Farmland Industries, Inc. v. Commissioner
| Citation | 78 T.C.M. 846 |
| Decision Date | 29 November 1999 |
| Docket Number | Docket No. 11881-93. |
| Parties | Farmland Industries, Inc. v. Commissioner. |
| Court | U.S. Tax Court |
Herbert N. Beller, Washington, D.C., Juan D. Keller, and Norman H. Lane, for the petitioner. Alan M. Jacobson and Davis L. Zoss, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies in petitioner's income tax for the years in issue:
Year Ended Deficiency
August 31, 1982 ................ $ 402,453
August 31, 1983 ................ 32,312,944
August 31, 1984 ................ 38,037,781
August 31, 1986 ................ 21,569
The sole issue for decision is whether the gains and losses that petitioner, a nonexempt cooperative, realized from the disposition of certain property should be classified as patronage income for purposes of subchapter T of the Internal Revenue Code (sections 1381-1388). Unless stated otherwise, all section references are to the Internal Revenue Code as in effect during the years in issue. The gains and losses at issue are from the disposition of the stock of three corporations, Terra Resources, Inc., Seaway Pipeline, Inc., and Mex-Am Crude Corp., and from the disposition of certain property used in a trade or business, as defined by section 1231(b).
Some of the facts have been stipulated and are so found. The amended stipulation of facts filed by the parties and the exhibits attached thereto are incorporated herein by this reference.
Petitioner is an agricultural cooperative organized under the laws of the State of Kansas. References to petitioner are to Farmland Industries, Inc. (Farmland), to all predecessor corporations merged into Farmland, and to all subsidiaries affiliated with Farmland, unless the context suggests otherwise.
During the years in issue, petitioner reported income and expenses on the basis of a fiscal year ending August 31. Petitioner's returns for fiscal years 1982 and 1983 were filed on Forms 1120, U.S. Corporation Income Tax Return. Petitioner's returns for fiscal years 1984 and 1986 were filed on Forms 990-C, Farmers' Cooperative Association Income Tax Return. Each of the returns was filed with respondent's service center in Kansas City, Missouri. At the time its petition was filed in this case, petitioner's principal place of business was Kansas City, Missouri.
Farmland was founded in 1931 as the Cooperative Union Oil Co. It was the successor to a Missouri cooperative corporation called the Union Oil Co., which had been founded in 1929 by Mr. Howard Cowden. Its corporate name was changed to Consumer's Cooperative Association in 1935, and to Farmland in 1966.
Mr. Cowden served as Farmland's president from the time of its incorporation until 1961 and as a member of its board of directors until 1963. He was a leader in the farmers' cooperative movement and believed that farmers could improve their overall financial condition by combining their market power.
Petitioner has operated continuously since 1931 as a farmers' cooperative. From 1931 to 1947, it was taxed as an exempt cooperative. From 1947 to 1961, it was taxed as a nonexempt cooperative under respondent's administrative interpretations and practices then in effect. See generally Farmers Coop. Co. v. Birmingham [49-2 USTC ¶ 9400], 86 F. Supp. 201 (N.D. Iowa 1949). Since 1962, petitioner has been taxed as a nonexempt cooperative under subchapter T of the Internal Revenue Code.
Petitioner is a regional cooperative. Its members are local cooperative associations whose members are farmers and ranchers. During the years in issue, petitioner's membership consisted of more than 2,200 local cooperatives which were located primarily in the Midwest. With the exception of petitioner's president, each member of its board of directors during the years in issue was either a working farmer or a manager of a local cooperative.
Petitioner's articles of incorporation provide that its primary purpose is to engage in agricultural supply and marketing activities for the benefit of its patrons. Its bylaws require that net income from cooperative activities be distributed to its patrons on a cooperative basis consistent with the provisions of subchapter T. Historically, petitioner's overall approach has been to conduct business in the most economically advantageous fashion possible to maximize patronage dividends.
The following chart shows petitioner's patronage and nonpatronage income for tax years 1982 through 1986:
NOL's and Patronage
FYE Patronage Deductible Income After Nonpatronage
8/31 Income Dividend Deductions Income
1982 .................... ($107,448,343) -- ($107,448,343) $13,013,6211
1983 .................... 28,048,015 ($28,048,015) -- 1,202,216
1984 .................... 104,087,552 (103,945,724)2 141,828 14,778,795
1985 .................... (17,151,510) -- (17,151,510) (1,936,452)3
1986 .................... 23,934,347 (24,361,501) (427,154) (29,700,543)4
1 Petitioner reported nonpatronage taxable income of $12,416,037 on its original return. The parties have
stipulated that the correct amount is $13,013,621
2 The deduction consisted of a patronage dividend deduction of $20,945,131, a net operating loss of $82,436,819
carried forward from 1982, and a patronage loss of $563,774 in respect of Farmland Agriservices, a
noncooperative subsidiary of petitioner, which represented a carryover of net operating loss incurred by the
company before its liquidation into petitioner
3 Petitioner carried back the nonpatronage loss to its taxable year ending August 31, 1982, and applied it against
the nonpatronage income for that year
4 Portions of the NOL were carried back and applied against nonpatronage income for taxable years ending
August 31, 1983, and 1984
Petitioner's consolidated operating results for fiscal years 1984 through 1986 are as follows:
Fiscal Year Net Savings (Loss)
1984 .............................. $11,193,000
1985 .............................. (61,082,000)
1986 .............................. (152,228,000)
Petitioner was organized for the primary purpose of supplying petroleum products such as gasoline, kerosene, motor oil, lubricating oils, and grease to its member cooperatives for sale to their patrons. Petitioner originally purchased these products in a packaged or processed state from various suppliers and then resold them to its members. During the 1930's and 1940's, petitioner expanded its product lines to include additional refined petroleum products as well as feed, seed, fertilizer, agricultural chemicals, tires, batteries, and miscellaneous farm supplies. Petroleum and fertilizer have been petitioner's two largest product lines, by volume of sales, since at least 1973.
In 1942, petitioner formed a subsidiary called the Cooperative Finance Agency to provide financing to local cooperatives. Petitioner also began a grocery business, a cannery, and a lumber mill to provide goods to its members. Many of petitioner's nonpetroleum lines of business produced little or no profit and required large capital investments. As a result, petitioner's expansion during the 1930's and 1940's required petitioner to incur substantial debt.
In 1952, petitioner considered constructing a nitrogen plant to produce fertilizer. However, the company did not have sufficient cash to finance the construction. The Wichita Bank for Cooperatives (Wichita Bank), petitioner's primary source of capital, would not lend the required money to petitioner without the approval of the Farm Credit Administration (FCA). The FCA was reluctant to approve a loan because petitioner lacked sufficient equity and permanent capital, had too much outstanding debt, and had a poor assets-to-liabilities ratio. The FCA also felt that the capital investment required to construct the plant was too large given the anticipated return. For that reason, the FCA suggested that petitioner sell assets and eliminate unprofitable product lines to reduce its debt.
Despite its financial difficulties, petitioner began constructing the nitrogen plant without obtaining complete financing for the project. It undertook this project through a new wholly owned subsidiary called Cooperative Farm Chemicals Association. The construction took place at a time when petitioner was experiencing poor financial returns. Nevertheless, in 1953 the Wichita Bank agreed to lend petitioner the funds required to complete the plant on the condition that petitioner raise cash through sales of common or preferred stock, certificates of indebtedness, or assets. The Wichita Bank also required petitioner to grant the Wichita Bank the right to examine petitioner's books and have a bank representative attend meetings of petitioner's board of directors.
Petitioner's financial difficulties continued into 1954. Petitioner took steps to cut costs and dispose of assets and was ultimately able to complete the nitrogen plant. By 1957, the nitrogen plant was operating profitably, and the financial crisis had dissipated.
In 1957, petitioner formed a subsidiary called Farmbest, Inc., for the purpose of marketing food products of its members. Farmbest's initial business consisted of slaughtering hogs and cattle and processing the meat into finished products. In 1970, petitioner transferred its food marketing business to another subsidiary called Farmland Foods, Inc. In 1976, petitioner acquired a grain marketing cooperative called Far-Mar-Co, Inc.
By the end of 1957, petitioner was one of the six largest industrial corporations in the United States. Petitioner's sales increased rapidly during the period from 1973 to 1980....
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