PLR 201007067: IRS approved Internet and TV services for a rural telephone cooperative

Plain-English summary

The IRS considered whether a rural telephone cooperative could offer Internet and television services over the same copper-wire network used for telephone service. It ruled that both services were activities of a “like organization” under section 501(c)(12). Providing the services on a cooperative basis would not jeopardize the exemption, assuming the cooperative principles described in the ruling were satisfied. The cooperative must calculate its 85-percent member-income test using income from all approved like-organization activities in the aggregate.

Ruling snapshot

• Question: Could a rural telephone cooperative provide Internet and television services without jeopardizing its section 501(c)(12) exemption?
• Outcome: Approved, subject to the stated facts and conditions.
• Key authorities: IRC § 501(c)(12); Rev. Rul. 57-240, Rev. Rul. 72-36, and Rev. Rul. 83-170; Puget Sound Plywood v. Commissioner.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201007067 Contact Person:
Release Date: 2/19/10
Date: November 25, 2009 Identification Number:
UIL: 501.12-02

Telephone Number:

Employer Identification Number:

Legend:

State =
Dear

We have considered your letter of October 31, 2007, requesting a ruling on the
proposed transactions described below and their tax consequences on your federal
income tax exemption under Section 501(c)(12) of the Internal Revenue Code.

FACTS

You are organized as a not-for-profit corporation under the laws of State for the
purpose of installing and maintaining a telephone system, exchange, and lines for the
mutual benefit of your members. You represent that you are a rural telephone
cooperative and are described in section 501(c)(12) of the Code.

Using Digital Subscriber Line (DSL) technology, you have begun to offer Internet
and television services to your members over the same copper wire that is used to
provide telephone services.

RULINGS REQUESTED

1. Internet service is an activity of a “like organization” as described by section
501(c)(12) of the Code.

2. Television service (TV) is an activity of a “like organization” as described by
section 501(c)(12) of the Code.

3. Providing Internet and TV services on a cooperative basis would not jeopardize
your exemption under section 501(c)(12) of the Code.

4. Your compliance with the annual 85 percent member income test prescribed by
the statute for income tax exemption will be computed based on all approved
“like organization” activities in the aggregate, not each separate function.

LAW

Section 501(c)(12) of the Code provides for the exemption from federal income
tax of benevolent life insurance associations of a purely local character, mutual ditch or
irrigation companies, mutual or cooperative telephone companies, or like organizations;
but only if 85 percent or more of the income consists of amounts collected from
members for the sole purpose of meeting losses and expenses.

Rev. Rul. 83-170, 1983-2 C.B. 97, describes a cooperative organization formed
to provide cable television service to its members. The revenue ruling states that the
term “like organization,” as used in section 501(c)(12) of the Code, is applicable to those
mutual or cooperative organizations that are engaged in activities similar in nature to a
public utility-type of service. The ruling finds that cable television service is a public
utility-type service, provided that 85 percent or more of the cooperative’s income
consists of amounts collected from members for the sole purpose of meeting losses and
expenses. The ruling concludes that the organization qualifies for exemption from
federal income tax as a “like organization” within the meaning of section 501(c)(12).

Rev. Rul. 72-36, 1972-1 C.B. 151, describes certain requirements that
cooperative companies must meet to be exempt under section 501(c)(12) of the Code.
Those include the requirement that the rights and interests of the members in the
savings of the organization be determined in proportion to their business with the
organization. The interests of members in the savings of the organization may be
determined in proportion to either the value or the quantity of the services purchased
from the organization. To maintain its mutual or cooperative character, an organization
must keep such records as are necessary to determine, at any time, each member’s
rights and interests in the assets of the organization.

In Puget Sound Plywood v. Commissioner, 44 T.C. 305 (1965), acq. 1966-1 C.B.
3, the court held that an organization must meet certain common law requirements in
order to be a cooperative. These common law requirements include: democratic control
of the organization by members, the organization operates at cost for the benefit of
members, and the contributors of capital to the organization do not control or receive
most of the pecuniary benefits of the organization’s operations (i.e. subordination of
capital).


ANALYSIS

Organizations exempt under section 501(c)(12) include telephone cooperatives
providing telephone services to their members. If an activity in question is not
telephone services, its activity must be similar to or “like” those activities described in
section 501(c)(12). In Rev. Rul. 57-240, the Service concludes that an organization that
provides and maintains a two-way radio system is a “like organization” for purposes of
section 501(c)(12) because it has a purpose similar to that of a mutual telephone
company, allowing members and patrons to communicate with other people. In the
situation here, the Internet telecommunication services via digital subscriber line (DSL)
technology will allow your members to communicate with others, sending and receiving
messages through telephone lines. It serves the same purpose for which the
organization described in Rev. Rul. 57-240 was held to be exempt under section
501(c)(12) of the Code. Hence, this service is an activity described within the meaning
of section 501(c)(12)(A).

In Rev. Rul. 83-170, supra, the Service holds that a cooperative that provides
cable television to its members may qualify for exemption from federal income tax as a
“like organization” under section 501(c)(12) of the Code. In the situation here, providing
television services via DSL technology is similar to cable television service.
Consequently, this service, like the activity described in Rev. Rul. 83-170, is an activity
described within the meaning of section 501(c)(12)(A).

In order to qualify for exemption under section 501(c)(12), an organization must
satisfy certain cooperative principles. One main cooperative principle is that a
cooperative must operate at cost — the excess of earnings and losses is returned to
each patron in direct proportion to his or her patronage. See Puget Sound Plywood,
Inc. v. Commissioner, 44 T.C. 305 (1965) and Rev. Rul. 72-36, supra. Hence, to
accomplish this requirement, a cooperative that operates several types of services must
at all times keep its cooperative earnings and losses separate from each service so as to
ensure that earnings and losses from a particular service be allocated properly to
each patron/member.

A cooperative, nevertheless, may combine two or more services into one or more
units for purposes of allocation of earnings and losses. Patrons of a particular service
may be grouped with patrons of another particular service into one allocation unit,
provided that the following criteria are satisfied. Many patrons of one service are also
patrons of the other services within the allocation unit. The cooperative’s articles of
incorporation, bylaws or agreements must provide details on the composition of all
allocation units and how earnings and losses are to be allocated within each allocation
unit. Members of the allocation unit are informed of the risk sharing engendered by
combining different types of services into one allocation unit. A majority of the members
of that allocation unit agrees to the grouping, and such agreement should be affirmed by

3

a periodic vote.

These criteria are intended to ensure that in establishing allocation units or
service divisions a cooperative does not divert a substantial amount of earnings from
one group of patrons to another.

In the situation here, you plan to offer Internet and television services in
conjunction with telephone services. As indicated in the previous paragraph, each line
of services must have separate patronage allocations for gains and losses. All criteria
discussed in the previous paragraph must be satisfied in order for a cooperative to meet
the basic cooperative operating principles.

Exemption under section 501(c)(12) also requires a cooperative to satisfy the 85
percent member income test. In calculating the 85 percent member income test, a
cooperative must combine income derived from all sources to calculate whether 85
percent of this income is derived from members. See section 501(c)(12)(A) of the
Code. Hence, in each taxable year you must combine income derived from the
provision of all services, telephone, Internet and television services, and other sources
to determine whether you satisfy the 85 percent member income test.

Accordingly, based on the foregoing and solely on the facts as represented
above and in the administrative file, and assuming that there will be no material change
of the facts, we rule as follows:

1. Providing Internet service on a cooperative basis is a “like organization” activity
as described by section 501(c)(12) of the Code.

2. Providing TV service on a cooperative basis is a “like organization” activity as
described by section 501(c)(12) of the Code.

3. Providing Internet and TV services on a cooperative basis would not jeopardize
your exemption under section 501(c)(12) of the Code.

4. Your annual 85 percent member income test prescribed by the statute for income
tax exemption will be computed based on all approved “like organization”
activities in the aggregate, not each separate function.

This ruling is based on the facts as they were presented and on the
understanding that there will be no material changes. This ruling does not address the
applicability of any section of the Code or regulations to the facts submitted other than
with respect to the sections described. A copy of this letter should be kept in your
permanent records.

This ruling will be made available for public inspection under section 6110 of the
Code after certain deletions of identifying information are made. For details, see
enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions
that we intend to make available for public inspection is attached to Notice 437. If you
disagree with our proposed deletions, you should follow the instructions in Notice 437.

In accordance with the Power of Attorney currently on file with the Internal
Revenue Service, we are sending a copy of this letter to your authorized representative.

This ruling is directed only to the organization that requested it. Section 6110(k)(3)
of the Code provides that it may not be used or cited by others as precedent.

If you have any questions about this ruling, please contact the person whose name
and telephone number are shown in the heading of this letter.

Sincerely,

Manager, Exempt Organizations
Technical Group 3

Enclosure
Notice 437