Land O'Lakes, Inc. v. United States

• Decision Date: 11 September 1973
• Docket Number: No. 3-71-Civ-49.,3-71-Civ-49.
• Citation: 362 F. Supp. 1253
• Parties: LAND O'LAKES, INC., formerly Land O'Lakes Creameries, Inc., a Minnesota corporation, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Minnesota

362 F. Supp. 1253

LAND O'LAKES, INC., formerly Land O'Lakes Creameries, Inc., a Minnesota corporation, Plaintiff, v. UNITED STATES of America, Defendant.

No. 3-71-Civ-49.

United States District Court, D. Minnesota, Third Division.

September 11, 1973.

Doherty, Rumble & Butler, Harold Jordan, and Irving Clark, St. Paul, Minn., for plaintiff.

Robert G. Renner, U. S. Atty., Scott P. Crampton, Asst. Atty. Gen., Daniel J. Dinan, D. Patrick Mullarkey, and John A. Flanagan, Attys., Dept. of Justice, for defendant.

MEMORANDUM AND ORDER

DEVITT, Judge.

In this civil tax refund action to recover $254,978.74 of income tax and interest paid for the calendar year 1963, the principal issue is whether plaintiff violated § 521 of the Internal Revenue Code of 1954 and thus lost its qualification as a tax exempt organization. If the Court finds Land O'Lakes did not qualify as a tax exempt organization for the year 1963, then numerous secondary issues which relate to deductions disallowed by the government must also be resolved. If the Court finds that Land O'Lakes did qualify as a tax exempt organization for the year 1963, then only one secondary issue which relates to deductibility must be resolved.

Land O'Lakes, Inc., a Minnesota corporation, is a farmers' cooperative which qualified as a tax exempt organization under § 521 of the Code from 1923 through 1962. On February 9, 1970, the Internal Revenue Service notified Land O'Lakes by letter that the exemption of the farmers' cooperative was revoked effective with the calendar year 1963. On October 1, 1970, the I.R.S. notified Land O'Lakes of a proposed assessment of an alleged deficiency in income tax for the calendar year 1963 in the amount of $186,393.57. On November 2, 1970, Land O'Lakes paid the alleged deficiency plus interest of $68,585.17 for a total of $254,978.74 and filed a claim for refund. On December 30, 1970, the I.R.S. notified Land O'Lakes that its claim for refund was disallowed. Plaintiff instituted this action for refund on March 5, 1971.

The matter was tried to the Court on June 19 and 20, 1973. The parties stipulated to most of the facts. Briefs have been filed. Jurisdiction rests on 28 U. S.C. § 1346.

The organizational structure of Land O'Lakes may be separated into two activities: (1) marketing activities and (2) supply activities. The marketing activities of Land O'Lakes were conducted by both retail and wholesale methods. The major portion of plaintiff's retail sales in 1963 was accomplished by Bridgeman Division. Bridgeman Division marketed both producer goods (dairy items) and nonproducer goods (nondairy items) at retail. The dairy items were supplied to Land O'Lakes by member-cooperatives and individual member-farmers (producers). The non-dairy items were supplied to Land O'Lakes by proprietary companies (nonproducers). The major portion of Land O'Lakes' marketing activities in 1963 was accomplished by the wholesale method. In addition to marketing producer goods at wholesale, Land O'Lakes also marketed nonproducer goods at whole-sale which were obtained from Northwest Dairy Products Company, Inc., a wholly-owned subsidiary. Northwest, a nonproducer, purchased the nonproducer goods from proprietary companies and sold the goods to plaintiff at cost. The supply activities of Land O'Lakes consisted of selling agricultural supplies to member-cooperatives, company stores, independent dealers, and agent-buyers who in turn resold the supplies to members and other patrons. The agent-buyer, a nonmember nonproducer, was used in geographical areas where Land O'Lakes did not have a member-cooperative or company store. Unlike the independent dealer, the agent-buyer executed an agreement with Land O'Lakes in which he agreed to provide the cooperative with all invoices based on sales of supplies to producers. At the end of each year, plaintiff distributed patronage dividends to all producers who purchased supplies from the agent-buyer as reflected by the invoices. The agent-buyer received patronage dividends attributable to purchases of supplies by nonproducers or by the agent-buyer himself.

The basic issue is whether Land O'Lakes was properly operating under the Internal Revenue Code as a tax exempt farmers' cooperative in 1963. To resolve this issue, the Court must analyze three sub-issues which involve the marketing and supply activities of Land O'Lakes. If the Court finds in favor of the government with regard to any one of the three sub-issues, then it must be concluded that plaintiff was improperly operating as a tax exempt organization for the calendar year 1963.

The first sub-issue is whether Land O'Lakes violated § 521(b)(1)(A) of the Code by marketing nonproducer goods at retail through its Bridgeman Division. Section 521(b)(1)(A) provides that "farmers" cooperatives exempt from taxation to the extent provided in subsection (a) are farmers', fruit growers', or like associations organized and operated on a cooperative basis (A) 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."

Neither the Code nor the Treasury Regulations promulgated thereunder make reference to the marketing of non-producer goods by exempt farmers' cooperatives. The courts have held that tax exemption statutes should be strictly construed against the taxpayer. See, e. g., Helvering v. Northwest Steel Rolling Mills, Inc., 311 U.S. 46, 61 S.Ct. 109, 85 L.Ed. 29 (1940); Co-operative Grain & Supply Co. v. Commissioner of Internal Revenue, 407 F.2d 1158 (8th Cir. 1969). However, there is also authority for the general proposition that tax exempt organizations may engage in certain "incidental activity which standing alone would be subject to taxation." United States v. Omaha Live Stock Traders Exch., 366 F.2d 749, 752 (8th Cir. 1966), quoting Evanston-North Shore Bd. of Realtors v. United States, 162 Ct.Cl. 682, 320 F.2d 375, 380 (1963). See also Trinidad v. Sagrada Orden, 263 U.S. 578, 44 S.Ct. 204, 68 L.Ed. 458 (1924) (exempt religious organization); Eugene Fruit Growers Ass'n v. Commissioner of Internal Revenue, 37 B.T.A. 993 (1938) (exempt farmers' cooperative).

More specifically, the I.R.S. has ruled that an exempt farmers' cooperative may market nonproducer goods in two limited situations. The first exception allows an exempt farmers' cooperative to market nonproducer goods in an emergency situation when necessary to fulfill outstanding orders based on pre-existing contractual commitments to facilitate dealings with member-patrons. Rev.Rul. 69-222, 1969-1 Cum.Bull. 161. This exception is not applicable here. The second exception allows an exempt farmers' cooperative to market nonproducer goods at retail if such goods are necessary to the effective marketing of producer goods. However, this exception is further limited by the requirement that the marketing of such nonproducer goods which are deemed "necessary" may not exceed five percent of the total retail sales unless the cooperative establishes that the total sales of nonproducer goods are "merely incidental" to the total sales of producer goods. Thus, if the sales of nonproducer goods are so substantial that they cannot be considered as merely incidental, the question of whether the nonproducer sales are a "necessary supplement" to the effective marketing of producer goods is immaterial because the cooperative has violated the Code provisions governing its exempt status. Rev.Proc. 67-37, 1967-2 Cum.Bull. 668. This exception is applicable to the retail marketing of nonproducer goods by Bridgeman Division.

Land O'Lakes argues that Bridgeman's marketing of nonproducer goods at retail was incidental to the marketing of producer goods at retail and was for the purpose of selling the producer goods more advantageously. In an attempt to prove its sales of nonproducer goods were incidental to its sales of producer goods, Land O'Lakes proposes three standards of measurement: (1) total sales of nonproducer goods at wholesale and retail measured against total sales at wholesale and retail, (2) total sales of nonproducer "soft" goods (non-dairy items marketed by Bridgeman) measured against total sales of soft goods (dairy and non-dairy items marketed by Bridgeman Division and Land O'Lakes Fluid Milk and Ice Cream Division), or (3) total sales of nonproducer soft goods measured against total sales of soft goods by Bridgeman only. Regardless of the standard of measurement employed, plaintiff asserts that it is unimportant upon which basis the percentage of nonproducer goods is computed because the important question is whether or not the nonproducer goods were marketed for the purpose of more advantageously selling the producer goods.

Land O'Lakes further argues that nonproducer goods were introduced in an attempt to turn losses incurred by Bridgeman into profits by attracting more customers who would purchase more producer goods. It is concluded that the availability of the nonproducer goods in 1963 did effect a substantial profit on the sale of producer items even though Bridgeman incurred a loss on the sale of nonproducer items. Given this motivation, Land O'Lakes states that the incidental marketing of nonproducer goods by Bridgeman and resulting profits made on the marketing of producer goods support its argument that the purpose of this activity was to enhance the sales of producer items and was not in violation of § 521(b)(1)(A).

The government argues that the marketing of nonproducer goods at retail was not incidental and was not proven by plaintiff to be necessary. In reliance on the Revenue Procedure explained above, the government states that the standard of measurement employed to determine the percentage of nonproducer goods marketed by Bridgeman should be the total retail sales of nonproducer goods measured against the...