internal_revenue_service number release date index number --------------------- ----------------------------- ------------------------------------- -------------------------------------- ---------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------------------- id no ---------- telephone number --------------------- refer reply to cc psi b05 plr-110378-10 date date legend taxpayer --------------------------------------------------------------------- ----------------------------------------- state a area year year b c dear --------------- ------------ ----------------------------------------------------------- ------- ------- ----------------------------------------- -------- this is in response to a request for rulings dated date submitted by your authorized representative the rulings concern the interplay of the rules in subchapter_t of the internal_revenue_code concerning the taxation of cooperatives and their patrons and the calculation of the sec_199 deduction for certain cooperatives contained in sec_199 taxpayer is organized as a cooperative corporation under the state a cooperative act taxpayer is a farmers’ cooperative whose members are --------b growers located in area plr-110378-10 shortly after it was formed taxpayer requested and received a determination_letter dated -------------------- confirming its status as an exempt sec_521 farmers’ cooperative sec_1381 of the code provides that part i of subchapter_t applies to sec_521 cooperatives thus among other things taxpayer is entitled to exclude or deduct distributions to its members and other nonmember producers that qualify as per-unit retain allocations or patronage_dividends provided the requirements of subchapter_t are met as a row crop b is planted each year in the spring the harvest of b begins in september at harvest the members of taxpayer truck their b to various receiving stations also referred to as -------- stations owned and operated by taxpayer taxpayer currently has-----strategically located -------- stations the b are ------------------ ----------------at the receiving stations until they are processed taxpayer then processes the b over a period of approximately ------to---------------- -------------------------------------------------------------------------------------------------months at processing plants the principal product is ------------------------- which is marketed in bulk form and in packaged form under the ---------brand name and over -------- private labels processing also results in several marketable by-products including b ------------- --------------------------------------------------------------------------------------------------------------------- ---------------------------------which are used for ----------------- in the fall of year at the beginning of taxpayer’s fiscal_year beginning ----------- ---------------------- and ending ------------------------------growers delivered ---------------------- tons of b grown on ------------acres of land to taxpayer for processing the b delivered in the fall of year are referred to in this ruling as the year crop the b processing began as the b were delivered and the processing of the year crop was completed during -------------------- the b were processed into --------------cwts of c pursuant to the terms of its b agreements with growers taxpayer made a series of payments to growers totaling dollar_figure----------------------for the year crop those payments and similar payments for each year’s b crop are referred to in this ruling as b payments the b payments are made in cash and nonqualified per-unit retain_certificates for the year crop dollar_figure----------------------was paid in cash and dollar_figure----------------- was paid in the form of nonqualified per-unit retain_certificates taxpayer plans to pay a patronage refund of dollar_figure--------------------to growers with respect to the year crop of this amount dollar_figure------------------is scheduled to be paid in cash and dollar_figure----------------is scheduled to be paid in qualified written notices of allocation taxpayer is a cooperative corporation organized under the state a cooperative act -------------------------of the state a revised statutes entities organized under the state a cooperative act as cooperatives are among other things required to operate at cost by adjusting the prices charged for goods or services or by returning any net margins at the end of a fiscal_year on a patronage basis to members and other persons plr-110378-10 qualified to share in the net margins pursuant to the articles and bylaws section -------- ------------- the state a cooperative act further provides net margins after deductions for reasonable reserves and for allowances for income_tax shall be calculated and allocated on a patronage basis at least once every twelve months to members or to members and other qualified persons on an equitable basis as determined by the board or in accordance with the articles or the bylaws section - ----------------- taxpayer’s articles of incorporation provide that its purposes are to receive handle manufacture process and market the b and other agricultural products of its members and other producers to purchase handle and distribute agricultural supplies and equipment to its members and other patrons to perform any and all related_services for its members and other patrons and to engage in any other lawful purpose this cooperative shall be operated on a cooperative basis for the mutual benefit of its members and patrons article iii sec_1 taxpayer is organized with capital stock article iv sec_1 there are two classes of capital stock - common_stock with a par_value of dollar_figure per share and patron preferred_stock with a par_value of dollar_figure per share the common_stock is membership stock only b producers and cooperative associations of b producers are entitled to be members and own common_stock article iv sec_2 each person who is admitted to membership is required to pay dollar_figure to purchase one share of membership common_stock article iv sec_2 members are not permitted to own more than one share of common_stock article iv sec_2 members are also required to purchase shares of patron preferred_stock each share of patron preferred_stock carries with it the right and obligation to deliver b from one acre of land article iv sec_3 thus a member desiring to market b grown on acres of land through taxpayer each year is required to purchase shares of patron preferred_stock dividends are not paid on the common_stock or the patron preferred_stock article iv sec_2 and b only the common_stock has the right to vote and since each member of taxpayer owns one share of common_stock taxpayer is organized on a one-member one-vote basis article iv sec_2 plr-110378-10 taxpayer’s articles of incorporation require that a ll net_income savings of this cooperative in excess of reserves established by the board shall be distributed to members and patrons on the basis of patronage as more particularly provided for in the bylaws article v taxpayer’s bylaws provide that it shall be operated on a cooperative basis article vii article viii describes how annual savings are determined and distributed each year as what taxpayer calls patronage refunds the determination begins by determining the annual income of taxpayer which equals gross_receipts less taxpayer’s costs and expenses for this purpose included in costs and expenses are b payments made to members and nonmember producers pursuant to the member and nonmember agreements for their b also deducted are operating_expenses and costs cost_of_goods_sold cost of services performed all taxes and other necessary expenses reasonable and necessary reserves bad_debts and current obligations on debt and patron preferred_stock article viii sec_2 the bylaws then provide that annual income shall be distributed and paid to members and patrons as provided in the bylaws article viii sec_3 most over percent of the year crop of the b that taxpayer processes and markets are grown by members taxpayer also processes and markets some b grown by nonmember producers taxpayer does business with both members and nonmember producers on a patronage basis and treats members and nonmembers alike with respect to both b payments and patronage_dividends the bylaws provide that the distribution of annual income to members and other patrons shall be based on their patronage with the cooperative article viii sec_4 for this purpose patronage is measured based upon the number of tons of b each member and nonmember delivers the bylaws provide that patronage refunds must be paid within eight and one-half months of year end and that they may be made in the form of cash or written notices of allocation which may be qualified or nonqualified or a combination of the two article viii sec_5 taxpayer customarily pays its patronage refunds in a combination of cash and qualified written notices of allocation which it sometimes refers to as patronage equities members are required to enter into a shareholder agreement bylaws article i sec_1 under the articles of incorporation and the member agreement a member is permitted and obligated to grow one acre of b for each share of patron preferred_stock the member owns article iv sec_3 of the articles of incorporation and sec_1 and of the member agreement failure of a member to plant grow and deliver b in accordance with this requirement may among other things result in termination of the member’s membership forfeiture of the member’s share of common_stock and shares of patron preferred_stock termination of the member’s member agreement and right to deliver b to taxpayer for processing and or the imposition of obligation to pay liquidated_damages to compensate other members for the member’s failure to bear his share of taxpayer’s fixed costs sec_2 plr-110378-10 members owning shares of patron preferred_stock in excess of the acres they plan to devote to b production may with the appropriate approvals from taxpayer subcontract their production obligation to a third-party grower if the third-party grower is not already a member of taxpayer the third-party grower must enter into a non- member grower agreement in this ruling the shareholder agreement is referred to as the member agreement and the non-member grower agreement is referred to as the nonmember agreement the member agreement and the nonmember agreement are identical in all material respects taxpayer accepts b only from member and nonmember producers and only as provided in the member and nonmember agreements members and nonmembers are required to designate the land on which they will raise b for delivery to taxpayer each year sec_1 of both agreements they agree to deliver all b grown on the designated acreage to taxpayer sec_1 and of both agreements they are not required to deliver and taxpayer is not obligated to take b grown on acres in excess of those designated in the member agreement sec_1 of both agreements members and nonmembers agree to grow b on the designated acreage in accordance with growing standards specified by taxpayer see sec_2 of both agreements for instance they must use approved b seed sec_2 of both agreements there are limits on the pesticides and chemicals that may be used sec_2 of both agreements nitrogen fertilizer may not be applied to the crop after july sec_2 of both agreements when a member or nonmember delivers b to a receiving station at the time of harvest the b are weighed the gross weight of the b is adjusted for dirt stones trash and other foreign substances determined on a sampling basis and a net weight measured in tons is determined the b are also tested at the time of delivery to determine their c content sec_4 of both agreements the member and nonmember agreements provide that taxpayer will pay members and nonmembers for their b an amount determined under a formula set forth in the agreements the amount depends upon the average net selling_price for c for the year and the adjusted c content of the member’s or nonmember’s b section of both agreements that payment is reduced by what is referred to as the shareholder freight participation charge which is equal to --- percent of the freight cost incurred by taxpayer for transportation of a member’s or nonmember’s b from the receiving station where they are delivered to the contracting factory section of both agreements the net selling_price for c is defined as the gross_proceeds received by the cooperative from c sold and delivered during the period of october through september taxpayer’s fiscal_year less all charges and expenditures of the kind plr-110378-10 regularly and customarily deducted from the gross_proceeds from such sales section of both agreements both agreements then provide without limiting the generality of the foregoing there shall be included among the items deductible from the gross_proceeds in determining net selling_price for c all excise sales or other taxes of any kind paid_or_incurred by the cooperative on or with respect to or arising out of the manufacture processing production ownership possession holding for sale sale marketing or shipment of such c or any part thereof or on all or any part of the selling_price from such sale the profit or loss if any resulting from hedging operation conducted by the cooperative in response to c customers requests for c pricing based on c------------- ----- -------------- listed on the ------------------------ c ------------------------------- all costs incurred in preparing c for sale including such costs as packaging ------------------------------and marketing cost including freight cash discounts brokerage loading and handling advertising and sales marketing administration and internalized b freight section of both agreements the adjusted average c content is determined separately for each member and nonmember that determination is based on the average c content of all deliveries of b by the member or nonmember each crop year section of both agreements the c content is determined based upon the testing described above that occurs at the time of delivery more is paid for b with a high c content because there is a direct correlation between the c content of a ton of b and the amount of c that can be produced from that ton taxpayer offers certain incentives including a relaxing of the c content standards and an early tonnage delivery premium to encourage early delivery which allows taxpayer to more efficiently handle and process the b of all members and nonmembers sec_5 and exhibit a of both agreements the agreements provide that members and nonmembers will receive b payments in installments section of both agreements these installments are referred to as the initial payment the 1st interim payment the 2nd interim payment and the final payment on occasion taxpayer also makes what it refers to as exceptional payments which are additional installment payments designed to accelerate payments to growers in years when that is deemed appropriate the initial payment is an advance made on november for b delivered through november sec_8_1 of both agreements the initial payment is based on ----------------------- ---------of the cooperative’s then current estimate of the net selling_price of c for the period october through september to a maximum of dollar_figure------ ----------per pound plr-110378-10 the 1st interim payment is an advance made on january each year this payment is based on -------of the cooperative’s then current estimate of the net selling_price of c for the period october through september to a maximum of ----------per pound less the initial payment section of both agreements the 2nd interim payment is an advance made on march this payment is based on-----percent of the cooperative’s then current estimate of the net selling_price of c for the period october through september minus the sum of all previous payments and the freight participation defined in paragraph section of both agreements exceptional payments may be made throughout the year if market conditions allow they are made to accelerate payments to members and nonmembers when that is deemed appropriate for example for the year crop taxpayer made an exceptional payment in february between it sec_1st interim payment and it sec_2nd interim payment to true-up the actual b payment from dollar_figure50 per pound to dollar_figure80 per pound after taxpayer’s fiscal_year closes on september the actual net selling_price for c is determined for the year a final payment for a member’s or nonmember’s b is then made equal to what is due to the grower under the agreements less what has previously been paid section of both agreements the final payment is made on october if the sum of the initial and interim payments exceeds the calculated total_payment based on actual net selling_price the excess paid will be deducted from the november payment of the following year if no crop is grown the following year the grower is obligated to refund the overpayment to taxpayer sections of both agreements taxpayer is authorized by article ix of its bylaws to require investments in its capital in addition to the investments from retained patronage these investments take the form of a retain on a per unit basis as defined by the board and they may be qualified or nonqualified it has been taxpayer’s practice to withhold a uniform per-ton retain from the initial payment each year for the year crop year that retain was dollar_figure---- --------per ton and was evidenced by a nonqualified_per-unit_retain_certificate the final payment for each crop year required by both agreements is not based upon taxpayer’s net_proceeds or net_earnings for the year rather it is based upon the formula contained in the agreements plr-110378-10 thus taxpayer’s final payment under both agreements is not like the final settlement payment made by many pooling cooperatives when a pool closes which is based upon the cooperative’s net_earnings for the year and is treated as a patronage_dividend for tax purposes taxpayer’s equivalent to the final settlement payment paid_by many pooling cooperatives is the patronage refund described above that it pays after the year closes taxpayer’s patronage refund is based upon its net_earnings for the year treating all b payments as a cost of the b thus notwithstanding the description of the last payment under both of the agreements as the final payment the final payment is not normally the last payment received by members and nonmembers from taxpayer with respect to each crop year in summary the payments that members and nonmembers receive with respect to each b crop fall in two categories - b payments made pursuant to the member and nonmember agreements and a patronage refund paid pursuant to the articles of incorporation and bylaws the payments made pursuant to the member and nonmember agreements include the initial payment the 1st interim payment the 2nd interim payment any exceptional payments and the final payment these are the payments referred to in this ruling as b payments the b payments may be made in cash or in per-unit retain_certificates which may be qualified or nonqualified the focus of this ruling is on whether the b payments made in cash to members and nonmembers are per-unit retain allocations paid in money for federal_income_tax purposes and if so on how they should be treated for purposes of sec_199 of the code in the event that taxpayer incurs a loss in any year its bylaws provide that the loss shall first be charged against the capital reserves if any article xiii sec_1 the bylaws provide that if the loss exceeds the capital reserves and results from business done with or for members or patrons then the board_of directors of the cooperative shall recover the loss from prior years’ annual savings from business done with or for members and patrons by charging the loss against the patronage credit accounts of the members and patrons whose patronage business generated the loss on the basis of their patronage during the loss_year article xiii sec_2 taxpayer has treated b payments to members and nonmembers made each year in cash pursuant to the member and nonmember agreements as purchases for tax purposes and reported them on schedule a line of its form 1120-c taxpayer has not reported these b payments as per-unit retain allocations paid in money and therefore has not reported them on schedule a line 4b of its form 1120-c for tax purposes taxpayer accounts for its inventories using the lower_of_cost_or_market for both financial statement and tax_return purposes the b payments paid in cash have entered into the determination of the cost of taxpayer’s inventories of c at year end taxpayer has treated patronage refunds paid in cash and written notices of allocation pursuant to its articles of incorporation and bylaws as patronage_dividends plr-110378-10 and therefore has reported them on schedule h line sec_3a and sec_3b of its form 1120-c taxpayer did not add back b payments paid in cash to members and nonmembers as part of its sec_199 computation in prior years but it did add back its patronage refunds in the past taxpayer used all of the sec_199 deductions it earned on its own tax_return and thus passed none through to members and nonmembers recent developments have caused taxpayer to reconsider how it should treat its b payments in cash to members and nonmembers for purposes of its sec_199 computation taxpayer now believes that such payments should be classified as per- unit retain allocations paid in money taxpayer seeks to obtain confirmation of that conclusion taxpayer plans to treat b payments in cash to members and nonmembers as per-unit retain allocations paid in money for purposes of computing its sec_199 deduction taxpayer does not currently plan to make any change the manner it accounts for inventories for tax purposes thus the timing of the deduction of its b payments will not be changed taxpayer will make certain that it does not exclude or deduct any b payments twice on its tax_return or add back any b payments twice in its sec_199 computation the b payments that taxpayer plans to add back in its sec_199 computation for a year will equal those deducted on its tax_return for the year as costs of goods sold that relate to products marketed during the year the amount will be computed by adding any b payments in opening_inventory for the year together with b payments made during the year and then subtracting any b payments in closing_inventory taxpayer may use all of the resulting sec_199 deduction on its own return pass through all of the resulting sec_199 deduction to growers or use part and pass through part of the deduction b rulings requested initial 1st interim 2nd interim exceptional and final b payments paid in cash to members and nonmembers each year constitute per-unit retain allocations paid in money within the meaning of sec_1382 of the code for purposes of computing its sec_199 domestic_production_activities_deduction taxpayer’s qualified_production_activities_income and taxable_income should pursuant to sec_199 of the code be computed without regard to any deduction for b payments paid in cash to members and nonmembers sec_521 cooperatives are permitted to exclude or deduct distributions to patrons that qualify as per-unit retain allocations or as patronage_dividends provided the distributions otherwise meet the requirements of subchapter_t of the code plr-110378-10 sec_1388 of the code defines the term per-unit_retain_allocation to mean any allocation by an organization to which part i of subchapter_t applies to a patron with respect to products marketed for him the amount of which is fixed without reference to net_earnings of the organization pursuant to an agreement between the organization and the patron per-unit retain allocations may be made in money property or certificates per- unit retain allocations paid in money and in property are excludable or deductible under sec_1382 of the code per-unit retain allocations paid in certificates are deductible under sec_1382 if the certificates are qualified if the certificates are nonqualified the cooperative is permitted a deduction under sec_1382 or a tax_benefit figured under sec_1383 when the certificates are later redeemed sec_1388 of the code provides that the term patronage_dividend means an amount_paid to a patron by a cooperative on the basis of the quantity or value of business done with or for such patron sec_1388 provides that a patronage_dividend is an amount_paid under an obligation that must have existed before the cooperative received the amount so paid sec_1388 provides that patronage_dividend means an amount_paid to a patron that is determined by reference to the net_earnings of the cooperative from business done with or for its patrons that section further provides that a patronage_dividend does not include any amount_paid to a patron to the extent that such amount is out of earnings other than from business done with or for patrons sec_1_1382-3 of the income_tax regulations states that income derived from sources other than patronage means incidental income derived from sources not directly related to the marketing purchasing or service activities of the cooperative association patronage_dividends may be paid in money property or written notices of allocation patronage_dividends paid in money and in property are excludable or deductible under sec_1382 of the code patronage_dividends paid in written notices of allocation are deductible under sec_1382 if the written notices of allocation are qualified if the notices are nonqualified the cooperative is permitted a deduction under sec_1382 or a tax_benefit figured under sec_1383 when the notices are later redeemed sec_1388 of the code provides that the term written_notice_of_allocation means any capital stock revolving fund certificate retain certificate certificate of indebtedness letter of advice or other written notice which discloses to the recipient the stated dollar amount allocated to him by the organization and the portion thereof if any which constitutes a patronage_dividend for cooperatives that use pooling revrul_67_333 1967_2_cb_299 provides that pool advances are treated as per-unit retain allocations and the final pool payment made after net_earnings have been determined is treated as a patronage_dividend plr-110378-10 under sec_199 of the code patrons that receive a qualified_payment from a specified agricultural or horticultural cooperative are allowed a deduction for an amount allocable to their portion of qpai of the organization received as a qualified patronage_dividend or per-unit_retain_allocation which is paid in qualified per-unit retain_certificates in particular sec_199 requires the cooperative to be engaged in the manufacturing production growth or extraction in whole or significant part of any agricultural or horticultural product or in the marketing of agricultural or horticultural products under sec_199 in the case of a cooperative engaged in the marketing of agricultural and horticultural products the cooperative is treated as having manufactured produced grown or extracted mpge in whole or significant part any qualifying_production_property marketed by the cooperative that its patrons have mpge this is known in the industry as the cooperative attribution rule in addition sec_199 requires the cooperative to designate the patron’s portion of the income allocable to the qpai of the organization in a written notice mailed by the cooperative to its patrons no later than the 15th day of the ninth month following the close of the tax_year under sec_1_199-6 of the regulations for purposes of determining a cooperative’s sec_199 deduction the cooperative’s qpai and taxable_income are computed without taking into account any deduction allowable under sec_1382 or c of the code relating to patronage_dividends per-unit retain allocations and nonpatronage distributions an agricultural or horticultural cooperative is permitted to pass-through to its patrons all or any portion of its sec_199 deduction for the year provided it does so in the manner and within the time limits set by sec_199 of the code when a cooperative passes-through all or any portion of the sec_199 deduction the cooperative remains entitled to claim the entire sec_199 deduction on its return but is required under sec_199 to reduce the deduction or exclusion it would otherwise claim under sec_1382 for per-unit retain allocations and patronage_dividends sec_199 of the code provides that a cooperative passes through an amount of its sec_199 deduction by identifying such amount in a written notice mailed to such person during the payment period described in sec_1382 sec_1382 provides that the payment period for a year is the period beginning with the first day of such taxable_year and ending with the fifteenth day of the ninth month following the close of such year sec_1_199-6 of the regulations provides that in order for a patron to qualify for the sec_199 deduction sec_1_199-6 requires that the cooperative identify in a written notice the patron's portion of the sec_199 deduction that is attributable to the portion of the cooperative's qpai for which the cooperative is allowed a sec_199 deduction this written notice must be mailed by the cooperative to its patrons no later than the 15th day of the ninth month following the close of the taxable_year the plr-110378-10 cooperative may use the same written notice if any that it uses to notify patrons of their respective allocations of patronage_dividends or may use a separate timely written notice s to comply with this section the cooperative must report the amount of the patron's sec_199 deduction on form 1099-patr taxable_distributions received from cooperatives issued to the patron while a cooperative is permitted to disregard per-unit retain allocations and patronage_dividends in its sec_199 deduction sec_1_199-6 of the regulations provide that a qualified_payment received by a patron of a cooperative is not taken into account by the patron for purposes of sec_199 sec_1_199-6 of the regulations defines the term qualified_payment to mean any amount of a patronage_dividend or per-unit_retain_allocation as described in sec_1385 or of the code received by the patron from a cooperative that is attributable to the portion of the cooperative’s qpai for which the cooperative is allowed a sec_199 deduction for this purpose patronage_dividends and per-unit retain allocations include any advances on patronage and per-unit retains paid in money during the taxable_year taxpayer is a specified agricultural or horticultural cooperative within the meaning of sec_199 of the code and sec_1_199-6 of the regulations it is an organization to which part i of subchapter_t applies ie it is a sec_521 cooperative to which subchapter_t applies it is engaged in the marketing of agricultural or horticultural products ie its members and nonmembers b which it processes and markets as a specified agricultural or horticultural cooperative taxpayer is entitled to the benefit of sec_199 of the code and sec_1_199-6 of the regulations which permit such cooperatives to disregard deductions under sec_1382 and c for purposes of computing qpai and taxable_income for purposes of sec_199 sec_1382 provides deductions for per-unit retain allocations paid in money property and qualified per-unit retain_certificates as well as for patronage_dividends paid in money property and qualified written notices of allocation it also provides for deductions when nonqualified per-unit retain_certificates and nonqualified written notices of allocation are redeemed as a specified agricultural or horticultural cooperative taxpayer is entitled to the benefit of sec_199 and sec_1_199-6 which permit such cooperatives to disregard deductions under sec_1382 and c for purposes of computing qpai and taxable_income for purposes of sec_199 sec_1382 provides deductions for per-unit retain allocations paid in money property and qualified per-unit retain_certificates as well as for patronage_dividends paid in money property and qualified written notices of allocation it also provides for deductions when nonqualified per-unit retain_certificates and nonqualified written notices of allocation are redeemed plr-110378-10 while taxpayer has never used the terminology customarily used by pooling cooperatives to describe how it operates it does in fact operate in a manner similar to many pooling cooperatives members and nonmembers are entitled to share equally taking into account quality differences in what is earned from processing and marketing their b they receive a series of payments the b payments pursuant to the member and nonmember agreements and a final payment the patronage refund pursuant to the articles of incorporation and bylaws the process described earlier in this ruling for determining the amount of the b payments and for determining the patronage refund each year is very much like a traditional pooling process with the b payments under the member and nonmember agreements functioning like harvest advances and progress payments and the patronage refund functioning like the final settlement payment after the pool closes the question presented in this ruling is whether the b payments made by taxpayer to patrons for b qualify as per-unit retain allocations paid in money within the meaning of sec_1388 of the code under sec_199 of the code and sec_1_199-6 of the regulations the answer to this question determines who gets to include the b payments in the sec_199 computation if the b payments to members and nonmembers are per-unit retain allocations paid in money then they should be added-back in taxpayer’s sec_199 computation and not included in the members’ and nonmembers’ sec_199 computations if the b payments to members and nonmembers are not per-unit retain allocations paid in money then they should not be added-back in taxpayer’s sec_199 computation but should be included in the members’ and nonmembers’ sec_199 computations these results are the same whether taxpayer decides to keep or to pass-through all or a portion of its sec_199 deduction while per-unit retains are often made on the basis of a specified amount per unit of product marketed what is important is that they not be made with respect to net_earnings revrul_68_236 1968_2_cb_236 provides that to constitute a per-unit_retain_allocation the allocation need not be made strictly on the basis of a specified amount per-unit of product marketed provided it is made with respect to products marketed for the patron and not with respect to the net_earnings of the organization whether an allocation meets the foregoing description will be a question of fact taxpayer’s b payments paid in cash to members and nonmembers meet the definition of per-unit retain allocations paid in money which are excludible or deductible under sec_1382 of the code in the case of b payments made in the form of nonqualified per-unit retain_certificates the payments are not currently deductible but when the certificates are some day redeemed taxpayer may be entitled to a deduction under sec_1382 plr-110378-10 taxpayer’s b payments are paid to members and nonmembers pursuant to an agreement namely the member and nonmember agreements described above they are made with respect to products marketed for patrons namely c processed from the b of taxpayer’s members and nonmembers the b payments are fixed without reference to the net_earnings of taxpayer they are paid pursuant to a formula which takes into account the adjusted average c content of each member’s and nonmember’s b and the net selling_price of c for the year this formula is not based on either the net_proceeds or net_earnings of taxpayer this is true not only for the initial 1st and 2nd interim and any exceptional payments but also for the payment described by taxpayer as the final payment the payment that taxpayer makes to members and nonmembers each year that is determined by reference to its net_earnings is its patronage refund taxpayer’s patronage refunds meet the definition of a patronage_dividend taxpayer’s patronage refund each year is made pursuant to an obligation of such organization to pay such amount which is set forth in the articles of incorporation and bylaws in contrast to the b payments the patronage refund is determined by reference to the net_earnings of taxpayer for the year the patronage refund is distributed on a patronage basis thus all of the requirements of the definition of patronage_dividend are met in summary taxpayer’s b payments meet all the requirements specified in subchapter_t of the code for per-unit retain allocations the portion paid_by check qualifies as a per-unit_retain_allocation paid in money the portion paid in the form of unit retains evidenced by certificates qualifies as a per-unit_retain_allocation paid in certificates taxpayer’s patronage refunds paid each year in the form of cash and written notices of allocation meet the requirements of a patronage_dividend historically taxpayer has not reported its b payments in cash in the manner that many pooling cooperatives report pool distributions taxpayer has treated such payments as purchases not as per-unit retain allocations paid in money and certificates however how the payments have been reported should not obscure what the payments really are sec_199 of the code provides that the sec_199 deduction of agricultural cooperatives is to be computed without regard to any deduction allowable under sec_1382 b or c relating to patronage_dividends per-unit retain allocations and nonpatronage distributions sec_1_199-6 of the regulations provides that this rule applies for purposes of computing both qualified_production_activities_income and taxable_income the fact that all members and nonmembers do not receive the same payments for their b does not mean that b payments should not be treated as per-unit retain allocations paid in money in farm service cooperative v commissioner f 2d plr-110378-10 8th cir the eighth circuit_court of appeals characterized payments to farm service’s poultry growers as per-unit retain allocations paid in money even though they were determined under a formula that resulted in some poultry growers receiving more than others depending upon the efficiency of their operations and the market price of chickens when they delivered their chickens to farm service the tax_court in 70_tc_145 described the formula as follows the grower was paid_by petitioner for growing chickens based on the delivery weight to the processing plant less the weight of chickens condemned by the u s department of agriculture the formula under which the grower was paid also took into account variable market rates for full grown chickens and an efficiency factor that related the number of pounds of feed to the pounds of chickens produced the efficiency factor was figured into the grower's compensation because farm service supplied all chicken feed under the contract provisions established with each of the growers there was also a guaranteed minimum amount the grower would receive from the cooperative irrespective of wholesale market variations for example the contract in effect on date provided that ‘in no event will the grower member receive less than dollar_figure cents per pound less u s d a condemnation ’ on its books petitioner treated payments to its growers as a cost of production whether or not taxpayer is pooling is a moot issue for purpose of this ruling because its b payments meet the definition of per-unit retain allocations paid in money in any event nothing in subchapter_t of the code limits the exclusion or deduction for per-unit retain allocations to cooperatives with pools sec_1_199-6 of the regulations provides that sec_1_199-6 is the exclusive method for the cooperative and its patrons to compute the amount of the sec_199 deduction the effect of these sections is that a cooperative such as taxpayer will compute the entire sec_199 deduction at the cooperative level and that none of the distributions whether patronage_dividends or per-unit retain allocations received from the cooperative will be eligible for sec_199 in the patron’s hands that is the patron may not count the qualified_payment received from the cooperative in the patron’s own sec_199 computation whether or not the cooperative keeps or passes through the sec_199 deduction accordingly the only way that a patron can claim a sec_199 deduction for a qualified_payment received from a cooperative is for the cooperative to pass-through the sec_199 amount in accordance with the provisions of sec_199 of the code and the regulations thereunder we note that to prevent a cooperative from deducting the per-unit retain allocations made in money or qualified certificates for the second time when the plr-110378-10 associated b is sold the cost_of_goods_sold mechanism associated with inventory must be adjusted to reflect the deductions allowable under subchapter_t of the code specifically cooperatives need to include the per-unit retain allocations in inventory cost for purposes of making inventory and sec_263a of the code computations and then adjust the ending inventory and cost_of_goods_sold to prevent double deduction of the per-unit retain allocations the adjustments can be made to either the inventory or the line item deduction for the per-unit retain allocations in other words if the per-unit retain allocations are deducted on a deduction line in the cooperative's tax_return they should be removed entirely from the ending inventory and cost_of_goods_sold computed for the tax_year alternatively if the per-unit retain allocations are not deducted on a deduction line in the tax_return the per-unit retain allocations reflected in the ending inventory should be removed and included in the cost_of_goods_sold amount for that tax_year this procedure will allow the cooperative to deduct the per-unit retain allocations once while also preserving the integrity of its sec_263a calculation for the reasons described above taxpayer’s b payments to members and nonmember patrons meet the definition of per-unit retain allocations paid in money the per-unit retains must be treated as such for all purposes of the code and are reported in box of form 1099-patr taxable_distributions received from cooperatives if properly treated as per-unit retain allocations paid in money then taxpayer will be entitled to disregard such payments in determining the amount of its sec_199 deduction accordingly we rule as requested that initial 1st interim 2nd interim exceptional and final b payments paid in cash to members and nonmembers each year constitute per-unit retain allocations paid in money within the meaning of sec_1382 of the code for purposes of computing its sec_199 domestic_production_activities_deduction taxpayer’s qualified_production_activities_income and taxable_income should pursuant to sec_199 of the code be computed without regard to any deduction for b payments paid in cash to members and nonmembers the conclusions set forth in this ruling address only purchases that are per-unit retain allocations paid in money as they relate to b marketed by the cooperative during the taxable_year and does not apply to purchases of b that remain in inventory at year end no opinion is expressed or implied regarding the application of any other provision in the code or regulations this ruling is directed only to the taxpayer that requested it under section plr-110378-10 k of the code it may not be used or cited as precedent in accordance with a power_of_attorney filed with the request a copy of the ruling is being sent to your authorized representative sincerely yours paul f handleman paul f handleman chief branch office of the associate chief_counsel passthroughs special industries


release number release date internal_revenue_service te_ge technical_advice_memorandum uil date area manager - taxpayer's name taxpayer's address taxpayer's identification_number years involved conference held legend t company issues whether funds derived by t a state-chartered credit_union described in sec_501 of the internal_revenue_code from the following activities should be treated as unrelated_business_taxable_income under sec_511 of the internal_revenue_code a b sale of accidental death and dismemberment ad d insurance sale of credit life and credit disability insurance facts established in t is a state-chartered credit_union which is recognized as exempt from federal_income_tax under sec_501 of the internal_revenue_code code as an organization described in sec_501 t's board_of directors supervisory committee and loan committee are comprised entirely of elected members of the credit_union who serve on a voluntary basis without compensation membership in t is limited to employees family members of those employees or retirees of company t’s purposes as stated in its articles of incorporation are to promote thrift and provide low cost credit for its members t’s activities include accepting deposits from and maintaining the accounts and savings of its members these deposit accounts include savings or share accounts on which members earn periodic dividends credited to the accounts and share draft accounts which are transaction accounts similar to bank checking accounts t represents that its day-to-day business operations differ from conventional banking institutions in several ways t states that it conducts its business to reflect its non-profit mutual structure t makes loans to its members and states that many borrowers have low incomes and might not otherwise qualify for credit from conventional for-profit banks t also represents that it regularly issues loans for very small amounts such as loans for auto repairs which are typically not made by for-profit banks t indicates that it serves smaller communities than those served by for-profit banks t also indicates that because of its mutual non-profit operation all members not just those maintaining high minimum balances are able to earn competitive rates on their deposits and pay low banking fees t represents that in order to maintain its financial viability and continue to satisfy its stated purposes of promoting thrift and providing a source of low cost credit it has endeavored to become a full service financial_institution consequently t offers more than just demand deposits and loans currently t makes ad d insurance and credit life and credit disability insurance available to members the different types of insurance are described in more detail below all of these insurance products are underwritten or otherwise provided by third-party insurance_companies or other third-party vendors in each case t makes its members aware of the purpose and availability of these products answers members’ questions about the products or refers the member to the vendor for additional information and with respect to some of the products obtains and submits applications for coverage premium payments and claims during the year at issue t made the following types of loans personal mortgage vehicle and other secured and unsecured loans the majority of the loans were personal mortgage and vehicle in a total of loans were made and of these loans were collateralized the default rate on these loans as a percentage of total loans for the year at issue wa sec_1 t filed form 990-t unrelated_business_income_tax return for the year at issue however the amounts derived from the sale of the products discussed herein were not included as income derived from unrelated_trade_or_business a sale of ad d insurance t offers ad d insurance to its members t states that providing this insurance is an activity that is beyond the scope of services directly associated with members’ monetary deposits and loans made to members rather the provision of ad d insurance is a financial security activity that is offered to members under the terms of the ad d policy if the member has an accident that triggers a claim meeting the terms of the policy then the member or the in member's beneficiary receive specified insurance payments under the policy the case of accidental death the member’s beneficiary would receive payments in the case of dismemberment the member would receive payments t markets and sells ad d insurance to its members under a policy issued by an independent insurance_company t makes its members aware of the purpose and availability of ad d insurance answers members’ questions about the product refers the member to the independent insurance_company for additional information if it is needed and obtains and submits applications for coverage premium payment and claims t receives an administrative allowance for ad d insurance based on services provided by t the reimbursement i sec_15 of gross premiums collected no information was provided regarding number of policies sold during the year at issue or the percentage of members that elected ad d insurance coverage b sale of credit life and credit disability insurance t offers its member borrowers the opportunity to purchase credit life and credit disability insurance on certain loans t is a party to and beneficiary under standard group credit life and credit disability policies with a third party insurance_company under these policies a member-borrower who obtains a loan mortgages and other loans secured_by real_estate are often excluded may if he or she chooses obtain credit life and credit disability insurance which pays the loan installments during the period of physical disability which impacts the borrower's employment a loan officer informs each member-borrower of the availability of credit life and credit disability insurance coverage and if the member-borrower elects to obtain the coverage the premium charge is added to the borrower's loan balance obtaining the credit life and credit disability insurance coverage is never a condition of the member's receiving the loan as reflected in the group credit insurance_policy and letter agreements the credit disability coverage is standard coverage that provides that the insurer will repay the balance of a member's loan up to the policy limit the maximum loan duration covered was not provided however only credit_union members are eligible protection home equity loans and real_estate loans t does not offer credit disability insurance in connection with overdraft under the terms of the policy t is also reimbursed for its administrative expenses in connection with its performance of the prescribed duties as the policyholder t’s employees perform the following duties with respect to the credit disability insurance program e e e e e during the loan process and as part of the loan transaction itself explain the insurance program to member-borrowers process insurance applications collect and forward the premiums to the insurance_company receive and forward claims claims can be filed directly by the member- borrower to the insurance_company and answer member-borrowers’ questions t's staff may recommend that the member opt to obtain coverage in situations where coverage appears beneficial based on the level of personal and family resources available for loan repayment in the event of disability the credit disability insurance coverage requires monthly premium payments the charges are calculated by t and added to the member's loan balance t remits the premiums it has collected less its expenses as noted above to the insurance_company t's commission for its role in coverage issuance and policy administration is of the premiums written for credit life and credit disability insurance this percentage is based on an agreement between t and the insurance_company at the time the insurance was purchased t pays bonuses to employees based on an amount per policy sold no information was provided regarding loans covered by credit life and credit disability insurance during the year at issue additionally no information was provided regarding what percentage of these loans to total loans made by t during that year law sec_501 of the internal_revenue_code code provides in part that organizations described in sec_501 are exempt from federal_income_tax sec_501 of the code specifically exempts from federal_income_tax credit unions without capital stock organized and operated for mutual purposes and without profit sec_1_501_c_14_-1 of the income_tax regulations regulations provides in part that credit unions other than federal credit unions described in sec_501 of the code without capital stock organized and operated for mutual purposes and without profit are exempt from tax under sec_501 state-chartered credit unions were first acknowledged as exempt from federal_income_tax in a opinion of the attorney_general the attorney_general considered credit unions organized under the laws of the commonwealth of purposes of credit unions existing at that time the attorney general’s opinion described the i t is apparent that the purpose of these financial associations is to help people save and to assist those in need of financial help whose credit may not be established at the larger banks in reality they are fundamentally similar and supplemental to the existing agencies for promoting thrift namely the savings banks and cooperative banks except on a much smaller scale the attorney general’s opinion also described some of the operations of credit unions--making loans in appropriate amounts to members on which a low rate of interest is charged and that p rompt payment of obligations is a fundamental requirement the opinion described in detail the procedures by which members’ savings were held by the credit_union and how the members earned interest on their deposits the opinion also pointed to the democratic character of the governance of these early credit unions by their members at the annual meeting of the association each member shareholder and depositor has but one vote after review of the features and operations of these early credit unions the attorney general’s opinion held that state-chartered credit unions would be exempt from federal_income_tax see u s op atty gen the legal analysis of the attorney general's opinion was adopted in treasury regulations issued in and this remained the official basis for the tax exempt status of state-chartered credit unions until the revenue act of granted express statutory tax-exempt status to state-chartered credit unions however the revenue act of removed tax exemption from savings and loan associations cooperative banks and mutual_savings_banks the legislative_history of the act suggests that the reason these entities lost their exemption was because of their increasing similarity to commercial banks and the resulting loss of their original characteristic of mutuality specifically referring to the early days of these institutions the legislative_history states the fact that the members were both the borrowers and the lenders was the essence of the mutuality of these organizations see generally s rep no date reprinted in u s code cong ad svc present-day sec_501 - as enacted in - incorporates the requirements of mutuality and non-profit operation which formed the basis for the attorney general’s recognition of credit unions’ tax-exempt status in accordingly the basic purposes of the credit_union tax exemption remain essentially the same today as they were in based on the attorney general’s opinion the basis for exemption is the provision of savings accounts and loans to members who may not be served by banks in a non-profit and mutual manner sec_511 of the code imposes a tax on the unrelated_business_taxable_income of organizations otherwise exempt from federal_income_tax under sec_501 sec_512 of the code provides that the term unrelated_business_taxable_income means with certain modifications the gross_income derived by an organization from any unrelated_trade_or_business regularly carried on by it less allowable deductions sec_513 of the code defines the term unrelated_trade_or_business in the case of any organization subject_to tax imposed by sec_511 as any trade_or_business the conduct of which is not substantially related aside from the need of such organization for the income or funds or the use it makes of the profits derived to the exercise or performance by such organization of its exempt_function sec_1_513-1 of the regulations provides that gross_income of an exempt_organization subject_to the tax imposed by sec_511 of the code is with certain exceptions includable in the computation of unrelated_business_taxable_income if it is income from trade_or_business such trade_or_business is regularly carried on by the organization and the conduct of such trade_or_business is not substantially related other than through the production of funds to the organization's performance of its exempt functions sec_1_513-1 of the regulations provides that the term trade_or_business has the same meaning it has in sec_162 of the code and generally includes any activity carried on for the production_of_income from the sale_of_goods or the performance of services sec_1_513-1 of the regulations states that in determining whether a trade_or_business is regularly carried on within the meaning of sec_512 of the code regard must be had to the frequency and continuity with which the activities are conducted and the manner in which they are pursued hence for example specific business activities will ordinarily be deemed regularly carried on if they manifest a frequency and continuity and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations sec_1_513-1 of the regulations provides that gross_income is derived from unrelated_trade_or_business within the meaning of sec_513 of the code if the conduct of the trade_or_business which produces the income is not substantially related other than through the production of funds to the purposes for which exemption is granted the presence of this requirement necessitates an examination of the relationship between the business activities that generate the particular income in question - the activities that is of producing or distributing the goods or performing the services involved - and the accomplishment of the organization's exempt purposes sec_1_513-1 of the regulations provides that a trade_or_business is related to exempt purposes in the relevant sense only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes other than through the production_of_income and it is substantially related for purposes of sec_513 only if the causal relationship is a strong one thus for the conduct_of_a_trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of the services from which the gross_income is derived must contribute importantly to the accomplishment of those exempt purposes whether activities contribute importantly to an organization’s exempt purposes depends in each case upon the facts and circumstances involved in 693_f2d_525 5th cir a business league described in sec_501 of the code engaged in severa activities including the endorsement of insurance to its members the court analyzed whether these activities were substantially related to the business league's exempt_purpose under sec_501 of advancing the credit_union movement in order to determine whether income generated from those activities resulted in unrelated_business_income to the business league in its analysis the court stated that the substantial relationship’ determination is necessarily a fact- based inquiry id pincite the court also noted that the regulations under sec_513 require a case-by-case identification of the exempt_purpose an analysis of how the activity contributes to that purpose and an examination of the scale on which the activity is conducted the league promoted the purchase of insurance policies from a particular carrier providing the carrier with convenient services in the marketing and administration of its programs the court stated that the league's endorsement of group_insurance plans was principally motivated by a desire to raise revenue the court also discussed at length the distinction between group and individual benefit the court said the distinction between inherently group benefits and individual benefits is analogous to the aggregate entity concept familiar in partnership_taxation just as a member of a partnership may enjoy benefits in his separate capacities as partner and non-partner so may a member of the league may enjoy benefits both as a league member and as an individual credit_union only those activities that benefit the credit unions in their capacities as league members can be considered substantially related to the league’s exempt_function this group benefit standard also accords with the requirement that a business league seek to improve the conditions of an entire line_of_business rather than perform discrete services for individuals see sec_1_501_c_6_-1 when the activities of a business league are directed toward the achievement of the common business_interest of its members the benefits that accrue to its members are inherently group benefits id pincite the court continued its analysis by stating that insurance endorsement and administration is not the sort of unique activity that satisfies the substantial relationship_test nor are its benefits group-related id pincite rather than merely advising members of the availability and desirability of insurance coverage to credit unions generally the league promoted the purchase of polices from a particular carrier the court affirmed the district court’s rationale that the league’s insurance activities did little more than generate revenue because the league’s endorsement was basically a fundraising activity it was by definition unrelated business activity under sec_513 id pincite therefore the court concluded that the league’s insurance activities were not substantially related to its tax-exempt purpose of advancing the credit_union movement rather the connection between the furtherance of the credit_union movement and the selling of insurance was at best tangential in 78_tc_246 aff'd 726_f2d_1097 cir the court held that promotional and administrative fees and an experience rating reserve refund received by a business league described in sec_501 of the code for promoting group_insurance programs for its members constituted unrelated_business_taxable_income under sec_512 in holding that the business league’s activities were not substantially related the court considered whether the league’s insurance activities contributed importantly to the league’s exempt_purpose of advancing the common business interests of independent insurance agents the court stated the burden is on the taxpayer to show that the challenged activities contribute directly and importantly to the improvement of conditions in a particular line_of_business the court noted that the petitioner’s insurance activities did little more than generate revenue for the association and provided members with a convenient and economical service in the operation of their agencies as such they stood in sharp contrast to petitioner's educational and legislative activities which served the broader purpose of improving the general business environment in which insurance agents operated thus the court found petitioner's activity of promoting insurance was not substantially related to its exempt_purpose in la caisse popu563_f2d_505 1st cir the government unsuccessfully challenged the exempt status under sec_501 of the code of an organization chartered as a credit_union by the state of new hampshire the government maintained that the organization was not exempt because it offered a wide variety of services typically offered by nonexempt full service banks and was therefore not organized or operated as a credit_union among these services were checking accounts mortgage loans banking by mail safe deposit boxes and a night depository this case focused solely on the taxpayer’s exemption under sec_501 and did not address the provisions of sec_511 through in 646_fsupp_1199 n d ala a credit_union described in sec_501 of the code offered cancer and group_life_insurance to its individual members the issue was whether commissions the credit_union received from servicing these particular types of insurance policies constituted unrelated_business_income under sec_512 the court did not reach the issue for jurisdictional reasons however it stated in a footnote that the petitioner would have lost on the merits of this issue because the policies benefited the insured without any reference to the member’s loans or accounts with the credit_union that court stated in dicta that cancer and group_life_insurance offered by a credit_union to its members would result in unrelated business table income for the following reasons petitioner earned commissions for servicing cancer and group_life_insurance policies these policies were for the express benefit of the insured without any reference to the member's loans or accounts with the credit_union petitioner derived no benefit from the policies other than commission on the sale of said policies earned from the insurance_companies which issued the policies the sale of the cancer and group_life_insurance policies referred to had no substantial causal relationship to petitioner's exempt purposes and the sale of the policies bore no relationship to petitioner's function as a credit_union id pincite n revrul_69_282 1969_1_cb_155 provides that an organization must be formed and operated under the state law governing the formation of credit unions to qualify for exemption under sec_501 of the code as a state- chartered credit_union revrul_72_37 1972_1_cb_152 provides that to qualify as a credit_union_exempt from income_tax under sec_501 a of the code an organization must in addition to being formed and operated under a state credit_union law operate without profit and for the mutual benefit of its members the revenue_ruling clarified revrul_69_282 stating that a state charter is a threshold requirement for exemption but not the sole requirement revrul_60_228 1960_1_cb_200 interprets the substantially related requirement of sec_513 an organization exempt from federal_income_tax as an agricultural_organization described in sec_501 of the code promoted wider insurance coverage among its members and other local farmers including life casualty and fire insurance the insurance programs are provided by several insurance_companies but the organization’s administrative and secretarial staff is assigned to the work the organization receives an overall fee from the insurance_company for office and other services rendered them in connection with the insurance programs the revenue_ruling provides that a trade_or_business is substantially related to an organization’s exempt_activities if the principal purpose of the trade_or_business furthers these exempt purposes however in this case such activities are not usually associated with the functions of an agricultural_organization and normally would not be carried on by such an organization in furtherance of its exempt purposes therefore these activities are not substantially related to the organization’s exempt purposes thus the income resulting from these activities is subject_to tax under sec_511 analysis in determining whether an income-producing activity is an unrelated_trade_or_business it is necessary to show that there is a trade_or_business the trade_or_business is regularly carried on and the conduct of the trade_or_business is not substantially related to the organization's exempt_purpose or function see sec_1_513-1 a of the regulations t has agreed that the activities at issue are trades_or_businesses that are regularly carried on therefore the sole issue is whether each activity is substantially related to the organization’s achievement of its exempt purposes gross_income is derived from an unrelated_trade_or_business if the conduct of the trade_or_business is not substantially related other than through production of funds to the purposes for which exemption is granted sec_1_513-1 of the regulations determination of the substantial relationship issue requires an examination of the relationship between the business activities which generate the particular income in question and the accomplishment of the organization’s exempt purposes id the regulations further state that for the conduct of trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of services from which the gross_income is derived must contribute importantly to the accomplishment of those purposes sec_1_513-1 of the regulations see also prof'l ins agents of michigan supra insurance activity was not substantially related because activity did little more than generate revenue and provide members with a service and did not further taxpayer’s exempt_purpose of improving business conditions and louisiana credit_union league supra league's endorsement of group_insurance plans was principally motivated by a desire to raise revenue and at best was only tangentially related to the furtherance of the league’s exempt_purpose of improving business conditions of one or more lines of business the court found the requisite substantial relationship lacking for t’s activities to escape taxation as unrelated_business_income the activities must contribute directly and importantly to the accomplishment of one or more of t’s exempt purposes-promotion of thrift and providing low cost credit for its members through mutual and nonprofit operation sec_1_513-1 of the regulations see also prof'l ins agents of michigan supra we address each of the activities below ad d insurance t argues that making ad d insurance available to members is substantially related to the credit union’s exempt_purpose of promoting thrift by providing basic financial protection to members on a mutual basis t also argues that ad d insurance facilitates prompt repayment of loans on a mutual basis by protecting the individual member's financial security the facts do not show how t’s sales of ad d insurance contribute directly and importantly to t’s exempt purposes t has not demonstrated that sales of ad d insurance encourage savings by members who purchase it t has also not provided information showing that the sale of ad d insurance aids a member in obtaining credit or reduces the cost of providing credit to members the facts do not demonstrate that the sale of ad d insurance to individual members advances t’s mutual operation ad d insurance provides a financial protection to an individual the individual’s purchase of the ad d insurance does not provide a benefit to the members as a whole the legislative_history of sec_501 of the code indicates that mutuality is tied to the same members being the borrowers and lenders in loan transactions rather than the general principles that t espouses s rep no date t has not stated how the sale of ad d insurance to an individual provides a mutual benefit to t members the facts also do not show how sale of ad d insurance benefits the members of the credit_union as a whole a member may purchase ad d insurance without obtaining credit or a loan from t of t receives accidental dismemberment insurance payments the member may use the insurance payments as he or she wishes rather than saving them or paying off an obligation to t beneficiary may or may not be a member of t and also may use the payments as he or she desires in the case of accidental death the member's if a member in alabama central credit_union supra the court stated in dicta several factors cited above relevant to the substantially related inquiry in this case t earns commissions for servicing ad d insurance policies sells policies for the express benefit of the insured without any reference to the member’s loans or accounts with the credit_union derives no benefit from the policies other than commission on the sale of the policies earned from the insurance_companies which issued the policies the sale of the insurance policies referred to has no substantial causal relationship to t’s exempt purposes and the sale of the policies bears no relationship to t’s function as a credit_union based on all of the facts and circumstances t’s activities with respect to the sale of ad d insurance do not contribute importantly to accomplishing t’s exempt purposes the ad d insurance sold benefits an individual and t receives no benefit other than the production_of_income therefore the sale of ad d insurance is not substantially related to t's exempt purposes and amounts received therefrom are subject_to unrelated_business_income_tax ubit credit life and credit disability t argues that the sale of credit disability insurance is directly related to the credit union’s specific exempt purposes of fostering thrift among the members including both the extension of credit to members on reasonable terms and encouraging savings among the members and providing services to members on a mutual basis t further maintains that credit insurance which is an integral part of a member loan transaction is a mechanism for assuring the prompt repayment of debts in situations where the financial resources of the borrower and the borrower's family become strained as a result of disability the facts do not show how sales of credit life and credit disability insurance contribute directly and importantly to accomplishing t’s exempt purposes credit life and credit disability insurance is not required for the approval of a loan in fact credit life and credit disability insurance is not available to members on certain types of loans such as mortgage and other real_estate loans the member decides whether to purchase credit life and credit disability insurance based on his or her own assessment of whether the insurance will provide a benefit to that individual member the individual member benefits in that the member need not worry about paying a loan to t in the event of death or disability while there is also a benefit to the credit_union as the beneficiary the facts do not show how the sale of credit life and credit disability insurance otherwise contributes importantly and directly to accomplishing t’s exempt purposes other than through the production_of_income availability of credit life and credit disability insurance does not encourage savings or assist t in offering low cost credit t does not take into consideration the need for this insurance by members t performs no studies to determine which members may need credit life and credit disability insurance and there is no required corresponding counseling to members who may have more need than others although t’s staff may recommend insurance based on the level of personal and family resources these recommendations are not mandatory in specific cases and coverage is not required in these cases additionally t’s arguments do not address the fact that bonuses are paid to employees based on the number of policies sold providing a profit-motive incentive to t’s employees rather than a membership benefit as a whole in addition t’s commissions are high pincite of premiums_paid for credit life and credit disability because the insurance is voluntary and has no bearing on the approval of a loan the individual benefit-to the selling employee-is the primary benefit of offering the insurance applying the factors of alabama central credit_union supra t earns commissions for providing credit life and credit disability insurance sells policies for the express benefit of the insured albeit with reference to a member's loan with the credit_union derives some benefit from the credit life and credit disability insurance but the primary benefit is production_of_income both through the commission on the sale of the insurance earned and the bonuses paid to t employees the insurance referred to has no substantial causal relationship to t’s exempt purposes and the insurance bears no relationship to t’s function as a credit_union looking at the facts with respect to credit life and credit disability insurance the sale of credit insurance is not substantially related to t’s exempt purposes the available information indicates that the sale of insurance is primarily for the purpose of generating income to t and some of its employees and for the benefit of the insured rather than for the benefit of t's membership based on all of the facts and circumstances t’s activities with respect to the sale of credit life and credit disability insurance do not contribute importantly to accomplishing t’s exempt purposes therefore the sale of credit life and credit disability insurance is not substantially related to t’s exempt purposes and amounts received therefrom are subject_to ubit conclusion for reasons set forth above we conclude that the income received by a sec_501 credit_union from the activities listed below are not substantially related to the furtherance of t’s exempt purposes and therefore are subject_to ubit a b sale of ad d insurance sale of credit life and credit disability insurance a copy of this technical_advice_memorandum is to be given to the taxpayer sec_6110 of the code provides that it may not be used or cited as precedent - end -