Bradshaw v. Commissioner

George Bradshaw, Petitioner, et al., 1 v. Commissioner of Internal Revenue, Respondent Bradshaw v. Commissioner Docket Nos. 20699, 20700, 20701, 20702, 20703, 20704 United States Tax Court 14 T.C. 162; 1950 U.S. Tax Ct. LEXIS 282; February 3, 1950, Promulgated *282 Decisions will be entered under Rule 50. Purchase rebates, or patronage dividends, issued by cooperative purchasing association in the form of registered redeemable interest-bearing promissory notes payable in any event upon dissolution of the association, held, accruable income to the participating members in the years when issued to them. Maurice R. McMicken, Esq., and Ivan Merrick, Jr., Esq., for the petitioners. William E. Koken, Esq., for the respondent. LeMire, Judge. LeMIRE *163 Income tax deficiencies have been determined against the petitioners for 1944 and 1945, as follows: Petitioner [1945] George Bradshaw $ 147.29 $ 232.41 Mary E. Bradshaw 382.29 232.40 Warren L. Murphy 351.94 229.38 Vera Rose Murphy 380.33 229.38 Clifford M. Schumacher 382.32 232.41 Lydia M. Schumacher 382.31 232.41 *283 The proceedings were consolidated for hearing. They all involve the same issue, namely, whether purchase rebates or patronage dividends issued by a cooperative purchasing association in the form of promissory notes of the association were accruable income to the contributing members in the years when the purchases on which they were computed were made or in the years when the notes were issued, or whether, in the circumstances, they were accruable at any time. FINDINGS OF FACT. Some of the facts have been stipulated and are found accordingly. The petitioners are all residents of Seattle, Washington. George Bradshaw, Warren L. Murphy, and Clifford M. Schumacher will be referred to hereinafter as the petitioners. Their wives are parties to these proceedings by reason of the fact that they and petitioners filed separate income tax returns on a community property basis for the years involved, the calendar years 1944 and 1945. The returns were filed with the collector of internal revenue for the district of Washington. During 1944 and 1945 the petitioners were equal partners in the operation of a chain of retail grocery stores located in King and Kitsap Counties, Washington, under *284 the name of Money-Savers Super Markets. The partnership was formed in 1943 as the successor of a corporation known as Money-Savers, Inc., whose stock was all owned by the members of the successor partnership. Both the corporation and the partnership were members of a cooperative purchasing association known as Associated Grocers Co-op. The association, hereinafter sometimes referred to as the Co-op, was *164 organized under the laws of the State of Washington in 1934. Its purpose, as set out in its articles of association, was, in part: 1. To unite in a non-profit Cooperative association, persons, firms and corporations engaged in the retail grocery business and in the raising, handling, and selling or otherwise marketing of any agricultural, live-stock, dairy, marine, or other products. 2. To procure and purchase for the members thus associated any or all merchandise, products, or other commodities used or useful in the conduct of the business of its members, and to purchase, manufacture, store and deliver the said merchandise, products and commodities. The Co-op had a capitalization at all times here material of $ 300,000, divided into 6,000 shares of stock of a par value*285 of $ 50 each. Article V of the articles of association provides, in part: The excess of income arising from monthly dues and any other payments by members, from charges to members for delivery of merchandise in excess of the cost of handling and of the administration of the association, shall first be applied to setting aside adequate reserves for taxes, depreciation, bad debts, inventory losses, and for other contingencies, and not less than ten per cent (10%), nor more than twenty-five per cent (25%) of the remainder shall be apportioned and credited to the statutory reserve fund account, and the then remaining balance shall be apportioned and credited to the members of the association in the proportion that each member's purchases bear to the total purchases of all members during the fiscal period in which the said excess of income was realized, said refund to be paid in cash, credits or notes of the association, payable upon such terms and conditions as the Board of Directors of the association shall, at the time of the issuance of such notes or establishments of such credits determine to be to the best interests of the association. During the taxable years 1944 and 1945 the *286 partnership purchased merchandise from the Co-op for retail sale to its customers in amounts as follows: Jan. 1 to June 30, 1944 $ 140,879.25 July 1 to Dec. 31, 1944 161,049.91 Jan. 1 to June 30, 1945 133,803.55 July 1 to Dec. 31, 1945 125,003.48 During these years the Co-op issued and delivered to the partnership as purchase rebates or patronage dividends registered redeemable notes, such as referred to in article V above, in the following amounts: Date issued Period of sales Amount 3-31-44 Last half 1943 $ 2,007.55 9-30-44 First half 1944 3,959.09 3-31-45 Last half 1944 1,306.70 9-30-45 First half 1945 2,427.19 3-31-46 Last half 1945 2,383.05 Each of the notes referred to above was issued pursuant to the following provisions of the corporation's bylaws: *165 Sec. 14. The Board of Trustees may further provide that all such dividends as described in Section 13 may be paid by the association at the discretion of the Board of Trustees in the registered redeemable notes of the association, such notes to bear interest at the rate determined by the Board, shall be payable upon the liquidation of the association, redeemable upon call of the Board of Trustees*287 in such manner as the Board may provide and shall be subordinated to the claims of all secured and general creditors of the association in the event of liquidation. It is intended that this privilege shall be exercised by the Board whenever necessary to maintain the working capital of the association at an efficient point, and the notes so issued shall be redeemed in order of issuance in such manner as the Board may provide when the working capital of the association is, in the opinion of the Board, equal to that required by the necessities of the business. * * * The notes so issued were credited to the partnership in the books of the Co-op in a separate notes payable account. This account for the period March 31, 1942, to March 31, 1946, shows credits totaling $ 26,495.02, including $ 6,632.93 of notes issued to the predecessor corporation during 1942, and a balance of $ 25,795.02 after a debit of $ 700 representing amounts applied in payment of fourteen additional shares of capital stock issued to the corporation September 30, 1942. Similar notes were issued to other members and credited to their accounts. These accounts showed notes outstanding in the total amounts of $ *288 119,185.29 at September 30, 1942; $ 305,170.27 at September 30, 1943; $ 479.197.30 at September 30, 1944; $ 520,421 at September 30, 1945; and $ 613,434.21 at March 31, 1946. The Co-op also issued to its members other than the partnership dividend notes bearing interest at 4 per cent, of which it had outstanding $ 321,753.82 at March 31, 1942. No new 4 per cent notes were issued after that date and by November 30, 1945, notes outstanding had been reduced to $ 233,599.82. The balance sheets of the Co-op for the years ended September 30, 1943, 1944, and 1945, show the following assets and liabilities: 9-30-43 9-30-44 9-30-45 ASSETS Cash $ 16,526.21 $ 51,072.32 $ 127,310.14 Notes and accounts receivable, less reserve for bad debts 498,969.12 519,122.50 548,045.92 Merchandise inventory 797,495.83 798,366.11 904,061.17 Merchandise in transit 18,696.45 75,819.17 32,295.07 Investments 8,842.65 10,774.19 18,665.19 Warehouse sites 29,250.00 59,552.40 61,696.84 Buildings and equipment, less reserve for depreciation 356,039.87 355,455.19 355,961.69 Deferred charges 2,230.09 8,754.66 14,581.71 Total 1,728,050.22 1,878,916.54 2,062,617.73 LIABILITIES Accounts payable 383,229.38 309,626.85 248,160.38 Notes payable 1,129,814.35 1,272,781.39 1,274,545.82 Accrued wages, taxes, and interest 26,060.16 52,076.03 54,032.31 Federal income taxes 16,782.42 10,499.58 9,793.41 Paving assessment 9,674.68 Members' deposits 77,000.00 89,250.00 96,250.00 Capital stock 15,400.00 31,850.00 261,450.00 Surplus 79,763.91 103,158.01 118,385.81 Total 1,728,050.22 1,878,916.54 2,062,617.73 *289 *166 Neither the partnership nor its corporate predecessor ever entered the notes in question in their books or reported them in their income tax returns. The notes that had been issued to the corporation were distributed to the stockholders when the company was dissolved and have since been held by them individually. None of the notes has ever been redeemed by the Co-op, but the interest on them has been paid promptly each year up to the present time. The partnership kept its books and made its returns on an accrual basis. It filed returns for the calendar years 1944 and 1945 showing distributable income of $ 90,200.87 for 1944 and $ 45,256.51 for 1945. In determining the deficiencies herein the respondent has added to partnership gross income for 1944 and 1945, as income accrued in those years, the full amount of the notes which it received from the Co-op on purchases made during those years. OPINION. In principle, the same question involved here was before us in Harbor Plywood Corporation, 14 T. C. 158, where we held that credit memorandums issued by a cooperative marketing association as rebates or patronage dividends were accruable and *290 taxable to a member reporting on the accrual basis in the years when received, although not paid until a subsequent year. We pointed out that the distributions were made out of earnings already realized by the association which, in reality, belonged at all times to the contributing members. 2 Substantially the same facts are present in the instant case. The notes issued to the partnership represented the partnership's proportional part of earnings already realized by the association which, under its articles of incorporation and bylaws, it was required to distribute to the partnership during the taxable years. The Co-op had the right to make the distributions in the form of registered redeemable notes, which it did, if, in the discretion of the trustees, this was necessary*291 in order to maintain a sufficient working capital. The amounts represented by the notes issued to the partnership and other members were credited to them and carried as liabilities in the corporation's books. Like the credit memorandums in the Harbor Plywood case, supra, the notes were payable at any time when there was sufficient cash available. There was an uncertainty as to the time when the partnership would receive the cash, but no contingency as to its rights to receive it or as to the amount, such as would have prevented its accrual. See United States v. Safety Car Heating & Lighting Co., *167 297 U.S. 88. The partnership's rights to definite amounts of income became fixed when the notes were issued. The petitioners argue that even if the notes are to be treated as dividends accruable in the taxable years when issued, they would have to be reported at their fair market value, under section 115 (a), Internal Revenue Code, and section 29.115-10, Regulations 111, and that the notes had no fair market value when received by the partnership. In the first place, the notes in question were not dividends, in the ordinary sense, of*292 corporate earnings voluntarily distributed to stockholders substantially in proportion to their stockholdings. They were, as described in the stipulation of facts, "a purchase rebate or so-called 'patronage dividend' on the amount of the purchases made * * * by said partnership from the Associated Grocers Co-op." The amounts of distributions were based not on stock ownership, but on the amount of patronage. Furthermore, we can not find from the evidence that the notes were entirely worthless when issued to the partnership, or at any time thereafter. Neither is there any evidence on which we could determine a fair market value of anything less than their face value. The notes bore interest at the rate of 2 per cent per annum, which has been paid regularly when due. The Co-op was in a sound position financially at the time the notes were issued and, for all the evidence shows, has continued so. Its balance sheets for 1943, 1944, and 1945 show that it was solvent and financially able to pay all of its obligations, including the notes in question, during all those years. There is no evidence that it will not still be able to do so if and when it is dissolved and the notes thereby*293 become due and payable. It is to be noted that in the notice of deficiency the respondent determined that the patronage dividends in dispute accrued to the partnership during the years when the purchases on which they were computed were made from the Co-op. On that theory, the amount accruable to the partnership was $ 5,265.79 in 1944 and $ 4,810.24 in 1945. In his brief the respondent advances the alternative theory that the patronage dividends are accruable and taxable to the partnership in the years when it received the notes, with the result that the amounts accruable to the partnership are increased from $ 5,265.79 to $ 5,966.64 for 1944 and decreased from $ 4,810.24 to $ 3,733.89 for 1945. We think that the issuance of the notes by the Co-op is what determined the time of the accrual of the income to the patrons. The amounts to be distributed under the Co-op's articles of association were not known until the accounting was made at the end of each half year and the trustees had determined how much of the income was to be set aside for reserves. It was only the remaining balance that was to be "apportioned and credited" to the members. (See *168 article V of the articles*294 of association set out above.) While the members' rights to some undetermined portion of the income may have attached at the time the sales were made, which is the theory on which respondent determined the deficiencies, the amounts could not be ascertained with any reasonable accuracy until they had been determined by the board of directors. We think that as a practical matter the time for the accruals was when the rebates or patronage dividends were determined and credited to the members in the Co-op's books and the notes issued to them. As noted above, a recomputation on this basis may result in an increased tax liability for 1944, but, since the respondent has not moved for any increase in the deficiency determined for either of the years before us, none may be found. Decisions will be entered under Rule 50. Footnotes 1. Proceedings of the following petitioners are consolidated herewith: Mary E. Bradshaw; Warren L. Murphy; Vera Rose Murphy; Clifford M. Schumacher; and Lydia M. Schumacher.↩ 2. San Joaquin Valley Poultry Producers' Assn., 136 Fed. (2d) 382; Midland Cooperative Wholesale, 44 B. T. A. 824; United Cooperatives, Inc., 4 T. C. 93↩.