tificates. As previously indicated, a cooperative gets no current deduction when it issues nonqualified certificates.

Validity of Existing Consents

Many cooperatives obtained individual written consents or adopted bylaw provisions to comply with Treasury's October 1965 regulations. Enactment of the 1966 amendments raised questions as to what action, if any, they needed to take to comply with the new law.

Written consents.-A written consent agreement obtained under the October 1965 regulations would continue in effect and no new agreement would be necessary if the following conditions were met:

1. The agreement clearly provided that the patron agreed to treat the stated dollar amount of all per-unit retain certificates issued to him as cash distributions which he had reinvested in the cooperative. (The October 1965 regulations called for an individual consent expressed in these terms.)

2. The patron could revoke the written agreement at any time after the close of the taxable year in which it was made.

3. It was effective during the period between October 15, 1965 and November 13, 1966.

4. It was effective on November 13, 1966, and the patron had not given the cooperative a written notice of revocation.

Bylaw Consent. In the case of a bylaw consent agreement adopted under the October 1965 regulations and in effect on November 13, 1966, the 1956 law provides that it will be effective as a basis for issuing qualified per-unit retain certificates only for taxable years of cooperatives that began before May 1, 1967.

If a cooperative adopted its bylaw consent under the October 1965 regulations (before November 13, 1966) and its taxable year began on April 1, 1967, the bylaw would be effective through March 31, 1968, as a basis for issuing qualified perunit retain certificates. Thereafter, a new bylaw would have to be adopted.

Cooperatives having taxable years beginning on and after May 1, 1967, had to adopt a new bylaw consent provision be

fore any patronage or marketing occurred as a basis for issuing qualified certificates.

Tax Treatment for Prior Years' Retains

The 1966 law applies to per-unit retains made during taxable years of cooperatives that begin after April 30, 1966. Internal Revenue Service Technical Information Release 775, October 15, 1965, and a subsequent Revenue Procedure248 provides certain guidelines for the tax treatment of per-unit retain certificates issued with respect to products marketed for patrons during a tax year beginning before May 1, 1966.

These guidelines state that the Internal Revenue Service will accept a cooperative's treatment of such per-unit retain certificates if this treatment is consistent with the general principles contained in sections 1.522-1 through 1.522-3 of the Income Tax Regulations, relating to amounts allocated by cooperatives on a patronage basis.

Thus, "pre-May 1, 1966," per-unit retain certificates disclosing to patrons the face amount of retains issued in accordance with a preexisting mandatory agreement and within 81⁄2 months after the close of the taxable year would seem to meet the guidelines. If the cooperative excluded from its gross income or added the face amount of its retain certificates to "its cost of goods sold," the Internal Revenue Service should not object.

Tax treatment of "pre-May 1, 1966," per-unit retains at the patron level was not mentioned in these first guidelines. In Revenue Ruling 68-236,249 however, the Service makes it clear that with respect to per-unit retain certificates issued in connection with products delivered in taxable years of the cooperative beginning before May 1, 1966, only the fair market value of the certificate at the time of receipt is to be included in the patron's gross income.

If the certificate had no fair market value at the time of receipt, the patron need not include it in gross income for the year received. The patron would report the amount received when the certificate is redeemed, sold, or otherwise disposed of.

248 Rev. Proc. 66-45, 1966-2 Cum. Bull. 1254.

2491968-1 Cum. Bull. 382, based on Technical Information Release 953, dated January 3, 1968.

Summary of Alternatives Available

Cooperatives and their patrons are subject to Federal income taxes. They are not tax exempt as so many seem to believe.

Today's Federal tax law preserves the principle of a single, current tax on income produced through farmers' and other cooperatives, provided they meet these conditions:

• Adhere to strict requirements as to the form in which they handle and distribute capital retains and patronage refunds.

• Make distributions within the prescribed time.

In complying with the tax law, a number of alternative choices are available.

CHOICE 1. The recent amendments to the taw applying to cooperatives do not repeal or modify in any way the requirements of section 521 of the Internal Revenue Code of 1954 relating to farmer cooperatives. If they can comply with its terms they are entitled to two deductions in addition to those allowed other corporations:

1. Amounts paid as dividends during the taxable year on capital stock (which has been construed to include any form of return on all genuine capital interests).

2. Amounts of nonpatronage income (such as income on business with the United States, rents, and interest) paid on a patronage basis to patrons, if distributed within 81⁄2 months after the year in which they were derived.

Thus, the first choice a farmer cooperative has is whether to operate in compliance with the requirements of section 521. If the cooperative does operate under its rigid requirements, it would not have to pay taxes on: (1) The part of its margins devoted to a return on capital interests and (2) the part arising from nonpatronage activities, including business done with or for the United States provided it is allocated to its patrons.

If the cooperative decides not to qualify under the requirements of section 521, the cooperative will pay taxes at regular corporate rates on this part of its net margins even though allocated.

CHOICE 2. The next choice relates to the form and time in which a cooperative pays its patronage refunds. For, to emphasize again it is the form and timing of refunds which determine their tax treatment under the law, at both the cooperative level and, in the main, at the patron level.

The law lays down precise and strict rules which cooperatives (including farmer cooperatives that qualify under section 521 of the Code) must follow before they may use patronage refunds to reduce their gross income for tax purposes.

First, the refund must meet the definition of a "patronage dividend" set forth in the statute. This means that the refund must be:

1. Computed on the basis of quantity or value of business done with or for the patron;

2. Made pursuant to a preexisting written obligation of the cooperative; and

3. Determined by reference to the "net earnings" of the organization from business done with or for patrons. (This excludes true "capital retains" from sales proceeds. In 1966, however, the law was amended to provide similar treatment for capital retains. In general, these are amounts allocated to patrons without reference to “net earnings.")

Second, the refund or capital retain must be paid in cash, property of a kind on which a current value can be placed, or in what the statute calls "qualified written notices of allocation," or, in the case of capital retains, “qualified per-unit retain certificates."

Third, the refund or capital retain must be “paid” within 81⁄2 months following the close of the cooperative's fiscal year. (The statute calls the 12-month fiscal year plus this 81⁄2 months period the cooperative's "payment period.")

CHOICE 3. A third choice is in qualifying the "written notices" or "certificates." To be "qualified" they they must meet the following requirements:

1. They must be in the form of a document that discloses the amount of the allocation and the portion thereof which is a patronage refund or capital retain (as compared to distributions of nonpatronage income);

2. At least 20 percent of the patronage refund must be paid in cash. No 20-percent cash payment is required to "qualify" capital retains.

At this juncture, however, the cooperative can choose between making refunds under circumstances in which it has a form of patron's consent, or in a form redeemable in cash by the patron within a period of 90 days following the date of issuance.

CHOICE 4. If the cooperative elects to get a form of patron's consent, it again has choices-three to be exact:

1. Individual patron's written consent. This form of consent must be given to the cooperative before the end of the year in which the patronage occurs. It applies to all patronage in that year. It also covers patronage in subsequent taxable years until a written revocation becomes effective.

A revocation of individual written consent is effective only on patronage occurring after the close of the cooperative's taxable year in which it is given.

2. Bylaw consent. The patron may consent by obtaining or retaining membership in a cooperative with a bylaw that sets forth the required members' agreement to take qualified written notices of allocation or per-unit retain certificates into account currently in computing their Federal income tax liability.

The bylaw must have been adopted after October 16, 1962 (November 13, 1966, in the case of capital retains), and it must clearly set forth this consent agreement. The consent under this method becomes effective only on patronage occurring after each patron receives a written notification of the adoption of the bylaw that explains its significance. A copy of the bylaw must accompany the notification.

Mailing this material by ordinary mail to the patron's last known address is permitted. New members must have this material before becoming members. Termination of membership or repeal of the bylaw terminates this form of consent.