*1868 1. A corporation which acts as purchasing agent for the purpose of purchasing supplies for the members of a cooperative association at cost, but at the same time carries on a substantial amount of business with nonmembers at a profit, is not exempt from taxation under the provisions of section 231(11) of the Revenue Act of 1921.
2. Where a corporation of the character referred to above pays patronage dividends to its members on the basis of purchases made for such members, such dividends which are paid out of profits from nonmember business may not be considered a reduction of the cost of the supplies to the members in the sense that they are deductible in determining the taxable income of the corporation. Similarly, excess earnings of such a corporation may not be considered as deductible accrued partronage dividends, where such dividends have not been declared or set aside and where such earnings arise from both member and nonmember business.
*315 This proceeding involves deficiencies in income and profits taxes*1869 as determined by the Commissioner for 1919, 1920, 1921, and 1923 in the respective amounts of $31,338.17, $45,237.06, $72,599.93, and $12,636.71. The errors assigned relate to the following questions: (1) That petitioner is exempt from taxation under the provisions of section 231(11) of the Revenue Act of 1921; (2) that even if not *316 exempt under the foregoing provision, in any event it is entitled to a deduction of its entire surplus receipts for each year, which would likewise have the effect of relieving it of the payment of any tax for the years involved; and (3) that the deficiencies proposed for 1919, 1920, and 1921 are barred by the statute of limitations. At the hearing it was stipulated by the parties that deductions not heretofore allowed should be allowed as follows:
| 1920 Interest | $34,826.57 |
| Amortization of bond expenses | 4,934.99 |
| 1921 Interest | 32,011.56 |
| Amortization of bond expenses | 4,934.99 |
| 1923 Amortization of bond expenses | 4,934.99 |
The petitioner is a California corporation which was organized in 1907 and has its principal place of business in Los Angeles. The petitioner was organized for the purpose of carrying*1870 on work theretofore carried on by the California Fruit Growers Exchange(hereinafter sometimes referred to as the Exchange) in purchasing supplies for its members, and under its charter it was given broad powers which permitted it to engage in many lines of business. TheExchange is a nonstock cooperative marketing association which was formed by the grower associations for the purpose of marketing their fruit in an orderly manner. The individual fruit growers are organized into local associations and the local associations are federated into district exchanges. The local associations own all of the memberships of the Exchange and also the stock of the petitioner. For the purpose of keeping the holdings in the petitioner by the local associations in proportion to their shipments of fruit through the Exchange, so-called "revolving fund agreements" were entered into prior to the taxable years here involved, which agreements were in existence during the years before us with respect to ownership of memberships in the Exchange and petitioner's stock. Under these agreements substantially all the stock of petitioner was placed with a depositary, and, as their production of fruit would increase*1871 or decrease, the stockholders would buy or sell stock, thereby keeping their respective holdings in proportion to their respective production of fruit marketed through the Exchange.
The petitioner, in performing its function as a purchasing agency for the fruit growers, purchases and manufactures for its members box shook suitable for boxing citrus fruits. It also purchases for its members packing house and orchard supplies, such as nails, fertilizer, fumigating materials and similar supplies. In order to manufacture box shook, petitioner found it expedient and necessary to purchase large tracts of timber. Approximately 70,000 acres are owned, upon *317 which are standing approximately 1,500,000,000 feet of virgin timber. In addition, in excess of 1,000,000,000 feet of timber are held undercontract with the United States Government in the Lassen and Klamath National Forests. In manufacturing the timber into lumber, the petitioner does not use the better grades of lumber for box shook, but sells it to the public on the open market, and it likewise sells at prevailing market prices to nonmember vegetable and deciduous fruit growers lower-grade box shook which is unsuited*1872 for the use of citrus fruit growers. The foregoing method is not only the most economical way of making use of the timber cut, but it is also in accordance with an understanding which the petitioner had with the Bureau of Forestry, United States Department of Agriculture,for the conservation of forestry products by using the same for their highest purpose.
In carrying out its purpose to furnish supplies to its stockholders at cost, petitioner bills supplies to its stockholders at a fixed price which is estimated to be sufficient to cover the cost of the supplies plus necessary overhead expenses. At the end of the year the books are balanced and the cost of operations obtained, and the prices of the various articles are adjusted to the stockholder accordingly. If the amount paid by the stockholder exceeds the adjusted price, a rebater "patronage dividend" is made to the stockholder, but if the adjusted price exceeds the billing price, the stockholder is called upon to pay the difference. In determining the amount of patronage dividends to be paid or whether the members should be called upon to make up a deficiency, business done with members and nonmembers is taken into consideration.
*1873 In Article V of petitioner's by-laws it is provided that it shall be the duty of the directors: To declare dividends out of the surplus profits, when such profits shall, in the opinion of the Directors, warrant the same, subject to the provisions of Article XIX of these By-Laws. Article XIX, as in effect prior to November 5, 1919, provided in part as follows:
1. In order to carry out the purpose of this Corporation the Board of Directors shall, out of the net profits made or arising from that part of its assets or capital devoted to or invested in the operating or manufacturing department declare and pay annually in dividends an amount not to exceed 6per cent. on the assets and capital devoted to or invested in said operating department, as aforesaid, as distinguished from that part of its assets or capital devoted to or invested in timber lands, lumber, and all other material from which said supplies shall be manufactured.
2. The Board of Directors shall sell and furnish to Stockholders who are affiliated with the California Fruit Growers Exchange their supplies for use in packing and marketing their fruits, at the actual cost of material and of manufacture, which shall include*1874 proper and necessary charges for depreciation or maintenance of the said operating department and such general expenses *318 as may be necessary to carry on said department, plus 6 per cent. on the assets and capital of said Company devoted to or invested in said operating department as aforesaid.
3. The Board of Directors shall from time to time have power to fix the price at which all supplies manufactured by the operating department shall be sold, but at the end of each shipping year the Board shall readjust its prices so that the price which each Stockholder shall pay for his supplies shall be in accordance with the provisions of these By-Laws.
Article XIX was amended on November 5, 1919, to read in part as follows:
Section 1. This corporation shall upon the conditions set forth herein, sell and furnish to such of its stockholders as market their citrus fruits through California Fruit Growers Exchange, their packing house, orchard and other supplies at cost, the cost including general expenses, proper and necessary charges for depreciation, maintenance, reserve for contingencies and six (6%) per cent interest payable if and when earned on the stockholders' investment*1875 in the corporation.
Section 2. The directors of this corporation are hereby authorized by resolution to prescribe, and from time to time to change the manner of billing to its patrons, the price to be paid, and the time and manner of readjustment with or refund to its patrons.
The board of directors, in compliance with the foregoing by-law, determined the surplus proceeds at the end of each shipping season, and, after providing for the 6 per cent dividend to be paid on the capital stock and for depreciation and contingencies, declared the remainder as patronage dividends. These dividends were paid only to stockholders and the petitioner has paid such dividends, as well as fixed dividends on its capital stock, throughout its existence. Thepatronage dividends included not only surplus arising from business done with members but also with nonmembers.
The amounts and percentages of business transacted by petitioner with members and nonmembers during they years 1919 to 1923, inclusive, were as follows:
| Amounts | Percentages | |||
| Year | Members | Nonmembers | Members | Nonmembers |
| 1919 | $7,427,367.04 | $457,145.06 | 94.20 | 5.80 |
| 1920 | 10,674,011.51 | 598,858.01 | 94,69 | 5.31 |
| 1921 | 11,078,187.02 | 762,185.02 | 93.56 | 6.44 |
| 1922 | 7,021,924.24 | 1,778,140.93 | 79.79 | 20.21 |
| 1923 | 10,626,234.11 | 1,577,527.87 | 87.08 | 12.92 |
*1876 During the years 1919, 1920, 1921, and 1923 the gross sales of the California Fruit Growers Exchange were as follows:
| 1919 | $59,735,298.49 |
| 1920 | 53,224,808.02 |
| 1921 | 62,379,836.24 |
| 1923 | 54,510,450.63 |
*319 The following extracts from the annual report of petitioner's manager for 1922 is illustrative of the extent of petitioner's operations and the service it renders to its members:
The freeze of January 1922 which greatly reduced the California citrus crop afforded an added illustration of the value of the Supply Company to its members. Without the flexible supply of citrus shook which the ownership of the lumber plants provides, the organization would in the normal course of events have anticipated its members' past season's requirements and contracted for its supply of shook prior to the freeze. However, with the availability of a more or less flexible reserve supply from its own plants the Company, with entire safety, was enabled to enter that period of the year with a portion of the estimated requirements from other sources not covered by contracts. Accordingly, when the freeze occurred, it was possible to divert that part of its own lumber held*1877 in reserve, which ordinarily would have been cut into citrus shook, to other channels at profitable prices.
| The total value of purchases by members through the Company | |
| since its organization aggregates | $61,721,657.00 |
| The total value of lumber and lumber products sold to other | |
| than members during the time is | 9,354,191.00 |
| Total value of business transacted | 71,075,848.00 |
| There has been paid to members as dividends on their capital | |
| stock investment | 1,030,040.87 |
| This represents 6% interest on their entire capital | |
| investment for the full term of the investment. In addition | |
| thereto there has been returned to members as refunds, or | |
| further reductions in the advance billing out price on their | |
| purchases | 3,722,300.30 |
| This represents a total returned to members in cash as | |
| dividends and refunds since the organization of the Company, of | 4,752,341.17 |
| The present paid up capital of the Supply Company is | 4,282,720.00 |
The direct saving to members on their purchases is really small as compared with the real accomplishment of the organization; the big saving is represented by that amount which it has not been necessary for them to pay because the Exchange*1878 growers own and operate a Supply Company. It is safe to assume that it exerts a valuable stabilizing influence in the markets and insures fair prices for those commodities which the entire citrus industry uses in quantity. Through its policy of direct purchases from manufacturer where possible, it eliminates and saves to its members those factors in cost which are not offset by essential service.
Further statements from the same report are:
On account of the freeze a considerable portion of lumber ordinarily manufactured into citrus shook was diverted to lumber or deciduous shook. This, together with the increased cut at Lassen, formed a considerable increase in lumber sales handled by this department during the past year. Nevertheless *320 the commodity was sold at satisfactory prices with minimum sales expense. Active building programs prevailing over much of the country indicate a favorable market for lumber products during 1923.
In a similar report for 1921 we find this statement:
Operating normally, it will be desirable and profitable for the Supply Company to sell in open market its production of the higher grades of lumber and on that basis should supply*1879 approximately one-half of its members' annual shook requirements, which now exceed 100,000,000 feet of lumber; however, when it is unable to replace the higher grades of lumber sold, through purchase of shook or low grade lumber from others based on the value of the lower grades, it can under these conditions manufacture its entire cut of lumber into boxes and supply its members' full requirements.
And in a similar report for 1923, it is stated that:
The price at which any commodity can ultimately be sold is necessarily regulated by the law of supply nd demand. Notwithstanding the continued building activity throughout the country, there was a slowing up in demand for upper grades of lumber during the latter part of the year. This resulted in more or less of a recession in price during that time. The financial position of the Company enabled it to refrain from selling during this period except at reasonable market values and to realize later, on the stronger market values that obtained after the close of the active operating season.
In the determination of the deficiencies here in question, the Com missioner reduced the amount of depreciation taken by the petitioner in its*1880 return and otherwise increased the income of the petitioner for the years involved in this proceeding to an amount in excess of that shown on its books nd in its returns. This petitioner's books were kept on the accrual basis for all years involved as well as prior years. The deficiency notice shows net income determined as follows:
| 1919 | |||
| Income - Los Angeles Branch, Members, | |||
| exhibit A, Revenue Agent's report, | |||
| January 22, 1927 | $394,316.48 | ||
| Income - Hilt Branch: | |||
| Shook Department, Members | $165,434.28 | ||
| Shook Department, Non-members | 9,005.00 | ||
| 174,439.28 | |||
| Lumber Department, Non-members | 51,642.75 | ||
| Total | 620,398.51 | ||
| Less: Patronage dividends (Los | |||
| Angeles) | 408,532.72 | ||
| Net income, Schedule 4, Revenue | |||
| Agent's report, January 22, 1927 | 211,865.79 | ||
| 1920 | |||
| Income, Los Angeles Branch, Member, | |||
| Exhibit A, Revenue Agent's report, | |||
| January 22, 1927 | $936,599.28 | ||
| Income, Hilt Branch, Lumber | |||
| Department, Non-members | $153,480.62 | ||
| Shook Department, Non-members | $16,888.33 | ||
| Shook Department, Members | 99,178.34 | ||
| 116,066.67 | |||
| 269,547.29 | |||
| Total | 1,206,146.57 | ||
| Less: Patronage dividends (Los | |||
| Angeles) | 920,303.75 | ||
| Net income | 285,842.82 | ||
| 1921 | |||
| Income, Los Angeles Branch, Members, | |||
| exhibit A, Revenue Agent's report, | |||
| January 22, 1927 | $1,476,145.81 | ||
| Income, Hilt Branch, See Exhibit B, | |||
| Revenue Agent's report, | |||
| January 22, 1927: | |||
| Shook Department, Members | $110,921.57 | ||
| Less: Shook Department, Non-members | 3,466.25 | ||
| Balance | 107,455.32 | ||
| Less: Lumber Department, See | |||
| Exhibit B, Revenue Agent's report, | |||
| January 22, 1927, for above | 42,476.58 | ||
| 64,978.74 | |||
| Balance | 1,541,124.55 | ||
| Add: | |||
| Susanville Branch, See Exhibit C, | |||
| Revenue Agent's report, | |||
| January 22, 1927 - | |||
| Lumber Department, Non-members | $75,776.82 | ||
| Shook Department, Non-members | 35,405.21 | ||
| Total | 111,182.03 | ||
| Shook Department, Members | 80,946.50 | ||
| 192,128.53 | |||
| Total | 1,733,253.08 | ||
| Deduct: Patronage dividends (Los | |||
| Angeles) | 1,312,114.21 | ||
| Net income | 421,138.87 | ||
| 1922 | |||
| Net income - Los Angeles | $42,008.74 | ||
| Less: | |||
| Loss, Hilt Branch, See Exhibit B, | |||
| Revenue Agent's report, | |||
| January 22, 1927 - | |||
| Lumber Department, Non-members | $17,162.56 | ||
| Shook Department, Non-members | 58,473.15 | ||
| Shook Department, Members | 86,482.46 | ||
| Total loss, Hilt Branch | 162,118.17 | ||
| Income, Susanville Branch, Exhibit C: | |||
| Lumber Department, Non-members | $160,597.85 | ||
| Shook Department, Non-members | 42,805.15 | ||
| Shook Department, Members | 16,044.60 | ||
| $219,447.60 | |||
| $57,329.43 | |||
| Total income | 99,338.17 | ||
| Less: Patronage dividend (Los Angeles) | 10,507.31 | ||
| Total taxable income | 88,830.86 | ||
| 1923 | |||
| Net income (Los Angeles) | $297,479.84 | ||
| Less: | |||
| Loss, Hilt Branch, Exhibit B, | |||
| Revenue Agent's report, | |||
| January 22, 1927 - | |||
| Lumber Department, Non-members | $45,623.43 | ||
| Shook Department, Non-members | 13,116.36 | ||
| Shook Department, Members | 5,560.09 | ||
| 64,299.88 | |||
| Balance | 233,179.96 | ||
| Less: | |||
| Loss, Susanville Plant, Exhibit C - | |||
| Lumber Department, Non-members (Loss) | $160,337.73 | ||
| Income, Shook Department, Non-members | $5,377.19 | ||
| Income, Shook Department, Members | 79,335.65 | ||
| 84,712.84 | |||
| 75,624.89 | |||
| Balance | 157,555.07 | ||
| Less: Patronage dividend, (Los | |||
| Angeles) | 56,461.37 | ||
| Taxable income | 101,093.70 |
*1881 *322 The petitioner filed its income and profits-tax returns for the years here involved on this following dates: 1919 on May 13, 1920 (extension granted for filing that date); 1920 on March 15, 1921; and 1921 on June 8, 1922 (extension granted for filing on that date). On November 28, 1924, the petitioner executed a waiver extending the time for the assessment and collection of taxes due for 1919 until November 28, 1925. On September 30, 1925, a second waiver was executed by the petitioner extending the time for the assessment of taxes for the years 1918 to 1921, inclusive, until December 31, 1925. On November 25, 1925, a third waiver was executed by the petitioner extending the time for the assessment of taxes for the years 1918 to 1921, inclusive, until December 31, 1926. And on September 18, 1926, a fourth waiver was executed by the petitioner extending the time for the assessment of taxes for the years 1918 to *323 1922, inclusive, until December 31, 1927. The name "D. H. Blair, Commissioner," is subscribed to each waiver, though in the instances of the second and third waivers initials appear thereunder and in the case of the fourth waiver the signature appearing*1882 is "D. H. Blair, Commissioner, by E. C. Wright, Supervising Internal Revenue Agent." The last three waivers also contain the usual provision with respect to an extension of time on account of the filing of an appeal with the Board. The notice of deficiency on which this proceeding is based was mailed on June 17, 1927, and a petition was duly filed with the Board within 60 days thereafter.
OPINION.
SEAWELL: The primary question here presented is whether the petitioner is exempt from taxation under the provisions of section 231(11) of the Revenue Acts of 1918 and 1921. In its brief, the petitioner admits (and we think properly so) that the Revenue Act of 1918 does not include corporations which act as purchasing agents among those exempt from taxation under its provisions, and therefore the petitioner can not be considered exempt for 1919 and 1920. This leaves for consideration the applicability of section 231(11) of the Revenue Act of 1921, which reads as follows:
SEC. 231. That the following organizations shall be exempt from taxation under this title -
* * *
(11) Farmers', fruit growers', or like associations, organized and operated as sales agents for the purpose*1883 of marketing the products of members and turning back to them the proceeds of sales, less the necessary selling expenses, on the basis of the quantity of produce furnished by them; or organized and operated as purchasing agents for the purpose of purchasing supplies and equipment for the use of members and turning over such supplies and equipment to such members at actual cost, plus necessary expenses.
We think it well established that petitioner was organized for the purpose of purchasing supplies for members of the California Fruit Growers Exchange, which members were likewise the stockholders of the petitioner, and it may also have been intended that it would not operate as a profit-making organization, though the powers granted under its charter are so broad that it might well engage in almost every kind of business, some of which might not be even remotely connected with the purchase of supplies for its members. We are concerned, however, not alone with what may have been the purpose in organizing the petitioner, but also with the manner in which it operated. The statute says "organized and operated" for the purposes therein named. Provisions of the law granting exemption*1884 from taxation must be strictly construed against those claiming the exemption. Waynesboro Manufacturers Association,1 B.T.A. 911">1 B.T.A. 911; *324 Farmers' Co-operative Milk Co.,9 B.T.A. 696">9 B.T.A. 696; Northwestern Drug Co.,14 B.T.A. 222">14 B.T.A. 222; and Riverdale Co-operative Creamery Association,18 B.T.A. 1159">18 B.T.A. 1159.
And when we come to examine the manner in which petitioner's operations were carried on, we are not convinced that it can be considered exempt from taxation. While its dealings with nonmembers arose through the necessity for disposing of certain grades of lumber in the most economical manner and in accordance with its understanding with the Bureau of Forestry, it is nevertheless true that this phase of its business is carried on for profit in the same sense as that of the ordinary taxable corporation. In order to have a supply of timber available from which to manufacture box shook, petitioner acquired a large boundary of valuable timber and also contracted with the Bureau of Forestry for large additional amounts of timber. Box shook, an essential supply for petitioner's stockholders, the need for which had much to do with*1885 the formation of the petitioner, was manufactured from this timber, and in addition there was also manufactured lumber which was sold for commercial purposes and to persons other than members or stockholders. These latter sales were at prevailing market prices and resulted in substantial profits to the petitioner. While the foregoing uses of the lumber manufactured were in accordance with an understanding had with the Bureau of Forestry for using the timber to its highest purpose, we do not think this the sole reason for such sale or that the petitioner would have pursued a very different course in the absence of such an agreement. The reports of petitioner's manager show that it was considered both desirable and profitable to sell the higher grades of lumber in the open market, but that if such higher grades were needed for the manufacture of box shook, they could be so utilized.
When we consider the extent of petitioner's lumber operations, and a comparison of its sales to members with those made to nonmembers (the latter being largely of lumber), we are unable to say that the transactions with nonmembers are negligible. In terms of percentages, the nonmember sales range from*1886 5.31 per cent of the total sales in 1920 to 12.92 per cent in 1923. In 1922, a year not before the Board because of an overassessment determined for such year, the percentage was 20.21 per cent. The sales were substantial in amount, running from slightly less than half a million to more than a million and a half dollars and the profits from this nonmember business were likewise substantial. From its organization to 1923, approximately 13 per cent of its business had been with nonmembers. The petitioner's answer to the profit feature of the nonmember business is that this is not in fact a profit to the petitioner, but rather only an amount realized from such business which serves to reduce the cost of *325 supplies to members. In a sense this is true, namely, the profits from the nonmember business are paid to the members as dividends and therefore the net amount paid by members for supplies might be said to have been reduced to that extent. But if we carry this argument to its logical conclusion, might it not be possible for such a corporation to furnish supplies to members without cost or even pay them to take the supplies furnished? We can not think Congress intended*1887 to exempt such profits or that a corporation thus engaged should be exempt from taxation. Congress may well have had the foregoing situation in mind when it provided in the 1926 and 1928 Acts (section 231(12)) that a cooperative purchasing association might still be considered exempt even though purchases were made for nonmembers, provided the value of such purchases does not exceed 15 per cent of all its purchases. And the further fact exists that the petitioner is necessarily a competitor of other corporations or individuals engaged in commercial activities in similar lines of business, and therein may well lie one of the reasons why Congress has not by specific enactment exempted from tax those corporations, including this petitioner, which, although engaged in some form of cooperative endeavor, are nevertheless commercial, competitive, and profitable with respect to a substantial portion of their business carried on. On the whole, we are of the opinion that the exemption claimed should not be allowed.
The next contention advanced by the petitioner is that, even if it is held not to be exempt under section 231(11) of the Revenue Act of 1921, it is entitled to a deduction, *1888 as patronage dividends paid or accrued, of its entire surplus earnings for each year. And closely related thereto is the further contention that in any event the petitioner could have no taxable income under the Sixteenth Amendment to determine the petitioner's net income for each year in a manner to determine the petitioner's net income for each year in a manner similar to that which would be followed in the case of any taxable corporation. Since we have held that the petitioner is not an exempt corporation, his initial step in such a determination would seem to be a proper one. From the total net income as thus determined the Commissioner then allowed a further deduction of all patronage dividends which were applicable to the respective years and considered the difference between the total net income and the patronage dividends as taxable income. And if we understand correctly the amounts which have been allowed in this latter deduction, the effect was to give the petitioner the benefit as a deduction of all patronage dividends declared or paid during the years with which we are concerned. The essence of what the petitioner asks is to say that all surplus earnings for a given*1889 year which have not been paid out as such dividends by the end of such year automatically *326 become patronage dividends accrued, without any action on the part of the petitioner declaring them as dividends, and that they are therefore deductible under its accrual system of accounting. This amounts to little more than saying that the petitioner can have no taxable income.
We are unable to agree with the foregoing contention. In the first place, we find nothing in the governing statute which provides for a partial exemption from taxation of corporations of the character of the petitioner. However, as stated by the Conference Report of Congress in considering the 1926 Act (Conference Report No. 356, p. 36, dated February 22, 1926), the Treasury Department in its regulations has construed the statute with which we are concerned with "great liberality" to the end that substantial justice may be done to an association which is engaged in cooperative marketing or purchasing work but which may not be exempt from taxation. In the instant case the effect of what the Commissioner did in allowing a deduction on account of patronage dividends was to relieve the petitioner from tax*1890 on account of what would otherwise be considered taxable profit. This may well be justified on the ground that to the extent these patronage dividends arise wholly out of business done with members they are rebates on such business and therefore should serve to reduce or eliminate profit arising from such transactions. The petitioner now asks that we increase the patronage-dividend deduction on account of an amount which has not been returned to the members and when no dividend declaration has been made with respect thereto. We find nothing in the petitioner's by-laws which would cause these patronage dividends to accrue as such without corporate action setting them apart as a liability of the petitioner to its members. The by-laws provide that it shall be the duty of the directors to "declare dividends out of surplus profits when such profits shall, in the opinion of the directors, warrant the same, subject to the provisions" of another section wherein it is provided that the directors are authorized to prescribe "the time and manner of readjustment with or refund to its patrons." A reasonable interpretation of the foregoing would seem to be that corporate action is required before*1891 patronage dividends accrue, and this conclusion is consistent with the minutes of the board of directors for the various years here involved. Illustrative of such minutes is the following:
The Manager reported that the total amount of business transacted for the season ending August 31, 1920 amounted to $9,837,073.83 that after deduction of the operating expenses and providing for the 6% annual interest on capital stock, and the transfer of $9,837.09 to the reserve fund, there remained for distribution the sum of $257,459.01, and recommended that the sums of $201,786.89 on packing house supplies and $55,672.12 on orchard supplies be *327 returned to members in proportion to their purchases as a further reduction in prices paid for materials, when funds were available for that purpose.
Moved by Whitcomb, seconded by Swan that the recommendation be approved. CARRIED.
The argument that because the by-laws provided that the petitioner should furnish supplies to members at cost all excess earnings would accrue as deductible patronage dividends may well be answered by the fact that excess earnings are attributable both to member and nonmember business. The petitioner urges*1892 that even the nonmember profits should be treated as a reduction of cost under its by-laws and therefore all excess earnings constitute deductible patronage dividends. This would amount to an indirect means of exempting from taxation profits of this character which, as stated under our discussion of the first issue, we do not consider proper. Certainly, there is nothing in the character of such earnings which would cause them to be considered other than income within the meaning of the Sixteenth Amendment.
The petitioner calls our attention to various cases decided by the Board where patronage dividends were considered accrued and therefore allowable as a deduction even though not paid in the year claimed, but we think those cases are distinguishable from the case at bar. The additional amount allowed in Home Builders Shipping Association,8 B.T.A. 903">8 B.T.A. 903, had been determined and authorized by the directors during the year for which the deduction was claimed. In Anamosa Farmers Creamery Co.,13 B.T.A. 907">13 B.T.A. 907, the books of the petitioner disclosed a net income at the close of the year which was then credited to the members or stockholders in proportion*1893 to the business done with them. The Board held that the amount so credited constituted an accrued patronage dividend which was deductible. In Farmers' Union Cooperative Association,13 B.T.A. 969">13 B.T.A. 969, the amount allowed was regularly authorized during the year for which claimed, though in the following year it was voted that the distributions authorized should be returned. We considered the foregoing situations different from the case at bar, where we are asked to say that all excess earnings, including the increase made by the Commissioner in his determination, should be considered to have accrued as patronage dividends without any setting apart or payment of such earnings to the members.
The further contention is advanced that the fixed dividend of 6 per cent paid by the petitioner is also deductible in computing its net income. While these payments are referred to in one of the bylaws as "interest," it is not understood that it is seriously contended that they differ in any material respects from the ordinary dividend of a corporation. In fact, they are so treated by the petitioner in its returns as filed for 1919, 1920, and 1921, not only in determining taxable*1894 net income, but also in adjustments for invested capital purposes. *328 The by-laws provide that these amounts shall be paid "if and when earned on the stockholders' investment in the corporation." They are not like interest which would be payable irrespective of earnings, and we find nothing in the by-laws which would be ground for legal proceedings against the petitioner for nonpayment when the earnings do not justify such payment. We are of the opinion that this question is controlled by prior decisions of the Board wherein similar payments have been held not deductible. Sacred Heart Cooperative Mercantile Co.,2 B.T.A. 24">2 B.T.A. 24; Farmers Cooperative Association,5 B.T.A. 61">5 B.T.A. 61; Trego County Cooperative Association,6 B.T.A. 1275">6 B.T.A. 1275; and Riverdale Co-Operative Creamery Association, supra.
The final issue is whether the statute of limitations has run with respect to the assessment of the deficiencies for 1919, 1920, and 1921. Admittedly, the original statutory period has run on the return as filed for each of the above years, but the Commissioner relies on certain waivers, which, if valid, are sufficient to extend*1895 the time for assessment beyond June 17, 1927, the date of the deficiency notice. The basic objections of the petitioner to these waivers are shown by the following paragraph in its brief:
The respondent did absolutely nothing to prove that the statute had been extended except that his counsel at the trial offered in evidence certified photostatic copies of certain papers. The petitioner stipulated that it had signed the originals of those papers. No other evidence was produced. The respondent did not prove where the originals were lodged. He did not prove who signed the originals on behalf of the other party to the documents. He did not prove that the person who signed them had authority to do so. He did not prove that they were signed by the Commissioner, nor that the Commissioner had authorized anyone else to sign them, or that if the Commissioner had authorized anyone else to sign them that the person authorized had signed them.
Substantially the same objections have heretofore been considered by the Board in other cases and held ineffective. *1896 Trustees for Ohio & Big Sandy Coal Co. et al.,9 B.T.A. 617">9 B.T.A. 617 (affirmed on this point, Trustees for Ohio & Big Sandy Coal Co. v. Commissioner, 43 Fed.(2d) 282; Pantlind Hotel Co. et al.,9 B.T.A. 878">9 B.T.A. 878; National Piano Manufacturing Co.,11 B.T.A. 46">11 B.T.A. 46; and Consumers Ice Co.,11 B.T.A. 144">11 B.T.A. 144. See also Liberty Baking Co. v. Heiner, 34 Fed.(2d) 513 (affd., 37 Fed.(2d) 203); Diamond Alakali Co. v. Heiner, 39 Fed.(2d) 645; and Pantages Theatre Co. v. Lucas, 42 Fed.(2d) 810, affirming Pantages Theatre Co.,17 B.T.A. 82">17 B.T.A. 82). In fact, the petitioner inferentially admits in its brief that the decisions of the Board are contrary to its position, but suggests, for reasons therein given, that such cases have been decided erroneously. We are of the opinion that the reasons advanced by the petitioner are fully answered in *329 the authorities cited above, and accordingly hold that the deficiencies in question are not barred.
Reviewed by the Board.
Judgment will be entered under Rule 50.
LANSDON, *1897 dissenting: I disagree with the majority opinion herein. The petitioner was organized and in the taxable years was operated for the sole purpose of purchasing supplies for the use of the members of the California Fruit Growers Exchange, a cooperative organization that markets the agricultural commodities produced by its own members and no others. The stockholders or members of the petitioner are the component units of the Exchange and all the capital used is supplied by such members who accumulated, held, and used it for the purpose of their organization.
One of the major needs of the Exchange is box shook for making containers in which fruit is shipped to the markets. Without abundant supplies of shook accessible at economically advantageous prices, the Exchange would be unable to realize the purposes for which it was organized. In order to effect substantial savings on the cost of shook, the petitioner found it advisable to acquire suitable timber and create the agencies for converting the same into material for the use of its members. Box shook, as set forth in the majority opinion, does not require high grade timber in its production. In the lumber cut from the timber*1898 of the petitioner there is necessarily a considerable quantity grading so high that its use for shook would be uneconomical and wasteful. This high grade lumber was sold, in part at least, to the public. It seems clear that such sales were a mere incident of the activities necessary to effect the purpose of the petitioner. If the membership had absorbed the entire output of high grade lumber none would argue that the petitioner is not entitled to exemption from tax under the provision of law upon which it relies. The annual average sales of lumber to nonmembers in the taxable years were only slightly in excess of 10 per cent of the total sales of all supplies to members and the proceeds thereof, whether retained as operating capital, or distributed profits to the members, served the single primary purpose of the petitioner's organization, which was to reduce the cost of necessary supplies for use in the production and marketing of fruit.
The record discloses that except in 1922 and 1923 petitioner's sales of lumber to outsiders averaged less than 6 per cent of its total turnover. In those years there were heavy and damaging frosts in the citrus fruit belt which reduced production*1899 and the growers' requirements for shook. This left an abnormal amount of material in the hands of the petitioner which sound business practice required that *330 it should dispose of on the best terms possible. It is obvious, therefore, that the sales of lumber in 1922 and 1923 are not indicative of any departure from the fixed policy of the petitioner, but resulted from extraordinary conditions over which it had no control.
It is apparent from the record that the manufacturing operations of the petitioner were not sufficiently extensive to supply the needs of its members for the quality of shook required in their business. The sale of higher grades of lumber to be used for purposes to which it was best adapted was in pursuance with an understanding with the Bureau of Forestry which was a part of the Departmental policy for the conservation of natural resources by the application of lumber and other products to the purposes for which they were best fitted. The sale of the higher grade lumber to outsiders and of some inferior shook to deciduous fruit growers enabled the petitioner to use the proceeds therefrom for purchasing for its members much suitable shook that it*1900 was unable to produce in its own operation and obviated any necessity for using high grade material where lower grades were equally or more adequate.
It is also of record that the sales of lumber to outsiders were at a profit-making price, while the sales of supplies to members were approximately at cost. If the usual commercial profit is added to the total of sales to members, it is obvious that the transactions with nonmembers constitute much less than 10 per cent of the total yearly business of the petitioner. It is hardly conceivable that Congress would create an exempt status for organizations like the petitioner and then take away all the advantages of exemption by the application of a definition to permitted activities narrowly precluding operations essential to success. Aside from the sale of the relatively small amount of its lumber production to nonmembers, there is nothing in the record that indicates that the petitioner is not entitled to the exemption provided in section 231(11) of the Revenue Act of 1921. Cf. *1901 Trinidad v. Sagrada Orden de Predicadores,263 U.S. 578">263 U.S. 578.
ARUNDELL agrees with this dissent.