TaxNewsFlash-Cooperatives

September 24, 2008
No. 2008-22

IRS Finds Gains on Rural Electric Cooperative’s Asset Swap May Be Allocated to Members as Patronage Dividends

The IRS recently issued a letter ruling in which it concluded that gains from an asset swap of a power sales agreement for cash and real assets that a rural electric cooperative would use to produce electricity to be sold to its patrons are gains realized in a transaction that is directly related to the cooperative’s enterprise of generating and purchasing electricity and are patronage sourced.

Accordingly, the IRS ruled that any gross income that might cause the cooperative to fail to qualify as a tax-exempt organization under section 501(c)(12) for the year of receipt will be deemed to be patronage-sourced income that the cooperative may allocate to its members as patronage dividends and deduct / exclude from its taxable income. PLR 200838008 dated June 9, 2008, and released September 19, 2008.

For an electronic version of the 11-page letter ruling: PLR 200838008

KPMG Observation

This ruling—in which KPMG assisted—presented a situation wherein the cooperative receives non-member income in a transaction which involved assets that the cooperative uses in its business. Under the ruling, if the cooperative loses its tax-exempt status under section 501(c)(12), the income will be considered patronage sourced income. The cooperative can therefore allocate the income to its members and deduct or exclude that income from the cooperative’s income under the pre-Subchapter T rules that apply to rural electric cooperatives.

Overview

The cooperative—a tax-exempt organization under section 501(c)(12)—generates, purchases, and transmits electric energy to its members. The cooperative’s excess revenues are allocated to its members based on their purchases from the organization.

Along with the other utility providers, the cooperative entered into a long-term power sales agreement with a state government authority. Under the agreement, each of the purchasing utilities agreed to operate and maintain its facilities and to purchase electrical power from the authority to the extent of available capacity. The cooperative is responsible for operating and maintaining a specific project and for purchasing all power produced by that project from the authority.

Subsequently, it was proposed that the cooperative withdraw from agreement. In exchange for withdrawing, the cooperative would be released from all obligations and rights under the agreements relating to the agency and would receive cash and ownership of the specific project assets—including the facility and the associated transmission lines, equipment, contracts, material, and real property interests.

The IRS ruled that in this case, the cooperative was swapping an asset used in its business (the power sales agreement) for cash and assets that would produce electricity which the cooperative would sell to its patrons. Thus, the gains are realized in a transaction that is directly related to the cooperative’s enterprise and are patronage sourced.

For more information, contact KPMG’s National Director of Cooperative Tax Services:

Teree Castanias, in Sacramento, (916) 554-1146, tcastanias@kpmg.com

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