Evolving Cooperative Business Structures

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

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

3. Tax Attributes of Coops • Subchapter 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. Tax Attributes of LLCs • Pure Pass-Through of Tax Attributes to Members • No Patronage Requirement (but it’s allowed) –– facilitates non-member equity • Publicly Traded Partnership Rules • Self-employment Tax • Passive Activity Loss Limitations

5. Is Capper Volstead Critical? • Capper-Volstead Does Not Mandate Cooperative Label • Price Fixing Exemption & Allows Market Power Unless Undue Price Enhancement • Joint Venture Analysis for new ventures • Importance for Common Marketing Pools

6. The Equity Limitation • Patronage based earnings distribution limits the pool of potential “investors” • Limits on preferred stock as an equity source • Dividend allocation rule • State law limits on dividend rate • Joint Ventures as an equity source -Tax and securities issues for New Coops -Cost & Complexity

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

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

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

10. Coop May be tax neutral (but with limits) Outside Equity Limits LLC Tax neutral Outside Equity Flexibility Choice of Entity – Coop v. LLC • The Tax / Equity Flexibility Factor

11. Securities Registration Cost 521 Exemption Intra-State Private Placement Tax Credits — Ethanol Blue Sky Exemptions Borrowing Eligibility Importance of Non-Producer Investment Special Program Eligibility Nature of the Farm Product Involved Nature of the Market and End Products Choice of Entity – Coop v. LLCSome Driving Factors

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

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

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

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

17. Wyoming Processing Cooperative Law – Issues • 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? • 50% governance can be an issue. Is it a cooperative?

18. What would Andrew Volstead say?

19. Wyoming Processing Cooperative Law – Issues • 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? • 50% governance can be an issue.

20. Proposed Minnesota and Wisconsin Cooperative Law Reform • Research and discussions well under way • Dividends • Voting • Governance • Clearer definition of who qualifies

21. QUESTIONS?