Is an agricultural cooperative that breeds cattle and sells semen, whose earnings benefit its members, subject to New York's unrelated business income tax?

Plain-English summary

Select Sires, Inc. is an agricultural cooperative that artificially breeds its members' cattle and sells semen and supplies. It asked whether it is subject to New York's unrelated business income tax under Article 13 (section 290).

No -- because it is not a tax-exempt organization in the first place. New York's unrelated-business-income tax reaches only the organizations described in IRC sections 511(a)(2) and 511(b)(2) -- which, by definition, are organizations exempt from federal income tax under section 501(a). The unrelated-business-income tax is a tax on the business income of otherwise tax-exempt entities; if an entity is not exempt, the tax does not apply to it at all.

Select Sires does not qualify as an exempt agricultural organization under section 501(c)(5): a 501(c)(5) organization must have no net earnings inuring to members, and its benefits must not be limited to those who buy its services. Here, all of Select Sires' net earnings and efforts inure to its members, and its breeding-and-semen activities directly benefit only the individual farmers who buy them (citing IRS authority that such breeding services are not exempt activities). Because Select Sires is not a section 501(c)(5) exempt organization, it is not described in section 511(a)(2) or 511(b)(2) and is therefore not subject to New York's unrelated business income tax. (It also cannot get Subchapter T cooperative treatment if it were exempt -- but it is not exempt; it is simply a regular taxable corporation.)

What this means for you

The unrelated-business-income tax presupposes tax-exempt status

Article 13 only taxes the unrelated business income of organizations that are exempt under section 501(a). A non-exempt entity is outside the tax entirely.

Earnings inuring to members defeats 501(c)(5) exemption

An agricultural cooperative whose net earnings inure to its members, and whose benefits run only to the members who buy its services, is not an exempt 501(c)(5) organization.

Not exempt means taxed as an ordinary corporation

Failing the exemption does not free the cooperative from tax -- it just means it is taxed as a regular corporation rather than under the unrelated-business-income regime.

Common questions

Q: My agricultural cooperative isn't tax-exempt. Do I owe the unrelated business income tax? A: No. That tax applies only to organizations that are tax-exempt under section 501(a); a non-exempt cooperative is outside it.

Q: Why doesn't my co-op qualify as a 501(c)(5) agricultural organization? A: Because its net earnings inure to its members and its benefits run only to the members who buy its services, which disqualifies it under 501(c)(5).

Q: So are we tax-free?
A: No. Not being exempt means you are taxed as a regular corporation, just not under the unrelated business income tax.

Citations and references

Statutes, regulations, and authorities:

• Tax Law section 290 (New York tax on unrelated business income, Article 13)
• IRC section 511(a)(2) and 511(b)(2) (organizations subject to the unrelated business income tax)
• IRC section 501(a) and 501(c)(5) (tax-exempt labor, agricultural, or horticultural organizations)
• IRC section 1381 (Subchapter T cooperative tax treatment does not apply to tax-exempt corporations)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1994.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a94_4c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-94 (4) C
Corporation Tax
February 18, 1994

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C930921B

On September 21, 1993, a Petition for Advisory Opinion was received from Select Sires, Inc., 11740 U.S. 42, P.O. Box 143, Plain City, Ohio 43064. The issue raised by Petitioner, Select Sires, Inc., is whether it is subject to unrelated business income tax under Article 13 of the Tax Law for the years ended December 31, 1987 through December 31, 1989. Petitioner is an Ohio corporation subject to tax as a cooperative under Subchapter T (sections 1381-1388) of the Internal Revenue Code (hereinafter "IRC"). Petitioner is taxed under section 185 of Article 9 of the New York State Tax Law Membership in the cooperative is limited to cooperative associations, their affiliates, subsidiaries or divisions engaged in the business of artificial insemination of livestock. Petitioner's amended Articles of Incorporation states that "[t]he purpose or purposes for which [Petitioner] is formed are to engage on a non-profit cooperative basis for the mutual benefit of its member common shareholders as producers of agricultural products and any activity in connection with the conducting of a general breeding business ..." (Emphasis added.) Its amended Code of Regulations similarly provides that "[t]he corporation shall be an agricultural cooperative corporation, operated without profit for the mutual benefit of its member patrons." (Emphasis added.) Consistent with that purpose, Petitioner provides bull semen and artificial insemination services to its members. Petitioner also sells such inventory and services to nonmembers. Petitioner sells its inventory and services internationally. In the United States, sales are made primarily through 12 member cooperatives. Sales in the northeast United States, including those in New York State, are made by company salespersons. As provided in Petitioner's amended Articles of Incorporation and amended Code of Regulations, all net savings or margins not necessary for reasonable reserves are used to pay dividends on its common stock or credited as patronage refunds. During 1987, Petitioner paid
$1,338,124 in patronage refunds to its members; during 1988, it paid patronage refunds of
$1,023,448; and during 1989, it paid patronage refunds of $642,895. The New York State tax on unrelated business income is imposed pursuant to section 290 of Article 13 of the Tax Law which states, in pertinent part: For every taxable year or part thereof, every organization described in paragraph two of subsection (a) of section five hundred eleven of the internal revenue code of nineteen hundred fifty-four and every trust described in paragraph two of subsection (b) of section five hundred eleven of such code carrying on an unrelated trade or business in New York shall pay a tax at the rate of nine per centum on its unrelated TP-9 (9/88)

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TSB-A-94 (4) C
Corporation Tax
February 18, 1994

business taxable income for such year, or on the portion thereof allocated to this state, as provided in section two hundred ninety-three, or two hundred fifty dollars, whichever is greater. Corporations described by section 511(a)(2) of the IRC are those that are exempt from Federal income taxation by reason of section 501(a) of the IRC, which defines exempt organizations by reference to several sections, including section 501(c) of the IRC. Section 501(c)(5) of the IRC provides tax exempt treatment to certain labor, agricultural or horticultural organizations. Section 1.501(c)(5)-1 of the Treasury Regulations clarifies that the only organizations exempted by section 501(c)(5) are those which: (1) have no net earnings inuring to the benefit of any member, and (2) have as their objects the betterment of the conditions of those engaged in such pursuits, the improvement of the grade of their products, and the development of a higher degree of efficiency in their respective occupations. An organization must satisfy all conditions to qualify for tax exempt status. In Internal Revenue Ruling 74-195 (Rev Rul 74-195, 1974-1 CB 135), the Internal Revenue Service ruled that a nonprofit organization formed to manage, graze and sell its members' cattle, with net earnings being remitted to organization members, was principally providing a direct business service for its members' economic benefit and the organization did not qualify as an exempt organization under section 501(c)(5) of the IRC. In Rev Rul 66-105, 1966-1 CB 145, the Internal Revenue Service held that an agricultural organization formed with the principal purpose of marketing its members' livestock, and secondary purpose of developing a livestock improvement program, was not exempt from tax under section 501(c)(5) of the IRC. Also, in Rev Rul 70-372, 1970-2 CB 118 the Internal Revenue Service held that an agricultural organization formed to process dairy farmers' production data for comparison with state standards was not exempt from tax under section 501(c)(5) of the IRC because the program was intended to benefit individual farmers. In Internal Revenue Service General Counsel Memorandum 36513 (December 12, 1975), it was held that an organization formed with the stated purpose of improving the livestock industry by acquiring superior herd sires to be used for artificial breeding purposes was not a section 501(c)(5) of the IRC tax exempt organization. "The question is whether providing breeding services and selling semen and supplies are exempt activities within the scope of Code section 501(c)(5) ... [the taxpayer's] activities of artificially breeding farmers' cows for a fee and selling semen and supplies to farmers may ultimately improve, and arguably have improved, the livestock industry ... [however, to qualify for the section 501(c)(5) exemption] direct benefits of the activity must not be limited to those buying the supporting services ... because these activities of [the taxpayer] directly benefit only individual dairy farmers rather than dairy farmers generally ... the activities of artificially breeding farmers' cows for a fee and selling semen and supplies to farmers do not serve an exempt purpose under Code section 501(c)(5)."

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TSB-A-94 (4) C
Corporation Tax
February 18, 1994

Since all of Petitioner's net earnings and efforts inure to the benefit of its members, it does not meet the conditions for tax exemption under section 501(c)(5) of the IRC. Further, Petitioner states that it is an organization taxable as a cooperative under Subchapter T of the IRC. Section 1381 of such Subchapter provides that the cooperative tax treatment does not apply to any corporation operating on a cooperative basis that is exempt from tax under Chapter 1 of the IRC. Accordingly, Petitioner is not an organization described in section 511(a)(2) or 511(b)(2) of the IRC and, therefore, is not subject to the tax on unrelated business income under Article 13 of the Tax Law.

DATED: February 18, 1994

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.