Did paying cash dividends on capital stock prevent a qualifying farmers' cooperative from deducting its cooperative-business income under former section 24404?

Plain-English summary

California Legal Ruling 292 held that a qualifying farmers' cooperative did not lose its former section 24404 deduction merely because it paid some income to members as cash dividends on capital stock.

The cooperative marketed members' and nonmembers' fruit, returned marketing proceeds on a patronage basis, and furnished farm supplies and equipment at cost. It retained no profits or surplus funds.

Because all income arose from business with members or from nonprofit business with nonmembers, the ruling treated the entire amount as deductible. Whether part of that income was distributed as a stock dividend rather than a patronage dividend was immaterial.

Facts addressed by the ruling

The taxpayer was a capital-stock corporation organized and operated as a farmers' cooperative.

Its activities were:

• marketing fresh fruit produced by members and nonmember producers; and
• buying and furnishing farm supplies and equipment to them at cost.

After expenses, including depreciation, the cooperative allocated and paid its operating income to members and nonmembers. It retained no profits or surplus.

Distributions took two forms:

• patronage dividends based on business done with the cooperative; and
• cash dividends of no more than 8% of the par value of members' capital stock.

Some members received a stock dividend but no patronage dividend because they apparently had no patronage during the period.

FTB had issued proposed assessments disallowing deductions for stock dividends in the income years ending February 28, 1958, 1959, and 1960.

How former section 24404 applied

The ruling described two qualifying cooperative purposes under former section 24404:

1. marketing products for members or other producers and returning proceeds after expenses on a patronage basis; or
2. purchasing supplies and equipment for members or others at cost plus necessary expenses.

This cooperative satisfied both. Its supplies were furnished at cost, and its net marketing proceeds were returned on a patronage basis.

The historical deduction covered income from business with members and income from business conducted with nonmembers on a nonprofit basis.

Why the stock dividend did not reduce the deduction

The cash stock dividend reduced what remained available for patronage dividends, but the ruling said that did not eliminate or reduce the cooperative's deduction.

The measure was the cooperative's qualifying business activity, not the form in which the resulting income was distributed. All income came from member business or nonprofit nonmember business, so the entire amount was deductible.

FTB concluded that the proposed assessments for all three years should be withdrawn.

Additional reason for the 1960 year

The ruling identified a separate statutory reason for withdrawing the assessment for the income year ending February 28, 1960.

A second paragraph added to section 24404 in 1959, effective for income years beginning after December 31, 1958, specified that income from business activities with members included amounts allocated to members during the income year whether or not derived from patronage.

What this means for you

Farmers' cooperatives

Under the historical ruling, a capital-stock dividend did not by itself destroy the special cooperative deduction. The cooperative still had to satisfy the statute through how it operated and dealt with members and nonmembers.

Cooperative members

The ruling distinguished distributions based on patronage from cash dividends based on shares owned, but held that the distinction did not change the cooperative's deduction on these facts.

Accountants and tax professionals

Review the cooperative's governing documents, member and nonmember transactions, pricing, patronage allocations, retained earnings, distribution methods, and the statute applicable to the tax year. Do not apply the 1965 provision without checking current law.

Common questions

Q: Were capital-stock dividends deductible by themselves?

A: The ruling framed the deduction more broadly. Because all of the cooperative's income arose from qualifying member business or nonprofit nonmember business, the entire amount was deductible, and paying part as a stock dividend was immaterial.

Q: Did the cooperative earn profits from nonmembers?

A: No. The ruling states that no profits were derived from business with nonmembers.

Q: Did every member receive both kinds of dividend?

A: No. Some members received a cash stock dividend but apparently lacked enough patronage to receive a patronage dividend.

Q: What happened to the proposed assessments?

A: FTB concluded that the assessments for the 1958, 1959, and 1960 income years should be withdrawn.

Q: Was there an additional rule for the 1960 year?

A: Yes. A 1959 amendment specifically included member allocations whether or not derived from patronage for income years beginning after December 31, 1958.

Citations and references

• Former Cal. Rev. & Tax. Code § 24404
• Appeal of Certified Grocers of California, Ltd. (Cal. St. Bd. of Equal., 1962)

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 292

Original ruling text

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Legal Ruling 1965-292

California Franchise Tax Board
Legal Ruling No. 292

April 23, 1965

Franchise-Cooperative: Deductibility of Dividends Paid on Its Capital Stock

Dividends paid by a cooperative on its capital stock are deduction under Section 24404, Revenue and Taxation Code.

The taxpayer is a capital stock corporation which was organized and is operated as a farmers' cooperative. Its purposes and functions are to market fresh fruit produced by its members and nonmember producers, and to purchase and furnish farm supplies and equipment to them at cost.

The income realized from its operations is allocated and paid to members and nonmembers after deducting all expenses, including depreciation on the cooperative's facilities. No profits or surplus funds are retained by the cooperative.

The income is distributed as (1) a patronage dividend to members and nonmembers based upon patronage and (2) as a cash dividend not exceeding 8 percent of the par value of the capital stock owned by members. During the years in question some members were paid a cash dividend on their stock but not a patronage dividend apparently for lack of patronage.

Notices of proposed assessment were issued disallowing the deduction claimed by the cooperative for dividends on capital stock paid to members for the income years ending February 28, 1958, 1959 and 1960. A question has been raised as to whether the deduction was properly disallowed.

Are the dividends paid by the cooperative on its capital stock deductible under Section 24404?

Farmers' cooperatives, such as the taxpayer, are granted a special deduction under Section 24404. In order to be eligible for this deduction the section requires that the cooperative be organized and operated on a cooperative basis for the purpose of:

(a) Marketing the products of members or other producers returning to them the proceeds after expenses on a patronage basis, or

(b) Purchasing supplies and equipment for members or other persons at cost plus necessary expenses.

If either or both of these requirements are met, the cooperative in computing its taxable income is allowed a deduction for ". . . all income resulting from or arising out of such business activities for or with their members carried on by them or their agents; or when done on a nonprofit basis for or with nonmembers."

The taxpayer in this case meets these requirements. Farm supplies are sold to members and nonmembers at cost and net proceeds from marketing are returned to members and nonmembers on a patronage basis. Since no profits were derived from the business activities carried on with nonmembers the income derived therefrom is deductible.

While the cash dividend, authorized by the bylaws and paid to members according to the number of shares owned, reduces the amount available for the patronage dividend, it will not deprive the cooperative of the deduction either in part or in whole. The deduction is measured by all business activities (income) with members and with nonmembers on a nonprofit basis. Since all of the taxpayer’s income arose from business with its members and nonmembers on a nonprofit basis, the entire amount is deductible. The fact that part was paid as a dividend on capital stock is immaterial. Appeal of Certified Grocers of California, Ltd., Board of Equalization, 1962, (interest paid on members' deposits). Accordingly, the assessments for all of the years in question should be withdrawn.

There is an additional reason for withdrawing the assessment for the income year ending February 28, 1960. In 1959 the second paragraph to Section 24404, applicable to income years beginning after December 31, 1958, was added. That paragraph specifically provides that "all income resulting from or arising out of such business activities for or with their members" includes all amounts, whether or not derived from patronage allocated to members during the income year.

Last updated: 09/24/2025