Additional 30 Percent Requirement

Under present law, cooperative organizations are permitted to reduce their taxable income by the amount of "qualified" patronage dividends distributed to members. This requirement is satisfied if a "qualified" written notice of allocation is distributed and if 20 percent or more of the amount of a patronage dividend is paid in money or by qualified check.

The House bill imposes an additional requirement in order for a written notice of allocation to be treated as "qualified." The bill provides that an additional 30 percent (phased-in over a 10-year period) must be paid to patrons either: (1) with respect to the current allocation; or (2) in redemption of prior allocations by the cooperative for any taxable year.

The additional payout requirement will result in complexity and administrative difficulty. The House bill provides that the requirement may be met either; (1) by an

additional cash payment on account of the patronage dividend

for the current year; or (2) by redemption of any prior qualified written notice of allocation by the cooperative for any taxable year. The following problems illustrate the difficulty of this rule.

Since the cooperative is allowed a period of 8-1/2 months after the close of its taxable year within which to pay a patronage dividend, a payment could be made by a fiscal year cooperative after April 15 (the patron's calendar year filing date) of a given year which the cooperative might allocate to a written notice of allocation issued by the cooperative prior to the end of the previous calendar year. This would thereby qualify a previously issued notice which had not yet otherwise been qualified, and which would then be taxable to the patron for the prior calendar year even though his return had already been filed. This could not occur under existing law where the 20 percent cash payment requirement must be satisfied at the time the written notice is issued.

Similarly, the cooperative might satisfy the additional 30 percent pay out requirement by redeeming prior written

notices of some patrons and not others. The bill contains

no requirement that redemptions be made on a pro rata basis. As a result, written notices of allocation could become

qualified, and become income to patrons, although some patrons receive more cash in relation to their allocations in a given year than others.

For example, a cooperative on a calendar year basis might pay patronage dividends of $1,000 each to Patrons A and B on March 15, 1970 ($200 in cash and $800 in written notices of allocation). The cooperative at that time might also pay $600 in cash in redemption of prior years' written notices of allocation held by A, thus qualifying the written notices issued to both A and B, though A received $800 in in cash and B only $200. In fact, the cooperative might instead pay only $300 in redemption of prior years' notices held by A but apply this to B's current written notice of allocation so that B would be taxed currently but A would not (since the additional 30 percent payout requirement would not be deemed satisfied with respect to A).

116

Treasury has considered whether better rules could be

developed with respect to the additional 30 percent payout

requirement but has concluded that the 15-year payout requirement, when fully effective, will be sufficient in and of itself to assure adequate annual payments to patrons. Thus, the complexities of the additional 30 percent payout requirement are unnecessary and the requirement should be deleted.

Treasury recommends that the provisions in the House

bill providing an election to state and local governmental units to issue taxable bonds and for payment by the Federal Government of a percentage of the interest yield on such taxable issues be deleted. The Administration is developing an alternative provision which will be submitted to the

Some states and localities have used funds received from the issuance by them of tax-exempt bonds to purchase higher yield taxable securities. Since municipal governments are not subject to Federal income taxes, the interest received is not taxed in their hands; the issuer thus profits in an amount equal to the spread between the tax-exempt interest paid and the higher interest received on the higher yield taxable securities. The House bill deals with this problem by providing that an "arbitrage obligation" shall not be entitled to tax-exempt status. The definition of an arbitrage obligation is left to regulations.