Opinion
Docket No. 17045.
1949-08-2
CONSUMER-FARMER MILK COOPERATIVE, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Jacob Rabkin, Esq., and Mark H. Johnson, Esq., for the petitioner. T. W. Wickersham, Esq., for the respondent.
Petitioner was organized under section 5 of the New York Cooperative Corporation law for the distribution to consumers of milk and other products. Petitioner claims that it is exempt from tax under section 101(8) of the Internal Revenue Code as a civic league not organized for profit, but operating exclusively for the promotion of social welfare. Held, that petitioner does not qualify as a tax exempt corporation. Jacob Rabkin, Esq., and Mark H. Johnson, Esq., for the petitioner. T. W. Wickersham, Esq., for the respondent.
Respondent determined deficiencies for the taxable year ended September 30, 1943, in petitioner's declared value excess profits tax in the amount of $439.41 and in its excess profits tax in the amount of $23,821.32. Certain adjustments made by respondent are not contested. One of the issues raised by the pleadings was abandoned by petitioner at the hearing. The only question is whether petitioner is exempt from tax as a civic league or organization under section 101(8) of the Internal Revenue Code.
FINDINGS OF FACT.
Part of the facts were stipulated and they are so found.
Petitioner was incorporated under the cooperative corporation law of the State of New York on December 10, 1937. Its tax returns for the year involved were filed with the collector of internal revenue for the second district of New York. It was organized as a non-stock producer-consumers' cooperative. Its purpose in organizing, as stated in the certificate of incorporation, was as follows:
2. The purposes for which it is to be formed are for mutual help, not conducted for profit, for the purpose of acting as the agent for its members or any of them, performing for them services connected with the purchase, manufacture, preservation, drying, canning, scoring, handling and utilization of agricultural, dairy, horticultural or other food products, family or other household supplies to be consumed by the families or guests of the members of the corporation; to carry on cooperatively any other household operation; to purchase, process and distribute milk, milk products or other household commodities, as limited by Article 5 of the Cooperative Corporation Law.
The bylaws of petitioner provided for the division of net earnings as follows:
ARTICLE VIII— FINANCE.
Section 2. Division of Earnings.
The Board of Directors shall apportion the net earnings from the operation of the business in the following manner in the proportion which it judges to be in the best interests of the Cooperative:
(a) At least 10% shall be set aside as a ‘general reserve fund‘.
(b) An amount equal to at least 5% shall be used for cooperative education.
(c) Special purpose reserve funds may be established at the discretion of the Board.
(d) Patronage dividends shall be payable to consumer members and to producer members in the proportion of two to one; that is, for every $2.00 declared payable to consumer members, $1.00 shall be declared payable to producer members.
(e) Uniform dividends shall be paid to consumer members in proportion to the amount of their purchases provided that such dividends shall not exceed the difference between the cost of producing these purchases and their selling price.
(f) Payments of dividends to consumer members shall be in proportion to their purchases as determined by evidence of purchase presented to the Cooperative, as the Board shall provide. Unclaimed consumer dividends payable shall be transferred to the general reserve fund after one year from date of declaration
(g) Payments of dividends to producer-members shall be uniform and in proportion to the volume of commodities sold through the Cooperative.
Petitioner was an outgrowth of the Milk Consumer's Protective Committee which was organized in 1936 primarily by a group of welfare organizations and welfare workers to protect the public interest in milk distribution and milk regulation. The committee desired to see what could be done to obtain a higher monetary return to farmers for the production of milk and a lower price for milk to the consumers.
At the meeting of the committee held on November 22 1937, it was agreed to form petitioner. Petitioner was organized to return a reasonable profit which, after reserves, was to be distributed to the consumers and farmers as patronage dividends and to continue the work of the committee as above described.
Any consumer is eligible to become a member of petitioner upon the payment of a 25-cent membership fee. Associations of farmers with whom petitioner has contracted for the supply of any part of the commodities which it distributes are also eligible for membership. The membership fee for such association is 25 cents for each of its farmer members. The membership fee of both consumers and farmers was collectible out of patronage dividends, at the discretion of the board of directors.
Consumers must turn in dividend vouchers showing purchases amounting at least to $5 in the dividend year before being entitled to claim and receive dividends. Unclaimed declared consumer dividends are canceled and transferred to the general reserve fund one year after declaration. Petitioner's consumer dividend vouchers are approximately the size of the top of a bottle of milk and are a part of, and are separable from, the cardboard container of the milk. Farmer members, however, receive their dividends promptly without restrictions. After its first full year of operation the directors of petitioner decided to pay a refund or patronage dividend of 15 cents per 100 quarts of milk purchased from petitioner and 7 1/2 cents per 100 quarts of milk furnished by the farmers to petitioner. Patronage dividends for its fiscal year 1943 were declared by petitioner at the rates above stated.
Only a small percentage of the dividend vouchers was turned in by the consumers. Petitioner's consumer dividend record from 1938 through the taxable year in question was as follows:
+--------------------------------------------+ ¦ ¦Amount set¦ ¦ +---------------------+----------+-----------¦ ¦Year ended Sept. 30--¦aside ¦Amount paid¦ +---------------------+----------+-----------¦ ¦1938 ¦ ¦$239.71 ¦ +---------------------+----------+-----------¦ ¦1939 ¦$3,975.89 ¦697.12 ¦ +---------------------+----------+-----------¦ ¦1940 ¦3,930.68 ¦856.54 ¦ +---------------------+----------+-----------¦ ¦1941 ¦3,595.71 ¦385.83 ¦ +---------------------+----------+-----------¦ ¦1942 ¦2,499.37 ¦871.05 ¦ +---------------------+----------+-----------¦ ¦1943 ¦25,920.88 ¦ ¦ +---------------------+----------+-----------¦ ¦Total ¦39,922.53 ¦3,050.25 ¦ +--------------------------------------------+
Petitioner's bylaws may be amended by its members. Three per cent of the members, or 300 members if the membership exceeds 10,000, constitutes a quorum. Its affairs are administered by a board of directors. Its officers are a president, vice president, secretary, and treasurer. Meyer Parodneck was petitioner's president during the year in question.
No director of petitioner receives compensation for his services as director. The salary of its president, Meyer Parodneck, was $4,000 during the taxable year, which represented his full compensation for full time services.
Petitioner's operations consist of taking delivery of milk at its two country plants, where milk is weighed, tested, cooled, and stored. The milk is then shipped by truck to companies which, under contract with the petitioner, pasteurize it and put it in containers furnished by the petitioner. These containers are then delivered to over 500 different distributing centers in New York City. From these distributing centers petitioner's trucks distribute the containers to retail selling points throughout New York City. Petitioner has no door-to-door delivery. Petitioner distributes about 1 per cent of the fluid milk sold in New York City. During the taxable year ended September 30, 1943, petitioner sold fifteen million quarts of milk.
Petitioner started business in 1938 with a borrowed capital of $6,000. By September 30, 1943, it had acquired substantial assets, including distribution facilities in Long Island City, New York, and a country milk plant at Belle Mead, New Jersey. The petitioner paid about $27,000 for the latter. Most of the purchase price was obtained by petitioner by appropriating unredeemed consumer dividends which had been converted into the general reserve fund. The balance was obtained from that part of the general reserve fund built up by transferring thereto 10 per cent of petitioner's annual net earnings. Petitioner also financed extensive alterations and purchased new equipment for its Belle Mead plant out of unpaid consumer dividends and current income.
Petitioner reported a gross income of $370,133.90 during the taxable year involved.
Petitioner's balance sheet as of September 30, 1943, as shown by its income tax return, was as follows:
+------------------------------------------------+ ¦ASSETS ¦ +------------------------------------------------¦ ¦ ¦ ¦ +-------------------------------------+----------¦ ¦Cash ¦$46,192.91¦ +-------------------------------------+----------¦ ¦Notes and accounts receivable ¦34,079.76 ¦ +-------------------------------------+----------¦ ¦Inventories--dairy products ¦9,316.81 ¦ +-------------------------------------+----------¦ ¦Investments in government obligations¦2,600.00 ¦ +-------------------------------------+----------¦ ¦Other investments ¦2,693.30 ¦ +-------------------------------------+----------¦ ¦Capital assets: ¦ ¦ +-------------------------------------+----------¦ ¦Depreciable assets ¦41,309.96 ¦ +-------------------------------------+----------¦ ¦Land ¦500.00 ¦ +-------------------------------------+----------¦ ¦Other assets--deferred charges ¦2,089.28 ¦ +-------------------------------------+----------¦ ¦Total ¦138,782.02¦ +------------------------------------------------+
LIABILITIES Accounts payable $69,367.64 Accrued expenses 14,142.16 Other liabilities 40,061.04 Paid-in or capital surplus 7,321.40 Earned surplus and undivided profits 7,889.78 Total 138,782.02
Through its officers, petitioner has interested itself in many aspects of the milk industry. It has sought to improve that industry for the benefit of both the farmers and consumers. Its efforts in this regard include the following:
(1) The elimination of the grading of milk sold in New York City into grades A and B. Grade A milk was sold at the higher price. Petitioner presented facts tending to show that there was no valid reason for the existence of the two grades and of the differential in price. The Board of Health of New York City in 1940 issued a regulation establishing the single grade of ‘Approved Milk.‘
(2) A propaganda program to discourage the purchase of so-called ‘high test‘ milk because it believed it was economically and nutritionally unsound.
(3) Opposition to retail price fixing on the ground that it destroys competitive conditions.
(4) The advocation of changes in the complex price formulas used by the market administrator in fixing the blended price of milk to be paid to farmers.
(5) The issuance of complaints to the proper governmental authorities whenever any facts indicated the rigging of commodity prices.
(6) The demonstration of the unsoundness of the additional charge in the New York City area of one cent per quart more for milk in paper containers than in bottles, because of the economies in the handling and transportation of the lighter paper containers. In areas where petitioner sells milk other distributors do not charge an extra cent for a quart of milk as they do in areas where petitioner does not sell milk.
(7) The education of the public that the extra charge for homogenized milk is unwarranted. Petitioner sells its own homogenized milk for ne extra charge. Its competitors do not charge one cent additional for a quart of homogenized milk in areas where petitioner distributes milk, but charge such additional cent in areas where petitioner does not distribute milk.
(8) It publicized the inadvisability of using ‘Vitamin D‘ milk indiscriminately.
(9) It cooperated with the New York City Council in petitioning the Office of Defense Transportation to permit the milk trucks to visit the New York Department of Health ‘milk stations‘ more than once a day during the early war years through the year in question. At those stations milk could be purchased in the early morning hours for 3 cents below the regular retail price. The servicing of those stations was largely abandoned by the large milk companies in the New York City area during the war years and petitioner then began to service them.
(10) It organized additional milk stations in settlement houses, churches, and similar community service organizations for the sale of milk at a reduced price during limited hours. With the approval of the New York City housing authorities it extended its milk program to many low cost housing developments.
(11) During two of the war years it participated at the request of the board of education in the subsidized school milk program and supplied milk under this program to schools which other distributors were unwilling to service.
Petitioner carries on an education program for both farmers and consumers concerning the milk industry. Apart from the distribution of its own publications, this program includes the delivery by its officers and directors of lectures at schools and colleges, appearances on the radio, the writing of articles in farm journals, and the reprinting and distribution of literature prepared by others. Part of this educational program is conducted through the New York City Consumer Council, a federation of consumer, civic, and welfare organizations. Petitioner is affiliated with this council and contributes to its maintenance.
The following table reflects the amounts set aside by petitioner for cooperative education from its organization to the end of the taxable year ended September 30, 1942. Thereafter it added no funds to this account.
+-------------------------+ ¦Year ended ¦Amount ¦ +-------------+-----------¦ ¦Sept. 30-- ¦set aside ¦ +-------------+-----------¦ ¦1938 ¦ ¦ +-------------+-----------¦ ¦1939 ¦$350.81 ¦ +-------------+-----------¦ ¦1940 ¦346.82 ¦ +-------------+-----------¦ ¦1941 ¦170.58 ¦ +-------------+-----------¦ ¦1942 ¦147.02 ¦ +-------------------------+
For the taxable year ended September 30, 1943, petitioner deducted from its gross income the sum of $25,920.88 for declared rebates or patronage dividends to consumer patrons. Only $871.05 of the total amount so declared was paid. The remainder lapsed as dividends and was converted into petitioner's general reserve fund. Respondent determined that the amount of $25,049.83 of such declared dividends was not deductible for tax purposes. Petitioner waived its assignment of error as to that determination.
For the taxable year ended September 30, 1943, petitioner paid income tax of $1,997.34. For the same year it paid an excess profits tax of $6,373.04. Petitioner filed consents extending the time for assessment for the taxable year. On October 29, 1947, petitioner filed a claim for refund of all income and excess profits taxes for the taxable year in question on the ground that it was exempt as a social welfare organization under section 101(8) of the Internal Revenue Code. Respondent disallowed the claim.
OPINION.
HILL, Judge:
Petitioner claims exemption under section 101(8) as a civic league ‘not organized for profit but operated exclusively for the promotion of social welfare.‘ The respondent contends that petitioner fails to meet the requirements of the statute.
The fact that petitioner was in a business which is ordinarily carried on for profit or that it was formed to make profit is not necessarily fatal to its claim, Debs Memorial Radio Fund, Inc. v. Commissioner, 148 Fed.(2d) 948, unless the facts disclose that a substantial portion of its net earnings was distributed or distributable to its members during the taxable year involved. In that event it could not be said that petitioner operated exclusively for the promotion of social welfare or for ‘charitable, educational, or recreational purposes.‘ Sec. 101(8), Internal Revenue Code.
We have found as a fact that petitioner was organized for a profit-making purpose, despite the statement in the certificate of incorporation that it was formed ‘for mutual help, not conducted for profit.‘ Helen Hall, one of its founders and directors, testified as follows at the trial:
Q. It was not your idea that milk should be sold to the public without a profit being made?
A. No.
Q. It was only to have a reasonable profit?
A. That is right.
On brief petitioner requested the following finding of fact: ‘* * * All of the petitioner's operations are intended to return a fair profit, without any price-cutting below cost. * * *‘
The facts also show that a substantial portion of petitioner's net earnings was distributed or distributable for purposes other than social welfare. Petitioner's bylaws provide for the distribution of ‘net earnings from the operation of the business‘ in the form of patronage dividends ‘to consumer members and to producer members.‘ Meyer Parodneck, petitioner's president and another of its directors, stated that petitioner was not formed to operate on a price-cutting basis, but followed a cooperative principle of selling at the lowest possible retail rates and dividing the profits among the members in proportion to the amount of milk that had been sold to or purchased from petitioner. The foregoing statement might indicate a contention on the part of petitioner that it was exempt from tax as a cooperative under section 101(12), notwithstanding its disavowal of such claim. If petitioner is advancing such contention, we direct attention to the fact that neither section 101(12) nor any other provision of the revenue law exempts from tax a consumer's cooperative. However, assuming arguendo, that petitioner may properly contend that it is exempt from tax as a consumers' cooperative, it has not brought itself within the requirements of law providing for tax exemption as a cooperative.
It appears that all of the patronage dividends declared payable to the producer (or farmer) members from 1943 earnings were paid. It also appears that less than 3 per cent of the dividends declared payable to consumer members out of earnings for such year was paid. Regarding dividends declared payable to consumer patrons, the facts show (1) that such declared dividend was 15 cents per hundred quarts of milk purchased during the dividend year, (2) that to entitle a consumer patron to claim and receive a dividend he must separate from the cardboard milk container a voucher for each quart of milk purchased and present it as proof of his purchase, (3) for each 100 vouchers so presented the patron would be entitled to a 15-cent dividend, less a 25-cent membership fee, and (4) petitioner canceled all such unclaimed dividends after the lapse of one year. In view of the restrictions as to payment of dividends to consumer patrons, it is small wonder that, of the $25,920.88 of dividends declared payable to them from 1943 earnings, only $871.05 was claimed and paid. The record shows that the total amount of dividends declared payable to consumers for the fiscal years 1939 to 1943, inclusive, amounted to $39,922.53 and of this amount only $3,050.25 was paid. The result is that at the end of the fiscal year 1943 petitioner had a net worth of $15,211.18. This net worth represents a surplus from earnings. The record does not disclose the amount of net earnings for the fiscal year 1943. It does not disclose the amount of such earnings placed in the general reserve fund. It does appear that no part of such earnings was put into the fund for cooperative education in the fiscal year 1943. The record does not disclose the proportion of the net earnings in 1943 which was declared payable as dividends to patrons, or what amount, if any, of the net earnings was not disposed of as above indicated.
Neither petitioner's certificate of incorporation nor its bylaws contains any statement concerning the distribution of its surplus. We believe the members of petitioner are the equitable owners of the surplus, as are the stockholders of an ordinary corporation, and that upon dissolution any surplus would be distributable to them. In any event, since section 22, New York's Co-Operative Corporation Law (McKinney's Consolidated Laws of New York, vol. 10(a)) provides that surplus shall be distributed in accordance with the articles of incorporation or bylaws, the members, by amending the bylaws, could provide for the distribution of any surplus to themselves.
We believe, therefore, that petitioner has not proved that it was not operated for profit, but exclusively for the promotion of social welfare.
The stated conclusion is further fortified by a consideration of the burden and impracticability of complying with the conditions upon which consumer dividends are payable. It will be observed that only a comparatively insignificant portion of the dividends declared payable to consumer patrons was paid. We think it inescapable that petitioner anticipated that result, since under the provisions of the bylaws respecting dividends to consumer patrons no other result could reasonably have been intended. We think, therefore, that it was not petitioner's expectation or intention that the main portion of the dividends declared payable or distributable to consumer patrons would be paid.
Petitioner made no door-to-door deliveries of milk and apparently had no arrangement with consumers to take a certain quantity of milk daily or on any other time basis. It had no record showing who were its consumers or how much milk any consumer purchased during the year. The consumer went personally to the retail milk station and purchased and paid for each quart of milk when purchased. Obviously, petitioner had no subscribing and contract consumers. In declaring dividends for consumer patrons petitioner could only declare a total amount determined by the total quantity of milk sold during the fiscal year. It did not and could not declare a patronage dividend in a definite amount to any individual consumer patron. We think it improbable that petitioner expected or intended that more than a negligible number of its consumer patrons would tear off, hoard during the year, and present purchase vouchers for the meager dividend of 15 cents per hundred quarts, less a 25-cent membership fee. Also, we think it improbable that petitioner contemplated or intended that it would be put to the task of counting fifteen million (the number of quarts of milk sold in 1943) vouchers in individual consumer lots to determine to whom and in what amounts the declared dividends were to be paid.
The obvious practical result of the operation in respect to consumer dividends was that petitioner built up a substantial net surplus out of its earnings which was not distributable as patronage dividends, but was, in our opinion, distributable in case of dissolution to petitioner's members as equitable owners. We think, however, that under the facts here the distribution of so-called patronage dividends was a distribution of profits to the members who received them. Industrial Addition Association, 1 T.C. 378; affd., 149 Fed.(2d) 294; see also Automobile Club of St. Paul, 12 T.C. 1152. See Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279.
Petitioner maintains, however, that it was not organized for profit, but exclusively for the promotion of social welfare within the meaning of the section involved. It states under this argument that ‘the major purpose of the petitioner (was) to increase the consumption of milk in low income families by passing on the economics of a special type of distribution.‘ It points out the many reforms it was interested in, such as eliminating grading of milk in New York City, and distributing milk in paper cartons at the same price as bottled milk. It carried on educational programs among farmers and consumers alike. As shown in our findings, however, only a small percentage of petitioner's income was set aside each year for educational purposes and after 1942 no additional sums were added to this fund. And as indicated above, petitioner also operated for a return of profit which was or might become distributable to its members otherwise than as so-called patronage dividends, and, therefore, we can not agree with petitioner that it was operated exclusively for social welfare.
The cases which petitioner cites in support of its argument are distinguishable. In Debs Memorial Radio Fund, Inc. v. Commissioner, supra, the profits of the taxpayer were used for its ultimate purpose of maintaining a free public forum for educational, cultural, and social services, ‘without financial gain to any individual.‘ The taxpayer was prohibited by its bylaws from using profits or surplus as dividends. In United States v. Pickwick Electric Membership Corporation, 158 Fed.(2d) 272; Hanover Improvement Society, Inc. v. Gagne, 92 Fed.(2d) 888; and Garden Homes Co. v. Commissioner 64 Fed.(2d) 593, the courts found as a fact that the taxpayers were not organized for profit.
It follows that respondent did not err in his determination.
Decision will be entered under Rule 50.