PLR 1208008: IRS confirms cooperative status after an organizational alignment

Plain-English summary

The IRS ruled that a cooperative serving hospitals would continue to operate on a cooperative basis after an alignment transaction with two related nonprofit organizations. The transaction would place the cooperative under a common parent, but its members would retain the economic benefits of patronage, voting control through proxies, and rights to residual assets. The IRS concluded that the cooperative would continue to operate at cost, retain subordinated capital, and remain democratically controlled on a one-member, one-vote basis. The ruling therefore confirmed continued status under IRC § 1381(a)(2).

Ruling snapshot

• Question: Will the cooperative continue to operate on a cooperative basis after the planned alignment transaction?
• Outcome: Approved, the cooperative retains its section 1381(a)(2) status on the described facts
• Key authorities: IRC § 1381(a)(2); Rev. Rul. 75-97; Rev. Rul. 93-21; Treas. Reg. and case authorities discussed in the release

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201208008 Third Party Communication: None
Release Date: 2/24/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1382.00-00 ----------------------------, ID No. ----------
Telephone Number:
---------------------
---------------------- Refer Reply To:
------------------------------------------ CC:PSI:B05
------------------------------------------------ PLR-123391-11
------------------------------ Date:
-------------------------------------------- November 29, 2011

LEGEND:

Taxpayer = ------------------------------------------------
-------------------------

State A = -------------

b = ----------------------------

c = ------------------------------------

Association 1 = ------------------------------------------------------------------------

Association 2 = ------------------------------------------------------------------------
-------------------------

Dear ----------------

    This is in response to a request for a ruling dated May 31, 2011, submitted by

your authorized representative. The ruling requests that Taxpayer will continue to be a
corporation operating on a cooperative basis within the meaning of section 1381(a)(2) of
the Internal Revenue Code after the alignment transaction described below.

      Taxpayer is a corporation operating on a cooperative basis organized under

State A law. Taxpayer was formed in -------. It was reorganized on a cooperative basis
in -------. At that time, Taxpayer received a private letter ruling (PLR 9235011, dated
May 21, 1992) confirming its status as a nonexempt cooperative subject to the
provisions of subchapter T of the Code.
PLR-123391-11 2

  Taxpayer is a cooperative serving b hospitals. Currently, the members of

Taxpayer are -----------------------b hospitals. Taxpayer’s members share data,
knowledge and buying power to reduce costs and improve clinical and operational
performance in b hospitals. The principal activities Taxpayer engages in on behalf of its
members are:

        Group purchasing. Taxpayer provides group purchasing and supply chain
         management services (“group purchasing”) for its members and their
         affiliates. Through Taxpayer, members and their affiliates have access to
         the c contract portfolio and to contracts that Taxpayer has itself negotiated
         with vendors. These contracts cover a broad array of medical, surgical,
         pharmaceutical and other products and services that Taxpayer’s members
         require to operate their b hospitals.

         During 2010, members and their affiliates purchased approximately
         ----------------of products and services under these contracts.

         Under the contracts, Taxpayer’s members typically place orders
         directly with the vendors, the vendors ship directly to them and bill
         them directly, and the members pay the vendors directly.

         The contracts provide for favorable pricing. They also usually
         require vendors to pay administrative fees to c (in the case of the c
         contracts) and to Taxpayer (in the case of the Taxpayer contracts).
         By virtue of the agreement that provides Taxpayer’s members with
         access to the c contracts, Taxpayer shares in administrative fees
         paid by vendors to c with respect to purchases made by Taxpayer’s
         members and their affiliates under the c contracts.

        Insurance services. In addition, Taxpayer provides insurance advisory
         and agency services (“insurance services”) to its members and their
         affiliates. Taxpayer is a registered insurance agent. Taxpayer helps
         members find and evaluate the insurance products that best fit their
         needs. For instance, Taxpayer helps the human resources departments
         of members’ affiliates evaluate and purchase life insurance, long term
         disability insurance and other insurance products. When members and
         their affiliates purchase insurance through Taxpayer, Taxpayer earns
         agency commissions.

        Other services. Taxpayer also provides a variety of other services (“other
         services”) to its members and their affiliates. These services are focused
         on enhancing clinical performance to improve the quality of care delivered
         to patients; improving business processes to reduce hospital costs,
         increase revenue and strengthen the competitive position of members;
         and education, knowledge and information sharing, and leadership
         training. Taxpayer facilitates these activities for members through

PLR-123391-11 3

         arranging forums for key employees, -------- (an active online learning
         management system) and database sharing among members.

    Taxpayer allocates patronage dividends by treating its activities as a single

allocation unit. Historically, Taxpayer’s group purchasing and insurance services have
been profitable, and its other services have broken even or operated at a modest loss.
Net earnings are shared by group purchasing and insurance services members and
their affiliates based upon patronage. Patronage is measured by each patron’s
contribution to the group purchasing and insurance services gross revenues for the
year.

  The b hospitals have a number of unique needs and interests. Historically, these

needs and interests have been served by Taxpayer and two other national
organizations.

        Association 1 nonprofit corporation which operates as a trade association
         for b hospitals. It is exempt from taxation under section 501(c)(6) of the
         Code. Association 1’s mission is to advocate for public policies that
         support the ability of b hospitals to fulfill their missions of clinical care,
         education, research and advocacy.

        Association 2 also is a nonprofit corporation. It operates as a charitable
         organization exempt from taxation under section 501(c)(3) of the Code.
         Association 2 provides a number of information and educational services
         to its members and also develops data for Association 1 to use in its
         advocacy efforts.

   There is considerable overlap in the membership of the three organizations.

Association 1 has ----- b hospitals as voting members, including all --- members of
Taxpayer. Association 2’s voting members are the same ----- hospitals that are the
voting members of Association 1 (including Taxpayer’s --- members). Association 2
also has --- non-voting members.

   The members and leadership of Taxpayer, Association 1 and Association 2 have

long felt that the three organizations could more effectively serve the needs of b
hospitals if their activities were more closely aligned. In early 2010, the Board of
Directors of Taxpayer and the Executive Committees of the Boards of Trustees of
Association 2 and Association 1 charged a joint Task Force to explore an alignment
between and among the organizations.

   On ---------------------------, the three organizations entered into a nonbinding

Memorandum of Understanding setting forth “the mutual intention of the Parties to work
together to restructure and consolidate the three organizations under a single parent
trade association for [b] health care providers…”
PLR-123391-11 4

  On ---------------------, Taxpayer, Association 1 and Association 2 entered into a

Consolidation Agreement (the “Consolidation Agreement”). The Consolidation
Agreement begins by reciting why the three organizations are taking steps to become
more closely aligned:

  “WHEREAS, on [---------------------------], the Parties signed a Memorandum
  of Understanding … signifying their intent to pursue an alignment of the
  three organizations that would restructure and consolidate the three
  organizations under a single parent trade association with aligned
  governance, consolidated operational leadership and a single nationwide
  advocacy voice for [b] health care providers (the ‘Alignment’);

  WHEREAS, the Parties are at pivotal moments in their respective
  histories, in which the national health care, economic and political
  environments are in a state of substantial change and the needs and
  responsibilities of [b] health care providers are being reshaped;

  WHEREAS, the members and owners of the Parties will require effective
  and coordinated representation in order to respond to these challenges
  and to continue to improve the quality and efficiency of the care they
  provide, while also continuously enhancing the health of all [b];

  WHEREAS, the executive leadership of the Parties is in transition, offering
  an opportunity for potential restructuring and alignment of the three
  organizations to better meet the challenges and needs of the future; and

  WHEREAS, the Parties have determined that the Alignment will better
  serve the needs of their members and owners and wish to create a new
  organization to advance their aims through the alignment of the Parties
  under a single fiduciary and executive leadership with streamlined
  operations.”

  The Consolidation Agreement then describes the purposes of the alignment.

Section 1.1 of the Consolidation Agreement provides:

  “1.1 Purposes: This Agreement is entered into in order to improve and
  enhance the ability of the members and owners of the Parties to achieve a
  number of important goals, including:

  1.1.1. Strengthening the prospects of advancing into the future ‘-------------
  --------’ as a single national b organization and advocate for all [b] health
  care providers.

  1.1.2. Rationalizing future information technology and related organizational
  investments that must be made to support continued advances in the quality,
  safety and costs of caring for b by sharing with greater economy the elements of

PLR-123391-11 5

  the fundamental infrastructure, data capture, processing, and support currently in
  use by the Parties.
  1.1.3. Sharing and cost rationalization of other selected services, including
  overall executive leadership structures, educational and meeting support,
  administrative support, performance improvement and quality transformation,
  and spending on outside assistance in order to improve the ability of the new
  organization to increase funding in critical areas such as public policy and
  advocacy.
  1.1.4. Aligning governance in order to maximize the most efficient use of
  member time and resources and more effectively define and implement
  consolidated programs on behalf of the sponsoring membership and avoid
  unnecessary duplication and redundancy.
  1.1.5. Promoting a more effective and coordinated development of services and
  activities that may be sponsored or purchased by subgroups within the combined
  membership.”

   Section 1.2 of the Consolidation Agreement provides a general overview of the

alignment transaction (the “Alignment Transaction”). The Consolidation Agreement
provides that Association 1 will become the “Parent Trade Association” and that
Association 2 and Taxpayer will become subsidiaries of Association 1. Association 1
will continue to operate as a section 501(c)(6) trade association, conducting its current
advocacy activities. Association 2 will continue to operate as a section 501(c)(3)
organization and will be responsible for the charitable activities of the three
organizations. Association 2’s activities will include its current information technology
and educational services. It is envisioned that Association 2 will eventually also assume
responsibility for the other services currently being provided to members by Taxpayer.
Taxpayer will continue to provide group purchasing and insurance services on a
cooperative basis.

   The Consolidation Agreement provides that the alignment will occur in two steps.

The first step in the alignment is alignment of governance of the three organizations.
This step, which took place on ------------------, focuses on aligning the Boards of the
three organizations and starting a search for a person to serve as the Chief Executive
Officer of all three organizations.

   As part of the alignment of governance, on ---------------------, the Taxpayer

members approved an amendment to the Bylaws of Taxpayer to reflect the alignment of
its Board of Directors with that of Association 1 and Association 2. In pertinent part,
Section 4.2 of the Bylaws was amended by adding:

  “As of [------------------], the directors shall consist of those persons elected
  at a meeting of the stockholders held on or about [---------------------], each
  to serve for either a one or two year term, as assigned to him or her at the
  time of election, provided that the effective date of such terms may occur

PLR-123391-11 6

   at a date other than [------------------] as determined in accordance with the
   resolution adopted by the stockholders at such meeting.”

     In accordance with this Bylaw, the Taxpayer members then elected new

directors. The members of Association 1 and Association 2 went through a similar
process. The same persons were elected to the Boards of each of the three
organizations. Each of the Boards now has thirteen members: the person serving as
President of Taxpayer, Association 1 and Association 2, seven representatives of --------
------------------ b hospitals, four representatives of institutions that are a b hospital within
a hospital or hospital system, and one representative of a specialty b hospital. Of these
directors, eight are representatives of institutions that are members of Taxpayer (the
representatives of the--------------------b hospitals and the representative of one of the b
hospitals within a hospital or hospital system).

    At the same meeting, the Taxpayer members also approved an Amended

Certificate of Incorporation and Amended and Restated Bylaws for Taxpayer which
become effective at a Final Closing to be held within thirty (30) days following this ruling.
As a result, the Amended Certificate of Incorporation and the Amended and Restated
Bylaws have not yet gone into effect.

   In addition, during --------- and ---------------, all members of Taxpayer entered into

a Stock Transfer Agreement with Taxpayer and Association 1 (the “Stock Transfer
Agreement”). As described in detail below, it is contemplated that the members of
Taxpayer will transfer their shares of Common Stock of Taxpayer to Association 1,
making Taxpayer a subsidiary of Association 1. Concurrent with such transfer of shares,
Association 1 will grant each member of Taxpayer a proxy entitling such member to
vote the transferred shares at stockholders’ meetings. The consummation of the stock
transfers contemplated in the Stock Transfer Agreements will occur at a Final Closing to
be held within thirty (30) days following this ruling, so the transfers have not yet
occurred.

    The second step in the alignment process will be the Final Closing, which will

occur after this ruling. See Section 1.3.2 of the Consolidation Agreement. At that time,
(i) the Amended Certificate of Incorporation will be filed with the Secretary of State A; (ii)
the Amended and Restated Bylaws will become effective; (iii) the transfers of the shares
of Common Stock pursuant to the Stock Transfer Agreements will occur; (iv) the initial
grant of voting proxies by Association 1 to the transferring Taxpayer members will take
place; and (v) Taxpayer will become a subsidiary of Association 1.

   The focus of this ruling is upon whether the Alignment Transaction will have any

effect on Taxpayer’s status as a nonexempt subchapter T cooperative. Taxpayer
believes it will not.

   Taxpayer currently operates at cost, its capital is subordinated, and it is

controlled by its members on a one-member, one-vote basis. In the event of
dissolution, its residual assets will be distributed on a patronage basis. None of these
PLR-123391-11 7

things will change as a result of the transfer by Taxpayer’s members of their shares of
Taxpayer Common Stock to Association 1 pursuant to the Alignment Transaction.

    The Alignment Transaction is driven by a desire to achieve aligned governance

among Taxpayer, Association 1 and Association 2 and to achieve improved efficiency
for their collective members, while at the same time preserving Taxpayer’s status as a
nonexempt subchapter T cooperative. Three key documents establish Taxpayer’s
continuing cooperative character after the Alignment Transaction – namely, Taxpayer’s
Amended Certificate of Incorporation (the “Certificate of Incorporation”), Taxpayer’s
Amended and Restated Bylaws (the “Bylaws”) and the Stock Transfer Agreement. The
pertinent portions of these documents are described below.

   Taxpayer’s Articles of Incorporation and Bylaws continue to provide that

Taxpayer “will be organized and operated on a cooperative basis for the benefit of the
members, associate members and their affiliates as patrons and not as stockholders.”
Articles of Incorporation, Article Fourth (J); Bylaws, Article II, Section 2.1.

     Historically, Taxpayer’s members have been --------------------b hospitals. All

current members will continue as Taxpayer members after the Alignment Transaction
(whether or not they remain members of Association 1). Certificate of Incorporation,
Article Fourth (J); Bylaws, Article II, Section 2.2(a). Other health care organizations
may become members of Taxpayer in the future. In order to be eligible to become a
new member of Taxpayer, an organization must be (i) a voting member of Association
1, (ii) committed to ------------ care, education and research, (iii) financially able to meet
its commitments to Taxpayer, and (iv) in good standing under, and in substantial
compliance with, applicable licensing and health laws. In addition, a prospective
member’s membership application must be approved by the Board of Directors of
Taxpayer. Bylaws, Article II, Section 2.2(b) and (c).

     Organizations interested in participating in Taxpayer’s group purchasing and

insurance services programs on a patronage basis that do not meet all of the
requirements for membership will continue to be eligible to become associate
(nonvoting) members. Bylaws, Article II, Section 2.3. Historically, Taxpayer has not
had any associate members, but this category has been preserved to maintain the
flexibility to be able to do business with institutions other than members on a patronage
basis should the occasion arise.

   Affiliates of members and associate members will continue to be eligible to do

business with Taxpayer on a patronage basis. For this purpose, “affiliate” means “an
entity which directly or indirectly, through one or more intermediaries, controls, is
controlled by, or is under common control with a member or an associate member.”
Bylaws, Article II, Section 2.2(c).

    Taxpayer may provide services to nonmembers on a nonpatronage basis, but

historically its business with nonmembers has been quite limited (i.e., less than -----
percent of its over-all business in recent years). For purposes of this ruling, Taxpayer
PLR-123391-11 8

represents that business on a patronage basis with or for members, associate members
and affiliates will constitute more than 50 percent of its overall business.

    Taxpayer continues to be required by its Certificate of Incorporation and Bylaws

to determine its net earnings from business done with or for members, associate
member and affiliates (its “patronage earnings”) and its net earnings from other sources
(its “nonpatronage earnings”) after the end of each year. Certificate of Incorporation,
Article Fourth (B)(i); Bylaws, Article VIII, Section 8.2(a). Taxpayer is then required to
allocate its patronage earnings among members, associate members and affiliates on a
patronage basis and to distribute and pay the amounts so allocated within eight and
one-half months of year end as patronage dividends in cash, property, written notices of
allocation (qualified or nonqualified) or some combination thereof. Certificate of
Incorporation, Article Fourth (B)(iii) and (iv); Bylaws, Article VIII, Section 8.2(c) and (d).

    Taxpayer continues to be authorized to retain nonpatronage earnings (after

payment of taxes) as unallocated reserves or surplus. Certificate of Incorporation,
Article Fourth (B)(ii); Bylaws Article VIII, Section 8.2(b). Amounts not retained (and not
used to pay taxes) are allocated among members, associate members and affiliates in
the same manner that patronage earnings are allocated. Certificate of Incorporation,
Article Fourth (B)(iii) and (iv); Bylaws, Article VIII, Section 8.2(c)and (d). While any
amounts of nonpatronage earnings added to reserves or surplus may be “unallocated,”
Taxpayer is required to apportion any unallocated reserves or surplus on the books on a
patronage basis each year (or to maintain the records to do so) “so that in the event of
distribution of amounts from such unallocated reserves or surplus, other than upon
dissolution, each past or present member, each associate member and each affiliate
may receive its pro rata share of such distribution.” Certificate of Incorporation, Article
Fourth (C); Bylaws, Article VIII, Section 8.3.

   Taxpayer’s Certificate of Incorporation authorizes it to issue two classes of

capital stock – Common Stock and Preferred Stock. Certificate of Incorporation, Article
Fourth. Currently, there are no shares of Preferred Stock issued and outstanding.

   The economic rights of holders of Common Stock and Preferred Stock are

limited. Neither class of shares is entitled to receive dividends. Certificate of
Incorporation, Article Fourth (A). Upon dissolution, the right of each class of stock to
share in assets is limited. Holders of shares of Common Stock are entitled to receive
an amount equal to what was paid for the shares and no more. Certificate of
Incorporation, Article Fourth (G). Holders of shares of Preferred Stock are entitled to
receive par value per share and no more. Certificate of Incorporation, Article Fourth
(G). In the event of dissolution, any residual assets are shared by members, associate
member and affiliates on a patronage basis. Certificate of Incorporation, Article
Fourth (G).

  The only class of stock with voting rights is the Common Stock, and each share

has one vote. Certificate of Incorporation, Article Fourth (E). Historically, only members
of Taxpayer have been permitted to own shares of Common Stock, and each member
PLR-123391-11 9

of Taxpayer was required to purchase five shares of Common Stock. Certificate of
Incorporation, Article Fourth (F). Thus, each member of Taxpayer had an equal number
of votes (i.e., five), and Taxpayer effectively operated on a one-member, one-vote
basis. This ruling refers to Taxpayer as operating on a “one-member, one-vote” basis
as a short-hand for the actual system where each member has an equal five votes.

    As part of the Alignment Transaction, all members of Taxpayer have entered into

Stock Transfer Agreements with Association 1 and Taxpayer. Upon issuance of this
ruling, the members will transfer their shares of Taxpayer Common Stock to Association
1, making Taxpayer a wholly-owned subsidiary of Association 1.

   Because of the way Taxpayer is structured and because of various provisions in

the Stock Transfer Agreement, the proposed share transfers should have no impact on
Taxpayer’s status as a nonexempt subchapter T cooperative.

    First, the Alignment Transaction will not change beneficial ownership of the

shares. The limited economic rights that accompany ownership of shares of Common
Stock in Taxpayer will remain with the members of Taxpayer, and thus members will
continue to be the beneficial owners of the Common Stock. Section 1 of the Stock
Transfer Agreement provides that a member agrees “to transfer legal title (and only
legal title)” to its five shares of Common Stock to Association 1. It goes on to provide
that:

  “All economic incidents of ownership of such Shares, as provided now and
  from time to time in Article Fourth of the Company’s Certificate of
  Incorporation and in Article VIII of the Company’s Bylaws and elsewhere
  in said Certificate of Incorporation or Bylaws shall remain in Member-
  Transferor for so long as Member-Transferor remains a member of
  Company. [Association 1] agrees to promptly pay over to Member-
  Transferor any amounts it may hereafter receive in any capacity with
  respect to the Shares.” (emphasis added).

   The economic rights of the shares of Common Stock will remain limited as

described above. The shares of Common Stock are not entitled to receive dividends.
Holders of shares of Common Stock are not under any circumstances entitled to receive
more than they originally paid for the shares ($5,000.00 per share). Moreover,
Association 1 has agreed “to promptly pay over to Member-Transferor any amounts it
may hereafter receive in any capacity with respect to the Shares,” thus preserving in the
Taxpayer members their right to their original investment in Taxpayer.

    Second, Association 1 will not have any patronage rights by reason of the

transfer of the shares. Association 1 will not become (and it will not be eligible to
become) a member, associate member or affiliate of Taxpayer by reason of the
transfers of shares of Common Stock from members to Association 1. Association 1
will not be a patron of Taxpayer.
PLR-123391-11 10

   The current members, associate members and affiliates will continue to be the

patrons of Taxpayer. As such, they (and not Association 1) will continue to be entitled
to share on a patronage basis in earnings, retained earnings and residual assets of
Taxpayer on dissolution. Section 4 of the Stock Transfer Agreement emphasizes that:

  “… no rights Member-Transferor enjoys by reason of its status as a
  member patron (or its historic status as a holder of shares of Common
  Stock/member) of the Company are being transferred or otherwise
  affected by virtue of the transfer of the Shares, including without limitation,
  Member-Transfer’s patronage rights.” (emphasis added).

   Third, the members of Taxpayer will continue to control Taxpayer on a one-

member, one-vote basis. As the record owner of the transferred shares of Common
Stock, Association 1 will have the legal right to vote the shares. However, Association 1
has committed in the Stock Transfer Agreement and elsewhere to give each member
(referred to in the Stock Transfer Agreement as “Member-Transferor”) a proxy to vote
the shares it transferred to Association 1:

  “As a condition of Member-Transferor’s transfer of the Shares,
  [Association 1] will grant to Member-Transferor immediately following the
  Closing Date, and periodically thereafter so long as Member-Transferor
  continues as a member of the Company in accordance with the
  Company’s Bylaws and such policies as the Company’s Board of
  Directors may from time to time approve, a proxy to vote the Shares on
  any matter submitted for a vote of the stockholders, including any matters
  on which a vote of the stockholders is required under the [State A -----------
  -----------------------], the Company’s Bylaws or the Company’s Certificate of
  Incorporation.” (emphasis added)

This grant of proxies ensures that Taxpayer will continue to be controlled by its member
patrons on a one-member, one-vote basis, just as it is today.

  This obligation to grant proxies contained in the Stock Transfer Agreement is

backstopped by a provision being added to the Bylaws of Association 1, which provides:

  “Section 11. Voting of Shares in [Taxpayer]. During 2011, the Association
  entered into a transaction with the [Taxpayer] and the [Association 2]
  designed to bring about greater alignment among the three organizations
  (the ‘Alignment Transaction’), pursuant to the terms of a consolidation
  agreement among the parties to the Alignment Transaction (the
  ‘Consolidation Agreement’). As part of the Alignment Transaction, certain
  holders of shares of the Common Stock of [Taxpayer] agreed, subject to
  the terms of a stock transfer agreement executed by each such holder,
  [Taxpayer] and the Association, to transfer legal title to their shares of
  Common Stock to the Association, intending such transfer to take effect in
  accordance with the Consolidation Agreement and in furtherance of the

PLR-123391-11 11

  objectives of the Alignment Transaction, but without relinquishing any of
  the economic incidents of ownership of such shares, as defined in Article
  Fourth of [Taxpayer]’s Amended and Restated Certificate of Incorporation,
  in Article VIII of [Taxpayer]’s Bylaws and in the stock transfer agreements
  (the ‘Stock Transfer Agreements’). For so long as the Association is a
  shareholder of [Taxpayer], the Association shall, in advance of each
  annual or special meeting of [Taxpayer] stockholders, grant to each
  member of [Taxpayer] that transferred shares to the Association in
  connection with the Alignment Transaction or thereafter, a proxy to vote
  the five shares of Common Stock transferred to the Association by such
  member, entitling the member to a corresponding number of votes at such
  meeting on any matter on which a vote of the stockholders is required
  under the [State A -----------------------------------], the Corporation’s Bylaws
  or the Corporation’s Certificate of Incorporation or on any other matter that
  may be submitted to the stockholders for a vote in accordance with the
  bylaws of [Taxpayer], and further entitling each such member to the right
  to approve, by the affirmative vote of a majority of such member, any
  amendment or repeal of this Section 11 prior to such amendment or
  repeal being presented for action in accordance with Article IX of these
  bylaws during the period in which the proxy held by such member is
  effective.” (emphasis added).

   Section 9 of the Stock Transfer Agreement provides for an automatic retransfer

of the shares to members upon the occurrence of a variety of events, including, among
other things, (i) the failure of Association 1 to grant a proxy to any member of Taxpayer
to vote the shares the member transferred to Association 1 pursuant to a Stock Transfer
Agreement, (ii) any actual or attempted vote of any of the shares by Association 1 itself
at any Taxpayer stockholder meeting other than in accordance with a proxy granted by
Association 1 pursuant to Section 3 of the Stock Transfer Agreement, (iii) any actual or
attempted transfer of the shares, or (iv) “[a]ny change to the Company’s Certificate of
Incorporation, Bylaws or other governing documents that effects a change to the
cooperative status of the Company pursuant to Section 1381(a)(2) of the code, or that
affects the patronage rights of members, associate members and their affiliates, unless
such change is duly adopted and approved” by the members.

   The provisions outlining the composition of Taxpayer’s Board of Directors after

the Alignment Transaction are contained in Section 4.2 of the Bylaws. While persons
that are not members (or representatives of members) will be eligible to serve on
Taxpayer’s Board of Directors, Taxpayer represents this arrangement is not unusual for
cooperative organizations. What is important is that Taxpayer’s members, and only
Taxpayer’s members, will remain the persons who will elect the members of Taxpayer’s
Board of Directors. In addition, members will continue to have the power to remove
Directors. Bylaws, Article IV, Section 4.4.

  One new provision in the Bylaws is the requirement that at least eight directors

approve certain specified actions, namely:
PLR-123391-11 12

  “(a) the approval of candidates to serve as Directors, including those
  proposed to fill vacancies; (b) the selection or removal of the President; (c)
  the election of the Chairman and the Vice Chairman; and (d) the approval
  of each annual budget and any capital budget; and (e) the issuance or
  incurrence of any significant debt.”

This provision was added to ensure that there be a consensus on important matters
among the various constituencies served by the aligned entities. It was added not only
to the Taxpayer Bylaws, but also to the organizational documents of Association 1 and
Association 2.

  Based on the foregoing, Taxpayer requests a ruling that after the Alignment

Transaction described above, Taxpayer will continue to be a corporation “operating on a
cooperative basis” within the meaning of section 1381(a)(2) of the Code.

   Section 1381(a)(2) of the Code provides that subchapter T shall apply to any

corporation operating on a cooperative basis with certain exceptions. Section 1.1381-
1(a) of the Income Tax Regulations states that subchapter T of the Code applies to any
corporation operating on a cooperative basis and allocating amounts to patrons on the
basis of business done with or for such patrons. However, section 1381(a)(2) excepts
from subchapter T an organization (A) which is exempt from tax under Chapter 1, (B)
which is subject to the provisions of part II of subchapter H (relating to mutual savings
banks, etc.), or subchapter L (relating to insurance companies), or (C), which is
engaged in furnishing electric energy, or providing telephone service, or persons in rural
areas.

  What it means to be operating on a cooperative basis within the mean of

subchapter T of the Code is not defined in the Code or the regulations. Rev. Rul. 93-21,
1993-1 C.B. 188, provides that the cooperative principles in Puget Sound Plywood, Inc.
v. Commissioner, 44 T.C. 305 (1965), acq. 1966-1 C.B. 3, provide the basis for
determining whether a corporation is operating on a cooperative basis for purposes of
subchapter T.

  In Puget Sound Plywood, the Tax Court described three principles as

fundamental to cooperative operation:

  “(1) Subordination of capital, both as regards control over the cooperative
  undertaking, and as regards the ownership of the pecuniary benefits
  arising therefrom; (2) democratic control by the worker-members
  themselves; and (3) the vesting in and the allocation among the worker-
  members of all fruits and increases arising from their cooperative
  endeavor (i.e., the excess of the operating revenues over the costs
  incurred in generating those revenues), in proportion to the worker-
  members' active participation in the cooperative endeavor.

PLR-123391-11 13

   Implementation of the first of these three principles, relating to the
   subordination of capital contributions in determining the right to the
   pecuniary benefits, is effected through the statutes under which the
   cooperatives are organized, and also by the charters and bylaws of the
   cooperatives themselves—all of which contain limitations upon the
   amounts that may be distributed to members in respect of the stock which
   represents the necessary capital that the members themselves supply.
   Indeed in the case of many cooperatives, distributions in respect of the
   worker-members' stock are forbidden entirely. Also, implementation of the
   subordination of capital as regards control over the management and
   direction of the cooperative, is achieved through bylaw provisions which
   vest in the members themselves the right and power to elect the trustees
   and the officers of the cooperative.

   Implementation of the second of the above principles, relating to
   democratic control, is effected by having the worker-members themselves
   periodically assemble in democratically conducted meetings at which each
   member has one vote and one vote only, and at which no proxy voting is
   permitted; and these workers there deal personally with all problems
   affecting the conduct of the cooperative.

   And finally, the third of the above-mentioned principles of cooperatives,
   relating to the proportionate vesting in and allocation among the worker-
   members of all fruits and increases from their cooperative endeavor, is
   achieved through statutes, bylaws, and contractual arrangements between
   the association and its members, whereby the elected officers of the
   association are required to make periodic allocations of the same among
   the members in proportion to their active participation as workers.”

    Taxpayer will continue to be a “corporation operating on a cooperative basis”

after the Alignment Transaction. Thus, it will continue to be a subchapter T cooperative
unless one of the exceptions listed in section 1381(a)(2) of the Code applies. Taxpayer
represents that it does not currently, and after the Alignment Transaction it will not, fall
in one of the exceptions listed in section 1381(a)(2) of the Code:

         Taxpayer is not and will not be exempt from tax under Chapter 1 of the
          Code.

         Taxpayer is not and will not be subject to the provisions of part II of
          subchapter H of the Code (relating to mutual savings banks, etc.). It is not
          involved in the banking business.

         Taxpayer is not and will not be engaged in furnishing electric energy, or
          providing telephone service, to persons in rural areas.

PLR-123391-11 14

         Taxpayer is not and will not be a corporation subject to the provisions of
          subchapter L of the Code (relating to insurance companies). While
          Taxpayer provides, among other things, insurance services to members
          and affiliates, it does not act as an insurance company assuming risks as
          an insurer or reinsurer. Taxpayer provides insurance advisory services
          and acts as an insurance agent, but neither of those activities makes it an
          insurance company subject to the provision of subchapter L. Taxpayer
          does not itself write insurance or annuity contracts or reinsure the risks
          underwritten by insurance companies.

     After the Alignment Transaction, Taxpayer will continue to be a corporation

“operating on a cooperative basis” within the meaning of section 1381(a)(2) of the Code.
Each of the Puget Sound Plywood principles and its application to Taxpayer is
considered in turn below. Taxpayer’s Certificate of Incorporation and Bylaws provide
that it “will be organized and operated on a cooperative basis for the benefit of the
members, associate members and their affiliates as patrons and not as stockholders.”

    The first characteristic of a cooperative identified in Puget Sound Plywood is

“subordination of capital.” Subordination of capital requires that control of the
cooperative and ownership of the pecuniary benefits arising from the cooperative’s
business remains in the hands of the member patrons of the cooperative rather than
with nonpatron equity investors in the cooperative. The purpose of this limitation is to
insure that the gains that accrue to the cooperative from the business that it transacts
with its patrons will largely or completely inure to the benefit of those patrons rather than
to its stockholders. To be operating on a cooperative basis, a cooperative must limit the
financial return with respect to its equity capital. Puget Sound Plywood, 44 T.C. at 308.
Stated differently, a cooperative may not be operated for the purpose of paying a return
on equity investments.

   Taxpayer has and will continue to have a single class of Common Stock. Shares

of Common Stock are not entitled to dividends and are limited on dissolution. After the
Alignment Transaction takes place, record ownership of all of the shares of Common
Stock will be in the hands of Association 1. However, Association 1 will be required to
give proxies to vote the shares to the members of Taxpayer, ensuring that the members
of Taxpayer, and not Association 1, will continue to control Taxpayer. Should
Association 1 fail for any reason to grant proxies, the shares will automatically be
transferred back to the members of Taxpayer who transferred shares to Association 1,
providing a firm backstop to the requirement that Association 1 grant proxies.

   Taxpayer is authorized to issue shares of Preferred Stock, but there are no

shares issued and outstanding. The Certificate of Incorporation and Bylaws provide
that any Preferred Stock that Taxpayer might issue in the future will not bear dividends
and will be nonvoting, and that upon dissolution, a holder of any shares of Preferred
Stock will be limited to receipt of par value, and no more. Thus, any Preferred Stock
that may be issued in the future will provide fixed and limited rights to share in earnings.
For this reason, and given the fact that the shares of Preferred Stock will not be entitled
PLR-123391-11 15

to vote, the tests for determining that “capital is subordinated” will be met. Thus, both
the Common Stock and Preferred Stock are subordinated to the interests of the
members, associate member and affiliates.

   The second characteristic of a cooperative identified in Puget Sound Plywood is

“democratic control by the worker-members.” Democratic control of the cooperative, as
envisioned in Puget Sound Plywood, is typically achieved by voting on a one-member,
one-vote basis. The only class of voting stock will be common stock, and each Member
will own one (and only one) share of common stock. Thus, voting will be on a one-
member one-vote basis. After the Alignment Transaction, Taxpayer will continue to be
democratically controlled by its members.

   While Association 1 will own all of the shares of Common Stock of Taxpayer, the

members of Taxpayer will retain beneficial ownership of the limited economic rights of
that stock. In addition, the Stock Transfer Agreements require Association 1 to grant to
each member of Taxpayer transferring shares of Common Stock a proxy to vote the
shares the member transfers. After granting such proxies, Association 1 will have no
remaining votes. As a consequence, at any meeting of the stockholders, the members
will have all of the votes, and, because each member will have transferred five shares of
Common Stock to Association 1, each member’s proxy will result in each member
voting on a one-member, one-vote basis.

  Article III, Section 3.8 and 3.10 of the Bylaws of Taxpayer expressly contemplate

and authorize this arrangement:

   “Section 3.8. Transfer of Legal Title to Shares of Common Stock to
   [Association 1] During 2011, certain holders of shares of the Common
   Stock of the Corporation agreed, subject to the terms of a stock transfer
   agreement executed by each such holder, the Corporation and
   [Association 1], to transfer legal title to their shares of Common Stock to
   [Association 1], intending such transfer to take effect in accordance with
   the Consolidation Agreement and in furtherance of the objectives of the
   Alignment Transaction … Legal title to any share of Common Stock of the
   Corporation issued to new members pursuant to Section 2.2(b) shall
   transfer automatically to [Association 1] subject to terms and conditions
   substantially similar to those of the Stock Transfer Agreements.”

   “Section 3.10. Proxies. It is expressly contemplated that [Association 1]
   shall at any time be entitled to a number of votes equal to the shares of
   Common Stock transferred to it in the manner described in Article III,
   Section 3.8, and that [Association 1] shall, in advance of each annual or
   special meeting of the stockholders, grant to each member of the
   Corporation that has transferred shares to [Association 1] a proxy to vote
   the five shares of Common Stock transferred to [Association 1] by such
   member entitling the member to a corresponding number of votes at that
   meeting on any matter on which a vote of the stockholders is required

PLR-123391-11 16

   under [State A -----------------------------------], the Corporation’s Bylaws or
   the Corporation’s Certificate of Incorporation or on any other matter that
   may be submitted to the stockholders for a vote, including without
   limitation the selection of the Corporation’s Board of Directors, any
   amendment or restatement of the Corporation’s Certificate of
   Incorporation or Bylaws, any sale of the Common Stock of the Corporation
   …, any merger or consolidation of the Corporation or any sale of all or
   substantially all of the Corporation’s assets.”

  In connection with the Alignment Transaction, Association 1 has amended its

Bylaws to require that proxies to vote the shares it will own in Taxpayer be granted to
the members of Taxpayer. Any change to that Bylaw requires approval of the Taxpayer
members entitled to receive proxies from Association 1.

  Further, if, for any reason, Association 1 fails to grant proxies to any or all of the

members who transferred shares to Association 1 or if Association 1 itself votes or
attempts to vote any of the shares of Common Stock at a Taxpayer meeting, all of the
shares of Common Stock will automatically be transferred back to the Taxpayer’s
members.

  These procedures will leave control of Taxpayer in the hands of its members,

thus ensuring that after the Alignment Transaction Taxpayer will continue to be
democratically controlled by its members.

   The Service has recognized that cooperatives may have proxy voting without

jeopardizing cooperative status. Rev. Rul. 75-97, 1975-1 C.B. 167, holds that an
exempt section 521 cooperative “will not be denied exemption solely by reason of …
proxy voting.” In Thwaites Terrace House Owners Corp. v. Commissioner, 72 T.C.M.
578 (1996), a housing cooperative was found to be “operating on a cooperative basis”
notwithstanding that it permitted proxy voting. In so holding, the Tax Court cited Rev.
Rul. 75-97.

   The proxy arrangements provided for in the Association 1 and Taxpayer

operative documents and in the Stock Transfer Agreements are designed to ensure that
the members of Taxpayer continue to remain in control of Taxpayer and that they
continue to vote on a one-member, one-vote basis. Thus, the democratic control
requirement will continue to be met.

    Rev. Rul. 93-21, 1993-1 CB 188, provides that a cooperative that operates on a

for-profit, nonpatronage basis with nonmembers will not be precluded from being
considered operating on a cooperative basis simply because it does less than
50 percent in value of its business with members on a patronage basis. Whether a
corporation is operating on a cooperative basis under section 1381(a)(2) of the Code
will be determined from all the facts and circumstances and the cooperative principles
enunciated in Puget Sound Plywood.
PLR-123391-11 17

   Taxpayer is authorized to provide services to nonmembers on a nonpatronage

basis. However, Taxpayer’s focus has historically been on business done with or for
members and their affiliates. Business with nonmembers on a nonpatronage basis has
been limited (less than ------percent of Taxpayer’s total business in recent years).
Taxpayer represents that after the Alignment Transaction over 50 percent of its
business will continue to be with members, associate members and affiliates and will be
conducted on a patronage basis.

   The third characteristic of a cooperative identified in Puget Sound Plywood is “the

vesting in and allocation among the members of all fruits and increases arising from
their cooperative endeavor.” Consistent with that objective, the Certificate of
Incorporation and Bylaws provide that members, associate members, and affiliates of
Taxpayer will share the “fruits and increases from their cooperative endeavor” in the
following manner:

         Each year Taxpayer will determine its net earnings or loss from business
          done with or for members, associate members and affiliates (its
          “patronage earnings”) and its net earnings or loss from other business (its
          “nonpatronage earnings”).

         Taxpayer will then allocate its patronage earnings among members,
          associate members and affiliates on a patronage basis, and it will
          distribute and pay the amounts so allocated within eight and one-half
          months after the end of the fiscal year as patronage dividends in cash,
          property and written notices of allocations (qualified or nonqualified), or
          any combination thereof, as the Board of Directors determines.

         Taxpayer will use any nonpatronage earnings to pay or provide for taxes.
          All or any portion of remaining nonpatronage earnings may, if the Board of
          Directors so determines, be allocated and distributed to members,
          associate members and affiliates in the same manner that patronage
          earnings are allocated. Amounts not so allocated and distributed will be
          added to unallocated reserves or surplus. While the amounts of
          nonpatronage earnings added to reserves or surplus may be
          “unallocated,” Taxpayer is required to apportion any unallocated reserves
          or surplus on the books on a patronage basis each year (or to maintain
          the records to do so) so that, if the amounts are later distributed, they will
          be shared on a patronage basis.

  These provisions are contained in Article Fourth of Taxpayer’s Certificate of

Incorporation and in Article VIII of Taxpayer’s Bylaws. In addition, Article Fourth (G) of
Taxpayer’s Certificate of Incorporation provides that upon dissolution any residual
assets will be shared by members, associate members and affiliates upon the basis of
the quantity or value of business done with Taxpayer as shown by the records of
Taxpayer. These provisions provide for a strict sharing of all earnings (not just
PLR-123391-11 18

patronage earnings) of Taxpayer on a cooperative basis, both currently and on
dissolution. Thus, Taxpayer will be operating at cost.

    In conclusion, after the Alignment Transaction, Taxpayer will continue to have all

of the characteristics necessary for an organization to be “operating on a cooperative
basis” as that term is used in section 1381(a)(2) of the Code. Taxpayer will operate at
cost, its capital stock will be subordinated to the patronage interests of its members,
associate members and affiliates, and it will be democratically controlled on a one-
member, one-vote basis by its members. In addition, it will continue to do over half of
its business with members, associate members, and affiliates on a patronage basis.

   Accordingly, we rule as requested that after the Alignment Transaction, Taxpayer

will continue to be a corporation “operating on a cooperative basis” within the meaning
of section 1381(a)(2) of the Code.

   This ruling is directed only to the taxpayer that requested it. Under section

6110(k)(3) of the Code it may not be used or cited as precedent. In accordance with a
power of attorney filed with the request, a copy of the ruling is being sent to your
authorized representative.

                                         Sincerely yours,



                                         Paul F. Handleman
                                         Chief, Branch 5
                                         Office of the Associate Chief Counsel
                                         (Passthroughs & Special Industries)

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