Land O'Lakes, Inc. v. U.S.

• Decision Date: 30 April 1975
• Docket Number: No. 74-1100,74-1100
• Citation: 514 F.2d 134
• Parties: 75-1 USTC P 9431 LAND O'LAKES, INC., formerly Land O'Lakes Creameries, Inc., a Minnesota Corporation, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 134

514 F.2d 134

75-1 USTC P 9431

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

No. 74-1100.

United States Court of Appeals,

Eighth Circuit.

Submitted Sept. 12, 1974.

Decided April 30, 1975.

Leonard J. Henzke, Jr., Atty., Tax. Div., Dept. of Justice, Washington, D. C., for defendant-appellant.

Harold Jordan, St. Paul, Minn., for plaintiff-appellee.

Before GIBSON, Chief Judge, BRIGHT, Circuit Judge, and TALBOT SMITH, Senior District Judge. ^*

BRIGHT, Circuit Judge.

In this action, Land O'Lakes, a cooperative corporation, seeks a refund of income taxes in the sum of $254,978.74 (including interest) which it paid under a deficiency assessment for the year 1963. This deficiency arose because the Government revoked Land O'Lakes' status as an exempt farmers' cooperative under § 521 of the Internal Revenue Code, 26 U.S.C. § 521 (1970), for its operations during calendar year 1963. The district court ruled in taxpayer's favor and granted the refund. Land O'Lakes, Inc. v. United States, 362 F.Supp. 1253 (D.Minn.1973). The Government brings this appeal. We reverse.

The taxpayer operates essentially as a federated cooperative (a cooperative whose members are other cooperatives) but it does have individual members. Taxpayer primarily markets its members' products (milk products, such as butter, milk powder, cheese, and fluid milk, as well as eggs, chickens, and turkeys) through wholesale and retail sales. It also performs a purchasing function for its members and patrons by buying and processing feed, fertilizer and seed and wholesaling them to member cooperative stores and other outlets for sale to farmers. ¹ The taxpayer engaged in a multi-million dollar business, grossing about $200,000,000 in marketing operations and expending approximately $30,000,000 to purchase supplies for its members and other patrons in 1963.

Taxpayer engaged in retail marketing through operation of 20 outlets (some of which were small restaurants) known as Bridgeman's. The Bridgeman Division sold dairy products, such as milk and ice cream, obtained from members of the cooperative and from other producers, and it also sold sideline items, such as hamburgers, frozen foods, soup, and fried potatoes.

The rules applicable to exempt farmers' cooperatives appear in § 521(b) of the Internal Revenue Code, 26 U.S.C. § 521(b). They require that such an organization operate on a cooperative basis 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, or operate on a cooperative basis for the purpose of purchasing supplies and equipment for the use of members or other persons and turning over such supplies and equipment at actual cost plus necessary expenses. ² The Code limits exempt farmers' cooperatives' transaction of business with nonmembers and nonproducers. See26 U.S.C. § 521(b)(4). As relevant here, a supply cooperative does not qualify for an exemption when it purchases supplies for persons who are neither members nor producers to the extent of more than 15 percent of the value of all its purchases. Id. ³

Only some of Land O'Lakes' total marketing and supply activities are under review in the instant case. First, the taxpayer, as part of its supply activities in 1963, made sales at wholesale to a number of agricultural supply stores. These stores were not member cooperatives of the taxpayer. The stores in turn sold the supplies or equipment at retail to their customers. The sales by taxpayer to these retail stores were made under an agreement which designated the retailer as an agent for the ultimate farmer-consumer and stipulated that the farmer-consumer would receive any patronage dividends attributable to the transactions.

Second, as part of its marketing activities, the taxpayer marketed at wholesale in 1963 certain products, such as special cheeses and brown eggs, which it obtained from nonmembers because they were not available from its member cooperatives. Taxpayer's wholly-owned affiliate, Northwest Dairy Products Company, made contracts for these items with a number of proprietary companies and received patronage dividends, as allocated by taxpayer, for marketing them. Ultimately, these dividends were reallocated to taxpayer's members and producers who marketed their products through Land O'Lakes.

Third, as we have noted, taxpayer sold at retail nonproducer items such as hamburgers, frozen foods, and soft drinks through its Bridgeman ice cream stores. These sales amounted to $977,475 in 1963, which the Government calculates as 17 percent of Land O'Lakes' marketing sales at retail that year.

In 1970, the Government declared that taxpayer had forfeited, beginning in 1963, its entitlement to be taxed as an exempt farmers' cooperative under § 521 because of these marketing and supply activities.

The primary issue before us is whether taxpayer violated § 521(b) of the Internal Revenue Code and thus lost its exemption on any of several grounds urged by the Government. ⁴ We hold that taxpayer exceeded the scope of permissible transactions for a tax-exempt cooperative in both its marketing and supply activities and we uphold the Government's denial of the exemption. We deem it necessary to discuss only the first three of the five grounds for reversal advanced by the Government. See note 4 supra.

Preliminarily, we note that both exempt and nonexempt farmers' cooperatives receive special tax treatment under the Internal Revenue Code. Such organizations can deduct from gross income amounts allocated and distributed to patrons out of the net earnings of the cooperative. Subchapter T of the Internal Revenue Act of 1954, as amended, 26 U.S.C. §§ 1381-1388. see generally logan, federal income taxatiOn of farmers' and otHer Cooperatives: Part II, 44 Tex.L.Rev. 1269 (1966). A farmers' cooperative qualifying as exempt obtains additional tax advantages, for it may also deduct from gross income (1) amounts paid during the taxable year as dividends on its capital stock and (2) amounts paid or properly allocated to its patrons from earnings derived from business done with the United States or its agencies, or from sources other than patronage (such as earnings on its investments). 26 U.S.C. § 1382(c). See generally Logan, Federal Income Taxation of Farmers' and Other Cooperatives, 44 Tex.L.Rev. 250, 279-85 (1965). In seeking retention of its exempt status, Land O'Lakes desires the benefit of all deductions from gross income authorized by law for an exempt cooperative. We turn to a consideration of whether its conduct in 1963 justified the Government's determination that it had lost its exempt status.

I. Agent-Buyer.

A. Prior to 1963, taxpayer distributed supplies and equipment to its members and other farmers through its member cooperatives, which at that time were exclusively creameries, and through company-owned stores. In the years immediately preceding 1963 the number of member cooperatives began to dwindle as small creameries either went out of business or were acquired by larger concerns. Taxpayer found that it was unable to compensate for this reduction in its distribution capacity by establishing company stores and by sales to cooperative grain elevators. To restore this capacity it formulated the device of the agent-buyer.

Agent-buyers were "primarily small businesses with a single owner-operator." (Order of district court, Dec. 4, 1973, Civ. No. 3-71-49, at 15.) They ranged in size from those with modest inventories to those with "a sizeable business." (Trial Tr. 117-18.) In addition to acting as agent-buyers of taxpayers, these businesses ordinarily were established feed and agricultural supply dealers. Whatever their motive in agreeing to act as agent-buyers, the dealers contracted with taxpayer, at taxpayer's initiative, to sell taxpayer's supplies to farmers. The terms of the agreement between these dealers and appellee are important and bear summarization:

1) Taxpayer agreed to deliver Land O'Lakes feed, seed, and fertilizer, as ordered by agent-buyer, on regularly established credit terms.

2) The agent-buyer agreed to sell these items to farmers by means of sales slips furnished by Land O'Lakes, with copies of the slips to be returned to Land O'Lakes.

3) Land O'Lakes agreed to calculate patronage dividends on the basis of sales slips returned by the agent-buyer and the agent-buyer agreed that such dividends belonged to the retail farmer-customers of the agent-buyer.

4) Feeds used as an ingredient in the agent-buyer's own feed mixture were not covered by the agreement. As to these feeds, the agent-buyer was deemed the patron and, as such, entitled to patronage dividends. (App. 100-01.)

Notwithstanding the taxpayer's intent to create a cooperative-patron arrangement with the farmer-consumer, the record establishes that Land O'Lakes sold its supplies unconditionally to the retail outlets without knowing the identity of the persons who would receive the products as alleged "principals." The risk of loss or sale remained with the retailers on delivery. The agent-buyer remained free to set the retail price on his sale to a customer and would gain the profit or bear any loss incident to the sale. Except for their obligation to forward sales slips to the taxpayer, agent-buyers, who operated farm stores and sold primarily to farmers, marketed Land O'Lakes' products just as they did any other inventory item.

The district court did not find any agency relationship between the agent-buyer and the ultimate farmer-consumer at the time that Land O'Lakes delivered its feed or other products to the agent-buyer. The court held that because these supplies ultimately reached the farmer, who thereby became entitled to the patronage dividend, their purchase by Land O'Lakes for sale to agent-buyers should not be considered a...