Rev. Rul. 54-297

Advice is requested as to the proper treatment of amortization of emergency facilities and Federal income taxes in the determination of the maximum allowable exclusion for patronage dividends in the case of a nonexempt cooperative association.

A `cooperative association,' as that term is defined in section 39.101(12)-2(b)(1) of Regulations 118, includes, with certain exceptions, any corporation operating on a cooperative basis and allocating amounts to patrons on the basis of business done with or for such patrons. The Internal Revenue Service has consistently held that such associations, even though not exempt from taxation, may exclude from gross income certain amounts returned to their patrons as true patronage dividends. See I.T. 1499, C.B. I-2, 189, and A.R.R. 6967, C.B. III-1, 287.

Section 23 of the Internal Revenue Code provides that in computing net income there shall be allowed as deductions all ordinary and necessary expenses paid or incurred during a taxable year including, among other things, a reasonable allowance for depreciation. Since the deduction for amortization of emergency facilities provided for in section 124A of the Code is in lieu of the deduction for depreciation allowable under section 23(1) of the Code, such deduction should be used in the determination of `net income' for the purpose of computing the maximum amount of patronage dividends that may be excluded from gross income in the case of a nonexempt cooperative association under the rule set forth in A.R.R. 6967, supra .

In Farmers Union Cooperative Exchange v. Commissioner , 42 B.T.A. 1200, (appeal dismissed), 122 F.(2d) 718, acquiescence C.B. 1944, 8, it was held that for the purpose of determining the maximum allowable exclusion for patronage dividends in the case of a nonexempt cooperative association under the rule set forth in A.R.R. 6967, supra , the `net income' of the association should not be reduced by Federal income taxes.

During the year 1917 refunds were paid to members of the cooperative considered in A.R.R. 6967, supra , in the amount of 39.16 x dollars. That ruling holds, in effect, that the amount of 39.16 x refund consists of that proportion of the net profits, after deducting the fixed dividend on outstanding capital stock, which the amount of business transacted with members bears to the entire amount of business transacted. Up to the amount available for refund thus computed, a distribution by a cooperative association to its members, upon the basis of the business transacted with them will be deemed to be a true patronage dividend, excludable by the association in computing its taxable net income for Federal income and profits tax purposes. This holding is based on the assumption that the dealings with members and nonmembers are equally profitable. Applying this rule to the facts there involved the following computation was set forth:

                                                   Dollars

Accordingly, it is held that the deduction for amortization of emergency facilities, where an election has been made under section 124A of the Internal Revenue Code, must be taken into consideration in computing the `net income' of a nonexempt cooperative association for the purpose of determining the maximum allowable exclusion for patronage dividends under the rule set forth in A.R.R. 6967, supra , described above. Federal income taxes paid by the association should not be taken into consideration in making this determination.