Rev. Rul. 69-576

Advice has been requested whether an amount allocated and paid by a nonexempt farmers' cooperative to its patrons (farmers) under the following circumstances qualifies as a patronage dividend.

A nonexempt farmers' cooperative borrowed money from a bank for cooperatives, itself a cooperative within the meaning of section 1381(a)(2) of the Internal Revenue Code of 1954. The money was borrowed to finance the acquisition of agricultural supplies for resale to its members. The loan was obtained on March 1, 1966, with both the principal and interest payable in full within the taxable year.

After the close of its 1966 taxable year, the bank for cooperatives determined its net earnings which it then allocated to its patrons, including the nonexempt farmers' cooperative, on a patronage basis. The patronage allocations were based on the proportion of the total interest paid to it by each cooperative patron during the 1966 taxable year. The nonexempt farmers' cooperative in the instant case included the patronage allocations received by it from the bank for cooperatives in its gross income for the taxable year received (1967) under section 1385 of the Code. Under a preexisting obligation the nonexempt farmers' cooperative then allocated and paid the same amount it received from the bank for cooperatives to its own patrons (farmers). The issue is whether this latter allocation and payment qualifies as a patronage dividend.

Section 1388(a) of the Code and the regulations thereunder define a "patronage dividend" to mean an amount paid by a cooperative organization to a patron (1) on the basis of quantity or value of business done with or for such patron, (2) under a valid enforceable written obligation of such organization to the patron to pay such amount, which obligation existed before the cooperative organization received the amount so paid, and (3) which is determined by reference to the net earnings of the cooperative organization from business done with or for its patrons. The term "patronage dividend" does not include an amount paid to a patron by a cooperative organization to the extent that such amount is paid out of earnings not derived from business done with or for patrons.

Section 1.1382-3(c)(2) of the Income Tax Regulations defines the term "income derived from sources other than patronage" to mean incidental income derived from sources not directly related to the marketing, purchasing, or service activities of the cooperative association. For example, income derived from the lease of premises, from investment in securities, or from the sale or exchange of capital assets, constitutes income derived from sources other than patronage.

The classification of an item of income as from either patronage or nonpatronage sources is dependent on the relationship of the activity generating the income to the marketing, purchasing, or service activities of the cooperative. If the income is produced by a transaction which actually facilitates the accomplishment of the cooperative's marketing, purchasing, or service activities, the income is from patronage sources. However, if the transaction producing the income does not actually facilitate the accomplishment of these activities but merely enhances the overall profitability of the cooperative, being merely incidental to the association's cooperative operation, the income is from nonpatronage sources.

Accordingly, inasmuch as the income received by the nonexempt cooperative from the bank for cooperatives resulted from a transaction that financed the acquisition of agricultural supplies which were sold to its members, thereby directly facilitating the accomplishment of the cooperative's purchasing activities, it is held that the allocation and payment of this same amount by the nonexempt farmers' cooperative to its own patrons (farmers) qualifies as a patronage dividend. If the allocation and payment to its own patrons (farmers) is made not later than 81/2 months after the close of its taxable year, as prescribed in section 1382(b) of the Code, the nonexempt farmers' cooperative is allowed a deduction for the allocation and payment on its Federal income tax return for 1967.