St. Louis Bank for Cooperatives v. United States

• Decision Date: 18 June 1980
• Docket Number: No. 410-75.,410-75.
• Citation: 624 F.2d 1041
• Parties: ST. LOUIS BANK FOR COOPERATIVES v. The UNITED STATES.
• Court: U.S. Claims Court

624 F.2d 1041

ST. LOUIS BANK FOR COOPERATIVES v. The UNITED STATES.

No. 410-75.

United States Court of Claims.

June 18, 1980.

Arthur E. Bryan, Jr., Chicago, Ill., attorney of record, for plaintiff; Don S. Harnack, George W. Benson, and McDermott, Will & Emery, Chicago, Ill., of counsel.

Robert N. Dorosin, Washington, D. C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D. C., for defendant; Theodore D. Peyser, Jr. and Robert S. Watkins, Washington, D. C., of counsel.

Before FRIEDMAN, Chief Judge, and KUNZIG and SMITH, Judges.

OPINION

PER CURIAM:

This federal income tax refund case comes before the court on both parties' exceptions to the recommended decision of Trial Judge Harkins filed on August 8, 1979.

The plaintiff is a nonexempt cooperative corporation. The questions are whether three items of the plaintiff's income for 1972 and 1973 were patronage sourced income under section 1382(b) of the Internal Revenue Code of 1954 and therefore deductible from the plaintiff's gross income. These items are: (1) interest received on demand deposits in Farm Credit Banks or on loans to brokerage firms; (2) interest received on federal bonds the plaintiff purchased to maintain liquidity; and (3) a gain of $386 upon the sale of an automobile used in the plaintiff's business. The trial judge held that items (1) and (2) were patronage sourced and deductible but that item (3) was not patronage sourced and therefore was not deductible.

Upon consideration of the briefs and after oral argument, we agree with the trial judge's conclusion with respect to the first two items and adopt, with modifications, his recommended opinion and findings as the basis for our decision on those issues. We disagree, however, with the trial judge on issue (3), and we conclude that the gain on the sale of the automobile also is patronage sourced. We therefore have substituted our own discussion for that of the trial judge in the portion of his opinion following the caption, "Sale of Automobile."^*

OPINION OF THE TRIAL JUDGE

HARKINS, Trial Judge: Plaintiff, the St. Louis Bank for Cooperatives, a nonexempt corporation operated on a cooperative basis, claims a refund of income taxes and assessed interest in the amount of $18,021.62 for the taxable year ended June 30, 1972, and $17,120.08 for the year ended June 30, 1973. Defendant has filed a counterclaim for additional income taxes and interest in the amount of $7,744.58 for the 1972 tax year and $13,247.36 for 1973.

At issue is whether the following items of income qualify for distribution as patronage dividends pursuant to section 1382(b) of the Internal Revenue Code of 1954, as amended:

(a) interest income from demand deposits in nonpatron farm credit system banks, or from short-term loans to several brokerage houses through repurchase agreements, received by plaintiff through its management of funds surplus to the daily needs of its patrons;

(b) interest income obtained from certain Federal bonds required to be held for liquidity purposes in support of its banking business; and

(c) a gain of $386 realized upon the sale of an automobile used as a pool car by plaintiff's officers and staff.

The following analysis shows that these three items qualify as section 1382(b) patronage sourced income.¹

As a corporation that operates on a cooperative basis, plaintiff is subject to the provisions of Subchapter T of the Internal Revenue Code of 1954, as amended.²

Subchapter T was added to the Internal Revenue Code in 1962 to clarify the tax status of patronage dividends paid by various types of organizations that operate on a cooperative basis. Prior to the 1962 amendments, farmers' marketing and purchasing cooperative organizations had enjoyed longstanding exemptions from Federal income taxation. Until 1951, these exempt farmers' cooperatives (about one-half the total cooperatives in the United States) were not required to file income tax returns; nonexempt organizations that operated on a cooperative basis, however, historically had been required to file. Commencing 1951, exempt farmers' cooperatives were required to file ordinary corporate income tax returns. Both exempt and nonexempt cooperatives, when computing taxable income, continued to be allowed to deduct the dollar value of patronage dividends from gross income. This deduction had been permitted for both exempt and nonexempt cooperatives as an administrative practice by the Internal Revenue Service as early as 1918.³ Exempt farmers' cooperatives, in 1951, were granted additional special deductions from gross income for amounts paid as dividends on capital stock and amounts allocated to patrons which were paid from funds derived from nonpatronage business.

The Internal Revenue Codes of 1939 (as amended) and of 1954 addressed only a defined group of exempt farmers' cooperatives, which were permitted all of the above deductions from gross income.⁴ Subchapter T permits all cooperatives covered to deduct from gross income amounts paid currently as patronage dividends; and retains the above special deductions as to exempt farmers' cooperatives.

As a nonexempt cooperative, plaintiff is authorized to deduct from its gross income amounts that were paid "as patronage dividends," which amounts are treated as items of gross income and as deductions therefrom.⁵ A "patronage dividend" is defined as an amount "paid to a patron" on the basis of quantity or value "of business done with or for such patron." Subchapter T specifically excludes (a) any amount paid to a patron that is out of earnings other than from "business done with or for patrons" or (b) any amount that is from earnings from business done "with or for other patrons" to whom different amounts were paid on transactions substantially the same.⁶ To determine plaintiff's income subject to tax, accordingly, its net earnings must be divided into two categories: net earnings from business done "with or for patrons" and earnings which are derived from sources other than patronage. Only earnings from business done with or for patrons may be excluded as patronage dividends.

Before the 1962 amendments to the Internal Revenue Code, patronage dividends were not specifically confined to amounts derived from business done "with or for" patrons. Nor was such a definition embodied in the Treasury regulations. The code, however, authorized exempt farmers' cooperatives specifically to deduct "amounts allocated to patrons with respect to income not derived from patronage."⁷ Subchapter T continues this special deduction for farmers' cooperatives in 26 U.S.C. § 1382(c).

Regulations pursuant to Subchapter T were promulgated April 2, 1963.⁸ With respect to the phrase "business done with or for" patrons, the regulations in essence restate the statute and do not elaborate on its content.⁹ They, however, do amplify the statutory phrase "sources other than patronage" applicable to exempt farmers' cooperatives.

Patronage sourced income and nonpatronage sourced income are mutually exclusive classifications. Definition of the content of the phrase "patronage sourced income," accordingly, can be inferred from interpretations that have been given the phrase "sources other than patronage." Whether the challenged items were properly classified by plaintiff as income from business done with or for its member patrons depends upon their exclusion from the factual content of the phrase "sources other than patronage."

A particular item of income is patronage sourced when the transactions involved are "directly related to the marketing, purchasing, or service activities of the cooperative association." The description of nonpatronage sourced income in the IRS regulations has remained identical since first introduced in 1951.¹⁰ The Subchapter T regulation, consistent with the provisions of section 1382(c), continues this description for income derived from sources other than patronage.¹¹

The IRS description of nonpatronage sourced income is a longstanding interpretation and the statutory provisions to which the regulations pertain twice have been reenacted by Congress without material change.¹² The Treasury regulation in these circumstances is deemed to have Congressional approval. A court may accord great weight to a longstanding interpretation placed on a statute by the agency charged with its administration.¹³

Plaintiff's Business

Plaintiff is part of the Federal farm credit system, which is under the supervision of the Farm Credit Administration (FCA), an independent agency of the Executive Branch. The United States is divided into 12 farm credit districts, with 37 banks in the system: 12 Federal land banks, 12 Federal intermediate credit banks, 12 district banks for cooperatives, and the Central Bank for Cooperatives. Plaintiff is chartered by the Federal Government pursuant to the Farm Credit Act of 1933, and now operates pursuant to authority in the Farm Credit Act of 1971.¹⁴

From 1933 to 1968, banks for cooperatives were funded by Government capital and were tax exempt. Legislation in 1955 authorized retirement of Government capital to facilitate borrower participation in the management, control and ultimate ownership in the banks for cooperatives.¹⁵ In June 1967, plaintiff retired all United States capital and, beginning with fiscal year 1968, plaintiff became subject to Federal income tax. Plaintiff continues to be regulated and supervised by the FCA; FCA examiners audit and examine plaintiff's operations at least once a year.¹⁶

Plaintiff is authorized to make loans to eligible farmers' cooperatives located in the St. Louis farm credit district, which consists of Illinois, Missouri and Arkansas. Plaintiff's members and owners are eligible farmers' cooperative borrowers, which contribute to the equity of plaintiff in proportion to business done with plaintiff. As a cooperative, plaintiff is obligated to distribute its annual net earnings to its member patrons as patronage dividends...