324 F. Supp. 1216 | S.D. Iowa | 1971
MEMORANDUM AND ORDER
Section 1382(b) (1) of the Internal Revenue Code of 1954 is part of Sub-chapter T relating to the taxation of cooperatives and their patrons.
The facts are established in their entirety by stipulation and the exhibits which accompany it. The sole issue to be resolved is one of law.
The taxpayer is the Des Moines County Farm Service Company, a marketing and purchasing farmers’ cooperative organization, dealing in grain and farm supplies. It is incorporated under Iowa law and has its principal place of business in Danville, Iowa. The taxable years involved are the fiscal years 1964 and 1965. The taxpayer filed corporate income tax returns for those years as a nonexempt cooperative under Subchapter T, Part I, Section 1381(a) (2).
In its corporate income tax returns for its fiscal years ending November 30, 1964 and 1965, the taxpayer reported taxable income totaling $142,744.63. In arriving at this figure, the taxpayer excluded $218,411.33 as margin either paid or allocated to its stockholder-patrons. The Commissioner promptly assessed de
The taxpayer has paid the deficiencies and the interest thereon. Its timely filed claims for refund were summarily denied. This action was subsequently filed under the provisions of 28 U.S.C.A. § 1346.
The center of controversy is the regulatory language which implements Section 1388 of the 1954 Code.
After careful consideration of the pleadings and briefs and of the
(1) Provisions authorizing nonexempt cooperatives to exclude amounts paid as patronage dividends from taxable income did not appear in the federal tax structure until enactment of the Revenue Act of 1951. See Ch. 521, § 314(a) (2), 65 Stat. 492, adding § 101(12) (A) (b) to the Internal Revenue Code of 1939. This Act provided that exempt and nonexempt cooperatives must be accorded equal tax treatment with respect to the exclusion of patronage dividends. Since exempt cooperatives had long been permitted by relevant statutory provisions to utilize such an exclusion, the inference is that Congress intended to extend similar benefits to nonexempt cooperatives.
(2) Aside from the Act of 1951, the prior statutory law did not deal with the taxation of nonexempt cooperatives. It has, however, long been the administrative practice of the Commissioner to permit nonexempt cooperatives to exclude from their taxable income amounts paid to member-patrons as true patronage dividends. The requirements imposed by the Commissioner with respect to the use of this exclusion were that the dividends be required to be paid or allocated under a pre-existing obligation of the cooperative and that such sums not include profits generated by transactions with other patrons to whom equal amounts were not paid or allocated. See e. g., Rev.Rul. 57-59, 1957-1 Cum.Bull. 24. The theory behind the exclusion can be explained in at least three ways: (a) the cooperative is merely an agent for the patron, with no income on its own account; (b) the patronage dividend is in essence a rebate which constitutes a price adjustment or discount given the patron; or (c) the patronage dividend is never the cooperative’s money because it always belongs to the patron. This administrative practice, and the theories on which it is based, have been recognized and approved by the courts. See Clover Farm Stores Corporation, 17 T.C. 1265 (1952) and Farmers Cooperative Co. v. Birmingham, 86 F.Supp. 201 (N.D.Iowa 1949).
(3) Subchapter T is the first specific statutory authorization for the exclusion of patronage dividends from the taxable income of nonexempt cooperatives. Although Congress did not speak to the question of how this exclusion is to be computed, it chose to treat the patronage dividend concept in essentially the same manner as did prior administrative interpretations and decisional law.
(4) The consequences which the taxpayer seeks to attach to the holding in Mississippi Chemical represent a sudden and unwarranted volte-face from a consistent administrative and judicial practice followed by the Commissioner and the courts since 1924. Compare Fribourg Navigation Co. v. Commissioner of Internal Revenue, 383 U.S. 272, 86 S.Ct. 862, 15 L.Ed.2d 751 (1966). The administrative practice of the Commissioner has always been to require corporations operating as nonexempt farmers’ cooperatives to reduce “apparent” net income by the amounts paid as dividends on capital stock when making the patronage dividend exclusion computation. See Valparaiso Grain & Lumber Co. v. Commissioner of Internal Revenue, 44 B.T.A. 125, 127 (1941) and Rev.Rul. 68-228, 1968-1 Cum.Bull. 385. This administrative precedent has been judicially sanctioned. See Farmers Cooperative, supra. Because Congress, in enacting Subchapter T, merely codified the prior
(5) The regulation is reasonable and consistent with the statute on which it is based. This without more is sufficient to validate it. See Bingler v. Johnson, 394 U.S. 741, 749-750, 89 S.Ct. 1439, 22 L.Ed.2d 695 (1969).
(6) The argument underlying the Government’s contentions in this case has much equitable appeal. The taxpayer derives a large portion of its operating capital through equity financing. It has outstanding two classes of common stock, one class of organization stock and one class of preferred stock. On the basis of this capital structure, the taxpayer transacts business with two separate classes of patrons. Nonmember patrons are customers of the taxpayer who receive none of its ordinary corporate distributions and have no voice in its affairs. Member patrons are stockholders as well as customers. They own more than 80 percent of the taxpayer’s capital stock and receive more than 90 percent of its ordinary corporate distributions. Additionally, member patrons receive patronage dividends on the basis of business done by each with or through the taxpayer. The investment capital of the taxpayer is used in the production of all its profits. Since business done with or for member and nonmember patrons is equally profitable, there is no logical basis for the taxpayer’s contention that the dividends paid with respect to its investment capital should be charged solely against profits attributable to nonmember business. Such a contention carries the implication that investment capital is employed for the sole purpose of generating profits from nonmember sources; this simply is not so.
It is ordered that judgment in this cause be and is hereby entered in favor of the defendant herein, the United States of America.
. Subchapter T was added to the 1954 Internal Revenue Code by the Revenue Act of 1962. See 26 U.S.C.A. §§ 1381-1388 (Supp.1962).
. Patronage dividends are herein treated as items which are “excluded” rather than “deducted” from the taxpayer’s gross income. See Mississippi Valley Portland Cement Co. v. United States, 408 F.2d 827, 831 (5 Cir. 1969).
. Section 3 of Article IX of taxpayer’s by laws (as amended February 7, 1962) provides:
“ * * * payment of dividends on stock * * * shall first be made out of the savings attributable to nonmember business * *
. Section 1388(a) defines a patronage dividend in substance as an amount paid to a patron on the basis of quantity or value of business done with or for the cooperative, which is determined by referenee to the net earnings attributable to business done with or for the patrons. To be an exeludible patronage dividend, such amounts must be paid under an obligation which antedates the cooperative’s receipt of the earnings being distributed. Finally, this section provides that the dividend cannot be attributable to profits from business done with other patrons to whom equal patronage dividends are not distributed, nor can it be from non-patronage income.