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The Law of Cooperative Corporations

The Law of Cooperative Corporations. University of Arkansas LLM Program, Agricultural Law, 2007 Fayetteville, Arkansas April, 2007 James R. Baarda. Income Taxation. 1. 2. Principles . 3. Subchapter T . 4. Section 521 . 5. Patronage refunds defined . Basic tax rules . Taxation. 6.

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The Law of Cooperative Corporations

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  1. The Law of Cooperative Corporations University of Arkansas LLM Program, Agricultural Law, 2007 Fayetteville, Arkansas April, 2007 James R. Baarda Income Taxation

  2. 1. 2. Principles 3. Subchapter T 4. Section 521 5. Patronage refunds defined Basic tax rules Taxation

  3. 6. 7. Patronage financing 8. Losses Income sources Taxation (cont.)

  4. 1. Principles

  5. Investment Operations Finance Purchases Short-term Liabilities Current Assets Administrative Expenses Physical Assets Long-term Liabilities Investments Financing Expenses Plant, Property Equipment Equity Sales NetMargins

  6. Expenses incurred in producing the income Dividends Retained Earnings Total Incoming Money Gross Income Capital Contributions Taxable Income Tax Syllabus: Taxation, pp. 1 - 6

  7. Cooperative Principles 3.The User-Benefits Principle: The cooperative's sole purpose is to provide and distribute benefits to its users on the basis of their use. Syllabus: Introduction, p. 23

  8. Corporate Entity

  9. Control Finance USE Benefit

  10. Dividends Total Incoming Money Gross Income Capital Contributions Expenses incurred in producing the income Taxable Income Tax Retained Earnings Syllabus: Taxation, pp. 1 - 7

  11. Dividends Total Incoming Money Gross Income Capital Contributions Expenses incurred in producing the income Taxable Income Tax Payments Syllabus: Taxation, pp. 1 - 7

  12. Total Incoming Money Gross Income Capital Contributions Expenses incurred in producing the income Taxable Income T a x Syllabus: Taxation, pp. 1 - 7

  13. Total Incoming Money Gross Income Capital Contributions ? ? Expenses incurred in producing the income ? Taxable Income T a x Syllabus: Taxation, pp. 1 - 7

  14. Net Margins Syllabus: Operations, p. 61

  15. Net Margins $10,000 Syllabus: Taxation, pp. 1 - 7

  16. Net Margins Syllabus: Taxation, pp. 1 - 7

  17. Rationale • Historical recognition • “Conduit” for dividends • Patron ownership (agency) • Price adjustment • I.T. 3208 (1938) • Rev. Rul. 83-135 Syllabus: Taxation, pp. 3 - 7

  18. 2. Subchapter T

  19. Application (§1388(a)) • Section 521 cooperatives • “[A]ny corporation operating • on a cooperative basis” • Exceptions • - Exempt organizations • - Savings banks, insurance • - Rural utilities Syllabus: Taxation, pp. 7 - 8

  20. Foundations • Puget Sound Plywood (1965) • Rochdale Pioneers – 1844 • 1. Subordination of capital • 2. Democratic control • 3. Vesting in and allocation • of increases • Facts and application Syllabus: Taxation, pp. 9 - 18

  21. Foundations • Mississippi Valley (1969) • Members, “patrons” and cement • Business done “with or for its • patrons” • “Paper patrons” Syllabus: Taxation, pp. 19 - 27

  22. Foundations • Mississippi Valley (1969) • “We have lifted the cooperative veil • and have unmasked the economic • realities of these transactions” Syllabus: Taxation, pp. 19 - 27

  23. Foundations • Rev. Rul. 82-51 • Poultry integrator - Transactions “lack economic substance” - “Consistent with ….” - No “business or economic reason” for sale Syllabus: Taxation, pp. 27 - 29

  24. Foundations • 50 percent rule • Conway County (1978) • - No quantitative requirement • - Exemption rule not applicable • - No legislative history • - Cannot narrow scope of statute • Focus on flow of funds Syllabus: Taxation, pp. 30 - 39

  25. 3. Section 521 Syllabus: Taxation, pp. 40 - 71

  26. Section 521 Requirements • “Farmers’, fruit growers’, like • associations” • “Organized and operated” on a • cooperative basis • Member or other producer • - Only producers • - Equal treatment Syllabus: Taxation, pp. 40 - 42

  27. Section 521 Requirements • Exceptions • - De minimus rule • - Emergency purchases • - Ingredients • - Incidental purchases • Equality of treatment Syllabus: Taxation, pp. 43 - 44

  28. Section 521 Requirements • Stock ownership • Etter Grain (1972) • - Voting preferred stock • - Owned by farmer-patrons • - Voting and control • Eight percent limit Syllabus: Taxation, pp. 45 - 49

  29. Section 521 Requirements • Active members • “Substantially all” stock • Owned by “producers who • market …or purchase … • through” the cooperative • The 85% rule Syllabus: Taxation, pp. 50 - 70

  30. Section 521 Requirements • Farmers Cooperative (I) (1985) • Farmers Cooperative (II) (1987) • Purging non-active members • Right to vote • Following close of taxable year Syllabus: Taxation, pp. 50 - 70

  31. Section 521 Requirements • Farmers Cooperative (III) (1987) • 50% patronage rule • “Any” marketing or purchasing Syllabus: Taxation, pp. 50 - 70

  32. Section 521 Requirements • 50% marketing – members • 50% purchasing – members • 15% purchasing – neither • members nor producers Syllabus: Taxation, pp. 50 - 70

  33. 4. Patronage refunds defined Syllabus: Taxation, pp. 71 - 114

  34. Statutory Definition [T]he term “patronage dividend means an amount paid to a patron …” Syllabus: Taxation, p. 71

  35. Statutory Definition (1) “On the basis of quantity or value of business done with or for such patron…” Syllabus: Taxation, p. 71

  36. Statutory Definition (2) “under an obligation … to pay such amount, which … obligation existed before the organization received the amount so paid….” Syllabus: Taxation, p. 71

  37. Statutory Definition (3) “which is determined by reference to the net earnings of the organization from business done with or for its patrons.” Syllabus: Taxation, p. 71

  38. Statutory Definition “Such term does not include amounts paid to patrons …” Syllabus: Taxation, p. 71

  39. Statutory Definition (1) “… out of earnings other than business done with or for patrons …” Syllabus: Taxation, p. 71

  40. Statutory Definition (2) “out of earnings from business with or for patrons to whom no amounts … or to whom smaller amounts are paid, with respect to substantially identical transactions.” Syllabus: Taxation, p. 71

  41. Control Finance USE Benefit

  42. Equitable Allocation • Income year v. business year • Lemesa Cooperative Gin (1982) • Operation at cost • Equitable allocation • Materially equitable • Income year v. business year Syllabus: Taxation, pp. 72 - 104

  43. Equitable Allocation • Lemesa Cooperative Gin (cont.) • Practicality • Board of director’s discretion • “Unjust discrimination” • De minimus item Syllabus: Taxation, pp. 72 - 104

  44. Equitable Allocation • Kingfisher Cooperative (1985) • Federated structure • - Union Equity – Wheat • - Farmland – Supplies • Allocation by department • Timing Syllabus: Taxation, pp. 72 - 104

  45. Equitable Allocation • Kingfisher Cooperative (cont.) • Practicality • Non-discriminatory • Board of director’s discretion • Accepted by membership Syllabus: Taxation, pp. 81 - 91

  46. Equitable Allocation • Farm Service Cooperative (1978) • Three pools + taxable activity • Losses in broiler pool • No offset against taxable activity • Exempt v. non-exempt • Legislative support Syllabus: Taxation, pp. 92 - 104

  47. Equitable Allocation • Tracing • Allocation of expenses • Netting amendment

  48. The Patronage Relationship • Iberia Sugar (1973) • Member landlords, • non-member tenants • Statutory specifications • Patronage-source income Syllabus: Taxation, pp. 104 - 108

  49. Dividends on Stock • FCX (1976) • “Dividend allocation rule” (DAR) • American Jobs Creation Act • of 2004, §312 Syllabus: Taxation, pp. 114

  50. American Jobs Creation Act of 2004, §312 For purposes of paragraph (3), net earnings shall not be reduced by amounts paid during the year as dividends on capital stock or other proprietary capital interests of the organization … Syllabus: Taxation, pp. 114

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