*14 Decisions will be entered under Rule 50.
1. Exemption -- Fruit Growers Cooperative -- Producer -- Section 101 (12). -- A fruit growers cooperative association which carries on, as one of its principal activities, the maintenance and caretaking of citrus groves and which markets for its members fruit purchased by them near harvest from nonmember growers does not qualify for exemption under section 101 (12).
2. Income -- Exclusion -- Patronage Dividends -- Revolving Fund Certificates -- Pre-existing Obligation -- Section 22 (a). -- A fruit growers cooperative, which, after distributing a part of the excess of its receipts over expenditures as cash patronage dividends, retains the rest in a reserve, may exclude from income the amount retained in the reserve to the extent that it issues, to those who contract with it, revolving fund certificates as evidence of the retained amounts, in accordance with a pre-existing contractual obligation.
*1003 The Commissioner determined deficiencies as follows:
| Declared | |||
| value | Excess profits | ||
| Fiscal year ended | Income tax | excess-profits | tax |
| tax | |||
| June 30, 1946 | $ 87,195.70 | $ 65,065.63 | $ 150,412.01 |
| June 30, 1949 | 51,977.99 |
*15 The issues for decision are whether the petitioner is a tax exempt agricultural cooperative under section 101 (12) of the Internal Revenue Code, and, if not, whether amounts retained as a reserve for capital expenditures, for which revolving fund certificates were issued, represent income taxable to the petitioner.
FINDINGS OF FACT.
The petitioner is an agricultural cooperative association organized under Florida laws on June 11, 1945. Its books are maintained on an accrual basis and closed annually on June 30. Its returns for the taxable years were filed with the collector of internal revenue for the district of Florida.
P. Phillips, his wife Della and son Howard incorporated the petitioner and, together with six corporations, were the only members of the cooperative from the time it began business, July 1, 1945, through June 30, 1949. The six member corporations were Dr. P. Phillips and Sons, Inc., Dr. P. Phillips Company, Dr. P. Phillips Canning Company, Dr. P. Phillips Investment Company, Inc., Citrus Fruit Products, Inc., and the Ozark Corporation. Dr. P. Phillips and Sons, Inc., owned all of the stock in the last four mentioned companies and 1,950 shares of the 2,000 outstanding*16 shares of Dr. P. Phillips Company. The remaining 50 shares were owned by P. Phillips and his sons Howard and Walter. Walter owned 4,999, Howard 4,999, and P. Phillips two shares of the 10,000 shares of the stock of Dr. P. Phillips and Sons, Inc. Walter sold all of his shares to P. Phillips, Della and Howard on March 11, 1948.
*1004 The articles of incorporation provided, inter alia, that the incorporators associated themselves together under the provisions of chapter 618 of Florida Statutes 1941 as a nonprofit cooperative association for the purposes of producing, harvesting, and marketing agricultural products; of purchasing, hiring, using or supplying machinery or equipment devoted to such production and marketing of agricultural products; and of engaging in any related activities such as the manufacture of fertilizers and insecticides. The rights and interests of each member were to be equal, each member was to have one vote, and new members could be admitted. The corporation could establish and maintain reasonable and necessary reserves.
Amendments to the original articles of incorporation were filed with the State of Florida on February 25, 1946. They provided, *17 among other things, that the corporation would have no stock (it never issued stock), it would be "operated on a cooperative basis for the mutual benefit of its members as producers," its membership would be limited to producers or associations of producers of agricultural products, and that "* * * the property rights and interests of each member in the association shall be unequal."
The cooperative began business on July 1, 1945. It purchased necessary equipment and supplies, then scarce, from its members as well as from nonmembers.
The petitioner's officers, from its inception through 1949, were P. Phillips, Della, Howard and three employees of the member companies.
The petitioner engaged in two types of activity, the maintenance or caretaking of groves, and the harvesting and marketing of different kinds of citrus fruits. The caretaking contracts provided for the use of caretaking machinery such as sprayers, for necessary supplies such as insecticides, and for the necessary labor. The contract usually provided that the grove owner would become a member of the petitioner and would not patronize any other caretaking service. Members were to be charged only for actual costs. *18 The petitioner performed grove caretaking services for all of its members but the record does not disclose to what extent the services were performed on groves owned by members. Caretaking receipts ranged from about $ 410,000 to about $ 750,000 during the fiscal years 1946 through 1949. The value of caretaking services rendered nonmembers during that period usually was less than a tenth of one per cent of the total value of all the services rendered.
Fruit marketing engaged in by the petitioner included the harvesting as well as the actual selling of fruit. The petitioner and the member entered into a contract similar in form to the caretaking contract, and the petitioner was appointed the "general agent of member for the purpose of marketing the citrus fruits grown by member." Marketing *1005 activities were conducted on the basis of pools. A pool would consist of one kind of fruit harvested during a certain season of the year. Members of the petitioner owning fruit in a given pool would share in the proceeds realized when the pool was closed out, on the basis of the amounts of fruit which they had contributed to the pool. Fruit marketing receipts ranged from about $ 1,900,000*19 to about $ 4,200,000 during the fiscal years 1946 through 1949.
All members of the petitioner owned fruit groves producing fruit marketed by the petitioner during the fiscal years ended June 30, 1946 and 1949. Three members, only, in 1946 and two, only, in 1949 marketed through the petitioner fruit grown on trees owned by nonmembers. The following table compares for the fiscal years 1946 and 1949 the number of boxes of fruit grown by those members on their own trees and marketed through the petitioner with those which they purchased from nonmembers and marketed through the petitioner:
| From | From nonmembers' | ||
| Year | Member | members' | groves |
| groves | |||
| 1946 | Dr. P. Phillips & Sons, Inc | 780,204 | 291,563 |
| Citrus Fruit Products, Inc | 22,742 | 46,536 | |
| Dr. P. Phillips Company | 51,126 | 70,917 | |
| Total | 854,072 | 409,016 | |
| 1949 | Dr. P. Phillips Company | 40,595 | 61,935 |
| Citrus Fruit Products, Inc | 24,476 | 353,181 | |
| Total | 65,071 | 415,116 |
The number of boxes of fruit grown by all members on their own trees constituted, during the period 1946 through 1949, from 60 to 80 per cent of the total number of boxes of fruit marketed by the petitioner. The approximate percentages were*20 70 for 1946 and 60 for 1949. The remainder was fruit purchased by members from nonmembers.
Seventy-nine boxes were purchased in 1946 from nonmembers on the date the fruit was picked. A contract for the purchase of 13,064 boxes was dated May 13, 1946, and the actual picking began and ended at dates, not shown by the record, within that same month. Purchases of about 9,000 boxes from nonmembers were made after the fruit was picked in 1949. About 2,000 boxes were purchased in 1949 on the day the picking of the fruit ended and over 10,000 boxes were bought in that year one to nine days before picking was completed.
The fruit purchased from nonmembers in 1946 was purchased entirely on bulk contracts, under which the entire crop was purchased for a fixed price that was not dependent upon the amount of fruit actually harvested. Substantially all of the purchases made in 1949 were similarly made in bulk, but in that year members also purchased fruit under contracts calling for a price dependent upon the number of boxes of fruit actually harvested. Full payment generally was *1006 made on the bulk contracts when the parties entered into those contracts.
Both types of contract imposed*21 upon the grove owner, referred to in the contracts as "grower," the responsibility for caring for the fruit "as directed and prescribed by Buyer," and, upon the grower's failure to exercise proper care, the purchaser was authorized to perform the necessary cultivation at the expense of the grove owner. The grove owner, in practice, after selling unripened fruit, generally carried out the necessary cultivation under the direction of the purchaser and agricultural experts provided by the petitioner. Cultivation expenses were in some instances borne by the grove owner and in others by the purchaser. The contract price depended in part upon who carried such expenses.
The petitioner for the fiscal years ended June 30, 1946 and 1949, realized net proceeds (receipts less costs) from marketing and caretaking activities, made distributions from those proceeds to members, and retained from those proceeds a reserve as follows:
| Year | Caretaking | Marketing | Totals | |
| 1946 | Net Proceeds | $ 75,718.24 | $ 2,795,854.21 | $ 2,871,572.45 |
| Distributions | 0 | 2,376,476.08 | 2,376,476.08 | |
| Retained in Reserve | 75,718.24 | 419,378.13 | 495,096.37 | |
| 1949 | Net Proceeds | 66,808.57 | 1,724,486.30 | 1,791,294.87 |
| Distributions | 60,127.71 | 1,574,186.12 | 1,634,313.83 | |
| Retained in Reserve | 6,680.86 | 150,300.18 | 156,981.04 |
*22 No proceeds were retained for the reserve in 1947 and 1948.
Revolving fund certificates were issued to the members as evidence of their interests in the amounts retained from caretaking and marketing proceeds in 1946 and 1949. The petitioner's articles of incorporation, as amended, provided that each member's share in retained proceeds be ascertainable at any time but did not require the issuance of certificates. The original by-laws required that certificates be issued but a subsequent amendment at a time not disclosed by the record left such issuance to the discretion of the board of directors. The petitioner's caretaking contracts provided for the return of caretaking receipts in excess of costs to the members except that:
* * * Association may defer the date of payment and retain all or any part thereof, as it may determine, and issue and deliver to member a certificate evidencing the same, as provided by the By-laws of the Association.
The marketing contracts contained no provision for the issuance of certificates.
The certificates issued were of two types, one covering marketing proceeds and the other caretaking. The written provisions of each *1007 type were identical. *23 They provided that the holder was entitled to a certain sum from the petitioner "on account of patronage refunds" subject to the conditions that the certificates could be retired "in the sole discretion of the Board of Directors." They were noninterest-bearing, the face amounts of the certificates could be reduced in the event that the certificates were charged with losses of the petitioner, and they were nonnegotiable and nonassignable.
Certificates were issued or patronage dividends were made in the amount of $ 16.85 in 1946 and $ 10.75 in 1949 to Dr. P. Phillips Fertilizer Company, a nonmember.
The amount retained in 1946 was used to pay for materials, machinery (particularly replacements thereof) and supplies necessary to the conduct of the petitioner's business. The amount withheld in 1949 was for similar purposes but the record does not indicate how that amount was actually used.
The petitioner had started business July 1, 1945, with depreciable assets purchased from members at their adjusted book value of $ 141,937.34. Those depreciable assets consisted generally of machinery, furniture, fixtures, automobiles, trucks, trailers, tractors, and buildings. The petitioner's *24 returns for the taxable years 1946 through 1949 show in the accounts for depreciable assets, cost balances, depreciation, and adjusted book values, as follows:
| 1945 | 1946 | 1947 | 1948 | 1949 | |
| Cost | 0 | $ 427,709.58 | $ 551,944.25 | $ 587,357.93 | $ 649,857.74 |
| Depreciation | 0 | 200,961.18 | 216,580.35 | 273,878.09 | 334,890.40 |
| Book Value | 0 | 226,748.40 | 335,363.90 | 313,479.84 | 314,967.34 |
The petitioner filed an "Exemption Affidavit" on November 15, 1946, claiming tax exemption under section 101 (12). The petitioner stated that of the value of products marketed for members, amounting to $ 4,567,030.33, $ 1,300,000 thereof was received for fruit supplied by members "but not produced by them." The petitioner was later advised that the application for exemption had been denied.
The returns of the petitioner for the taxable years 1946 and 1949 reported the proceeds that it distributed, as part of its cost of operations, i.e., the patronage refunds were subtracted in determining gross income. The amounts retained as a reserve were reported as "other deductions authorized by law" and were described on a schedule as "Provision for capital expenditures." The returns showed no net income.
*25 The Commissioner disallowed the petitioner's deductions of $ 495,096.37 on its return for the fiscal year ended June 30, 1946, and $ 156,981.04 on its return for the fiscal year ended June 30, 1949.
*1008 OPINION.
The petitioner claims that it is exempt from tax for 1946 and 1949 under the provisions of section 101 (12). That section provides that farmers, fruit growers, or like associations organized and operated on a cooperative basis for the purpose of marketing the products of members or other producers, and turning back to them, on the basis of the quantity or value of the products furnished by them, the proceeds of sales, less the necessary marketing expenses, or for the purpose of purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses, shall be exempt; exemption shall not be denied because such an association accumulates and maintains a reasonable reserve for any necessary purpose; and the products of nonmembers can be marketed but not to the extent that their value exceeds the value of the products marketed for members, and supplies and equipment may be purchased*26 for nonmembers provided the value of purchases for nonmembers and nonproducers does not exceed 15 per centum of the value of all purchases. The Commissioner, in determining the deficiencies, gave no explanation for holding the petitioner liable for the tax instead of holding that it was exempt under section 101 (12). The petitioner, under such circumstances, has the full burden of proving that it is exempt.
Each of the nine members of the petitioner during each of the taxable years marketed, through the petitioner, some fruit grown in the grove or groves of that member. Furthermore, patronage dividends were received by each of the members as a result of that marketing in each year. The petitioner was organized and operated to that extent on a cooperative basis for the purpose of marketing the products of members and turning back to them the proceeds of sales, less the necessary marketing expenses on the basis of the quantity or value of the products furnished by them. However, the activities of the petitioner did not end there. Three of the members in 1946 and two in 1949 marketed through the petitioner and received patronage dividends on fruit grown in the groves of nonmembers*27 and purchased by the members. The petitioner makes no argument that one who merely purchased a ripe crop at harvest and marketed it through the petitioner would be a farmer, a fruit grower, or a producer within the meaning of section 101 (12). The provision does not exempt an association of such persons. The petitioner contends, in respect to the purchases by members, that the members were fruit growers and producers of the fruit and were not mere purchasers of fruit grown and produced by others. Its reasoning is that most of those purchases were bulk purchases in which the member agreed to pay a fixed price for an existing crop on the trees without regard to the quantity of fruit *1009 actually picked and packed at harvest; the member either cultivated the crop from that date to harvest or employed the owner of the grove to do that cultivating, and in some or all instances the caretaking facilities of the petitioner were availed of; the members purchasing fruit assumed the risks of a grower or producer from the date of purchase of the crop to the date of harvest; and in a real sense the member was a grower and producer of that crop.
That contention is supported by evidence*28 that in some instances a substantial period of time elapsed between the date of the contract of purchase and the date when picking began so that the member might have taken some of the risks and responsibilities of a grower. But, the evidence shows affirmatively that the date of one of the 1946 contracts of purchase relied upon was the day on which the fruit was picked. The member was obviously not a grower or producer of that particular crop. It amounted to only 79 boxes of fruit but the member received patronage dividends on the marketing of that fruit. Another contract in that year on which 13,064 boxes of fruit were marketed and on which patronage dividends were received was dated May 13, 1946, and the picking began and ended at dates, not shown by the record, within that same month. That might have been a purchase of ripe fruit in respect to which the purchaser was not a grower or producer. The record shows the date of all of the other contracts for 1946 and the date upon which picking began and ended, but it is impossible to tell to what extent, if any, in some of those contracts the purchaser might fairly be regarded as having taken the risks and responsibilities of the*29 owner of a growing crop. The evidence in regard to 1949 is less favorable to the petitioner. There it shows affirmatively that the purchases of about 9,000 boxes were made after the fruit had been picked. Contracts for the purchase of about 2,000 boxes were dated on the same day on which picking ended. Contracts for over 10,000 boxes were dated from one to nine days before picking ended. Some of the contracts in 1949 were contracts in which the purchaser agreed to pay a stated amount for boxes of merchantable fruit at harvest time. The purchaser under those contracts did not take any of the risks inherent in a growing crop but only took the risk of market conditions at the time of harvest. There is no evidence as to the contract dates and picking dates for 61,935 boxes purchased by Dr. P. Phillips Company in 1949. The evidence fails to show in regard to some of the other contracts the extent to which the purchasers might fairly be regarded as growers.
Thus, the record shows that the marketing activities of the petitioner were not limited to marketing for growers in either year and, to that extent, the petitioner does not come within the exempting provisions of section 101*30 (12). Furthermore, its operation during *1010 each year included another important activity which section 101 (12) does not purport to exempt, that of maintaining or taking care of groves. That activity can not qualify as "purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses." Congress did not provide exemption in section 101 (12) for a corporation marketing the products of mere purchasers and taking care of groves. The question of whether the reserves were in violation of the section and other questions argued by the respondent need not be decided.
Although the Commissioner has held that the petitioner is not exempt under section 101 (12), nevertheless he has allowed the petitioner as a cooperative to exclude from income for tax purposes the amounts which it has distributed in cash as patronage dividends. There is no express statutory authority for this action but for many years the practice has been followed by the Treasury Department and it has received judicial sanction. The theory is that the cooperative is merely a conduit for the patronage dividends which*31 are in effect an additional cost of goods sold by a marketing cooperative or a rebate by a cooperative which purchases goods or performs services for its members. This exclusion has been applied to amounts retained as reserves by the cooperative where, pursuant to a pre-existing obligation or liability, revolving fund certificates are issued for the amounts retained. United Cooperatives, Inc., 4 T. C. 93, and Colony Farms Cooperative Dairy, Inc., 17 T.C. 688">17 T. C. 688. The petitioner contends that the amounts which it retained for its reserves are to be excluded from income because it was obligated to issue revolving fund certificates for those amounts.
The petitioner had a right under the laws of Florida, its charter, and its amended by-laws to retain amounts from its marketing activities without issuing any revolving fund certificates or other evidence of interest of the members therein. The original by-laws had required that revolving fund certificates be issued but they were amended to eliminate that requirement at some time not shown by the record, but possibly and therefore, presumably under the burden of proof, before *32 these two taxable years began. The contracts in regard to marketing contain no provision requiring the issuance of revolving fund certificates for funds retained. Therefore, the petitioner has failed to establish a factual situation which would bring this case within the cited cases and the principle of law established therein in so far as funds retained from the marketing operations are concerned. Since the patrons had no right to those retained amounts and have not received them, they could not be regarded as having contributed them to the petitioner. The situation in regard to caretaking *1011 activities is different to this extent, that the caretaking contracts contained a provision requiring the issuance of revolving fund certificates for any excessive receipts over expenses retained by the petitioner. It retained the net proceeds from caretaking for 1946 in the amount of $ 75,718.24 and it retained $ 6,680.86 from the same source in 1949. It issued revolving fund certificates for those amounts and they may be excluded from income under the two cases cited above.
Decisions will be entered under Rule 50.