1. The Role of Federal and State Policy in Formation and Success of Cooperative Businesses Agricultural and Food Cooperatives in Rural Development: Implications of Business Dynamics for Public Policy June 16-17, 2004 Dave Swanson 612-343-8275 swanson.dave@dorsey.com

2. 2 Definitions of Cooperative Tax Law DefinitionTax Law Definition Capper-Volstead Definition for Farm CoopsCapper-Volstead Definition for Farm Coops Borrowing Eligibility – CoBank, CFA, NCBBorrowing Eligibility – CoBank, CFA, NCB Coop Trade Association Eligibility StandardsCoop Trade Association Eligibility Standards Rochdale PrinciplesRochdale Principles State & Federal Securities LawsState & Federal Securities Laws Common Theme: Allocate Margins by Patronage

3. 3 Evolution in Organizational Models Generally Historical model: tax neutrality (partnerships and tax-exempts) v. limited liability (corporations)Historical model: tax neutrality (partnerships and tax-exempts) v. limited liability (corporations) Current model: increasing options to combine tax neutrality with limited liability and more emphasis on public (highly liquid) v. private (less liquid) ownershipCurrent model: increasing options to combine tax neutrality with limited liability and more emphasis on public (highly liquid) v. private (less liquid) ownership

4. 4 Comparison of “Traditional” and “New Generation” Coops Traditional Cooperative Open MembershipOpen Membership Voluntary MembershipVoluntary Membership Low Up-Front Membership CostLow Up-Front Membership Cost Retain Margins/Revolve Patronage EquitiesRetain Margins/Revolve Patronage Equities

5. 5 Comparison of “Traditional” and “New Generation” Coops New Generation Cooperatives Limited MembershipLimited Membership High Up-Front Membership CostHigh Up-Front Membership Cost Longer-Term Contractual CommitmentLonger-Term Contractual Commitment Shares Are TradedShares Are Traded Margins Are DistributedMargins Are Distributed

6. 6 Tax Attributes of Coops Subchapter TSubchapter T –Patronage Sourced Income Deduction –Operation on a “Cooperative Basis” –Patronage Allocation (pre-existing duty) –Democratic Control –Subordination of Capital –Mutuality of Interest –20% Cash Distribution in 8½ Months –Sourcing of Income/Expense

7. 7 Tax Attributes of LLCs Pure Pass-Through of Tax Attributes to MembersPure Pass-Through of Tax Attributes to Members No Patronage Requirement (but it’s allowed) –– facilitates non-member equityNo Patronage Requirement (but it’s allowed) –– facilitates non-member equity Publicly Traded Partnership RulesPublicly Traded Partnership Rules Self-employment TaxSelf-employment Tax Passive Activity Loss LimitationsPassive Activity Loss Limitations

8. 8 Is Capper Volstead Critical? Capper-Volstead Does Not Mandate Cooperative LabelCapper-Volstead Does Not Mandate Cooperative Label Price Fixing Exemption & Allows Market Power Unless Undue Price EnhancementPrice Fixing Exemption & Allows Market Power Unless Undue Price Enhancement Joint Venture Analysis for New VenturesJoint Venture Analysis for New Ventures Importance for Common Marketing PoolsImportance for Common Marketing Pools

9. 9 Securities Law Attributes of Coops Section 521 ExemptionSection 521 Exemption Forman caseForman case Blue Sky ExemptionsBlue Sky Exemptions

10. 10 The Equity Limitation Patronage based earnings distribution limits the pool of potential “investors”Patronage based earnings distribution limits the pool of potential “investors” Limits on preferred stock as an equity sourceLimits on preferred stock as an equity source –Dividend allocation rule –State law limits on dividend rate Joint ventures as an equity sourceJoint ventures as an equity source -Tax and securities issues for new coops -Cost and complexity

11. 11 Cooperative Conversions EExisting Coops → conversion to LLC EExisting Coops → conversion to LLC potentially a taxable transaction for coop & members

12. 12 Conversion Examples: Dakota Growers Pasta Minnesota Corn Processors South Dakota Soybean Processors Cooperative Conversions

13. 13 Choice of Entity For New Ventures– Coop v. LLC It’s an “Art” Not a “Science” It’s an “Art” Not a “Science”

14. 14 Choice of Entity For New Ventures– Coop v. LLC Coop  May be tax neutral (but with limits)  Outside equity limits LLC  Tax neutral  Outside equity flexibility The Tax / Equity Flexibility Factor The Tax / Equity Flexibility Factor

15. 15 Choice of Entity For New Ventures– Coop v. LLC Some Driving Factors Securities RegistrationSecurities Registration –Cost –521 Exemption –Intra-State –Private Placement Tax Credits — EthanolTax Credits — Ethanol Blue Sky ExemptionsBlue Sky Exemptions Borrowing EligibilityBorrowing Eligibility Importance of Non- Producer InvestmentImportance of Non- Producer Investment Special Program EligibilitySpecial Program Eligibility Nature of the Farm Product InvolvedNature of the Farm Product Involved Nature of the Market and End ProductsNature of the Market and End Products

16. 16 Some Other Coop Strengths & Weaknesses STRENGTHS Common interests (other than profit) can promote long-term view in decision- makingCommon interests (other than profit) can promote long-term view in decision- making Potential to achieve greater market powerPotential to achieve greater market power Greater potential to share know-how?Greater potential to share know-how?

17. 17 Some Other Coop Strengths & Weaknesses WEAKNESSES Limits on farmer-owners’ ability to access equity and appreciation (especially traditional coops) Limits on farmer-owners’ ability to access equity and appreciation (especially traditional coops) Problems with retiring farmers (especially NEWGEN coops)Problems with retiring farmers (especially NEWGEN coops)

18. 18 An Idea for Redefining Federal Cooperative Policy Primary Farmer Benefit Test v. Cooperative (or 100% Farmer Ownership) Test