BIR Ruling No. 003-64

January 27, 1964 BIR RULING NO. 003-64 Mr. Guillermo A. Dugenia Suite 403 Bengson Building Osmea St., San Fernando La Union S i r : This is in reply to your request for a ruling on the following query: LLpr "This is to secure a specific ruling of your office as to the proper treatment for income tax purposes on the part of the corporation paying the so-called 'Patronage Refund', whether the total amount paid is a part of the taxable income or be deducted from the taxable income. "For purposes of clarity, the 'Patronage Refund' is declared out of the current net income. It is in the form of 'rebate' to the members of stockholders of a part of the selling price of the goods which they have sold to the corporation for the reason that the purchase prices have apparently been understated as manifested by the excess of the revenue over the cost of sales and expenses. The amount to be paid therefore is based on the quantity, sometimes on the amount, sold by the member or stockholder to the corporation. Any member or stockholder who has not sold his product to the corporation will not be paid or is not entitled to such 'Patronage Refund'. In contrast thereto, dividends will be paid to stockholders on the basis of their shareholdings." We have no specific statutory provisions for the deduction of patronage dividends, refunds or rebates from the gross income of a cooperative association. Resort, therefore, should be made to American authorities on the matter, the same having a persuasive effect in this jurisdiction. prll For purposes of the Code provisions dealing with farmers' cooperatives, the Regulations define "patronage dividend, rebate or refund" to include "any amount allocated by a co-operative association, to the account of a patron on the basis of the business done with or for such patron". (p. 73, chap. 21, Vol. 3A Mertens) However, the distribution of refunds or patronage dividends by co-operative corporations raises tax questions for both the corporation and its member-patrons. A distinction should be made as to whether a particular corporate distribution is a dividend or some other type of payment. From the standpoint of the corporation, a dividend distribution is non-deductible. (p. 29, Chap. 9, Vol. 1, Mertens) In your query some of the stockholders or members sell their goods to the corporation at lower prices, than the corporation sells them out with profit. At the end of the year, out of its current net income, the corporation distributes to the stockholders (vendors) certain amount "based on the quantity, sometimes on the amount, sold by the member of stockholder to the corporation". It is clear from the facts and circumstances of this case that the stockholder vendors participate in the profits of the corporation, which is strongly indicative of the fact that the transaction in question merely serves as a cover for an actual distribution of dividends. Accordingly, the said corporation is not entitled to deduction for the patronage dividends consisting of refunds of profits paid to some of its members or stockholders in proportion to their trading operations with the company, even if some is made without regard to the amount of stock held by the distributee of such refunds. In this connection, the authorities are clear that a distribution of profits maybe made on a basis other than stockholdings and still be a dividend distribution (Peoples Gin Co., 41, B.T.A. 343; Lincoln National Bank vs. Vurnet, 63 Fed., (2d) 131; Kate Hudson, 34 B.T.A. 155). In fact, a distribution, to be a dividend need not be called a "dividend", nor need there be a formal declaration by the board of directors. It is sufficient if, on all the evidence, there is a distribution of earnings or profits. (pp. 26-27, Chap. 9, Vol. 1, Mertens) cdta Moreover, whether or not the aforementioned patronage refund is taxable or deductible from a corporation's gross income would depend upon the existence or absence at the time of purchase of a liability to make such refund to the member-patrons. If such refunds are made pursuant to a binding obligation, they are excluded in determining the corporation's income. Income to the member-patron is generally realized when the amounts of refunds or patronage dividends are determined and credited to them. (Uniform Printing Supply Co. v. Com's 38 F (2d) 75; Farmers Union Cooperative Exchange, 42 B.T.A. 1200, cited in Chapter 21 Federal Income, Gift and Estate Taxation by Rebkin and Johnson). In this case, the patronage refunds in question are distributed and paid by the corporation not on account of any binding obligation or existing liability to do so, but just because the distributees have sold their goods to the said corporation at purchase prices which "have apparently been understated as manifested by the excess of the revenue over the cost of sales and expenses". In view of the foregoing, this Office believes and so holds, that the refunds having been voluntarily paid, are mere dividends. As such, they are, therefore, not deductible by the corporation. (Peoples Gin Co. v. Com'r; 118 F (2d) 72; Juneau Dairies, Inc., 44 B.T.A. 759; American Box Export Ass' n., 4 TC 758, aff'd 156 F (2d) 629, cited Federal Income, Gift and Estate Taxation by Rabkin & Johnson, supra) cdti Very truly yours, (SGD.) BENJAMIN N. TABIOS Acting Commissioner of Internal Revenue