Legal ruling 418

Farmers' Cooperatives. Amounts Allocated to Members which are Attributable to NonMember Rates of Transactions are Deductible.

Facts

The taxpayer, a farmers' cooperative association within the provisions of Section 24404, for its income year ended June 30, 198X, received over $10,000 from interest on a savings account and from the sale of a petroleum plant. During this period its net profit was $63,500. Of this amount $58,900 was allocated to its members, and the balance of $4,600 was added to undistributed surplus.

Questions

1. May farmers' cooperatives, as described in Section 24404, deduct amounts allocated to members which are attributable to nonmember sales or transactions?

2 (a). Is the surplus (net income) from transactions with members subject to tax if such income is not allocated within 8 months and fifteen days after the close of the income year?

2 (b). Is the surplus (net income) from transactions with nonmembers subject to tax if such income is not allocated within 8 months and fifteen days after the close of the income year?

3. If income described in 2 (a) is not subject to tax and the income described in 2 (b) is subject to tax, how is the taxable portion to be determined?

Decision

1. Yes.

2 (a). No.

2 (b). Yes.

3. By including total amount of unallocated nonmember income, after allowing reasonable expenses.

Discussion

1. Prior to the 1959 amendment to Section 24404, which added the last paragraph, farmers' cooperatives were subject to tax on income which did not result from or arise out of specified 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. Legal Ruling 173, approved December 29, 1955. In 1959, the section was amended to permit farmers' cooperatives a deduction for income derived from sources other than member activities, if the net profit from such activities was allocated to the members.

The amendment provides in part that "[f]or purposes of this section 'all income resulting from or arising out of such business activities for or with their members' shall include all amounts . . . allocated to members during the income year." (Emphasis added.) The question raised is whether or not the parts included within the quotation marks in the preceding sentence limits the type of income which can be allocated to members.

In our opinion if this construction is adopted the 1959 amendment is meaningless because the type of income referred to was already deductible prior to the adoption of the amendment. Thus, to so construe the section, as suggested, would violate a cardinal rule of statutory construction which is that when a statute is amended a change in meaning is intended. See 45 Cal. Jur. 3d Statutes, p. 445. In the instant case, the parts in quotations are therefore considered as words of description and not limitation, since the amendment expressly provides that all amounts, whether or not derived from patronage are deductible if allocated to members. The language "whether or not derived from patronage" refers specifically to any patron with whom the cooperative associations do business whether or not the patrons are members.

In view of the above, it is concluded that a farmer's cooperative may deduct all income, if all amounts, regardless of source, are allocated to members within 8 months and fifteen days after the close of its income year.

2 (a). Since the 1959 amendment states that "[f]or purposes of this section 'all income resulting from or arising out of such business activities for or with their members' shall include all amounts . . . allocated . . . ," a question has been raised as to whether or not members income in order to be deductible, is required to be allocated. As stated in the discussion to question 1, the purpose of the amendment was to expand the deductions allowed to farmers' cooperatives. Income from transactions from members was deductible prior to the amendment. The amendment only expanded a deduction provided for by existing law; therefore, amounts deductible prior to the 1959 amendment remain deductible without regard to whether they are allocated.

2 (b). Income from nonmember transactions conducted on a profit basis is deductible only if allocated to members within 8 months and fifteen days after the close of the income year. The 1959 amendment specifies the various means by which an allocation may be made. In the instant case the only allocation was by the addition of a certain amount to surplus. Since this addition did not advise the members of the dollar amounts allocated to them, the addition is not an allowable deduction.

3. As previously pointed out, under Section 24404, all amounts derived from profitable nonmember transactions are subject to tax unless allocated to members within 8 months and fifteen days after the close of the income year. To determine the taxable portion, in our opinion a computation similar to that contained in Legal Ruling 289 should be used. First determine the gross income from deductible business activities (i.e., allocated amounts or amounts otherwise deductible) and the gross income from nonmember business conducted on a profit bases. From each figure deduct the direct expenses applicable thereto and a portion of the general overhead. The overhead apportionment can be made on a gross income ratio in some instances, but in others some more reasonable method must be used since the time devoted to each type of business may not compare with the gross income produced. The resulting net income (gross unallocated profitable nonmember income, less deductions attributable thereto) is the amount subject to tax.