Farmers Coop. Co.  v. Comm'r of Internal Revenue

• Citation: 89 T.C. No. 47,89 T.C. 682
• Decision Date: 29 September 1987
• Docket Number: Docket No. 15643-82
• Parties: FARMERS COOPERATIVE COMPANY (SUCCESSOR-IN-NAME TO FARMERS CO-OP OIL COMPANY), Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: United States Tax Court

89 T.C. 682

89 T.C. No. 47

FARMERS COOPERATIVE COMPANY (SUCCESSOR-IN-NAME TO FARMERS CO-OP OIL COMPANY), Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15643-82

United States Tax Court

Filed September 29, 1987.

P, a farmers cooperative association, sought to qualify as an exempt cooperative association under sec. 521, I.R.C. of 1954. R, by means of a revenue ruling, set an 85-percent patronage requirement by active capital stockholder, which standard was approved by the Eighth Circuit and this Court. R, by means of a revenue procedure, attempted to set a 50-percent patronage requirement for each patron who was a capital stockholder and considered to meet the 85-percent test of the revenue ruling. HELD, for purposes of sec. 521, I.R.C. of 1954, any amount of patronage will be sufficient for a patron to be considered active for purposes of the ‘substantially all‘ or 85- percent test. Respondent's 50-percent test is rejected. Richard S. Wheeler and Stanley W. Rosenkranz, for the petitioner.

Ruud L. DuVall, for the respondent.

OPINION

GERBER, JUDGE:

This opinion is necessitated by a mandate, issued July 22, 1987, from the United States Court of Appeals for the Eighth Circuit affirming in part, reversing in part and remanding for proceedings consistent with their opinion rendered regarding an appeal from our opinion in Farmers Cooperative Co., et al. v. Commissioner, 85 T.C. 601 (1985) (Farmers I).

In Farmers I we held that two separate cooperatives ¹ did not qualify as exempt cooperative associations under section 521 ² because ‘substantially all‘ of their capital stock was not owned by producers who market their products or purchase their supplies through the cooperatives. Our holding was premised on an ‘85-percent test‘ to meet the ‘substantially all‘ requirement of section 521 as published by respondent in Rev. Rul. 73-248, 1973-1 C.B. 295, and approved in West Central Cooperative v. United States, 758 F.2d 1269, 1271 (8th Cir. 1985); also see discussion in Farmers I, 85 T.C. at 612 to 617. In applying this petitioner's facts to the ‘85-percent test,‘ we did not give credit for patrons who became entitled to (but had not been issued) capital stock due to patronage during the year in question and we did include those who owned capital stock but did not patronize. Because neither of the petitioners in Farmers I was found to have met the 85-percent test, we did not consider the second part of the statutory requirement that the patrons be current and active.

The United States Court of Appeals for the Eighth Circuit held that ‘for purposes of applying the 85% test, the relevant consideration is whether the right to vote has actually accrued or been terminated by the time of the annual shareholder's meeting following the close of the tax year.‘ Farmers Cooperative Company v. Commissioner, 822 F.2d 774, 779, (8th Cir. 1987), affg. in part, revg. in part and remanding 85 T.C. 601 (1985). Based on that standard, petitioner was found to have met the 85-percent test for one (1977) of the two years in issue. Because of this finding, the matter is remanded to us for consideration of the second part of the statutory requirement regarding the quantity of business, if any, that patrons are required to conduct with the cooperative.

A cooperative will not lose its exempt status because it has capital stock, ‘if substantially all such stock * * * is owned by producers who market their products or purchase their supplies and equipment through the association. ‘ Section 521(b)(2). Respondent quantified the ‘substantially all‘ requirement in a revenue ruling (Rev. Rul. 73-248, supra) and the patronage test in a revenue procedure. In Rev. Proc. 73-39, 1973-2 C.B. 502, respondent published an examination guideline of 50-percent patronage. ³ Respondent, for litigating purposes in a case presented and briefed prior to the issuance of Rev. Proc. 73-39 argued, ‘that SUBSTANTIALLY ALL of the shareholder-producers must market SUBSTANTIALLY ALL of their products and purchase SUBSTANTIALLY ALL of their supplies through the cooperative,‘ but the Eighth Circuit suggested ‘that imposition of the »the substantially all standard for patronage purposes† could produce impractical and perhaps oppressive results.‘ Co-operative Grain & Supply Co. v. Commissioner, 407 F.2d 1158, 1164 n.10 (8th Cir. 1969), remanding on another issue a Memorandum Opinion of this Court. In declining to address this issue in Farmers I, we noted ‘that consideration of this area is fraught with many difficulties and problems. Does respondent contemplate that cooperatives will keep track of shareholders' transactions outside the cooperative in order to police the 50-percent test * * *? Would cooperatives effectively serve their congressionally intended purpose if patrons were required by contract to transact a minimum amount of business with the cooperative?‘ 85 T.C. at 617 n. 11..

Petitioner's records reflect the amount of marketing or purchasing business transacted by each patron with petitioner each year, but not the amount of a patron's total marketing or purchasing business with or from all entities or sources for the same year. It would be impossible for petitioner to determine from its records whether any patron met the 50-percent test.

With this background, we must consider whether the respondent's ‘50-percent patronage test‘ comports with the plain language of the statute or the underlying congressional intent. If not, we must determine whether any minimum annual quantity of patronage is statutorily required or intended.

STATUTORY BACKGROUND

Exempt status for cooperative associations within the context of Federal taxing statutes is a concept which has been in existence for more than 65 years, beginning before the Revenue Act of 1921, 42 Stat. 227. The ‘substantially all‘ requirement has been a part of the statutory scheme since the Revenue Act of 1926, 44 Stat. 9, 40, ⁴ under circumstances where the cooperative was ‘owned‘ by means of capital stock. Permitting cooperatives to be corporate entities and to act for the benefit of individuals other than cooperative members was a liberalization permitted in Treasury Department regulations under the Revenue Act of 1921. Congress permanently codified this liberalization in section 231(12) of the Revenue Act of 1926 which is essentially unchanged in its present form in section 521. The Senate Committee on Finance in discussing the need for this codification as part of the Revenue Act of 1926, commented:

Section 231(12): The existing law, strictly construed, allows exemption only to those farmers', fruit growers' or like associations which act as sales or purchasing agents for producer members and which return to such members the entire proceeds of their operations, except necessary sales or purchasing expenses. However, in order that any such association, not operated for profit, and which is a true cooperative association, shall get the benefit of this exemption, the Treasury Department in its regulations has construed the existing law with great liberality, enlarging the term ‘member‘ to mean any producer whether or not a member, if treated by such an association on the same basis as a member; exempting such an association not acting as an agent, but taking title to products or supplies; allowing such associations to have outstanding capital stock and to pay dividends on such stock (subject to certain limitations); permitting such associations to build up reserves for State requirements or other necessary purposes; and allowing such associations to manufacture their products, to change the form of raw materials, and in some cases to operate subsidiaries, SO LONG AS THE OPERATIONS ARE NOT CONDUCTED ON AN ORDINARY PROFIT-MAKING BASIS. »Emphasis supplied. Senate Committee on Finance, S. Rept. 52, 69th Cong., 1st Sess. at 23 (1926); 1939-1 C.B. (Part 2) 332, 350.†

Respondent, in Mim. 3886, X-2 C.B. 164, declared obsolete by Rev. Rul. 74-268, 1974-1 C.B. 367, expressed his understanding of the purposes of the exempt cooperative provisions in conjunction with the liberalization contained in the Revenue Act of 1926. In that context respondent observed that exempt cooperatives could retain their non- profit status and have dealings with non-members so long as the net proceeds of transactions were passed back through to members and non-...