of a transaction. The court in the Long Poultry Farms case recognized this when it stated:

The

'Economic realities, not legal formalities, determine tax consequences.' truth is that the taxpayer never received anything except a credit on the cooperative's books which did not entitle it to receive anything except upon the conditions enumerated, and only then if the directors of the cooperative should so determine." 249 F. 2d at 728.

A number of the panelists who discussed the subject of cooperatives before this committee in the tax revision hearings suggested that a cooperative be taxed on profits derived from any business activities which are distinct from its essential purposes. An analogy was drawn to the tax now imposed on the income of certain exempt organizations. Certainly this proposal merits consideration by your committee, although it may present troublesome administrative problems. We believe that the proposal offered by the Treasury, embodied in H.R. 7875, avoids some of the difficulties encountered in the various other proposals. Under H.R. 7875, cooperatives would be allowed a deduction for patronage refunds paid in cash or in the form of a document constituting an unconditional promise to pay in cash the face amount thereof, with interest at the rate of four percent per annum, within three years after the close of the taxable year. Patronage refunds allocated and represented by documents which do not meet these requirements would be deductible when paid in cash. Exempt cooperatives will still be permitted to deduct dividends paid on capital stock and they would also be permitted to deduct payments or allocations of income not derived from patronage which are paid in the same form as deductible patronage refunds.

The Treasury's proposal has a number of objectives. It is intended (1) to assure approximate current taxation of all cooperative income, (2) to restrict to a reasonable degree the competitive advantages cooperatives now have of expansion on untaxed retained earnings, (3) to ease the compliance problems of patrons, and (4) to simplify administration of the law for the Treasury.

Under the Treasury proposal, all cooperative income would be taxed currently either to the cooperative or its patrons except to the extent that it is allocated to patrons in the form of interest-bearing documents redeemable in three years. Even as to these documents, payment of tax by either the cooperative or the patron cannot be deferred beyond three years.

The Treasury recognizes the important function performed by cooperatives in our agricultural economy, and the need to strike a balance between the interests of farmers on the one hand, and of business organizations which are in competition with cooperatives. The Treasury proposal seeks to strike a fair balance by imposing one single tax on cooperative earnings and by permitting cooperatives to retain earnings for three years with no tax at the cooperative or patron level. Of course, this three-year period is much shorter than the nine or ten-year period that earnings are now typically retained by cooperatives. However, we believe that it provides sufficient opportunity to accumulate a reasonable reserve out of tax-free earnings. Thus, if a cooperative earns ten percent per year on its equity, before taxes and patronage refunds, it could continually retain as much as 30 percent of its beginning equity by a three-year rotation of its noncash patronage refunds. Moreover, an expanding organization could add additional amounts to its tax-free reserve.

Opponents of the Treasury proposal, H.R. 7875, will argue that a cooperative, because of its legal relationship to its patrons, has no income. As I pointed out earlier in discussing the proposal advocated by representatives of cooperatives, we do not believe that such an argument is well founded. Moreover, H.R. 7875 permits a deduction for cash refunds when paid. Thus the cooperative is taxable only with respect to retained net margins not paid out in deductible form. During the period of retention, the cooperative has possession of the taxable net margins and full enjoyment of their use. As mentioned earlier, the time and mode of payment of those net margins is so much subject to the discretion of the Board of Directors of the cooperatives that for Federal income tax purposes, the cooperative's obligation to return its profits to its patrons is frequently one of form rather than substance. In fact, the patron may never see those net margins for the cooperative might suffer losses before redeeming its paper allocations. In this connection, it is interesting to note the provision of the bylaws in the Long Poultry Farms case. In that case the cooperative bylaws provided that:

"In the event the association suffers a loss in any year, the Board of Directors shall prescribe the basis on which the capital furnished by patrons shall be reduced

on account of any such loss, so that it will be borne by the patrons on as equitable a basis as the Board of Directors finds practicable." See 294 F. 2d 727.

Opponents of H.R. 7875 may also argue that the proposal ignores the immediate reinvestment theory. As I have stated before, the courts have rejected that theory. Opponents may also criticize the proposal on the ground that it does not tax patrons on the fair market value of noncash patronage distributions. This is true. However, it must be recognized that there are serious administrative difficulties in valuing noncash patronage refunds. H.R. 7875 completely avoids this problem by providing that the patron of a cooperative is required to include in income only cash distributions.

Objection also might be raised against the requirement that the paper refund carry interest at the rate of four percent per annum and be redeemed within three years. This requirement is an attempt to balance the favorable treatment to be granted cooperatives against the proposition that competing businesses should be taxed equally. Further, if the cooperative obtains a deduction for $100, it seems only fair to require that the patron receive something fairly equivalent to $100.

Summary

area.

In summary, I would like to emphasize the urgent need for legislation in this We believe that H.R. 7875 presents a fair and workable method of taxation both from the standpoint of the cooperative and its members and from the standpoint of competing business and the general tax-paying public. This is not to say that there may not be other methods of achieving fair and equitable taxation of cooperative income. The staff of the Treasury will continue to work cooperatively with the staff of your committee in developing whatever method your committee may decide is most appropriate for handling this troublesome problem.

TABLE I.-Allocation of earnings of 21 farmers' marketing and purchasing cooperatives for the 5-year period, 1954-58, and relation of untaxed retained earnings to assets and equity at the beginning of the period.

10. Proportion of earnings before income tax retained (net) as noncash patronage refunds. 11. Ratio of net noncash patronage refunds to beginning assets..

48%

25%

12. Ratio of net noncash patronage refunds to beginning equity..

42%

1 Total patronage refunds exceed income after income tax and dividends on stock because patronage re funds during a year sometimes exceeded income.

* Includes patronage refunds payable if they had not been converted to a formal debt instrument.

TABLE II. Data on net income and allocation of net income of farmers' marketing and purchasing cooperatives

Returns for nonexempt cooperatives do not show patronage refunds and they are estimated on the basis of data for "exempt" cooperatives.

* In addition, cash distributions are made to retire patronage refunds declared in noncash form in previous years. Such payments were about 50 percent of noncash payments during the period 1950-54. SOURCES.-Department of Agriculture, Methods of Financing Farmer Cooperatives, pp. 34 and 41; Treasury Department, Farmers' Cooperative Income Tax Returns for 1953.

TABLE III.-Number and volume of business of farmers' marketing and purchasing cooperatives, 1940-56

1 Figures are for the marketing seasons for crops produced in the specified year. 2 Data for 1940 and 1945 not completely comparable to subsequent years. The earlier figures are somewhere between the gross and net figures shown for later years.

Gross volume less the volume of business done between cooperatives. Both the gross and net figures include the total value of products handled on a commission basis.

SOURCE.-Department of Agriculture, Statistics of Farmer Cooperatives, 1956–57, pp. 3, 16, 71, 73.

TABLE IV.-Corporations classified by size of assets, 1953

SOURCE.-Treasury Department, Statistics of Income for 1953, Part 2, p. 67.

TABLE V.-Farmers' marketing and purchasing cooperatives classified by size of

assets, 19531

1 "Exempt" cooperatives are those meeting the requirements of section 521 of the Internal Revenue Code. 2 Less than .05 percent.

SOURCE.-Treasury Department, Farmers' Cooperative Income Tax Returns for 1953, p. 9. NOTE. Returns for "nonexempt" cooperatives selected by sampling and data therefore are subject to sampling error.

International Financial and Monetary Developments

EXHIBIT 30.-Remarks by Secretary of the Treasury Anderson, February 8, 1960, at the first meeting of the Board of Governors of the Inter-American Development Bank, San Salvador, El Salvador

First of all, I wish to express our deep appreciation to the Government and people of El Salvador, who are making us feel so much at home in this beautiful capital city. It is a great pleasure for me to have the opportunity of meeting once again with so many of my colleagues from Latin America in one of the American Republics. We are here for an important purpose; yet I am happy that, thanks to the excellent work which was done in advance first, by the negotiating committee and, more recently, by the preparatory committee-we have not found our task so burdensome that we are unable to enjoy the delightful climate and the gracious hospitality of our hosts.

This meeting is truly a momentous one for all of our countries. The inauguration of the Inter-American Development Bank brings into being an institution that should become a dramatic instrument of responsible and progressive financial cooperation among the American Republics. It was a little more than two years ago that many of us were present in Buenos Aires, when the Conference of Ministers of Finance and Economy adopted the resolution which has led directly to this meeting. As time is measured in international affairs of this nature, we have moved swiftly.

We have also moved with sure and careful steps. In the United States, we were able to submit the agreement creating the Inter-American Bank to the Congress of our country in full confidence that we were presenting a workable blueprint for a dynamic institution through which the countries of the Americas could further implement and improve their mutual cooperation in the field of economic development. I am sure this has been true for each of you in presenting the agreement to your own governments.

The agreement, as you know, is drawn in broad terms in order to leave a large measure of flexibility in carrying out the day-to-day work of the institution. This, I believe, is the most practicable way to insure that the institution can be a vital force in a changing world.

The Washington meeting which negotiated the agreement creating the Bank is a good augury for the future. Many divergent points of view were brought to the meeting; yet, above all, there prevailed a spirit of effective cooperation and of mutual devotion to a basic common goal which has produced an instrument well conceived to help meet the economic problem of the Americas.

From all of this we can see that while the road ahead is not easy, there is sound cause for optimism. The creation of the Bank does not in itself solve any of the problems with which we are all so concerned; yet it does provide us with an effective framework in which men of good will can join with the confidence that through the exercise of thought, diligence, and mutual respect they can achieve great benefit for their peoples.

In the context of these thoughts let us look at a few of the problems of the future. It is essential, in my opinion, that the Bank should build its organization with great care. We should be concerned as much with the position and prestige which this Bank will enjoy in the decades ahead as with the speed with which it undertakes its first operations. It is a matter of overriding importance that through sound planning and sound operations this new institution should earn the confidence of the credit markets of the world.

Another matter to which the most careful attention must be given from the outset is that of relationships between the Bank and other institutions, both national and international, which are already providing capital for the development of the Americas. A deep concern of many of our representatives, both in the negotiating committee and in the Committee of Twenty-one, which endorsed the idea of establishing this Bank, was that the total of public and private funds available for development in Latin America should be increased. Nothing would be gained, they wisely pointed out, if lending by the Inter-American Development Bank should simply replace lending by existing national or international institutions. It should be emphasized in this regard that, in addition to its own lending operations, the Bank can serve valuably by assisting in the sound planning of projects and by helping to develop other appropriate sources of financing for such projects.