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U.S. DEPARTMENT OF AGRICULTURE
FARMER COOPERATIVE SERVICE
FCS INFORMATION 34 -
Basic Requirements, 2
Relation of patronage refunds to
cooperative features ................. 4
Member ownership and control ..... 5 Service at cost .................... 5
Limited returns on capital .......... 5 Obligation to finance .............. 6
FCS Information 34 Revised April 1977
Senior Agricultural Economist, Organization and Finance
Patronage refunds or patronage dividends
are terms distinctive to cooperatives. Rebate is
the term more often used in other businesses.
The Internal Revenue Code of 1954 as
amended,' defines a "patronage dividend" as
an amount paid to a patron by an
organization which part I of this subchapter
1. on the basis of quantity or value of busi
ness done with or for such patron,
2. under an obligation of such organization
to pay such amount which obligation -existed before the organization received the amount so
3. which is determined by reference to the
net earnings of the organization from business
done with or for its patrons.
Such term does not include any amount naid
to a patron to the extent that:
A) such amount is out of earnings other than
from business done with or for patrons, or
B) such amount is out of earnings from buc.
ness done with or for. other patrons to whom no amounts are paid, or to whom smaller amounts are paid with respect to substantially identical
We use the Internal Revenue Service (IRS)
definition as a basis for achieving some understanding of the term "patronage refund" because the IRS definition provides legal status and guidelines for implementing the cooperative concept of operating on a "service at cost" basis. We prefer to use the term "refund" rather than "divi'See Section 1.1388-1(a)(1) of the income tax
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that patronage refunds arise only from trans actions with its patrons. Thus, income that a cooperative receives from so-called "unrelated"' activities are per se not derived from patronage t ransActions and would not be included in the IRS definition of a patronage refund. Such distfibuti'ns, however, may be computed and distributed on a patronage basis in compliance with Section 521 of the IRS Code. Examples of nonpatronage income would include income items such as rental income, interest income, and capital gains.
Fifth, the obligation of the cooperative to pay patronage refunds must exist before any patronage transaction takes place. Thus, both the cooperative and its patrons have knowledge prior to any transaction that net margins derived from the transaction will be paid in whole or in part as a patronage refund. A typical bylaw provision that sets forth the obligatory nature of a patronage refund reads as follows:
"The association is obligated to make payments of all such amounts in excess of operating costs and expenses in cash refunds or by credits to a capital account for each patron."
Under such'a preexisting mandatory obligation to pay patronage refunds, it is clear that a cooperatives board of directors has no discretionary posture as to whether the cooperative will or will not pay a patronage refund. That decision already exists. The board's purview fies only in the decision area of the time and form of the patronage refund, not if it will be made.
The preexisting obligation must be in enforceable written form. Valid examples include a cooperatives bylaws, articles of incorporation, marketing agreement, sales receipt, or other, written contract obligating the association to make such payment. If a State law makes such patroneage unds mandatory, that law also is considcred as a valid obligation.
Sixth, patronage refunds are distributions of net earnings (net margins or net savings) derived from business transactions with or for patrons. A question as to what constitutes "net earnings" may come up. The Federal income tax regu nations define net earnings as the excess of
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Reato ofPtong efns
Member Ownership and Control
As patrons increase their equity interest in their cooperatives as a result of receiving patronage distributions in the form of allocated equities, their ownership interest increases. But their patronage, the resulting patronage allocations, other forms of participation in the affairs of their cooperative and, in fact, their loyalties, are unequal. As a result, some cooperatives, as a means of achieving their perceived interpretation of equitability adopt a system of weighted voting that takes into account members' investments arising primarily from their proportionate use of their association.
Based on this analysis, many associations have adopted weighted or proportional voting in preference to the one-member, one-vote method. In other words, patronage refunds appear to contribute to a shift from democratic control to socalled equitable control.
Service at Cost
Patronage refunds strengthen the operationat-cost concept. One point of view is that because costs cannot be estimated accurately in advance, patrons of a cooperative usually. pay the "going or competitive price" for goods or services and generally receive an advance or the going market price for products marketed that is less than the actual value of the product. Adjustments are made at the end of the year when costs are known. The amount of any necessary adjustment then goes to member-patrons as refunds based on patronage, thus reducing the operation to a cost baSiL The refund results in the cooperative not making a profit for itself nor for nonpatron investors.
Limited Returns on Capital primary
Members of a cooperative are i ily
interested in the benefits they derive as patrons of the organization. Because benefits in a cooper ative are distributed to patrons on the basis of
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OTHER PUBLICATIONS AVAILABLE
Handling Net Margins Under Federal Tax Law. :FCS Information 39. Revised September 1976.
Using Co-op Members' Money. C. H. Kirkman, Jr. FCS Information 79. Revised 1975. 16 pp.
Federal Income Taxes. Part 11-Legal Phases of Farmer Cooperatives. Morrison Neely. FCS Information 100. May 1976. 126 pp.
How Farm Marketing Cooperatives Return Savlings to Patrons. Donald R. Davidson. FCS Research Report 7. 1970. 81 pp.
A Financial Profile of Farmer Cooperatives in ,the United States. Nelda Griffin. FCS Research Report 23. 1970. 95 pp.
How The Adjustable Revolving Fund Capital Plan Works. Nelda Griffin. FCS General Report I 11. 1963, 8 pp.
Methods -and Policies Used in Making Patronage Refunds By Selected Cooperatives. Donald R. Davidson. FCS General Report 137. 1966. 22 pp.
For copies, write Farmer Cooperative Service, U.S. Department of Agriculture, Washington, D. C. 20250.
UNIVERSITY OF FLORIDA
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3 1262 08500 2094
agement, and edctoa assact
tive leaders and FdrladS improve organization, ledrhi,4 cooperatives and to gv ud development.
The Service (1) helpsfamran dents obtain supplies andsevcsa, to get better prices for'po i the rural residents ondvlpn X
through cooperativeactiont na helps cooperatives improesri efficiency; (4) informs mr employees, and the ublcohwc and~ benefit their mebes ndp'W and (5) encorgsitentoa programs.
The Service publishes resac nW materials and isses arerC programs and activities arecnutd criminatory basis, without ear o color, sex, or national origin.