Burr Creamery Corp. v. Commissioner

BURR CREAMERY CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Burr Creamery Corp. v. Commissioner

Docket No. 26983.

United States Board of Tax Appeals

23 B.T.A. 1007; 1931 BTA LEXIS 1797;

June 30, 1931, Promulgated

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Held, under the circumstances in this proceeding, that the petitioner, a corporation, the majority of the stock of which was held by a mutual cooperative organization, exempt from tax under section 231(11) of the Revenue Act of 1921, is not itself exempt from tax under said provision.

Ralph W. Smith, Esq., for the petitioner.

J. Arthur Adams, Esq., for the respondent.

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MCMAHON

This is a proceeding for the redetermination of deficiencies in income and excess-profits taxes for the years 1922 and 1923 in the amounts of $3,786.50 and $12,636.87, respectively. It is alleged that the respondent erred in holding that the petitioner did sell stock to others than producers who marketed their products through the organization and therefore, article 522 of Regulations 62 as amended controlling, the organization is not entitled to exemption under section 231(11) of the Revenue Act of 1921.

FINDINGS OF FACT.

During 1919 Ebenezer Burr was the president and the sole stockholder of the Burr Creamery Company, a corporation engaged in the business of buying, Pasteurizing and distributing milk. Burr himself was a large producer of milk. In 1919 he was milking between 300 and 400 cows. In 1922 and 1923, he was milking between 400 and 500 cows. In November or December, 1919, Burr became a member of the California Milk Producers' Association, a mutual cooperative organization which was, during 1922 and 1923, exempt from tax under section 231(11) of the Revenue Act of 1921. This Association had been organized in 1915 by the milk producers of the "milk shed" of Los Angeles, covering a radius of about 90 miles from that city. In 1922 and 1923 Burr was one of the largest producers of milk in the California Milk Producers' Association.

At a meeting of the members of the California Milk Producers' Association held July 26, 1919, it was resolved to acquire or build a plant or plants suitable to handle the milk of the Association, to be financed by assessing the members 2 cents per pound butterfat on their produce. At a meeting held September 26, 1919, a resolution was passed ratifying the action of the board of directors in the purchase of the Burr Creamery plant.

In October, of 1919, the petitioner, Burr Creamery Corporation, was organized under the laws of the State of California, to take over a part of the assets of the Burr Creamery Company.

The incorporators, who were also the first directors and who each owned one share of the capital stock of petitioner, were A. Russell, E. Burr, C. Burr, B. A. Rhoades, T. H. Brice, W. F. Holt, and George H. Ennis. The articles of incorporation of the petitioner provided that the amount of capital stock should be $100,000, divided into 1,000 shares of $100 par value per share. The articles of incorporation state that the purposes for which petitioner was formed were to acquire the whole or a part of the properties, real and personal, belonging to Burr Creamery Company, and to hold, own, manage, mortgage, lease, sell or otherwise dispose of the same or any part thereof; to buy or otherwise acquire, manufacture, produce, market, sell, deal in, impoart and export all kinds of milk, cream, butter, cheese and milk products, feed and feed products, and feed preparations of every kind to carry on a general dairy business; to raise, buy and sell, deal in and with all garden, farm and dairy products; to deal in cattle and other live stock; to deal in real estate of every description and to farm the same; to deal in agricultural and horticultural products and render salable all by-products and residual products therefrom; to acquire goods, wares, merchandise and personal property of every kind and to dispose of the same; to conduct farming, dairying, horticulture and agriculture; to acquire, operate and dispose of mines and mining lands; to carry on the business of drilling for oil products; to refine and deal in oil, natural gas and other mineral and hydrocarbon substances; and to deal in lumber, shingles, and building material.

The by-laws of the petitioner provide that the directors shall have power:

4th. To declare dividends out of the surplus profits arising from the conduct of the business whenever such profit shall, in the opinion of the directors, warrant the same.

On December 27, 1919, the following written agreement was executed:

THIS AGREEMENT, Made this 27 day of December, 1919, between BURR CREAMERY ERY COMPANY, a corporation, herein referred to as "vendor", the party of the first part, and CALIFORNIA MILK PRODUCERS' ASSOCIATION, a corporation, herein referred to as "Vendee", the party of the second part.

WITNESSETH: Whereas, Burr Creamery Corporation has been incorporated for the purpose of purchasing certain of the personal and real property of the Vendor, which property is particularly set forth in that certain indenture of date December 8, 1919, wherein said Burr Creamery Company is first party, and said Burr Creamery Corporation is second party; the consideration to be paid by Burr Creamery Corporation to Vendor for said property is the entire authorized capital stock of said Burr Creamery Corporation, viz; One Thousand (1,000) shares of the par value of One hundred ($100.00) Dollars Each, said stock to be issued as, and to be, fully paid stock, and

WHEREAS, it is the desire of the Vendor and Vendee that if and when Vendor shall become the owner of said stock, it will sell to the Vendee Six Hundred (600) of said shares of stock, and at Vendor's option Vendee will purchase the remainder of said One Thousand (1,000) shares, namely four hundred (400) shares, all upon the terms, for the consideration, and as herein provided.

NOW, THEREFORE, In consideration of the foregoing and for valuable adequate consideration, the parties hereto hereby agree: -

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SECOND: - Vendor hereby agrees to sell to Vendee, and Vendee hereby agrees to purchase of Vendor, subject to the provisions of the foregoing paragraph, Six Hundred (600) Shares of the Capital stock of Burr Creamery Corporation, if and when Vendor becomes the owner thereof, for the consideration or sum of Sixty Thousand ($60,000.00) Dollars, payable as follows: Twenty-five Thousand ($25,000.00) Dollars thereof cash on the 1st day of January, 1920. The balance of the said purchase price, amounting to Thirty-five Thousand ($35,000.00) Dollars to be paid at the rate of One Thousand ($1,000.00) Dollars per month, the first payment to be made on the 1st day of February, 1920, and on the first day of each month thereafter until the entire amount of said purchase price shall have been paid by said Vendee to Vendor: Deferred payments shall draw interest from January 1, 1920 at the rate of seven (7%) per cent per annum, payable monthly at the time and place of making the said monthly payments. Vendee has the option to pay the whole or any part of the purchase price, in addition to said monthly payments, prior to the maturity of any of them. * * *

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FIFTH: - The parties hereto also agree as part of the consideration for the execution of this agreement that Vendee will, at the option of the Vendor expressed to Vendee in writing, at least ninety (90) days prior to January 1, 1923 purchase the remaining Four Hundred (400) shares of said capital stock of Burr Creamery Corporation on the following terms: For the sum of Forty Thousand ($40,000.00) Dollars, being at the rate of One Hundred ($100.00) Dollars per share, which Forty Thousand ($40,000.00) Dollars shall be paid and is hereby agreed to be paid at the rate of One Thousand ($1,000.00) Dollars per month: the first payment to be made by Vendee to Vendor on February 1, 1923, and a like sum on the first day of each month thereafter until the entire amount of said Forty Thousand ($40,000.00) Dollars shall have been paid to Vendor: the first payment shall draw interest from January 1, 1923, but not before, until paid at the rate of seven (7%) per cent per annum payable monthly at the time and place of making payments on the purchase price for said stock. Vendee has the option to pay the whole or any part of said purchase price in addition to said monthly payments, prior to the maturity of any of them.

If and when Vendor exercises the said option required of Vendee to purchase said Four Hundred (400) shares of the capital stock of the Burr Creamery Corporation, the Vendee shall have the option to require Vendor to assign and transfer said stock to it, said Vendee, upon the books of the Burr Creamery Corporation, in which event said stock shall be immediately transferred and delivered to Vendor as pledgee and by way of collateral security for the making of the payments herein provided for to be made by it to Vendor for said Four Hundred (400) shares of stock: in either event the Vendee shall be entitled, whenever it shall make payments to the Vendor on the purchase price of any of said Four Hundred (400) shares of stock, to secure from the Vendor a release of stock so pledged by it to the Vendor of the face value equal to one-half of such payments being made by it, the purpose being to release an amount of stock at par equal to one-half of the payments made by the Vendee to the Vendor on account of the purchase price; if, however, Vendee does not exercise its option to require said stock to be transferred to it, and such stock shall remain on the books of the Burr Creamery Corporation in the name of said Vendor, then Vendee shall be entitled, and said Vendor agrees to convey to said Vendee a similar amount of stock for payments as and when made to it by the Vendee.

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(Signed) BURR CREAMERY COMPANY

(A corporation)

By E. BURR Its President

By H. A. LOZIER Its Secretary

(Burr Cr'y Co. seal)

CALIFORNIA MILK PRODUCERS' ASSOCIATION

(A corporation)

By B. A. RHOADES Its President

By T. H. BRICE Its Secretary

(Calif. Milk Producers' Ass'n seal)

The petitioner duly transferred the full amount of its authorized capital stock, $100,000 par value, to the Burr Creamery Company for certain of the assets of that company. The assets acquired by the petitioner consisted simply of the equipment used for the distribution of milk.

Pursuant to the terms of the agreement of December 27, 1919, the Burr Creamery Company transferred 600 shares of stock of petitioner to the California Milk Producers' Association and received during 1920 the full purchase price of $60,000 therefor.

Sometime in February, 1920, Burr had a conversation with T. H. Brice, who was manager of the California Milk Producers' Association, and informed him that he would like to have the California Milk Producers' Association take over as soon as possible the remaining 400 shares of stock of petitioner which the Burr Creamery Company held. Brice told him that he would put the matter before the board of directors of the California Milk Producers' Association. Brice told Burr that the California Milk Producers' Association was getting more members and that it would be able to take up the balance of the stock during that year. He told Burr that as fast as money came in from the farmers it would be applied to the purchase of stock. No written request was made by the Burr Creamery Company on the California Milk Producers' Association to purchase the stock.

The minutes of a meeting of the directors of the California Milk Producers' Association held April 23, 1921, contain the following:

Mr. Brice informed the Board that Mr. E. Burr had offered to sell to the California Milk Producers' Association one hundred shares of Burr Creamery Corporation stock for $10,000.00. After a brief discussion Mr. Geo. Thomas moved that we buy this stock. Seconded by Mr. W. J. Coke and unanimously carried. This arrangement to take effect the first of May.

The minutes of a meeting of the directors of the California Milk Producers' Association held June 18, 1921, contain the following:

Mr. Brice brought the matter of Mr. Burr's desire to sell 100 shares of the Burr Creamery Corporation stock to the Association, for $10,000.00. It was moved by Mr. Wicker and seconded by Mr. Frampton that the Association purchase from Mr. Burr 100 shares of the aforesaid stock at $10,000.00. Carried.

The California Milk Producers' Association paid the following amounts on the following dates to the Burr Creamery Company or to Burr for stock of the petitioner corporation:

May 13, 1921	$10,000
June 25, 1921	10,000
July 7, 1922	10,000

The California Milk Producers' Association obtained the money to make these payments by assessing its members 2 cents per pound of butterfat upon their produce. The Burr Creamery Company was legally dissolved by court proceedings on May 13, 1921, and Burr being the sole stockholder, took over any property of the company which remained, including the stock of the petitioner which the Burr Creamery Company held. Each time one of the above payments of $10,000 was paid, Burr, purporting to represent the Burr Creamery Company, assigned to the California Milk Producers' Association a stock certificate representing 100 shares of stock of petitioner. The last mentioned payment of $10,000 went to Burr personally. In 1922 and 1923, Burr held 100 shares of stock of the petitioner. It was not until 1925 that Burr disposed of the remaining 100 shares of stock of the petitioner to the California Milk Producers' Association.

The following is a statement taken from the stock certificate book of the petitioner purporting to show the stockholdings during the years 1922 and 1923:

Name of stockholders	Shares held during period Jan. 1, 1922, to Aug. 2, 1922	Shares held during period Aug. 2, 1922, to July 18, 1923	Shares held during period July 18, 1923, to Sept. 17, 1923	Shares held during period Sept. 17, 1923, to Dec. 31, 1923
California Milk Producers' Association	596	596	896	1,896
Burr Creamery Co	397	397	97	97
E. Burr	1	1	1	1
C. Burr	1
A. Russell
B. A. Rhoades	1	1	1	1
T. H. Brice	1	1	1	1
W. F. Holt
Geo. H. Ennis	1
Geo. M. Brown	1	1	1	1
E. H. Graham	1	1
Geo. R. Frampton		1	1	1
E. A. Bost		1	1	1
Geo. Thomas			1	1
Total	1,000	1,000	1,000	2,000

In 1922 and 1923, the California Milk Producers' Association appointed all the directors of the petitioner.

From January 1, 1920, until May 1, 1925, Burr was manager of the petitioner and received as compensation a straight salary and also a percentage of the profits of the business based upon the amount of stock of petitioner which he owned. The minutes of a special meeting of the directors of the California Milk Producers' Association held August 26, 1922, contain the following:

The matter of Mr. Burr's salary was discussed at length, the Board being of the opinion that Mr. Burr should receive $500.00 per month, starting in from January, 1922, and that 10% of the profits of the Burr Creamery Corporation should go to Mr. E. Burr, and 10% to the employees of the Burr Creamery, and the balance to be paid bonus on milk to the members of the Association. This was recommended by the California Milk Producers' Association Directors to the Directors of the Burr Creamery Corporation to be put into effect as soon as possible.

In 1920 Burr received a salary of $3,600 and $7,200 on the percentage basis. At that time Burr owned 400 shares of the petitioner through his ownership of the Burr Creamery Company. In 1921, he received a salary of $4,700 and $4,800 on the percentage basis. In 1922 he received a salary of $5,200. In 1923, he received $5,200 salary and $20,000 par value stock. In his income-tax returns Burr treated the income which he received from the petitioner as dividends received. A stock dividend was declared by petitioner on September 17, 1923, and Burr received 200 additional shares of stock. At that time he held only 10 per cent of the stock of petitioner, but he received 20 per cent of the additional stock issued by petitioner. During the years 1920 to 1923, inclusive, Burr had not received the exact amount of the agreed percentage of the profits as compensation and half of the stock which he received was intended to cover this deficiency in compensation. A day or two after Burr received this stock he transferred it to the California Milk Producers' Association and received a check for $20,000 therefor. In his income-tax return he reported this $20,000 as a dividend since there would be less tax. Thereafter Burr held only 5 per cent of the stock of petitioner, but he continued to get 10 per cent of the profits.

At December 31, 1921, the petitioner had a surplus of $89,483.56. At December 31, 1922, the surplus was $116,609.21. At December 31, 1923, the surplus was $169,082.83. These amounts were retained in the business of the petitioner for the purchase of additional equipment. The remainder of the profits of the petitioner, other than those paid to Burr as compensation, were turned over to the California Milk Producers' Association at the end of each month. Money was also paid over upon demand of the Association whenever it was available.

In 1922, the California Milk Producers' Association expended $18,496.57 for advertising the milk sold by the petitioner. In 1923 it expended for this purpose $20,724.62. This advertising was authorized by the petitioner, but petitioner never repaid the Association.

The business of the petitioner during 1922 and 1923 was distributing milk, cream and dairy products to its customers. Petitioner obtained raw milk from the California Milk Producers' Association, and Pasteurized it in its plant. The Association charged petitioner the same amount for milk that it charged any other creamery. The California Milk Producers' Association did not produce certified milk and petitioner purchased such milk, amounting to about one-third of the total of milk purchased, from persons not connected with the California Milk Producers' Association. There was a certain class of people who required certified milk and the petitioner, in order to meet competition, had to deal in this type of milk. There was also a comparatively small amount of cottage cheese and butter purchased from persons not connected with the California Milk Producers' Association, but nothing was bought from outsiders that could be bought from members of the Association. The petitioner's percentage of profit on milk which it purchased from persons not connected with the California Milk Producers' Association was about one-half of the percentage of profit on products purchased from the California Milk Producers' Association. No refunds were made to those persons not connected with the California Milk Producers' Association.

The petitioner handled approximately one-third of the milk and cream of the California Milk Producers' Association in 1922 and 1923. The California Milk Producers' Association required petitioner to take all the milk which could not be sold to other creameries. At times this surplus milk was churned and the butter sold to jobbers. Due to the fact that petitioner was required to take this surplus milk, its profits were sometimes reduced and during the last six months of 1922 petitioner operated at a loss.

The following tabulation shows the amounts of produce purchased by the petitioner during the years 1922 and 1923 from the California Milk Producers' Association and from others:

	Purchased from California Milk Producers' Association	Purchased from outsiders	Total combined
YEAR 1922
January	$70,168.79	$16,669.91	$86,838.70
February	63,650.77	15,547.32	79,198.09
March	70,136.24	16,503.95	86,640.19
April	71,067.39	15,544.86	86,612.25
May	74,120.15	16,596.99	90,717.14
June	71,797.82	15,759.05	87,556.87
July	83,580.39	16,525.84	100,106.23
August	85,761.35	16,956.01	102,717.36
September	90,990.92	15,178.43	106,169.35
October	78,495.57	16,613.32	95,108.89
November	79,923.89	16,016.78	95,940.67
December	81,846.11	15,786.37	97,632.48
Total	921,539.39	193,698.83	1,115,238.22
Percentage	82.63	17.37	100
YEAR 1923
January	88,927.94	25,287.53	114,215.47
February	112,395.87	26,161.33	138,557.20
March	127,290.21	23,334.32	150,624.53
April	122,181.41	33,786.13	155,967.54
May	136,083.68	30,677.79	166,761.47
June	126,672.38	30,982.73	157,655.11
July	120,596.61	31,866.99	152,463.60
August	131,509.87	15,759.22	147,269.09
September	128,890.19	14,510.67	143,400.86
October	123,039.12	22,609.22	145,648.34
November	123,568.58	23,900.28	147,468.86
December	133,893.81	22,901.21	156,795.02
Total	1,475,049.67	301,777.42	1,776,827.09
Percentage	83.02	16.98	100

The minutes of the various meetings of the board of directors of the petitioner state that dividends were declared in 1920 and 1921, which are not the years in question, as follows:

Date of meeting	Amount per share of stock
Mar. 31, 1920	$2
July 9, 1920	4
Aug. 25, 1920	2
Oct. 12, 1920	2
Nov. 22, 1920	$2
Jan. 6, 1921	4
Apr. 25, 1921	4
Aug. 22, 1921	4

The minutes of a meeting of the board of directors of petitioner held February 2, 1921, contain the following:

It was moved by Mr. Geo. Frampton and seconded by E. A. Bost that until further notice the profits of the Burr Creamery Corporation, if needed, are to be used for the purchase of real estate, buildings, and creamery equipment necessary for conducting said business; After said real estate and buildings, and creamery equipment is paid for, Mr. E. Burr is authorized to draw out his percentage of the profits earned by the Corporation. The motion carried.

The deficiency letter, dated February 23, 1927, states in part as follows:

You are advised that this office holds that in this case Article 522 of Regulations 65 as amended is controlling. According to the provisions of that Article, an exempt cooperative association must show that it "has not voluntarily sold or issued any (common) stock to non-producers." The evidence submitted shows that the BURR CREAMERY CORPORATION did sell stock to others than producers who marketed their products through the organization and is, therefore, not entitled to exemption under section 231(12) so long as 10% of its capital stock was held by others than producers.

OPINION.

MCMAHON: The only question here presented is whether the petitioner is exempt from tax for the years 1922 and 1923 under the provisions of the Revenue Act of 1921. Section 231(11) of that act provides.

That the following organizations shall be exempt from taxation under this title:

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(11) Farmers', fruit growers', or like associations, organized and operated as sales agents for the purpose of marketing the products of members and turning back to them the proceeds of sales, less the necessary selling expenses, on the basis of the quantity of produce furnished by them.

The petitioner contends that during the years in question all of its stock was owned by the California Milk Producers' Association, a mutual cooperative organization, which, it has been stipulated, was during the years in question exempt from tax under section 231(11) of the Revenue Act of 1921, and that, being the subsidiary of an exempt organization, petitioner is also exempt. As a basis for the contention that the California Milk Producers' Association owned all of the stock of the petitioner during the years in question, petitioner claims that under the written agreement of December 27, 1919, between the Burr Creamery Company and the California Milk Producers' Association, the former company exercised its option of requiring the latter organization to purchase the remaining 400 shares of stock of the petitioner which the former company held.

However, irrespective of whether the California Milk Producers' Association owned all the stock of the petitioner in the years in question, we do not believe that the petitioner is entitled to exemption under section 231(11) of the Revenue Act of 1921. Since this section grants exemption from taxation, it must be strictly construed. A taxpayer attempting to avail itself of the benefits of this section must prove clearly that it comes within its provisions. , and ; affd., . We can not go beyond the plain terms of the statute. Clearly, the petitioner did not operate in the manner contemplated by the statute. It did not have members for whom it acted as sales agent and to whom it turned back the proceeds of sales, less the necessary selling expenses, on the basis of the quantity of the produce furnished by them. This petitioner being an entity entirely separate from the California Milk Producers' Association, even though all its stock were owned by the California Milk Producers' Association, must meet the test of the statute. To hold that the members of the California Milk Producers' Association were indirectly "members" of the petitioner would, we believe, be putting a strained construction upon the statute. Even if we were to so hold, we would then be confronted with evidence that approximately 17 per cent of the total products purchased by petitioner in the years in question were obtained from persons who were not members of the California Milk Producers' Association, a situation inconsistent with the idea of cooperative enterprise. See . We therefore hold that the respondent did not err in denying exemption to the petitioner.

Judgment will be entered for the respondent.