Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 66-98

1966-1 C.B. 200

Sec. 1381

Sec. 1382

Sec. 1388

IRS Headnote

A financing corporation which purchases accounts receivable with recourse from all its department store members at face value (of which an amount is deducted as a holdback and credited to a reserve account); charges all members the same discount rate based on the net dollars actually paid for the accounts receivable (face amount minus holdback); charges its members approximately the same discount rate they would have to pay if they discounted their accounts receivable on an independent basis with independent factors; distributes its net savings ratably to its members on the basis of the discounts charged them pursuant to a preexisting obligation; and otherwise operates on a cooperative basis, is an organization described in section 1381(a) of the Internal Revenue Code of 1954. Furthermore, cash distributions made to the member-patrons by the corporation, which are based on the discounts charged each member as compared with the total discounts charged all members, are patronage dividends as defined in section 1388(a)(1) of the Code and thus are deductible from the corporation's gross income to the extent provided in section 1382 of the Code.

Full Text

Rev. Rul. 66-98

The Internal Revenue Service has been asked whether a corporation which conducts a financing activity in the manner described below is operating on a cooperative basis and whether annual cash distributions paid to its members are patronage dividends.

A financing corporation was created by certain department stores to purchase their accounts receivable, thus supplying its member-patrons with working capital. The corporation purchases the accounts receivable with recourse and charges a so-called `discount' equal to a specified rate of interest on the monthly unpaid balance of such accounts. This `discount' is paid by each member monthly on a `settlement date.'

All members sell their accounts receivable to the financing corporation at face value. However, an amount designated as a holdback is deducted from the face amount of the receivable and credited to a reserve account. The holdback is based on the loss experience of each individual store and thus varies from member to member. However, the `discount' charged is the same to all members and is based on the net dollars-the face amount of the receivables minus the holdback-actually dollars-the face amount of the time the receivables are purchased. The `discount' charged is approximately the same as the member stores would have to pay if they discounted their receivables on an independent basis with independent factors.

The corporation's articles obligate it to distribute in cash a proportionate part of its annual net savings to each of its members in the ratio that the `discounts' charged such member bear to the total `discounts' charged all of the members.

Section 1381(a)(2) of the Internal Revenue Code of 1954 provides, with exceptions not material here, that any corporation operating on a cooperative basis shall be subject to the tax treatment provided in part I of subchapter T, chapter 1 of the Code, which includes among its provisions section 1382 of the Code.

Section 1382(b)(1) of the Code provides, in part, that in determining the taxable income of a cooperative there shall not be taken into account amounts paid during the payment period for the taxable year as patronage dividends with respect to patronage occurring during such taxable year. Such amounts are treated as deductions in the Income Tax Regulations. See section 1.1382-1 of the regulations.

Section 1388(a)(1) of the Code provides that the term `patronage dividend' means an amount paid to a patron by a cooperative on the basis of quantity or value of business done with or for such patron.

The corporation in the instant case is supplying its members with needed working capital at cost. The discount rate charged is the same to all members and is based on the net dollars actually paid to the members at the time the accounts receivable are purchased. While the discount rate may vary, depending upon the cost to the corporation of borrowing funds, each participating member is treated on an equal basis at any given time.

That each member will bear all losses attributable to its accounts receivable sold with recourse to the corporation does not prevent this corporation from being considered cooperative in character. Cooperative operation of a financing corporation does not necessitate acquisition of accounts receivable on a basis different from that on which such receivable would customarily be acquired by a comparable commercial institution.

The amount of the cash distribution paid to each member following the close of each taxable year is based on the `discounts' charged such member as compared with the total `discounts' charged all of the members. This fulfills the requirement of section 1388(a)(1) of the Code that, to be considered patronage dividends, distributions must be paid to a patron `on the basis of the quantity or value of business done with or for such patron.'

Accordingly, the corporation is operating on a cooperative basis within the meaning of section 1381(a)(2) of the Code. The required annual distributions to the member-patrons by the corporation are patronage dividends as defined in section 1388(a)(1) of the Code and are deductible from the gross income of the corporation to the extent provided in section 1382 of the Code.