Evolving Cooperative Business Structures 5 th Annual Farmer Cooperative Conference November 13-15,...

Evolving Cooperative Business Evolving Cooperative Business StructuresStructures

55thth Annual Farmer Cooperative Conference Annual Farmer Cooperative Conference

November 13-15, 2002November 13-15, 2002

Dave Swanson and Robert HensleyDave Swanson and Robert Hensley

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55thth Annual Farmer Cooperative conference Annual Farmer Cooperative conference

Definitions of CooperativeDefinitions of Cooperative

• Tax Law DefinitionTax Law Definition

• Capper-Volstead Definition for Farm CoopsCapper-Volstead Definition for Farm Coops

• Borrowing Eligibility – CoBank, CFA, NCB Borrowing Eligibility – CoBank, CFA, NCB

• Coop Trade Association Eligibility StandardsCoop Trade Association Eligibility Standards

• Rochdale PrinciplesRochdale Principles

• State & Federal Securities LawsState & Federal Securities Laws

Common Theme:Common Theme:Allocate Margins by PatronageAllocate Margins by Patronage

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Tax Attributes of CoopsTax Attributes of Coops

• Subchapter TSubchapter T

– Patronage Sourced Income DeductionPatronage Sourced Income Deduction

– Operation on a “Cooperative Basis”Operation on a “Cooperative Basis”

– Patronage allocation (preexisting duty)Patronage allocation (preexisting duty)

– Democratic ControlDemocratic Control

– Subordination of CapitalSubordination of Capital

– Mutuality of InterestMutuality of Interest

– 20% Cash Distribution in 8½ Months20% Cash Distribution in 8½ Months

– Sourcing of Income/ExpenseSourcing of Income/Expense

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Tax Attributes of LLCsTax Attributes of LLCs

• Pure Pass-Through of Tax Attributes to Pure Pass-Through of Tax Attributes to MembersMembers

• No Patronage Requirement (but it’s No Patronage Requirement (but it’s allowed) allowed) –– facilitates non-member –– facilitates non-member equityequity

• Publicly Traded Partnership RulesPublicly Traded Partnership Rules

• Self-employment TaxSelf-employment Tax

• Passive Activity Loss LimitationsPassive Activity Loss Limitations

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Is Capper Volstead Critical?Is Capper Volstead Critical?

• Capper-Volstead Does Not Mandate Capper-Volstead Does Not Mandate Cooperative LabelCooperative Label

• Price Fixing Exemption & Allows Market Price Fixing Exemption & Allows Market Power Unless Undue Price EnhancementPower Unless Undue Price Enhancement

• Joint Venture Analysis for new venturesJoint Venture Analysis for new ventures

• Importance for Common Marketing PoolsImportance for Common Marketing Pools

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The Equity LimitationThe Equity Limitation

• Patronage based earnings distribution limits the Patronage based earnings distribution limits the pool of potential “investors”pool of potential “investors”

• Limits on preferred stock as an equity source Limits on preferred stock as an equity source

– Dividend allocation ruleDividend allocation rule

– State law limits on dividend rateState law limits on dividend rate

• Joint Ventures as an equity sourceJoint Ventures as an equity source

-Tax and securities issues for New Coops-Tax and securities issues for New Coops

-Cost & Complexity-Cost & Complexity

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Choice of Entity – Choice of Entity – Coop v. LLCCoop v. LLC

Existing Coops → conversion to LLC a Existing Coops → conversion to LLC a taxable transactiontaxable transaction

coop & memberscoop & members

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Choice of Entity —Choice of Entity —Coop v. LLCCoop v. LLC

Four Tax Models:Four Tax Models:

• Straight Coop (corporation operated on a Straight Coop (corporation operated on a cooperative basis)cooperative basis)

• Straight LLC (LLC operated as a Straight LLC (LLC operated as a partnership)partnership)

• LLC taxed as a corporation operated on a LLC taxed as a corporation operated on a cooperative basis. PLR 200119016cooperative basis. PLR 200119016

• Cooperative LLC (LLC taxed as a Cooperative LLC (LLC taxed as a partnership but operated on a cooperative partnership but operated on a cooperative basis)basis)

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• New Coops — It’s an “Art” Not a “Science”New Coops — It’s an “Art” Not a “Science”

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CoopCoop

May be tax neutral May be tax neutral

(but with limits)(but with limits)

Outside Equity Outside Equity LimitsLimits

LLCLLC

Tax neutralTax neutral

Outside Outside Equity Equity FlexibilityFlexibility

The Tax / Equity Flexibility FactorThe Tax / Equity Flexibility Factor

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Some Driving FactorsSome Driving Factors

• Securities RegistrationSecurities Registration

– CostCost

– 521 Exemption521 Exemption

– Intra-StateIntra-State

– Private PlacementPrivate Placement

• Tax Credits — EthanolTax Credits — Ethanol

• Blue Sky ExemptionsBlue Sky Exemptions

• Borrowing EligibilityBorrowing Eligibility

• Importance of Non-Importance of Non-Producer InvestmentProducer Investment

• Special Program Special Program EligibilityEligibility

• Nature of the Farm Nature of the Farm Product InvolvedProduct Involved

• Nature of the Market Nature of the Market and End Productsand End Products

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Redefining CooperativeRedefining Cooperative

• To Date:To Date: Heavy emphasis on tax Heavy emphasis on tax definitiondefinition

• Evolution in Thinking About Evolution in Thinking About Organizational Models in GeneralOrganizational Models in General

• In the Future: Earnings Distributed In the Future: Earnings Distributed “Primarily” on Patronage?“Primarily” on Patronage?

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Wyoming Processing Wyoming Processing Cooperative Law – Cooperative Law –

Membership and GovernanceMembership and Governance

• Membership is made up of both patrons and Membership is made up of both patrons and investment membersinvestment members

• Not less than 3 directorsNot less than 3 directors

• A majority of the directors shall be membersA majority of the directors shall be members

• At least 1 member elected by patronage membersAt least 1 member elected by patronage members

• Directors elected by patron members must have Directors elected by patron members must have at least 50% of the voting powerat least 50% of the voting power

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Wyoming Processing Wyoming Processing Cooperative Law – Financial Cooperative Law – Financial

RightsRights

• Patron members receive allocations and Patron members receive allocations and distributions based upon patronagedistributions based upon patronage

• Investment members receive allocations Investment members receive allocations and distributions based upon their and distributions based upon their investmentinvestment

• At least 15% of the profit allocations and At least 15% of the profit allocations and distribution must go to patron membersdistribution must go to patron members

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Wyoming Processing Wyoming Processing Cooperative Law – Tax Cooperative Law – Tax

TreatmentTreatment

• Eligible for Subchapter K tax treatment. Eligible for Subchapter K tax treatment. All earning “pass through” to membersAll earning “pass through” to members

• Eligible for Subchapter T tax treatmentEligible for Subchapter T tax treatment

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Wyoming Processing Wyoming Processing Cooperative Law – IssuesCooperative Law – Issues

• Investment member causes the Investment member causes the processing coop to sacrifice its Capper-processing coop to sacrifice its Capper-Volstead protection.Volstead protection.

• Questions concerning forming under the Questions concerning forming under the statute to “market” if there is an outside statute to “market” if there is an outside investor – regulatory issues?investor – regulatory issues?

• 50% governance can be an issue. Is it a 50% governance can be an issue. Is it a cooperative?cooperative?

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What would Andrew Volstead What would Andrew Volstead say?say?

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Wyoming Processing Wyoming Processing Cooperative Law – IssuesCooperative Law – Issues

• Investment member Investment member causes the processing coop causes the processing coop to sacrifice its Capper-to sacrifice its Capper-Volstead protection.Volstead protection.

• Questions concerning Questions concerning forming under the statute to forming under the statute to “market” if there is an “market” if there is an outside investor – outside investor – regulatory issues?regulatory issues?

• 50% governance can be an 50% governance can be an issue. issue.

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Proposed Minnesota and Proposed Minnesota and Wisconsin Cooperative Law Wisconsin Cooperative Law

ReformReform

• Research and discussions well under wayResearch and discussions well under way

• DividendsDividends

• VotingVoting

• GovernanceGovernance

• Clearer definition of who qualifiesClearer definition of who qualifies

QUESTIONS?QUESTIONS?

Evolving Cooperative Business Structures 5 th Annual Farmer Cooperative Conference November 13-15,...

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