2008 Subcommittee Reports of the Legal, Tax and Accounting Committee

2008

Legal, Tax and Accounting

Subcommittee Reports

INTRODUCTION

The LTA subcommittee reports are prepared annually through the efforts of individuals who serve on NCFC’s Legal, Tax and Accounting Committee. NCFC is deeply grateful for the dedication and generosity of these volunteers, many of whom are national experts in their respective areas of practice.

The purpose of the reports is to interpret and highlight the legal, tax and accounting events of the past year, and to discuss in detail many of the issues faced by cooperatives.

The legal, tax and accounting issues of farmer cooperatives are affected by a number of external forces and general practice issues, with the added focus of specific industry issues. The LTA subcommittee reports are the only resource summarizing all these issues in a single volume.

If you have questions or need materials referred to in the reports, please notify me by email at [email protected] or by telephone at 202.879.0825.

Sincerely,

Marlis Carson General Counsel & Vice President, Legal, Tax & Accounting

2 The following reports do not constitute specific advice and may fail to address aspects of an issue or development relevant to the reader. Readers should be particularly aware of the importance of checking for subsequent developments, as these reports may not have been updated since originally composed.

3 Table of Contents

2008 Subcommittee Reports of the Legal, Tax and Accounting Committee

Page

Introduction...... 2

Financial Reporting and Audit Issues of Agricultural Cooperatives...... 5 by Dick Cisne, Jay McWatters and Ken Wise

Overview of New Tax, Other Legislation and Implementation Issues...... 17 Affecting Farmer Cooperatives by Barry Jencik and Kevin Feeley

Operating on a Cooperative Basis for Subchapter T and Section 521 Cooperatives ...... 23 by Terry Costello and Ron Peterson

Cooperative Structures: Mergers, Acquisitions, Joint Ventures and Subsidiaries ...... 24 by Dave Swanson and Charlie Woltmann

Issues Specific to Marketing Orders and Bargaining Cooperatives ...... 37 by Ken Manock, Julian Heron and Steve Zovickian

Litigation between Cooperatives and Their Members, Including Member Insolvency ...... 46 by David M. Hayes, Terry D. Bertholf and William P. Hutchison

AMT, Tax Accounting and State and Local Tax Issues Affecting Agricultural Cooperatives...... 56 by Dave Simon and Wayne Sine

Antitrust ...... 61 by William Sippel, Michael Lindsay and Don Barnes

Environmental Laws and Regulation...... 73 by Randon Wilson and Andy Brown

Digest of Cases ...... 82 by George Benson

IRS Industry Specialist ...... 114 by Marla Aspinwall

4 Financial Reporting and Audit Issues of Agricultural Cooperatives

2008 Report

Chair Vice-Chair Vice-Chair

Dick Cisne Jay McWatters Ken Wise Hudson, Cisne & Co. LLP Dopkins & Company, LLP PricewaterhouseCoopers 11412 Huron Lane 200 International Drive 225 South 6th St, Ste 1400 Little Rock, AR 72211 Williamsville, NY 14221 Minneapolis, MN 55402 Ph: 501-221-1000 Ph: 716-634-8800 Ph: 612-596-6427 Fax: 501-221-9236 Fax: 716-634-8987 Fax: 612-373-7160 E-mail: [email protected]

The information available on financial reporting and audit issues which could be applicable to agricultural cooperatives is vast and is beyond the scope of this subcommittee’s resources to analyze and report on each one. This year’s report will cover the most talked about developments, some with effective dates prior to 2008, but whose application is still of interest to cooperatives and their advisors.

Pronouncements of the Financial Accounting Standards Board can be obtained from its website at www.FASB.org. Statements and pronouncements on auditing standards along with statements of position, interpretations and professional pronouncements by the American Institute of CPA’s can be obtained from its website at www.AICPA.org. Exposure drafts outstanding are listed each month in the Journal of Accountancy by issuer, which also lists the issuer’s web address and mailing address.

Definitions/Terms:

GAAP - Generally Accepted Accounting Principles AICPA - American Institute of Certified Public Accountants EITF - Emerging Issues Task Force FASB - Financial Accounting Standards Board FSP - FASB Staff Position IASB - International Accounting Standards Board IFRS - International Financial Reporting Standards APB - Accounting Principles Board ARB - Accounting Research Board SFAS - Statement of Financial Accounting Standards SOP - Statement of Position SAS - Statement of Auditing Standards SEC - Securities and Exchange Commission

5 FASB Codification Project

The objective of the codification project is to integrate and topically organize all relevant accounting guidance issued by the U.S. standard setters (FASB, AICPA, EITF, and SEC). The codification project takes the existing GAAP pronouncements from all sources and organizes them into roughly 90 topics using a consistent structure. Once it is adopted, the Codification will be the sole source of non-SEC authoritative GAAP. The FASB launched a one-year verification phase in January 2008. Constituents are encouraged to use the online Codification Research System free of charge to research accounting issues and provide feedback on whether the Codification content accurately reflects existing U.S. GAAP. During the verification period, Codification content will be updated for changes resulting from constituent feedback and new standards. The Codification is open for comments through January 15, 2009 and is scheduled to become effective on July 1, 2009.

IFRS – Moving Towards a Single International Accounting Standard

Presently, approximately 100 nations, including those of the European Union, have adopted IFRS as their accounting standards of choice. Recent trends clearly suggest that IFRS is on track to become the high quality set of common global accounting standards that many have been calling for. The much anticipated release in August 2008 by the SEC affirms that IFRS clearly have the “inside track” to achieving that distinction. In their subsequent releases, the SEC provides a timeline for US public companies to adopt IFRS in a phased-in approach from 2010 through 2017. Large companies approved to be in the first wave of adopters can use the rules for filings they submit in 2010 for their 2009 fiscal years.

It is generally held that the IFRS rules are more principles-based and generally less prescriptive than their present U.S. GAAP counterparts. For example, the number of revenue recognition standards that exist in U.S. GAAP far outnumber those in place under IFRS – there are many other examples as well. Some have asserted, with good authority, that IFRS has a tendency to report generally higher earnings than U.S. GAAP. One area that will be particularly interesting to watch for U.S. cooperatives is the distinction between liability and equity instruments under these rule sets. More instruments are likely to be classified as liabilities, as opposed to equity, under IFRS than under U.S. GAAP. After some successful discussion with the FASB to assist them in obtaining a better understanding of cooperative equity, the prospect of repeating these debates in an IFRS context might sound daunting to cooperative financial leaders. Needless to say, the standard setters’ deliberations over coming months and years will need to be carefully monitored by the cooperative community to head off any unintended accounting consequences from these inevitable changes we face.

Financial executives of many of the country’s larger public companies as well as representatives of the Big Four accounting firms are expressing the view that the process of converging from U.S. GAAP to IFRS will be a complex and costly initiative. Some even contend that the cost of implementing this GAAP conversion will far outpace the stratospheric costs of implementing the Section 404 internal control assessment requirements of the Sarbanes-Oxley Act. What is clear

6 is that the process of converting and restating US GAAP financial statements will be a significant endeavor.

Companies will need to thoroughly assess, document and compare their existing accounting practices to the corresponding IFRS requirements; decide what changes are necessary, and; measure and implement the new policies. Additionally, financial statement disclosures will need to be reconsidered as will the potential need to modify various pre-existing business agreements (e.g. debt covenants), strategic relationships (e.g. joint venture agreements) and operational policies (e.g. employee compensation plans). These steps do not even address the question of whether these entities have the appropriate knowledge and experience in-house to implement IFRS.

Since 2002, the FASB has been working aggressively with the IASB to harmonize their respective set of accounting standards. It is clear from their slate of projects, the public statements of their leaders and the SEC’s recent actions that those harmonization efforts will only increase. Noteworthy US standards (such as SFAS 160, SFAS 159, SFAS 157 and SFAS 141R, all discussed below) are by-products of these joint efforts. What will likely result from these efforts over time will be a set of U.S. GAAP standards that have morphed to look very much like the international standards (logically, the reverse will also be true of the IFRS’ proximity to U.S. GAAP). On one end of that particular spectrum, this process could mean that there will remain few, if any, meaningful differences between U.S. GAAP and IFRS when the harmonization efforts are concluded. In such a case, there would be no practical implication of a mandated conversion to IFRS – U.S. GAAP would already be there.

Further, in October 2008, a Joint Discussion Paper entitled Preliminary Views on Financial Statement Presentation was issued by the IASB and FASB. This discussion paper contains an analysis of the current issues in financial statement presentation and the initial plans to tackle those issues. The proposed presentation model requires an entity to present information about the way it creates value (its business activities) separately from information about the way it funds or finances those business activities (its financing activities). The discussion paper shows examples of financial statements that are drastically different from the current requirements, including a new footnote that reconciles cash flows to comprehensive income and disaggregates comprehensive income into cash received or paid other than in transactions with owners, accruals other than remeasurements, remeasurements that are recurring fair value changes or valuation adjustments, and remeasurements that are not recurring fair value changes or valuation adjustments. If adopted, the basic equation of assets equals liabilities plus equity would no longer be shown on the statement of financial position. Instead, that basic equation would be shown as a footnote to the financial statements.

The model is designed to make an entity’s financial statements more useful by requiring entities to provide detailed information organized in a manner that clearly communicates an integrated (cohesive) financial picture of an entity. Comments are due April 14, 2009.

7 SFAS 160 – Noncontrolling Interests in Consolidated Financial Statements:

A noncontrolling interest, generally less than a 50% interest and sometimes called a minority interest, is the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. This standard requires:

• The ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent's equity. • The amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income. • Changes in a parent's ownership interest while the parent retains its controlling financial interest in its subsidiary to be accounted for consistently. A parent's ownership interest in a subsidiary changes if the parent purchases additional ownership interests in its subsidiary or if the parent sells some of its ownership interests in its subsidiary. It also changes if the subsidiary reacquires some of its ownership interests or the subsidiary issues additional ownership interests. All of those transactions are economically similar, and this Statement requires that they be accounted for similarly, as equity transactions. • When a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value. The gain or loss on the deconsolidation of the subsidiary is measured using the fair value of any noncontrolling equity investment rather than the carrying amount of that retained investment. • Entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners.

This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited.

SFAS 141R – Business Combinations:

FASB Statement No. 141(R) requires that the acquiring entity in a business combination (a) recognize all the assets acquired and liability assumed in the transaction, (b) establish the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed, and (c) disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combinations. This statement specifically establishes principles and requirements for how the acquirer

• recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree;

• recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and

8 • determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.

This statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. This statement applies to all transactions or other events in which an entity (the acquirer) obtains control of one or more businesses (the acquiree), including those sometimes referred to as true mergers or mergers of equals and combinations achieved without the transfer of consideration (for example, by contract alone or through the lapse of minority veto rights). This statement applies to all business entities, including mutual entities that previously used the pooling-of-interests method of accounting for some business combinations. It does not apply to

• the formation of a joint venture;

• the acquisition of an asset or a group of assets that does not constitute a business;

• a combination between entities or businesses under common control; and

• a combination between not-for-profit organizations or the acquisition of a for-profit business by a not-for-profit organization.

SFAS 150 - Liabilities vs. Equity Project:

Many cooperatives do not apply the provisions of SFAS No. 150 by classifying their patron equities as liabilities because they believe their patronage and other certificates are not mandatorily redeemable if their redemption is subordinate to the general creditors or the Board may defer redemption if it would violate loan covenants.

In November 2007, FASB issued their Preliminary Views - Financial Instruments with Characteristics of Equity, and opened a comments period through May 2008. The main concern with the latest Preliminary View is the FASB has decided on the “basic ownership approach” for distinguishing between equity and liability. Under this approach, “an instrument would be classified as equity if it 1) is the most subordinated interest in an equity (i.e. the members have a claim to a share of the assets that would have no priority over any other claims if the organization were to liquidate) and 2) entitles the holder to a share of the entity’s net assets after all higher priority claims have been satisfied (i.e. the members are entitled to a percentage of the assets that remain after all higher priority claims have been satisfied). All other instruments, for example, all forward contracts, options, and convertible debt, would be classified as liabilities or assets. If the instruments have a basic ownership component and a liability component, then the values would be separated and only the basic ownership component would be classified as equity.

9 In September 2008, a roundtable discussion was held by the FASB to discuss this issue. It seems that the FASB and the IASB are truly searching for the theoretical hooks that would provide the “best” definition of equity. As SFAS 150 pertains to the equity of cooperatives, several lines of thought emerged or were implied by the discussions:

1) Allocated equity might be perceived of as a liability because it is a deferred price adjustment or rebate – not an acceptable line of reasoning to cooperatives, but one that had to be discussed. 2) Allocated equity might be viewed as retained earnings since it is residual – after the payment of the cash portion of the price adjustment – viewed from the entity perspective, there would be no difference between allocated equity in a cooperative and retained earnings in an investor-owned entity. The decision to redeem allocated equity by the coop and the investor-owned entity decision to pay a dividend would be economically identical. 3) Allocated equity might be a basic ownership instrument so long as the “no upper limit” criteria was removed from the definition in the current Preliminary Views document. 4) Allocated equity might be a perpetual instrument. If perpetual instruments were allowed to be treated as equity under a revised Basic Ownership Approach, then allocated equity would still be treated as equity, rather than a liability. 5) Allocated equity that is puttable by the member or has a mandatory redemption provision is still problematic due to both the nature of the obligation (inescapable) and the fact that a strict book value (no appreciation value formula) redemption is not acceptable; the “no upper limit” criteria again.

During the roundtable, some time was spent describing for the Board the practical steps for liquidation of a cooperative entity, and who it is that actually participates in any excess liquidation. FASB members asked for assistance in crafting revisions that would work, not only for cooperatives, but also for other entities that have similar pass through residual capital (i.e. LPs, S Corps, etc).

In November and December 2008, the Joint Project of the FASB and IASB continued to deliberate on this issue. A total of 65 respondents provided comments to the project, of which 23 identified themselves as either a preparer or professional organization relating to Cooperatives. The majority of the respondents do not support the basic ownership approach. The significant issues raised include: • The classification as liabilities of all perpetual instruments that are not basic ownership instruments (measurement was also cited as a potential issue) • The classification as equity in consolidated financial statements of basic ownership instruments of a subsidiary • Reporting changes in fair values of many types of liabilities in net income • Certain puttable financial instruments and obligations arising on liquidation (for example, certain partnership arrangements) that are currently classified as equity would be liabilities under the basic ownership approach

10 • Many instruments classified as equity by cooperatives would be classified as liabilities under the basic ownership approach because they have fixed redemption prices or upper limits on the amounts the holders would receive in liquidation.

The majority of the cooperative respondents expressed a preference for International Financial Reporting Interpretations Committee (IFRIC) 2. IFRIC 2 states that a redemption requirement does not prevent shares (that otherwise would be equity) from being equity if either a) the entity has an unconditional right to refuse redemption or b) if redemption is unconditionally prohibited by local law, regulation, or the entity’s governing charter. The cooperative respondents also encouraged the Board to consider incorporating certain features of the Loss Absorption Approach in any model that is developed. One change in particular that was identified was to classify all perpetual instruments as equity and remove references to upper limits on distributions from the definition of a basic ownership instrument.

Overall, this situation is very fluid, with convergence issues and the desire of both boards to reach a consensus theory.

SFAS 158 - Postretirement Benefit Obligations, Including Pensions:

This standard requires an employer to:

(a) recognize in its balance sheet an asset for a defined benefit plan’s overfunded status or a liability for its underfunded status; (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions); and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur through other comprehensive income (for a business entity) or changes in unrestricted net assets (for a not-for-profit organization).

The requirement to recognize the funded status of a defined benefit plan and the related disclosure requirements are effective for the employer Company's year ending after December 15, 2006, for entities that are publicly traded, and for year's ending after June 15, 2007, for all other Companies. The requirement to measure plan assets and benefit obligations as of the employer’s year-end is effective for years ending after December 15, 2008. Earlier application of the recognition or measurement date provisions is encouraged.

SFAS 157 - Fair Value Measurements:

This standard defines fair value and expands disclosures about fair value measurements. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances.

SFAS 157 provides increased consistency and comparability in fair value measurements. Expanded disclosures about the use of fair value to measure assets and liabilities should provide

11 users of financial statements with better information about the use of fair value in the financial statements, the inputs used to develop the measurements, and the effect of the measurements on earnings (or changes in net assets) for the period.

In February 2008, the FASB issued FSP Financial Accounting Standards (FAS) 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, which amends FASB Statement No. 157 to exclude SFAS 13, Accounting for Leases, and other accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS 13. However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination that are required to be measured at fair value under SFAS 141 or SFAS 141(R), regardless of whether those assets and liabilities are related to leases. This FSP is effective upon the initial adoption of SFAS 157.

In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157, which is effective upon issuance. This FSP delays the effective date of FASB Statement No. 157 until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for fair value measurements of all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The delay is intended to allow the FASB and its constituents the time to consider the various implementation issues associated with SFAS 157.

In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for that Asset is Not Active, which is effective upon issuance, including prior periods for which financial statements have not been issued. This FSP clarifies the application of FAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.

As described in SFAS 157, valuation techniques, which are consistent with the market approach, income approach, cost approach, or some combination of these approaches, should be used to measure fair value:

• The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. Valuation techniques consistent with the market approach include matrix pricing and often use market multiples derived from a set of comparables.

• The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. Valuation techniques consistent with the income approach include present value techniques, option-pricing models, and the multiperiod excess earnings method.

12 • The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (often referred to as current replacement cost). Fair value is determined based on the cost to a market participant (buyer) to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence.

Derivatives Simplification Project

The objective of the Accounting for Hedging Activities project is to amend Statement 133, Accounting for Derivatives and Hedging Activities, to achieve the following: 1. Resolve practice issues that have arisen under SFAS 133.

2. Simplify accounting for hedging activities.

3. Improve the financial reporting of hedging activities to make the accounting model and associated disclosures easier to understand for users of financial statements.

4. Address differences in the accounting for derivative instruments and hedged items or transactions.

The Board issued an Exposure Draft, Accounting for Hedging Activities, on June 6, 2008. The comment period ended on August 15, 2008. This proposed Statement would establish a fair value approach to hedge accounting. The approach would eliminate many elements that exist under the current hedge accounting model, including bifurcation-by-risk, the shortcut method, critical terms match, and the requirement to quantitatively assess effectiveness in order to qualify for hedge accounting.

As a result, when accounting for the hedging relationship, an entity would be required, in all cases, to independently determine the changes in fair value of the hedged item for fair value hedges and the present value of the cumulative change in expected future cash flows on the hedged transaction.

The Board's goal is to issue a final Statement by December 31, 2008. The proposed Statement would require application of the amended hedging requirements for financial statements issued for fiscal years beginning after June 15, 2009, and interim periods within those fiscal years.

SFAS 161 – Disclosures about Derivative Instruments and Hedging:

The use and complexity of derivative instruments and hedging activities have increased significantly over the past several years. Constituents have expressed concerns that the existing disclosure requirements in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities do not provide adequate information about how derivative and hedging activities affect an entity's financial position, financial performance, and cash flows. Accordingly, this Statement requires enhanced disclosures about an entity's derivative and hedging activities and thereby improves the transparency of financial reporting.

Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows.

This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. In September 2008, FASB issued FSP FAS 133-1 and FIN 45-4 Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161. This FSP requires disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument and requires additional disclosure about the current status of the payment/performance risk of a guarantee.

Differential Accounting (i.e. Big GAAP, Little GAAP):

In June of 2006, the FASB and the AICPA issued a joint proposal intended to improve the financial reporting process for private company constituents. Specifically, the joint initiative seeks constituent feedback on proposed enhancements to the FASB's standard setting procedures that would determine whether the board should consider differences in accounting standards for private companies within generally accepted accounting principles (GAAP).

The FASB and the AICPA have established a joint committee to serve as an additional resource to the FASB to further ensure that the views of private company constituents are incorporated into the standard-setting process. The joint committee formed is known as the Private Company Financial Reporting Committee (PCFRC). PCFRC members represent users and preparers of private company financial statements as well as CPA practitioners.

The Committee has made recommendations or offered its views to the FASB on FIN 48 (addressed later in this report), Subsequent Events, the Preliminary Views – Financial Instruments with Characteristics of Equity, Disclosure of Certain Loss Contingencies, and the SEC concept release Allowing U.S. Issuers to Prepare Financial Statements in Accordance with IFRS.

Current FASB projects that the Committee is addressing or will address include FASB Interpretation Number (FIN) 46R Consolidation of Variable Interest Entities, SFAS 123R Share-Based Payment, and Goodwill, long-term asset valuation and impairment.

Current FASB projects that the Committee may address include Financial Statement Presentation, Leases, International Convergence, SFAS 133 Derivatives and Hedging, Small- and Medium-Sized (SME) Entities (IASB-related), Revenue Recognition, and SFAS 5 Contingencies. As the PCFRC further studies the timetable for these projects, it will develop its priorities from a timing perspective.

The PCFRC's recommendations to the FASB are available at http://www.pcfr.org/recommendations. The PCFRC is committed to maintaining an open dialogue with interested parties and PCFR stake-holders. Anyone interested in learning more about the PCFRC should visit its Web site to read meeting highlights or join the committee's resource group.

Income Tax Project:

The objective of the income tax project is to improve the accounting for income taxes, while reducing the existing differences between SFAS 109, Accounting for Income Taxes, and International Accounting Standard (IAS) 12, Income Taxes. Although SFAS 109 and IAS 12 are based on similar principles, there are certain differences in the application of those similar principles that result in noncomparability of financial information reported internationally. The FASB and the IASB boards are jointly deliberating the issues in this project.

FIN 48 - Accounting for Uncertainty in Income Taxes:

FIN 48 was issued in June 2006 and is effective for fiscal years beginning after December 15, 2006. However, subsequent to its issuance, FASB issued FSP FIN 48-2, Effective Date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises, which defers the effective date of FIN 48 for nonpublic enterprises included in the FSP’s scope to the annual financial statements for fiscal years beginning after December 15, 2007.

On November 4, 2008, the Board issued proposed FSP FIN 48-c, Effective date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises. On December 17, 2008, the Board discussed the comments received and affirmed its previous decision that nonpublic enterprises may elect to defer their application of FASB Interpretation No. 48 for an additional year until annual financial statements for fiscal years beginning after December 15, 2008. The Board also affirmed its previous decision to NOT permanently exempt nonpublic enterprises from the scope of FIN 48. The Board decided that nonpublic enterprises that elect the deferral should include an explicit disclosure of that election and also disclose their accounting policy for evaluating uncertain tax positions in each set of financial statements to which the deferral applies. The Board will use the time during the deferral period to develop guidance about the application of FIN 48 to pass-through entities.

Interpretation 48 applies to all tax positions accounted for in accordance with SFAS No. 109. Tax positions are items reported on an entity's tax return for which the entity receives an economic benefit, such as a reduction in the amount of income taxes payable. Different tax positions often have different degrees of uncertainty. Generally that uncertainty relates to whether the tax position will be sustained upon examination by an informed taxing authority, such as the IRS. Management must believe that it is "more likely than not" that a tax position will pass under examination. Having a good argument is not enough any more!

15 The Interpretation requires the evaluation of tax positions by management using a two-step process. An entity must first determine whether a tax position should be recognized. If so, the Interpretation then provides guidance on measuring the amount of the benefit related to the tax position.

On May 2, 2007 the FASB released FASB Staff Position FIN 48-1 which provides guidance on how management should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits.

Also, during the year the AICPA’s Professional Ethics Committee released information related to the issue of auditor independence in to the application of FIN 48. It states that an auditor can perform FIN 48 work if “the client can make an informed judgment on the results of the auditor’s services.”

Lease Accounting Revisions (joint IASB and FASB project):

The primary objective of the leases project is to develop a new model for the recognition of assets and liabilities arising under lease contracts to ensure that financial statements provide useful, transparent, and complete information about leasing transactions to investors and other users of financial statements.

At the technical plan meetings in June 2008, the staff presented a revised project plan for leases. This should result in the publication of a new lease accounting standard by mid-2011 based on various assumptions. At their July meetings, the Boards discussed:

1. The scope of the project and whether to include or exclude lessor accounting options to extend or terminate a lease 2. Contingent rentals 3. The initial and subsequent measurement of a lessee’s right-of-use asset and obligation to make rental payments 4. Whether to retain the requirement to classify leases as operating leases or finance leases.

This concludes out committee’s coverage of selected current issues and pronouncements for 2008. We welcome any comments or additional information and would appreciate any suggestions and information related to these issues which should be covered in future reports.

END. December 30, 2008

16 Subcommittee on New Tax, Other Legislation & Implementation Issues Affecting Farmer Cooperatives

2008 Report

Subcommittee Chair: Barry Jencik, Standera & Jencik Subcommittee Vice-Chair: Kevin Feeley, McDermott Will & Emery

This Report provides a summary of the key provisions of Federal tax legislation adopted in 2008 that may be of interest to farmer cooperatives and their members. The legislation described below is set forth in the reverse order of adoption.

The Worker, Retiree, and Employer Recovery Act of 2008 (P.L. 110-458)

At the end of 2008, the continuing deterioration in the economy prompted Congress to pass The Worker, Retiree, and Employer Recovery Act of 2008. This legislation includes a package of provisions to assist qualified retirement plans, particularly in providing relief to pension funds that are unable to meet new funding obligations imposed by the Pension Protection Act of 2006 (“PPA”). It also contains technical corrections to the PPA. For single-employer plans, two provisions are noteworthy

• Under the new law, plans that fall below the funding percentage target for a particular year are required to make subsequent contributions up to such percentage. This eliminates a “cliff” provision in the PPA, under which if a plan missed its target, the target would generally jump to 100%.

• The new law clarifies the use of “smoothing” the recognition of unexpected gains and losses over a two-year period. The PPA had reduced the smoothing period from 4 years to 2 years.

The new law makes several technical corrections to the PPA. One item of note relates to nonspouse beneficiaries of qualified plan participants and IRA owners. For plan years beginning after 2009, company plans must offer nonspouse beneficiaries a rollover option.

For multi-employer plans, the new law relaxes funding requirements imposed by the PPA, providing a three-year extension, from 10 to 13 years, of the current funding improvement period for multi-employer plans in critical or endangered status.

For retirees, the law contains a relief provision designed to mitigate the effect of the severe drop in retirement account values caused by falling prices in the stock and bond markets. Specifically, the law suspends for 2009 required minimum distributions from qualified retirement accounts, including 401(k) plans, IRAs, and similar retirement accounts.

17 The Emergency Economic Stabilization Act of 2008 (P.L. 110-343)

On October 3, 2008, President Bush signed into law an economic stabilization package. This legislation provides funds of up to $700 billion to bail out financial institutions. It also provides and extends a number of incentives, including incentives for renewable fuels. It includes the following provisions of note:

• As to the Section 45 renewable energy credit, the law extends the credit for producing electricity through qualified wind facilities through December 31, 2009 and the credit for producing electricity through biomass and other qualifying renewable sources through December 31, 2010. It also expanded the definition of some renewable energy sources, such as biomass.

• The law provides an immediate write-off of 50 percent of the cost of facilities that produce cellulosic biofuels, provided the facilities are placed in service before January 1, 2013. This is an expansion of the existing benefit available to cellulosic biomass ethanol plan property.

• The per-gallon incentives for alternative fuels (biodiesel, agri-biodiesel and renewable diesel) have been extended through December 31, 2009.

• The law increases the tax credit for biodiesel from 50 cents to $1 per gallon.

• Trumping an IRS position, the law allows fuel coproduced from biomass and petroleum to qualify as a renewable diesel mixture and thus eligible for the tax credit for alternative fuels.

• The law expends through December 10, 2010, the credit for installing alternative fuel vehicle refueling property, which is 30% of the cost of the property placed in service.

• The law extends by two years the placed in service requirements and construction requirements for the election to expense 50% of the cost of qualified refinery property under Section 179C of the Code.

• For farmers, the law provides a five-year recovery period for depreciation purposes to any machinery or equipment placed in service during 2009 in a farming business, with the exception of a grain bin, cotton ginning asset, fence or land improvement.

As a revenue raiser, the new law limits the benefit under Section 199 for taxpayers with oil related qualified production activities. In 2010, the deduction would have increased from 6% to 9% of the income from the taxpayer’s oil related qualified production activities. Instead, the deduction will remain at 6%.

For tax return preparers, the law changes the disclosure standard for non-abusive positions. Under legislation passed in 2007, the standard for disclosure was heightened from realistic possibility of success to the more likely than not standard. This new law reduces the standard to

18 substantial authority, which occupies a middle ground between the realistic possibility of success standard and the more likely than not standard.

Finally, the law provides a one year “patch” (for 2008) to the alternative minimum tax, increasing the AMT exemption amounts to better insulate middle-income taxpayers from being subject to the AMT.

. Housing and Economic Recovery Act of 2008 (P.L. 110-289)

This legislation was designed to address the subprime mortgage crisis. In addition to the strengthening the regulation of housing government sponsored entities (i.e., Fannie Mae, Freddie Mac and the Home Loan Banks, the Act provides various tax benefits primarily targeted to home ownership and providing affordable housing. The legislation will:

• provide first-time home buyers (as defined) with a refundable credit of 10% of the purchase price of a home, up to $7500 (recipients would be required to repay any credit amount received over a 15 year period and the credit is phased out for individuals with an adjusted gross income in excess of $75,000 (or $150,000 for joint filers));

• provide taxpayers who claim the standard deduction an additional standard deduction of up to $500 (or $1000 for joint filers) for state and local property taxes;

• provide an increase the state-by-state allocation of low-income housing tax credits; and

• simplify the rules applicable to tax-exempt housing bonds.

The Act would allow a corporation to elect to claim a limited amount of its unused credits for pre-2006 alternative minimum tax (AMT) liabilities and/or pre-2006 research expenditures if, after March 31, 2008, it acquires and places in service depreciable property that qualifies for MACRS bonus depreciation. If the election is made the corporation may not claim the bonus depreciation deduction on any bonus depreciation property acquired and placed in service after March 31, 2008, and must depreciate the property using the MACRS straight-line method. The credit is approximately equal to 20 percent of the bonus depreciation that could have been deducted but may not exceed the lesser of six percent of the corporation's unused pre-2006 credit amounts or $30 million.

19 The Heartland, Habitat, Harvest, and Horticulture Act of 2008, Title XV of the Food, Conservation, and Energy Act of 2008 (P.L. 110-246) (The Farm Bill)

The Farm Bill's tax title provides significant benefits to farmers, ranchers and timber producers, while raising revenue from certain gentlemen farmers, ethanol producers and large corporations. These include the following:

• Taxpayers, other than C corporations, who receive Commodity Credit Corporation loans or certain other farm subsidies are limited as to the amount of net Schedule F losses from farming they may take. The limit for any given tax year is the greater of $300,000 ($150,000 for a married taxpayer filing separately) or the taxpayer's net farm income for the prior five tax years.

• An income tax credit is provided for agricultural businesses who handle chemicals and fertilizers to offset security-related expenses. The credit is for 30 percent of the costs of protection of certain chemicals or pesticides. This should be of interest to cooperatives involved with the manufacture, distribution and sale of fertilizer and pesticides. That credit is described in what is now Section 45O of the Internal Revenue Code. The new chemical securities tax credit will be reported as a general business credit on new IRS Form 8931, “Agricultural Chemical Security Credit.”

• Conservation reserve payments (CRP) received by retirees and the disabled who receive Social Security benefits are excludable from self-employment income under the Code and for purposes of Social Security.

• For purposes of the self-employment tax, the payment thresholds applicable to the farm and nonfarm optional methods of computing net earnings from self-employment are based on the sum of the minimum earnings required for a quarter of coverage under the Social Security Act for each quarter of the tax year. Self-employed individuals who elect an optional method can secure four quarters of Social Security coverage in each tax year beginning in 2008.

• A nonrefundable income tax credit of up to $1.01 per gallon for the production of cellulosic biofuel has been added as a component of the alcohol fuels income tax credit. A comprehensive study analyzing current scientific findings pertaining to biofuels has also been authorized.

• The alcohol fuels income tax credit applicable to ethanol blenders is reduced to 45 cents per gallon for ethanol with a proof of 190 or greater, and to 33.33 cents per gallon for ethanol with a proof that is at least 150 but less than 190 for the calendar years 2009 and 2010. However, the credit rate for ethanol of 190 proof or greater shall remain at 51 cents per gallon if the Secretary of the Treasury makes a determination, with respect to any year after 2007, that less than 7.5 billion gallons of ethanol has been produced in or imported into the United States.

• An alternative maximum capital gains tax rate is provided for qualified timber gain of a C corporation

20 • Exchanges of shares in certain mutual ditch, reservoir or irrigation companies qualify for tax deferral treatment under Code Sec. 1031 as like-kind exchanges.

The Economic Stimulus Act of 2008 (P.L. 110-185)

Signed by the President in February 2008, this legislation was designed to provide various economic stimuli to boost the economy and ward of a recession.

• The centerpiece of the new law is a refundable credit against tax (the "recovery rebate credit") to low and middle-income individuals for 2008 in an amount calculated as the greater of: (i) net income tax liability, not to exceed $600 ($1,200 for joint filers), or (ii) $300 ($600 for joint filers) if the individual has either: a) At least $3,000 of any combination of earned income, Social Security benefits and certain veterans' benefits (including survivors of disabled veterans), or b) Net income tax liability of at least $1 and gross income greater than the sum of the applicable basic standard deduction amount and personal exemption(s) ($8,950 for singles, $17,900 for joint filers).

• The new law almost doubles the amount of deductible Code Sec. 179 expensing for 2008 to $250,000 and increases the threshold for reducing the deduction to $800,000. It applies to property placed in service in tax years beginning in 2008. Unlike the amounts under current law, the amounts in the stimulus package are not indexed for inflation.

• The new law also provides qualifying taxpayers 50 percent first-year bonus depreciation of the adjusted basis of qualifying property as well as 50 percent first-year bonus depreciation for qualified cellulosic biomass ethanol plant property.

• The new law also raises the limitations on "luxury" auto depreciation. The first-year limit on depreciation for passenger automobiles placed in service in 2008 is projected to be $2,960 for passenger vehicles and $3,160 for vans and trucks. However, this limit is increased when bonus depreciation is claimed.

The Small Business and Work Opportunity Act of 2007 (P.L. 110-28)

This legislation was enacted as part of the U.S Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007. The Act targets tax incentives primarily to small business, Hurricane Katrina victims, and S Corporations. The following provisions may be of potential interest to farmer cooperatives or their members.

• Section 179 limited expensing base limit is increased to $125,000 through 2010, subject to an investment limitation. The investment limitation was also increased to $500,000.

• The Work Opportunity Tax Credit is extended through August 31, 2011.

• A Married Couple jointly operating an unincorporated business who file a joint return may elect to not be treated as a partnership

21 • Observation: This provision may be useful to family farms by elimination the need to file a partnership return.

• The Act includes a number of S corporation reforms including eliminating capital gains form the sale of securities form the definition of passive investment income for purposes of the passive investment income tax

22 2008 Report of the LTA Reporting Subcommittee on Operating on a Cooperative Basis for Subchapter T and Section 521 Cooperatives

Terrance A. Costello Ronald C. Peterson Lakes and Plains Office Building Hanson, Bridgett, LLP 842 Raymond Avenue 425 Market Street, 26th Floor St. Paul, Minnesota 55114 San Francisco, CA 94105 Telephone: 651-698-8102 Telephone: 415-995-5005 E-mail: [email protected] E-mail: [email protected]

OPERATING ON A COOPERATIVE BASIS

I. Timber Cooperative Denied Section 521 Exemption: Private Letter Ruling 200843022 (August 22, 2008).

A. In this ruling, a cooperative operated for the mutual benefit of its members that harvested timber. The cooperative filed an Application for Exemption under Section 521. The IRS denied the request for Section 521 status reasoning that the cooperative is not a farmers’, fruit growers’, or other like organizations because harvesting timber is not a farming activity. While not particularly noteworthy, the ruling does provide a good review of the Code’s definitions of farm and farming for purposes of Section 521.

II. Equity Redemptions at a Discount

A. A number of rulings were issued in this area, which was reported on extensively in this Subcommittee’s 2006 and 2007 reports. See, Private Letter Ruling 200803021 (Oct. 23, 2007); Private Letter Ruling 208806018 (Feb. 8, 2008); Private Letter Ruling 200806017 (Feb. 8, 2008); and Private Letter Ruling 200806014 (Feb. 8, 2008).

October 1, 2008 Terrance A. Costello Ronald C. Peterson

2008 REPORT OF THE LTA REPORTING SUBCOMMITTEE ON COOPERATIVE STRUCTURES: MERGERS, ACQUISITIONS, JOINT VENTURES, AND SUBSIDIARIES

As of December 31, 2008

Prepared by: David P. Swanson, Chair Dorsey & Whitney LLP 50 South Sixth Street, Suite 1500 Minneapolis MN, 55402 Telephone: (612) 343-8275 Email: [email protected]

AND Charles L. Woltmann Sr. Vice President and General Counsel Sunkist Growers, Inc. 14130 Riverside Dr. Sherman Oaks, CA 91423 Telephone: (818) 379-7532 Email: [email protected]

Introduction

There are five sections in this year’s subcommittee report for the Reporting Subcommittee on Cooperative Structures. The first four sections reflect the different types of transactions highlighted by the news media this year and are as follows: Sales or Acquisitions of Assets; Mergers; Miscellaneous Transactions; and Takeovers. The last section discusses board duties when responding to a proposed takeover proposal and some possible defenses cooperatives can employ to discourage unsolicited takeover proposals.

I. News Regarding the Sale of, or Acquisition of Assets

1. Berkshire Wind Power Cooperative Corp. and Massachusetts Municipal Wholesale Electric Co. Purchases the Assets of Berkshire Wind Power LLC for $4 million.

Berkshire Wind Power Cooperative and Massachusetts Municipal Wholesale Electric Co. have acquired easements, permits, and other assets that relate to preliminary work done on a proposed 15 MW wind power project on Brodie Mountain in Massachusetts. The Cooperative is a municipal cooperative of 14 Massachusetts municipal utilities. The utilities have purchased the assets for the purposes of finishing the wind power project that began approximately 10 years ago. Source: CO-OP Buys Assets of Berkshire Wind Project, NORTH AM. WIND POWER, June 16, 2008. 2. New Horizon Farm and Home Cooperative’s Acquired by Beachner Grain

Facing the threat of bankruptcy if a sale of assets was not approved, New Horizon Farm and Home Cooperative of Kansas received the requisite 2/3 majority vote on its plan to sell substantially all of its assets to Beachner Grain Inc. New Horizon was created in the August 2006 merger of Miami County Cooperative Association and United Cooperatives Inc. Beachner has been in business since 1987 and owns several grain, feed and fertilizer facilities spanning Kansas and Oklahoma. Source: Beachner takes over at former New Horizon cooperative sites, KCCOMMUNITYNEWS, June 18, 2008. 3. Alto Dairy Co-Op Sells Assets to Saputo Cheese, Inc.

Saputo Cheese, Inc, a Canadian dairy products company purchased the assets of Alto Dairy Cooperative in a deal valued at $160 million. Alto was operated as a farmer-owned cooperative in Wisconsin for 114 years. The cooperative however had been struggling recently, losing money in four of the past six years. The move drew support from 98% of the cooperative’s members. All equity holders will receive 100% of their equity, and there will be additional payments to active shipping members based on patronage. Saputo is the 15th largest dairy processor in the world, the largest in Canada, the 3rd largest in Argentina, and among the top 3 cheese producers in America.

Source: Dan Campbell, Alto members approve sale to Saputo Cheese USA, RURAL COOPERATIVES, March/April 2008. 4. CHS Buys Provista Renewable Fuels, Spokane’s Zip Trip

Provista Renewable Fuels Marketing, a marketer of ethanol that markets and distributes approximately 550 million gallons annually, was fully acquired by CHS Inc. CHS was formed in 1998 via the merger of Cenex and Harvest States Cooperatives. Separately, CHS has purchased 33 Zip Trip convenience stores in the Spokane, Wash., area from Jopo Inc. and Jo-By Enterprises LLC. These stores will be converted to Cenex branded convenience stores. Source: US Dept. Agriculture, CHS buys Provista Renewable Fuels, Spkane’s Zip Trip, RURAL COOPERATIVES, May/June 2008. 5. ANEC Purchases the Electricity Distribution Assets of Delmarva Power

A&N Electrical Cooperative (ANEC), a Touchstone Energy Cooperative, has purchased the electricity distribution assets of Delmarva Power in Accomack and Northampton counties in Virginia. ANEC expects the consolidation to reduce duplication of effort and expense by the two power providers resulting in a 3 million dollar short-term savings and additional possible future long-term savings. Source: ANEC, ANEC/Delmarva Power Acquisition FAQs 6. Credit Suisse Purchases Central Illinois Energy Co-Op

Illinois Energy Co-op Inc., was purchased out of bankruptcy by some of its creditors including Credit Suisse. The co-op was organized to construct an ethanol plant in Canton, Ill., but construction was derailed by skyrocketing costs and worker walk-offs. The plant’s name has changed to Riverland Biofuels LLC with plans to finish the project in late 2008 or early 2009. Source: Central Illinois Energy Sold, ETHANOL PRODUCER MAGAZINE, July 2008. 7. Agropur Cooperative Reaches Agreement to Acquire Trega Foods Inc.

Trega Foods Inc., a large Wisconsin producer of cheese and milk products was acquired by Agropur Cooperative, Canada’s largest dairy cooperative. Trega employed 300 employees and processed approximately 1.3 billion pounds of milk and achieved sales of around 300 million dollars. Agropur was founded in 1938 and is the industry leader in Canada with sales of approximately 2.4 billion dollars. Source: Agropur cooperatives continues its growth with expansion in the United States, GROUPE CNW, Jan. 31, 2008. 8. Delmarva Power Sells Transmissions Operations to A&E/Old Dominion

In addition to selling its distribution assets to ANEC, Delmarva sold its transmissions operations to A&E/Old Dominion Electrical Cooperative.

Source: Delmarva power sells operations to A&N/OLD DOMINIUM, ENTREPRENEUR.COM, Feb 1, 2008. 9. CHS Acquires Legacy Foods

In another transaction involving CHS, CHS has acquired Legacy Foods of Hutchinson, Kansas, a premier producer of Ultra Soy textured soybean-based food products and TSP textured soy protein used in the production of human and pet-food products. Source: Press Release, CHS, Inc., CHS Acquires Legacy Foods, (April 1, 2008). 10. Heritage FS Acquires Fruendt Crop Service

Heritage is an agricultural cooperative serving counties in Northern Illinois and is part of the GROWMARK system. Fruendt served approximately 85 active farm accounts in Kankakee County Illinois. Source: GROWMARK News, 3/17/2008 II. Merger and Consolidation News

1. Carroll County REMC Rejects Proposed Consolidation with White County

Carroll County Rural Electric Membership Corporation’s (“REMC”) members narrowly rejected a proposed consolidation with White County REMC slated to take place on January 1, 2009. The new entity was to be named Tioga Cooperative Inc. The Carroll county board had unanimously approved the consolidation, which they say would have saved $6 million over 8 years. Carroll County REMC members seemed concerned with adding White County’s $12 million in debt to Carroll County’s own $5 million in debt. Source: Kevin Howell, REMC consolidation a no-go, HERALD JOURNAL (Monticello, In), July 7, 2008. 2. International Co-op News: Three Co-Ops Merge Dairy Operations to Create France’s Third Largest Milk Producer

French cooperatives Coopagri Bretagne, Even and Terrena plan to merge at the end of December creating France’s third largest milk producer. The combined company will produce 397 million gallons of milk a year. Source: Three Co-ops to Merge Dairy Operations, Create France’s Third Largest Milk Producer, FLEXNEWS, June 11, 2008. 3. Central Grocers, INC. and Certified Grocers Inc. Merge

Certified Grocers, Inc. will be absorbed into rival Central Grocers, Inc pending approval of shareholders. Both are independent retailer-owned cooperatives based in Chicago Illinois. Central is an $800 million wholesaler and Certified is a $600 million wholesaler that would together serve 225 members that operate 450 stores in the Midwest. Source: Sandra Guy, Last 2 independent grocery co-ops to merge, CHICAGO SUN TIMES, May 29, 2008.

4. Howard County Equity and Innovative Ag Merger

Innovative Ag of Iowa and Howard County Equity of Iowa merged on April 1st. The combined cooperative provides roughly 2,200 members with farm supplies and grain services. Source: Iowa Farmer and Co-op Wound up in controversy, KIMT News 3, Iowa 5. Ridgeland-Chetek Cooperative and Rice Lake Farmers Cooperative Merge to Form Lakeland Co-operative

Ridgeland –Chetek Cooperative and Rice Lake Farmers Cooperative became Lakeland Cooperative as a result of their March 1st merger. The combined cooperative serves around 1000 members in Wisconsin. The decision to merge was done to allow the co-op to obtain lower prices on agronomy and petroleum products. Source: Eric Quade, Cooperatives Merge, BARRON NEWS SHIELD, Mar. 7, 2008. 6. Merger Between Green Plains Renewable Energy, Inc. and Great Lakes Co-Op.

Great Lakes Co-op has merged with Green Plains Renewable Energy Inc, becoming a wholly owned subsidiary of Green Plains. Great Plains provided agronomy, seed, feed, and petrochemical services to its members. These services will become integrated along with Green Plains Renewable Energy’s sizeable ethanol production business. Green Plains operates a 50 million gallon ethanol plant in Iowa, and is currently building a second 50 million gallon plant. As consideration for the business, Great Lakes members will receive $12.5 million in cash, and 551,000 shares of Green Plains stock. th Source: Russ Oechslin, Area Co-op, ethanol producer to combine, SIOUX CITY JOURNAL, Feb 6 2008. 7. AgCountry Farm Credit Services and Farm Credit Services of Grand Forks Merge

AgCountry Farm Credit Services and Farm Credit Services merged on January 1st 2008 forming AgCountry. Both are North Dakota credit and financial services cooperatives. The newly combined entity will serve 12,000 farmers in 18 counties in North Dakota and 25 counties in Minnesota. th Source: Two Ag Co-ops to Merge, KFYR-TV NEWS STORIES (Bismarck, ND), Dec. 11 2007 8. South Central Grain to Merge with CHS Inc.

In another transaction involving CHS, South Central Grain in North Dakota will merge with CHS Inc. South Central members voted 154 for the merger and 25 against it. South Central Grain owns four grain elevators that were already being leased by CHS. Source: US Dept. Agriculture, South Central Grain to Merge with CHS, RURAL COOPERATIVES, JANUARY/FEBRUARY 2008. 9. Sully Cooperative Exchange and Heart of Iowa Co-op Explore Merger

SCE, formed in 1920, serves nearly 5,000 customers in the South Central Iowa area and offers its members agronomy services, fuels, grain, feed and construction material sales among other services. The Heart of Iowa Cooperative is a seven-location cooperative, serving the majority of

Story and other surrounding counties in Iowa. Based in Roland, Iowa, the cooperative focuses on grain, energy, agronomy, and feed advice.

The merger study will take approximately 5 months for completion, followed by a possible merger vote by members if the merger is approved by the boards of the two cooperatives. The cooperatives expect to be able to improve market access for grain and farm inputs and improve market power through combined volumes, among other benefits. [DPS to Update]

Source: SCE and HOIC approve merger study, SCE INFORMER, July 2008.

10. Belle Plaine Co-op and Hwy Ag Services Unify

Effective August 1st 2008, Belle Plaine Co-op and Hwy Ag Services will unify creating a new co-op with $55 million in sales. Both co-ops are located southwest of Minneapolis and Saint Paul Minnesota and specialize in agronomy, energy, feed and retail products and services. Belle Plain members overwhelmingly approved the transaction by voting 79.5% in favor. No vote of Ag Services is necessary due to the structure of the transaction. Source: Member Services (Mbrservices.com), Member coop news, 4/3/2008 11. Champaign Landmark, Inc. and Farmer’s Commission Company Plan Consolidation

The board of directors of Champaign Landmark approved at a board meeting on May 21, 2008 a “Plan of Consolidation” with Farmers Commission Company. Farmers Commission’s board approved the plan on May 16, 2008. The cooperatives cited competition in a global marketplace together with dramatic changes in grain prices, input costs, and related capital requirements as driving the move. The consolidated co-op plans to construct a fertilizer facility in Kenton, Ohio with the capacity to handle unit train quantities on the mainline rail to improve efficiency. Member votes on the plan are scheduled for August 2008. [DPS to Update] Champaign Landmark serves over 12 counties in West Central Ohio and provides agronomy, energy, grain, feed and farm, and tire services to its members. Farmer’s Commission Company has 1,785 members and serves Northwest Central Ohio and sells fertilizer, chemicals, seed, feed, and general farm supplies. Farmer’s Commission Company also provides grain and seed related services, agronomy services, and others. Source: Letter to Shareholders from Champaign Landmark, Inc., May 23, 2008. III. Miscellaneous News

1. South Carolina Clears the Way Toward Health Care Co-Ops

A piece of legislation working its way towards passage in South Carolina allows small business to join cooperatives to purchase health insurance for their employees. The bill had already passed the state Senate, and was expected to be signed by the Governor Mark Sanford. Source: Robert W. Dalton, House OKs health plan cooperatives, SPARTANBURG HERALD- JOURNAL, January 30, 2008.

2. Upstate Niagara Co-Op Closes Plant in Niagara Falls

Upstate Niagara Cooperative will close a plant in Niagara Falls in May, shifting production to an Upstate facility. The plant was acquired as a result of a 2006 merger with Niagara Milk Cooperative, and resulted in a duplication of operations. Source: Upstate Niagara Cooperative to close Falls plant: workers to be offered jobs at Cheektowaga facility, THE BUFFALO NEWS, January 12, 2008. 3. Co-Alliance LLP Issues Equity Redemption

Co-Alliance LLP recently made $600,000 in equity redemption payments to farmer members to redeem long-standing equity credits that they had received over the years. This contrasts with its normal practice of redeeming these only when the member/shareholder passed away. The payments made by Co-Alliance were made to long-standing, living members. In total, the equity redemption was made to around 565 shareholders. Co-Alliance LLP is a partnership of four cooperative businesses focused on energy, agronomy, grain marketing and swine and animal nutrition. Source: Tom J Bechman, Huge Hoosier Co-Op Breaks Tradition With Equity Redemption, INDIANA PRAIRIE FARMER, January 18, 2008. IV. Takeover News

1. Ag Processing Inc. Rejects Takeover Bid

Ag Processors Alliance LLC (APA), was formed in August of 2007 by an investment group with the purpose of acquiring Ag Processing Inc (AGP), the world’s largest soybean processing coop. Backing APA was Ag and Food Associates, a company that provides investment-banking services for agribusiness, food-processing and energy. APA first delivered a letter of intent on August 14th 2007 to AGP stating an offer to acquire AGP for up to $850 million, according to APA. The plan was promoted as allowing the local coop owners of AGP to realize new liquidity, and to allow a restructuring of AGP to “improve the business focus that emphasizes core business operations.” This letter of intent was followed on the same day by a letter to the coop owners stating APA’s intentions. That same day, the AGP board of directors met and rejected what they described as a “hostile” takeover bid by APA. APA in a release on August 23, 2007, called this a “knee-jerk reaction” and intimated that the board had not fulfilled its fiduciary duties to its members to properly evaluate the offer given the quick rejection. APA then began making personal visits and calls to AGP owners trying to persuade them to pressure the board of AGP to sell. On August 31, 2007 AGP released a press release regarding the offer. In it they claimed that 99% of the voting members supported the transaction, and stressed the cooperative values to members. On October 12th 2007, APA raised its offer to $910 million reflecting “higher soybean crushing margins.” In a letter issued to the AGP members, APA accused AGP’s board of failing to meet with them to discuss the offer; making a series of misguided statements about the offer;

discouraging members from attending APA’s meetings about the offer; and accused AGP of exaggerating member support. The letter concludes by saying that “Honesty and integrity are two very good qualities in a business partner. You can be sure that with APA, you’ll get both.” Again, that same day, AGP rejected APA’s bid simply stating that AGP “is not for sale.” As of the time of this report, it is unclear whether APA has given up on its efforts. V. Takeover Duties, Responsibilities and Defenses

This section provides a general introduction to the fiduciary duties of directors and management in a unsolicited take-over situation or in a friendly sale of control transaction. This is only a general overview. In a takeover or sale of control transaction, a cooperative should engage an attorney who can advise it on its specific situation and ensure that the board’s actions are not likely to result in legal consequences later. The threat of a legal misstep is very real, as board members have often been confronted with fiduciary duty suits over their decisions with respect to takeover offers. Furthermore, litigation in this area is a real likelihood given that many of these transactions are hotly contested on both sides. In a famous case, the directors of the Trans Union corporation were found to have breached their fiduciary duties to the company when approving a proposed merger and to be liable to the companies’ shareholders for a total of $23 million. [Cite the Case] Today, the prospects of such unlimited personal liability are slim given developments in corporate law following that case that provided for board and officer indemnifications and liability limitations. Despite this however, shareholder derivative actions are not dead. To avoid the cost and distraction of a shareholder action, it is important to understand the legal landscape surrounding corporate takeovers and defenses. The legal framework discussed below is based on Delaware statutes and case law. Individual states and situations may vary, but Delaware is seen as a leader in corporate law, and many states follow Delaware’s lead on such issues. Defensive Mechanisms

The key goal of defensive mechanisms is to make a potential acquirer deal with the board of directors. In general, there are two broad classes of anti-takeover provisions. The first aims to reduce the desirability of the company. These are often termed “shark repellents” and typically, but not always, focus on provisions stalling the transfer of control over a period of years once the acquiring company has acquired a majority of the shares of the target company. The theory is that the longer the acquiring company has to wait once they acquire a majority of the target company’s shares, the less attractive the target company will be as a target in the first place. The second broad class of anti-takeover provision focuses on making it difficult, or impossible, to acquire the necessary shares of the target company regardless of the desirability of the company. Shark Repellants

1.) Golden Parachutes for Management The idea here is that in any change of control, key management or employees get a contractual severance package typically equal to approximately three times salary for executives and varying

degrees for other employees. This makes the company more expensive to acquire if the acquiring company is unhappy with management and wants to make wholesale changes. 2.) Staggered Board of Directors This defense “classifies” the board of directors into typically three classes where only one class of directors is up for re-election in a year. This imposes at least a two year (or more) wait on a potential acquirer before the acquirer could obtain a majority representation on the board. 3.) Staggered Board and Board Size Protections Staggered board provisions are often combined with provisions that any amendment to the bylaws affecting the staggered board or increasing the number of directors requires a supermajority approval of stockholders (often a two-thirds majority). 4.) Restrictions on the Removal of Directors By default the Delaware General Corporate Law (DGCL) allows for removal of any director or the entire board with or without cause by the majority of the voting stockholders. However, if the board is staggered, then directors may only be removed for cause. A potential acquirer could gain control of a majority of shares, then subsequently vote to remove the entire board and then elect their own slate of directors unless removal is restricted as being only for cause. 5.) Board Vacancy Provisions Provisions requiring that a vacancy on the board of directors be filled by the current board of directors serves as an additional impediment to a hostile owner’s takeover attempt, and thus serves to make the company unattractive to a hostile bidder. 6.) Meeting Notice and Stockholder Voting Provisions Under Delaware law, nominations for directors and stockholder proposals at the annual meeting can generally be made without notice from the floor. Inserting provisions in the company’s bylaws to require that nominations and proposals be submitted to the company in advance can buy a company time to develop a strategy to effectively address those proposals and inform stockholders about these matters and the board’s views as to the desirability of the proposals or candidates. 7.) Limitations on Shareholder Written Action Under Delaware law, stockholders may take action without a meeting by written consent if holders of the minimum number of votes required to take such action sign a written consent and prompt notice is sent to the other stockholders. This gives a hostile acquirer powerful rights to alter the Board through Certificate or Bylaw amendments. Elimination of this power would serve as an additional layer of delay as it would force the stockholders to call a meeting or wait for the next annual meeting to make their proposals. 8.) Supermajority Provisions Another takeover defense is to require the approval of certain types of corporate business to be done via a supermajority vote (say 2/3 approval required) of either the board of directors (if it is board business) or the stockholders (if it is stockholder business). Such transactions could

include: changing the size or composition of the board, significant transactions such as mergers or acquisitions, amending the bylaws, or amending the certificate of incorporation among others. Essentially this makes it harder for an acquiring party to complete the second step of a two-stage takeover and serves the purpose of protecting other anti-takeover measures from being undone by a new owner. Defenses Which Make Share Acquisition Difficult

1.) Poison Pill A poison pill is a device often euphemistically termed a “shareholder rights plan.” This defense is not available to all situations and organizations, and it is usually necessary for the board to have “blank check” authority to create and issue preferred shares without shareholder approval. These plans typically give the holder of any stock in the company (except the acquiring party) the right to purchase many more shares at a significantly discounted price should an acquiring party reach (without board approval) a triggering threshold of ownership interest. This has the effect of severely diluting the value of the acquiring parties shares. Poison pill provisions are so effective that none have ever been triggered, and simply triggering one is thought to be a violation of the duty of care and would subject the board and management of the acquiring company to fiduciary duty suits. 2.) Share Transfer Restrictions Share transfer restrictions could be implemented which would restrict the persons or entities to whom stockholders could sell their shares. This may completely bar an acquiring entity from taking control of the company. This defense could be a complete shield if all stock can be restricted. Regardless, even if a substantial minority of shares were subject to such restrictions, such a provision could help the company fight off a potential hostile bidder. Such provisions take many forms, including requiring approval of the board before stock can be sold, limiting the sale of stock to agricultural producers or associations of agricultural producers or cooperatives and other related entities, or other such restrictions. Board Fiduciary Duties

The board will play a very important role in the events that are generated by a hostile bidder. As such it is important that the board follow proper procedures and principles in order to insulate itself and its decisions from attack. There are two main fiduciary duties involved principally: the duty of care, and the duty of loyalty. Further, there are certain situations that courts apply a heightened scrutiny when evaluating the actions of the board of directors. Duty of Care

The duty of care requires that before taking action the board must engage in a process of informed decision-making that consists of two parts: 1.) obtaining adequate information, and 2.) engaging in adequate deliberation. If this is done, the decisions of the board of directors will be

subject to the business-judgment rule, under which, courts will not interfere with the business judgment of the board of directors. The board is allowed to rely on information, opinions, reports, financial statements, and other data prepared or presented by officers or employees of the corporation, legal counsel, public accountants and financial advisors, and duly established board committees as to matters within the committee’s designated authority. The board members must have a reasonable belief that the person or committee is competent and reliable. Duty of Loyalty

Duty of loyalty mostly deals with cases in which the directors are interested in the outcome of the transaction, either because they seek to gain directly (as they would by being on both sides of a transaction with the corporation), or indirectly (by having an interest in continued employment with the company). A director has a duty to put the interests of the corporation above his or her own in all matters relating to the corporation. The first step to satisfy this requirement is for the interested director to disclose everything to the rest of the board. Often times approval of the disinterested directors, or a committee comprised of disinterested directors will be sufficient to overcome a duty of loyalty challenge. If this is not done, or cannot be done, the burden then shifts to the board (and in particular to the interested director or directors) to show that the transaction was fair to the company. In the cooperative context, the specter of loyalty conflicts might possibly arise when a board member of a larger cooperative sits on the board of a local member cooperative which is also a stockholder of the larger cooperative. The determination in this case is highly fact specific, and it would be best to consult legal counsel to address this issue. Enhanced Scrutiny Situations

1.) Implementing or Maintaining a Takeover Defense Mechanism Implementing or maintaining a defense mechanism such as a poison pill requires applying a heightened level of scrutiny because of the prospect of interested directors (rejecting the takeover means they often will keep their jobs). The directors must establish that their actions with respect to implementation or maintenance of a defense mechanism were 1.) in response to a reasonably perceived threat to the corporate existence or policies, and 2.) within a range of proportionate and reasonable responses to such threat. 2.) Sale of the Company Once the directors decide to engage in a transaction that involves a change in control of the company, the courts have required the boards to act as an auctioneer – getting the best value for the company. Thus the board cannot play favorites with bidders. 3.) Actions that Impede Stockholder’s Right to Vote Any board decision made without stockholder approval that is primarily aimed at impeding the stockholder right to vote will require the board to prove that they acted with “compelling justification.” This means that the board must prove that the action 1.) serves and is motivated by a legitimate corporate objective, and 2.) is reasonable in relation to this legitimate objective and not preclusive or coercive.

Takeover Tips

The following are a list of tips for cooperative boards faced with a hostile takeover attempt. 1) Obtain Adequate Information

a. Have company management evaluate all aspects of the proposal.

b. Keep in mind the loss of a “cost-based” business source for the Members.

c. Obtain materials concerning the acquirer and future plans of the acquirer.

d. Obtain competent, outside accountants, financial advisors, legal advisors, or other advisors and have them present their findings regarding the offer to the board.

e. Interview the Acquirer’s management team.

f. Analyze independence at all levels (officers, directors, legal department) to make sure there are no conflicts of interest.

2) Engage in Sufficient Deliberation

a. Conduct a sufficient number of Board Meetings with as much advance notice as possible to discuss all aspects of the proposed transaction.

b. All materials requiring Board consideration should be distributed to all members sufficiently in advance to enable all the directors to review them.

c. Allow each board member input into the agenda for each meeting

d. The board should have internal management and outside consultants give presentations about the merits of the proposal.

e. The board should be engaged and ASK QUESTIONS

f. Deliberations should be documented in the meeting minutes.

3) Consider Alternatives

a. Identify and analyze any other companies with which a strategic alliance could be formed.

b. Evaluate other prospective or potential suitors (often termed a “white knight” company).

c. Remember that pursuing these alternatives might subject the board to heightened duties.

4) Avoid Conflicts of Interest

a. Any director who is also affiliated with the acquirer should not participate in the deliberations or vote.

b. Consider whether a special committee of the board consisting of independent (non employee) directors ought to be utilized which would make recommendations to the full board. These are important for management buy-out proposals.

5) Remember Your Disclosure Obligations

a. If an acquisition is approved and submitted for the stockholder’s approval, the board must disclose certain information related to the transaction. These disclosure obligations will likely include the process undertaken by the Board in evaluating and approving a proposed transaction, a description of independent experts engaged to assist the Board in this process, and a description of any dissenting views among the directors. Therefore, careful documentation of the actions taken and matters considered by the Board should be made in order to simplify the ultimate disclosure task, and to enable directors to demonstrate that this important duty has been adequately undertaken.

6) Confidentiality

a. Until such time as the proposed transaction is either publicly announced or terminated with or without disclosure, members of the Board should maintain strict standards of confidentiality with respect to all information about the proposed transaction (for example, refrain from any discussions involving the proposed transaction with any person not directly involved in the transaction and carefully maintain the confidentiality of all documentation concerning the proposed transaction).

7) Obtain Legal Advice Where Appropriate

Conclusion

In conclusion, an unsolicited tender offer brings with it a plethora of practical and legal considerations. It is important for cooperatives to have in place defense mechanisms before an offer is made that will enable the board of directors to act as a buffer between the acquirer and the shareholders. It is equally important that once an offer is made that the board of directors follow the proper process and procedures in order to prevent a fiduciary duty suit that may be both expensive and time-consuming to both the individual directors and the cooperative.

2008 LTA REPORTING SUBCOMMITTEE

COOPERATIVE ISSUES SPECIFIC TO MARKETING ORDERS

Kendall L. Manock, Chair BAKER MANOCK & JENSEN, PC 5260 N. Palm Avenue, Suite 421 Fresno, California 93704

Julian B. Heron, Jr., Vice‐Chair TUTTLE, TAYLOR & HERON 1025 Thomas Jefferson St., NW Suite 407 West Washington, DC 20007

Richard Emde SUN‐MAID GROWERS OF CALIFORNIA 13525 S. Bethel Avenue Kingsburg, California 93631

Clayton Galarneau MICHIGAN MILK PRODUCERS ASSOCIATION 41310 Bridge Street Novi, Michigan 48376‐8002

2008 SUBCOMMITTEE ON COOPERATIVE ISSUES

SPECIFIC TO MARKETING ORDERS

In 2008, a number of courts decided cases concerning Federal marketing orders. Of these cases, two specifically involved free speech and marketing orders, while others concerned various procedural and substantive aspects of marketing orders for milk, table grapes, raisins, avocados, and apples.

FREE SPEECH AND MARKETING ORDERS

In the past 11 years, the Supreme Court in three different cases has decided issues relating to the free speech implications of mandatory assessments imposed by Federal agricultural marketing orders upon producers. In 1997, the Supreme Court, in Glickman v. Wileman Bros. & Elliot, Inc., 521 U.S. 457 (1997),decided that mandatory assessments used to fund the promotion of tree fruit were constitutional, because they were part of a broad regulatory scheme. Then, in 2001, the Court rejected assessments collected by the mushroom order because the assessments were used only for advertising that did not fit within a broad regulatory scheme. United States v. United Foods, Inc., 533 U.S. 405 (2001). Finally, in 2005, the Court expanded protection for marketing orders by holding, in Johanns v. Livestock Marketing Association, 125 S. Ct. 2055 (2005), that assessments used to promote specific commodities qualified as government speech under the constitution and do not violate the free speech rights of objecting assessment payers. In Johanns the Court held that Livestock Marketing Association assessments, used to pay for beef promotion, were constitutional because the message at issue was established by the Federal Government and was, therefore, “government speech.”

As a result of the decisions in Glickman, United Foods, and Johanns, it can be anticipated that mandatory assessments will be upheld where they are either part of a broad regulatory scheme, or where the speech involved is considered government speech.

In 2008, two cases involving challenges to promotional marketing order programs were decided on the basis of the Supreme Court’s rulings. First, in Gallo Cattle Company v. A.G. Kawamura 159 Cal.App.4th 948 (2008), the California Court of Appeal held that the generic advertising for California cheese by the California Department of Food and Agriculture (CDFA) is constitutional. The court held that

there are no persuasive reasons, under People v. Teresinski 30 Cal.3d 822 (1982)1, for California courts to diverge from the Federal precedent set in Johanns. Therefore the CDFA’s advertising of California cheese through assessments collected under the Marketing Order for Research, Education and Promotion of Market Milk and Dairy Products in California (California Food & Agriculture Code §§ 58601 et. seq.) is protected government speech. The court further held the voluntary use of a package certification seal is constitutional and does not constitute economically compelled speech.

In another case, Delano Farms Company v. The California Table Grape Commission 546 F. Supp. 2d 859 (2008), the United States District Court for the Eastern District of California upheld assessments used for generic marketing of table grapes. The court held that the California Table Grape Commission’s speech is government speech under Johanns because the general message communicated by the Commission is mandated by the California legislature; the Commission itself is a governmental entity under Lebron v. National Railroad Passenger Corp., 513 U.S. 374 (1995)2, and the CDFA has effective control over the Commission as required by Johanns. The Delano court also concluded:

• Even if government speech was not involved, the court denied the Commission’s additional grounds for summary judgment, holding Central Hudson3 test for commercial speech does not apply when mandatory assessments are used for a collective action program;

• The court denied Plaintiff’s cross‐motion for partial summary judgment that United Foods and not Glickman should apply, concluding that the table grape industry is facially collectivized and, unless the Plaintiff could show otherwise, Glickman applies.

• The court granted the Commission’s motion for summary judgment that the legislation authorizing the Table Grape Commission is

1 Teresinski provided four categories of persuasive reasoning which, if applicable, justify California courts to diverge from Supreme Court precedent: (1) where the language and history of the California law suggests a contrary intention; (2) where an inconsistency would arise; (3) where dissenting opinions and academic criticisms warrant reconsideration; or (4) where following the Federal rule would overturn established California doctrine affording greater rights. 2 Holding, “[W]here…the Government creates a corporation by special law, for the furtherance of government objectives, and retains for itself permanent authority to appoint a majority of the directors of that corporation, the corporation is part of the Government for purposes of the First Amendment.” 3 Central Hudson Gas & Electric Corp. v. Public Service Commission of New York 447 U.S., 557 (1980).

constitutional under the germaneness test articulated in Abood v. Detroit Board of Education (1977) 431 U.S. 209.

FEDERAL MILK MARKETING ORDER: STANDING

In Arkansas Dairy Cooperative, Inc., et al. v. United States Department of Agriculture 576 F. Supp. 2d 147 (2008), a group of milk producers and cooperatives brought an action against the USDA, challenging the USDA’s final order reducing the minimum process dairy farmers receive under Federal milk marketing orders (7 U.S.C. § 608 c(7) (FMMO). Upholding precedent, the court held that producers do not have standing to challenge milk order unless they are seeking to protect a definite personal right granted by statute.

FEDERAL MILK MARKETING ORDERS: FALSE CLAIMS ACT

In United States ex rel. Kyle Fellhoelter v. Valley Milk Products, L.L.C. 2008 WL 217116 (E.D.Tenn.), the USDA charged the Maryland & Virginia Milk Producers Cooperative Association, Inc. with having violated the False Claims Act (31 U.S.C. §§ 3729 et seq.) (FCA). The USDA claimed that Valley Milk was involved in three fraudulent schemes: (1) that it failed to pay farmers the blend price; (2) that it acquired the right to become a pool plant under the Appalachian Federal Order (Federal Order No. 5) with qualifying milk that was allegedly supplied by two of its competitors; and (3) that it processed milk that did not meet USDA standards for Grade “A” milk. The USDA moved to have its complaint sealed, but immediately served all defendants with copies. Defendants brought a motion for summary judgment alleging that the USDA had violated the sealing provision of the FCA. The court granted the motion, determining that the USDA had lost its right to bring the statutory cause of action and that it failed to state a claim under the False Claims Act.

FEDERAL MILK MARKETING ORDERS: REPORTING UNIT

In Lanco Dairy Farms Cooperative v. Secretary of Agriculture 572 F. Supp. 2d 633 (2008), the court upheld the Secretary of Agriculture’s administrative determination that an in‐state handler is a “reporting unit” within the meaning of the Northeast Milk Marketing Order (7 C.F.R. § 1001.2) and therefore subject to the same shipping standards as out‐of‐state reporting units. Lanco had argued that it was not a reporting unit under the order. The court based its decision on two reasons: (1) that substantial deference is given to an issuing agency when there is ambiguity in the regulations and (2) that a contrary holding would result in economic trade barriers for out‐of‐state reporting units in violation of the Agricultural Marketing Agreement Act (AMAA).

CALIFORNIA MILK MARKETING ORDER: ORGANIC HANDLER

The California Court of Appeal held, in A.G. Kawamura v. Organic Pastures Dairy Company LLC 73 Cal. Rptr. 3d (Ct. App. 2008), that all milk packaged and processed by a processing firm is included in a pricing pool. Organic Pastures Dairy Company argued that it was not a “handler” within the statutory meaning of the term because it produced and processed its own milk and did not receive milk from any outside source. The court held that California’s legislature had intended to include operations like Organic Pastures in its definition of handlers. Therefore, Organic Pastures was considered a handler under the California Milk Stabilization and Marketing Act (California Food & Agriculture Code §§ 61801 et seq.) and obligated to participate in the milk pricing pool under the Gonsolves Milk Pooling Act (California Food & Agriculture Code §§ 32700 et seq.).

RAISIN MARKETING ORDER: DAMAGES

In In re Marvin D. Horne and Laura R. Horne et al. 2008 WL 4888689 (U.S.D.A., April 11, 2008), the U.S.D.A. Judicial Officer (JO) ruled on a petition to reconsider from the U.S.D.A. Administrative Law Judge’s determination that the Hornes and their partners were handlers subject to damages for violating the AMAA and the Marketing Order for Raisins Produced from Grapes Grown in California (7 C.F.R. pt. 989.) (“the Raisin Marketing Order.”) The Hornes had argued that their business of charging farmers a toll for processing their raisins did not make the Hornes a handler under the Order. The JO held that the Hornes had acquired the raisins for processing and that under the Order “acquire” meant to obtain possession which was sufficient to make them a handler required to pay the assessments imposed by the Raisin Administrative Committee. His order concluded that the Hornes had violated the order in the 2002‐2003 and 2003‐2004 crop years by: (1) failing to hold raisins in reserve, (2) failing to pay the Raisin Administrative Committee (RAC) the dollar equivalent of California raisins not held in reserve, and (3) failing to pay assessments to the RAC. With regard to failure to hold reserve raisins, the JO found that the appropriate measure of damages is the announced price of such raisins – equaling $236,324.13 for the 2002‐2003 crop year and $247,519.40 for the 2003‐2004 crop year. The JO also found that Horne owed past assessments at the rate of $8 per free ton equaling $2,936.76 for the 2002‐2003 crop year and $5,819.63 for the 2003‐2004 crop year. Finally, the JO held that Horne owed $202,600 in civil penalties for violating the Raisin

Marketing Order.4 In addition to the damages award, the JO held that: the Administrator’s petition to reconsider need not contain a specific section devoted to claimed errors made in the prior decision, but need only contain a specific statement of claims it alleges were erroneously decided; the evidence presented by the Administrator was clear; the JO cannot decide the constitutionality of the Raisin Marketing Order; the Farmer‐to‐Consumer Direct Marketing Act of 1976 (7 U.S.C. §§ 3001‐3006) does not exempt raisin producers from the requirements of the Raisin Marketing Order; and Horne was a first handler who “acquired” raisins during the operative crop years.

The investigation of the Hornes’ failure to abide by the Raisin Marketing Order in subsequent crop years is ongoing and has resulted in several other decisions outlined below.

RAISIN MARKETING ORDER: DISCLOSURE OF GROWER DOCUMENTS

In United States v. Marvin D. Horne, et. al., 2008 WL 905219 (E.D.Cal.), the USDA brought administrative proceedings against Respondents to recover damages for violation of the Raisin Marketing Order. The court denied Respondents’ motion to quash subpoenas duces tecum through which the government sought documents from Respondents’ customers to aid in determining whether Respondents were “handlers” or “producers” under the AMAA and the Raisin Marketing Order. The court denied the motion on three grounds: (1) that the court lacked jurisdiction over the matter; (2) that Respondents lacked standing because the motion should have been brought by the customers of Respondents and not Respondents; and (3) that “it is reasonable for the USDA to use subpoenas to verify the records produced by Respondents.”

In United States v. Richard Chaves, et. al., 2008 WL 4218502 (E.D.Cal.), the court granted the USDA’s petition for summary enforcement of administrative subpoenas, where the USDA sought certain documents in determining whether Respondents and/or Marvin and Laura Horne (see above) engaged in handling activities and violated the Raisin Marketing Order between Dec. 2003 and July 2006. The subpoenas were issued as part of an USDA investigation of Defendants and the Hornes. The court held that, in a statutorily sanctioned investigation, documents

4 The court calculated that “[t]he appropriate civil penalties for these violations are: (1) $300 per violation for filing inaccurate reporting forms, in violation of 7 C.F.R. § 989.73, for a total of $6,000; (2) $300 per violation for the failure to obtain incoming inspections, in violation of 7 C.F.R. § 989.58 (d), for a total of $17,400; (3) $1,000 for the failure to allow access to records, in violation of 7 C.F. R. § 989.77, (4) $300 per violation for the failure to pay the assessments, in violation of 7 C.F.R. 989.80, for a total of $600; and (5) $300 per violation for the failure to hold raisins in reserve, in violation of 7 C.F.R. §§ 989.66, .166, for a total of $177,600.”

related to the acquisition and/or purchase of raisins are relevant to a determination of whether a marketing order is a “handler.”

RAISIN MARKETING ORDER: JURISDICTION

In Marvin and Laura Horne v. United States Department of Agriculture, No. 1:08 CV‐00402‐OWW‐SMS, slip op. (E.D.Cal., filed Nov. 13, 2008), Plaintiffs sought modification or exemption from the Raisin Marketing Order and filed an administrative petition before the Secretary of Agriculture pursuant to the AMAA to determine their status as a handler. After the Judicial Officer dismissed the petition because they lacked standing to object to a USDA investigation. Plaintiffs filed an appeal with the District Court more than 20 days after the entry of the dismissal order. The USDA brought a motion to dismiss the appeal for lack of subject matter jurisdiction. Plaintiffs alleged that the administrative ruling was not mailed by the court clerk until 24 days after entry and that Plaintiffs should be credited for such delay. Granting the USDA’s motion, the District Court held that the 20‐day period within which to file an appeal with a District Court begins when the decision is filed by the court clerk and not when it is mailed by the clerk or received by the appealing party. The court also held that the statutory limitation does not violate the Due Process Clause of the U.S. Constitution and that the court, in such situations, does not have independent jurisdiction under the Administrative Procedures Act (5 U.S.C. § 702, et seq.).

RAISIN MARKETING ORDER: DISCLOSURE OF USDA DOCUMENTS

USDA investigation of alleged violations of the Raisin Marketing Order by Lion Raisins, Inc. has given rise to several procedural issues discussed below.

In Lion Raisins, Inc. v. United Stated Department of Agriculture 2008 WL 3834271 (E.D.Cal.), in an ongoing action against Lion for allegedly violating the Raisin Marketing Order, Lion sought disclosure from the USDA of certain USDA Certificates of Quality and Control. The court denied Lion’s motion for relief from judgment based on changed circumstances under Federal Rules of Civil Procedure 60(b)(5) and (60)(b)(6), holding that USDA Certificates of Quality and Condition could be exempt from disclosure because the information therein could reasonably be expected to cause harm to a pending proceeding.

RAISIN MARKETING ORDER: PROCEDURE

In Lion Raisins, Inc. v. United States Department of Agriculture 2008 WL 783337 (E.D.Cal.), Lion alleged that its procedural rights under the AMAA had been violated by the USDA because Lion had been deprived of a hearing in accordance with the Rules of Practice Governing Proceedings on Petitions to Modify or To Be Exempted From Marketing Orders. Lion had challenged provisions of the Raisin Marketing Order, asking to be exempt from inspection requirements imposed on handlers, and was denied relief. The Federal District Court held that a handler who files such a petition does not have a right to a hearing, where a motion to dismiss is properly granted before the hearing takes place. The court also held that the Judicial Officer’s determination that Lion’s petition was barred by res judicata was supported by law.

Unsatisfied with that result, Lion tried again. In Lion Raisins, Inc. v. United States Department of Agriculture 2008 WL 2762176 (E.D.Cal.), Lion moved to alter or amend the judgment entered in Lion Raisins, Inc. v. United States Department of Agriculture 2008 WL 783337 (E.D.Cal.) (The same judgment described above). The District Court denied the motions, holding that the “law does not advise the parsing of claims to divide into varieties that permit serial reassertion of related claims.” The court invoked the doctrine of res judicata and determined that all subsequent claims concerning regulations which have already been challenged are barred because the claims could have been raised in earlier litigation.

OTHER CASES INVOLVING MARKETING ORDERS

In Department of Agriculture v. Appletree Marketing, 280 Mich.App. 635 L.L.C. 2008 WL 4365981 (Mich.App.), Plaintiff, the Michigan Department of Agriculture, appealed the trial court’s determination under Michigan law that a producer, Appletree Marketing, L.L.C. was not liable for treble damages for failing to remit to the Michigan Apple Committee assessments it had collected from Michigan apple orchards. The Michigan Court of Appeals held that remedies provided in the Agricultural Commodities Marketing Act (ACMA) (MCL 290.651 et seq.) are the exclusive remedies when a statute sets forth new rights and responsibilities not found in the common law and prescribes new remedies. For those rights the remedies conferred by the statute are the exclusive remedies for violation of the ACMA

In Association De Productores, Empacadores Y Exportadores De Aguacate De Michoacan, A.C. and Its Members, v. The California Avocado Commission 2008 WL 2169508 (E.D.Cal.) the Association (a producer, packer, and exporter of Mexican avocados) sued the California Avocado Commission (California Food & Agriculture Code §§ 67001 et

seq.) for undertaking “a massive effort to stop the importation of Mexican‐grown avocados into California.” The United States District Court for the Eastern District granted Defendant’s motion to transfer venue to the Central District, because it is more convenient for the Commission and Plaintiffs presented no reason why venue should not be transferred.

DMS: 686616_1.DOC

NATIONAL COUNCIL OF FARMER COOPERATIVES

LEGAL TAX & ACCOUNTING COMMITTEE

Report of Subcommittee on Litigation Between Cooperatives and Their Members, Including Member Insolvency

Chair: David M. Hayes, Esq. Bond, Schoeneck & King, PLLC One Lincoln Center Syracuse, NY 13202 Phone: (315) 218-8188 Fax: (315) 218-8100 [email protected]

Vice-Chair: Terry D. Bertholf, Esq. Kansas Farmers Service Association 1515 East 30th Avenue P.O. Box 2560 Hutchinson, KS 67504-2560 Phone: (620) 663-5453 Fax: (620) 663-1653 [email protected]

Vice-Chair: William P. Hutchison, Esq. Foster Pepper Tooze, LLP 601 SW 2nd, Suite 1800 Portland, OR 097204 Phone: (503) 219-8133 Fax: (800) 600-2138 [email protected]

Dated: November 10, 2008

TABLE OF CONTENTS

1. Enforceability of a Liquidated Damages Clause

United Dairymen of Arizona v. Rawlings

Bybee Farms, LLC et al v. Snake River Sugar Company, et al.

2. Stark Packing Corporation v. Sunkist Growers, Inc.

3. Andrews Farms, et al. v. Calcot, Ltd., et al.

4. Walnut Producers of California, et al v. Diamond Foods, Inc.

5. Nakata, et al v. Blue Bird, Inc.

6. In re: Southeastern Milk Antitrust Litigation.

47 1469920.14

1. Enforceability of a Liquidated Damages Clause

In two pending legal actions, the issue has been addressed: whether a liquidated damages clause in a cooperative’s marketing agreements with its members is legally enforceable?

In United Dairymen of Arizona v. Rawlings, 217 Ariz. 592, 177 P. 3d 334 (Feb. 2008), the cooperative, United Dairymen of Arizona, brought suit for breach of the cooperative marketing agreement against a dairy farmer member, Rawlings. The Arizona Court of Appeals held that the statute providing that liquidated damages clauses in cooperative marketing agreements between cooperative marketing associations and their members “shall be valid and enforceable in the courts”, A.R.S. § 10-2016(D). The statute reflects the legislative intent that such clauses are not subject to common law principles limiting the enforceability of liquidated damages clauses, e.g., a requirement of reasonableness agreed to by parties or difficulty in calculating actual damages. The Court upheld liquidated damages in the cooperative’s marketing agreement requiring the dairy farmer to pay the cooperative 40 percent of the gross sales price of milk not sold to the association when the farmer breached his contract obligation to deliver all milk to the cooperative.

Rawlings has filed a petition for review with the Arizona Supreme Court.

The cooperative marketing statutes of many states include similar provisions permitting liquidated damages clauses in cooperatives’ marketing agreements.

In United Dairymen of Arizona v. Rawlings, Id, the Court held that the liquidated damages clause was enforceable.

A contrary rationale was applied in Bybee Farms, LLC v. Snake River Sugar Co. United States District Court, Eastern Division of Washington, CV-06-5007-FVS, WL 2873364 (July 2008). This is a complicated ongoing case in which the Court has issued tentative conclusions to cross- motions for summary judgment. The District Court is considering the enforceability of a liquidated damages provision in the defendant cooperative’s marketing agreement which establishes penalties in the event that the member does not fulfill his contractual obligations as follows: “In the event Grower has failed to plant or deliver all or any portion of the Grower’s full Quota, the Grower will pay to the Cooperative 100% of the Distributable Cash Per Acre Decrease for each acre which was not planted or delivered”, and “In the event that Grower does not pay the Distributable Per Acre Decrease (within 90 days but not later than the following February 1) the Grower’s Patron Preferred Stock in an amount equivalent to the number of acres to which said payment failure applies shall immediately revert and transfer to the Cooperative”. Id.

The Court in Bybee first reviewed the law of the State of Washington, which would apply a two part test to determine whether a contractual liquidated damages clause is enforceable. “First, the amount fixed must be a reasonable forecast of just compensation for the harm caused by the breach. Second, the harm must be such that it is incapable or very difficult of ascertainment” as in Walter Implement, Inc. v Focht 107 Wash. 2d 553, 559, 730 P. 2d 134. In Bybee Farms the federal court further noted that the Washington test would be applied at the time the contract was

executed, and is therefore “prospective” citing Watson v Ingram 124 Wash. 2d 845, 851, 881 P. 2d 247. Under the Washington State common law, the liquidated damages must have been a “reasonable forecast of just compensation at the time that the contract was executed, and ignores the damages actually suffered, except as evidence of the reasonableness of the estimate of potential damage.” Id, Watson. In view of today’s volatile commodity prices, Washington law, as interpreted by the federal court, would encourage inappropriate seller speculation as risk of unforeseeable price increase is transferred to the buyer of farm commodities if damages must be reasonable at the time that the contract was executed.

The marketing agreement with Snake River Sugar Co. contained a choice of law clause and designated Idaho law. Id, FN4. The U.S. District Court noted that the Idaho Supreme Court would apply a different test, stating “In Idaho parties to a contract may agree upon liquidated damages in anticipation of a breach, in any case where (accurate) determination of damages would be difficult or impossible” and the fixed liquidated damages “bear a reasonable relation to actual damages” referring to Graves v. Cupic 75 Idaho 451, 456, 272 P.2d 1020, 1023. By considering the non-breaching party’s actual damages, the Idaho test is at least partially retrospective in nature.

Under Idaho law, the test of reasonableness of damages relates to the actual damages that were sustained by the non-breaching party. The Bybee Court held that the plaintiffs/producers had the burden of proving that the forfeiture (of stock) provision was unenforceable. The Court noted that plaintiffs do not dispute that an accurate determination of damages would have been difficult, but they focused on the second part of the Graves test, arguing that they paid $400 per share for the stock, and that the forfeiture of the stock vastly exceeds the cooperative’s actual damages.

According to its tentative conclusions, the Bybee Court will order an evidentiary hearing or trial on the issue of actual damages before determining whether the liquidated damages are reasonable.

There are lessons to be learned from the Court’s machinations in Bybee Farms Id. compared to the strict application of the marketing agreement in United Dairymen of Arizona v. Rawlings. Id. The cooperative’s marketing agreements should:

• When possible, prescribe application of the law of a state specifically authorizing liquidated damages in cooperatives’ marketing agreements by statute or court decision. (If the cooperative’s marketing agreement does not specify application of the law of a cooperative friendly state (with respect to liquidated damages), then, the cooperative should attempt to bring the action first in Arizona or another cooperative friendly state, or in Idaho or other states that allow the retrospective (at the time of trial) test of reasonableness.)

• Provide for liquidated damages that reasonably relate to the cooperative’s potential actual damages.

• State that damages are difficult or impossible to determine.

• State that the parties agree that the specified liquidated damages are reasonable under the circumstances.

• Avoid use of the words “penalty,” “forfeiture” and the like to reinforce that the provision is a legally enforceable liquidated damages clause and not an unenforceable penalty clause.

• State that the cooperative has the right to bring successive claims for each breach of contract.

• State that the cooperative may pursue, in addition to liquidated damages, all other legal and equitable remedies available to the cooperative. Liquidated damages are not the cooperative’s exclusive remedy.

* * * * * * * * * * * * * * * * * * * *

In September 2008, some shareholder-members of The Western Sugar Cooperative filed a class action complaint in U.S. District Court, District of Colorado, seeking to terminate their contracts with the Cooperative which obligate them to grow and deliver sugar beets to the Cooperative. According to the complaint, the Cooperative imposed penalties on several members who failed to grow sugar beets during the 2007 season. In the complaint, the plaintiffs have requested the Court to declare that the Cooperative has never been empowered or authorized to impose liquidated damages for the failure to grow and deliver sugar beets.

There is a 2001 decision which was favorable to a grocery cooperative enforcing a withdrawal payment under the stockholders’ agreement between the cooperative and a member. Big V Supermarkets, Inc. v. Wakefern Food Corporation, U.S. Bankruptcy Court, District of Delaware, Case No. 00-4372 (September 14, 2001, Judge Raymond T. Lyons). The member, Big V Supermarkets, sought a declaratory judgment that the withdrawal payment (or adherence to a minimum patronization requirement) under the cooperative’s agreements with its stockholders was unenforceable. The Court ruled in favor of the cooperative and enforced the requirement that the member-stockholder was obligated to satisfy the minimum patronage requirement in its purchases from the cooperative or to pay the withdrawal payment to the cooperative. The Court relied on general corporate and contract law principles, not on a cooperative marketing statute.

In 1992, the U.S. Department of Agriculture published Cooperative Marketing Agreements – Legal Aspects (USDA, ACS Research Report 106). Pages 40-44 of the USDA Report discuss liquidated damages.

2. Stark Packing Corporation v. Sunkist Growers, Inc.

On December 20, 2006, a jury in the Superior Court of California, Tulare County, returned a verdict of $13.5 million against Sunkist Growers, Inc. in favor of former Sunkist for-profit licensed packinghouses, Stark Packing Corporation and Millwood Packing, Inc. The packinghouses are not producers and are not members of Sunkist. After the U.S. Supreme Court’s decision in Case-Swayne Co. v. Sunkist Growers, Inc., 389 U.S. 384 (1967), Sunkist changed its organizational structure in 1968 and eliminated for-profit packinghouses as members.

The jury verdict was based upon the alleged breach by Sunkist of an implied term in the packinghouse license agreements. During the trial, at the close of the plaintiffs’ evidence, the trial judge ruled that there was an implied term in the agreements: “that all packers be provided equal marketing opportunity, but not equal results.” The judge may have derived this implied new term in the packinghouse license agreements from a Sunkist Marketing Equity Policy which applied to Sunkist members. The plaintiff-packinghouses were not growers or Sunkist members, and Sunkist did not intend or provide that the Marketing Equity Policy applied to Sunkist’s dealings with non-member packinghouses. The jury verdict rested entirely on breach of contract – on Sunkist’s alleged breach of this implied term.

Sunkist filed an appeal. Sunkist filed its brief in May 2008. The reply brief from the plaintiffs is to be filed in October 2008.

3. Andrews Farms, et al. v. Calcot, Ltd., et al.

A lawsuit was first filed January 2007 in the Superior Court of California, Kern County, by two members, Andrews Farms and Greg Palla, seeking class action status, against Calcot, Ltd., a cotton marketing cooperative in Bakersfield, CA. Also named as defendants were Eadie and Payne, LLP, the cooperative’s auditors. The legal action was removed to U.S. District Court, Eastern District of California.

The complaint alleged breach of fiduciary duty; constructive fraud and deceit based upon fiduciary relationship; accounting; fraud and deceit – intentional misrepresentation of material fact; negligent misrepresentation against the auditors; and, violations of the federal RICO (Racketeer Influenced and Corrupt Organizations) statute, 18 U.S.C. § 1962.

According to the suit, Calcot improperly charged its members more than $23 million in interest expenses during the last two decades to pay for a commercial real estate development. The plaintiffs claimed that interest costs were incurred for a real estate venture unrelated to marketing Calcot members’ cotton, but the interest was deducted from the amounts due members for their cotton. The plaintiffs alleged that the interest deductions were concealed from members and from the Board of Directors. The suit relates to the accounting treatment of interest and the disclosures related to interest. The plaintiffs seek treble damages under RICO as well as punitive damages.

The original complaint was dismissed with leave to amend the complaint. In July 2007, the plaintiffs filed an amended complaint in federal court containing similar allegations. In October 2007, the U.S. District Court denied Calcot’s motion to dismiss the amended complaint in its entirety. On motions to dismiss by Calcot’s auditors, Eadie and Payne, LLP, the Court denied both the auditors’ motion to dismiss and its motion to strike the plaintiffs’ request for punitive damages; but, the Court did grant the auditors’ motion to strike plaintiffs’ request for attorneys’ fees and granted, in part, the auditors’ motion for a more definite statement.

4. Walnut Producers of California et al v. Diamond Foods, Inc.

In March 2008, a walnut grower and a cooperative bargaining association named Walnut Producers of California filed suit against Diamond Foods, Inc., the publicly traded successor entity to Diamond Walnut Growers, Inc., a California cooperative, in San Joaquin County Superior Court, California, for breach of contract relating to the alleged underpayment for walnuts delivered to Diamond Foods for the 2005 and 2006 crop years. The plaintiffs brought the suit individually, on their own behalfs, and as a class action of walnut growers who entered into contracts with Diamond Foods.

As background, in 2005, the members of Diamond Walnut Growers, Inc. voted to approve the conversion of the agricultural cooperative into a stockholder-owned corporation, Diamond Foods, Inc. The corporation is a branded food company specializing in processing, marketing and distributing culinary, snack, inshell and ingredient nuts under the Diamond of California and Emerald of California brands. Products include walnuts, pine nuts, pecans, peanuts, macadamia nuts, hazelnuts, cashews, Brazil nuts and almonds. Diamond Foods is a publicly owned company with its common stock trading on the NASDAQ Exchange.

In the lawsuit, the growers allege that they have not been paid a “competitive price” for their products since the conversion of the organization from an agricultural cooperative to a publicly owned company. Plaintiffs filed their original complaint in March of 2008 and have been seeking from the Court a class designation. There may be as many as 1,600 growers involved. The plaintiffs include an individual and the Walnut Producers of California, a bargaining association, which can directly assert its members’ claims; it could constitute a class representative.

The plaintiffs filed an amended complaint on September 19, 2008. The underlying theory continues to be a breach of contract for failure of the defendant to pay the growers the competitive price (sometimes referred to as reasonable, market, or competitive price) for walnuts they have delivered. Since the conversion of the cooperative to a stockholder-owned corporation, the defendant has paid the growers a price that is reported to be significantly less than the market price. Apparently, the contract itself includes a commitment by Diamond Foods to establish the price in good faith. Historically, the cooperative paid growers above market prices for their walnuts. The contract between Diamond Foods and its former members does not include a price, which may be contrary to California law. (California Food and Agriculture Code section 62801.) It appears that plaintiffs may rely upon a promissory estoppel theory and the practices that pertained at the time of the execution of the contracts.

Upon reflection, counsel for plaintiffs observed the so-called “horizon problem” that is inherent in conversion to a stockholder-owned corporation. The older members desire an exit strategy to realize the value that has accumulated over the years while the younger generation is more interested in assuring a continuing market for their products.

5. Nakata, et al. v. Blue Bird, Inc., et al

In Nakata, et al. v. Blue Bird, Inc., et al, No. 26434-3-lll, 2008 WL 2623970 (Wash. Ct. App. July 3, 2008), the Court of Appeals of the State of Washington affirmed the trial court’s order granting summary judgment in favor of Blue Bird, Inc., a cooperative association, in a suit by a member of the cooperative to recover damages because the cooperative refused her demand to repay personal or business “equity accounts.” The appellate court concluded that the trial court properly dismissed the complaint because the plaintiff failed to make out a cause of action in either law or equity.

The plaintiff conceded that the cooperative has no legal obligation to pay, either under any agreement with her or under any bylaw of the cooperative or of any statute. Instead, she argued that the court should order payment of her equity accounts based on “some theory in equity.”

Both the trial court and the appellate court refused to recognize the plaintiff’s theory that she had some equitable right to the payment of her equity accounts.

6. In re: Southeastern Milk Antitrust Litigation.

The Antitrust Subcommittee will report on this litigation.

Report of LTA Subcommittee

Alternative Minimum Tax, Tax Accounting and State and Local Tax Issues Affecting Agricultural Cooperatives

Chair: David R. Simon [email protected] Farleigh Wada Witt 121 SW Morrison Street, Suite 600 Portland, Oregon 97204

Vice Chair: Wayne E. Sine [email protected] Southern States Cooperative, Inc. 6606 West Broad Street Richmond, VA 23230

The subcommittee wishes to report on three issues of relevance to agricultural cooperatives. Those issues include:

Issue # 1: A new federal income tax credit which will be of significant value to NCFC members operating as agricultural supply cooperatives.

Issue # 2: An adverse state tax issue that has been raised by the State of Illinois in the audit of an agricultural cooperative.

Issue # 3: Increased importance of maintaining proper sales tax exemption certificates by supply cooperatives; solutions through use of technology and/or outsourcing.

Issue # 1 Agricultural Chemicals Security Credit

The 2008 Farm Act established a non-refundable Agricultural Chemicals Security Credit for eligible agricultural businesses. The credit amount is 30% of eligible expenditures incurred to comply with security and anti-terrorism requirements for specified agricultural chemicals. The credit took effect with enactment of the 2008 Farm Bill on May 22, 2008 and is scheduled to expire on December 31, 2012. This credit is subject to annual limitations of $2 million per year and $100,000 per facility. The relevant section of the Internal Revenue Code, § 450 entitled Agricultural chemicals security credit, is incorporated herein, following this introduction.

This credit is likely to be of significant value to members of the National Council of Farmer Cooperatives (NCFC) who operate as agricultural supply cooperatives. Subsection (h) of Code

Section 450 provides that the Secretary (of Treasury) may prescribe such regulations as may be necessary or appropriate to carry out the purposes of the code section. It is recommended that a working group of the Legal Tax and Accounting (LTA) committee and NCFC staff participate in the drafting of such regulations to facilitate the issuance of taxpayer guidance that is as timely and practical as possible.

§ 45O Agricultural chemicals security credit.

(a) In general. For purposes of section 38, in the case of an eligible agricultural business, the agricultural chemicals security credit determined under this section for the taxable year is 30 percent of the qualified security expenditures for the taxable year.

(b) Facility limitation. The amount of the credit determined under subsection (a) with respect to any facility for any taxable year shall not exceed—

(1) $100,000, reduced by

(2) the aggregate amount of credits determined under subsection (a) with respect to such facility for the 5 prior taxable years.

(c) Annual limitation. The amount of the credit determined under subsection (a) with respect to any taxpayer for any taxable year shall not exceed $2,000,000.

(d) Qualified chemical security expenditure. For purposes of this section, the term “qualified chemical security expenditure” means, with respect to any eligible agricultural business for any taxable year, any amount paid or incurred by such business during such taxable year for—

(1) employee security training and background checks,

(2) limitation and prevention of access to controls of specified agricultural chemicals stored at the facility,

(3) tagging, locking tank valves, and chemical additives to prevent the theft of specified agricultural chemicals or to render such chemicals unfit for illegal use,

(4) protection of the perimeter of specified agricultural chemicals,

(5) installation of security lighting, cameras, recording equipment, and intrusion detection sensors,

(6) implementation of measures to increase computer or computer network security,

(7) conducting a security vulnerability assessment,

(8) implementing a site security plan, and

(9) such other measures for the protection of specified agricultural chemicals as the Secretary may identify in regulation.

Amounts described in the preceding sentence shall be taken into account only to the extent that such amounts are paid or incurred for the purpose of protecting specified agricultural chemicals.

(e) Eligible agricultural business. For purposes of this section, the term “eligible agricultural business” means any person in the trade or business of—

(1) selling agricultural products, including specified agricultural chemicals, at retail predominantly to farmers and ranchers, or

(2) manufacturing, formulating, distributing, or aerially applying specified agricultural chemicals.

(f) Specified agricultural chemical. For purposes of this section, the term “specified agricultural chemical” means—

(1) any fertilizer commonly used in agricultural operations which is listed under—

(A) section 302(a)(2) of the Emergency Planning and Community Right- to-Know Act of 1986,

(B) section 101 of part 172 of title 49 , Code of Federal Regulations, or

(2) any pesticide (as defined in section 2(u) of the Federal Insecticide, Fungicide, and Rodenticide Act), including all active and inert ingredients thereof, which is customarily used on crops grown for food, feed, or fiber.

(g) Controlled groups. Rules similar to the rules of paragraphs (1) and (2) of section 41(f) shall apply for purposes of this section.

(h) Regulations. The Secretary may prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section, including regulations which—

(1) provide for the proper treatment of amounts which are paid or incurred for purpose of protecting any specified agricultural chemical and for other purposes, and

(2) provide for the treatment of related properties as one facility for purposes of subsection (b).

(i) Termination. This section shall not apply to any amount paid or incurred after December 31, 2012.

Issue # 2 Adverse state tax issue raised by the State of Illinois In the audit of an NCFC member cooperative

An NCFC member cooperative reported the following issue as being raised during an income tax audit by the State of Illinois. The cooperative reported on its Illinois tax returns both losses and income, in varied years, from patronage and non-patronage sources. This resulted in some years having NOL carry-forwards for either type of income. The state is saying they will not recognize any loss carry-forwards if there is “taxable income” in the same year – i.e. if the cooperative has a patronage loss and non-pat income, the State is asserting that the cooperative will lose the patronage NOL carry-forward because there is “taxable income.” At the time of this writing, the cooperative was in the hearing phase of the process.

This would appear to be a new issue, as the subcommittee is not aware of such assertions by a state department of revenue in the past. If Illinois’ statutes are found to support the state auditor’s assertions, then this could have significant negative implications for many cooperatives subject to taxation in Illinois. With the IRS’ increasing scrutiny over the transparent separation of patronage and non-patronage earnings and losses, with the ongoing pressure on state budgets, and with the sharing of information among state departments of revenue, this assertion by the State of Illinois bears close monitoring by NCFC’s membership.

Issue # 3 Increased importance of maintaining proper sales tax exemption certificates by supply cooperatives; solutions through use of technology and/or outsourcing.

In states which impose sales tax on the sale of tangible personal property, there is generally some level of exemption for farm supplies and equipment sold to customers engaged in the business of farming. In most states, such exemption must be supported by a properly completed and signed sales tax exemption certificate. When the agricultural supply cooperative or other agricultural supply retailer is examined by state sales auditors, such retailer must be able to provide the auditor with a properly completed and signed certificate in support of the exempt sale. Although state laws provide that the seller shall obtain a properly completed certificate prior to exempting

eligible sales from tax, state auditors have historically allowed retailers to procure missing exemption certificates at the time of the audit. However, the practice of allowing retailers to obtain missing certificates at the time of audit is ending in some states. The subcommittee has identified at least one state which has issued several rulings stating that an exemption certificate must have been obtained from the purchaser at the time of sale in order for the exemption to apply in years under audit. Exemption certificates completed and signed at the time of the audit will only qualify to exempt sales made on and after the date signed by the purchaser.

With more and more states increasing their strict enforcement of sales tax exemption certificate requirements, it has become increasingly important for agricultural supply cooperatives to improve their exemption certificate compliance. A number of software vendors and service providers ha entered into the business of sales tax exemption certificate compliance. Offerings include:

• Exemption certificate compliance as an add-on module to existing sales tax calculation software. • Software which will e-mail an exemption certificate request to the customer, with instructions for the customer to go online, complete the certificate, print and sign it, then fax it back to the software provider. Such software is impressive, but how many agricultural retailers have correct e-mail address for each of their farm customers? Furthermore, if the retailer did have e-mail addresses, would a majority of such customers be willing to go to a website, complete the form, print it, sign it, then fax it back to the software provider? • Software for use at the store’s customer service counter or check-out line which prompts the customer to answer questions which determine which exemptions the purchaser is eligible for, then populates the proper exemption certificate, then captures the customer’s signature from an electronic signature pad onto the proper exemption certificate, and finally images the certificate for audit purposes. This software is also very impressive, but it is costly and many agricultural supply cooperatives do not have customer service desks and staff to accommodate such exception processing without disrupting the checkout line for other customers during the busy spring and fall planting seasons. • Other vendors will mail out exemption certificate requests to the retailer’s customers, handle questions from the customers, scrutinize returned certificates for accuracy, then scan, image, and host the exemption certificates for access during sales tax audits. This approach would appear to be a more acceptable approach for agricultural supply cooperatives which may not have the infrastructure, staff and/or budget to make use of some other solutions.

With increasing scrutiny of sales tax exemption certificates in state sales tax audits, NCFC members who operate as agricultural supply cooperatives may be well advised to consider some of the automation tools that have become available in recent years to improve compliance with exemption certificate requirements.

ANNUAL REPORT OF THE ANTITRUST COMMITTEE OF THE NATIONAL COUNCIL OF FARMER COOPERATIVES

William L. Sippel (Chair) Michael Lindsey (Vice-Chair) Donald Barnes (Vice-Chair) Christopher Ondeck (Contributor) Marlis Carson (Contributor)

OVERVIEW

More so than in previous years, the Capper-Volstead Act has been the subject of active litigation, and also the focus of legislative and review. On the legislative and policy side, the Antitrust Modernization Commission forwarded its recommendations concerning Capper-Volstead and other antitrust immunities to Congress. As more fully described later in this report, the Commission recommendations are before the House Judiciary Committee which has reauthorized the Commission until January 2009. The Judiciary Committee has also created a Committee Task Force to review the Commission recommendations. For further information, see p. 2 of this Report. Unfortunately for the litigants, the vast majority of Capper-Volstead activity was in the courts, however. The NCFC has been active in monitoring, and, as its own interest dictate, participating in the litigation through amicus and other activities. It also has kept its members informed of the relevant exemption issues in these cases. The National Council of Farmer Cooperatives submitted an Amicus Brief in the In Re Mushroom Direct Purchase Antitrust Litigation. The amicus was drafted by Chris Ondeck and Beth Wimsatt at Crowell and Moring with editorial input by an LTA Antitrust Working Group consisting of Marlis Carson, Terry Bertholf, Todd Eskelsen, David Hayes, Michael Lindsay, Ken Manock, Chris Ondeck, Ronald Peterson, and William Sippel. For a summary of the issues in the Mushroom Litigation, see p. 2-3 of this Report. A copy of the Amicus Brief is posted in the Members Section of the NCFC website (www.ncfc.org) under the link for 2008 LTA Memoranda. The NCFC Antitrust Committee is monitoring a recent class action antitrust lawsuit involving raw processed egg products and raw shell eggs. United Egg Producers and some farmer cooperatives have been listed as defendants in the litigation. For a more detailed description of the antitrust issues in that case, see pp. 3-4 of this Report. Finally, Dairy Farmers of America is defendant in two pieces of litigation that are the subject of this report, one alleging it suppressed the price of raw milk and the other alleging it raised the price of raw milk. Plaintiffs apparently filed their actions in different districts to minimize judicial schizophrenia from having a court deal with allegations that DFA raised and at the same time depressed raw milk prices. In the first set of cases, In re Southeastern Milk Antitrust Litigation, DFA and other defendants are alternatively alleged to have suppressed the price of raw milk and raise the price of processed milk. This litigation is more fully described at pp.5-11 of this Report. The second case involves alleged manipulation of the price of cheese on the Chicago Mercantile Exchange in order to raise the price of raw milk. This antitrust case follows DFA’s s settlement with the CFTC concerning alleged manipulation of Class III milk futures contracts. For a fuller description of this litigation, see p.11 of this Report. All in all, Capper-Volstead and cooperative antitrust litigation are alive and well and merit close attention to developments which this Committee provides to NCFC members.

A. Antitrust Modernization Commission Update by Marlis Carson.

Following a three-year study of all aspects of antitrust law, the Antitrust Modernization Commission released its report on federal antitrust laws in April 2007. The Commission recommended imposing sunset provisions on all immunities and exemptions. The recommendation would apply to all statutory antitrust immunities utilized by farmer cooperatives, including the Capper-Volstead Act, the Agricultural Marketing Agreement Act, the Webb-Pomerene Act, the Export Trading Company Act, and others. The Commission further recommended that in order to renew a sunsetted immunity or exemption, the Federal Trade Commission should be authorized to study the competitive effects of and justifications for the immunity or exemption.

NCFC submitted extensive comments to the Commission in support of Capper-Volstead and other agricultural immunities and requested the opportunity to testify before the Commission. The Commission denied that request, saying it did not want to hear from the affected industries. As urged by NCFC, the full Senate unanimously approved a Sense of Congress Resolution in support of farmer cooperatives (S.Con.Res. 119) on November 16, 2006. The resolution was sent to the Commission by the Co-Chairs of the Congressional Farmer Cooperative Caucus.

A House Judiciary Committee Task Force has held two hearings since the release of the report. The recommendations on immunities and exemptions were discussed at both hearings, but no legislation has been introduced. The Senate has not yet acted on the Commission’s report. NCFC staff members continue to monitor legislative activity for signs of any activity related to Capper-Volstead.

The House Judiciary Committee on September 10, 2008, took action to re-authorize its Antitrust Task Force through January 2009. The purpose of the task force is to allow the Judiciary Committee to more closely examine important matters of antitrust and competition policy. Judiciary Committee Chairman John Conyers, Jr. (D-Mich.) serves as chairman of the task force; the ranking minority member is Representative Steve Chabot (R-Ohio).

B. In Re Mushroom Direct Purchaser Antitrust Litigation by Christopher Ondeck.

On July 8, NCFC filed an amicus brief in the In re Mushroom Direct Purchase Antitrust Litigation, in the U.S. District Court for the Eastern District of Pennsylvania. NCFC’s brief focuses on three issues of interpretation of the Capper-Volstead Act’s protections for farmer cooperatives. As background, the case is an antitrust lawsuit involving the Eastern Mushroom Marketing Cooperative (EMMC), the largest mushroom farmer cooperative in the United States. The case is the joinder of eight class action antitrust lawsuits filed against EMMC and approximately twenty-two member and non-member mushroom producers, all filed between February and April, 2006. The cases were filed as a follow-along civil action in response to an investigation and later settlement by the Department of Justice in a case against EMMC. The Department alleged the cooperative launched a campaign in 2001 to prevent nonmember farmers from buying or leasing available mushroom farms.

The procedural course of the class action case has been as follows. The defendants filed motions to dismiss in July, 2006. The Court denied these motions. Subsequently, the Court issued an order limiting discovery solely to whether Capper-Volstead Act immunity covered some or all of the claims in question. After discovery, the parties filed cross-motions for summary judgment on the issue of Capper-Volstead Act immunity in June/July of 2008. Those motions are pending.

NCFC filed an amicus brief as part of the summary judgment briefing because the case raises a substantial risk that the court may issue an opinion that limits the protection provided by the Capper-Volstead Act. Such an opinion could have a negative precedent-setting effect. In its brief, NCFC did not take a position on the underlying facts involved in the case. Instead, NCFC addressed three specific issues with regard to interpretation of the Capper-Volstead Act. First, NCFC argued that agricultural producers who are “vertically integrated” (those who process agricultural products as well as grow them) are permitted to be members of a cooperative within the immunity provided by the Act, i.e., vertical integration is not a bar to membership in a cooperative under the Act. Second, NCFC maintained that the “50% rule” in the Capper- Volstead Act (a cooperative is permitted to handle as much third-party products as member products) applies only at the level of the cooperative, and not on a member-by-member basis. Third, NCFC asserted that members of a cooperative are not liable for conduct of a cooperative that is found to be predatory under Section 2 of the Sherman Act.

NCFC filed its brief on July 8. On September 2, 2008 the Court entered an order extending the date for reply briefs from September 15 to September 30. Unfortunately, the motions to dismiss, oppositions, and reply briefs filed by the parties are not available to the public (including NCFC). The parties requested a protective order to seal the summary judgment briefs, due to concerns about proprietary information (possibly related to contracting and pricing) contained in them. The LTA is monitoring the case for further developments.

C. In Re Processed Egg Products Antitrust Litigation by Chris Ondeck.

Beginning in late September 2008, a series of class action antitrust lawsuits was filed against approximately 16 companies engaged in producing raw shell eggs and processed egg products, as well as against an agricultural cooperative, United Egg Producers (“UEP”) and two related entities. These cases followed media reports beginning September 23, 2008 and later regarding a Department of Justice antitrust investigation into the pricing and marketing of certain processed egg products.

To date, approximately 20 separate lawsuits has been filed, listing both direct and indirect purchasers as plaintiffs. The plaintiffs filed these cases in several courts, including the Eastern District of Pennsylvania, the District of New Jersey, and the District of Minnesota. On December 2, 2008, the Judicial Panel on Multi District Litigation consolidated the cases into a single matter in the United Stated District Court in the Eastern District of Pennsylvania. The consolidated proceeding is titled In re Processed Egg Products Antitrust Litigation and is before Judge Gene E.K. Pratter.

The complaints allege violations of Section 1 of Sherman Act; specifically, that defendant egg producers and alleged co-conspirators engaged in a continuing combination and

conspiracy in unreasonable restraint of trade, with the purpose and effect of fixing, raising, maintaining, and stabilizing prices of shell eggs and processed egg products at artificially high, noncompetitive levels in the United States. However, the specific allegations of conduct and the relevant products involved in the different complaints vary to a degree. As to the products involved, one set of complaints focuses on raw shell eggs, i.e., eggs in the shell that have not been pasteurized or further processed. Another set of complaints focuses on processed egg products, i.e., eggs out of the shell that have been pasteurized and further processed into liquid or powdered forms.

The conduct alleged by the complaints to be anticompetitive also varies, and falls into two primary categories: (1) that UEP and its members engaged in pretextual animal husbandry guidelines (involving, e.g., cage-sizes, molting practices and schedules, delaying and reducing chick hatching) and (2) that UEP, its affiliates, and their respective members reduced supply by selective exportation of eggs at a loss to increase domestic price. Some complaints include garden-variety conspiracy allegations of price-fixing and supply control. Some complaints also allege an agreement to allocate and divide markets.

The current procedural status of the matter is as follows: the Court has directed the direct purchaser plaintiffs to file an amended consolidated complaint by January 30, 2009. The Court has stated that it will consult with counsel for the indirect purchaser plaintiffs regarding a date by which they too must file an amended consolidated complaint. Defendants have until April 2, 2009 to respond by motion or answer to the complaints. The Court has stayed all discovery.

D. In Re Southeastern Antitrust Litigation by Donald Barnes.

In July of 2007, two antitrust class action lawsuits were filed against Dean Foods, Dairy Farmers of America, National Dairy Holdings, and others in federal court in Tennessee. Shortly thereafter, five additional “tag along” dairy farmer class actions were filed along with two direct purchaser suits, including one by the Food Lion supermarket chain.

All of the cases have been consolidated before Judge Ronnie Greer in the Greeneville Division, Eastern District of Tennessee.

In a consolidated amended complaint the Dairy Farmer Classes alleged that the Defendants conspired and refused to compete for raw Grade A milk, thereby causing reduced pay prices to members of the Class. In addition, a sub-class of DFA members had additional claims for “breach of contract,” i.e., the duty of DFA management to use corporate resources for the benefit of the members.

Various preliminary motions to dismiss the complaint pursuant to Rule 12(b)(6) have been denied, including one motion based upon alleged Capper-Volstead Act immunity.

On July 29, 2008 the court entered an extensive Order directing the parties to participate in a mediation effort. The first mediation meeting was conducted on September 15 and all parties were directed to submit a joint mediation plan within 30 days. Another mediation session has been scheduled in late January 2009. Meanwhile, document discovery on the class certification and merits issues will continue.

The discovery cut-off date is currently set for September 2009.

A chronological outline of the various complaints and claims is set out below: Date Case name

7/5/2007 Sweetwater Valley Farm, Inc., et al., v. Dean Foods Company, et al., No. 07- 00051 (M.D. Tenn. filed Jul. 5, 2007).

• Antitrust class action complaint filed by:

o Plaintiffs Sweetwater Valley Farm, Inc., Harrison Dairy, Inc., D.L. Robey Farms, Barbara and Victor Atwood d/b/a Vba Dairy, John M. Moore, Jeffrey P. Bender, Randel E. Davis, Mountain View Farms of Virginia, LC, Sam Smith, and Thomas R. Watson.

o Against Defendants Dean Foods Company, National Dairy Holdings, LP, Dairy Farmers of America, Inc., Dairy Marketing Services, LLC, Southern Marketing Agency, Inc., James Baird, Gary Hanman, and Gerald Bos.

• Antitrust case alleging that defendants conspired to operate a cartel that refuses to compete for the purchase of Grade A milk and fixes the prices of milk paid to dairy farmers in the Southeast United States in violation of Sections 1 and 2 of the Sherman Act.

• Class consists of:

o All independent dairy farmers, whether individuals or entities, who produced Grade A milk within Orders 5 or 7, and, either directly through Dairy Marketing Services, LLC, sold Grade A milk to Defendants in Orders 5 and/or 7 during any time from January 1, 2001 to the present.

o All dairy farmer members of Maryland & Virginia Producers Cooperative Association, Inc., whether individuals or entities, who produced Grade A milk within Orders 5 and/or 7, and, through Southern Marketing Agency, Inc., sold Grade A milk to Defendants in Orders 5 and/or 7 during any time from January 1, 2001 to the present.

7/5/2007 James D. Baisley and Eva C. Baisley, et al., v. Dean Foods Company, et al., No. 07-00052 (MD. Tenn. filed Jul. 5, 2007).

• Antitrust class action complaint filed by:

o Plaintiffs James D. Baisley and Eva C. Baisley d/b/a Baisley Farms, Stephen J. Cornett, William C. Frazier and Branson McCain d/b/a

McCain Dairy, Jerry L. Holmes, Rocky Creek Dairy, Inc., and Van Der Hyde Dairy, Inc.

o Against same Defendants as Sweetwater Valley Farm, Inc., et al., v. Dean Foods Company, et al., No. 07-00051 (M.D. Tenn. filed Jul. 5, 2007) above.

• Class consists of:

o All DFA members, whether individuals or entities who produced and sold Grade A milk in Orders 5 or 7 during any time from January 1, 2001 to the present.

8/9/2007 Fidel Breto, d/b/a Family Foods, v. Dean Foods Company, et al., No. 07-188 (E.D. Tenn. filed Aug. 9, 2007).

• Antitrust class action complaint filed by:

o Plaintiff Fidel Breto, d/b/a Family Foods, a grocery store.

o Against same Defendants as Sweetwater Valley Farm, Inc., et al., v. Dean Foods Company, et al., No. 07-00051 (M.D. Tenn. filed Jul. 5, 2007) above.

• Class consists of:

o “Direct milk purchaser” class, defined as All Direct Purchasers of Grade A milk in the States of Alabama, Arkansas, Florida, Georgia, Indiana, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee, Virginia, and West Virginia, whether individuals or entities, from January 1, 2001 to the present.

8/27/2007 Scott Dairy Farm, Inc., et al., v. Dean Foods Company, et al., No. 07-208 (E.D. Tenn. filed Aug. 27, 2007).

• Antitrust class action complaint filed by:

o Plaintiff Scott Dairy Farm, Inc., William H. Price, Highland Dairy Farm, LLP, Jeff Whatley, and Robert D. Stoots.

o Against Defendants Dean Foods Company, National Dairy Holdings, LP, Dairy Farmers of America, Inc., Mid-Am Capital LLC, Dairy Marketing Services, LLC, and Southern Marketing Agency, Inc.

• Class consists of:

o All independent dairy farmers (whether individuals or entities) who produced Grade A milk within Orders 5 or 7, and sold Grade A milk directly or through an agent to Defendants or their co-conspirators in Orders 5 or 7 during any time from January 1, 2001 to the present.

10/3/2007 George C. Aker, et al., v. Dean Foods Company, et al., No. 07-248 (E.D. Tenn. filed Oct. 3, 2007).

• Antitrust class action complaint filed by:

o Plaintiff George C. Aker, a dairy farmer.

• Defendants, type of action filed, and class definition same as Scott Dairy Farm, Inc., et al., v. Dean Foods Company, et al., No. 07-208 (E.D. Tenn. filed Aug. 27, 2007).

11/15/2007 James Farrar and Farrar & Farrar Dairy, Inc., et al., v. Dean Foods Company, et al., No. 07-272 (E.D. Tenn. filed Nov. 15, 2007).

• Antitrust class action complaint filed by:

o Plaintiff James Farrar and Farrar & Farrar Dairy, Inc., and Fred Jaques, dairy farmers.

• Defendants, type of action filed, and class definition same as Scott Dairy Farm, Inc., et al., v. Dean Foods Company, et al., No. 07-208 (E.D. Tenn. filed Aug. 27, 2007).

1/7/2008 Transfer order from Judicial Panel on Multidistrict Litigation, granting defendants’ motion for coordinated or consolidated pretrial proceedings. The panel granted the motion, pursuant to 28 U.S.C. § 1407, and transferred the actions pending in the

Middle District of Tennessee to the Eastern District of Tennessee, creating MDL No. 1899. The litigation was renamed In re: Southeastern Milk Antitrust Litigation, No. 1899.

2/13/2008 Ernest Groseclose & Sons, Inc., et al., v. Dean Foods Company et al., No. 08- 00053 (E.D. Tenn. filed Feb. 13, 2008).

• Antitrust class action complaint filed by:

o Plaintiff Ernest Groseclose & Sons, Inc., and Virgil C. Willie, dairy farmers.

o Against Defendants Dean Foods Company, National Dairy Holdings LP, Dairy Farmers of America, Inc., Dairy Marketing Services LLC, Maryland and Virginia Milk Producers Cooperative Association, Inc., and Southern Marketing Agency, Inc.

• Type of action filed and class definition same as Scott Dairy Farm, Inc., et al., v. Dean Foods Company, et al., No. 07-208 (E.D. Tenn. filed Aug. 27, 2007).

3/28/2008 Food Lion, LLC, and Fidel Breto, d/b/a Family Foods, et al., v. Dean Foods Company, et al., No. 07-188 (E.D. Tenn. filed Mar. 28, 2008).

• Antitrust class action complaint filed by:

o Plaintiffs Food Lion LLC and Fidel Breto, d/b/a Family Foods.

o Against Defendants Dean Foods Company, National Dairy Holdings, LP, Dairy Farmers of America, Inc., Dairy Marketing Services, LLC, and Southern Marketing Agency, Inc.

• Antitrust case alleging that Dean Foods Company monopolized the market for the sale of processed milk in the Southeast and entered into exclusive agreements with Dairy Farmers of America and National Dairy Holdings, LP to lessen competition for sales and processed milk, in violation of Section 1 and 2 of the Sherman Act and Section 3 of the Clayton Act. Plaintiffs allege that the defendants’ actions compelled Food Lion, Breto, and the Class to pay unlawfully inflated prices for processed milk.

• Class consists of:

o All persons, other than schools and school districts, within the Southeast United States who have purchased, at any time from January 1, 2002 until the present, directly from any Defendant, Grade A milk which has been pasteurized and processed for human consumption and then packaged into containers which are sold to retail outlets and other

customers.

6/6/2008 In re: Southeastern Milk Antitrust Litigation, MDL No. 1899 (E.D. Tenn. Jun. 6, 2008) denying motion to dismiss by Southern Marketing Agency (“SMA”) and James Baird (“Baird”).

• SMA and Baird argued, inter alia, that the court should grant their motion to dismiss for failure to state a claim because the Capper-Volstead Act, 7 U.S.C. § 291, immunizes them from antitrust liability.

• The court, however, denied the motion finding that the defendants’ claim of Capper-Volstead immunity was “largely conclusory” and ultimately holding that the competing arguments on this issue necessitated a fact-intensive inquiry which the court could only conduct after proper discovery had been completed. The court concluded that an affirmative defense, such as one of Capper- Volstead immunity, could not be resolved through a 12(b)(6) motion.

6/20/2008 Consolidated amended complaint filed as Sweetwater Valley Farm, et al., v. Dean Foods Company, et al., No. 08-1000 (E.D. Tenn. filed Jun. 20, 2008).

• Antitrust class action complaint filed by:

o Plaintiffs Sweetwater Valley Farm, Inc., Barbara and Victor Atwood d/b/a VBA Dairy, Jeffrey P. Bender, Randel E. Davis, Farrar & Farrar Dairy, Inc., Fred Jaques, John M. Moore, D.L. Robey Farms, Robert D. Stoots, Virgil C. Willie, James D. Baisley and Eva C. Baisley d/b/a Baisley Farms, Stephen J. Cornett, William C. Frazier and Branson McCain d/b/a McCain Dairy, and Jerry L. Holmes.

o Against Defendants Dean Foods Company, National Dairy Holdings, LP, Dairy Farmers of America, Inc., Dairy Marketing Services, LLC, Southern Marketing Agency, Inc., Mid-Am Capital LLC, James Baird, Gary Hanman, and Gerald Bos.

• Antitrust case alleging that the defendants conspired to refuse to compete for raw Grade A milk marketed, sold, or purchased in the Southeast United States, fixed prices paid to dairy farmers for that milk, and unlawfully acquired and maintained monopoly power in order to reduce the price paid by defendants for Grade A milk bought from plaintiffs and other class members in violation of Sections 1 and 2 of the Sherman Act.

• Class consists of:

o All dairy farmers, whether individuals or entities, who produced Grade A milk within Orders 5 and/or 7, and sold Grade A milk directly or through an agent to Defendants or Co-Conspirators in Orders 5 and/or 7

during any time from January 1, 2001 to the present.

o The plaintiffs also sought certification of two subclasses, claiming that that DFA member dairy farmers (as opposed to all dairy farmers) had additional claims for breach of contract:

Independent dairy farmer and independent cooperative member subclass—All independent dairy farmers and independent cooperative members (whether individuals or entities) who produced Grade A milk within Orders 5 or 7 and sold Grade A milk directly or through an agent to Defendants or Co- conspirators in Orders 5 or 7 during any time from January 1, 2001 to the present. The terms “independent dairy farmer” and “independent cooperative member” refer to Southeast dairy farmers who were not members of DFA at the time of their Grade A milk sales.

DFA member dairy farmer subclass—All DFA members (whether individuals or entities) who produced Grade A milk within Orders 5 or 7 and sold Grade A milk directly or through an agent to Defendants or Co-conspirators in Orders 5 or 7 during any time from January 1, 2001 to the present. The term

“DFA member dairy farmer” refers to Southeast dairy farmers who were members of DFA at the time of their Grade A milk sales.

7/29/2008 Mediation order filed in In re Southeastern Milk Antitrust Litigation, MDL No. 1899 (E.D. Tenn. filed Jul. 29, 2008).

• The court ordered the parties to participate in mediation pursuant to LR 16.4(a) of the Local Rules of the United States District Court for the Eastern District of Tennessee and also ordered that the mediation should occur simultaneously with discovery and pretrial litigation. The court appointed the mediator and instructed counsel for the defendants to meet with him to develop, among other things, a comprehensive plan and framework for the mediation.

*** Note—Discovery on the merits is continuing concurrently with the mediation. The first mediation took place on Sep. 15, 2008 with more sessions to follow. The discovery cut-off date for all document discovery is currently in September 2009. The discovery cut-off date for all discovery is set for September 2009.

E. DFA CFTC Settlement and Resulting Antitrust Litigation by William L. Sippel

Soon after reaching a settlement with the Commodities Futures Trading Commission (CFTC) for allegedly attempting to manipulate the Class III milk futures

market, DFA and some former executives were sued under Section 2 of the Sherman Act for monopolizing the raw milk market by manipulating the price of cheese on the Chicago Mercantile Exchange (CME) in order to raise the price of raw milk. The allegations of the private antitrust class action mirror some of the allegations of the CFTC settlement In the Matter of Dairy Farmers of America, Inc. et. al, CFTC Docket No. 09- 02 (December 16, 2008).. In the antitrust case, Stew Leonard’s Inc. v. DFA, et. al, plaintiffs alleged that DFA cornered the market for the spot price of cheese and was thereby able to raise the price of raw milk established by the federal marketing orders. Plaintiffs contend that over the past nine years defendants have used their dominant position in the CME spot cheese market for the purpose of spiking prices. Plaintiffs restate allegations in the CFTC complaint that during a three month period in 2004 DFA acquired on the CME cheese at prices which made no economic sense other than to raise the price of raw milk futures contract in which DFA had a long position. The complaint also identifies confidential witnesses whom it claims stated that DFA made money by selling milk, not by selling cheese. The complaint alleges that DFA caused members of the class to pay artificially high raw milk prices for their processing plants.

NATIONAL COUNCIL OF FARMER COOPERATIVES

Report of the Standing Subcommittee On Environmental Laws and Regulations For 2008

Legal, Tax and Accounting Committee

Co-Chairman: Co-Chairman: Randon W. Wilson, Esq. B. Andrew Brown JONES WALDO HOLBROOK DORSEY & WHITNEY LLP & McDONOUGH PC 50 South Sixth Street 170 South Main Street, Suite 1500 Minneapolis, MN 55402-1598 Salt Lake City, UT 84101 [email protected] [email protected] Tel: 612-340-5612 Tel: 801-521-3200 Fax: 612-340-8800

National Council of Farmer Cooperatives 2008 Update on Environmental Law

2008 FEDERAL FARM BILL...... 74 RECENT DEVELOPMENTS RELATED TO GENETICALLY MODIFIED ORGANISMS...... 75 BIOTECH ...... 75 BIOTECH REGULATION...... 75 SPILL PREVENTION, CONTROL AND COUNTERMEASURE (SPCC)...... 75 ENERGY SECURITY AND INDEPENDENCE ACT OF 2007 ...... 76 RECENT DEVELOPMENTS RELATED TO ANIMAL FEEDING OPERATIONS ...... 76

PROPOSED RULE EXEMPTING ANIMAL WASTE RELEASES INTO THE AIR FROM CERCLA AND EPCRA REPORTING REQUIREMENTS ...... 77 PROPOSED REGULATION FOR CLEAN WATER ACT NPDES EFFLUENT LIMITATIONS FOR CAFOS...... 78 THE CLEAN WATER ACT: NON-POINT SOURCES, TMDLS AND NUTRIENT TRADING ...... 80

2008 FEDERAL FARM BILL

The Food, Conservation and Energy Act of 2008 (the “Farm Bill”) was passed over President Bush’s veto on June 18, 2008. The Farm Bill is revised and passed every five years. The previous version, passed in 2002, expired in September 2007 before Congress could agree on a revised version. The 2008 Federal Farm Bill provides approximately $289 billion in funding for commodity price support, research, food assistance, rural development, disaster assistance, and nutrition and conservation programs, among other things. Bill Analysis: Food, Conservation and Energy Act of 2008, Congressional Quarterly (June 25, 2008). The 2008 Farm Bill reauthorized all of the 2002 Farm Bill programs until 2012. The 2008 Farm Bill also added new programs and increased the funding of existing programs. The 2008 Farm Bill faced stiff opposition from President Bush, who disapproved of the size of the expenditures. In a May 2008 press release, President Bush expressed his “deep disappointment” in the Farm Bill and vowed to veto it if it reached his desk. Press Release, President George W. Bush, Statement by the President on the Farm Bill (May 13, 2008), available online at http://www.whitehouse.gov/news/releases/2008/05/print/20080513-2.html (accessed July 14, 2008). President Bush fulfilled his promise and vetoed the 2008 Farm Bill twice. Twice his veto was overriden by Congress. (The first version of the Bill mistakenly contained only 14 of the 15 titles.) Title II of the 2008 Farm Bill addresses environmental conservation and increases spending on conservation programs by $7.9 billion. House Committee on Agriculture, “2008 Farm Bill Conservation Title,” available online at agriculture.house.gov/inside/legislation/110 /fb/conf/title_ii_fs.pdf (accessed July 14, 2008). This summary will highlight just a couple of the expansions made. The 2008 Farm Bill doubled the funding for the Farm Protection Program, which now has funding totaling $773 million. Id. The Farm Protection Program provides

matching funds to local governments and non-governmental organizations who purchase land development rights in order to ensure that the land continues to be used for agriculture. Title II also provides $438 million in additional funding to help farmers and ranchers in the Chesapeake Bay region comply with strict regulatory requirements designed to restore the Bay. Id.

RECENT DEVELOPMENTS RELATED TO GENETICALLY MODIFIED ORGANISMS

Biotech

Our subcommittee and NCFC have not traditionally dealt with biotech issues, generally deferring to other organizations to take the lead. There appears to be much interest in this field across many crops, and our subcommittee will increase its monitoring of biotech issues and report developments from time to time. Biotech Regulation

The U.S. government has regulated biotech products since 1986. The U.S. Food and Drug Administration (FDA) approves the safety of all foods and new food ingredients. FDA places a duty on producers to ensure food safety. FDA requires pre-market testing of genetic modifications that alter nutritional value of the host food, use genetic material from outside the traditional food supply or use known allergens. FDA also requires labeling of any food product produced through biotech that significantly alters the host food's nutritional value or uses material from a known allergen. USDA and EPA impose safety requirements and/or performance standards on the development of pesticides, herbicides and genetically enhanced test crops. EPA also coordinates with USDA and FDA, using its own statutes to regulate the growing of plants with pest- protection characteristics. The EPA sets allowable food residue tolerance levels for any novel compounds that might be used. On October 6, 2008, USDA's Animal and Plant Health Inspection Service (APHIS) released a proposed rule to revise its regulations (7 CFR 340) governing agricultural biotechnology. Several trade associations and interested parties have provided input into the proposed regulations. NCFC and our committee will continue to monitor this process.

SPILL PREVENTION, CONTROL AND COUNTERMEASURE (SPCC)

The EPA has issued SPCC regulations amending certain requirements for facilities subject to the SPCC Rule. The amendments do not remove any regulatory requirement for owners or operators of facilities in operation before August 16, 2002, to develop, implement and maintain an SPCC Plan under regulations then in effect. Such facilities continue to be required to maintain their Plans during the interim until the date set forth in the amendments. EPA has also announced a proposed rule to extend the compliance dates for all facilities to November 2009 and to establish new compliance dates for forms (Nov. '09), certain qualified forms (Nov. '10) and marginal oil production facilities (Nov. '13) subject to SPCC. The revised

dates should allow owners and operators the opportunity to understand the regulations promulgated in 2006 and 2008 and any amendments.

ENERGY SECURITY AND INDEPENDENCE ACT OF 2007

The Energy Security and Independence Act of 2007 was signed into law on December 19, 2007 (“Energy Act of 2007”). Among other things, the Energy Act of 2007 set renewable fuel standards through 2022. Renewable fuel is defined as “fuel that is produced from renewable biomass and that is used to replace or reduce the quantity of fossil fuel present in a transportation fuel.” Energy Security and Independence Act of 2007, Pub. L. No. 110-140, § 201(1)(J) (2007). The Energy Act of 2007 dramatically increased the renewable fuel standards, for example by requiring 11.1 billion gallons of renewable fuel in 2009, and tripling that requirement by 2022. Id. at § 202(a)(2). These changes will continue the demand for corn. Corn-based ethanol is the primary biofuel used to meet renewable fuel standards. Ethanol production is estimated to become the second-largest use of corn in 2008. Chad E. Hart, The Outlook for Corn and Ethanol, 14.1 Iowa Ag. Rev. 9, 9 (Winter 2008). Corn prices rose due to corn-based ethanol and corn exports. The extensive flooding in the Midwest this summer drove corn prices to record highs at the end of June, although prices in corn futures have fallen significantly since then. Higher prices are good news for corn farmers, but bad news for pig and other animal farmers who depend on corn as the basis of their feed. The Energy Act of 2007, while contributing to a reduction in air pollution, will continue the demand for corn.

RECENT DEVELOPMENTS RELATED TO ANIMAL FEEDING OPERATIONS

There have been recent developments in both air and water pollution regulation for animal farmers. The EPA has issued a proposed rule that would exempt farmers from the federal reporting requirements for the release of animal waste into the air. The EPA has also issued a proposed rule that would alter water pollution restrictions by allowing Concentrated Animal Feeding Operations (“CAFOs”) to certify that they do not discharge and do not intend to discharge any water pollutants. This certification would insulate the CAFO from liability for failure to apply for a permit in the event of an unintended discharge. The CAFO would still be liable for the unpermitted discharge, however. Both of these proposed rules would be favorable to farmers – at least in part. Both rules would limit liability for failure to provide the EPA with documentation. The proposed air pollution regulation would decrease paperwork requirements and also decrease liability. The proposed water pollution regulation would offer insulation from liability in exchange for increased paperwork for those farmers choosing to take advantage of the provision. Of course, these changes do not take place until the EPA issues final regulations implementing the elements of each proposed rule.

Proposed Rule Exempting Animal Waste Releases into the Air From CERCLA and EPCRA Reporting Requirements The Environmental Protection Agency (“EPA”) has proposed a rule that would exempt animal waste releases from the reporting requirements of the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) and the Emergency Planning and Community Right-to-Know Act (“EPCRA”). CERCLA/EPCRA Administrative Reporting Exemption for Air Releases of Hazardous Substances from Animal Waste, 72 Fed. Reg. 73,700 (proposed Dec. 28, 2007) (to be codified at 40 C.F.R. Parts 302 and 355). CAFOs’ reporting requirements under CERCLA and EPCRA have been in debate for several years. In 1999, the EPA brought an action against a hog operation for failure to comply with CERCLA reporting requirements. Martha Noble, Update on Confined Animal Feeding Operations and Federal Air Emission Regulation, 10.1 Agricultural Management Committee Newsletter 12, 13 (Sept. 2005). This action was eventually dropped due to pressure from Congress, the livestock industry and the Department of Agriculture. Environmental groups followed the EPA’s lead and began bringing citizen suits under CERCLA and EPCRA. See, for example, Sierra Club v. Seaboard Farms, Inc., 387 F.3d 1167 (10th Cir. 2004) (CERCLA suit against a hog operation); Sierra Club v. Tyson Foods, Inc., 299 F. Supp. 2d 693 (W.D. Ky. 2003) (CERCLA and EPCRA suit against chicken operation). In 2005, the EPA entered into a compliance agreement with several AFOs. Press Release, Environmental Protection Agency, EPA Announces Air Quality Compliance Agreement for Animal Feeding Operations (Jan. 21, 2005), available online at http://www.epa.gov/newsroom/newsreleases.htm (accessed July 14, 2008). Participating AFOs paid fines between $200 and $100,000 and funded a two-year air quality monitoring program. In return, participating AFOs were protected from suit for some past violations of CERCLA, EPCRA and the Clean Air Act. Press Release, Environmental Protection Agency, EPA Takes Important Step in Controlling Air Pollution from Farm Country Animal Feeding Operations (Aug. 22, 2006), available online at http://www.epa.gov/newsroom/ newsreleases.htm (accessed July 14, 2008). The EPA reserved the right to “take action in the event of imminent and substantial danger to public health or the environment.” Press Release, EPA Announces Air Compliance Agreement (Jan. 21, 2005). The recent proposed rule would permanently exempt AFOs from the reporting requirements of CERCLA and EPCRA. This rule would have limited applicability, however. The rule would only exempt farms from the reporting requirement for releases of hazardous substances from animal waste into the air. In other words, the hazardous substances must (1) come from animal waste, (2) be emitted into the air, and (3) be at a farm. First, the emissions must come from animal waste. “Animal waste” is defined as feces, urine, digestive emissions, and urea that is produced by livestock. 72 Fed. Reg. 73,703. Emissions from any source other than animal waste would still be subject to the reporting requirements of CERCLA and EPCRA. Second, the exemption for the reporting requirement would only apply to releases into the air – not into the soil or water. Id. at 73,700, 73,704. Third, the emission must come from a farm – “any place whose operation is agricultural and from which $1,000 or more of agricultural products were produced and sold.” Id. at 73,703. The EPA has stated that the exemption is justified because “there is no reasonable expectation that Federal, state or local emergency responders would respond to such reports.”

Environmental Protection Agency, Proposed CERCLA/EPCRA Administrative Reporting Exemption for Air Releases of Hazardous Substances from Animal Waste, available online at http://www.epa.gov/ emergencies/content/epcra/cercla_dec07.htm (accessed July 14, 2008). In fact, as of December 28, 2007, the EPA had never initiated a response to a notification of a release of hazardous materials into the air from animal waste at farms. 72 Fed. Reg. 73,704. The EPA noted that “[e]liminating such reporting requirements will allow emergency response officials to better focus on releases where the Agency is more likely to take a response action.” Id. at 73,700. The EPA estimates that if the proposed rule is adopted, the elimination of the reporting requirement would save farmers over $160 million and 3.4 million hours over ten years. Id. at 73,705. The EPA estimates that the proposed rule would save federal, state and local governments $8.1 million and 161,000 hours over ten years. Id. at 73,705. The notice-and-comment period for responding to the proposed rule ended on March 27, 2008. A final rule providing for this exemption has not yet been issued. Proposed Regulation for Clean Water Act NPDES Effluent Limitations for CAFOs

The EPA has issued a revised proposed rule for regulation of CAFOs under the Clean Water Act (“CWA”) National Pollutant Discharge Elimination System (“NPDES”). The proposed revisions would alter two aspects of the 2006 proposed rule: (1) the revised rule would allow CAFOs to certify that they do not discharge or propose to discharge water pollutants, and (2) the revised rule describes which elements of a Nutrient Management Plan (“NMP”) must be included in a permit application and proposes three methodologies for quantifying those elements. The 2008 proposed revised rule is the most recent step in a prolonged process to update regulations governing water emissions by CAFOs. The EPA first began regulating animal feeding operations in the 1970s. The EPA issued two regulations in the mid-1970s that defined CAFOs and created effluent limitations. See Waterkeeper Alliance, Inc. v. EPA, 399 F.3d 486, 494 (2d Cir. 2005) (describing 41 Fed. Reg. 11,458 (Mar. 18, 1976) and 39 Fed. Reg. 5604 (Feb. 14, 1974)). The EPA did not take steps to update or revise these regulations for more than a decade. Various environmental groups sued the EPA in 1989 to force the revision of the CAFO effluent limitation regulations. See Waterkeeper, 399 F.3d at 494 (describing the 1989 litigation). The EPA entered into a consent decree – agreeing to update the regulations – but did not issue proposed regulations until 2001. See id. The EPA issued a final rule in 2003, which substantially changed regulation of water emissions by CAFOs. See CAFO Final Rule, 68 Fed. Reg. 7,176 (Feb. 12, 2003) (codified at 40 C.F.R. §§ 9, 122, 123, 412). A few of the major changes are described here. The 2003 rule required all large CAFOs to apply for a NPDES permit, unless the administrator determined that the large CAFO has “‘no potential to emit’ manure, litter or process wastewater.” 40 C.F.R. § 122.23(d)(2). The 2003 rule also required CAFOs to develop NMPs. 40 C.F.R. § 122.42(e)(1)(i)-(ix). The 2003 rule was quickly challenged in court and portions of the rule were struck down. In Waterkeeper, Inc. v. EPA, the Court of Appeals for the Second Circuit struck down some portions of the rule, upheld other portions of the rule, and directed the EPA to clarify still other portions of the rule. 399 F.3d 486 (2d Cir. 2005). First, the Second Circuit ruled that the EPA

did not have statutory authority to require all CAFOs to apply for permits. The court found that the 2003 violated the Clean Water Act, because it imposed obligations on CAFOs even if they have not discharged any pollutants into navigable waters. Waterkeeper, 399 F.3d at 505. This ruling lifted a substantial burden off of animal farmers who do not emit water pollutants. Second, the court held that the NMPs must be more fully integrated into the permit process. More specifically, the NMPs must be reviewed and approved by the permitting authority, must be included in the permits, and must be subject to public comment. Id. at 524. The court upheld the 2003 rule’s regulatory exemption for discharges from “agricultural stormwaters” and the agency’s decision to regulate land application discharges. Id. at 509, 511. Finally, the court directed the EPA to clarify the portions of the rule addressing new source performance standards and control technology requirements. Id. at 524. The EPA issued a proposed rule in 2006 in response to Waterkeeper. Among other things, the 2006 rule made two changes: (1) it modified the entities required to apply for a permit, and (2) it modified the process for creation and approval of NMPs. First, the rule eliminated the general “duty to apply” for permits. Instead, the EPA proposed that only CAFOs that “discharge or propose to discharge” water pollutants be required to obtain a permit. Revised National Pollutant Discharge Elimination System Permit Regulation and Effluent Limitation Guidelines for Concentrated Animal Feeding Operations in Response to Waterkeeper Decision, 71 Fed. Reg. 37,748 (proposed June 30, 2006) (to be codified at 40 C.F.R. Parts 122 and 412). The EPA would also abolish the exemption for CAFOs with no potential to discharge. The EPA noted that this exemption “would be irrelevant because the proposed rule requires only those CAFOs that discharge or propose to discharge to seek coverage under a permit.” Id. at 37,749. Second, the EPA proposed modifications to the procedures for reviewing and approving NMPs. Prior to Waterkeeper, NMPs that were part of an individual permit were reviewed by the administrator, but those that were part of a general permit were not always reviewed. Id. at 37,751. The EPA proposed changes to the application process so that each NMP is reviewed by the administrator. The proposed 2006 rule also contained provisions for public participation and incorporation of the NMP into the final permit. Id. at 37,752-54.

The EPA issued a revised proposed rule on March 7, 2008. This 2008 proposed rule would make two changes to the 2006 proposed rule: (1) it would allow CAFOs to affirmatively certify that they do not discharge or propose to discharge water pollutants, and (2) it would establish guidelines and standards for elements that would be incorporated in NMPs. First, the 2008 proposed rule would establish a process by which a CAFO could certify that it does not discharge or propose to discharge water pollutants. Revised National Pollutant Discharge Elimination System Permit Regulations for Concentrated Animal Feeding Operations; Supplemental Notice of Proposed Rulemaking, 73 Fed. Reg. 12,324 (proposed Mar. 7, 2008) (to be codified at 40 C.F.R. Part 122). This certification would not be reviewed by the administrator and would not be open to public comment. The EPA explained its rationale for this provision:

[The certification] would provide a structured process for CAFOs that wish to certify to establish that they do not discharge or propose to discharge. EPA believes that such a structured process would be helpful to CAFOs as they determine whether or not to seek permit coverage. Furthermore, a CAFO with a valid no discharge certification would not be subject to liability for violation of the duty to apply . . . in the unlikely event that a

discharge should occur, though it would still be liable for violation of the prohibition on unpermitted discharges.

Id. at 12,324. CAFOs seeking to procure a valid certification would be required to conduct an evaluation of their facilities, develop an NMP and maintain appropriate documentation. Id. at 12,325, 12,326.

The 2008 proposed rule would also clarify which elements of the NMP would be incorporated into the permit and thus be enforceable. Id. at 12,329. The EPA proposed three different approaches. The “linear approach” would “express rates of application [of animal waste to agricultural fields] as tons of manure or litter, and gallons of manure or wastewater.” Id. at 12,331. The “matrix approach” would describe rates of application as the “amount of plant available nitrogen and phosphorus, in pounds, from manure, litter, and process wastewater.” Id. at 12,332. The “narrative rate approach” would derive the permissible rates of application by calculating “the maximum amounts of total nitrogen and phosphorus from all sources of nutrients” and then use a “specific, quantitative method for calculating the amount, in tons or gallons, of manure, litter, and process wastewater to be land applied.” Id. at 12,333 (emphasis in original). The EPA sought comments on all three of these approaches. The comment period closed on April 7, 2008. Id. at 12,322.

There was a favorable ruling on July 30th of this year by the Second Circuit Court of Appeals holding that a New York dairy could not be the subject of lawsuits brought under the Resource Conservation and Recovery Act (RCRA) because CAFOs were already regulated under the Clean Water Act (CWA). This case marked the first time that a court has ruled on the jurisdiction of RCRA as it relates to activities that are already covered under other regulatory acts such as the CWA.

THE CLEAN WATER ACT: NON-POINT SOURCES, TMDLs AND NUTRIENT TRADING

Oxygen depletion caused (in part) by agricultural runoff continues to be a challenge, especially in the Mississippi Basin and the Chesapeake Bay area. Nutrient-rich agricultural runoff fosters the development of giant “algae blooms.” The algae then depletes the oxygen content in portions of water sources to create “dead zones.” This problem has led to increased discussion of nutrient trading programs and the imposition of Total Maximum Daily Load (“TMDL”) limits. Efforts underway in the Mississippi Basin and the Chesapeake region may affect area farmers. The Chesapeake Bay region has long been the target of rehabilitation efforts. Virginia must implement a TMDL program by 2011. See American Canoe Ass’n v. EPA, 54 F. Supp. 2d 621 (E.D. Va. 1999). However, the 2008 Farm Bill specifically allocates resources to help farmers comply with stringent water pollution regulations in the Chesapeake region. There are also recent developments for the Mississippi River Basin. On June 16, 2008, the Mississippi River/Gulf of Mexico Watershed Nutrient Task Force unveiled its 2008 Action Plan. This Action Plan seeks to implement comprehensive nitrogen and phosphorus reduction strategies on a state-by-state level. Mississippi River/Gulf of Mexico Watershed Nutrient Task

Force, Gulf Hypoxia Action Plan 2008 (June 16, 2008), available online at http://www.epa.gov/ msbasin/taskforce/actionplan08.htm (accessed July 14, 2008). The Plan provides several examples of state programs, including an Arkansas program that funds on-farm structures designed to curb sediment and nutrient runoff, and the massive coastal restoration program in Louisiana. Id. at 33, 38. The Plan highlights an Ohio nutrient trading program encompassing the Greater Miami River, where point sources can purchase credits from nonpoint sources (primarily farmers) that utilize best management practices. Point sources hope that the trading program will “improve water quality enough to lessen the stringency of or eliminate the need for a TMDL.” Id. at 11. The Plan also highlights a Minnesota phosphorus trading program, which has succeeded in reducing phosphorus emissions to their pre-1900 levels. Id. at 31. Nutrient trading programs are increasingly viewed as a mechanism for reducing nutrient emissions into water sources without implementing strict TMDL requirements.

NCFC LTA COMMITTEE

DIGEST OF CURRENT COOPERATIVE TAX DEVELOPMENTS

12/1/2007 – 11/30/2008

George W. Benson McDermott Will & Emery LLP Chicago, Illinois

This digest outlines the significant cooperative tax developments since December 1, 2007. The focus of this annual digest is primarily upon federal income taxes and upon issues of taxations that are peculiar to Subchapter T cooperatives. In addition, from time to time state tax developments involving cooperatives are described. Index and Capsule Summary

1. Rev. Proc. 2008-9, 2008-2 IRB 258. Annual update on procedures for requesting a determination of Section 521 status.

2. Rev. Rul. 2008-26, 2008-21 IRB 985. IRS still reconsidering the treatment of manufacturer rebates.

3. Ltrs. 200803021 (October 23, 2007), 200806014 (November 13, 2007), 200806017 (November 13, 2007) and 200806018 (November 14, 2007). Discount redemption programs of Section 501(c)(12) rural electric and telephone cooperatives.

4. ILM 200806011 (October 22, 2007). Marketing cooperatives that pool are not treated better than marketing cooperatives that do not pool for Section 199 purposes; suggests that crop payments by nonpooling cooperatives are per-unit retain allocations paid in money which can be added back for Section 199 purposes.

5. ILM 200814025 (December 14, 2007); Letter from Bob Dineen (Renewable Fuels Association) to Dennis Tingey (Treasury) and Kathleen Reed (IRS), dated November 21, 2007, found at 2007 TNT 240-25; ILM 200835032 (August 27, 2008); 2008-2009 Priority Guidance Plan issued by the Office of Tax Policy and the Internal Revenue Service (September 10, 2008), found at 2008 TNT 177-25. After initially concluding that assets in an integrated facility for converting corn into ethanol using a dry milling process should be treated as seven-year property (not as five-year property as the Industry argued) for MACRS depreciation purpose, the IRS withdrew the determination, decided to further study the issue and to include the goal of releasing published guidance with respect to the issue in its 2008-2009 Priority Guidance Plan.

6. Ltr. 200817018 (January 24, 2008). IRS approves program to facilitate charitable contributions by members to a cooperative’s foundation.

7. Ltr. 200818028 (February 8, 2008). Organization formed to operate a farmers’ market held not to qualify as a tax-exempt Section 501(c)(3) organization.

8. ILM 200826004 (February 26, 2008). Applies step transaction doctrine to transactions involving a controlled cooperative to limit the amount of income earned by the controlled cooperative in an effort to thwart efforts to defer taxation of that income.

9. ILM 200829028 (April 4, 2008). Dismisses arguments made by a controlled cooperative included as part of a consolidated return that the inter-company transaction rules contained in Treas. Reg. §1.1502-13 should not apply.

10. Coordinated Issue Paper Agriculture Industry: Section 118 – Characterization of Bioenergy Program Payments (April 8, 2008), found at 2008 TNT 69-58. Bioenergy program payments received by ethanol and biodiesel producers must be included in income.

11. Ltr. 200833031 (May 23, 2008). Community market to serve farmers and artisans is found not to be exempt under Section 501(c)(6) and not to qualify as a Section 521 cooperative.

12. Ltr. 200834022 (March 5, 2008). Cooperative formed to serve timber harvesters does not qualify as a Section 521 cooperative and is not exempt under Section 501(c)(5) as an agricultural organization.

13. Ltr. 200836005 (May 29, 2008). Energy cooperative is an instrumentality of the state and is therefore able to issue tax-exempt bonds.

14. Ltr. 200838008 (June 9, 2008). Gain realized by a rural electric cooperative upon withdrawal of a favorable pooling arrangement is patronage-sourced income.

15. Ltrs. 200838011 (June 18, 2008), 200843015 (July 21, 2008), 200843016 (July 21, 2008), and 200843023 (July 24, 2008). Dairy cooperatives receive confirmation that milk checks qualify as per-unit retain allocations paid in money and can therefore be added back for Section 199 purposes.

16. Ltr. 200841038 (July 15, 2008). Organization of brine shrimp harvesters does not qualify as a Section 521 cooperative.

17. Ltr. 200842011 (July 11, 2008). Gain from the sale of a warehouse building held to be patronage-sourced.

18. 2007 Form 1120-C. Contains changes to address concerns raised by NCFC in connection with the development of the 2006 Form 1120-C.

19. “Description of the Revenue Provisions Contained in the President’s Fiscal Year 2009 Budget Proposal” prepared by the Joint Committee on Taxation (March 2008). Suggests that electronic filing of the new form 1120-C will ultimately be required.

20. “Fairness and Taxation: The Law of Deferred Income Recognition for the Members of Agricultural Cooperatives,” by Kathryn J. Sedo and Mychal S. Brenden, Akron Tax Journal, 23 Akron Tax J. 81 (2008). Discusses concerns with deferred crop contracts and cooperatives. Written by attorneys who handled the Scherbart case.

21. Treas. Reg. §1.179B-1T, T.D. 9404 (June 26, 2008) and Treas. Reg. §179C-1T, T.D. 9412 (July 3, 2008). Temporary and proposed regulations affecting cooperative refiners.

22. Section 45O. New agricultural chemical security credit added by the Heartland, Habitat, Harvest and Horticultural Act of 2008.

23. IRS Exempt Organizations Division Annual Report and Workplan for Fiscal, 2009 (November, 2008). The workplan states that the Division plans to examine Section 501(c)(12) organizations that may have failed the 85% member test to see whether they filed the proper tax return.

24. Section 168(k)(4). Bonus depreciation developments of interest to cooperatives.

Detailed Analysis

1. Rev. Proc. 2008-9, 2008-2 IRB 258.

A farmer cooperative associations seeking Section 521 status is required to obtain a determination letter from the Internal Revenue Service confirming that it is entitled to that status. Treas. Reg. §1.521-1(e) provides: “(e) An organization is not exempt from taxation under this section merely because it claims that it complies with the requirements prescribed therein. In order to establish its exemption every organization claiming exemption under section 521 is required to file a Form 1028.”

The Internal Revenue Service periodically issues guidance outlining the procedures for obtaining determination letters and rulings confirming the exempt status of organizations under Sections 501(c)(3) and 521 of the Code. The most recent version of that guidance is Rev. Proc. 2008-9, 2008-2 I.R.B. 258. Rev. Proc. 2008-9 continues in place the long-standing process for requesting a Section 521 determination letter. That process begins by completing a Form 1028 (Application for Recognition of Exemption Under Section 521 of the Internal Revenue Code). The Form 1028 is a four-page form requiring detailed information about the cooperative. The purpose of the form is to elicit information necessary to confirm to the IRS that the organization meets the requirements of Section 521. Among other things, the form asks for a description of the activities in which the organization is or will be engaged and a description of the requirements for membership in the organization. The form asks for information to confirm that the organization meets the

limitations contained in Sections 521(b)(4) and (5) upon the amount of business done with nonmembers and nonproducers. If the association is formed with capital stock, the form seeks information regarding the rights of the shares (including dividend rights), who owns the shares (including the percentage owned by current and active producers), what provision is made to retire voting shares held by nonproducers, what voting rights each person has, and whether holders of nonvoting preferred shares are entitled to participate in the profits of the organization beyond fixed dividends. The form asks what provisions are contained in applicable state law for the accumulation and maintenance of reserves and whether the association maintains or plans to maintain any other reserves. The form asks whether there is a pre-existing legal obligation to pay patronage dividends and, if so, where it is contained and how net earnings will be shared. The form asks whether the organization plans to do business with nonmembers and if patronage dividends will be paid to members and nonmembers on the same basis. The form asks whether all net earnings (after payment of dividends) are distributed as patronage dividends. If not, the form asks whether undistributed net earnings are apportioned on the records to all patrons on a patronage basis. Finally, the form asks for detailed financial data for the cooperative. The completed Form 1028 is submitted for processing in the Exempt Organization (EO) Determinations office in Cincinnati, Ohio. The form must be accompanied by the correct user fee and by Form 8718 (User Fee for Exempt Organization Determination Letter Request) which is used to help compute the correct user fee. The Cincinnati office now has the responsibility for processing applications nationwide, but Rev. Proc. 2008-9 provides that some applications may be processed in other EO Determinations offices. The EO Determinations office has authority to issue determinations letters, but some are referred to the IRS National Office for technical assistance and/or actual processing. For Section 521 determination letters, technical assistance is provided by the Association Chief Counsel (Passthroughs and Special Industries), the group that handles matters related to Subchapter T. Rev. Proc. 2008-9 provides that a favorable determination letter will be issued only if an association’s “application and supporting documents establish that it meets the particular requirements of the section under which exemption from Federal income tax is claimed.” The IRS does not do an independent investigation or audit of the facts as part of the determination process. However, it may ask for additional facts and information to answer questions it has or to perfect the application. It is the responsibility of the association to accurately describe the facts. Rev. Proc. 2008-9 warns that the “failure to disclose a material fact or misrepresentation of a material fact on the application may adversely affect the reliance that would otherwise be obtained through issuance by the Service of a favorable determination letter or ruling. The normal result of the process is a favorable determination letter. However, sometimes the IRS concludes that issuance of a favorable letter is not warranted. In that situation (if the request is not withdrawn), the IRS generally issues a proposed adverse determination or ruling describing the rationale for its conclusion and advising the taxpayer of its appeal rights. An organization may exercise its appeal rights by preparing the equivalent of a protest and asking for an Appeals Office conference (if it so desires), which are due within thirty-days of the receipt of the proposed adverse determination. If the taxpayer does not withdraw the request or exercise Appeal rights, an adverse determination letter will be issued

If the matter is appealed, Appeals may agree with the organization, and a favorable determination letter will then be issued. If Appeals does not agree with the organization, the organization is entitled to a conference (if one has been requested). There also are procedures for involving the IRS National Office under certain circumstances. If Appeals still agrees with the proposed adverse determination, a final adverse determination will be sent to the association by certified or registered mail (which denial with identifying details redacted will eventually be made public in the same manner as private letter rulings are made public). If the association still disagrees with the adverse determination, it can bring a declaratory judgment proceeding under Section 7428 of the Code in the Tax Court, the Court of Federal Claims or the U.S. District Court for the District of Columbia. This right to seek declaratory judgment relief has been in the Code for some time for Section 501(c)(3) organizations, but was extended to Section 521 associations only recently by the American Jobs Creation Act of 2004. Rev. Proc. 2008-9 has not been revised to reflect this law change. In no event may a declaratory judgment action be brought earlier than 270 days of filing the determination request. Generally, in order to be able to bring a suit for declaratory judgment relief, an association must have filed a substantially completed Form 1028, have timely complied with any requests from the IRS for additional information, and generally have exhausted its administrative remedies (including its right to go to Appeals). However, if the IRS has not acted on a request within 270 days of filing, then notwithstanding the requirement that an association shall exhaust its administrative remedies, the association may bring suit provided that it “has taken, in a timely manner, all reasonable steps to secure a determination letter or ruling.” Generally a favorable determination letter may be relied upon by an organization and is effective as of the date of the formation of an organization if its purposes and activities prior to the date of the determination letter were consistent with the requirements of the exemption. However, Rev. Proc. 2008-9 further provides: “A determination letter or ruling recognizing exemption may not be relied upon if there is a material change, inconsistent with exemption in the character, the purpose, or the method of operation of the organization. Also, a determination letter or ruling may not be relied upon if it was based on any inaccurate material factual representations.”

The IRS occasionally audits Section 521 cooperatives and checks to see if they are operating in conformity with the requirements of Section 521. If an organization is not, then its Section 521 status can be revoked. Rev. Proc. 2008-9 warns that if “there is a material change, inconsistent with exemption, in the character, the purpose, or the method of operation of an organization, revocation or modification ordinarily take effect as of the date of such material change.”

2. Rev. Rul. 2008-26, 2008-21 IRB 985.

Several years ago, the Digest reported on Rev. Rul. 2005-28, 2005-1 C.B. 997, which concluded that Medicaid Rebates incurred by pharmaceutical manufacturers should be treated as purchase price adjustments that are subtracted from gross receipts in determining gross income and not as ordinary and necessary business expenses deductible under Section 162.

The facts in that ruling are complicated. In a nutshell, the manufacturer sold a prescription drug to a wholesaler, who in turn sold it to a retail pharmacy, who in turn sold it to a Medicaid beneficiary. The retail pharmacy then filed a reimbursement claim with a state Medicaid agency, who approved the claim and reimbursed the pharmacy for the cost of the drug plus a dispensing fee. The manufacturer then paid a rebate to the state Medicaid agency based upon a Rebate Agreement, which it had entered into with Health and Human Services (acting on behalf of all state Medicaid agencies) to gain access to the Medicaid-funded segment of the pharmaceutical market. The ruling concluded that the rebate paid by the manufacturer to the state Medicaid agency was a price adjustment to be subtracted from gross receipts in determining gross income, not an ordinary and necessary business expense deductible under Section 162. The ruling also suspended Rev. Rul. 76-96, 1976-1 C.B. 23, to the extent it allowed a manufacturer an ordinary and necessary business expense for a rebate paid to consumers, while it gave further consideration to the issue. This area has long been a troublesome area for taxpayers and the IRS, as evidenced by the IRS treatment over the years of one of the leading cases in this area. See, Pittsburgh Milk Co, 26 T.C. 707 (1956), nonacq 1959-2 C.B. 8-9, nonacq. withdrawn and acq. 1962-2 C.B. 5-6, acq withdrawn and nonacq. 1976-2 C.B. 3-4, and nonacq. withdrawn in part and acq. in part 1982-2 C.B. 2. Recently the IRS issued Rev. Rul. 2008-26, 2008-21 IRB 985, to clarify and supersede Rev. Rul. 2005-28. It is not clear why the IRS issued Rev. Rul. 2008-26. There are very few differences in the two rulings except that Rev. Rul. 2008-26 makes it clear that the “holding is limited to Medicaid Rebates that a pharmaceutical manufacture pays pursuant to the Medicaid Rebate Program …” Perhaps the IRS was concerned that taxpayers were reading too much into its conclusions in that ruling and applying it in areas where the IRS did not think it should be applied. Rev. Rul. 2008-26 continues to caution that it is reconsidering the conclusion in Rev. Rul. 76-96. Thus, this is an area that is still unsettled. A spokesperson for the IRS was reported as acknowledging that Rev. Rul. 2008-26 does not address timing issues (i.e., when the manufacturer can subtract the rebate in determining gross income) and indicating that “the Service … hopes to address it in the next business plan year.” 2008 TNT 92-5 (May 12, 2008).

3. Ltrs. 200803021 (October 23, 2007), 200806014 (November 13, 2007), 200806017 (November 13, 2007) and 200806018 (November 14, 2007).

Rural electric and/or telephone cooperatives continue to ask for rulings related to capital plans involving early retirements of patronage equities at a discount, and the IRS continues to issue those rulings. During the past year, the IRS issued Ltrs. 200803021 (October 23, 2007), 200806014 (November 13, 2007), 200806017 (November 13, 2007) and 200806018 (November 14, 2007). All of these rulings dealt with rural electric or telephone cooperatives exempt from federal income tax under Section 501(c)(12). These organizations typically allocate all of their patronage earnings each year to their patrons in the form of credits to a capital account or some other form of patronage equity. Each of the cooperatives involved in the rulings revolved its

patronage equities over a 20-year period. Each proposed to start redeeming patronage equities on an accelerated basis, but at a discount. The cooperative involved in the first ruling proposes to establish a mandatory program. It plans to use a discount rate equal to the prime rate plus 1%. The ruling states: “Under this policy, you may pay the discounted amount to current and former patrons and record the discount as part of your net savings. Thus, your patrons retain a continuing property right in the net savings for the difference between the stated value of the patronage allocation and the discounted value that has been paid. You represent that you are not causing your current and former patrons to forego any of their previously allocated capital credits.”

The ruling indicates that any unclaimed proceeds from the retirement of patronage equities will revert to the cooperative as a contribution to capital. Apparently the cooperative enjoys an exception from the state’s unclaimed property law. The cooperative indicates that it does not plan to reallocate the amounts to any current or former patrons.

Each cooperative involved in the last three rulings plans to establish a voluntary program. Each plans to use a discount rate equal to the 20-year Treasury Bond rate plus an unspecified risk premium. The rulings all state: “Amounts retained by you [i.e., the amount of the discount] will be reclassified from allocated equity to permanent equity.”

Each of the rulings concludes that the proposed discount redemption program does not present issues with the cooperative’s status as exempt under Section 501(c)(12). The last three rulings also conclude that the redemption will not constitute a forfeiture of patronage capital of the sort found inconsistent with tax exempt status in Rev. Rul. 72-36, 1972-1 C.B. 151, and that the “proposed methodology for determining the discount rate is consistent with the precepts of cooperative tax law.” The first ruling also concludes that the cooperative’s “bylaws related to the contribution of unclaimed credits to the net savings of the cooperative will not adversely affect your cooperative status.”

4. ILM 200806011 (October 22, 2007).

Over the past few years, the inventory accounting practices of two marketing cooperatives that pool were challenged on audit by the IRS. The cooperatives had followed the consistent practice of not taking into account any payments to growers (including harvest advances, other cash advances, per-unit retain allocations paid in certificates and patronage dividends) in determining their year-end inventory at lower of cost or market. The Cooperative Industry Technical Advisor took the position that harvest advances and cash advances were product cost and should be taken into account in valuing inventory at year end. The IRS National Office did not support the Cooperative Industry Technical Advisor, concluding that harvest and other cash advances were per-unit retain allocations paid in money and therefore currently deductible under Subchapter T. Ultimately, the issue was conceded by the Government in both cases.

Apparently not satisfied with that result, the Cooperative Industry Technical Advisor asked the IRS National Office whether this treatment of pooling cooperatives resulted in more favorable treatment of marketing cooperatives that pool under Section 199 than is accorded to marketing cooperatives that do not pool. This ILM represents the answer by the IRS National Office to that inquiry. The ILM begins by confirming the IRS National Office’s prior conclusions that harvest and other advances should not be treated as product cost for inventory accounting purposes: “After reviewing your e-mail, we continue to agree with the Industry Counsel memorandum’s conclusion that per-unit retains paid in money (PURPIMs) are deductible by a marketing cooperative using pooling whether or not the product marketed for the farmers has been sold during the taxable year. While the Industry Counsel’s memorandum discusses many aspects of this issue with which we agree, our primary reason for our conclusion is the clear language of the statute.”

The ILM then states three reasons why it concludes that pooling cooperatives are not treated more favorably than nonpooling cooperatives. First, and most interesting from a cooperative tax perspective, the IRS National Office suggests that the grower payments made by nonpooling cooperatives should be treated as per- unit retain allocations paid in money, notwithstanding the fact that they do not pool. Thus, the IRS National Office suggests that they should not be taken into account for inventory purposes and should be added back for Section 199 purposes. Second, the IRS National Office suggests that, in any event, the nonpooling cooperative could reach the same result as the pooling cooperative by not making harvest and other advances but rather distributing all earnings as patronage dividends, which can be added back for Section 199 purposes. The fact that members would never permit a cooperative to operate in this manner is not noted by the IRS National Office. Finally, the IRS National Office observes that, if the nonpooling cooperative could not treat harvest and other advances as per-unit retain allocations paid in money, the growers would be entitled to treat those payments as domestic production gross receipts and they could claim the benefit of the Section 199 deduction with respect to those amounts on their own tax returns. The IRS National Office does not note that the growers’ expenses would be taken into account and that growers would need to have W-2 wages in order to claim a Section 199 deduction. While noting this logical possibility, the IRS National Office indicates that this approach is not consistent with the regulations: “The express purpose of §1.199-6(c) and (l) of the Income Tax Regulations is to have the entire §199 calculation done at the cooperative level and not splitting it between patrons and the cooperative…. [T]he correct answer that the ‘purchases’ are in fact PURPIMs in the examples involving non-pooling and pooling cooperatives fulfills that regulatory purpose as well.”

As discussed later in this Digest, encouraged by this ILM, several marketing cooperatives have requested and received confirmation from the IRS National Office that cash payments to their members for their products are per-unit retain allocations paid in money, notwithstanding

the fact that the cooperatives had never treated them as such and had taken them into account as product cost in determining the value of their year-end inventory.

In ILM 200814025 (December 14, 2007), the IRS analyzes what is the appropriate asset class for depreciation purposes for assets used by a taxpayer in an integrated facility for converting corn to ethanol using a dry milling process. There is some confusion as to the proper citation for ILM 200814025. Tax Analysts uses the ILM citation, RIA cites it as a “CCA” (chief counsel advice) and reportedly CCH cites it as a private letter ruling (which it clearly is not). The first sentence of the document refers to it as a chief counsel advice. In this article, we follow the Tax Analysts citation. However it is cited, ILM 200814025 was prepared by the Office of Chief Counsel in the IRS National Office (and, in particular by Branch 7 of the Income Tax & Accounting Group, the branch that normally handles matters of this sort). It is directed to the Large and Mid-Sized Business (LMSB) examination group and appears to be in response to a request for assistance arising from an examination of a specific ethanol producer. The ILM begins with a description of the assets and the process used to produce ethanol at the producer’s facility. The asset classes to be used for depreciation purposes are set forth in Rev. Proc. 87-56, 1987-2 C.B. 674. At issue is whether ethanol plants fall in Asset Class 28.0, Manufacture of Chemicals and Allied Products, or in Asset Class 49.5, Waste Reduction and Resource Recovery Plants. Asset Class 28.0 has a shorter class life (9.5 years instead of 10 years) and a shorter alternative depreciation system recovery period (9.5 years instead of 10 years) than Asset Class 28.0. By virtue of having a shorter class life, assets in Asset Class 28.0 are five-year property for MACRS purposes while assets in Asset Class 49.5 are seven-year property. The specific asset classes are not mandated by Congress, but rather are determined by the IRS. Each asset class listed in Rev. Proc. 87-56 has a detailed, but necessarily general, description of the assets it is intended to cover. Over the years, there have been many disputes between taxpayers and the IRS as to what asset class is the appropriate asset class for particular assets or facilities. Asset Class 28.0 includes “assets used to manufacture basic organic and inorganic chemicals…” Asset Class 49.5 includes among other things “assets used in the conversion of … biomass to a … liquid … fuel …” The ILM concedes that ethanol “whether from petroleum- based source or a grain-based source is an organic chemical (carbon containing)” arguably fitting into Asset Class 28.0. However, after reviewing the meaning of “biomass,” a term not defined in Rev. Proc. 87-56, and looking to the Energy Tax Act and the Windfall Profit Tax Act for guidance, the memorandum concludes “that biomass, for purposes of Asset Class 49.5 …

includes corn” and thus the facility “fits the more specific language for the description of Asset Class 49.5.” At the end of the day, the issue appears to be what to do with assets that appear to be described in two separate asset classes. The IRS’s argument appears to be that the more specific language of Asset Class 49.5 trumps the more general language of Asset Class 28.0. As noted earlier, this ILM is drafted as advice from the IRS National Office to LMSB with respect to an ongoing examination of a specific ethanol producer. However, it has been reported that there are ongoing audits of other producers that took the same position. The ILM does not do a good job of reporting the taxpayer’s side of the argument, leaving readers to guess what it was. Readers who are interested in learning more about the industry’s arguments for the use of Asset Class 28.0 are referred to a whitepaper prepared by the Renewable Fuels Association. See letter from Bob Dineen (Renewable Fuels Association) to Dennis Tingey (Treasury) and Kathleen Reed (IRS) dated November 21, 2007, 2007 TNT 240-25. The ILM was not issued in a form of a formal legal pronouncement like a published ruling or revenue procedure, but rather as a written determination that, pursuant to Section 6110(k)(3), may not be used or cited as precedent. Nevertheless, at the time it was issued it represented the position that an ethanol producer could expect the IRS to assert on audit if the ethanol producer was using Asset Class 28.0, and it was reported that this ILM was in fact being relied upon by agents in at least one other audit. In response to continued dialogue with the ethanol industry, the IRS later issued CCA 200835032 (August 27, 2008). In that chief counsel advice, the IRS concluded that the issue is “better addressed through the published guidance process” and that the earlier chief counsel advice “is not to be followed for determining appropriate tax depreciation deductions.” Several weeks later, the 2008-2009 Priority Guidance Plan issued by the Office of Tax Policy and the Internal Revenue Service (September 10, 2008) listed “[g]uidance under §168 addressing the recovery period of ethanol production equipment” as one of the items on the agenda for the upcoming year. See 2008 TNT 177-25. The meaning of these developments for the ethanol industry remains to be determined. Stay tuned for further developments.

6. Ltr. 200817018 (January 24, 2008).

Many cooperatives and their members make contributions to charities. Usually, each does so independently. Cooperatives that distribute all or most of their earnings as patronage dividends or per-unit retain allocations often can not deduct all of the charitable contributions they make since Section 170(b)(2) limits charitable contributions of corporations to 10% of taxable income. Ltr. 200817008 (January 24, 2008) focuses on a proposed program to facilitate contributions by members to a cooperative’s charitable foundation. The program is designed to make it possible for members to direct that proceeds from the redemption of nonqualified written notices of allocation be paid to the cooperative’s charitable foundation. The program also permits members to elect to do the same thing with rebates earned under an affinity credit card

program. The ruling is addressed to a member and concludes that the member will be entitled to a charitable contribution deduction under Section 170 of the Code. The ruling indicates that the cooperative is in the business of selling consumer products used for personal, living or family purposes to its members and other customers. The cooperative distributes its earnings from member patronage business to members as patronage dividends paid entirely in the form of nonqualified written notices of allocation. The cooperative also sponsors an affinity credit card program. Members who participate in the credit card program earn rebates equal to a percentage of their credit card purchases. Historically members have been permitted to use their nonqualified written notices of allocation and their credit card rebates to purchase merchandise as soon as they receive notice of their allocations each year. In addition, members have the option of asking for redemption of their nonqualified written notices of allocation and payment of their credit card rebates in cash or check. That option is available during a window period beginning in the year they first receive the nonqualified notices and notice of the credit card rebates and ending at the close of the subsequent year. The cooperative proposes giving members a third option. During the window period, a member will now also be given the opportunity to direct the cooperative to redeem his or her nonqualified written notices of allocation and credit card rebates and to pay the proceeds to the cooperative’s charitable foundation on the member’s behalf. In the ruling, the IRS concluded that the amount paid to the charity at the member’s direction will be deductible by the member to the extent provided in Section 170. The IRS also observed that, since the cooperative will not be acting as the agent of the charity in receiving the payment, the charitable contribution will be treated as made when the cooperative transfers the payment to the charity, not when the member asks the cooperative to redeem his or her nonqualified written notices of allocation and credit card rebates. The cooperative plans to provide the foundation with information with respect to each contribution (e.g., the name and address of the contributor, the amount and the date) so that the foundation can provide members with any written acknowledgements required under Sections 170(f)(8) and (17). In reaching the conclusion that the member will be entitled to a charitable deduction, the IRS emphasized that it is important that the member be given the choice between retaining the proceeds from the redemption of his or her nonqualified written notices of allocation or credit card rebates or contributing the proceeds to the foundation. If there is no choice, then one of the critical prerequisites to a charitable deduction – namely, that the charitable contribution have been made voluntarily and with donative intent – will not be present. The cooperative’s proposed program clearly gives members a choice. The ruling is addressed to a member and thus does not discuss the tax treatment to the cooperative of the arrangement.

7. Ltr. 200818028 (February 8, 2008).

In Ltr. 200818028 (February 8, 2008), the IRS concluded that a non-profit corporation formed “to promote direct marketing of farm products and handcrafted goods … to operate a farmer’s market” did not qualify as a tax exempt Section 501(c)(3) organization.

The IRS concluded that the organization was not exempt because it primarily served private interests, not public interests. Section 501(c)(3) provides for the exemption of organizations “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes.” Treas. Reg. §1.501(c)(3)-1(d)(1)(ii) describes what this entails: “(ii) An organization is not organized or operated exclusively for one or more of the purposes specified in subdivision (i) of this subparagraph unless it serves a public rather than a private interest. Thus, to meet the requirement of this subdivision, it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.”

According to Ltr. 200818028, the organization was formed as a non-profit corporation. Membership was available for “anyone who sells locally grown farm products and similar goods, such as flowers and artisan crafts.” No membership fee was charged. Members were charged rent for booths at the market. Rent accounted for over 90% of the organization’s revenue. About 70% of the organization’s expenses were for advertising to promote the market. The other expenses related to the actual operation of the market. Only members could rent booths at the market. All directors were members and vendors at the market. According to the IRS, these facts showed that the organization was principally serving a private, not a public interest. The IRS stated: “When a group of individuals associate to provide a service for themselves, they are serving a private interest. … Your primary activities are providing a location for members to sell goods and promotion of their sales activity. Ninety percent of your funding comes from those same individuals. In addition, all of your directors are vendors at the market and personally benefit from your operation. These facts demonstrate that you provide a substantial private benefit to your members.

The presence of a single substantial non-exempt purpose will prevent the grant of tax exemption.”

The ruling does not discuss alternative tax treatments for the organization. In NSAR 0296 (September 6, 2001), a non-docketed significant advice review, the IRS concluded that a similar organization did not qualify as tax exempt as a business league or board of trade under Section 501(c)(6) for similar reasons. It cited Treas. Reg. §1.501(c)(6)-1, which provides: “A business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. … Thus, its activities should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons. An organization whose purpose is to engage in a regular business of a kind ordinarily carried on for profit, even though the

business is conducted on a cooperative basis or produces only sufficient income to be self sustaining, is not a business league.”

NSAR 0296 suggests that the organization could qualify as a Section 521 cooperative, provided it made appropriate changes to its documents, but it also indicates that the organization did not want to make those changes.

In fact, there is precedent for organizing and operating farmers’ markets in cooperative form. Rev. Rul. 67-430, 1967-2 C.B. 220, concludes that operating a farmers’ market constitutes “marketing” for purposes of Section 521. It observed: “Furnishing facilities for use in the assembling, grading, displaying, advertising, and selling of farm products is considered to be an integral part of the marketing function. Accordingly, the association may be exempt as a farmers’ cooperative under section 521 of the Code, if it otherwise meets the requirements of that section.”

Rev. Rul. 67-430 updated and superseded I.T. 2720, XII-2 C.B. 71 (1933), so the recognition that an organization operating a farmers’ market could qualify as a Section 521 cooperative is long-standing.

It appears that the organization involved in Ltr. 200818028 is not devoted exclusively to providing a market for agricultural products – according to the ruling, it also provides a market for “artisan crafts.” Because of this, it is possible that the organization would not qualify as a Section 521 farmers cooperative. However, with appropriate changes to its documents and operations, it might qualify for treatment as a nonexempt Subchapter T cooperative.

8. ILM 200826004 (February 26, 2008).

Last year, the Digest reported on ILM 200729035 (April 11, 2007), a chief counsel advice using anti-avoidance rules in the consolidated return regulations to combat claimed deferral of income arising from the use by a parent corporation and its domestic and international subsidiaries of a controlled group of cooperatives. Reportedly over $1 billion of tax deferral is at issue in the case. This year the IRS National Office issued a second chief counsel advice with respect to the same case. The second chief counsel advice suggests an alternative approach for combating the arrangement, namely, the step transaction doctrine. Under the step transaction doctrine, “a series of transactions designed and executed as parts of a unitary plan to achieve an intended result … will be viewed as a whole regardless of whether the effect of so doing is imposition of or relief from taxation.” Normally, the step transaction doctrine is applied in the corporate arena to reorder or collapse the steps of a transaction. In the situation covered by the ILM, the controlled cooperatives purchased merchandise from vendors and resold the merchandise to the parent and its subsidiaries. The controlled cooperatives negotiated arrangements with the vendors that called for a discount from the full list price of the merchandise, but they resold the merchandise to the parent and subsidiaries (referred to in the ILM as the “OpCos”) for the full list price. The spread less expenses became the profit

of the cooperatives, which was eventually paid to the parent and subsidiaries in the form of patronage dividends. However, as a result of using staggered fiscal years and waiting to pay patronage dividends until the end of the payment period, the parent, its subsidiaries and the cooperatives deferred taxation on the spread, which cumulatively appears to have been a very large amount. There are three different formulations of the step transaction doctrine applied by Courts in tax cases. The most liberal formulation of the doctrine is the “end result” test, “under which the transaction will be collapsed if it appears that a series of formally separate steps are really prearranged parts of a single transaction intended from the outset to reach the ultimate result.” The ILM asserts that this test is met: “In this case, the US OpCos paid the full list price of the merchandise only as a component part of a single overall transaction, which included the repayment to each US OpCo of the difference between the full list price and the negotiated discount price. All parties – including the OpCo, the Supplier, and the Parent – knew the precise bottom-line price of each item on the day the order was placed. … The OpCos understood that their actual COGS would be the Negotiated Discount Price, not the List Price. Thus, the end result test is satisfied.”

The second formulation is the “mutual interdependence” test, where the doctrine will be applied if “the steps are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series.” The ILM asserts that this test is met as well: “This test concentrates on the relationship between the steps, rather than on the end result. The inquiry here is whether the US OpCos would have paid full list price for merchandise without assurances that the Spread would be returned to them, thus ensuring that the true price was the Negotiated Discount Price. … The OpCos simply would not have paid full list price. Rather, they would have resorted to seeking their own discounts. Thus, the mutual interdependence test is satisfied.”

The final formulation is the “binding commitment” test. Under this test, the step transaction doctrine will be applied only if “at the time the first step is entered into, there was a binding commitment to undertake the later step.” Here, the ILM reasons that since the OpCos knew the Negotiated Discount Prices at the time they bought merchandise from the cooperatives, and it was apparently understood that they would ultimately be charged those prices, “[i]f the OpCos had not received their promised refund/rebate payments, those OpCos presumably would have legal standing to compel payment.” Application of the step transaction doctrine in a cooperative context is, to my knowledge, unprecedented. It is by no means clear that it is appropriate to do so. It will be interesting to see whether the IRS pursues this theory and how this case will ultimately be resolved.

9. ILM 200829028 (April 4, 2008).

This chief counsel advice deals with a consolidated group of corporations manufacturing and selling products and services in domestic and foreign markets. The consolidated group includes a cooperative, which, according to the chief counsel advice, has conducted most of the group’s manufacturing and procurement activities since its formation. The patrons of the cooperative are the parent corporation and five of its subsidiaries, all of which, along with the cooperative, are included in the parent’s U.S. consolidated federal income tax return. The focus of the ILM is on the consolidated group’s treatment of the patronage dividends paid by the cooperative to other members of the group. For patronage dividends with respect year 1 income that are paid by the cooperative in year 2 (during the payment period for year 1), the group has taken the position that the cooperative is entitled to a deduction on the consolidated return in year 1 and that the recipients do not have to include the patronage dividends received in income on the consolidated return until year 2. This deferral apparently attracted attention of revenue agents auditing the group’s consolidated return, and they asked for assistance from the IRS National Office. In the ILM, the IRS National Office takes the position that the “matching rule” described in the consolidated return inter-company transaction regulations should apply. See Treas. Reg. §1.1502-13. Under that rule, the patronage dividend deduction can not be claimed by the consolidated group until year 2, the year that the group includes the patronage dividend in income. The IRS observes: “Application of this timing rule results in Cooperative taking into account its patronage deduction (its intercompany item) one year later than generally required outside of consolidation, under section 1382(b). Parent Consolidated Group will not be able to take advantage of the deferral provided under the rules of subchapter T with regard to its intercompany transactions. This is admittedly a different outcome than would obtain if Cooperative had not been a member of Parent Consolidated Group.”

This is the same position taken by the IRS last year in a chief counsel advice involving a controlled cooperative that had not been included in the group’s consolidated return. In that chief counsel advice, the IRS relied on an anti-abuse rule in Treas. Reg. §1.1502-13 to reach the same result. See, ILM 200729035 (April 11, 2007). In reaching this conclusion, the IRS rejects two arguments made by the group. First, the group argued that the matching rule did not apply to the patronage dividends paid by the cooperative by reason of the “special status rule” contained in Treas. Reg. §1.1502- 13(c)(5), which provides: “Notwithstanding the general rule of paragraph (c)(1)(i) of this section [application of the matching rule to attributes], to the extent an item's attributes determined under this section are permitted or not permitted to a member under the Internal Revenue Code or regulations by reason of a member's special status, the attributes required under the Internal Revenue Code or regulations apply to that member's items (but not to the other member).” (emphasis added).

The ILM rejects this view. It is apparent that the group made a number of technical arguments in support of the position that the “special status rule” applies. Among them appears to be that patronage dividends are exclusions and that characterization is an “attribute.” It is very likely that the description of these arguments in the ILM does not do them justice. Suffice it to say, the ILM asserted that this exception did not apply because the consolidated return regulations contain a definition of “attribute,” which specifically excludes “timing.” The IRS summarily dismissed that taxpayer’s argument that patronage dividends are exclusions by reference to Section 1382(b) (which provides that patronage dividends will “be treated in the same manner as an item of gross income and a deduction therefrom”). Second, the group argued that “the Legislative intent behind the subchapter T rules may not be overridden by application of the intercompany transaction rules.” Here as well, the ILM flatly disagreed with the group’s argument: “The Taxpayer is wrong. Although Congress sanctioned a timing mismatch between cooperatives and their patrons, as discussed above, through section 1502, Congress specifically charged the Secretary with promulgating regulations to ensure clear reflection of income of members of a group and the group as a whole. Congress gave the Secretary explicit and retroactive permission to ‘prescribe rules that are different from the provisions of chapter 1 that would apply if such corporations filed separate returns.’ As discussed in detail above, application of the Matching Rule to achieve single entity treatment of Cooperative and Patrons ensures clear reflection of income and is clearly sanctioned by Congress under section 1502.”

10. Coordinated Issue Paper Agriculture Industry: Section 118 – Characterization of Bioenergy Program Payments (April 8, 2008), found at 2008 TNT 69-58.

From 2001 through 2006 many producers of ethanol and biodiesel received payments from the U.S. Department of Agriculture Commodity Credit Corporation under a program known as the Bioenergy Program (“BEP”). The goals of the BEP were “to encourage increased purchases of eligible commodities [corn, soybeans, cotton seed, sunflower seed, canola and a number of other specified commodities] for the purpose of expanding production of such bioenergy [i.e., fuel grade ethanol and biodiesel] and supporting new production capacity for bioenergy.” 8 U.S.C. §8108(b)(1). According to the USDA, during the life of the program (which came to an end in 2006), payments to producers totaled approximately $537 million. At its inception in 2001, 26 ethanol producers and 5 biodiesel producers participated in the program. By 2006, the final year of the program, 77 ethanol producers and 54 biodiesel producers were participating. Payments were distributed according to a formula that was designed to encourage participation of producers with less than 65 million gallons of annual production capacity. Payments to large producers were capped at 5% of available funding each year. A recently released IRS coordinated issue paper focuses on whether the recipients of BEP payments must be include them in income. See, Coordinated Issue Paper Agriculture Industry: Section 118 – Characterization of Bioenergy Program Payments, LMSB-04-0308-019 (April 8, 2008).

Apparently, some recipients of BEP payments have taken the position that the payments may be excluded from income under Section 118(a) as nonshareholder contributions to capital. The coordinated issue paper does not describe their position in detail, but does state: “In the case of the BEP, some taxpayers contend that BEP payments are contributions to capital and make the following arguments: 1) the motive of the USDA is to benefit the public good by enhancing bioenergy production throughout the United States; and 2) the USDA is not the actual consumer of the bioenergy production, therefore IRS section 118 capital contribution treatment is appropriate. … Some taxpayers argue that the federal government must be the actual recipient of the services performed by the bioenergy providers in order for the BEP payments to be included in gross income.”

Although the coordinated issue paper does not say, presumably the producers also reduced the basis of property used to produce ethanol or biodiesel by a corresponding amount pursuant to Section 362(c).

In the coordinated issue paper, the IRS takes issue with this treatment of BEP payments. The IRS does not view the payments as contributions to capital. They are not tied to the acquisition of any particular asset or assets. Rather, according to the paper: “The USDA’s intent and motivation in making BEP payments is to supplement the operating income of the bioenergy producers for the increased purchase and use of agricultural commodities to expand production.”

What the purpose of the BEP payments actually was appears to be at the center of the dispute over whether the payments are nonshareholder contributions to capital. I suspect that taxpayers that treated the payments as contributions to capital would not agree with many of the factual statements contained in this coordinated issue paper.

After reviewing applicable Code sections, regulations and Court cases, the IRS concludes that BEP payments must be currently included in income by their recipients under Section 61(a). The coordinated issue paper then concludes by observing: “Finally, additional evidence that the BEP payments represent gross income appears through the issuance of Form 1099-G by the USDA to all BEP participants. The USDA’s issuance of Form 1099-G to bioenergy producers reflects the USDA’s consistent intent to treat the BEP payments as income subsidies, not contributions to capital.”

A coordinated issue paper sets forth the position that examiners from the LMSB division of the IRS are expected to take upon audit when an issue described in a paper is identified. Normally, coordinated issue papers are developed for controversial issues involving a number of taxpayers. As noted above, over 100 ethanol and biodiesel producers received BEP payments over the years. The number of potentially affected taxpayers is much greater since many of the recipients operated as LLCs. For LLCs, the affected taxpayers ultimately are their members. The IRS website describes the purpose of coordinated issue papers and their status in the following manner:

“A major objective of the IRS Large and Mid-Size Business Division's Issue Management Strategy is to identify, coordinate and resolve complex and significant industry wide issues by providing guidance to field examiners and ensuring uniform application of the law. Uniformity is achieved through the issuance of coordinated issue papers, which, following review by the Office of Chief Counsel, are issued by the Commissioner, Large and Mid-Size Business Division. Although these papers are not official pronouncements on the issues, they do set forth the Service's current thinking.”

As the IRS acknowledges, coordinated issue papers are not authority, but are more akin to an IRS brief or position paper on a contested issue. Often issues first identified in coordinated issue papers ultimately end up in Court. Time will tell whether this position will ultimately be sustained.

11. Ltr. 200833031 (May 23, 2008).

This ruling is similar to Ltr. 200818028 (item 7 above). The organization in question is an unincorporated association formed to encourage and establish a farmers’ market in a community to serve as a place where farmers and artisans can sell products to members of the community. The ruling concludes that the organization is not exempt under Section 501(c)(6) as a business league because it is not “promoting the improvement of the business conditions of one or more lines of business or promoting the general economic welfare of all the commercial enterprises in a given trade community.” Rather, the ruling concludes that the organization is “simply providing a convenient place for individuals to market their products for their private benefit.” The ruling also concludes that the organization is not exempt under Section 501(c)(4) as a civic league or organization not organized for profit but operated exclusively for the promotion of social welfare. Rather, the ruling concludes that the organization is “primarily organized and operated as an economic convenience for … vendors.” Finally, the ruling concludes that the organization does not qualify as a Section 521 cooperative. As described above (see item 7 above), the IRS has in the past recognized that farmers’ markets can qualify for Section 521 status. However, in this case, the ruling observes that the organization is not organized on a cooperative basis and that the “vendors include nonmembers and persons who are not producers of agricultural products within the meaning of Code section 521.”

12. Ltr. 200834022 (March 5, 2008).

In this letter ruling, the IRS concluded that an organization did not qualify either as an exempt Section 521 farmers cooperative or as an exempt Section 501(c)(5) agricultural organization.

The organization was formed to act as a purchasing cooperative for timber harvesters and associations of timber harvesters. Its members included “independent business people that are in the timber harvesting business, the haulers of forest products in their natural state (logs or chips), forest road contractors, or those businesses that prepare forest sites for planting, plant trees, do fertilization, or other on-site work that enhances the forest stand.” The organization does not itself harvest timber of market timber products. Rather, it helps members purchase products and services needed in their timber harvesting business. The IRS concluded that the organization did not qualify as a Section 521 cooperative because a prerequisite for such status is that an organization be a “farmers’, fruit growers’ or like association.” In the IRS view, harvesting of timber is not a farming activity. The IRS also concluded that the organization did not qualify as a Section 501(c)(5) agricultural organization. Since harvesting timber is not an agricultural activity, the organization is not an agricultural organization. Moreover, it does not act like a farm bureau or similar organization, organized at the state or county level to represent the interests of its members at various governmental regulatory agencies. Rather, the organization’s principal purpose is to provide a direct business service for its members’ economic benefit. The ruling does not discuss whether the organization would qualify as a nonexempt Subchapter T cooperative. From what is disclosed in the ruling, it appears that it could.

13. Ltr. 200836005 (May 29, 2008).

This ruling considers the tax status of a cooperative formed to develop and own renewable and non-renewable electric generation facilities and to procure and sell electricity and other energy-related goods or services to its members, a County, a Town and a Compact (consisting solely of counties and towns within the State). The County and Town are political subdivisions of the State. The Compact is exempt from tax under Section 115(l). Because of the membership of the cooperative and the nature of its expected activities, the IRS concluded that its income would be exempt under Section 115(l). Section 115(l) provides that gross income does not include income derived from any utility or the exercise of any essential governmental function and accruing to a state or any political subdivision of a state. The IRS then concluded that contributions made to the cooperative exclusively for a public purpose may be deductible by a donor as charitable contributions under Section 170(c)(1). Finally the IRS ruled that the cooperative is eligible to issue tax-exempt bonds under Section 103 on behalf of the Town, the County and the members of the Compact.

14. Ltr. 200838008 (June 9, 2008).

Four hydroelectric power plants serving two rural electric cooperatives (“Coops X and Y”) and three municipalities historically were owned by a state power authority and later were transferred to a power agency treated as a political subdivision of the state (the “Pool Project”). Each cooperative operated one of the plants, one of the municipalities operated the third plant and the other two municipalities operated the fourth plant. Each used the power generated by the hydroelectric power plant it operated (supplemented by power generated by conventional power

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plants they each owned). Costs were pooled so each participant in the Pool Project was charged the same wholesale power rate for power purchased from the Pool Project under a Long Term Power Sales Agreement (“PSA”). For one of the cooperatives (Coop Y) and for the three municipalities, the cost of power was higher than it would have been if the plants were not pooled. For the other cooperative (Coop X, the person requesting the letter ruling) the pooling arrangement reduced its costs “because the cost to operate the D project [the power plant operated by and serving Coop X] is more than [Coop X] pays for power under the PSA.” For it, the PSA was a valuable asset. For various reasons, Coop Y desired to withdraw from the Pool Project and to take over ownership of the plant it operated. After negotiation, all participants agreed to a restructuring of the pool arrangement. The basic terms of the restructuring were as follows: • Coop Y, the cooperative which wished to withdraw, was permitted to do so. It agreed to purchase the plant it operated (and related assets) for $x million of cash.

• Coop X, the cooperative that was benefited from the arrangement, agreed to withdraw. Its PSA was cancelled. In compensation for the cancellation of the favorable PSA, the Pool Project transferred to Coop X the hydroelectric power plant which it operated and related assets (the high-cost facility) and $y million of cash.

• The three municipalities agreed to continue the Pool Project on a reduced scale operating two hydroelectric plants.

In order for a rural electric cooperative to qualify as tax-exempt under Section 501(c)(12), at least 85% of its income must consist of “amounts collected from members for the sole purpose of meeting losses and expenses.” Apparently, Coop X anticipated that the amount it was to receive (the plant and $y of cash) would cause it to lose its exempt status for the year the restructuring occurred, leaving it subject to tax as a cooperative under pre-Subchapter T law for that year. See, Rev. Rul. 83-135, 1983-2 C.B. 149. Thus, Coop X asked the IRS to rule that the consideration that it was to receive upon withdrawal qualified as patronage-sourced income. Here, as in other rulings in the past few years involving rural electric and telephone cooperatives disposing of assets at a gain, the IRS looked to Subchapter T law to determine whether the organization qualified as a cooperative and then to determine whether the income would be patronage-sourced. The IRS concluded that the income realized by Coop X would be patronage-sourced and that it could be allocated to members as part of a deductible or excludable patronage dividend. The IRS observed: “In the instant case, [Coop X] is swapping an asset used in the cooperative’s business, the PSA, for the real assets that produce electricity that Taxpayer sells to its patrons and cash. Thus, the gains at issue are realized in a transaction that is directly related to the cooperative enterprise and patronage sourced.”

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15. Ltrs. 200838011 (June 18, 2008), 200843015 (July 21, 2008), 200843016 (July 21, 2008), and 200843023 (July 24, 2008).

Section 199(d)(6) permits specified agricultural or horticultural cooperatives to determine taxable income for purposes of the taxable income limitation on the Section 199 domestic production activities deduction “without regard to any deduction allowable under subsection (b) or (c) of section 1382 (relating to patronage dividends, per-unit retain allocations, and nonpatronage distributions).” This is commonly referred to as computing the Section 199 deductions by “adding back” patronage dividends and per-unit retain allocations. In the final regulations under Section 199 the IRS repeated this rule and stated that it applied not only for purposes of computing taxable income but also for computing qualified productions activities income. Treas. Reg. §1.199-6(c). In addition, the IRS made it clear that the term “qualified payment” included all patronage dividends and per-unit retain allocations. Treas. Reg. §1.199-6(e). The regulation provides: “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.”

Marketing cooperatives that have used the pooling provisions in Subchapter T and that historically characterized the cash advances paid to patrons as per-unit retain allocations paid in money generally found these provisions to be favorable and began computing their Section 199 deduction accordingly. However, there are a number of marketing cooperatives that have operated like pooling cooperatives, though they have never considered themselves as pooling cooperatives. These cooperatives have consistently characterized their payments to growers as purchase price and have taken those payments into account in determining their year-end inventory for tax purposes. Some of those cooperatives began to ask whether their payments to growers should be treated as per-unit retain allocations paid in money and added back for Section 199 purposes. In ILM 200806011 (October 22, 2007), released earlier in the year and described in detail in item 4 above, the IRS suggested that payments to growers made by a cooperative that did not pool should nevertheless be treated as per-unit retain allocations paid in money. Encouraged by that chief counsel advice, during the past year a number of milk marketing cooperatives submitted ruling requests to the IRS National Office asking for confirmation that payments to dairy farmer members for their milk qualify as per-unit retain allocations paid in money and can be added back for Section 199 purposes. The IRS has responded favorably, notwithstanding the fact that historically the cooperatives have treated the payments as the purchase price for milk, not as per-unit retain allocations paid in money, and reported them accordingly on their tax returns. All of the milk marketing cooperatives that have received rulings act like pooling cooperatives, though not all of their organizational documents look like those used by cooperatives that historically regarded themselves as pooling cooperatives. In the milk industry, typically all patrons delivering milk receive semi-monthly milk checks and a patronage dividend after the end of the year. This system reflects the payment system developed under the federal milk orders. The semi-monthly milk checks represent an advance for the milk delivered each month, with a final settlement payment after the end of the month. These are typically referred

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to as “milk checks.” The patronage dividend check is based on net earning for the year (after deducting the milk checks). All milk is pooled for purposes of determining the size of the milk checks. For smaller dairy cooperatives, all patrons share on the same basis in the milk checks (with quality differentials). For larger dairy cooperatives, there are often regional pay zones. All patrons in a pay zone are paid the same price for their milk (with quality differentials). For both large and small cooperatives, typically the final patronage dividend is determined on a cooperative-wide basis and typically is paid on a quantity basis (measured in hundred weights) without regard to quality differentials. Since milk marketing cooperatives have not viewed themselves as pooling cooperatives, they have effectively closed their pools each year, by valuing their inventories of products at the lower of cost or market. Because of the perishable nature of milk, for most milk marketing cooperatives the amount of product in inventory at year end is negligible compared to overall sales, and thus there is no compelling reason to keep pools open at year end. In Ltr. 200838011 (June 18, 2008), the IRS ruled: “Section 199(d)(3) of the Code allows certain payments from the cooperative to its patrons to be added back for purposes of computing the section 199 amount. Coop should include all ‘net proceeds’ payments or allocations, including the c Check and patronage dividend, in its computation of the section 199 amount. Specifically, the c Check is considered a per-unit retain paid in money under section 1382(b)(3).”

In reaching this conclusion, the IRS concluded that the milk checks met all of the requirements specified for per-unit retain allocations paid in money in Subchapter T:

“Coop's c Checks qualify as per-unit retain allocations within the meaning of section 1388(f) of the Code because they were distributed with respect to c that Coop markets for its patrons, and by the fact that the patrons receive the payments based on the quantity of c delivered; the c Checks are determined without reference to the Coop's net earnings; the c Checks were paid pursuant to a contract with the patrons establishing the necessary pre-existing agreement and obligation; and the c Checks were paid within the payment period of section 1382(d).”

This result has implications not only for the cooperative, but also for its members. If payments to members for their products are in fact “per-unit retain allocations paid in money,” then the members can not include the payments in their own Section 199 deduction computations. The only person entitled to take them into account is the cooperative. The IRS articulated its vision of how Section 199 applies to marketing cooperatives as follows: “The effect of these sections is that the cooperative will compute the entire section 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 section 199 in the patron's hands. That is, the patron may not count the qualified payment he receives from the cooperative in his own section 199 computation whether or not the cooperative keeps or passes

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through the section 199 deduction. Accordingly, the only way that a patron can claim a section 199 deduction for a qualified payment received from a cooperative is for the cooperative to pass-through the section 199 amount in accordance with the provisions of 199(d)(3) of the Code and the regulations thereunder.”

These rulings raise a number of questions, not the least of which is how far they extend. Do they extend to cooperatives that are engaged in marketing activities, but do not pool their results? There are a number of cooperatives that pay the market price existing at the time members decide to deliver their crops to the cooperative. For these cooperatives, the payments on delivery are not pooled. Are payments made by these cooperatives per-unit retain allocations? The ILM suggests that the IRS National Office thinks that they are. But the situation is different that that involved in the rulings issued to date. The approach that the IRS has taken should be favorable to many cooperatives and their members. Generally, since many members do not have W-2 wages and since the expenses incurred by members drop out of the computation, when the Section 199 deduction is figured at the cooperative level and passed through, the result is better than it would be if the deduction was figured at the member level. However, this is clearly not the case in all instances. For instance, it would not be the case where a cooperative buy and resells members’ products and has little or no W-2 wages. Buy/sell marketing agents in common (as opposed to those acting as agents) could lead to a significant loss of Section 199 deductions. While the potential Section 199 deduction for such a cooperative (adding back grower payments and patronage dividends) may be very large, the cooperative’s Section 199 deduction is limited to 50% of W-2 wages “properly allocable to domestic production gross receipts.” There is no rule attributing the W-2 wages paid by members to the cooperative or allowing the W-2 wage limitation to be computed at the member level. Stay tuned for future developments in this area.

16. Ltr. 200841038 (July 15, 2008).

In this ruling, the IRS concluded that an organization formed by brine shrimp harvesters to help them market brine shrimp cysts and other products and to help them purchase necessary supplies does not qualify as an exempt Section 521 cooperative. The IRS’s rationale for this conclusion is that the brine shrimp harvesters are not engaged in farming. For this purpose, the IRS apparently distinguishes persons who raise, harvest and market fish grown in privately-owned water from those who market fish caught in public waters. The ruling treats the former as farmers for Section 521 purposes, but not the latter. The IRS concluded that the brine shrimp harvesters were not farmers because the cooperative “harvests, processes and markets brine shrimp from the [Great Salt Lake], which is not privately owned by [the cooperative].”

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17. Ltr. 200842011 (July 11, 2008).

Retail merchants in a metropolitan area organized a cooperative to “consolidate and share the delivery resources of its members to develop a spoke-hub distribution network and thereby increase the efficiency of deliveries throughout the Metropolitan Area.” The cooperative acquired a centrally located warehouse to serve as the hub of its operations. According to the ruling, the cooperative had several reasons for purchasing a warehouse: (i) “to establish a certain level of permanence for the centrally located hub of its broad ranging spoke-hub distribution network,” (ii) to limit its exposure to inflation in rental costs for a necessary warehouse, and (iii) to “better its overhead.” The cooperative sold its warehouse building at a gain. The sale was prompted by a decline in the cooperative’s membership “as a result of many market and industry factors, including internet Product deliveries…” The IRS ruled that the gain from the sale of the building is patronage-sourced because “the warehouse building was used exclusively in the Cooperative’s business to facilitate the efficient distribution of the members’ Product through the establishment of a spoke-hub distribution network serving the collective interest of the members…” The cooperative proposed to share the gain among current and former members based upon patronage during the period it owned the building. The cooperative described this method as “compound patronage” and the sharing was to be based upon the members “respective average annual patronage percentages.” The cooperative’s Bylaws provided that net earning from the sale of any “major asset” would be shared in this manner if they exceeded a dollar threshold (the amount of which is redacted in the ruling). The IRS concluded the gain could be shared on that basis.

18. 2007 Form 1120-C.

Prior Digests have described the development of the new Form 1120-C, the comments made by the National Council of Farmer Cooperatives (“NCFC”) when a draft version of the form was released in 2006, and the changes that were made to the final version of the 2006 form. The Digest also described the confusion surrounding the roll-out of the form resulting from the failure of the IRS to approve the amended regulations authorizing the form until mid-year last year. Since the final 2006 form did not respond to all of the NCFC’s comments, the NCFC renewed many of its original comments in a letter last year providing suggestions for improving the 2007 form. The IRS recently released the Form 1120-C for 2007 and instructions for that form. The 2007 form and instructions are in most respects identical to the 2006 version. There are, however, a handful of changes made in response to the NCFC comments. First, when nonqualified written notices of allocation or per-unit retain allocations are redeemed, a cooperative is entitled to a deduction for the amounts paid or (if the tax savings is greater) a benefit equal to the tax savings that would have resulted in prior years if the notices redeemed had originally been qualified. If the look-back computation produces the better result,

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the tax savings are reflected on line 29g of Form 1120-C and treated like a payment of tax on the “last day prescribed by law for the payment of tax for the taxable year.” In some cases, that can result in a tax refund. For years, the Form 990-C erroneously described the amount entered on line 29g as a “credit.” The look-back adjustment is not a credit and is not subject to rules that apply to credits. It is treated as a tax payment. The erroneous description was carried over into the 2006 Form 1120-C. The description has been corrected in the 2007 Form 1120-C to use a more neutral term. Second, for years the Form 990-C included erroneous and confusing instructions for cooperatives with FSCs. These errors were carried over into the 2006 Form 1120-C. Schedule C of the form provided that cooperatives were entitled to a 100% dividends-received deduction for dividends received from FSCs. While correct in some cases, this was erroneous in other instances. Buried in the instructions was a direction to report 8/23 of any dividend received from a FSC that was not entitled to 100% dividends-received deduction treatment as “other income” on line 9. This treatment confused and misled some cooperatives. In the 2007 Form 1120-C the IRS has finally corrected Schedule C so that the proper dividends-received deduction will be reported, eliminating the necessity to report part of the dividend as “other income” on line 9. While this change is welcome, for most cooperatives the issue is now moot since FSCs were eliminated a number of years ago. Third, the 2006 Form 1120-C eliminated the old Form 8817, incorporating the information previously reported on the old Form 8817 in Schedule G. However, in the process, it created confusion over whether the IRS was trying to change the rules with respect to the treatment of nonpatronage losses. Schedule G is designed to prevent cooperatives from offsetting patronage losses against nonpatronage income. However, for years it has been recognized that cooperatives may net nonpatronage losses against patronage income, but that they are not required to do so. The Form 8817 had been carefully designed to permit that result. When the IRS left a critical line out of Schedule G, questions arose as to whether the IRS was trying to change the rules. The critical line has been restored to the 2007 Schedule G (line 11, for combined taxable income) and the instructions have been conformed to those that were contained in the old Form 8817. Presumably these changes signal that no change was intended with respect to the treatment of nonpatronage losses. Fourth, the instructions for the 2007 Form 1120-C have been revised to reflect the change made to the Section 199 regulations during the past year. The final Section 199 regulations erroneously provided that, if a cooperative did not pass its Section 199 deduction through to patrons, the cooperative was not permitted to avail itself of the rule that attributes farming activities of its members to a cooperative and of the rule that allows a cooperative to add back patronage distributions in figuring its Section 199 deduction. In response to comments from the NCFC, the regulations were amended to make it clear that the attribution and add-back rules apply whether or not Section 199 deductions are passed through. The Form 1120-C instructions have been amended to conform to this change.

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Fifth, question 11 in Schedule K has been modified. The 2006 form asked cooperatives with over 100 patrons to enter the number of patrons they had. The 2007 form now asks cooperatives to enter the number of foreign patrons that they have and the amount of the patronage distributions to those patrons. This change was not in response to anything the NCFC submitted. Apparently someone in the IRS is seeking to learn more about the extent to which U.S. cooperatives have foreign patrons. The 2007 Form 1120-C and instructions do not address several concerns raised by the NCFC in 2006 and 2007. The NCFC questioned whether Section 521 cooperatives should be required to complete Schedule G since the Farm Service rule applies only to nonexempt cooperatives. The NCFC questioned the requirement that all cooperatives with at least $250,000 sales are required to complete Schedule G, arguing that the threshold was too low. The IRS has not modified the form or instructions in response to either comment. The NCFC suggested that per-unit retain allocations should be reported on a different line and not included in cost of goods sold. There has been a concern in recent years that inclusion of per-unit retain allocations on Schedule A might suggest that some portion of per-unit retain allocations should be included in inventory of crops on hand at year end. The IRS has not changed the form to accommodate this comment, but the instructions were changed in 2006 to include the affirmative statement that a “cooperative is allowed to deduct from its taxable income amounts paid during the payment period for the taxable year as per-unit retain allocations to the extent paid in money, qualified per-unit retain certificates or other property with respect to marketing occurring during such tax year.” Recently, ILM 200806011 (October 22, 2007) confirmed that per-unit retain allocations “are deductible by a marketing cooperative using pooling whether or not the product marketed for the farmers has been sold during the taxable year.” Together, these statements should eliminate any confusion on the part of IRS agents with respect to the proper treatment of per-unit retain allocations. The IRS failed to correct a technical problem with respect to the instructions related to the ETI. Those instructions state that cooperatives must reduce their deduction for patronage dividends or per-unit retain allocations by the amount of their ETI exclusion. The instructions should provide for a reduction only where the ETI exclusion is passed-through to patrons. The ETI now is only of historical interest for most (if not all) cooperatives since it has now generally been phased out.

19. “Description of the Revenue Provisions Contained in the President’s Fiscal Year 2009 Budget Proposal” prepared by the Joint Committee on Taxation (March 2008).

Cooperatives are not currently required to file their federal income tax returns electronically. There has been talk that, with the development of the new Form 1120-C, cooperatives will eventually be required to do so. Section 2001(a) of the IRS Restructuring and Reform Bill of 1998 set a target for the IRS to have at least 80 percent of all federal tax and information returns filed electronically by 2007. That target has not been met.

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Currently, for taxable years ending on or after December 31, 2006, corporations are required to file electronically if they report total assets at the end of the corporation’s taxable year that equal or exceed $10 million on Schedule L of their Form 1120 and file more than 250 returns (including information returns such as W-2s and Form 1099s). Treas. Reg. §301.6011-5. Since cooperatives do not file a Form 1120, they are not subject to this requirement. To encourage further development of electronic filing, the President’s Budget Proposal proposed that all corporations and partnerships required to file Schedule M-3 (Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More) be required to file income tax returns electronically. If enacted, such a requirement would sweep in large cooperatives since currently corporations (including cooperatives) with total assets in excess of $10 million are required to file Schedule M-3. This proposal is not new. Similar proposals were included in the 2006, 2007 and 2008 budget proposals. Expanding the scope of the electronic filing requirements to sweep in cooperatives filing Form 1120-C should not require legislation, but it may require an amendment to the regulations. The 2008-2009 Priority Guidance Plan of the Office of Tax Policy and the Internal Revenue Service (September 10, 2008) does not include expanding the scope of the electronic filing requirements.

This article on deferred crop payment arrangements and their implications for cooperatives is written by the attorney of record in Scherbart v. United States, 87 TCM 1418 (2004), aff’d 453 F.3d 987 (8th Cir. 2006) and one of the University of Minnesota Law School students who assisted her on the case (which was handled by the University of Minnesota Law School Tax Clinic). This case held that a Scherbart, a shareholder of Minnesota Corn Processors (when it was operating as a closed cooperative), was not eligible to defer the receipt of value-added payments received with respect to corn bought by the cooperative on the shareholder’s behalf. At the time Scherbart was no longer engaged in farming, and therefore did not raise the corn necessary to meet his commitment to Minnesota Corn Processors. Scherbart did not himself buy grain to meet the commitment. Rather, he availed himself of a program established by the cooperative where the cooperative acquired grain on his behalf. Both the Tax Court and the Eighth Circuit Court of Appeals held that the deferred crop payment arrangements were ineffective. These decisions and related cases have been discussed extensively in the Digest in prior years. This article attempts to develop general principles dealing with the treatment of deferred crop payment arrangements from the results of that case. Any attempt to generalize from that case to the arrangements of many cooperatives should be undertaken very cautiously. What should have been regarded as the critical facts of that case, namely the fact that Scherbart was not engaged in farming, the fact that he did not sell grain he raised (or even grain he purchased) to the cooperative, and the fact that the cooperative purchased the grain on his

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behalf, were, for whatever reason, not the focus of the decisions in the Scherbart case. As a result, the holdings of the Courts are confusing, and any attempt to apply them generally to legitimate deferred crop payment contracts between cooperatives and their members is suspect.

21. Treas. Reg. §1.179B-1T, T.D. 9404 (June 26, 2008) and Treas. Reg. §179C-1T, T.D. 9412 (July 3, 2008).

In recent months, the Treasury released temporary and proposed regulations under Sections 179B (deduction for capital costs incurred in complying with EPA sulfur regulations) and 179C (election to expense certain refineries) that not only provide general rules for the application of the sections, but also provide rules describing how cooperatives can elect to pass the benefits through to members. In each case, the temporary and proposed regulations are the same. The temporary regulations under Section 179B (Treas. Reg. §1.179B-1T) were released in T.D. 9404 (June 26, 2008), and the temporary regulations under Section 179C (Treas. Reg. §1.179C-1T) were released in T.D. 9412 (July 3, 2008). Both sections permit certain refiners to deduct a portion of expenses that they would otherwise have had to capitalize. Section 179B permits small refiners to elect to deduct 75% of the costs incurred to comply with the EPA sulfur regulations. (A related Code Section, Section 45H, allows small refiners a credit equal to the remaining 25% and also includes a pass-through provision). Section 179C permits refiners to elect to deduct 50% of expenses related to increasing the production capacity of the refinery. The remaining 50% is capitalized as it otherwise would have been. Both sections have identical provisions allowing cooperative refiners to pass the deductions through to members. See Sections 179B(e) and 179C(g). In each case, the pass- through is based upon relative ownership interests in the refinery (not on patronage), though it is normal for ownership in cooperative refineries to track patronage. Besides having rules of general applicability to refiners describing how these provisions apply, both sets of temporary and proposed regulations describe how cooperative refiners can elect to pass-through the accelerated deductions. The new regulations add to the body of law dealing with pass-throughs from cooperatives to members of credits and other special tax items (such as the extraterritorial income exclusion and the Section 199 deduction). One interesting difference is that the item being passed through is not a credit or a special deduction or exclusion (giving rise to a permanent difference), but rather accelerated deductions resulting from what is essentially a timing difference. As a consequence, any pass-through needs to be carefully analyzed to consider the impact on the cooperative and its members in later years as the cooperative’s book depreciation expense exceeds its tax depreciation expense.

22. Section 45O.

As part of the Heartland, Habitat, Harvest and Horticultural Act of 2008 (the “Farm Bill”), Congress enacted a new agricultural chemicals security credit which should be of interest

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to cooperatives involved with the manufacture, distribution and sale of fertilizer and pesticides. That credit is described in what is now Section 45O of the Internal Revenue Code. The Conference Committee Report accompanying the Farm Bill describes the reasons for enacting the new credit: “The Committee believes that a security tax credit would help the agricultural industry to properly safeguard agricultural pesticides and fertilizers from the threat of terrorists, drug dealers and other criminals. These safeguards are necessary to help alleviate a heightened concern as to the vulnerability of chemical storage facilities. This credit will help ease the substantial increase in production costs faced by agriculture related to installing improved security measures that will better protect the American public from the potential threat of terrorism or other illegal activities.”

The credit applies to “qualified security expenditures” paid or incurred after May 22, 2008 and on or before December 31, 2012. Section 45O(i). The credit may be claimed by “eligible agricultural businesses,” which include (i) persons selling “agricultural products, including specified agricultural chemicals, at retail predominantly to farmers and ranchers,” and (ii) persons “manufacturing, formulating, distributing or aerially applying specified agricultural chemicals.” Section 45O(e). The credit is equal to 30% of the “qualified security expenditures” for the taxable year, subject to two limitations. First, the amount of credit claimed with respect to “any facility” may not exceed $100,000 in any year less the amount of credits claimed with respect to the facility in the prior five years. This means that a credit may be claimed for up to $333,333 of “qualified security expenditures” related to a facility during the life of the credit. Second, the total credit that may be claimed by a taxpayer with respect to all of its facilities in any year may not exceed $2 million. The section does not define the term “any facility” for purposes of the first limitation, and it is likely that this will give rise to issues of interpretation. The section authorizes the IRS to promulgate regulations providing “for the treatment of related properties as one facility” for this purpose. Section 45O(h)(2). For controlled groups of corporations, the second limitation is applied treating all members of the group as one taxpayer. Sections 45O(g) and 41(f). To avoid a double benefit, Section 280C(f) provides that the taxpayer’s deduction otherwise allowable for that qualified security expenditures is reduced by the amount of credit claimed under Section 45O. The term “qualified security expenditures” is defined to include the following kinds of expenditures, but “only to the extent that such amounts are paid or incurred for the purpose of protecting specified agricultural chemicals.” Section 45O(d). • Employee security training and background checks

• Limitation and prevention of access to controls of specified agricultural chemicals stored at the facility

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• Tagging, locking tank valves, and chemical additives to prevent the theft of specified agricultural chemicals or to render such chemicals unfit for illegal use

• Protections of the perimeter of specified agricultural chemicals

• Installation of security lighting, cameras, recording equipment and intrusion detection sensors

• Implementation of measures to increase computer or computer network security

• Conduction a security vulnerability assessment

• Implementing a site security plan

• Any other measures for the protection of specified agricultural chemicals as the IRS may identify in regulations.

The section does not specifically address what should be done with a dual use expenditure (e.g., costs incurred for a security vulnerability assessment that involves more than just protecting specified agricultural chemicals). Here again, there will be interpretation issues and appropriate allocations will need to be made. The section authorizes the IRS to issue regulations which “provide for the proper treatment of amounts which are paid or incurred for [the] purpose of protecting any specified agricultural chemical and for other purposes.” Section 45O(h)(1).

Finally, the term “specified agricultural chemical” is defined to include (i) “any fertilizer commonly used in agricultural operations” listed under various of the sections of the U.S. Code and regulations, and (ii) “any pesticide (as defined in section 2(u) of the Federal Insecticide, Fungicide and Rodenticide Act), including all active and inert ingredients thereof, which is customarily used on crops grown for food, feed or fiber.” Section 45O(f). The Federal Insecticide, Fungicide and Rodenticide Act defines “pesticide” to mean with certain limitations “(i) any substance or mixture of substances intended for preventing, destroying, repelling, or mitigating any pest, (2) any substance or mixture of substances intended for use as a plant regulator, defoliant, of desiccant, and (3) any nitrogen stabilizer…” 7 U.S.C. 136(u). The term “pest” is defined to mean among other things “any insect, rodent, nematode, fungus [or] weed…” In October, the IRS released a new form to be used in claiming the agricultural chemicals security credit. See, Form 8931 (Agricultural Chemicals Security Credit).

23. IRS Exempt Organizations Division Annual Report and Workplan for Fiscal, 2009 (November, 2008).

The IRS Exempt Organizations Division released its Annual Report and Workplan for Fiscal 2009 in November. This document is available at the IRS website at http://www.irs.ustreas.gov/pub/irs-tege/finalannualrptworkplan11_25_08.pdf

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Listed among the compliance initiatives is an item of interest to Section 501(c)(12) mutual organizations. In pertinent part, the Workplan states: “In order to qualify for tax exemption, a mutual organization must be organized and operated on a cooperative or mutual basis, receive at least 85 percent of its income from its members, and use its member income for specific services. If, in any year, its member income falls below 85 percent of its total income for the year, the organization does not automatically lose its tax exemption, but is required to file a Form 1120, U.S. Corporation Income Tax Return, for that year.

In FY 2009, we will send compliance check letters to a number of organizations whose Forms 990 indicate they may have failed the member income test and we will take appropriate action, such as obtaining the delinquent tax Forms 1120 or conducting field examinations.”

24. Section 168(k)(4) – special election with respect to bonus depreciation.

The Economic Stimulus Act of 2008 amended Section 168(k) to extend the 50% bonus depreciation provisions to cover certain new property acquired after 2007 and placed in service before 2009. The provision also applies to certain property with a long production period and certain aircraft placed in service before 2010. Taxpayers are, as in the past, permitted to elect out of this provision for all eligible property or for specific classes of eligible property. Section 168(k)(2)(D)(iii). The Housing and Economic Recovery Act of 2008 further amended Section 168(k) to provide an alternative to taxpayers who are unable to benefit from bonus depreciation. Such taxpayers may elect enhanced limitations on the use of alternative minimum tax (AMT) and research credits in lieu of bonus depreciation. See, Section 168(k)(4). The credits covered by the enhanced limitations are potentially refundable if they can not be used. Section 168(k)(4)(F). The election to choose enhanced credit limitations in lieu of bonus depreciation applies only to property otherwise eligible for bonus depreciation acquired after March 31, 2008 and placed in service before 2009 (2010 in the case of some property). To benefit, a corporation must have AMT credits and research credits carrying over to its first taxable year ending after March 31, 2008 which arose in taxable years beginning before January 1, 2006 (“pre-2006 carryovers”). The corporation must also be willing to forego not only bonus depreciation on all eligible property acquired during the applicable period, but also accelerated depreciation. The enhanced credit limitation equals 20% of the depreciation that would otherwise have been claimed on the eligible property for the year. However, the enhanced limitation may not exceed 6% of the “pre-2006 carryovers” or $30 million, whichever is less. Thus, a taxpayer with $10 million of “pre-2006 carryovers” could potentially be entitled to an enhanced limitation on use of the credit carryovers of $600,000, provided that the depreciation that could otherwise have been claimed on the eligible property for the year exceeds $3 million. To the extent that the taxpayer could not use the increased limitation on its tax return for the year, the $600,000 would be refundable.

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Cooperatives with “pre-2006 carryovers” which would not otherwise receive much benefit from bonus and accelerated depreciation should take a look at this provision. However, a careful analysis needs to be made based on the facts of each situation to determine whether waiving bonus depreciation makes sense. For instance, a cooperative with significant taxable nonmember and nonpatronage income may find that the waiver does not make sense because it could benefit from bonus and accelerated depreciation. Some guidance has been released with respect to Section 168(k). See, Rev. Proc. 2008- 65. More is promised. The guidance that has been released so far reinforces the need for careful study. For instance, if a cooperative makes an election under Section 168(k)(2)(D)(iii) to forego bonus depreciation on certain classes of eligible property, it appears that it will not able to make an election under Section 168(k)(4) with respect to that property. See, Section 4.04 of Rev. Proc. 2008-65.

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2008 Report of LTA Subcommittee on the IRS Industry Specialist

Marla Aspinwall, Chair Loeb & Loeb LLP 10100 Santa Monica Boulevard, Suite 2200 Los Angeles, California 90067-4164 Telephone: (310) 282-2377 Fax: (310) 282-2200 E-Mail: [email protected]

Our Industry Specialist, Tracy Holtslag is located in Dallas Texas at 4300 MSRO, 4050 Alpha Rd. Dallas, Texas 75244; phone: (972)308-1631; fax: (972)308-1545; e-mail: [email protected]. The Industry Specialist provides the Internal Revenue Service with an overview of the examinations in a particular industry and acts as a repository of knowledge and experience for auditors examining taxpayers in such industry.

Few of our members have reported any contact with Tracy this year. One large cooperative did call her to help resolve a problem that he was having with the misapplication of funds issues resulting from conversion to the new Form 1120-C. We understand that Tracy did put him in touch with someone in the Service Center that was able to resolve the various issues in an efficient manner. As always, we ask that you not contact Ms Holtslag directly without first discussing the nature of your contact with a member of this Committee. If Ms Holtslag attends your audit or otherwise makes contact with you, we would appreciate it if you notify us of such contact.

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