The cooperative is a form of organization for business or for consumers that works for the betterment of the local community - its people, environment, and its economy.
This is Part 3 in a three-part series on co-ops.
Part 1 is here http://caucus99percent.com/content/resilience-co-ops-101-introduction-co...
Part 2 http://caucus99percent.com/content/resilience-co-ops-101-introduction-co...

If you haven't noticed by now, allow me to point out that in the Resilience Group we're building a resource base for political revolution at the local community level. (And at the personal level.)

* We have a four-part series on Democratic Socialism herehttp://caucus99percent.com/content/local-resilience-democratic-socialism...
* We have this three-part series on the basics of Cooperatives, with many more specific posts planned.
* We have the concrete examples of towns that have transformed themselves into flourishing local resilience:
Totnes, England, the most resilient town in the world and founder of the global Transition Town movement. See here http://caucus99percent.com/content/local-resilience-transition-town-totn...
Wilpoldsried, Germany, which used renewable energy to transform itself into a resilient social-democratic rural town. See here http://caucus99percent.com/content/resilience-democratic-socialism-appro...

If we keep at it, we will collect tons of resources on c99 for folks willing and able to do the work of transforming their local communities. The Community Page will continue to raise consciousness of the iniquities of our corporate-ruled world. And the Resilience Group will continue to build resources for building resilient local communities and resilient individuals to thrive despite the corporatist rule.

As for Part 3 of Co-ops 101, see below.

Might as well play the good old stuff

Corporate capitalism has failed western societies. In the western world, inequality is at its highest on record, the environment is threatened, and local communities have become corporate dependencies. Presently, many businesses in a community are not local, but are franchises of a national or multinational corporation that pays its workers as little as possible, ruins the environment, and sends the profits to investors far away. Many consumers are left isolated individually with no bargaining power.

In order to grow resilient local economies, communities will have to develop co-operative local businesses and local organizations to break the stranglehold that multinational corporations have on them.

Set out below is an overview of cooperatives, summarized from a 1997 U.S. Department of Agriculture Information Report.* Please note that the report is from 1997. Laws, sigh, change. But this gives the general picture.

Folks, this really is Co-ops 101; it's a basic, simple introduction. Following this series, we'll get into the details of various co-ops and especially workers co-ops and credit unions.

I should emphasize their importance: co-ops are the primary vehicle for weaning a local community off of perfidious corporations. The only legal forms of conducting in towns should be single-owner, partnership, and co-op.

The corporation has no place in the human future: it is a sociopathic invention by pathologically greedy people to rob society blind.

Chapter 8: Sources of Equity

One of the greatest challenges facing cooperatives is raising equity capital.
Because cooperatives pass earnings through to users on a patronage basis, they cannot attract equity from outside sources to the same extent as investor-owned businesses. Cooperatives are not alone.
Sole proprietorships, partnerships and closely held corporations face similar problems acquiring equity.
Their equity capital usually is provided by the owners or acquired via retained earnings.

Only a single tax is placed on their income, to help overcome the capital accumulation problem.
Earnings of investor-owned corporations are subject to taxation twice, once at the corporate level when earned and again at the ownership level if and when distributed as dividends.
Owner(s) of a sole proprietorship, partnership, limited liability company or cooperative can generally reduce tax liability at the firm level if they meet specific Internal Revenue Code (Code) requirements.
A greater portion of income is therefore available for reinvestment in the business.

The three primary ways members provide equity to their cooperative are:

• direct investment,
• retained margins, and
• per-unit capital retains.
• nonmember/non-patronage earnings

Direct Investment
Direct investment refers to cash purchases of membership certificates, common and preferred stock or other forms of equity.
Most cooperatives require a member to make a direct payment when joining the cooperative. In return, the member receives a membership certificate in a non-stock cooperative or a share of common stock in a stock cooperative.
The certificate or share of stock usually conveys to the owner the right to vote on matters submitted for decision to the cooperative membership and the owner is generally referred to as a member of the cooperative.
Direct investment by members is often a minor source of equity to a cooperative.
Most cooperatives are trying to retain current members and attract more members and member business. And members generally prefer the cooperative to generate its own equity, rather than solicit checks from them. Thus the cost of a membership certificate or share of common stock is usually modest.
Equity that evidences membership usually does not pay a dividend.

Retained Margins
While cooperatives are sometimes described as businesses that operate “at cost,” few if any can do so on a day-to-day basis. Rather, cooperatives seek to generate income that exceeds expenses on an ongoing basis. Then, usually after the close of the fiscal year, they return earnings from business conducted on a cooperative basis to the persons responsible for the business generating those earnings, who are called patrons.

These returns, based on the amount of business each patron does with the cooperative during the year, are called “patronage dividends” in the Code. This report refers to them as “patronage refunds,” the term used in cooperative literature. This reduces the likelihood such refunds will be confused with traditional dividends, which are based on stock ownership rather than the amount of business conducted with the firm.

The board usually determines how the earnings will be distributed.
All of the earnings may be returned to the patrons as cash patronage refunds.
Or the directors may decide to have the cooperative retain some or all of the patronage refunds as an equity investment in the cooperative.
Single tax treatment is available only for patronage-sourced earnings that are returned to the patrons as cash or “other property,” or retained under procedures set out in the Code.

Per-Unit Capital Retains
Cooperatives that market products produced by their members have a third means of acquiring equity capital, per-unit capital retains.
These are capital investments based on either the number of physical units handled by the cooperative or on a percentage of sales revenue. Per-unit retains are deducted from sales proceeds due the members from the cooperative.

As with patronage refunds, per-unit capital retains returned to patrons as cash or retained by the cooperative, under rules in the Code, are only subjected to a single income tax.
And again, single tax treatment is discretionary. A cooperative may place some or all of these retains into an unallocated reserve, thereby forfeiting access to single tax treatment.

People sometimes blur the distinction between patronage refunds and per-unit capital retains.
Patronage refunds are based on the earnings of the cooperative; per-unit retains on the volume or value of business done with the cooperative. Thus, a cooperative can acquire capital, even in a year of limited margins or a loss, through the use of per-unit capital retains.

Nonmember/Nonpatronage Earnings
Non-tax laws, such as the Capper-Volstead Act and state cooperative incorporation statutes, frequently require affected cooperatives to do a majority of their business with members.
This still leaves those associations free to do up to 49 percent of their business with nonmembers on a non-cooperative basis.
Earnings on this business are usually not eligible for single tax treatment.
But the after-tax earnings can be used to build the equity base of the cooperative to improve its balance sheet and finance services it provides to members.
Again, an exception is made for section 521 cooperatives, which may deduct non-patronage income distributed to patrons on a patronage basis.

Chapter 9; Financial and Tax Planning

Sources and Types of Equity

An understanding of the alternatives and their tax treatment is especially important when allocating patronage-based sources of equity, retained margins, and per-unit retains.

Direct investments usually are made to purchase membership equity, the membership certificate or a share of common voting stock.

Non-patronage income is likewise usually placed into a single type of account, an unallocated reserve.

Patronage-based sources of equity can be used for at least four purposes:

• cash refunds,
• qualified retained patronage allocations,
• non-qualified retained patronage allocations and
• unallocated reserves.

Cash Refunds
Cooperatives can distribute their margins and per-unit capital retains as cash refunds to the patrons.
Cash distributions are generally tax deductible by the cooperative in the year earned and taxable income to the recipient in the year of receipt.
Cash refunds do not add to the equity of the cooperative, but provide an immediate additional return to the patron on his or her use of the cooperative.

Qualified Retains
Cooperatives can retain margins and per-unit capital retains and allocate the retained funds to equity accounts of the patrons, based on the amount of business each patron did with the cooperative during the year.
If the cooperative follows the rules in the Code to “qualify” the equity, the cooperative deducts the amount of the allocations from its taxable income in the year the margins and retains were realized.
Patrons include the amount allocated in their taxable income in the year they receive a required written notice of the allocation.
The retained funds become an equity investment by the patron in the cooperative.
An example illustrates how this works for a typical agricultural marketing cooperative.

The cooperative pays the producer $600 for his/her crop at the time of delivery.
It costs the cooperative $300 to market the crop. The cooperative sells the crop for $1,000.
The resulting margin of $100 is returned to the patron as a patronage refund.
Thus the patron receives a total payment of $700 for the crop, a $600 advance at the time of delivery and a $100 patronage refund.
When the cooperative figures its taxable income, it is allowed to deduct the initial payment for the crop ($600), its other expenses of marketing the crop ($300), and the patronage refund ($100).
Thus, it ends up with no taxable income.
The patron includes both the initial payment ($600) and the patronage refund ($100) in taxable income, for a total of $700.

Tax Treatment Of Cooperative And Patron
The Code requires at least 20 percent of a qualified patronage refund be paid in cash.
But the cooperative can still retain up to 80 percent of its margins without having to pay a tax (at the co-op level) on any of the patronage refund.
There is no 20-percent cash distribution requirement for qualified per-unit retains, so a cooperative can keep the entire amount free of tax liability at the co-op level.

The patron must report the entire $100 refund as taxable income, even though $20 or less may have been paid in cash. The redemption of qualified equity is a tax-free event for both the cooperative and the patron, since the tax was paid by the member when the patronage refund was received.

The tax treatment of qualified retained equity is similar to the pass-through procedures that provide single tax treatment for partnerships and other single-tax corporations. But, cooperatives have additional flexibility not generally available to other pass-through entities.

Non-qualified Retains
Cooperatives may delay the pass-through of the tax obligation from the cooperative to the patron without jeopardizing single tax treatment of those moneys. Any patronage-based allocation not meeting the requirements of the Code to be “qualified,” has “non-qualified” status.
When a non-qualified allocation is made, the cooperative pays corporate income taxes on the funds retained. The patron has no tax obligation on these funds in the year of allocation.

Non-qualified Retained Equity
If the cooperative in the earlier example issues its patronage refunds as non-qualified written notices of allocation, it would have taxable income of $100, the amount of the margin. The patron’s taxable income would have been $600, the payment for the crop.
At some later time, when non-qualified retained equity is redeemed, the cooperative receives a tax benefit based on the tax paid at the time of allocation. The patron is taxed on the funds received.
In the example, the cooperative would deduct the $100 paid to the patron (or receive a credit under certain circumstances). The patron would report the $100 as income in the year the cash payment was received.

Thus the single tax treatment of cooperatives doing business with or for members is complete and consistent with that accorded other single-tax entities. Income is ultimately taxed once, at the level of the owner-user of the business.
Non-qualified allocations have particular appeal to cooperatives with member-patrons in high marginal tax brackets.

If the cooperative uses qualified allocations, it must make substantial cash payouts or high income patrons may suffer a negative cash flow on the margins they generate. This occurs when the total tax owed on the allocation (Federal and State) exceeds the amount of cash paid out as part of the distribution.
By using non-qualified allocations, no tax is due from patrons until the allocation is redeemed. Also, there is no 20-percent cash payout rule for non-qualified allocations.

Unallocated Reserves
Cooperatives can treat margins just as noncooperative firms treat earnings, by putting them into an unallocated reserve and paying corporate income tax. Under this approach, single tax treatment is forfeited. If the funds are later distributed, the recipients must pay a second income tax.
Cooperatives are free to use a combination of cash payouts, unallocated reserves, and qualified and nonqualified allocations. This makes it possible for the leadership to develop a program that reflects the best interests of the membership.

Chapter 10: Equity Management

Another practice unique to cooperatives is the regular redemption of outstanding equity. Capital contributions from continuing patrons build as time passes. But the level of patronage will fall for some members, and others will likely cease using the cooperative at all. A program of adjusting patronage based equity requirements on a regular basis matches the responsibility of financing the cooperative to current use of its services.

Three methods of matching patronage and equity obligations have achieved general acceptance:

• revolving fund plans,
• special plans, and
• base capital plans.

Although the systems are often viewed as unrelated, they may, in fact, operate together.

Revolving Fund Plan
“Revolving fund financing” refers to systems in which patrons make annual capital contributions, typically through retained patronage refunds or per-unit retain allocations.
The cooperative, in turn, redeems earlier capital contributions on a regular basis. Redemption is usually on a first-in, first-out basis.
The cooperative determines what its total capital requirements are and the excess is redeemed each year, the earliest or “oldest” equity being revolved out first.
A revolving fund plan is frequently described as “systematic” if older equities are retired on a regular basis, usually a given number of years after they were issued. In a systematic plan, member investment is related to recent and current use.
Newer members usually add equity to their account during their early years in the cooperative.

The accounts of established members are adjusted each year to better reflect current patronage.
They make new investments based on current year’s patronage and have their earliest year’s equity redeemed.
The accounts of former members are commonly paid off during the life of the revolving cycle, usually beginning the year after they cease patronizing the cooperative.
Redemption is normally dependent on a board of directors determination that funds for revolvement are available.

This insures that there is room for flexibility if the situation warrants it.
For instance, if there is a shortfall in new equity or a need to increase the cooperative’s total equity, equity requirements can be met by lengthening the revolving cycle (the cooperative keeps equity for a longer period of time).
This tactic should be used sparingly, as it deviates from the objective of having current users finance the cooperative. Also, it can create member relations problems if the members have the expectation that their oldest equities will be redeemed on a fixed schedule, sometimes without regard for the cooperative’s financial condition.

Special Plans
A special plan is one in which a specific event or condition, such as a member’s death, triggers equity redemption. The most common events covered are death, retirement or reaching a specified age.
Once the condition is verified, the member’s equity may be returned at once or over a prescribed number of years.
Special plans are often popular with members, who see redemption of their equity investments supplementing retirement income or their estates.

But special plans can complicate financial planning for the cooperative.
One problem is forecasting how much equity will be redeemed in a given year.
Another difficulty is dealing fairly with members who are partnerships or corporations and whose business activity or life may continue well beyond that of individual partners or shareholders.
One approach is for the association to redeem that portion of the member firm’s equity equal to the ownership interest in the firm of the person meeting the special redemption condition.
Then the firm would be expected to make up the difference just as if it had been under-invested by the amount of the redemption.
Special plans are sometimes combined with revolving fund or base capital plans.

Base Capital Plan
A “base capital plan” is a special equity capital management plan. It focuses directly on the current proportion of capital a patron should have in the cooperative at a particular time, based on the degree of use.

Development of the base capital plan involves several steps.

• 1. The cooperative determines its total equity capital needs.
• 2. The equity capital needs are allocated among patrons based on the proportion of the cooperative’s business each patron did with the cooperative during a base period, typically the past 3 to 7 years.
• 3. Each year the cooperative’s equity requirements are reviewed and adjusted as the board of directors finds appropriate. Each patron’s share of the equity requirement is also adjusted to reflect (a) any change in the total requirement of the cooperative and (b) any change in the patron’s proportional share in the new base period.
• 4. Under invested patrons must add to their equity account, usually through the current year’s retained patronage refunds or per-unit retains, or by direct contribution.
• 5. Fully invested and over-invested patrons generally are paid a cash rebate of current year’s patronage refunds and per unit retain allocations. Over-invested patrons may receive an additional payment in redemption of their excess share of the equity.
• The proportional share of former patrons will fall each year, reaching zero at the end of the base period beginning the first year after they cease patronizing the cooperative.

That is the end of Co-ops 101: An Introduction to Cooperatives.

Concluding Thoughts

The most important difference between a corporate business and a cooperative business is that the co-op structure motivates people to, well, co-operate, whereas the corporate structure motivates people towards greed without personal responsibility.

This fundamental difference is the basis upon which we have to build a new economy.

Cooperatives must play a large role in a new foundation for a new economy, one where there is more balance between the three domains of sustainability: the economy, the society, and the environment.
And if we promoted co-operatives as the basic form of organization for a new economy, we would would not be starting from scratch. Look where we are already.

We need sustained consciousness-raising, determined innovation, and local community action to promote the co-operative business model as part of the foundation of a new, fair, green economy towards a sustainable future. More on this in posts to come.

As always, I look forward to your comments. I would love to hear your stories of how co-ops changed your local community.

Peace be with us, if we use the co-operative instead of the corporation,
gerrit

*This summary was taken from Co-ops 101: An Introduction to Cooperatives.
It was written Donald A. Frederick, Program Leader, Law, Policy & Governance, Cooperative Resources Management Division, Rural Business-Cooperative Service, U.S. Department of Agriculture.
It is called Cooperative Information Report 55 (April 1997, Slightly revised June 1997.)