[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.521-1]

[Page 217-220]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.521-1  Farmers' cooperative marketing and purchasing associations; 
requirements for exemption under section 521.

    (a)(1) Cooperative associations 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, are exempt 
from income tax except as otherwise provided in section 522, or part I, 
subchapter T chapter 1 of the Code, and the regulations thereunder. For 
instance, cooperative dairy companies which are engaged in collecting 
milk and disposing of it or the products thereof and distributing the

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proceeds, less necessary operating expenses, among the producers upon 
the basis of either the quantity or the value of milk or of butterfat in 
the milk furnished by such producers, are exempt from the tax. If the 
proceeds of the business are distributed in anyother way than on such a 
proportionate basis, the association does not meet the requirements of 
the Code and is not exempt. In other words, nonmember patrons must be 
treated the same as members insofar as the distribution of patronage 
dividends is concerned. Thus, if products are marketed for nonmember 
producers, the proceeds of the sale, less necessary operating expenses, 
must be returned to the patrons from the sale of whose goods such 
proceeds result, whether or not such patrons are members of the 
association. In order to show its cooperative nature and to establish 
compliance with the requirement of the Code that the proceeds of sales, 
less necessary expenses, be turned back to all producers on the basis of 
either the quantity or the value of the products furnished by them, it 
is necessary for such an association to keep permanent records of the 
business done both with members and nonmembers. The Code does not 
require, however, that the association keep ledger accounts with each 
producer selling through the association. Any permanent records which 
show that the association was operating during the taxable year on a 
cooperative basis in the distribution of patronage dividends to all 
producers will suffice. While under the Code patronage dividends must be 
paid to all producers on the same basis, this requirement is complied 
with if an association instead of paying patronage dividends to 
nonmember producers incash, keeps permanent records from which the 
proportionate shares of the patronage dividends due to nonmember 
producers can be determined, and such shares are made applicable toward 
the purchase price of a share of stock or of a membership in the 
association. See, however, paragraph (c)(1) of Sec. 1.1388-1 for the 
meaning of payment in money for purposes of qualifying a written notice 
of allocation.
    (2) An association which has capital stock will not for such reason 
be denied exemption (i) if the dividend rate of such stock is fixed at 
not to exceed the legal rate of interest in the State of incorporation 
or 8 percent per annum, whichever is greater, on the value of the 
consideration for which the stock was issued, and (ii) if substantially 
all of such stock (with the exception noted below) is owned by producers 
who market their products or purchase their supplies and equipment 
through the association. Any ownership of stock by others than such 
actual producers must be satisfactorily explained in the association's 
application for exemption. The association will be required to show that 
the ownership of its capital stock has been restrictedas far as possible 
to such actual producers. If by statutory requirement all officers of an 
association must be shareholders, the ownership of a share of stock by a 
nonproducer to qualify him as an officer will not destroy the 
association's exemption. Likewise, if a shareholder for any reason 
ceases to be a producer and the association is unable, because of a 
constitutional restriction or prohibition or other reason beyond the 
control of the association, to purchase or retire the stock of such 
nonproducer, the fact that under such circumstances a small amount of 
the outstanding capital stock is owned by shareholders who are no longer 
producers will not destroy the exemption. The restriction placed on the 
ownership of capital stock of an exempt cooperative association shall 
not apply to nonvoting preferred stock, provided the owners of such 
stock are not entitled or permitted to participate, directly or 
indirectly, in the profits of the association, upon dissolution or 
otherwise, beyond the fixed dividends.
    (3) 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 the exemption. An 
association will not be denied exemption because it markets the products 
of nonmembers, provided the

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value of the products marketed for nonmembers does not exceed the value 
of the products marketed for members. Anyone who shares in the profits 
of a farmers' cooperative marketing association, and is entitled to 
participate in the management of the association, must be regarded as a 
member of such association within the meaning of section 521.
    (b) 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. The term 
supplies and equipment as used in section 521 includes groceries and all 
other goods and merchandise used by farmers in the operation and 
maintenance of a farm or farmer's household. The provisions of paragraph 
(a) of this section relating to a reserve or surplus and to capital 
stock shall apply to associations coming under this paragraph. An 
association which purchases supplies and equipment for nonmembers will 
not for such reason be denied exemption, provided the value of the 
purchases for nonmembers does not exceed the value of the supplies and 
equipment purchased for members, and provided the value of the purchases 
made for nonmembers who are not producers does not exceed 15 percent of 
the value of all its purchases.
    (c) In order to be exempt under either paragraph (a) or (b) of this 
section an association must establish that it has no taxable income for 
its own account other than that reflected in a reserve or surplus 
authorized in paragraph (a) of this section. An association engaged both 
in marketing farm products and in purchasing supplies and equipment is 
exempt if as to each of its functions it meets the requirements of the 
Code. Business done for the United States or any of its agencies shall 
be disregarded in determining the right to exemption under section 521 
and this section. An association to be entitled to exemption must not 
only be organized but actually operated in the manner and for the 
purposes specified in section 521.
    (d) Cooperative organizations engaged in occupations dissimilar from 
those of farmers, fruit growers, and the like, are not exempt.
    (e) An organization is not exempt from taxation under this section 
merely because it claims that it complies with the requirements 
prescribed therein. In order to establish its exemption every 
organization claiming exemption under section 521 is required to file a 
Form 1028. The Form 1028, executed in accordance with the instructions 
on the form or issued therewith, should be filed with the district 
director for the internal revenue district in which is located the 
principal place of business or principal office of the organization. 
However, an organization which has been granted exemption under the 
provisions of the Internal Revenue Code of 1939 or prior law may rely on 
that ruling, unless affected by substantive changes in the Internal 
RevenueCode of 1954 or any changes in the character, purposes, or 
methods of operation of the organization, and it is not necessary in 
such case for the organization to request a new determination as to its 
exempt status.
    (f) A cooperative association will not be denied exemption merely 
because it makes payments solely in nonqualified written notices of 
allocation to those patrons who do not consent as provided in section 
1388 and Sec. 1.1388-1, but makes payments of 20 percent in cash and 
the remainder in qualified written notices of allocation to those 
patrons who do so consent. Nor will such an association be denied 
exemption merely because, in the case of patrons who have so consented, 
payments of less than $5 are made solely in nonqualified written notices 
of allocation while payments of $5 or more are made in the form of 20 
percent in cash and the remainder in qualified written notices of 
allocation. In addition, a cooperative association will not be denied 
exemption if it pays a smaller amount of interest or dividends on 
nonqualified written notices of allocation held by persons who have not 
consented as provided in section 1388 and Sec. 1.1388-1 (or on per-unit 
retain certificates issued to patrons who are not qualifying patrons 
with respect thereto within the meaning of Sec. 1.61-5(d)(2)) than it 
pays on qualified written notices of allocation held by persons who have 
so consented (or on per-

[[Page 220]]

unit retain certificates issued to patrons who are qualifying patrons 
with respect thereto) provided that the amount of the interest or 
dividend reduction isreasonable in relation to the fact that the 
association receives no tax benefit with respect to such nonqualified 
written notices of allocation (or such certificates issued to 
nonqualifying patrons) until redeemed. However, such an association will 
be denied exemption if it otherwise treats patrons who have not 
consented (or are not qualifying patrons) differently from patrons who 
have consented (or are qualifying patrons), either with regard to the 
original payment or allocation or with regard to the redemption of 
written notices of allocation or per-unit retain certificates. For 
example, if such an association pays patronage dividends in the form of 
written notices of allocation accompanied by qualified checks, and 
provides that any patron who does not cash his check within a specified 
time will forfeit the portion of the patronage dividend represented by 
such check, then the cooperative association will be denied exemption 
under this section as it does not treat all patrons alike.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6643, 28 FR 
3162, Apr. 2, 1963; T.D. 6855, 30 FR 13135, Oct. 15, 1965]