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LAURA FARMERS COOPERATIVE ELEVATOR CO. v. U.S.

October 10, 1967

LAURA FARMERS COOPERATIVE ELEVATOR CO., A CORPORATION, PLAINTIFF,
v.
UNITED STATES OF AMERICA, DEFENDANT.



The opinion of the court was delivered by: Robert D. Morgan, District Judge.

OPINION AND ORDER

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 cooperative basis.

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 accounts receivable.

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 ...


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