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Central Farmers Fertilizer Co. -Selected financial data year ending
Apr. 30, 1958


of dollars Total assets (year-end)

14, 670 Net worth (year-end).

9, 864 Sales

16, 069 Net margins.-

336 1 A cooperative enterprise engaged in the manufacture and sale of fertilizer materials, and owned by the following member cooperatives on Nov. 17, 1958: Consumers Cooperative Association, Kansas City, Mo. Farm Bureau Cooperative Association, Columbus, Ohio. Farm Bureau Service, Inc., Lansing, Mich. Farmers Union Central Exchange, St. Paul, Minn. Illinois Farm Supply Co., Chicago, Ill. Iowa Farm Supply Co., Des Moines, Iowa. Midland Cooperative, Inc., Minneapolis, Minn. Farm Bureau Service Co., St. Paul, Minn. Missouri Farmers Association, Columbia, Mo. Farm Bureau Service Co. of Missouri, Jefferson City, Mo. Nebraska Non Stock Cooperative Association, Lincoln, Nebr. Ohio Farmers Grain & Supply Co., Fostoria, Obio. Wisconsin Farmco Service Cooperative, Madison, W18. Indiana Farm Bureau Cooperative Association, Indianapolis, Ind. Farmers Union State Exchange, Omaha, Nebr. Central Cooperative, Inc., Superior, Wis. Farmers Chemical Co., Joplin, Mo. Pacific Supply Cooperative, Walla Walla, Wash. Cooperative Farmers Association, Seattle, Wash. Utah Cooperative Association, Salt Lake City, Utah. Utah Poultry & Farmers Cooperative, Salt Lake City, Utah.

Source : Trade Information.



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By Roswell Magill President Eisenhower recommended "corrective amendments of the laws on taxation of cooperatives” in his 1960 budget message. Secretary of the Treasury Anderson made specific legislative recommendations to Chairman Wilbur D. Mills of the Committee on Ways and Means and to the Speaker of the House of Representatives in January 1959 which “would ensure the ultimate payment of a single tax on cooperative income.” Various bills have been introduced relative to the taxation of cooperatives, but as yet no congressional action has been taken.

This statement is a study of the exemption contained in section 521 of the Internal Revenue Code of 1954 of "farmers', fruitgrowers', or like associations organized and operated on a cooperative basis”; and, in particular, of the taxability of the incomes of such organizations. The basic questions are: What is the present mode of taxation of the income of cooperatives? Is it satisfactory or should it be revised?

HISTORY OF THE EXEMPTION OF COOPERATIVES While the first income tax act in 1913 exempted a number of designated organizations from income tax, including "labor, agricultural, or horticultural organizations,” 2 the specific exemption of cooperatives dates from the Revenue Act of 1921, which provided an exemption for

Farmers', fruitgrowers', or like associations, organized and operated as sales agents for the purpose of marketing the products of members and turning back to them the proceeds of sales, less the necessary selling expenses, on the basis of the quantity of produce furnished by them; or organized and operated as purchasing agents for the purpose of purchasing supplies and equipment to such members at actual cost, plus necessary expenses. * * * 3

The requirement that the exempt organization be a sales agent was eliminated in section 231 (12) of the Revenue Act of 1926. That section provided that exemption should not be denied because the cooperative (1) has capital stock with a fixed dividend not to exceed the greater of 8 percent or the legal rate of interest in the State of incorporation; (2) has accumulated reasonable tax-free reserves; or (3) buys from or sells to nonmembers, with restrictions on amount. Section 101(12) of the 1939 code retained the substance of the 1926 act subsection.


1. See, for example, H.R. 199, H.R. 3150, H.R. 3848, and H.R. 7875, all introduced in the 86th Cong., 1st sess.

> Revenue Act of 1913, sec. II G(a). • Revenue Act of 1921. sec. 231(11).


(1) Exempt cooperatives.-Prior to the enactment of the Revenue Act of 1951, farmers' cooperatives that were exempt from Federal income tax under section 101(12)4 of the 1939 code enjoyed the following tax advantages from their exempt status:

(a) Earnings of exempt cooperatives paid to shareholders in the form of dividends on their capital stock were not taxable, but were taxable to nonexempt cooperatives;

(6) Net margins or profits which were retained as reserves and not allocated to the accounts of patrons were not taxable to exempt cooperatives but were taxable to nonexempt cooperatives; and

(c) Nonoperating income such as interest, dividends, rents, capital gains and income from certain business done with the U.S. Government and its agencies, was taxable to nonexempt cooperatives even when allocated to the accounts of patrons, but was tax free to an exempt cooperative whether or not allocated.

(2) Nonexempt cooperatives.-As a result of a series of Treasury rulings dating back to 1914,6 all cooperatives were allowed to exclude from gross income their net margins or profits which had been distributed to members or nonmembers, pursuant to a preexisting obligation, in the form of patronage dividends. The theory of the exclusion seems to be that the net margins distributed as patronage dividends do not represent a distribution of profits but rather an adjustment of price between members and the cooperative-an increase in price in the case of sales by members to the cooperative and a rebate in the case of sales by the cooperative to its members.

Sec. 101 (12) exempted from the tax on corporations : "Farmers', fruit growers', or like associations organized and operated on a cooperative basis, fa.) for the purpose of marketing the products of members or other producers, and turning back to them the proceeds of sales, less the necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them, or (b) for the purpose of purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost. plus necessary expenses. Exemption shall not be denied any such association because it has capital stock, if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued, and if substantially all such stock (other than nonvoting pre ferred stock, the owners of which are not entitled or permitted to participate, directly or indirectly, in the profits of the association, upon dissolution or otherwise, beyond the fixed dividends) is owned by producers who market their products or purchase their supplies and equipment through the association; nor shall exemption be denied any such association because there is accumulated and maintained by it à reserve required by State law or a reasonable reserve for any necessary purpose. Such an association may market the products of nonmembers in an amount the value of which does not exceed the value of the products marketed for members, and may purchase supplies and equipment for nonmembers in an amount the value of which does not exceed the value of the supplies and equipment purchased for members, provided the value of the purchases made for persons who are neither members nor producers does not exceed 15 per centum of the value of all its purchases. Business done for the United States or any of its agencies shall be disre. garded in determining the right to exemption under this paragraph. * * *"

5 S. Rept. 781, 82d Cong., 1st sess., nn. 20–22 (1951).

6 T.D. 1996 (1914); T.D. 2737 (1918); 0.D. 64, 1 Cum. Bull. 208 (1919); I.T. 1499, 1-2 Cum. Bull. 189 (1922): I.T. 1566. IÍ-1 Cum. Bull. 85 (1923); S.M. 2288, 111--2 Cum. Bull. (1924); S.M. 2595, III-2 Cum, Bull. 238 (1924),; A.R.R. 6967, III-1 Cum. Bull. 287 (1924); G.C.M. 12393, XII-2 Cum. Bull. 398 (1933) ; G.C.M. 17895, 1937-1 Cum. Bull. 56 ; I.T. 3208, 1938-2 Cum. Bull. 127.

7 Farmers' Cooperative Co. v. Birmingham (D.C. Iowa 1949) 86 F. Supp. 201; United Cooperatires, Inc., 4 T.C. 93 (1944); Midland Cooperative Wholesale, 44 B.T.A. 824 (1941); Valparaiso Grain c Lumber Co., 44 B.T.A. 125 (1941); Farmers' Union Cooperative Association, 13 B.T.A. 969 (1928) ; Anamosa Farmers Creamery Co., 13 B.T.A. 907 (1928); Home Builders Shipping Association, 8 B.T.A. 903 (1927) ; Albany Creamery 188'n. v. United States, 51-1 U.S.T.C. 9256 (D. Ore. 1950): Colony Farms Cooperative Dairy, Inc., 17 T.C. 688 (1951), Acq., 1952-1 C.B. 1; Dr. P. Phillips Cooperative, 17 T.C. 1002 (1951); C.F. Beaver Valley Canning Company, 9 T.C.M. 1120 (1950) (deduction disallowed in absence of preexisting legal obligation).


The exclusion was allowed whether the preexisting obligation was by charter provision, bylaw, or express contract, and whether the patronage dividends were distributed to members in the form of cash, stock, revolving fund certificates, certificates of indebtedness, letters of advice, or book credits. Under these rulings and decisions, a nonexempt cooperative did not need to pay any Federal income tax on its operating profits or net margins so long as they were allocated to patrons whether in the form of cash or in paper certificates of indebtedness, letters of advice, etc.

(3) Patrons of cooperatives.—The tax consequences of receipt of patronage dividends by patrons of a cooperative based on the amount or value of produce furnished by them to the cooperative or the value of supplies or equipment purchased by them from the cooperative was not affected by the status of the cooperative as exempt or nonexempt. Patrons of cooperatives were required to include in their gross income the face amount of any patronage dividends received by them regardless of whether the distribution was made in cash or some form of certificate or paper evidencing the amount of the cooperative’s net margins or profits allocated to the patron. As a practical matter, however, many farmers did not include in gross income patronage dividends paid in noncash forms regardless of Treasury instructions to the contrary.10


Section 101 (12) of the 1939 code was redesignated as 101 (12)(A) of the 1951 act, which also added a new subsection 101(12)(B). Subsection (B), in effect, eliminated the broad exemption from tax formerly accorded to cooperatives qualifying under section 101 (12) by providing that such exempt cooperatives were subject to regular corporation income tax on their net incomes, 11 less certain special deductions. These special deductions from gross income, granted by subsection (B) to exempt cooperatives, but not permitted to nonexempt cooperatives, that is, those not meeting the prerequisites of section 101(12)(A), were for (1) amounts paid as dividends during the taxable year upon its capital stock and (2) amounts allocated to patrons with respect to its income not derived from patronage, whether paid in cash, property, certificates of indebtedness, letters of advice, and so forth.

In addition, subsection (B) provided that patronage dividends, refunds, and rebates to patrons with respect to their patronage, whether paid in cash, property, certificates of indebtedness, letters of advice, and so forth, might be excluded from gross income “* * * in

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8 All such forms of payment were regarded as the equivalent of cash distributions in the hands of patrons, the theory being that they were cash payments automatically reinvested under the provisions of the charter, bylaws, or other contracts previously agreed to by the patrons. See United Cooperatives, Inc., 4 T.C. 93 (1944).

91.T. 3208, 1938-2 C.B. 127. (Amounts credited to a patron on the books of a cooperative were held to have represented contributions to the capital of the cooperative and as such were taxable to the patron whether or not certificates were issued.)

10 Income Tax Information Release No, 2, Apr. 13, 1950, 5 CCH 1950 Stand. Fed. Tax Rept. 6111.

111 Sec. 101 (12)(B) provided in part as follows:

“(B) 'An organization exempt from taxation under the provisions of subparagraph (A) shall be subject to the taxes imposed by sections 13 and 15, or section 117(c) (1), except that in computing the net income of such an organization there shall be allowed as deductions from gross income (in addition to other deductions allowable, under section

23) * * * "

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the same manner as in the case of a cooperative organization not exempt under subparagraph (A). ** *" *This provision seemed to give legislative recognition to the series of Treasury rulings and lower court decisions, cited above, which held that cooperatives could exclude from gross income their net margins or profits allocated to members or nonmembers in the form of patronage dividends pursuant to a preexisting obligation.

The Senate Finance Committee report 12 states the result as follows:

Section 314 of your committee's bill continues the exemption provided by section 101 (12) of the code but removes from its application earnings which are placed in reserves or surplus and not allocated or credited to the accounts of patrons. In addition to being tax free with respect to patronage dividends paid or allocated to patrons, as is generally also true in the case of other cooperatives, the cooperatives coming under section 101 (12) are also to remain exempt with respect to amounts paid as dividends on capital stock, and with respect to amounts allocated to patrons where the income involved was not derived from patronage, as for example in the case of interest or rental income, and income derived from business done with the Federal Government. Moreover, they will not be taxed in any way with respect to reserves set aside for any necessary purpose, or reserves required by State law, if such reserves are allocated to patrons.

The purpose of Congress in making this change was stated by the committee as follows:

As a result of this action, all earnings or net margins of cooperatives will be taxable either to the cooperative, its patrons or its stockholders with the exception of amounts which are paid or allocated to patrons on the basis of purchases of personal, rather than business, expense items. *

To summarize, the amendment of section 101(12), effected by the Revenue Act of 1951, was evidently intended to provide for the taxation of all the net margins or profits of an exempt cooperative either to the cooperative itself or to the patron.13 Previously, an exempt cooperative's “reasonable reserves” were not subject to Federal income tax in the hands of the cooperative or its patrons. The taxation of retained earnings not allocated or apportioned by an exempt cooperative was the most important aspect of the 1951 legislative changes.


ACT OF 1951

Following the enactment of the Revenue Act of 1951, the expressed congressional desire to provide for the taxation of the net margins of cooperatives, either to the cooperative or to the patron, was realized when patronage dividends were paid in cash. All cooperatives were allowed to deduct cash distributions from income. The cash patronage dividend was income to the recipient. A difficulty arose, however, when patronage dividends were paid in the form of letters of advice, credit memoranda, etc. In view of its longstanding practice of allowing cooperatives to exclude noncash patronage dividends from income, the Treasury attempted to impose a tax on such paper allocations at the patron level.

1 S. Rept. 781, supra, note 5.

13 In order to insure greater compliance by patrons in reporting patronage dividends paid other than in cash, sec. 148(f) was added to the law. This section required cooperatives to report to the Commissioner the amount and payee of all patronage dividends of $100 or more paid or allocated during a year. It also authorized the Secretary of the Treasury to require cooperatives to report all patronage dividends.

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