Company Seeks Exception for Reporting of Co-Op Patronage Distributions

[1] We are writing to offer comments with respect to Proposed Treas. Reg. § 1.6011-4T. In particular, we are responding to the request in T.D. 9017 for comments as to whether "other exceptions should be provided" to the provision that treats certain transactions with a significant book-tax difference as "reportable transactions."

[2] For reasons set forth below, we believe that an exception should be provided for patronage distributions of the type routinely made by Subchapter T cooperatives. These distributions often result in book-tax differences and may be swept into the category of transactions with significant book-tax differences that could be treated as "reportable transactions."

Background.

[3] Land O'Lakes, Inc. is a national food and agricultural cooperative serving family farmers from the East Coast to the West Coast. Land O'Lakes processes over 10 billion pounds of milk annually and markets more than 300 dairy products across the United States and around the world. Land O'Lakes food products -- primarily dairy products -- are found in supermarkets and food service establishments such as restaurants, hospitals and airlines across the nation and are used by various food processors. Land O'Lakes also provides approximately 1,300 member cooperatives with production materials including dairy, beef and swine feed, alfalfa seed, plant food and crop protection products.

[4] Land O'Lakes is owned by and serves more than 7,000 producer-members and approximately 1,300 local community cooperatives. All Land O'Lakes members -- both local cooperatives and individual producers -- are owners of the cooperative. All members also share in the profits of the company, based on their business volume. Such profits are distributed annually after the end of the year in the form of patronage dividends.

[5] Land O'Lakes 2001 annual sales were approximately $6 billion. The company has total assets of $3.1 billion. Land O'Lakes is an SEC reporting company.

[6] For federal income tax purposes, Land O'Lakes is what is commonly referred to as a "nonexempt Subchapter T cooperative." As such, it is entitled to exclude from taxable income the patronage dividends which it pays to its patrons. For 2001, Land O'Lakes reported earnings for financial statement purposes of approximately $71.5 million and distributed patronage dividends totaling approximately $70.6 million.

Patronage distributions generally give rise to book-tax differences.

[7] For federal income tax purposes, cooperative organizations subject to the provisions of Subchapter T (Sections 1381-1388 of the Internal Revenue Code) are permitted to exclude or deduct from income certain distributions that they make to their patrons.

[8] Section 1382(b) allows all Subchapter T cooperatives to exclude:

• patronage dividend distributions paid in money, qualified written notices of allocation or other property. Section 1382(b)(1).

• distributions of money or other property in redemption of nonqualified written notices of allocation. Section 1382(b)(2) and Section 1383.

• per-unit retain allocations paid in money, qualified per-unit retain certificates or other property. Section 1382(b)(3).

• distributions of money or other property in redemption of nonqualified per-unit retain certificates. Section 1382(b)(4) and 1383.

• dividends on capital stock (within the limits set by Section 521(b)(2)). Section 1382(c)(1).

• distributions on a patronage basis (in the form of money, qualified written notices of allocation or other property) of income derived from nonpatronage business or from business done for the United States or any of its agencies. Section 1382(c)(2)(A).

• distributions of money or other property in redemption of nonqualified written notices of allocation which were paid with respect to income derived from nonpatronage business or from business done for the United States or any of its agencies. Section 1382(c)(2)(B) and 1383.

[11] Recipients of patronage distributions are required to include them in taxable income as provided in Section 1385. Generally, Section 1385 requires patrons to include patronage dividends and per-unit retain allocations in income in the year received except to the extent the distributions are made in nonqualified written notices of allocation or in nonqualified per- unit retain certificates. Patrons are taxable on amounts received in redemption of nonqualified notices and certificates in the year redeemed.

[12] For financial reporting purposes, a cooperative's GAAP income statement generally shows the net earnings or net proceeds of the cooperative before patronage distributions². Thus, patronage distributions often give rise to book-tax differences. Many cooperatives also provide supplemental information on their income statement as to the disposition of the net earnings or net proceeds, indicating what portion of the net earnings or net proceeds was or will be distributed by the cooperative to patrons as patronage distributions. However, normally patronage distributions are not shown as expenses in arriving at income for financial statement purposes.

[13] In Land O'Lakes case, its GAAP income statement reports net earnings before patronage distributions. The income statement then identifies the amount of the net earnings that will be distributed as patronage refunds. This gives rise to a book-tax difference.

[14] For income tax reporting purposes, farmers' cooperatives filing a Form 990-C report patronage distributions on line 2 (see Schedule A, lines 4a, 4b and 5) or on line 27c (See Schedule H), depending upon the nature of the distribution. Subchapter T cooperatives filing a regular Form 1120³ typically report patronage distributions as other deductions on line 26. Cooperatives that determine net income for financial statement purposes before patronage distributions typically also report patronage distributions on line 8 of Schedule M-1 and lines 5, 6 and 7 of Schedule M-2. (The Schedules M-1 and M-2 are the same on Forms 990-C and 1120.)

[15] Land O'Lakes patronage dividends are reflected on line 27c (and Schedule H) of its Form 990-C and also are reported in the detail of its Schedules M-1 and M-2.

Patronage distributions should not be "reportable transactions."

[16] We are concerned that patronage distributions of Subchapter T cooperatives appear to be swept into the list of "reportable transactions" by virtue of Treas. Reg. § 1.6011- 4T(b)(6) (transactions with a significant book-tax difference) when:

[17] We see no useful tax administrative purpose to be served by classifying patronage distributions of the type routinely made by Subchapter T cooperatives as "reportable transactions."

[18] The disclosure and list maintenance rules seek to identify potentially abusive tax shelter transactions. Patronage distributions made by Subchapter T cooperatives do not fit that profile. While patronage distributions often give rise to book-tax differences, they are not the result of a potentially abusive tax shelter transaction nor are they an indicator of or a badge of a potentially abusive tax shelter transaction.

[19] Rather patronage distributions are a normal part of operating on a cooperative basis. They are how a Subchapter T cooperative returns its earnings to patrons. Functionally, they are no different than dividends paid by a C corporation or an S corporation or distributions made by a partnership or a limited liability company except that patronage distributions are excludable or deductible by the cooperative and includible in the income by members as part of the over-all arrangement provided by Subchapter T for taxing cooperatives and their members.

[20] In addition, patronage dividends already are prominently identified on the tax returns currently filed by Subchapter T cooperatives. Requiring additional disclosure (which for many large cooperatives would be an annual disclosure) serves no useful purpose.

[21] We ask that an additional exception be carved out of Proposed Treas. Reg. § 1.6011-4T(b)(6) to exclude patronage distributions. Suggested language for such an exception, to be added to Proposed Treas. Reg. § 1.6011-4T(b)(6)(iii) is:

²In the case of marketing cooperatives, net earnings are often referred to as net proceeds.

³Form 990-C is intended for use only by farmers' cooperatives.

⁴One of the exceptions already recognized in the regulations is for "dividends." Treas. Reg. § 1.6011- 4T(b)(6)(iii)(J). While patronage distributions are akin to dividends in some respects, they are not generally classified as "dividends" as that word is used for federal income tax purposes. The only exception is for dividends paid by Section 521 cooperatives, which, as noted above, are deductible. Dividends deductible by Section 521 cooperatives constitute only a small fraction of the patronage distributions made by Subchapter T cooperatives.