Legal Ruling 1965-289

Cooperative: Deduction of Excess Expenses

The facts are, briefly, that cooperatives contend in determining their net income that they may deduct all operating expenses and also, with respect to business done with members and done with nonmembers on a nonprofit basis, are entitled to a deduction of the gross income under Sections 24404 and 24405 of the Bank and Corporation Tax Law.

For the purpose of computing the taxable income of cooperatives should the expenses incurred in producing member and nonprofit income, to the extent the expenses exceed such income, be used to offset income from business done with nonmembers for profit?

The theory that a cooperative is entitled to deduct from its gross income all its gross income from business activities with members or from nonprofit business activities with nonmembers plus all the expenses incurred in earning that gross income is completely at variance with the established principle of construing the deduction provisions of an income tax law so as to preclude the deduction twice of the same item. Furthermore, as might be expected from this rule against double deductions, that treatment clearly would defeat the legislative intent as to the taxation of cooperatives.

It is clearly apparent from a reading of Sections 24404 and 24405 that they provide different treatment for two classes of income, namely:

1. income from business activities with members and from nonprofit business activities with nonmembers, and
2. income from business activities on a profit basis with nonmembers.

It is equally apparent that the Legislature desired to relieve from taxation the first class of income but to apply the tax with respect to the second class of income.

The Board's method of treating cooperatives achieves this legislative objective in all respects. In fact, only by so treating a cooperative having both classes of income may that objective be attained.

Under a contrary position cooperatives would always have a loss from their cooperative business in the amount that expenses were incurred in carrying on that business, and this loss would substantially, if not entirely, offset income from profit-making activities, which should be taxable.

Even if it were assumed that the deduction permitted by Sections 24404 and 24405 is the entire gross income from member and nonprofit business, the cooperative would not be entitled to also deduct a net loss incurred in producing that income. Section 24425 provides that in computing net income no deduction shall be allowed for any amount otherwise allowable as a deduction which is allowable to one or more classes of income not included in the measure of the tax imposed by the Bank and Corporation Tax Law. Application of this section in computing the net income of a cooperative will lead to the same result as is reached under the Board's method.