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William F. Lenihan, Lenihan, Ivers & McAteer, 1218 Third Avenue, Seattle, Wash. 98101, Robert C. MacDonald, MacDonald, Dean, McAllister & Snow, 801 Commercial St., Astoria, Ore. 97103, for plaintiff. Sidney I. Lezak, United States Attorney, Portland, Ore. 97207, Gerald A. Kafka, James N. Flaherty, Department of Justice, Washington, D. C. 20530, for defendant.

Astoria makes plywood and veneer. It was organized in 1950 and became a workers' cooperative association in 1966.

Workers' cooperatives are owned by member shareholders. Astoria gives a preference in hiring to members although it also employs nonmembers. It distributes the portion of its net income attributable to the work of members to its members. These distributions are called patronage dividends.

Workers' cooperatives receive special tax treatment under Subchapter T of the Internal Revenue Code. [26 U. S. C. Sections 1381-88] The part of a cooperative's income paid to its members through patronage dividends, its "patronage source income", is not included in the cooperative's taxable income [26 U. S. C. Sections 1382(b) and 1388(a)] but is taxed as part of each member's gross income. [26 U. S. C. Section 1385(a)] These provisions allow each member to realize the results of his work through the cooperative without paying both a corporate income tax and an individual income tax on his income.

Astoria contends that the IRS improperly treated income from three sources as taxable income: a sale of machines, the cancellation of a lease, and a judgment.

Astoria argues that part of this income is patronage source income which should not be taxed./1/

I find that the lease cancellation payment is patronage source income. I also find that the income from the sale of the machines and the judgment income are not patronage source income.

The government contends that all capital gains are not patronage source income and that it is unnecessary to consider whether the lease cancellation payment and Astoria's income from the sale of the machines are otherwise directly related to the cooperative's activities because both are capital gains.

Astoria asserts that the lease and the machines are not capital assets. It contends that capital gains which are directly related to a cooperative's activities and are not income from sales of capital assets, may be patronage source income. IRS has determined that other capital gains, such as from the disposition of timber, may be entitled to patronage source income treatment. Rev. Rul. 74-24, Cum. Bull. 1974-1, p. 244; Rev. Rul. 71-439, Cum. Bull. 1971-2, p. 321-2.

In my view, capital gains may be patronage source income. In each instance, it depends on whether the income is "directly related" to Astoria's activities.

In my view, this judgment income, which compensated the corporation for the loss incurred, and deducted, before it became a cooperative, is not directly related to the cooperative's business. It is not patronage source income.

I also find that the payment for the cancellation of the lease is patronage source income and that Astoria is entitled to a tax refund for 1968 for the tax paid on the portion of this income attributable to the work of member employees.

This opinion shall serve as findings of fact and conclusions of law pursuant to Fed. R. Civ. P. 52(a).