Legal Ruling 1965-292

Franchise-Cooperative: Deductibility of Dividends Paid on Its Capital Stock

Dividends paid by a cooperative on its capital stock are deduction under Section 24404, Revenue and Taxation Code.

The taxpayer is a capital stock corporation which was organized and is operated as a farmers' cooperative. Its purposes and functions are to market fresh fruit produced by its members and nonmember producers, and to purchase and furnish farm supplies and equipment to them at cost.

The income realized from its operations is allocated and paid to members and nonmembers after deducting all expenses, including depreciation on the cooperative's facilities. No profits or surplus funds are retained by the cooperative.

The income is distributed as (1) a patronage dividend to members and nonmembers based upon patronage and (2) as a cash dividend not exceeding 8 percent of the par value of the capital stock owned by members. During the years in question some members were paid a cash dividend on their stock but not a patronage dividend apparently for lack of patronage.

Notices of proposed assessment were issued disallowing the deduction claimed by the cooperative for dividends on capital stock paid to members for the income years ending February 28, 1958, 1959 and 1960. A question has been raised as to whether the deduction was properly disallowed.

Are the dividends paid by the cooperative on its capital stock deductible under Section 24404?

Farmers' cooperatives, such as the taxpayer, are granted a special deduction under Section 24404. In order to be eligible for this deduction the section requires that the cooperative be organized and operated on a cooperative basis for the purpose of:

(a) Marketing the products of members or other producers returning to them the proceeds after expenses on a patronage basis, or

(b) Purchasing supplies and equipment for members or other persons at cost plus necessary expenses.

If either or both of these requirements are met, the cooperative in computing its taxable income is allowed a deduction for ". . . all income resulting from or arising out of such business activities for or with their members carried on by them or their agents; or when done on a nonprofit basis for or with nonmembers."

The taxpayer in this case meets these requirements. Farm supplies are sold to members and nonmembers at cost and net proceeds from marketing are returned to members and nonmembers on a patronage basis. Since no profits were derived from the business activities carried on with nonmembers the income derived therefrom is deductible.

While the cash dividend, authorized by the bylaws and paid to members according to the number of shares owned, reduces the amount available for the patronage dividend, it will not deprive the cooperative of the deduction either in part or in whole. The deduction is measured by all business activities (income) with members and with nonmembers on a nonprofit basis. Since all of the taxpayer's income arose from business with its members and nonmembers on a nonprofit basis, the entire amount is deductible. The fact that part was paid as a dividend on capital stock is immaterial. Appeal of Certified Grocers of California, Ltd., Board of Equalization, 1962, (interest paid on members' deposits). Accordingly, the assessments for all of the years in question should be withdrawn.

There is an additional reason for withdrawing the assessment for the income year ending February 28, 1960. In 1959 the second paragraph to Section 24404, applicable to income years beginning after December 31, 1958, was added. That paragraph specifically provides that "all income resulting from or arising out of such business activities for or with their members" includes all amounts, whether or not derived from patronage allocated to members during the income year.