Farmers Union Co-Op. Co. v. Commissioner of Int. Rev.

• Decision Date: 17 June 1937
• Docket Number: No. 10772.,10772.
• Citation: 90 F.2d 488
• Parties: FARMERS UNION CO-OP. CO. OF GUIDE ROCK, NEB., v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Eighth Circuit

90 F.2d 488 (1937)

FARMERS UNION CO-OP. CO. OF GUIDE ROCK, NEB., v. COMMISSIONER OF INTERNAL REVENUE.

No. 10772.

Circuit Court of Appeals, Eighth Circuit.

June 17, 1937.

Louis B. Montfort, of Washington, D. C., for petitioner.

John J. Pringle, Jr., Sp. Asst. to Atty. Gen. (James W. Morris, Asst. Atty. Gen., and Sewall Key, Sp. Asst. to Atty. Gen., on the brief), for respondent.

Before STONE, SANBORN, and THOMAS, Circuit Judges.

STONE, Circuit Judge.

This is a petition to review a determination of the Board of Tax Appeals that petitioner is not exempt from income taxation for the year 1928. Petitioner made no return for taxation. The Commissioner assessed a tax and a penalty for failure to make return. Petitioner contended it was not subject to taxation because it was a farmers' co-operative association within section 103 (12) of the Revenue Act of 1928 (45 Stat. 791, 812, 813 26 U.S.C.A. § 103 note) which exempts such organizations. The Board sustained the Commissioner.

Petitioner presents here four issues: (1) That what is sought to be taxed as income is not income; (2) that it is within the exemption of section 103 (12); (3) that the Board erred in denying petitioner's motion to amend its findings of facts in the respects set forth in the motion; (4) that the Board erroneously admitted certain evidence and erroneously excluded certain other evidence — both over objection of the petitioner.

It is unnecessary to discuss and rule on the action of the Board in denying the motion to amend its findings or in admitting or excluding evidence. This is true because had the Board ruled in favor of petitioner as to all of these matters, it would not have altered the facts which are determinative of this controversy. This leaves for examination the two contentions: (1) Was what is here sought to be taxed "income" within the meaning of the Sixteenth Amendment; and (2) even if such is taxable "income," was petitioner exempt from income taxation in 1928 because within the exemption expressed in section 103 (12) of the Revenue Act of 1928?

(1) Taxable "Income."

The matter sought to be taxed as income is the net earning of petitioner resulting from the following method of doing business: Petitioner was organized, in 1915, under a statute of Nebraska permitting organization of corporations described as "Co-operative Companies." This statute defined a "co-operative company" as being one "which authorizes the distribution of its earnings in part,¹ or wholly, on the basis of, or in proportion to the amount of property bought from or sold to members, or of labor performed, or other service rendered to the corporation." R.S.Neb.1913, p. 260, § 733. Among the corporate powers was "to make by-laws for the management of its affairs, and to provide therein the terms and limitations of stock ownership, and for the distribution of its earnings." R.S.Neb.1913, p. 261, § 735.

The articles of incorporation of petitioner provided for quite broad and general powers which are not stated here because they do not affect the issues in this case except that they provided for capital stock and stockholders. The by-laws (in force in 1928) provided as follows:

"Any person who is a member of the Farmers' Educational and Co-operative Union and in good standing may be a stockholder in this corporation.

* * * * * *

"Article IV.

"Dividends and Net Profits

"Section 1. The Board of Directors shall set aside from time to time such sums from the net profits as in their judgment they shall deem desirable for a surplus.

"Section 2. After taking from net profits such surplus as stated in section 1, then there shall be paid an annual dividend from the net profits of 8 per cent per annum on the par value of all the paid in capital stock of this corporation; provided, however, if such remaining net profits are insufficient to pay such 8 per cent, then in that event such per cent shall be paid as said remaining net profits amount to.

"Section 3. There shall be and there is hereby created a fund to be known as the `Contingent Reserve Fund' which fund shall be composed of such percentage of the pro-rated net profits credited to individual members as hereinafter provided as the Board of Directors of this corporation shall annually order diverted to such fund, and said Board of Directors is hereby authorized to divert annually not to exceed 25 per cent of said annual individual credits to said `Contingent Reserve Fund' until said `Contingent Reserve Fund' amounts to the par value of the paid in capital stock.

"Section 4. No interest shall be paid on said `Contingent Reserve Fund' and no part of same shall be paid out or withdrawn, except when a member dies, sells shares or becomes ineligible to membership in this corporation in which event the total amount diverted from his individual credit to this fund shall be paid to him or his legal representative upon demand, without interest.

"Section 5. All remaining net profits, shall be pro-rated to stockholders in proportion to the amount of business they have done with corporation during business year.

"Section 6. All stockholders must be in good standing with the F. E. & C. U. and shall have paid their dues prior to May 1 in order to receive patronage dividends from the years business."

In 1928, there were outstanding 1931 shares of stock (par value $10) held by about 220 individuals. The business then being transacted by petitioner consisted of running a grain elevator, a feed store, a general merchandise store, the purchase, the sale, and shipping of grain and other farm products, and handling machinery supplies and repairs. Its plan of purchase from producers and others was to pay the market price less estimated costs to it of handling. Its plan of sale to stockholders and others was to add to its cost price the estimated cost to it of handling. If these received estimates of costs of handling exceed the actual costs therefor for any year, there resulted a cash balance for disposition by the directors in accordance with the by-laws. In 1928, there was such a balance of $11,882.76. This is the sum claimed to be taxable as income for that year.

Petitioner contends that this balance, so earned, is not income within the Sixteenth Amendment to the Constitution but is "accumulated savings." The supporting arguments are as follows: This balance is "accumulated patron savings" and, as such, is: "monies belonging to the patron which he has advanced in a cooperative transaction knowing it will eventually be returned to him or used for him. It is not the property of the petitioner and never was. The petitioner is a bailee that must return the bailment when the co-operative transaction is completed, unless used for a legitimate legal purpose.

"The petitioner experiences no gain from capital or through sale or conversion of capital assets, because the savings were legally held as assets and from the assets debts were paid. * * *

"In farmer cooperative activities the element of departure from ordinary corporate economic practice is found in the fact that the benefits resulting from the cooperative buying and selling is enjoyed by the patrons in proportion to their individual dealings with the cooperative association, rather than in proportion to the capital contributed by each to the conduct of the business. It is this difference of economic principle governing the distribution of wealth that in general is the line of demarcation between what is income and what is not income.

"And this is true even though the receipt of the benefits are immediate or postponed while the cooperative association accumulates a reserve for contingencies or increases its working capital for the conduct of its business.

"Accumulated farmer patron savings are not income and are tax exempt even though not distributed, being a liability of the cooperative association to its members under the laws of the State of Nebraska and under the charter and by-laws of the association."

The argument that petitioner is merely a bailee of this money and not the owner thereof is unsound. Although organized for cooperative purposes, petitioner is a separate legal entity — a corporation. Its relation to this money must be determined by the law under which it was organized and operates. Among the statutory powers are "to make by-laws for the management of its affairs, and to provide therein * * * for the distribution of its earnings." Such by-laws were made. Those earnings might be (under the statute) and were (under the by-laws) usable to pay dividends of not exceeding 8 per cent. on corporate stock and usable for other corporate uses before being subject to distribution as patronage dividends. Also, such corporations can sue and be sued and hold such real and personal property as necessary for their legitimate businesses. R.S.Neb.1913, p. 261, § 735. In fact, such corporations seem to possess all of the main attributes of an ordinary business corporation except as to the basis of distribution of their net earnings, which instead of being distributed on some stock share basis must "in part," at least, be distributed "on the basis of, or in proportion to the amount of property bought from or sold to members, or of labor performed, or other service rendered to the corporation." R.S.Neb.1913, p. 260, § 733. Clearly this money is property of the corporation as genuinely and truly as is the grain elevator or the stock of merchandise owned by it. While those who might be entitled to patronage dividends have, in a sense, an interest in the money, it is a character of interest not greater, if as great, as that of a stockholder in an ordinary corporation. Such interest never ripens into an individual ownership or right of ownership until and if a patronage dividend be declared. Fruit Growers' Supply Co. v. Commissioner, 56 F.(2d) 90, 93 (C.C.A.9); and see Penn Mutual Life Ins. Co. v. Lederer, 252 U.S. 523, 40 S.Ct. 397, 64 L.Ed. 698. Until such...