The opinion of the court was delivered by: Robert D. Morgan, District Judge.
Plaintiff, Laura Farmers Cooperative Elevator Company,
instituted this suit to recover certain income tax payments
made for its fiscal years ended May 31, 1962 and May 31, 1963.
The facts giving rise to the controversy are stipulated. The
cause is now before the court upon cross-motions by the
plaintiff and defendant for summary judgment.
Plaintiff was incorporated in the early 1920's, under the
Illinois statutes, as a business corporation for the purpose
of marketing grain of its shareholder members and others and
for the further purpose of selling farm supplies to its
patrons. Its activities were conducted on a partially
As of March 31, 1961, plaintiff had outstanding 349 shares
of common stock, having a par value of $100 per share, for
which plaintiff had received a cash consideration of $34,900
upon the issuance of such stock. The earned surplus of the
corporation was then $187,652.18, no part of which had been
allocated to patrons as patronage refunds. No dividends
chargeable to that surplus had been declared.
On July 24, 1961, pursuant to the consent of its
shareholders, plaintiff was reorganized as a cooperative under
the provisions of the Illinois Agricultural Cooperative Act,
Ill.Rev.Stat. 1959, Ch. 32, § 440 et seq. Under the
reorganization plan adopted, plaintiff agreed to exchange one
share of first preferred, $100 par, five percent, cumulative
dividend stock, and twenty shares of second preferred, $25 par,
two percent noncumulative
dividend stock for each share of its old common stock.
During its fiscal year ending May 31, 1962, 329 shares of
the old common stock were exchanged for 329 shares of the
first preferred stock and 6580 shares of the second preferred
stock. In the same fiscal year, plaintiff sold an additional
63 shares of first preferred stock at the par value of $100
per share. During the same period, one share of first
preferred stock and 40 shares of second preferred stock were
turned in to the plaintiff and applied at par value to
During the fiscal year ending May 31, 1963, plaintiff issued
11 additional shares of the first preferred stock and 220
shares of the second preferred stock in exchange for 11 shares
of the original common stock. During the same period of time,
plaintiff sold 21 shares of first preferred stock at par value
and redeemed 3 shares thereof.
The plan of reorganization contemplated the capitalization
of the earned surplus account of the corporation, and to issue
therefor the second preferred shares in an amount equivalent
to the shareholders' equity in that portion of the assets of
the corporation. Prior to May 31, 1962, the sum of $164,500
was transferred from earned surplus to capital, that sum being
the par value of the 6,580 second preferred shares issued. In
the year ending May 31, 1963, an additional $5,500 was
transferred from the earned surplus account to capital on the
same basis. The aggregate result of those transactions was to
reduce the earned surplus account standing on the plaintiff's
books to $17,652.18.
On August 28, 1962, plaintiff filed an application with the
District Director of Internal Revenue claiming an exemption
from taxation as a farmers' cooperative, pursuant to the
provisions of Section 521 of the Internal Revenue Code of
1954, as amended, 26 U.S.C.A. § 521. On September 28, 1962, the
District Director denied the exemption.
Plaintiff filed income tax returns for the two taxable years
as a regular business corporation. In the fiscal year ending
in 1962, plaintiff paid tax, so computed, in the amount of
$3,142. The tax computed on the same basis, and paid for the
fiscal year ending in 1963, was $1,848.52.
During the same period of time, plaintiff paid dividends on
its first and second preferred stock in the amount of $5,225
for the year ending May 31, 1962, and $5,645 for the year
ending May 31, 1963.
Thereafter, plaintiff filed a claim for a refund for each of
the taxable years, based upon the theory that plaintiff was
qualified for exempt status under Section 521 of the Code, and
was, therefore, entitled to a deduction for the amount of
dividends paid on its capital stock. The District Director
disallowed both claims, rejecting plaintiff's contention that
it was entitled to an exempt status under Section 521.
The parties have stipulated that plaintiff has satisfied all
conditions of Section 521, with the exception of the 8 percent
limitation placed by the Code on dividends which may be paid
to shareholders. The plaintiff's claim was disallowed by the
District Director on the theory that the dividends paid on its
preferred stock for each of the taxable years in question was
in excess of the 8 percent allowable return on the investment
of plaintiff's shareholders. The District Director's view was
that the cash consideration for the issuance of the new stock
issues was limited to the $100 per share which the
shareholders had originally paid for their old common stock.
He held that the 20 shares of second preferred stock issued
for each share of common stock exchanged was issued by
plaintiff without any consideration moving to the corporation
from the shareholder.
Upon that basis, the District Director determined that the
consideration for all preferred stock outstanding, as of the
end of the fiscal year ending May 31, 1962, was $39,100, and
that the consideration for all preferred stock outstanding at
the end of the fiscal year ending May 31, 1963, was the sum of
$42,000. In each instance, the figure is the aggregate of
the $100 per share paid for the original common stock and the
par value consideration ...