201835010: Denies section 521 exemption to a consumer-oriented local food co-op

Plain-English summary

A local food co-op sought exemption as a farmers' cooperative under section 521. Most of its members were consumers, and the organization connected them with producer members through an online marketplace rather than cooperatively marketing producers' goods or purchasing supplies and equipment for members. Its sellers offered items such as fish, chocolate, tea, and ice cream that were not shown to satisfy the statutory definition of farm products. Its governing documents allowed the board to retain surplus for unspecified purposes, and its income statement did not show cooperative profit distributions to members. The IRS denied exemption because the co-op did not meet the requirements for a section 521 farmers' cooperative, and the applicant did not protest, making the adverse determination final.

Ruling snapshot

• Question: Did the consumer-oriented local food co-op qualify for exemption as a farmers' cooperative under section 521?
• Outcome: Denied
• Key authorities: IRC §§ 464(e)(1), 521(b)(1), and 521(b)(3); Treas. Reg. § 1.521-1(a)(1), (a)(3), and (b); Rev. Rul. 64-246

Full text (IRS public release)

[Redaction note: the IRS release blanks the applicant's identity, employer identification number, contact information, required return, and tax years.]

Department of the Treasury
Internal Revenue Service
P.O. Box 2508
Cincinnati, OH 45201

Date:
June 5, 2018
Employer ID number:

Number: 201835010
Release Date: 8/31/2018 Contact person/ID number:

Contact telephone number:
Form you must file:

Tax years:

UIL: 521.00-00

Dear

This letter is our final determination that you don’t qualify for tax-exempt status under Section 521 of the
Internal Revenue Code (the Code). Recently, we sent you a proposed adverse determination in response to your
application. The proposed adverse determination explained the facts, law, and basis for our conclusion, and it
gave you 30 days to file a protest. Because we didn’t receive a protest within the required 30 days, the proposed
determination is now final.

You must file federal income tax returns for the tax years listed at the top of this letter using the required form
(also listed at the top of this letter) within 30 days of this letter unless you request an extension of time to file.

We’ll make this final adverse determination letter and the proposed adverse determination letter available for
public inspection (as required under Section 6110 of the Code) after deleting certain identifying information.
Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in the Notice
437 on how to notify us. If you agree with our deletions, you don’t need to take any further action.

If you have questions about this letter, you can contact the person listed at the top of this letter. If you have
questions about your federal income tax status and responsibilities, call our customer service number at
1-800-829-1040 (TTY 1-800-829-4933 for deaf or hard of hearing) or customer service for businesses at
1-800-829-4933.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:

Notice 437

Redacted Letter 4034, Proposed Adverse Determination
Redacted Letter 4040, Final Adverse Determination - No Protest

Department of the Treasury
Internal Revenue Service
Cincinnati, OH 45201
Date:

April 12, 2018
Employer ID number:

Contact person/ID number:
Contact telephone number:

Contact fax number:

Legend: UIL:
B = State 521.00-00
C = Date

d dollars = Amount
Dear

We considered your application for recognition of exemption from federal income tax under Section 521 of the
Internal Revenue Code (the Code). Based on the information provided, we determined that you don’t qualify for
exemption under Section 521. This letter explains the basis for our conclusion. Please keep it for your records.

Issues
Do you qualify for exemption under Section 521 of the Code? No, for the reasons stated below.

Facts
You were incorporated in the state of B on C. Your Articles of Incorporation state that you are formed for the
following purposes:

1. To create a cooperative, rooted in local food production, that strengthens the physical and financial well-
   being of the community
2. To provide local food producers and consumers a year-round market for buying and selling goods and
   services according to consumer cooperative and financially sound principles
3. To provide your members with any cooperative services or products
4. To inspire the extension of the cooperative model and the expansion of agricultural and food-based
   enterprise in your region
5. To empower the community to educate itself, and
6. To engage in all such activities as are incidental or conducive to attainment of your purposes.

Your Articles of Incorporation state that your membership shall include, “individuals, firms, partnerships,
limited liability companies, associations, corporations, federal, state or local governmental bodies or any
subdivision therefore, or any other person or legal entity that applies for the services and products furnished by
the corporation.”

Some of your members are producers, but you said that the majority of your members are consumers buying
from your member producers. You function like a food co-op. Your consumer members buy products from your
various producer members.

You do not purchase supplies or equipment for your members. You also do not market or sell products to non-
members. Customers must be members to make purchases. Your annual membership fee is d dollars.

You describe yourself as a local food hub where your members order products via an online market place and
pick up products at a specified location. Products are purchased directly from the producers based on the orders
placed on your website. Your website describes the goods your producers sell, which includes things such as
fruits, vegetables, fish, tea, honey, chocolate, and ice cream. Producers can bring excess produce, not listed on
the website, to the pick-up location for sale to either members or non-members. Sales made by your producer
members to non-members are minimal.

Your Articles of Incorporation and Bylaws allow for surplus funds to be held. Both documents state:

The corporation shall operate for the mutual benefit of its members as nearly as possible at cost,
provided that reasonable reserves, as determined by the Board of Directors, may be set aside and
accumulated for the purposes as the Board of Directors may determine are in the best interest of the
corporation. All activities of the corporation shall be consistent with applicable law and the public
interest. After all expenses and expenditures of the corporation have been paid and reasonable reserves,
as determined by the Board of Directors, set aside, the net earnings of the corporation shall be
accumulated in a surplus fund. The surplus fund, or any portion thereof, shall be distributed to members
as determined by the Board.

Your income statement includes sales which is offset by cost of goods sold. Your income statement does not
include distribution of profits to your members.

Law

Section 464(e)(1) of the Code defines the term “farming” as the cultivation of land or the raising or harvesting
of any agricultural or horticultural commodity including the raising, shearing, feeding, caring for, training, and
management of animals. For purposes of the preceding sentence, trees (other than trees bearing fruit or nuts)
shall not be treated as an agricultural or horticultural commodity.

Section 521(b)(1) of the Code states that the type of farmers’ cooperative exempt from taxation are farmers,
fruit growers, or like associations organized and operated on a cooperative basis (A) for the purpose of
marketing the products of members or other producers, and turning back the proceeds of sales, less the
necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them,
or (B) for the purpose of purchasing supplies and equipment for the use of members or other persons, and
turning over such supplies and equipment to them at actual cost, plus necessary expenses.

Section 521(b)(3) of the Code permits exempt cooperatives to accumulate certain reserves for two specified
purposes, without loss of exemption:

• To satisfy a state statutory duty, not mere legal privilege, to maintain a reserve, or

• For any necessary purpose.

Treasury Regulation Section 1.521-1(a)(1) states that a cooperative association engaged in the marketing of
farm products for farmers, fruit growers, livestock growers, dairymen, etc., and turning back to the producers
the proceeds of the sales of their products, less the necessary operating expenses, on the basis of either the
quantity or the value of the products furnished by them, is exempt from income tax.

Treas. Reg. Section 1.521-1(a)(3) provides in part that the accumulation and maintenance of a reserve required
by State statute, or the accumulation and maintenance of a reasonable reserve or surplus for any necessary
purpose, such as to provide for the erection of buildings and facilities required in business or for the purchase
and installation of machinery and equipment or to retire indebtedness incurred for such purposes, will not
destroy exemption.

Treas. Reg. Section 1.521-1(b) states that cooperative associations engaged in the purchasing of supplies and
equipment for farmers, fruit growers, livestock growers, dairymen, etc., and turning over such supplies and
equipment to them at actual cost, plus the necessary operating expenses, are exempt.

In Revenue Ruling 64-246, 1964-2 C.B. 154, an organization was engaged in the business of harvesting,
processing, buying, selling, storing, and otherwise handling fish and fish products for its members and other
patrons. Its membership was restricted to persons engaged in the production of agricultural commodities,
including fish of commercial value produced in privately-owned waters. The Service held that because the
association was engaged in cooperatively marketing fish in privately-owned waters, it was considered to be an
organization composed of producers of “farm-raised fish” which are, in other words, farm products. The Service
held that the organization was exempt under Section 521 as a farmers’ cooperative.

Application of law

You are not described in Section 521(b)(1) of the Code and Treas. Reg. Section 521-1(a)(1) because you are not
a cooperative of producers who are joining together to sell their produce at a fair price. You also do not
purchase supplies for your members. Instead, your membership is a mixture of farmers, community members,
businesses and anyone interested in selling and purchasing fresh food. The majority of your members are not
farmers or producers; rather, they are consumers.

Your website includes among your producers some that sell fish and other non-crops. Regarding the fish, you
did not indicate where the producers catch them. In Rev. Rul. 64-246, the Service emphasized that fish and fish
products must be harvested from privately owned waters to be considered “farm-raised fish” to be classified as
a farm product under Section 521 of the Code. Additionally, you have producers that sell other non-crops, such
as chocolate, tea and ice cream. Even if you would otherwise qualify under Section 521, it is unlikely that all of
these items would qualify as “farm” products as described in Section 464(e)(1).

Your Articles of Incorporation and Bylaws allow for surplus funds to be held. The surplus funds may be set
aside and accumulated for any purpose that your board determines is in your best interest. After all expenses
have been paid, the board may distribute either all or part of the surplus fund to your members. This surplus
fund held for unspecified purposes does not meet the requirements of Section 521(b)(3) of the Code and Treas.
Reg. 1.521-1(a)(3).

Additionally, you are not a farmers’ cooperative as described in Section 521(b)(1) of the Code and Treas. Reg.
Section 1.521-1(b) because you do not purchase supplies and equipment for your members.

Section 521 of the Code provides a way for farmers to either market or purchase items cooperatively, with the
profits being shared amongst the members. Your income statement does not include the distribution of profits to
your members. Also, a large portion of your members are consumers. You provide a way to connect farmers
and consumers, but your activities do not fall within the purview of Section 521 as a farmers’ cooperative.

Conclusion

Based on the information submitted, you do not qualify for exemption under Section 521 of the Code as a
farmers’ cooperative. You do not market your members’ products in a cooperative manner and you do not
cooperatively purchase supplies or equipment for your members. Your members are largely consumers, and not
farmers or the like. Your producer members sell non-crop items and you allow surplus funds to be held. You
also do not distribute profits to your members cooperatively. Therefore, you are not a farmers’ cooperative as
described in Section 521.

If you don’t agree
You have a right to file a protest if you don’t agree with our proposed adverse determination. To do so, you
must send a statement to us within 30 days of the date of this letter. The statement must include:

• Your name, address, employer identification number (EIN), and a daytime phone
  number

• A copy of this letter highlighting the findings you disagree with

• An explanation of why you disagree, including any supporting documents

• The law or authority, if any, you are relying on

• The signature of an officer, director, trustee, or other official who is authorized to sign for the
  organization, or your authorized representative

• One of the following declarations:

For an officer, director, trustee, or other official who is authorized to sign for the organization:
Under penalties of perjury, I declare that I examined this protest statement, including

accompanying documents, and to the best of my knowledge and belief, the statement contains all
relevant facts and such facts are true, correct, and complete.

For authorized representatives:

Under penalties of perjury, I declare that I prepared this protest statement, including

accompanying documents, and to the best of my knowledge and belief, the statement contains all
relevant facts and such facts are true, correct, and complete.

Your representative (attorney, certified public accountant, or other individual enrolled to practice before the
IRS) must file a Form 2848, Power of Attorney and Declaration of Representative, with us if he or she hasn’t
already done so. You can find more information about representation in Publication 947, Practice Before the
IRS and Power of Attorney.

We'll review your protest statement and decide if you provided a basis for us to reconsider our determination. If
so, we'll continue to process your case considering the information you provided. If you haven't provided a
basis for reconsideration, we’ll forward your case to the Office of Appeals and notify you. You can find more
information about the role of the Appeals Office in Publication 892, How to Appeal an IRS Decision on Tax-
Exempt Status.

If you don’t file a protest within 30 days, you can’t seek a declaratory judgment in court at a later date because
the law requires that you use the IRS administrative process first (Section 7428(b)(2) of the Code).

Where to send your protest
Please send your protest statement, Form 2848, if needed, and any supporting documents to the applicable

address:
U.S. mail: Street address for delivery service:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008
P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

You can also fax your statement and supporting documents to the fax number listed at the top of this letter. If
you fax your statement, please contact the person listed at the top of this letter to confirm that he or she received
it.

If you agree

If you agree with our proposed adverse determination, you don’t need to do anything. If we don’t hear from you
within 30 days, we’ll issue a final adverse determination letter. That letter will provide information on your
income tax filing requirements.

You can find all forms and publications mentioned in this letter on our website at www.irs.gov/formspubs. If
you have questions, you can contact the person listed at the top of this letter.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosure:
Publication 892