, though, but it will be available, and if you omitted any part of your statement, it should be pointed out that your entire statement will be included in the record. Mr. RUMBLE. Thank you. The CHAIRMAN. Are there any questions of Mr. Rumble? The CHAIRMAN. Mr. Rumble, let me ask you one question. I have had a little difficulty with the suggestion that has been made by someone that there is a simple solution to this whole problem by merely imposing a tax upon the patron for those cash allocations to the patron and a tax upon the cooperative for that which is not paid in cash. Just this question occurs to my mind. Let's assume a situation that may, as a matter of fact, be not the usual situation, but that may be a prevalent situation. A $100 is earned by the cooperative. The cooperative decides to distribute in cash in the year affected by those earnings $50 and to retain $50. At the same time the cooperative reaches back and distributes $50 that was earned 10 years before but which had been retained. Now, is there any question, actually, about the taxation of that $100 in the hands of the patron and the $50 in the hands of the cooperative? Does it constitute a determination of income that year, or is it a taxation upon more than the income of the cooperative in that year? Mr. RUMBLE. I should think it would be the taxation more by the amount they reached back and took. The CHAIRMAN. What would we do then with respect to the back years if we should adopt that theory? Certainly we could not just blandly say that we shall tax the amounts that are retained in the hands of the cooperative and the amounts disbursed in cash to the patron without having a considerable doubling of revenues for tax purposes in the hands of one or the other. Isn't that possible? Mr. RUMBLE. I suppose it is possible, but, Mr. Chairman, of course I don't know how all co-ops operate. I only really know how they operate up in my country. You couldn't do that where I come from because our patrons have always reported their distributions, cash and paper, as current income in the year in which received. There may be areas where what you suggest could happen. The CHAIRMAN. Actually what I am getting to is this: If we started new, get the facts, and we say that from here on out with respect to each taxable year those amounts that are held by the cooperative will be taxed to the cooperative and those amounts that are paid out in cash to the patrons will be taxed in the hands of the patrons, we would have completely disregarded the fact that some of what is paid to the patron in that particular taxable year may have resulted from earnings of previous years and there may be all together involved 50 percent more than was earned in the one taxable year than is being subject to tax in that year. Mr. RUMBLE. That could happen. say. The CHAIRMAN. If the committee should go that route it is not as simple as has been portrayed to the committee by some of the wit nesses. Mr. RUMBLE. I don't think it is at all. You really have a problem there. Of course, I don't want anybody to think that by answering as I have here I would favor any such method of taxation. The CHAIRMAN. No, I understand that. I am not recommending it. I am just pointing out that certain witnesses have said to us that that represents a very simple solution of this whole problem, but I think a simpler solution is to be found in making the 1951 act effective and making the act carry out fully the intentions that Congress had with respect to that enactment. I believe that is the simpler way to go. Mr. RUMBLE. I think it is the only simple way to go. The CHAIRMAN. Any further questions? Mr. King? Mr. KING. Mr. Rumble, I have been prompted to consider a recent Supreme Court decision that held the proceeds of embezzlement to be taxable income. Doesn't that cast some doubt on the validity of the argument against taxing co-ops and their retained earnings, or does it? Does that not reverse previous decisions? Mr. RUMBLE. It certainly reverses the previous decisions in the Supreme Court which said they weren't taxable. Now they have turned it right upside down and go the other way. Mr. KING. Is that one of the reasons you say that no man could predict what the Supreme Court would do? Mr. RUMBLE. Well, I suppose you are pressed for time. I would like to talk a little bit about that but I had better not. I don't know, Mr. King, whether you are a lawyer or not. Mr. KING. I am not. Mr. RUMBLE. The chairman is a lawyer. Mr. KING. A good one. Mr. RUMBLE. I am sure he is. Mr. Mason I don't think is a lawyer. Mr. MASON. No, sir. He is a teacher. Mr. RUMBLE. Oh, that is completely different, but I will just say to you, and Mr. Mills knows it is true, in respect to this constitutional question, you could get six lawyers up at this table and ask them how many letters there are in the alphabet, and you would get six different answers, and I never saw it fail. Did you, Mr. Mills? Mr. MILLS. Never. Mr. KING. What makes them that way, Mr. Rumble? The CHAIRMAN. Thank you again, Mr. Rumble. Thank you very much. Mr. Smith, Mr. Smith, and Mr. Schroeder. Maybe I should have said Mr. Smith, Mr. Schroeder, and Mr. Smith. Mr. Wilmer Smith, are you the one to make the statement? STATEMENTS OF WILMER SMITH, HORACE SMITH, AND BRUNO SCHROEDER, IN BEHALF OF THE TEXAS FEDERATION OF COOPERATIVES AND THE PLAINS COOPERATIVE OIL MILL Mr. WILMER SMITH. Mr. Schroeder will introduce the statement and then I will make one; yes, sir. The CHAIRMAN. Mr. Schroeder, you are recognized, then, to proceed as you desire. Identify yourself for the record and the other two, if you will. Mr. SCHROEDER. Yes, sir. May I say, Mr. Chairman and members of this committee, that we are appreciative of the opportunity to appear here before you. I am Bruno Schroeder from Austin, Tex., executive vice president of the Texas Federation of Cooperatives. The federation is a conference body of agricultural farmer cooperatives in Texas made up of approximately 500 local and regional farmer cooperatives with more than 200,000 farm families as patron members of these local and regional cooperatives. I, myself, will not make a formal statement to this committee. I have with me here two members of the board of directors of the Texas Federation of Cooperatives. Mr. Wilmer Smith will speak for the federation and Mr. Horace Smith will speak for himself, so with the committee's permission, I would like to introduce to you, and I don't think he needs an introduction to most of you, Mr. Wilmer Smith from New Home, Tex. The CHAIRMAN. Mr. Smith, we are pleased to have you with us today, sir, and you are recognized. Mr. WILMER SMITH. My name is Wilmer Smith. I live in New Home, Lynn County, Tex. I am a farmer, gaining all of my income from the production of cotton and grain, and am a member and stockholder of the New Home Cooperative Gin. I am also a member of the board of directors of the Texas Federation of Cooperatives on whose behalf I appear today. The Texas Federation of Cooperatives is an organization composed of 525 farmer-owned marketing, purchasing, and service cooperative associations in the State of Texas having a combined individual membership of some 250,000 or more farm families. During the 1st session of the 80th Congress, hearings were held before the Committee on Ways and Means of the House of Representatives in connection with proposed revisions to the Internal Revenue Code as it applied to cooperative organizations. Part 4 of the published record of those hearings contains a number of statements presented on behalf of cooperative organizations as well as statements on behalf of those who were opposed to the principles advocated by the cooperatives. The positions taken by both groups were thoroughly founded upon exhaustive research. Although the documented testimony and evidence consumed several hundred pages of printed matter the fundamental issue then, as at this time, related to the nature of patronage refunds made by cooperative organizations and the point at which the funds represented by such patronage refunds should be taxed. All other points at issue are inconsequential by comparison. The position taken by the cooperatives in those hearings, and which was then supported by court decisions and government regulations, may be summarized briefly as follows: 1. That it is legally permissible for a cooperative or other corporation to become bound by contract, to refund to its patrons the margins made on the business done with or for them, over and above cost of operation. 2. That in such cases the contractual relationship may encompass a legal obligation on the part of the patrons to reinvest in the capital of the corporate entity all or a part of the patronage refunds representing such margins. 3. That when such a contractual relationship exists, the margins made on such business become the property of the patrons and do not constitute taxable income to the corporate entity. 4. That where a patron has so contracted to reinvest his patronage refunds in the capital of the cooperative, all patronage refunds made to him in the form of capital stock, revolving fund certificates, certificates of indebtedness, certificates of equity, book credits, or other noncash media constitute taxable income to the patron in the taxable year in which he receives evidence thereof or notice of the allocation, in the dollar amount of such refund. These basic principles have been under attack by critics of cooperative organizations for many years. Those attacks were responsible for the hearings before the 80th and 82d Congresses and later hearings just as they are in large measure responsible for the hearings here today. Following the hearings above mentioned, Congress passed the Revenue Act of 1951. In that act, section 101 (12) of the Internal Revenue Code of 1939, which related to farmer cooperative associations, was amended by adding the provisions incorporated in section 101 (12) (b) of that act. This added section related specifically to patronage refunds and set forth the requirements which must be complied with by farmer cooperatives if the amounts represented by such patronage refunds were to be excludable from income to the corporate entity. Sections 101(12) (a) and (b) of the Internal Revenue Code of 1939, as amended, are now sections 521 and 522 of the Internal Revenue Code of 1954. Section 522 of the Internal Revenue Code provides that regardless of the manner in which patronage refunds are made to patrons, the cooperative must disclose to each patron the dollar amount of such dividend or rebate if it is to be permitted to exclude the amount from its income. It is also of interest to note that in section 314 of the Revenue Act of 1951 that portion of the code relating to information returns was amended by adding a subsection (f) which required each corporation making patronage rebates or refunds amounting to $100 or more during the calendar year, whether in cash or noncash media, to report the same on information returns. Undoubtedly, this was to enable the Internal Revenue Service to verify the fact that such amounts were taken into income by the individual recipients when making their income tax returns. This would seem to indicate that it was the clear intention of Congress to provide for the collection of a single tax on all income developed by farmers through their cooperatives during the taxable year in which such income was created, and that the tax should be levied at the patron's level. This view was taken by the Internal Revenue Service when it adopted section 39-22(a)-23 of Income Tax Regulations No. 118. That regulation, among other things, provided that allocations of patronage refunds in the form of capital stock, revolving fund certificates, letters of advice or similar documents were taxable to the recipient at the face amount of such documents, if made in fulfillment and satisfaction of a preexisting valid obligation of such association to the patron. However, it might be pointed out that the sense of this regulation was not new. This is indicated by a statement made by the Internal Revenue Service in Revenue Ruling 54–10 with respect to regulation 39-22(a)-23 and the treatment of patronage refunds, which reads: These provisions as to the tax treatment of allocations in the hands of the patron where there is a contractual obligation involved do not represent a departure from rules previously in effect, but set forth in regulation form a policy of the Service which has been long established. While the amendment to the Revenue Act of 1951 carried into the Internal Revenue Code provisions for the treatment of the patronage refunds of cooperative associations at the corporate level, it did not contain any amendment to the code which might deal specifically with the treatment of noncash patronage refunds in the hands of the patron. This, we feel, is perhaps the fundamental reason for the line of court decisions which permitted certain recipients of noncash patronge refunds to take them into income at "fair market value" instead of at the face or stated dollar amount of the refunds. This enabled those recipients to successfully challenge section 39-22(a)-23 of the income tax regulations. The Internal Revenue Service then capitulated and amended its regulations to conform with the holdings of the courts. There was thus created the paradoxical situation now existing which enables a cooperative organization to exclude from income patronage refunds made in noncash form and, on the other hand, enables the recipient thereof to take such refunds into income at the fair market value, which may be quite normal. The cooperatives in Texas, through their delegates in the Texas Federation of Cooperatives, are opposed to any legislation which would destroy the four fundamental principles of cooperative endeavor set forth in the early part of this statement. It is our position that margins made by cooperatives in their operations should be taxed but that the tax should be based upon the patronage refunds at the patrons' level and that such tax should be computed on the basis of the stated dollar value of patronage refunds which are made in noncash media. We feel that the present state of confusion with respect to the taxation of farmer cooperative associations and the patronage refunds made by them can be clarified by amending the Internal Revenue Code so as to require all patrons receiving noncash patronage refunds to include them in their income at face or stated dollar amount in the taxable year of the recipient in which notice of the allocation is received. This can be accomplished by amending part 2 of subchapter B of chapter 1 of subtitle A of the Internal Revenue Code of 1954 by add |