Doing Business as a Cooperative A Legal Perspective

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Doing Business as a Cooperative A Legal
Perspective

• Indiana Cooperative Development CenterSummit
  Presentation
• November 10, 2009
• Jeremy L. Fetty

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Considerations in Choosing Cooperative Structure

• Statutory Considerations
• What corporate forms are available under state
  law that can be operated as cooperatives?
• Tax Considerations
• In order to enjoy available tax benefits, the
  organization must operate under the three
  fundamental principals of cooperative operation.

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Statutory Considerations

• Under Indiana law, to be a cooperative an
  organization must be organized under
• one of the states Cooperative Acts or
• be formed as a mutual benefit corporation under
  the Nonprofit Corporation Act.

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Cooperative Statutes

• Agricultural Cooperatives Ind.Code 15-12-1
  (1925, recodified 2008)
• Rural Electric Membership Corporations Ind.Code
  8-1-13 (1935)
• Rural Telephone Cooperatives Ind.Code 8-1-17
  (1951)
• Farm Mutual Insurance Companies Ind.Code 27-5.1
• Mutual Savings Banks Ind.Code 28-6.1

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Nonprofit Corporation Act Mutual Benefit
Corporation

• Under Indiana law (Ind. Code 23-17), a
• cooperative can be formed as mutual
• benefit corporation under the Nonprofit
• Corporation Act, and can engage in any
• lawful activity, including those subject
• to regulation under other Indiana
• statutes.

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Nonprofit Corporation Act Mutual Benefit
Corporation

• More flexibility than other cooperative statutes
  in that
• Membership is not as limited
• Flexibility in type of business operated as
  cooperative (marketing, purchasing, service)
• Flexibility to form cooperative in manner which
  is tax favorable (through articles bylaws)

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Nonprofit Corporation Act Mutual Benefit
Corporation

• Potential use of this section
• Consumer produce market
• Housing
• Education
• Food/Groceries
• Florists
• Hardware
• Health or medical
• Infant or nursery
• Burial or cemetery
• Etc.

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Organization as Mutual Benefit Corporation

• Under Indiana law, a mutual benefit corporation
  must (among other requirements)
• File articles of incorporation with the Indiana
  Secretary of States Office
• Hold an organizational meeting to appoint
  officers/elect board of directors, adopt by-laws,
  carry out related business
• Maintain a board of directors (may be paid unless
  articles of incorporation specify otherwise)
• Maintain registered agent with State

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Liability--Board of Directors of Mutual Benefit
Corporation

• A director is not liable for an action taken as
  a director, or failure to take an action, unless
  the        (1) director has breached or failed
  to perform the duties of the director's office in
  compliance with this section and        (2)
  breach or failure to perform constitutes willful
  misconduct or recklessness. Ind. Code
  23-17-13-1(d)
• Subject to the section above, a director can be
  liable for an unlawful distribution of dividends
  if the director votes for or assents to the
  unlawful distribution.

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Liability--Member of Mutual Benefit Corporation

• Corporation members are not personally liable for
  the corporations acts or debts, but they can
  become personally liable based on their own
  actions or conduct.
• Caveat If a member has outstanding debts to the
  corporation, a creditor can join them in a suit
  against the corporation for debts unpaid.

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Indemnification of Director, Employees, Officers
Agents

• A corporation organized as a mutual
• benefit corporation MUST indemnify
• directors, employees, officers agents
• if they are wholly successful in the
• defense of a proceeding against them
• Ind. Code 23-17-16-9 13

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Indemnification of Director, Employees, Officers
Agents

• A corporation organized as a mutual benefit
  corporation MAY indemnify directors, employees,
  officers agents if
• the individuals conduct was in good faith and
• the individual reasonably believed
• (A) in the case of conduct in the individual's
  official capacity with the corporation, that the
  individual's conduct was in the corporation's
  best interests and
• (B) in all other cases, that the individual's
  conduct was at least not opposed to the
  corporation's best interests and
• where a criminal proceeding is involved, the
  individual     
• had reasonable cause to believe the individual's
  conduct was lawful or
• had no reasonable cause to believe the
  individual's conduct was unlawful.
• Ind. Code 23-17-16-8 13

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Loans from Members of Mutual Benefit Corporation

• Members of a mutual benefit
• corporation can loan or advance sums
• to the corporation and can earn
• reasonable interest on the loan.
• Reasonable interest rate generally means not in
• excess of market rate (fixed or variable) that
• would otherwise be available to the corporation
• without premium at the time of the loan.

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Tax Considerations

• Cooperative Principles Recognized by the Courts
  and the IRS
• Subordination of capital
• Democratic control and ownership by the members
• Operation at cost accomplished by returning net
  margins on the basis of patronage.
• Puget Sound Plywood, Inc. v. Commissioner

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Subordination of Capital

• Subordination of capital requires that most or
  all benefits from the coops business remain with
  the members/patrons.
• A cooperative is not to be operated for the
  primary purpose of paying a return on equity
  investment.

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Democratic Control and Ownership

• Democratic control is achieved by voting on a
  one-member, one-vote basis.
• IRS will consider alternate voting schemes (e.g.
  volume based voting) if no single member
  exercises too much control (e.g. not greater than
  5).
• Democratic ownership means that each members
  interest in the cooperative is based on their
  participation in the cooperatives business.

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Operation at Cost

• Operation at cost means that the cooperatives
  net operating margins are distributed back to the
  members/patrons in proportion to their patronage.
• The concept also means that members are not be
  served below cost in the aggregate.

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Other Cooperative Attributes

• Mutuality of interests.
• Equitable treatment of all members open
  membership.
• Equitable distribution of remaining cooperative
  assets to all current and former members upon
  dissolution or liquidation.

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Tax Code Provisions

• IRC 501(c)(12) Certain cooperatives federal
  income tax exemption.
• Subchapter T (IRC 1381-1383) Not exempt from
  federal income tax, but usually only taxed on
  margins at either the organization level or
  patron level.
• IRC 521 Certain farmer cooperatives can use
  deductions along with Subchapter T to reduce
  taxable income to 0.

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Tax Code Provisions

• IRC 501(c)(12) - exempts the following
  organizations from federal income tax
• benevolent life insurance associations of a
  purely local character
• mutual ditch or irrigation companies
• mutual or cooperative telephone companies
• "like organizations" (e.g. electric coops,
  cable TV)

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Tax Code Provisions

• IRC 501(c)(12) - exempts these
• organizations from federal income tax
• only if 85 or more of income is from
• amounts collected from members for
• purposes of meeting losses and
• expenses.

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Tax Code Provisions

• IRC 501(c)(4) includes an exemption for social
  welfare organizations
• Exemption status was denied to grocery
  cooperative because the cooperative was operated
  primarily for the benefit of members and any
  social benefits were insufficient to meet
  requirement that organization be operated
  primarily for common good and welfare of
  community. --Rev. Rul. 73-349, 1973-2 C.B.
  179.

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Tax Code Provisions

• Subchapter T Cooperatives may
• deduct patronage dividends from gross
• income to the extent they are in
• proportion to the amount of business
• the patron does with the cooperative.

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Tax Code Provisions

• Subchapter T In order to qualify for the
  deduction must
• Be a farmers cooperative that is exempt under
  Section 521 or
• A corporation operating on a cooperative basis
  (excludes certain cooperatives, such as, mutual
  savings banks, insurance cooperatives, and rural
  electric or telephone cooperatives)

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Cooperative Taxes

• Cooperatives generally pay the following taxes
• Real estate and personal property
• Sales
• Employment
• Gasoline diesel fuel
• License and motor vehicle registration
• Excise taxes on utility services
• Unrelated business income tax

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Operating as a Cooperative

• Cooperatives share similarities with other
  entities, such as for-profit corporations, for
  example
• Same general statutory purpose, engaging in any
  lawful business unless a more limited purpose is
  set forth in the articles of incorporation
• Similar liability-limiting advantages for
  officers, agents, and employees and
• Similar requirements for meetings and
  documentation (e.g. bylaws, articles of
  incorporation, etc.)

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Operating as a Cooperative

• Cooperatives, however, have special statutory
  requirements and advantages over other entities,
  for example
• Ownership by the consumer members they serve
• Democratic control by membership (required to
  obtain tax advantages) and
• Distribution to members based upon patronage
  rather than a percentage of ownership

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• jfetty_at_parrlaw.com
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