Kerner, Income Tax and Cooperatives, California Farm and Ranch Law 447 (1967).

Neely & Volkin, Tax Laws Changed on Capital Retains, News for Farmer Cooperatives, Reprint 328 (March 1967).

Pearson, The Farm Cooperative and the Federal Income Tax, 44 N. Dak. L. Rev. 490 (1967-68).

Cinnamon, The Farmer, The Cooperative, and The Commissioner, 19 Hastings L. Rev. 323 (1968).

Blair, Farmers' Cooperatives and Their Patrons Face New Problems in Reporting Income, 28 J. Taxation 180 (1968). McCullough, Cooperatives, Exempt or Nonexempt, American Cooperation-1968, 147.

Harmanson, Jr., The Cooperative Tax Picture, Cooperative Accountant, Winter 1968, 4.

Caplin, Taxing the Net Margins of Cooperatives, 58 Geo. L. J. 6 (1969).

Zivan, Need for Reform in Taxation of Agricultural Cooperatives, 5 Ga. L. Rev. 529 (1971).

Taylor, Taxation and Sound Cooperative Growth, American Cooperation, 1972-73, 274.

Fleck, Nonqualified Written Notices of Allocation May Salvage a
Coop's Otherwise Lost Benefits, 38 J. Taxation 378 (1973).
Note, 34 Va. L. Rev. 314 (1948).

Note, 23 Notre Dame Law 342 (1948).

Note, 32 Minn. L. Rev. 785 (1948).

Note, 27 Ind. L. J. 447 (1952).

Note, 5 S.D. L. Rev. 79 (1960).

Note, 1966 Wis. L. Rev. 930 (1966).

Patronage Refunds

To ensure that a cooperative will achieve its purpose of operating on a service-at-cost basis, it should be obligated to account on a patronage basis to all its patrons for all amounts received from the furnishing of services in excess of operating costs and expenses properly chargeable against the type of service furnished. Such amounts are sometimes referred to

'See "Nonprofit Associations," supra, p. 219 and "Sample Legal Documents," infra, p. 578.

as patronage refunds. Originally they were called patronage dividends, but the trend is to call them refunds. Actually they are not dividends at all in the sense in which the term is ordinarily employed. Rather, they are savings.

The aim of a cooperative, whether marketing or purchasing, is to operate on a cost basis, or as near thereto as practicable. Refunds based on patronage are simply a means of enabling associations to achieve this result more easily.2

As a Federal district court has stated:

*** Since October 24, 1844, *** the so-called Rochdale
principles have been recognized. *** While these princi-
ples have been variously stated by different authorities,
they all agreed upon the inclusion therein of the
principle that distribution of the surplus originating in
the economic activity of an organization is in direct
proportion to the participation of members ***.3

Accordingly, the court said:

The patronage dividends to be paid to producers in a
farmers' cooperative need not be and should not be the
same to every patron.

Patronage refunds are not a part of the gross income of a cooperative, since the cooperative is obligated to return these amounts to the persons to whom they are paid.4

2Adcock, Patronage Dividends: Income Distribution or Price Adjustments, 13 Law & Contemp. Prob. 505 (1948); Jensen, The Collecting and Remitting Transactions Of A Cooperative Marketing Corporation, 13 Law & Contemp. Prob. 403 (1948); Gardner and Volkin, What Are Patronage Refunds?, FCS Information 34, Farmer Cooperative Service, U.S. Dept. Agr. (1972); Davidson, Methods and Policies Used in Making Patronage Refunds by Selected Farmer Cooperatives, FCS General Report 137, Farmer Cooperative Service, U.S. Dept. Agr. (1966); Davidson, How Farm Marketing Cooperatives Return Savings to Patrons, FCS Res. Rpt. 7, Farmer Cooperative Service, U.S. Dept. Agr. (1970).

3 Bowles v. Inland Empire Dairy Association, 53 F. Supp. 210, 216 (E.D. Wash. 1943).

4State v. Morgan Gin Company, 186 Miss. 66, 189 So. 817 (1939). See "Federal Income Taxes," at p. 367. See also Gallatin Farmers Co. v. Shannon, 109 Mont. 155, 93 P. 2d 953 (1939); Uniform Printing and Supply Co. v. Commissioner, 88 F. 2d 75 (7th Cir. 1937); Appeal of Paducah &

In general, any business, cooperative or otherwise, may pay patronage refunds. Statutes may bar the payment of refunds or rebates by railroads and public utilities, but those engaged in private business may ordinarily make such payments so long as they do not conflict with the contract rights of shareholders.5

The proprietor of a commercial cotton gin opposed the granting of a license to a cooperative that desired to engage in the cotton ginning business. He contended that the cooperative was specifically authorized to pay patronage refunds by the statute under which it was incorporated, while he was barred from doing so. The commercial operator argued that he was denied the equal protection of the laws. The Supreme Court of the United States found that inasmuch as no law or regulation of the State had been adduced prohibiting the commercial operator from making patronage refunds, no discrimination was involved."

Patronage refunds depend on the success of the enterprise and are subject to its hazards. They should be distinguished from rebates.7

Patronage refunds result from the obligation to return the proceeds of sales, less necessary expenses, to producers. For

Illinois Railroad Co., 2 B.T.A. 1001 (1925); United Cooperatives, Inc., 4 T.C. 93 (1944); United Grocers, Ltd. v. United States; 308 F.2d 634 (9th Cir. 1962), affirming 186 F. Supp. 724 (N.D. Calif. 1960); Certified Grocers of Florida, Inc. v. United States, 18 AFTR 2d 5012 (M.D. Fla. 1966); and discussion at notes 8 and 9 under "Nonprofit Associations," supra.

5 Klein v. Greenstein, 24 N.J. Super. 348, 94 A. 2d 497 (1953), where a State law provision relating to payment of dividends to stockholders did not preclude a plan for patronage refunds. But see Midland Cooperative Wholesale v. Ickes, 125 F.2d 618 (8th Cir. 1942).

"Corporation Commission of Oklahoma v. Lowe, 281 U.S. 431 (1930). See also Guthrie Cotton Oil Co. v. Farmers' Custom Gin, 156 Okla. 16, 9 P. 2d 32 (1932); Southwestern Cotton Oil Co. v. Farmers' Union Coop. Gin Co., 165 Okla. 31, 24 P.2d 658 (1933); Chickasha Cotton Oil Co. v. Cotton County Gin Co., 40 F.2d 846 (10th Cir. 1930), 74 A.L.R. 1070; Choctaw Cotton Oil Company v. Corporation Commission of Oklahoma, 121 Okla. 51, 247 P. 390 (1926).

'Bunn, Consumers' Cooperatives And Price Fixing Laws, 40 Mich. L. Rev. 165 (1941); Certified Grocers of California, Ltd. v. State Board of Equalization, 100 Cal. App. 2d 289, 223 P. 2d 291 (1950); Eaton v. Brock, 124 Cal. App. 2d 10, 268 P. 2d 58 (1954).

instance, some marketing cooperatives have a fixed charge per unit for the marketing of the commodity they handle. Generally this is the same as the going rate charged by other operators. Other cooperatives pay the current price or a series of advances as inventories are sold. In each case, it is contemplated that at the end of the year, or of a fixed period, the operating costs and expenses of the association will be ascertained and the amount remaining will be distributed among the members on the basis of the quantity or value of the products marketed by the association for each of them.

When marketing associations use a schedule of charges, it is expected that returns from marketing will more than cover all operating expenses, but obviously the exact amount of the expenses cannot be known in advance. Likewise, in the case of associations that pay a series of advances or the current price for products handled, it is contemplated that the products will be sold for prices that will leave a balance after meeting all expenses. But, here again, the amount of this balance is unknown in advance. At the end of the year, or of a fixed period, the expenses of the association are ascertained; and this amount is subtracted from the total amount received by the association for handling charges or from the total sale price of the products. The balance is then returned to the patrons of the association on the basis of the volume, or of the value, of the products each marketed through the association.8

Patronage refunds are a means of returning to patrons savings effected by their cooperatives in marketing their products or purchasing their supplies. Manifestly, this is fundamental to cooperation, because there would be less incentive to cooperate if the savings effected in marketing expenses, or elsewhere, could not be returned to patrons. Patronage refunds are based upon products delivered and sold or upon purchases made and not upon money invested.

Some associations ascertain the amount of the patronage refund to which a patron is entitled in substantially the following manner: First, the total amount available for distribution among the patrons at the end of the year or other period is determined. Then, this amount is divided by the volume of business handled by the association in terms, for instance,

8Sometimes the distribution is only among patrons who are members. In such cases, only that part of the distribution which represents the margins on the member business is a true patronage refund. See Iberia Sugar Cooperative, Inc. v. United States, 480 F. 2d 548 (5th Cir. 1973).

of cars, bushels, pounds, head, or the value of the product handled in dollars, or the amount paid to the association as handling charges. The figure thus found, when multiplied, for example, by the number of bushels handled for a given member, gives the amount of his patronage refund."

Other associations ascertain their patronage refunds by dividing the total amount available for distribution by the total sale price of the products handled and then multiplying the resulting percentage by the price received for the products of each patron.

Patronage refunds would not be necessary if, at the time the members delivered their products to their association, or at the time of their sale, the association knew the exact amount it would cost to market the products of its members.

Patronage refunds simply furnish a medium by which the undertaking of the association to operate on a cost basis, or as near thereto as possible, may be carried out.

A novel patronage refund case involved a plaintiff who was not only a farmer and a stockholder in the defendant cooperative but who also engaged in the grain business. 10 The court concluded that the plaintiff was not entitled to patronage refunds on grain he had purchased from the cooperative, but that the other shareholder patrons were entitled to the amount involved. The Kansas statute under which the elevator cooperative was incorporated, provided that, after the payment of a fixed dividend upon stock, the remaining "earnings" should be prorated to its several stockholders upon the basis of their purchases or sales, or on both. The court took the view that the purchase by the plaintiff of grain from the elevator on a commercial basis was not such a purchase ás was contemplated by the statute and, hence, that he was not entitled to patronage refunds.

The Grain Futures Act of September 21, 1922,11 provides that the Secretary of Agriculture may designate any board of trade as a "contract market," if among other things

'Mooney v. Farmers' Mercantile & Elevator Co., 138 Minn. 199, 164 N.W. 804 (1917).

10 McClure v. Co-operative Elevator & Supply Co., 105 Kan. 91, 181 P.573 (1919). See Rev. Rul. 66-380 as distinguished in Rev. Rul. 72-547 and commented on in T.I.R. 1208, Oct. 20, 1972, all discussed at p. 433 under "Federal Income Taxes."

1142 Stat. 998, 1000, 1001.