It is true that Congress cannot convert into a corporation an organization which by the law of its State is deemed a partnership. But nothing in the Constitution precludes Congress from taxing as a corporation an association which, although unincorporated, transacts its business as if it were incorporated. The power of Congress so to tax associations is not affected by the fact that, under the law of a particular State, the association cannot hold title to property, or that its shareholders are individually liable for the association's debts, or that it is not recognized as a legal entity. Neither the conception of unincorporated associations prevailing under the local law, nor the relation under the law of the association to its shareholders, nor their relation to each other and to outsiders, is of legal significance as bearing upon the power of Congress to determine how and at what rate the income of the joint enterprise should be taxed.

This same principle has been followed by the Supreme Court in Commissioner v. Tower (327 U. S. 280 (1946)), Commissioner v. Lusthaus (327 U. S. 293 (1946)), and Commissioner v. Harmon (323 U. S. 44 (1944)).

It is also well established that a corporation cannot avoid tax by arguing that it is not an entity for tax purposes but is merely an agent of its owners (Moline Properties v. Commissioner, 319 U. S. 436 (1943), and National Carbide Corporation v. Commissioner, 336 U. S. 422 (1949)). In the Moline Properties case the Supreme Court said:

The doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the State of incorporation or to avoid or to comply with the demands of creditors or to serve the creator's personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity.

II. THE NET Margins oF THE COOPERATIVES ARE INCOME TO THEM WITHIN THE MEANING OF THE SIXTEENTH AMENDMENT AND MAY CONSTITUTIONALLY BE TAXED AS SUCH

A. THE FEDERAL TAXING POWER IS SUFFICIENTLY BROAD TO TAX COOPERATIVES' NET MARGINS

Perhaps the most concise definition of the Federal taxing power was laid down by the Supreme Court in Steward Machine Company v. Davis (301 U. S. 548 (1937)), in which the Court said:

The subject matter of taxation open to the power of the Congress is as comprehensive as that open to the power of the States, though the method of apportionment may at times be different. "The Congress shall have power to lay and collect taxes, duties, imposts, and excises" (art. 1, sec. 8). If the tax is a direct one, it shall be apportioned according to the census or enumeration. If it is a duty, impost, or excise, it shall be uniform throughout the United States. Together, these classes include every form of tax appropriate to sovereignty.

The power of Congress to tax income of all types without apportionment is derived from the sixteenth amendment:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration,

The definition of income has been broad. The leading case defining income under the sixteenth amendment is the case of Eisner v. Macomber (252 U. S. 189 (1920)). In this case the Supreme Court said:

The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. For the present purpose we require only a clear definition of the term "income"

as used in common speech, in order to determine its meaning in the amendment * *

After examining dictionaries in common use we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 "Income may be defined as the gain derived from capital, from labor, or from both combined," provided it be understood to include profit gained through a sale or conversion of capital assets

Congress has an equally broad power to determine, on practical grounds, to whom income should be taxed. This is illustrated by Burnet v. Wells (289 U. S. 670 (1933)) in which the Supreme Court held that Congress was within its constitutional power in subjecting the grantor of an irrevocable trust to tax on the income of the trust which the trustee used (pursuant to the directions of the trust instrument) for payment of insurance premiums on the life of the grantor. The Court's opinion in this case stated:

*

* Government in casting about for proper subjects of taxation is not confined by the traditional classification of interests or estates. It may tax not only ownership but any right or privilege that is a constituent of ownership. Liability may rest upon the enjoyment by the taxpayer of privileges and benefits so substantial and important as to make it reasonable and just to deal with him as if he were the owner, and to tax him on that basis. A margin must be allowed for the play of legislative judgment.

The only case in which the Supreme Court has passed on a Federal statute which taxes the net margins of a cooperative is the case of Penn Mutual Life Insurance Company v. Lederer (252 U. S. 523 (1920)). In this case the cooperative organization was a mutual life-insurance company which paid dividends to its policyholders both by applying the dividends against premium receipts due from the policyholders and by actual payment in cash. The mutual insurance company argued that its gross income should have been reduced, under the Revenue Act of 1913, by the amount of the dividends to policyholders which were paid in cash and not used by the policyholders in the payment of premiums. The Supreme Court, in an opinion by Justice Brandeis, held that, while the act permitted a reduction of gross receipts by the amount of any dividends applied by policyholders against premiums, it did not permit deduction of dividends paid in cash and not used in payment of premiums.

The Penn Mutual case deals with a situation where dividends to policyholders represented a mixture of two elements: (1) profit on the investment by the company of the insurance premiums placed with it, and (2) savings on the expense of insurance protection to the policyholders. Congress had chosen to define the latter element (the rebate element) as being limited to the dividends applied by policyholders to reduce their current premiums, and Congress had chosen to treat dividends paid in cash and not so applied as a part of the income element of the mutual company. The Supreme Court said that Congress made this distinction, not because it resulted in a technically perfect measure of the two elements, but simply because the difference between the two types of dividends to policyholders "may well have seemed to Congress sufficient to justify the application of different rules of taxation." The Court said that where the net cost of life insurance proves to be less than the premiums paid, "the difference may be regarded either as profit on the investment or as a saving in the expense of protection." This shows that Congress may use any reasonable standard in measuring the taxable income of

a cooperative, and the mere fact that the corporation is a cooperative does not impose a constitutional restraint on Congress in the measurement of its taxable income. This was true in the Penn Mutual case even though the dividends in question were paid out in cash.

A mutual life-insurance company like the Penn Mutual Co. operates on the same basic principles as an ordinary marketing cooperative. In the case of the marketing cooperative, the patron turns his goods over to the cooperative for processing and resale. He receives the price of the goods he sells to the cooperative plus a patronage dividend which represents the profit margin on the processing of these goods by the cooperative. The policyholder in the mutual insurance company turns over to the company his insurance premiums and eventually these premiums are returned in the form of the face amount of the policy. Meanwhile the policyholder receives dividends which represent a return on the investment the mutual insurance company has made on the premiums the policyholder paid in. The cooperative is under an obligation to pay its net profit margins from the processing of the goods to the patron and the mutual insurance company is under an obligation to pay to its policyholder the return on its investment of his premiums to the extent that this return exceeds the reserve requirements necessary to afford the policyholder insurance protection. The constitutional right of Congress to tax a mutual insurance company on its income before payment of such dividends to policyholders as unquestioned in the Penn Mutual case. In that case, the Court said:

The fact that the investment resulting in accumulation or dividend is made by a cooperative as distinguished from a capitalistic concern does not prevent the amount thereof being properly deemed a profit on the investment. Nor does the fact that the profit was earned by a cooperative concern afford basis for the argument that Congress did not intend to tax the profit. Congress exempted certain cooperative enterprises from all income taxation, among others, mutual savings banks; but, with the exception of fraternal beneficiary societies, it imposed in express terms such taxation upon "every insurance company."

In Morrissey v. Commissioner (296 U. S. 344 (1935)), the Supreme Court held that a trust, bearing a fiduciary relationship to its beneficiaries, may be taxed as a corporation if it is created as a medium for carrying on a business enterprise. It has also been held that a research organization established by casualty insurance companies, even though organized for nonprofit purposes, might be subjected to the corporate income tax if it could not meet the statutory requirements for exemption (Underwriter's Laboratories v. Commissioner, 135 F. (2d) 371 (1943)).

B. THE COOPERATIVES' NET MARGINS ARE INCOME TO THEM REGARDLESS OF PATRONAGE DIVIDEND CONTRACTS

As was pointed out above, a cooperative is a separate legal entity and taxable as a corporation. It is of course possible for a cooperative to act for others as an agent. However, in the typical case of a cooperative dealing with its members, it is not acting merely as their agent. As the Supreme Court indicated recently in the case of National Carbide Corporation v. Commissioner (336 U. S. 422 (1949)), some of the relevant considerations in determining whether a true agency exists are

whether the corporation operates in the name and for the account of the principal by its actions, transmits money received to the principal, and whether receipt of

income is attributable to the services of employees of the principal and to assete belonging to the principal

*

These considerations appear largely absent in the typical cooperative case. The employees of a cooperative are its employees and not the employees of the alleged principals, the members. Thus in Lake Region Packing Association v. United States (146 F. (2d) 157 (1944)), it was held that the cooperative was liable for unemployment compensation and social-security taxes. The Court specifically rejected the contention that the cooperative was merely the agent of the members and that the employees were thus in effect the employees of the members:

After all, the stockholders of corporations, whether cooperative or ordinary, intend to, and do, derive advantages from the use by them of the corporate form. It is for Congress, and not for us, to say whether there should be an exemption extended to the one class of corporations and denied to the other. We think it clear that appellant stands exactly in the same case as if it were a corporation organized in the usual way for the distribution of profits to its members.

The legal title to property of the cooperative is ordinarily vested in the cooperative (Maryland and Virginia Milk Producers' Associa tion v. District of Columbia, 119 F. (2d) 787 (1941)). As the court there indicated

Even when a cooperative's contracts with its milk-producing members have been phrased clearly in terms of agency, it has been conceded that title to the milk passed to the association

*

Moreover, the cooperative sells for its own account and not for the account of the member. The circuit court in the Maryland and Virginia Milk case, above, stated further

* the association, and not the member, was the actual seller of the milk which the distributors bought.

Also, the member does not set the price for which his particular products must be sold, and the sums returned to him are not attributable to profits on sales of his products but to profits on sales on all members' products (Maryland and Virginia Milk Producers' Association, supra).

It should also be noted that ordinarily, whether the cooperative is incorporated under the business corporation laws or under a special cooperative provision, the liability of a member for debts of the cooperative is limited, irrespective of whether the cooperative is a stock, nonstock, or membership organization (Packel, the Law of Cooperatives (2d ed.) p. 203).

The incidents of agency which the Supreme Court in the National Carbide case, supra, indicated as controlling thus appear to be entirely absent in the typical cooperative case. Moreover, it seems clear that legal title to the income of a cooperative is not in the members but in the cooperative. In the Maryland and Virginia Milk case noted above, undistributed profits of the year were carried into a revolving fund. The court held that "the fund is the corporation's property, and the member's interest in it is much like the stockholder's interest in the surplus of a stock corporation." At the most, there seems to be an obligation on the part of the cooperative to return to its members some part of the amounts which have been earned by it.

There has been little doubt that where income has been earned by one entity, such income can be taxed to it even though such entity is wholly owned by another (Moline Properties v. Commissioner, supra).

This proposition is equally true even though there is a binding obligation to pay over such income to another. The Supreme Court in the National Carbide case noted above, held that the mere fact that subsidiaries were required by agreement to pay over all profits in excess of 6 percent of capital did not prevent the imposition of income tax on such profits. A similar result was reached in Fontana Power Company v. Commissioner (127 F. (2d) 193 (C. C. A. 9, 1942)) where all the net profits of a corporation, paid over to its stockholders, pursuant to a contract, were held to be taxable to it. Finally, it is well established that where income is earned by one entity, an anticipatory assignment of such income, even though such assignment vests title to the income in the assignee, is not sufficient to prevent taxation of such income to the person who earns it (Lucas v. Earl, 281 U. S. 111 (1930); Helvering v. Horst, 311 U. S. 112 (1940)). In the Earl case, which dealt with assignment of earned salary income, the Supreme Court said:

There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipating arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it.

That a cooperative itself earns income seems difficult to dispute. It has assets and employees, it buys, sells, and performs services. The Supreme Court has recognized that profits derived from activities of this type are the profits of the organization owning the assets, employing the workers, and carrying out the commercial activities, even though another person has a legally enforceable claim to these profits. In the case of National Carbide Corporation v. Commissioner (336 U. S. 422 (1949)), the Supreme Court held that the corporation was taxable on its profits in spite of its contract to pay to its parent corporation all profits in excess of 6 percent on a nominal amount of capital stock. The recognition by the Supreme Court of the economic realities in such a situation is illustrated by the following quotation from the opinion in the National Carbide case:

The same fallacy is apparent in the contention that petitioners are agents of Airco. They claim that they should be taxable on net income aggregating only $1,350, despite the fact that during the tax year (1938) they owned assets worth nearly $20,000,000, had net sales of approximately $22,000,000, and earned nearly 41⁄2 million dollars net. Their employees number in the thousands.

Moreover, dividends paid by a cooperative on its capital stock, and amounts placed by it in reserves, stem from earnings resulting from its activities and are taxed at the present time to the cooperative as its income. This could not be the case if the cooperatives were in fact mere agents and earned no income.

There are a number of court decisions which show that taxable income is not necessarily affected by the payment of patronage dividends. In the Penn Mutual case, described earlier, Congress was upheld in its decision to treat certain cash dividends paid by mutual insurance companies to their policyholders as being taxable in the hands of the mutual corporation. In Cleveland Shopping News v. Routzahn (89 F. (2d) 902 (1937)), the circuit court of appeals for the sixth circuit held a corporation taxable on amounts collected from its patron-stockholders in connection with the furnishing of advertising services, which amounts were distributed to those same patrons in proportion to patronage. The same result was reached by the Tax