tinuation of the trends of the past 10 years from 1970 through 1985, these cooperatives would face a 100 percent cash distribution requirement in 1985: The necessary cash would simply not be available unless all of the following impossible assumptions were made for 1985 and all subsequent years: 100 percent of the dividends received from regional cooperatives were in cash; accounts receivable did not increase; inventories did not increase; no replacements or additions were required for facilities and equipment; all patrons' equities issued prior to 1970 had already been redeemed. Local cooperatives are owned and controlled by their patrons. In general, they have followed the equitable procedure of retiring patronage equities in the order of their issuance oldest first. It can be fairly assumed that they would desire to continue this procedure. Many of them are obligated to do so by provisions in their by-laws. To do so (in order to retire such presently-outstanding equities before the compulsory redemptions called for by the 15-year require. ment of the Bill), the 400 cooperatives covered by the data would somehow have to make average annual redemptions of the following dimensions beginning in 1969: An 85 percent cash distribution can not be made because none of the necessary assumptions are true for 1969. In other words, it is simply not true that the dividends from the regional cooperative are all in cash. It is not true that accounts receivable, inventories and facilities investments fail to increase. On the other hand, they must inevitably increase. In at least one state (Wisconsin), a dairy marketing cooperative is required by law to maintain a ratio of current assets to current liabilities of 1.25. The issuance of notices of allocation with a fixed maturity will alter that ratio adversely, putting the cooperatives subject to that law into receivership within the first few years. Thus, the 15-year requirement has immediate impact on the many cooperatives of our area which are already obligated to retire their oldest outstanding equities first. It will force them to strive to retire those existing equities at a pace they cannot achieve or maintain, with many inevitable failures far sooner than 15 years. D. Recent business trends have diminished the ability of increasing numbers of cooperatives to revolve patrons' capital on any sort of predetermined basis. The ability of any business organization to make cash distributions is not determined by either net earnings or by cash on hand. Assuming no plans for facility additions and no shortages of working capital, it is determined by the "acid test" ratio: The ratio of the total of cash and accounts receivable to current liabilities. This concept applies in the case of cooperatives and of ordinary business organizations. The factors involved are ignored by Section 531 of the Bill, even though they are given full recognition in the Regulations under the present Section 537 of the Internal Revenue Code, determining whether accumulations. of earnings by ordinary corporations are reasonable or unreasonable, As indicated previously, the data on the sample of 400 strong local coopera tives reveals increasing amounts of capital tied up in receivables, inventories, facilities and investments in regional cooperatives during the past 10 years. During the past 10 years these strong cooperatives have, on the average, been able to make cash distributions and redemptions averaging 50 percent of their total earnings, but the ability to continue such payments has been markedly diminished, as these figures show: Average 1968 earnings were $35,241 and non-cash patronage dividends distributed averaged $28,192. Further analysis shows that 155 of the 400 "strong" cooperatives had no excess cash and receivables, and would be unable to make any cash redemptions without further increasing their present financial difficulties. By disregarding such changes in overall business trends and changes in financial ability of individual cooperatives, the requirements of Section 531 would render insolvent the majority of the 400 strong local cooperatives covered by the summarized data, and even more certainly, the majority of the 2400 cooperatives not covered by the data. E. The Bill ignores the fact that as a matter of economic necessity substantial portions of the annual earnings of individual cooperatives are represented by increased investments in regional organizations. Local farmers' cooperatives have banded together to form regional organizations to provide them with marketing services or a source of farm supplies at reasonable prices. The regional organizations are a necessary extension of the · operations of the local cooperatives. In the case of the 400 farm supply cooperatives, earnings developed through their regional organizations have increased to over 60 percent of their total average earnings. To develop their sources of supply at reasonable costs the patrons, who first joined together in the ownership of petroleum storage tanks and delivery trucks, have had to join together in the ownership of interests in oil refineries and pipelines. The maintenance of these regional organizations is essential to the operation of the local cooperatives. The necessary investments to finance these organizations have increased substantially in recent years to finance increased working capital needs and more complex and costly facilities and equipment. Regional .cooperative investments account for approximately half of the capital investments required of the patrons of local cooperatives. The regional organizations have obtained the cash needed for their facilities investments, receivables, etc., by retaining a portion of the cash and distributing the equivalent in “qualified written notices of allocation." To require the regionals to increase their distributions to an ultimate 100 percent cash would result in their insolvency and the loss of both the regional investments and the necessary part they play in the operation of the local cooperatives. Changing economic conditions of recent years (higher volume, lower mar -gins, increasing costs of facilities) have seriously reduced the ability of the regionals to make cash distributions of as much as 50 percent. Consequently, a' major part of the total earnings of each local cooperative has been in the form of non-cash earnings, which diminishes its own ability to make cash distributions of a major part of its own total earnings. Furthermore, any regional cooperative, no matter how well managed, can have a loss year. Two of the regionals in our Midwestern group have had loss years within the last five years, and it can happen again. That means that they will be unable to redeem patronage refunds previously issued, even though they may have a "due date" under the provision of Section 531 of the Bill. F. The arbitrary cash distribution provisions of Section 531 ignore the busipess needs of individual cooperatives to repay necessary loans, replace facilities and equipment, build up working capital, or to meet unforeseen financial problems. The ability of any business organization to make substantial cash distributions is determined by its financial position and not by its annual earnings. By ignoring this fact, Section 531 of the Bill becomes a possible source of eventual insolvency to all cooperatives under certain circumstances. The following table shows that even the healthiest of the three cooperatives, Cooperative A, will be trapped by the obligations imposed by the Bill, and will be unable to meet those obligations in spite of an increase in annual earnings. Cooperative B, having level earnings, will be even farther behind. Cooperative C, whose earnings have dropped, will fail that much sooner: While these particular cases are hypothetical, the factors which cause the failures are not hypothetical. The data on the 400 strong local cooperatives shows that average financial positions of such organizations have been seriously weakened in recent years. As a group, they face increasingly severe financial problems under present conditions. This is clearly shown by the data for the 400 strong local cooperatives and applies with even more force to the 2400 weaker local cooperatives not covered by the data. For example, the 400 cooperatives are strong supply Cooperatives. A sample of grain marketing local elevators showed a decline of 31 percent in local earnings in the five years 1963 to 1968. At the same time the regional to which they belong suffered a decline in earnings of 40 percent. A similar sampling of dairy cooperatives showed a decline of 11 percent in combined local and regional earnings in the same period This is a highly critical period of time in the financial affairs of cooperatives and their patrons. It would be indeed ironic if Section 531, in the name of aid to the patrons, is allowed to wreck financial havoc upon such cooperatives resulting in the loss to patrons of the necessary service they require together with their accumulated investments in these organizations. G. The arguments advanced in favor of the provision are mistaken. The Staff Report of the Joint Committee on Internal Revenue Taxation and the (1) By requiring the cooperative to pay to the patron all of the patronage dividends within fifteen years, the Bill assures the patron that he will eventually Teive the patronage income on which he has been taxed, In fact, the Bill assures the patron nothing of the sort. Instead, it requires that all patronage dividends not paid in cash shall be in the form of fixed obligations due within fifteen years or sooner. Since the effect of this provision must be the eventual replacement of all of the equity capital of each cooperative with a form of long-term debt with a fixed due date, the ore probable result is to assure the patron that he will lose both the services of his cooperative and all of his accumulated investments in it in some future ar when it has low earnings or a loss, causing its insolvency and forced liquidation. The report recognizes this to a degree in its "Arguments Against," saying: The requirements for an early payout of patronage dividends and retains will impair the working capital of the cooperative, since these amounts repreent, in effect, the cooperative's equity capital and serve as a base to support its borrowings." The second "Argument For" reads: 2) Farmers today have little dominion over the treatment of patronage dividends despite the fact that they must pay tax on them as if they did. The Bill will give them full control over one-half of the patronage dividend immediately with assurances that the remaining one-half (retained by the cooperafive) will be paid out to them in 15 years This greater control over the income on which they are taxed makes the tax more equitable." This is simply not so. The patrons do have control, unlike the situation in an rdinary business corporation. Dominion over treatment of patronage dividends is vested in Boards of Directors of members elected by members at annual meetings with one vote per stockholder. Most local cooperatives have less than 500 members. Their directors are neighbors who share their viewpoints and are personally known to most of them. Their control and voice in the affairs of their cooperative is real, unlike that of stockholders of large business corporations. Patrons of a local cooperative who pay the tax on their share of the earnings of the cooperative do so voluntarily under the 1962 Act. They have consented to this tax treatment voluntarily. Under the 1962 Act they may withdraw their consent if they are not a member, or revoke their membership if they are a member, and the cooperative will pay the tax on their share of the earnings. They are aware of this right but, except for a very small number of cases, have not withdrawn their consents. Through their elected Directors, the members of each cooperative currently do have full control of the patronage dividends taxed to them The Directors are able to determine the amount of cash that needs to be retained to meet the needs of the business and the amount available for payment to farmer patrons in the form of distributions and redemptions. This is reported to the members at well-attended annual meetings, and the members accept the decision because it is based on the facts. The third "Argument For" reads: "(3) By requiring cooperatives to pay out more of their income currently the amounts they can retain tax-free for expansion of facilities in competition with fully tax-paying businesses is lessened. This is a desirable way of limiting the taxfree growth of business enterprises." This is mistaken policy, and unfairly discriminatory. Ordinary corporations, under current law, are required to pay income taxes at the rate of 22 percent of the first $25,000 of taxable income and at the rate of 48 precent of their taxable income in excess of $25,000. Ordinary corporations are not required to make any payments to stockholders of earnings required in the operation of their business. Two-thirds of our local cooperatives have earnings of less than $25,000 per year. They are now required to pay out 20 percent of the amount of their patronage dividends in the form of cash. Under the proposed Bill they would be required to pay out 50 percent of their earnings in the form of cash. The result of this is that the cooperatives will be able to retain a maximum of 50 percent of their earnings for the needs of the business-and often less. Ordinary business cor porations of comparable earnings will, on the other hand, be able to retain 78 percent. That this discriminatory policy is a mistaken one is well stated in the “Arguments Against" as follows: "(2) The Bill ignores the roll farm cooperatives play in improving the incomes of farmers by providing them with alternative methods of marketing their crops or of acquiring farm equipment, machinery and supplies at reasonable prices. "(3) There is no showing that the present balance between farm cooperatives and regular businesses should be upset to the detriment of the cooperative movement." It is a myth that cooperatives and regular businesses are "in balance"; cooperatives are, in fact, losing ground. While active business corporations as a whole gained 52.4 preent in sales in the period 1960 to 1966, farmer cooperatives gained 29.6 percent. Statistical Abstract of the United States, 1969, Tables 694 and 903. 3. SUMMARY a. The Bill requires a “phased” step-up in percentage of earnings paid out in cash from 20 percent to 50 percent in ten years. It also requires that the cooperative issue non-cash patronage dividends in a form which it is obligated to redeem within 15 years. b. These provisions would not work : A. Most of the local cooperatives have annual earnings of $25,000 or less. Their cash requirements are in excess of 50 percent of their earnings. A business corporation having earnings of the same level is permitted to retain 78 percent of the earnings. B. It is erroneous to treat "annual earnings" as equivalent to "cash." They come to the enterprise tied up in the form of assets, and remain tied up in such form. C. In the case of fairly level earnings, the requirement for redemption in 15 Tears has the effect of forcing annual cash distributions in excess of 50 percent, often 100 percent of earnings. This will begin in the near future, not in 15 years. D. The ability of cooperatives to revolve patrons' capital on any “due date” basis is diminishing, rather than increasing. The legislation would put them in a straitjacket. E. The investments in regional organizations are a matter of economic necessity for the local cooperatives. F. The cash distribution requirements of the provision ignores existing debt and other business needs. G. The arguments advanced in favor of the provision are mistaken and illusory. SUMMARIZED DATA ON 400 LOCAL SUPPLY COOPERATIVES Senator CURTIS. The committee will stand adjourned until 9:30 to morrow morning. (Whereupon, at 7:05 p.m., the committee adjourned, to reconvene at 9:30 a.m., Tuesday, September 23, 1969.) |