Cooperative Information Report 55
Co-ops 101: An Introduction to Cooperatives
This report provides a comprehensive summary of basic information on the cooperative way of organizing and operating a business. It covers the nature and extent of the use of cooperatives, compares cooperatives to other business structures, explains the roles various people play in a cooperative, and discusses equity accumulation and income taxation. The purpose is to make available, in a single report, the information someone would need to acquire a general understanding of how cooperatives function.
Keywords: Cooperative, Business, Finance, Structure, Tax
Co-ops 101: An Introduction to CooperativesDonald A. Frederick, Program Leader
Law, Policy & Governance
Cooperative Resources Management Division
Rural Business-Cooperative Service
Cooperative Information Report 55
April 1997, Slightly revised June 1997
Welcome to the dynamic world of cooperation--people working together to solve common problems and seize exciting opportunities. Cooperatives are business entities that people use to provide themselves with goods and services.
This booklet introduces you to the attributes that distinguish a cooperative from other ways to organize and conduct a business. Its purpose is to help you understand what makes a cooperative unique. It contains a great deal of information to absorb. Use it as a reference and refer to it when specific problems arise. Over time, you will learn more about cooperatives and your experience with them should be more rewarding.
The author gratefully acknowledges the cooperation of the National Society of Accountants for Cooperatives (NSAC) in simplifying the preparation of this report. NSAC allowed me to base parts of this publication on material I had written earlier for Welcome to Cooperatives, an NSAC booklet designed to introduce accountants, financial, and tax professionals to cooperatives. This saved me the time and effort of reworking the presentation of some basis concepts that everyone associated with cooperatives should understand. This is consistent with the concept of sharing knowledge freely that should be a cornerstone of cooperative education.
An Introduction to Cooperatives
There is no universally accepted definition of a cooperative. In general, a cooperative is a business owned and democratically controlled by the people who use its services and whose benefits are derived and distributed equitably on the basis of use. The user-owners are called members. They benefit in two ways from the cooperative, in proportion to the use they make of it. First, the more they use the cooperative, the more service they receive. Second, earnings are allocated to members based on the amount of business they do with the cooperative.
In many ways, cooperatives resemble other businesses. They have similar physical facilities, perform similar functions and must follow sound business practices. They are usually incorporated- under state law by filing articles of incorporation, granting them the right to do business. The organizers draw up bylaws and other necessary legal papers. Members elect a board of directors. The board sets policy and hires a manager to run the day-to-day operations.
But in some ways, cooperatives are distinctly different from other businesses. These differences are found in the cooperative's purpose, its ownership and control, and how benefits are distributed. They are reflected in cooperative principles that explain the unique aspects of doing business on a cooperative basis.
In one sense, cooperation is probably as old as civilization.
Early people had to learn to work together to meet their common needs, or perish. The
Pilgrims who settled at Plymouth, MA, jointly cleared fields abandoned by the Indians,
broke up the soil, and planted and cared for their corn. After the harvest, celebrated
with the Indians in 1621 with a Thanksgiving feast, the corn was shared equally among the
The Grange, founded in
1867, quickly became the major thrust behind agricultural and rural cooperatives in
America. In 1874, a Grange representative went to Europe to gather information about
cooperatives. In 1875, the Grange published a set of rules for the organization of
cooperative stores, based on the Rochdale principles.
Various writers over
the past century have analyzed and observed the application of cooperative principles.
Although slight differences in terminology appear on the various lists, three principles
emerge as being widely recognized and practiced.
The User-Benefits Principle
Members unite in a
cooperative to get services otherwise not available, to get quality supplies at the right
time, to have access to markets or for other mutually beneficial reasons. Acting together
gives members the advantage of economies of size and bargaining power. They benefit from
having these services avail-able, in proportion to the use they make of them.
The User-Owner Principle
The people who use a cooperative own it. As they own the assets, the members have the obligation to provide financing in accordance with use to keep the cooperative in business and permit it to grow. Accumulating adequate equity is a major challenge facing many cooperatives. How this task is accomplished is discussed later.
The User-Control Principle
As owners, a
cooperative's members control its activities. This control is exercised through voting at
annual and other membership meetings, and indirectly through those members elected to the
board of directors. Members, in most instances, have one vote regardless of the amount of
equity they own or how much they patronize the organization.
Certain business practices have developed that implement and facilitate these basic principles. They further differentiate a cooperative from other forms of doing business.
The Patronage Refund System
strive to return earnings to members, this can't be done on a transaction-by-transaction
basis. Rather, cooperatives usually charge market prices for supplies and services
furnished to members and competitive prices for products delivered for further processing
and marketing. Normally, this allows them to generate sufficient income to cover costs and
meet continuing needs for operating capital.
Limited Return on Equity Capital
Members form a
cooperative to get a service--source of supplies, market for products or performance of
specialized functions--not a monetary return on capital investment.
Cooperation Among Cooperatives
especially local associations, are too small to gather the resources needed to provide all
the services their members want. By working with other cooperatives--through federated
cooperatives, joint ventures, marketing agencies in common, and informal networks--they
pool personnel and other assets to provide such services and programs on a collaborative
basis at lower cost.
While cooperatives are often most closely identified with agriculture, they are found working effectively to meet people's needs in all sectors of American life. The National Cooperative Business Association reports that in the United States a network of 47,000 cooperatives directly serve 100 million people -- nearly 40 percent of the population. Here are some examples and facts and figures about cooperatives in your community.
The largest single
segment of the cooperative industry is credit unions. The roughly 12,600
credit unions in the United States have more than $280 billion is assets and almost 65
million members. Building on their base of member savings and consumer loans and home
mortgages, credit unions now offer additional services to their members including credit
cards, automated teller machines, tax-deferred retirement accounts and certificates of
Consumer Service Cooperatives
America has about 1
million units of cooperative housing, nearly 600,000 of them in New York
City. New units are being developed in many other areas including senior citizen
communities, trailer parks, low-income complexes, and student housing near college
More than 15,000
independent grocery stores rely on cooperative grocery wholesalers for
identity, brand names, and buying power they need to compete with the chains and the
discounters. Members also receive training and financing. Several cooperative grocery
wholesalers are multi-billion dollar firms rivaling the largest farmer cooperatives in
sales and assets.
In the agricultural
sector, USDA's Cooperative Services' survey of farmer cooperatives for calendar year 1995
reported 4,006 cooperatives in operation. Of these associations, 2,074 primarily marketed
farm products; 1,458 handled primarily farm production supplies; and 474 provided services
related to marketing or purchasing activities.
People buy stock in a non-cooperative business to make money on their investment. The more
of the company you own, the more benefits (stock appreciation and dividends) you will
realize if the business succeeds.
1. Access to quality supplies and services at reasonable cost. By banding together and
purchasing business supplies and services as a group, individuals offset the market power
advantage of firms providing those supplies. You can gain access to volume discounts and
negotiate from a position of greater strength for better delivery terms, credit terms, and
other arrangements. Suppliers will be more willing to discuss customizing products and
services to meet your specifications if the purchasing group provides them sufficient
volume to justify the extra time and expense.
2. Increased clout in the marketplace. Marketing on a cooperative basis, like purchasing
supplies and services, permits members to combine their strength while maintaining their
status as independent business people. They can lower distribution costs, conduct joint
product promotion, and develop the ability to deliver their products in the amounts and
types that will attract better offers from purchasers.
3. Share in the earnings. Some people talk about non-cooperative firms operating "for
profit" while cooperatives operate "at cost." This isn't totally accurate.
Most cooperatives generate earnings. They differ from non-cooperative firms in how they
allocate and distribute their earnings.
4. Political action. Growers, small business owners, and other rural residents have to
realize that no one gives you a favorable law or regulatory ruling just because you think
you deserve it. You have to build your case and argue your point convincingly.
5. Local economy enhanced and protected. Having its businesses owned and controlled on a
cooperative basis helps your entire community. Cooperatives generate jobs and salaries for
local residents. They pay taxes that help finance schools, hospitals, and other community
In the United States, historically there are three basic categories of private business firms--individually owned, partner-ships and corporations. Cooperatives are a type of corporation. Recently, most States have approved a new business structure, the limited liability company. This section explains the similarities and differences between cooperatives and the other business forms.
Individually Owned Businesses
The individually owned business is the oldest and most common form. One person owns, controls and conducts the business. Characteristics of individually owned businesses include:
Control. The owner is responsible for management, makes all the major operational decisions an sets the business policies
Capital. The owner supplies the equity and is responsible for all debts.
Earnings. Profits belong to the owner.
Profits are taxed once, as income of the owner.
Life. The life of the individually owned business is tied to the one owner. It continues until the owner sells the business, retires or dies. At that point the business is either taken over by a new owner or discontinued.
Many farms are operated as individually owned businesses. Other examples of business commonly operated by an individual owner include service stations, hardware stores, restaurants, flower shops and dry cleaners.
Partnerships consist of two or more people who jointly own, control and operate a business. The responsibilities of each are usually based on a partnership agreement. Characteristics of partnerships include:
Control. Partners usually share management and make
policy decisions by mutual agreement or majority vote. Some agreements provide for senior
partners whose votes may carry greater degrees of weight.
Partners provide the equity capital. Usually, each partner is personally liable, up to the
value of all the property he or she owns (both within and outside the partnership), for
the debts of the partnership. Some partnerships have "limited" partners, who
relinquish any voice in managing the business in exchange for a limit on their personal
Earnings. Profits (or losses) are shared by the partners
in accordance with the terms of the partnership agreement. This is usually determined by
the amount of capital invested and the nature of the work performed by each partner.
Earnings are taxed once, as income of the partners.
Life. The life of the partnership as a business is deter-mined by the partners, but if one dies or leaves the organization, it often must be dissolved and a new partnership formed.
Some farms are owned and operated on a partnership basis. Other examples include law and accounting firms, insurance and real estate companies. Partnerships may operate an auto repair firm, store and any other business.
General Business Corporations
Most businesses that
have more than a small number of owners are organized as corporations. Corporations are
legal entities, authorized by law to act much like an individual person. A corporation has
the right to provide services, own property, borrow money, enter into contracts and is
liable for its own debts.
Management is controlled by a board of directors and officers who are elected by the
stockholders. Each stockholder usually has as many votes as the number of shares of voting
stock he/she owns. Business decisions and policy are made by the board and officers. The
directors have no obligation to use the firm's products or services and may have no
contact with the firm outside of board meetings.
Equity is raised by selling shares of stock to investors for their profit-making
potential. The corporation is responsible for its own debts. If the business fails, each
owner of stock can lose only the amount invested.
Profits are distributed to stockholders as dividends according to the number of shares of
stock owned or used to expand the business. The timing and amount of such dividend
distributions are decided by the board of directors.
Earnings are taxed twice, as income of the corporation when earned and as income of the
stockholders when distributed as dividends.
Life. A corporation enjoys a continuing existence, regardless of changes that may occur in the ranks of its shareholder owners.
Limited Liability Company
A new form of business
gaining widespread attention is the limited liability company (LLC). It combines the
single-tax treatment of a partnership and the limited personal liability of owners of a
corporation. Characteristics of an LLC include:
The owners, called members as in a cooperative, may share management and make policy
decisions by mutual agreement or majority vote, or turn the management over to nonmembers.
The operating agreement among the members determines voting rights of each member.
Members usually provide the equity capital. Liability of the members is usually limited to
their investment in the corporation.
Profits (or losses) are shared by the members in accordance with the terms of the
operating agreement. This is usually based on the amount of capital invested and the
nature of the work performed by each member.
The Treasury Department assumes an LLC wants to be taxed as a partnership. However, an LLC
has the option to elect to be taxed as a general business corporation.
Life. An LLC may have a perpetual existence, or the members may chose to be governed by the partnership rules.
The LLC is still developing as a business structure. It is already proving a useful vehicle for organizing joint ventures among established corporations, including those involving cooperative and noncooperative firms. Whether it can be used to organize a number of individuals, who may want the flexibility to join and leave the venture at will, is undetermined at this time.
A cooperative is also a state-chartered business, organized and operating as a corporation under applicable state laws. Cooperative attributes are:
Management is controlled by a board of directors who are elected by the members. One
unique feature of a cooperative is that each member usually has only one vote in selecting
directors, regardless of the amount of equity that member has in the cooperative. Another
is that all or most of the directors must be members of the cooperative. Thus, the leaders
are regular users of the firm's products or services.
Equity comes from the members, rather than outside investors. It is obtained by direct
contributions through membership fees or sale of stock, by agreement with members to
withhold a portion of net income based on patronage, or through retention of a portion of
sales proceeds for each unit of product marketed. If a cooperative fails, the liability of
each member is limited to the amount he/she has invested.
Earnings (or losses) on business conducted on a cooperative basis, often called margins,
are allocated to the members on the basis of the use they made of the cooperative during
the year, not on the basis of equity held. The allocations may be distributed in cash or
retained as additional equity. Members usually receive a combination of cash and an
allocation of equity.
Earnings from business with members are taxed once, either as income of the corporation
when earned or as income of the members when allocated to them.
Life. A cooperative usually has a perpetual existence. Members can routinely join or resign without disrupting ongoing operations.
Examples of businesses that operate as cooperatives include agricultural marketing, purchasing and service organizations; credit unions; health care providers and multi-unit housing facilities.
Chapter 6. Classifying Cooperatives by Structure
Cooperatives are regularly described by a number of classification schemes. The more important ways to categorize are by the geographical territory served, the governance system and the functions they perform.
Geographic Territory Served
One factor determining cooperative structure is the size of the area served. Cooperatives are loosely categorized as local, super local, regional, national and international.
Local cooperatives operate in a relatively small geographic area, typically a single county or an area within a radius of 10 to 30 miles. They usually have only one or two facilities, from which to serve members.
Super local cooperatives operate in two or more counties, often with several branch facilities.
Regional cooperatives serve an area comprising numerous counties, an entire State or a number of States.
National cooperatives serve a major portion or most of the United States.
International cooperatives operate in more than one country, with headquarters in the United States or another country.
Cooperatives can also be classified based on membership structure, as centralized, federated or mixed.
cooperatives have individuals and business entities (including partnerships and family
corporations) as members. Virtually all locals and super locals are centralized. Regional,
national, and international cooperatives may also be centralized.
cooperatives have other cooperatives as their members. Each member of a federated is a
separate cooperative that owns a membership share entitling it to voting rights in the
affairs of the federated. Local cooperatives commonly form federateds to perform
activities too complex and expensive for them to do individually, such as manufacturing
production supplies, tapping major financial markets, and marketing on a national or
Mixed cooperatives have both individuals and other cooperatives as members, who are usually given voting rights representative of their own membership.
Cooperatives may perform one or more of three core functions: marketing products, purchasing supplies and providing services.
cooperatives assist members maximize the return they receive for goods they produce. Most
cooperative marketing activity involves either agricultural products or those of producers
in related industries such as forestry, aquaculture and horticulture. New marketing
ventures are developing in such diverse industries as handicrafts, professional services
and information technology.
Purchasing cooperatives were first
used by farmers to gain access to affordable, quality production supplies such as feed,
fuel, fertilizer and seed. These early efforts often became businesses having full-time
managers and warehouses to handle other production supplies and services such as farm
chemicals, animal health products, fencing, building supplies, construction contracting,
automotive accessories, etc.
Service cooperatives were also
developed to serve farmers. Some of these services are farm-specific, such as recommending
and applying fertilizer, lime, or pesticides; animal feed processing; and crop harvesting.
Others are general in nature, such as credit through the Farm Credit System, electricity
through rural electric cooperatives and communications service through rural telephone
Because a cooperative
is owned and controlled by the people who use its services, the various persons affiliated
with a cooperative must work even more closely together than in a noncooperative firm.
Customer service and satisfaction are the driving forces behind a cooperative, not
maximizing bottom-line return to investors. These take on a highly personal tone when the
owners and directors, in their role as users, have regular contact with management and
Members are the
foundation of the cooperative. They organized it. Their needs are the reason for its
existence. Their support, through patronage and capital investment, keeps it economically
healthy. And their changing requirements shape the cooperative's future.
To adopt and amend the articles of incorporation and bylaws.
To elect and, if necessary, remove directors.
To decide whether to dissolve, merge or consolidate the cooperative or form a joint venture with other cooperative or noncooperative firms.
To make sure officers, directors and other agents comply with laws applicable to the cooperative and with its articles of incorporation, bylaws and membership contracts.
Members also have general responsibilities toward their cooperative. Unlike the passive investor in a general business corporation, the member-owner-user of a cooperative must patronize and guide the venture for it to succeed. Employees and advisers need to understand these member obligations and help members fulfill them.
1. Patronize the cooperative. Members must make a conscious decision to be committed to the cooperative, even when short-term prices or services may be better elsewhere. If members don't want to use the cooperative, the need for it must be reexamined.
2. Be informed about the cooperative. To carry out their other duties, members must know what the cooperative is about; what it can do for them; its purpose, objectives, policies; and the issues it faces. They can obtain information through annual meetings, reports and newsletters, and from talking to the manager, staff, directors and other members. To effectively exercise their right of ownership, a member needs a good understanding of the present situation and projected future operations.
3. Be conscientious when selecting and evaluating directors. Although the cooperative is a user-owner, democratically controlled form of business, members can't make all the decisions directly. They select from among their peers individuals with the best judgment and business management skills to represent them in management affairs as the cooperative's board of directors. Loyalty, integrity, the ability to make wise business decisions and willingness to serve are necessary characteristics for board members.
4. Provide necessary capital.
Members must provide the equity financing their cooperative needs for acquiring inventory,
facilities, services and working capital. This is done initially through the purchase of
stock or a membership. It continues by permitting the cooperative to retain a portion of
the earnings allocated to each member and through the collection of per-unit retains from
checks to members for the proceeds of sale from marketing member products.
5. Evaluate performance of the cooperative. Members should examine the annual report and observe whether the cooperative is meeting their needs. If they are dissatisfied with cooperative performance, they should share their concerns with the directors. They should also express support for things the cooperative is doing well. Directors can't effectively represent the members if they don't know the members' true feelings.
Directors in a
cooperative occupy a key position between members and hired management. They are both
users of its services and representatives of other members who depend on those same
a competent manager, determine the salary, outline the duties and authority of the
position and formally review his/her performance at least annually.
and adopt long-range business strategies.
written monthly financial reports and operating statements for board meetings to be
informed of adverse as well as favorable operations.
the manager to prepare, before the close of each year, an operating budget for the next
fiscal year for board approval. This budget should estimate the volume of sales and gross
income of various items to be handled, the expenses by account classifications and the net
income expected. This constitutes necessary forward planning by the board and management.
The budget should be reviewed at intervals throughout the year to determine the trends of
a qualified auditor to make an independent audit at least once each year to determine the
accuracy of the financial records. An audit is the primary method the board uses to verify
the financial condition of the cooperative. Many successful cooperatives also use the
audit report to evaluate the effectiveness of the policies and budget, performance of the
manager and gain insight into the effect of past decisions and the need for new ones.
With the aid of the manager, plan and conduct the annual meeting to keep the membership informed about the status of their business, including operations, finances and policies.
Determine the patronage refund allocation and per-unit retain level. Factors to consider include legal requirements, member needs and desires for cash refunds, the desirability of providing money to retire old equities, and current and future capital needs.
Assure competent legal counsel is available.
Keep a complete record of the board's actions.
A cooperative director should not expect to receive special favors from the manager or employees, and a director does not:
Act independently on matters that should be decided by the entire board. Individual directors have no authority outside of board meetings.
Represent special interests, factions or political entities. Directors are elected to oversee the business activities of the cooperative, not serve as an agent of these groups.
In carrying out their responsibilities, directors serve much like trustees, charged with a legal obligation to protect the assets of the members. Directors who act outside the parameters of the law or don't exercise due care in their decisionmaking can be personally liable for the harm they cause the members, the cooperative or third parties.
The board usually elects the cooperative's officers shortly after the annual membership meeting. Each officer has specific duties as detailed in the cooperative's bylaws.
The president presides at all meetings and watches over the association's affairs, serving as the main communication link between hired management and the other directors and members.
The vice president, in the absence or disability of the president, performs the duties of the president.
The secretary keeps a complete record of all meetings of the board of directors and general membership and also is the official custodian of the cooperative's seal, bylaws, and membership records.
The treasurer oversees the bookkeeping and accounts to ensure accuracy and proper handling and also is responsible for presenting periodic financial reports.
Success of a
cooperative largely depends on good board/ manager relationships. The working relationship
between board and general manager requires respect and an understanding of each other's
Supervise and coordinate, under board direction, the business activities of the co-op by managing the people, capital, and physical resources.
Hire, train, supervise, and set compensation for employees. The manager also needs to review their performance and train, reassign, or replace those employees not meeting acceptable performance levels.
Oversee the detailed operations of the cooperative, within policies established by the board of directors, such as purchasing inventory and selling commodities, maintaining the general appearance of the co-op, and making sure employees respond to member needs.
Maintain, and revise as necessary, an adequate bookkeeping and accounting system; develop for board approval a financial budget annually; prepare proper financial reports regularly for board review; and present a report of the cooperative's operational highlights to the membership at the annual meeting.
Furnish information needed for long-range planning. This will bring matters, such as fixed asset additions or revisions, to the board's attention for review.
Represent the cooperative and portray a positive image to members and others in the community.
Encourage membership and active patronage.
Communicate developments at the cooperative to members.
Keep current on local, State, and Federal legislative and regulatory developments affecting cooperatives.
In many ways, working for a cooperative is similar to doing the same job at a noncooperative firm. But special features of a cooperative--the role of the member-owner as user and the emphasis on service over bottom-line numbers--place unique obligations on the employees.
1. Understand the purpose and objectives of the cooperative. Employees need to know how cooperatives are different from other methods of doing business. By understanding cooperative purposes, objectives, operations and their role as employees, they can help improve member relations, the cooperative's image and the general public's understanding of cooperatives.
2. Fully perform duties. In many cooperatives, like other business firms, the largest operating expense is for personnel. While the cooperative has responsibility for recruiting and providing training, the employee is responsible for using these opportunities to provide the best possible service to members.
the relationship to member-owners. All employees have a responsibility to
maintain a high level of customer satisfaction and good relations between the cooperative
organization and its member-users. Immediate feedback from members should be encouraged to
keep the manager informed of problems, needs and customer satisfaction.
Employees, like their manager, can be community boosters by taking part in religious, school or community affairs. Their efforts can positively affect the cooperative image held by members, the general public and other businesses.
One of the greatest
challenges facing cooperatives is raising equity capital. Because cooperatives pass
earnings through to users on a patronage basis, they cannot attract equity from outside
sources to the same extent as investor-owned businesses.
refers to cash purchases of membership certificates, common and preferred stock or other
forms of equity.
A resurgence in
cooperative value-added processing of commodities is being fueled by a system of direct
investment, called transferable delivery rights. Members who wish to
share in the benefits from the value-added processing are required to provide necessary
up-front capital by purchasing long-term delivery rights in the cooperative. These
delivery rights entitle and obligate the member to deliver to the cooperative all of the
production from specified acreage or specific quantities of product (so many tons or
bushels). The purchase of delivery rights assures members of a long-term "home"
for their production and provides an opportunity to share in the benefits of value-added
processing based on their patronage.
While cooperatives are
sometimes described as businesses that operate "at cost," few if any can do so
on a day-to-day basis. Rather, cooperatives seek to generate income that exceeds expenses
on an ongoing basis. Then, usually after the close of the fiscal year, they return
earnings from business conducted on a cooperative basis to the persons responsible for the
business generating those earnings, who are called patrons.
Per-Unit Capital Retains
market products produced by their members have a third means of acquiring equity capital,
per-unit capital retains. These are capital investments based on either the number of
physical units handled by the cooperative or on a percentage of sales revenue. Per-unit
retains are deducted from sales proceeds due the members from the cooperative.
Non-tax laws, such as
the Capper-Volstead Act and state cooperative incorporation statutes, frequently require
affected cooperatives to do a majority of their business with members. This still leaves
those associations free to do up to 49 percent of their business with nonmembers on a
Chapter 9. Financial and Tax Planning
As the following flow chart illustrates, cooperatives have flexibility in designing an equity accumulation program to meet their individual needs. An understanding of the alternatives and their tax treatment is especially important when allocating patronage-based sources of equity, retained margins, and per-unit retains.
usually are made to purchase membership equity, the membership certificate or a share of
common voting stock.
Cooperatives can distribute their margins and per-unit capital retains as cash refunds to the patrons. Cash distributions are generally tax deductible by the cooperative in the year earned and taxable income to the recipient in the year of receipt. Cash refunds do not add to the equity of the cooperative, but provide an immediate additional return to the patron on his or her use of the cooperative.
retain margins and per-unit capital retains and allocate the retained funds to equity
accounts of the patrons, based on the amount of business each patron did with the
cooperative during the year. If the cooperative follows the rules in the Code to
"qualify" the equity, the cooperative deducts the amount of the allocations from
its taxable income in the year the margins and retains were realized.
TAX TREATMENT OF COOPERATIVE AND PATRON
QUALIFIED RETAINED EQUITY
The Code requires at
least 20 percent of a qualified patronage refund be paid in cash. But the cooperative can
still retain up to 80 percent of its margins without having to pay a tax (at the co-op
level) on any of the patronage refund. There is no 20-percent cash distribution
requirement for qualified per-unit retains, so a cooperative can keep the entire amount
free of tax liability at the co-op level.
Cooperatives may delay
the pass-through of the tax obligation from the cooperative to the patron without
jeopardizing single tax treatment of those moneys.
TAX TREATMENT OF COOPERATIVE AND PATRON
NONQUALIFIED RETAINED EQUITY
If the cooperative in
the earlier example issues its patronage refunds as nonqualified written notices of
allocation, it would have taxable income of $100, the amount of the margin. The patron's
taxable income would have been $600, the payment for the crop.
Cooperatives can treat
margins just as noncooperative firms treat earnings, by putting them into an unallocated
reserve and paying corporate income tax. Under this approach, single tax treatment is
forfeited. If the funds are later distributed, the recipients must pay a second income
Chapter 10. Equity Management
unique to cooperatives is the regular redemption of outstanding equity. Capital
contributions from continuing patrons build as time passes. But the level of patronage
will fall for some members, and others will likely cease using the cooperative at all. A
program of adjusting patronage-based equity requirements on a regular basis matches the
responsibility of financing the cooperative to current use of its services.
Revolving Fund Plan
financing" refers to systems in which patrons make annual capital contributions,
typically through retained patronage refunds or per-unit retain allocations. The
cooperative, in turn, redeems earlier capital contributions on a regular basis. Redemption
is usually on a first-in, first-out basis. The cooperative determines what its total
capital requirements are and the excess is redeemed each year, the earliest or
"oldest" equity being revolved out first.
A special plan is one
in which a specific event or condition, such as a member's death, triggers equity
redemption. The most common events covered are death, retirement or reaching a specified
age. Once the condition is verified, the member's equity may be returned at once or over a
prescribed number of years.
Base Capital Plan
A "base capital plan" is a special equity capital management plan. It focuses directly on the current proportion of capital a patron should have in the cooperative at a particular time, based on the degree of use. Development of the base capital plan involves several steps.
1. The cooperative determines its total equity capital needs.
2. The equity capital needs are allocated among patrons based on the proportion of the cooperative's business each patron did with the cooperative during a base period, typically the past 3 to 7 years.
3. Each year the cooperative's equity requirements are re-viewed and adjusted as the board of directors finds appropriate. Each patron's share of the equity requirement is also adjusted to reflect (a) any change in the total requirement of the cooperative and (b) any change in the patron's proportional share in the new base period.
4. Under invested patrons must add to their equity account, usually through the current year's retained patronage refunds or per-unit retains, or by direct contribution.
5. Fully invested and overinvested patrons generally are paid a cash rebate of current year's patronage refunds and per-unit retain allocations. Overinvested patrons may receive an additional payment in redemption of their excess share of the equity.
The proportional share of former patrons will fall each year, reaching zero at the end of the base period beginning the first year after they cease patronizing the cooperative.
Cooperation is a very
old concept, with the potential for a very bright future. That potential will only be
realized if the people with an interest in cooperatives make the effort to make them work.
Reading and studying this booklet, and others like it, is an important first step. But
that alone won't make you an expert. Learning about cooperatives can be a life-long
1. This chapter is based primarily on chapters 1 and 2 of Farmers, Cooperatives, and USDA: A History of Agricultural Cooperative Service, Agricultural Information Bulletin 621 (USDA 1991).
2. This explanation of cooperative principles and practices was developed by the author for Welcome to Cooperatives, available from the National Society of Accountants for Cooperatives, Springfield, VA. Welcome to Cooperatives is particularly appropriate- for educating accounting, financial and tax professionals with limited knowledge of cooperatives.
3. Most of the material in this chapter is from A Day in the Life of Cooperative America, a fascinating collection of facts and figures on cooperatives, sponsored by the National Cooperative Bank, Washington, DC.
4. The first 3 paragraphs of this section are based on Farmer Cooperative Statistics, 1995, RBS Service Report 52 (USDA 1996).
5. This chapter was written originally for Do Yourself a Favor: Join a Cooperative, RBS Cooperative Information Report 54 (USDA 1996).
6. Much of this chapter was also prepared by the author for Welcome to Cooperatives (see note 2, above).
7. This chapter reflects material originally published in Under-standing Cooperatives, a series of circulars that can be used individually or collectively for teaching people about cooperatives. RBS Cooperative Information Report 45, sections 4-6 (USDA 1994).
8. Much of the last 3 chapters was first drafted for Income Tax Treatment of Cooperatives: Background, RBS Cooperative Information Report 44, part 1 (USDA 1993), the first in a technical series of reports on Federal income taxation of cooperatives.