The court then pointed out that one of the conditions of the application of this rule is that the patronage refunds must be payable pursuant to a contractual obligation, saying:

"However, this practice of excluding patronage dividends from gross income has been limited to those cases in which the right of patrons to such dividends arises by reason of the corporation charter, or bylaws, or some other contract, and does not depend upon some corporate action taken subsequent to its receipt of the money later so distributed, such as the action of the corporation's officers or directors.

"This limitation recognizes that if the money later distributed to patrons is received by the corporation without a legal obligation existing at the time of its receipt to later distribute it, it must be considered as the gross income of the corporation and, since there is no deduction permitted by statute of the amounts later distributed to patrons, it is taxable as such. (See Midland Cooperative Wholesale, supra; Fruit Growers Supply Co., 21 B. T. A. 315; affd., 56 Fed. (2d) 90.)"

In the above case a portion of the patronage refunds was paid to the members and patrons in cash and another portion was applied to the purchase of the cooperative's capital stock which was distributed to the patrons in lieu of cash. Holding that refunds so distributed were to be excluded from gross income in like manner as patronage refunds distributed in cash, the court said:

"The fact that member patrons were under obligations with regard to the purchase of petitioner's stock under certain circumstances and that petitioner had a right to apply a part of the “patronage dividends” to a satisfaction of such obligations, is immaterial.

"It does not affect the right of the member patrons to receive 'patronage dividends' but merely constitutes a permanent directive to their application. "The result of the procedure set up by the petitioner's bylaws was as if the stockholder member who was under obligation to purchase additional stock had received, in cash, the 'patronage dividend' and had thereupon applied this sum to the payment of his stock.

"The stock, when thus paid and issued to him, was not in the nature of a stock dividend, but represented an additional investment on his part to the capital of the corporation out of his savings from the annual transactions with petitioner." The Bureau has announced a similar rule with respect to patronage refunds distributed in stock.

In I. T. 3208, C. B. 1938-2, page 127, consideration was given to the statute of "deferred patronage dividends" of a cooperative organized under the Iowa law. After determining that the deferred patronage dividends represented in effect a third class of capital stock, and therefore the patrons' interest therein was an interest in the capital or equity of the corporation, the Bureau held that such amounts so deferred were not income to the corporation, saying:

"In view of the foregoing, it is apparent, in the opinion of this office, that patrons of the corporations in question are required by the terms of the code to take stock of the corporation in lieu of the usual patronage dividends.

"As such credits represent contributions for capital stock, the amount thereof is not income to the corporation but the value thereof is income to the patrons credited. That is, a patron member of one of the instant corporations agrees to buy or sell through the corporation with the understanding that in addition to the fixed consideration passing at the time of the transaction, his proportionate share of the proceeds of the corporation over its statutory operating expenses shall be credited to his capital account with the corporation.

"The above conclusion applies only to the extent that the credits involved represent earnings or receipts in excess of operating expenses on transactions with patron members.

"Under section 8512-g3 of the Iowa Code, 1935, the corporations may deal with nonmembers, but patronage dividend credits may be made only to members. “Accordingly, to the extent such credits represent earnings or receipts in excess of operating expenses on transactions with nonmembers, the amount thereof is ordinary income to the corporation and the credits therefor to members should be treated as the issuance of stock dividends to members."

SAME RULES APPLICABLE TO ANY CORPORATION

The rule that patronage refunds paid pursuant to contractual obligation are to be excluded from gross income applies not only to cooperatives but to any corporation in any kind of business whatsoever where refunds are made pursuant to contractual obligation on the basis of patronage.

This rule is well illustrated by the case of Uniform Printing and Supply Company v. Commissioner (88 Fed. 2d 75).

There the taxpayer was an Illinois corporation which had been organized by a group of insurance companies to print insurance forms. The bylaws required that all receipts in excess of costs be distributed to the stockholders in proportion to the gross amount of business furnished by each.

The Board of Tax Appeals had sustained the Commissioner in his holding that the so-called refund was a dividend. The circuit court of appeals reversed the Board, saying:

"Had the taxpayer given a customer (whether stockholder or outsider) a discount promptly after filling the order, no one would call it a dividend

"If a rebate were given promptly upon the customer's business reaching a certain volume, the same conclusion as to its character would follow. To make cost estimates and adjust them at or near the end of each year returning the excess payment to the customer should not change the reasoning which leads to this conclusion. Nor should the fact that the customer is a stockholder materially affect the result" (p. 76).

The Uniform Printing & Supply Co. in the above case was acting for its insurance company patrons in the same way as an agricultural purchasing cooperative acts for its farmer patrons.

In another case, California Pine Box Distributors v. Commissioner (U. S. Tax Court, Memorandum Opinion, 2 (CCH) T. C. Dec. No. 13404 (m), (PH) T. C. Memo. Dec. 43365, July 29, 1943), the petitioner was acting as a marketing agent for its patrons who were manufacturers of wooden boxes.

It operated on a cost basis under a contract which required that all receipts in excess of expenses must eventually be refunded to members, although permitting them to be retained for capital purposes in the form of reserves at the discretion of the directors.

The court said:

"All funds coming into its possession, in excess of operating expenses, belong to the members and have to be returned to them. We think that the amounts added to the reserves during the taxable years should either be eliminated from petitioner's gross income entirely or should be deducted from gross income as accrued liabilities" (p. 17368 C. C. H.).

The rule is further illustrated in the case of several railroads which combined in the ownership of a bridge company, Paducah and Illinois Railroad Company (2 B. T. A. 1001).

Under the operating contract, any revenues which were paid by the owning lines to the bridge company, in excess of its expenses were to be divided between the parties in the proportion which each of them had contributed to the revenue of the bridge company.

Preferred stock of the bridge line was issued to each participating railroad for its share of such surplus revenues. The Board, after holding that the bridge company was a separate taxable entity, decided that the excess revenues refunded by the bridge company to its railroad patrons did not constitute income to the bridge company.

The foregoing rulings and decisions are the statements of the law by the duly constituted tribunals charged with the administration and interpretation of the internal-revenue laws.

Unless and until changed by subsequent court decision or by legislation, such statement of the law should be accepted by all Government agencies, including committees of the Congress.

In view of the foregoing, it is plain that it is erroneous to speak of patronage refunds as constituting net income or income of any kind to a cooperative.

It is likewise incorrect to suggest that any other corporation would pay a tax on a net income equal to the sum of a nonexempt cooperative corporation's net income plus its patronage refunds.

Any corporation may, by appropriate contracts, obligate itself to refund to its customers on a patronage basis the excess of its gross income over its expenses. That was what the Uniform Printing Co., the California Pine Box Distributors, and the Paducah & Illinois Railway did-and their patronage refunds were excluded from their gross income in computing net income subject to tax.

Some years ago the Ford Motor Co. announced that if a certain number of Ford cars were sold during the year, there would be a refund on each car sold. The number was reached; the refunds were made. Those refunds were not included in the income on which the Ford Motor Co. paid a tax.

If instead of making a refund in cash, the Ford Motor Co. had issued a share of stock to each purchaser, it would have done the same thing that a purchasing cooperative does when it issues a share of stock as a refund to its patrons. In both cases the refund would be excluded from corporate income. In neither case would the corporation pay an income tax on the amount of such refunds. Mr. WILCOX. Mr. Chairman, we appreciate the committee coming out here and giving us this opportunity to discuss these very simple problems with you.

We hope you will come back to California again.
Chairman PLOESER. We thank

you.

Would you care to make any further comment or say anything further?

Mr. WILCOX. I think the hearing here has been very profitable to us and has been conducted in a very fine manner.

We definitely appreciate the opportunity of discussing these problems which we feel should be considered very carefully and very vitally looking toward progress in our tax matters and in the progress of these very acute business problems which we have.

You have helped us and we appreciate it.

Chairman PLOESER. We thank you.

All of the witnesses have been most helpful and we appreciate it. Mr. MORRISON. Mr. Chairman, during the day may I say that I have heard various reports concerning the committee and, as far as the hearing is concerned, the committee has been essentially fair, it has given everybody who desired to be heard that opportunity. We appreciate it very much, indeed.

Chairman PLOESER. We thank you.

The committee adjourns.

(Thereupon, at 11: 15 a. m., the hearing adjourned.)

RE COOPERATIVE HEARINGS

On November 24, 1947, the chairman of the Select Committee on Small Business of the House of Representatives, the Honorable Walter C. Ploeser (Republican), Missouri, and on November 20, 1947, the ranking minority member of the committee, the Honorable Wright Patman (Democrat), Texas, appeared before the House Ways and Means Committee to offer testimony on the issue of whether cooperative corporations enjoy tax-exemption privileges unfair to the interests of proprietary business and how the existing tax burdens between cooperative and proprietary business should be equalized.

Mr. Ploeser, utilizing the evidence gathered by the House Small Business Committee during its study of cooperative enterprise, which began in June of 1947 and resulted in a number of public hearings, offered to the House Ways and Means Committee data showing that cooperative enterprise does enjoy an unfair tax-exemption status over proprietary enterprise. The chairman of the House Small Business Committee also made specific recommendations for remedying the situation so as to put proprietary enterprise on a fair tax basis with cooperative enterprise. His chief recommendation was that all cor porations in the United States, whether proprietary or cooperative, should be granted an exemption of $25,000 on their net income.

Mr. Patman took a contrary view, insisting that cooperative enterprise did not enjoy tax-exemption privileges which discriminated against proprietary enterprise. He asked the Ways and Means Committee to continue the existing tax-exemption privileges of cooperatives as they now stand.

The remarks of both Mr. Ploeser and Mr. Patman before the Ways and Means Committee are as follows:

STATEMENT OF HON. WALTER C. PLOESER, REPRESENTATIVE IN CONGRESS FROM THE STATE OF MISSOURI (CHAIRMAN OF THE SELECT COMMITTEE ON SMALL BUSINESS)

Mr. PLOESER. Mr. Chairman, my appearance before your committee today is as a result of your invitation and an obligation on the part of the Select Committee on Small Business to present whatever information it may have which may be helpful to the Ways and Means Committee's consideration of the tax problems growing out of certain exemptions allowed by the Internal Revenue Act and Treasury rulings to cooperative types of enterprise.

Our committee has been at work for several months, both in public hearings and in exhaustive staff research. Our hearings have not been completed and, therefore, the results of our work which I present here today must, of necessity be considered the knowledge which we have gained to date. It cannot be considered as a report of the House Small Business Committee because this committee will not be ready to submit a report until it has exhausted the subject. Accordingly, the data which I offer is presented by me as an individual Member of the Congress, in the hope that it will be helpful in your consideration of the problem.

This subject has many ramifications and cannot be settled by emotional arguments or a mere reliance upon economic theory.

The Ways and Means Committee is faced with a very practical situation from the standpoint of revenue, while the House Small Business Committee is faced with the very practical study affecting competitive forces in our economy. Our interest is not identical, but the facts involved affect the work and studies of both committees.

PROCEDURE

For a number of months, a subcommittee of the House Committee on Small Business has been making a study of the legislative and administrative privileges enjoyed by cooperatives for the purpose

of

endeavoring to determine whether such privileges impose unfair burdens upon proprietary businesses. Tax-exemption privileges of cooperatives have been particularly studied. Two avenues of inquiry were explored. Does tax exemption permit cooperative enterprise to grow more effectively than proprietary enterprise? Does tax exemption permit cooperative enterprise to market products, distribute products, manufacture products, or perform services at prices which are more attractive to its customers than to the customers of competing proprietary corporations?

The committee prepared a list of about 100 cooperatives. Included in this list were samples, large and small, of the various kinds cooperatives-agricultural marketing cooperatives, agricultural purchasing cooperatives engaged in distribution manufacturing, or the furnishing of services and urban consumer cooperatives. To each of these selected cooperatives, the committee sent the following letter and questionaire:

GENTLEMEN: The House Committee on Small Business is making an investigation into Government competition with business and Government financial' assistance to business. One line of inquiry which the committee feels it must pursue is the governmental privileges enjoyed by cooperatives alleged to be imposing an unfair burden upon private business competing with cooperatives. Many complaints have been received by this committee from private business making this charge, and in fairness to all the committee feels that they should either be sustained or disproved.

The committee is fully cognizant of the fact that cooperative business is lawful and legitimate, is engaged in by many persons of the highest standing in their local communities and has been singled out by the Congress from time to time. for legislative recognition. The committee's inquiry is being made solely for the purpose of enabling it to report to Congress whether the governmental privileges conferred on cooperatives by Congress have put private business at an unfair disadvantage. I feel confident that you will see nothing unfair in Congress reappraising from time to time any benefits, which it has conferred upon special types of business.

I therefore ask you to assist the committee's efforts by promptly furnishing to it certain information specified in the enclosed questionnaire. The furnishing of such information requires mainly only the forwarding to the committee of annual audit reports already prepared and in your files. The committee requests that these annual audit statements described in detail in question 3 of the enclosed questionnaire be sent to the committee so they may be received in Washington as soon as possible but not later than

Attached to this letter is a Government frank which will relieve you of all costs of shipment of the material.

Sincerely,

COOPERATIVE QUESTIONNAIRE

1. Give date of organization of your cooperative and the original financial set-up.

2. Does your cooperative have a tax-exempt status under section 101 of the Internal Revenue Code, and, if so, how long has it had such exemption?

3. Please send to the committee a copy of your annual audit report for each year including 1935 to the end of your latest accounting year. These reports should contain a detailed balance sheet at the end of each year; a detailed operating statement for each year, and all supporting schedules and exhibits as prepared by your accountants in their annual audit. The comments and conclusions of the accountants together with their certificate are also generally included in these reports.1

The material requested above will be kept securely by the committee and returned to your cooperative. if you so desire, as soon as the committee has finished with it. Please, therefore, indicate when you forward the material whether you wish part or all of it to be returned, or whether the committee may keep such material for its files.