1. Evolving Cooperative Business Structures 5 th Annual Farmer Cooperative Conference November 13-15, 2002 Dave Swanson and Robert Hensley Dave Swanson and Robert Hensley

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

4. 4 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

5. 5 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

6. 6 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 & Complexity

7. 7 Choice of Entity – Coop v. LLC Existing Coops → conversion to LLC a taxable transaction Existing Coops → conversion to LLC a taxable transaction coop & members

8. 8 Choice of Entity — Coop v. LLC Four Tax Models: Straight Coop (corporation operated on a cooperative basis)Straight Coop (corporation operated on a cooperative basis) Straight LLC (LLC operated as a partnership)Straight LLC (LLC operated as a partnership) LLC taxed as a corporation operated on a cooperative basis. PLR 200119016LLC taxed as a corporation operated on a cooperative basis. PLR 200119016 Cooperative LLC (LLC taxed as a partnership but operated on a cooperative basis)Cooperative LLC (LLC taxed as a partnership but operated on a cooperative basis)

9. 9 Choice of Entity – Coop v. LLC New Coops — It’s an “Art” Not a “Science”New Coops — It’s an “Art” Not a “Science”

10. 10 Choice of Entity – 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

11. 11 Choice of Entity – 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

12. 12 Redefining Cooperative To Date: Heavy emphasis on tax definitionTo Date: Heavy emphasis on tax definition Evolution in Thinking About Organizational Models in GeneralEvolution in Thinking About Organizational Models in General In the Future: Earnings Distributed “Primarily” on Patronage?In the Future: Earnings Distributed “Primarily” on Patronage?

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14. 14 Wyoming Processing Cooperative Law – Membership and Governance Membership is made up of both patrons and investment membersMembership is made up of both patrons and investment members Not less than 3 directorsNot less than 3 directors A majority of the directors shall be membersA majority of the directors shall be members At least 1 member elected by patronage membersAt least 1 member elected by patronage members Directors elected by patron members must have at least 50% of the voting powerDirectors elected by patron members must have at least 50% of the voting power

15. 15 Wyoming Processing Cooperative Law – Financial Rights Patron members receive allocations and distributions based upon patronagePatron members receive allocations and distributions based upon patronage Investment members receive allocations and distributions based upon their investmentInvestment members receive allocations and distributions based upon their investment At least 15% of the profit allocations and distribution must go to patron membersAt least 15% of the profit allocations and distribution must go to patron members

16. 16 Wyoming Processing Cooperative Law – Tax Treatment Eligible for Subchapter K tax treatment. All earning “pass through” to membersEligible for Subchapter K tax treatment. All earning “pass through” to members Eligible for Subchapter T tax treatmentEligible for Subchapter T tax treatment

17. 17 Wyoming Processing Cooperative Law – Issues Investment member causes the processing coop to sacrifice its Capper- Volstead protection.Investment member causes the processing coop to sacrifice its Capper- Volstead protection. Questions concerning forming under the statute to “market” if there is an outside investor – regulatory issues?Questions concerning forming under the statute to “market” if there is an outside investor – regulatory issues? 50% governance can be an issue. Is it a cooperative?50% governance can be an issue. Is it a cooperative?

18. 18 What would Andrew Volstead say?

19. 19 Wyoming Processing Cooperative Law – Issues Investment member causes the processing coop to sacrifice its Capper- Volstead protection. Investment member causes the processing coop to sacrifice its Capper- Volstead protection. Questions concerning forming under the statute to “market” if there is an outside investor – regulatory issues? Questions concerning forming under the statute to “market” if there is an outside investor – regulatory issues? 50% governance can be an issue. 50% governance can be an issue.

20. 20 Proposed Minnesota and Wisconsin Cooperative Law Reform Research and discussions well under wayResearch and discussions well under way DividendsDividends VotingVoting GovernanceGovernance Clearer definition of who qualifiesClearer definition of who qualifies

21. QUESTIONS?