IRS approves novel structure for cooperative of foreign members.

• Author: Shakow, David J.

In Letter Ruling 200430028, the IRS took a flexible approach in deciding whether to treat an entity as a cooperative for tax purposes. The Service looked to the underlying structure of the business arrangement, rather than focusing on mechanical details, suggesting that it may be prepared to approach issues relating to the treatment of cooperatives flexibly in the future.

Background

In the ruling, growers proposed a novel structure to market their foreign-grown produce in the U.S. Three members, each a corporation in foreign country A, created a U.S. cooperative. Each member dealt exclusively with one of three crops that the cooperative would market in the U.S. A group of mostly unrelated growers (described as "primarily unrelated closely-held corporations whose farming activities are conducted in" A) own these three companies. For purposes of sales in the U.S., each grower will be a voting owner of one (and only one) of the cooperative's three member companies (the company whose crop is the grower's predominant crop). Any grower who produces more than one crop can be a nonvoting patron of the company that sold the crop the grower does not specialize in.

The growers market their produce in A through a single grower-owned company. That company will initially coordinate the allocation of crops between distribution in the U.S. and distribution in A, for which the growers will pay a fee. To the extent crops are allocated for U.S. distribution, each of the cooperative's three members will authorize its grower-shareholders to sell produce to the cooperative at an arm's-length price.

Division of earnings: The cooperative will market the produce and distribute its net earnings as patronage dividends to the three members, based on the business done with the cooperative by each member's respective grower-shareholders. Similarly, on liquidation, residual assets will be distributed based on patronage, to the extent practicable. Each cooperative member's capital contributions will be made in proportion to the anticipated patronage in the cooperative; it is intended that ownership will be maintained in alignment with sales.

The three member corporations are governed internally by rules similar to those that govern U.S. cooperatives. The shares of each are held only by growers; they do not plan to have nongrower investors. Annually, each member corporation is required to allocate to its growers (presumably including those who are shareholders of one of...