Rev. Rul. 83-135

ISSUE

May a cooperative that is not exempt under section 501(c)(12) of the Internal Revenue Code (hereinafter "taxable cooperative") that is engaged in furnishing electric energy to persons in rural areas and thus not subject to the provisions of subchapter T exclude from gross income the patronage dividends paid or allocated to its patrons under the circumstances described below?

FACTS

Coop, a corporation, operates on a cooperative basis and provides wholesale electric service to member and nonmember patrons in rural areas. Coop does not qualify for tax exemption under section 501(c)(12) of the Code.

Coop's by-laws provide that Coop shall account on a patronage basis to all patrons for all amounts received from the furnishing of electric energy that are in excess of operating costs and expenses properly chargeable against the furnishing of electric energy, including any surplus, margins, or amounts deposited in reserve funds established by Coop. in the event of dissolution or liquidation, after all debts and liabilities of Coop have been paid and all capital furnished through patronage has been retired, the remaining assets are to be distributed to patrons and former patrons based on prior patronage.

LAW AND ANALYSIS

Subchapter T (sections 1381-1388) of the Code sets forth the rules concerning the taxation of organizations operating on a cooperative basis. Section 1381(a)(2)(C) specifically excludes corporations engaged in furnishing electric energy, or providing telephone service, to persons in rural areas from the provisions of subchapter T.

Subchapter T was enacted by the Revenue Act of 1962, 1962-3 C.B. III. The underlying committee reports state that presently taxable organizations engaged in furnishing electric energy, or providing telephone service, to persons in rural areas do not come within the provisions of subchapter T and that these organizations "will continue to be treated the same as under present law." See H.R. Rep. No. 1447, 87th Cong., 2d Sess. (1962), 1962-3 C.B. 405, 483, and S. Rep. No. 1881, 87th Cong., 2d Sess (1962), 1962-3 C.B. 707, 819.

Prior to the enactment of subchapter T there were no specific Code sections pertaining to the taxation of taxable cooperative organizations. However, it had been the long standing position of the Internal Revenue Service to allow patronage dividends to be excluded from a taxable cooperative's gross income if the patronage dividends were paid or allocated to patrons pursuant to a pre- existing legal obligation in proportion to patronage. See Rev. Rul. 54-10, 1954-1 C. B. 24, and Rev. Rul. 57-59, 1957-1 C.B. 24. The justification for this treatment is based upon the theory that these patronage dividends represent either an additional consideration due the patron for goods sold through the cooperation or reduction in the purchase price of supplies or equipment purchased by the patron through the cooperative. See Rev. Rul. 54-10.

In the present situation Coop's bylaws require that it pay or allocate patronage dividends to all of its patrons. A preexisting legal obligation to pay or allocate patronage dividends can be created by a cooperative's by-laws. See United Cooperatives, Inc., v. Commissioner, 4 T.C. 93 (1944), acq., 1945 C.B. 6. Therefore, Coop may exclude the patronage dividends from its gross income because they were paid or allocated to the patrons in proportion to patronage pursuant to a preexisting legal obligation created by Coop's by-laws.

HOLDING

A taxable cooperative engaged in furnishing electric energy to persons in rural areas and thus not subject to the provisions of subchapter T of the Code may exclude from gross income the patronage dividends paid or allocated to its patronage under the circumstances described above.

Consistent with section 1381 (a)(2)(C) of the Code, this holding is also applicable to a taxable cooperative engaged in providing telephone service to persons in rural areas.