Some Aspects of the Taxation of Canadian Co-operatives
Daniel Ish *
I.
INTRODUCTION
II. THE NATURE OF CO-OPERATIVE INCOME
A. THE PROBLEM STATED
B. THE CO-OPERATIVE – MEMBER RELATIONSHIP
NON-INCOME CO-OPERATIVES
IN
III. TAXATION OF CO-OPERATIVE INCOME
A. BACKGROUND: THE INCOME WAR TAX ACT, 1917 – 1946
B. THE PRESENT INCOME TAX ACT
1. Deduction of Patronage Dividends
2. Exempt Co-operatives
C. TAXATION OF THE CO-OPERATIVE CUSTOMER ON
PATRONAGE DIVIDENDS
IV. OBSERVATIONS AND PROPOSALS
A. THE NON-PROFIT CO-OPERATIVE
B. THE NON-INCOME CO-OPERATIVE
C. THE INCOME EARNING CO-OPERATIVE
D. CONCLUSION
* Of the Faculty of Law, McGill University, and the Bar of the Province of
Alberta.
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I.
INTRODUCTION
Co-operatives have traditionally been regarded as economic
organizations differing somewhat from the ordinary business cor-
poration, but there is no authoritative definition of a co-operative that
is universally accepted. One Canadian writer has attempted to define
a co-operative as
… a voluntary democratically controlled association of persons who
operate an enterprise for the purpose of supplying
themselves with
commodities or services, on the basis that they share any surplus created
in carrying on the enterprise substantially in proportion to the use they
make of the association.’
Co-operatives are incorporated under provincial 2 or federal 3
legislation in much the same way as are other corporations and they
possess many of the characteristics common to all corporations.
However, there are a number of important differences which are
traditional features of co-operatives and which are reflected in the
incorporating statutes. Co-operatives have been characterized, in
contrast to ordinary business corporations, as lacking the speculative
or profit making element. The main objective of the common
business corporation is to reap a return to investors based on the
amount of capital invested in the corporation by the shareholder,
while the co-operative de-emphasizes the role of the member as
investor and stresses his role as patron. The aims of a co-operative
have recently been succinctly stated to be:
to socialize the interests of the members by eliminating or minimizing
…
the role of the member qua investor and maximizing the role of the
member qua patron, restricting the return on invested capital to a
nominal rate, requiring that the surplus of the co-operative be distributed
to the members according to their patronage rather than their investment
and by substituting for the capitalist principle of “one vote per share”
the co-operative principle of “one vote per member” regardless of the
number of shares
1W.B. Francis, Canadian Co-operative Law (1959), 1.
2 Each province in Canada has specific legislation relating to the incorpora-
tion of co-operatives. All provinces have a separate co-operative statute except
Ontario and Manitoba, which have special parts of the general companies
legislation devoted to co-operatives; see The Corporations Act, R.S.O. 1970,
c.89, Part V and The Companies Act, R.S.M. 1970, c.160, Part X.
3 Canada Co-operative Associations Act, S.C. 1970-71-72, c.6.
4 Report on Co-operatives (Select Committee on Company Law, Ont. 1971), 2;
most co-operative incorporating legislation enshrines these basic co-operative
precepts. See Canada Co-operative Associations Act, ibid., which allows an
association organized on a co-operative basis to seek incorporation (s.5); “co-
operative basis” is defined in s.3(1)(d) as meaning “the carrying on of an
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Co-operatives have become “big business” in Canada 5 and im-
portant questions arise as to the treatment they have received and
are receiving under Canada’s income tax laws. An attempt here is
made to analyse and exaluate the position of co-operatives from an
income tax point of view.
II. THE NATURE OF CO-OPERATIVE INCOME
A. The Problem Stated
Co-operatives in Canada fall into two general categories for the
purposes of taxation: the non-income co-operative and the income-
earning co-operative6 The income-earning co-operative is the type
of main concern for income tax purposes as the problem of taxation
clearly does not arise if the particular co-operative enterprise is
deemed to have no income. However, the distinction is more than
enterprise organized, operated and administered in accordance with the
following principles and methods:
(i) except in the case of an association the charter by-laws of which
otherwise provide, each member or delegate has only one vote,
(ii) no member or delegate may vote by proxy except that a member
of an association may vote by proxy for the election of directors if the
charter by-laws of the association so provide,
(iii) interest or dividends on share or loan capital is limited to the per-
centage fixed in the articles of incorporation or application for con-
tinuation, or by-laws of the organization, and
(iv) the enterprise
is operated as nearly as possible at cost after
providing for reasonable reserves and the payment or crediting of in-
terest or dividends on share or loan capital; and any surplus funds
arising from the business of the organization, after providing for such
reasonable reserves and interest or dividends, unless used to maintain
or improve services of the organization for its members or donated for
community welfare or the propagation of co-operative principles, are
distributed in whole or in part among the members or the members and
patrons of the organization in proportion to the volume of business they
have done with or through the organization.”
5See Co-operation in Canada (Dept. of Agriculture, Can. 1972), 7, where
it is stated that the gross volume of marketing and purchasing co-operatives
in Canada exceeded $2.6 billion in 1972. Marketing and purchasing co-operatives
compose the bulk of co-operative business in Canada; the former include
the large marketing co-operatives which are formed for the purpose of
marketing their members’ products and the latter include the typical con-
sumer co-operative.
69Formerly there existed a third category for tax purposes: newly or-
ganized co-operatives could claim complete exemption under s.73(1) of the
Income Tax Act, R.S.C. 1952, c.148; see infra, Part III.
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of academic interest as several co-operatives have been found to
come within the former category with the result that surplus retained
or earned by the enterprise was not taxable in its hands. The
deductions allowed co-operatives 7 only become relevant once sums
are brought within the taxing statute. If an amount is not income
within the meaning of the Income Tax Act, the question of exemp-
tions or deductions never arises.
In Canada an incorporated co-operative, like an ordinary business
corporation, is a “person ‘ 8 within the meaning of the Income Tax
Act and is liable for income tax on what it receives in the nature of
a profit or gain. If at the end of a given accounting period the
co-operative is in possession of more than in the beginning of the
period, the question arises as to the taxability of the surplus.
However, if it can be shown that the surplus does not belong to the
co-operative, that is, the co-operative does not own or have a right
to the surplus, then it is arguable that it cannot be taxed on the
amount. Hence, the co-operative may then be deemed to be a non-
income co-operative.
If the co-operative as a separate entity has not earned the surplus
or does not have a right to it, who does have the right? The obvious
answer is that the right belongs to the members or shareholders.
It is thus essential to determine the circumstances which must exist
before that co-operative will be deemed to be of the non-income type
and therefore not taxable on surplus which it may possess. This
determination depends upon the nature of the relationship that exists
between the member and the co-operative. If it is such that the
member has a right to the surplus or, conversely, that the co-
operative has no right to the surplus, it can be said that the
amount is not taxable in the hands of the co-operative. The courts
have found the relationship between member and co-operative to be
one of agency, trust or some contractual relationship less than a
legal agency or trust in holding that a particular co-operative did not
possess sufficient ownership in the surplus to be taxable on it.
What must be ascertained, then, is the relationship which must exist
between the co-operative and member to bring about this result.
7 Income Tax Act, S.C. 1970-71-72, c.63, s.135 allows for deduction of patron-
age dividends in the computation of taxable income; see infra, Part III.
8 Ibid., s.248(1) defines “person” as including “any body corporate and politic,
and the heirs, executors, administrators or other legal representatives of such
person, according to the law of that part of Canada to which the context
extends”.
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B. The Co-operative- Member Relationship in Non-Income
Co-operatives
To determine whether or not a co-operative as an entity separate
and apart from its members earns an income in its own right, the
relationship between the co-operative and the member must be
analysed. The issue first arose in two cases which came before the
Supreme Court of Canada within a year of each other.
In M.N.R. v. The Saskatchewan Co-operative Wheat Producers
Ltd.9 the Supreme Court of Canada had to decide whether certain
deductions from sale proceeds which were placed in a reserve fund
were taxable in the hands of the co-operative as income. The
respondent, commonly known as the Saskatchewan Wheat Pool, had
been incorporated for the purpose of enabling its members to market
their grain co-operatively. Shares in the co-operative were issued
only to Saskatchewan grain growers who entered into an agreement
with the company for the marketing of grain.
The memorandum of association stated that the objects were,
inter alia, to buy, sell, market, and export grain either as principal
or agent and to act as agent or broker for its shareholders. The
articles of association provided that no profit was to be made by
the co-operative on the marketing of grain. The memorandum of
association also contained a provision prohibiting the declaration
or payment of a dividend to the shareholders. In addition to being
subject to the memorandum and articles of association, each member
entered into a marketing agreement with the co-operative, the terms
of which were very important in the ultimate determination of the
case. The agreement contained a clause under which the member-
grower appointed the co-operative as his sole agent for the purposes
of marketing the grain. The agent’s powers included borrowing on
its own account on the security of the member’s grain and exercising
all rights of ownership without limitation in respect of the grain.
The marketing agreement also allowed certain deductions to
be made by the co-operative from the gross returns upon sale
of the wheat. The first deduction was an amount necessary to cover
all operating costs; the second allowable deduction was a com-
mercial reserve “to be used for any of the purposes or activities
of the association”. 10 A maximum of one per cent of the gross selling
price of the grain could be deducted as a commercial reserve. In
9 [1930] S.C.R. 402, [1928-34] C.T.C. 47.
10 Ibid., 405 and 50.
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addition, the co-operative could deduct a third amount, known as
the elevator reserve, to be used for future capital expenditures.
The amount reserved was not to exceed two cents per bushel
calculated on the quantity of the grain sold. The amounts deducted
by the Saskatchewan Wheat Pool in the years 1925 and 1926 as
commercial and elevator reserves totalled over $3 million. It was
this amount that was in question for income tax purposes.
A further provision stated that the amounts deducted were to be
credited on the books of the co-operative to the member, However,
the member had no absolute right to realize upon the amounts
credited to him: this was a matter within the discretion of the
directors and, according to the evidence before the Court, such a
distribution was made only in exceptional circumstances.”
On the basis of the terms of the marketing agreement, the Court
held the co-operative association to be the agent of its shareholders.
The reserves were merely advances made by the growers to their
agent, the co-operative, to enable it to carry out marketing oper-
ations. The Court stated that the co-operative was “merely machinery
for collecting contributions from the growers [members], not
as shareholders of the Association but as subscribers to the fund,
and for using those moneys for the benefits of the growers and
handing them back in some form or other when -no longer re-
quired.
…. s The sums therefore were found not to be “profits or
gains” of the- co-operative and thus not taxable under the Income
War Tax Act. 3
The Supreme Court of Canada arrived at this conclusion notwith-
standing the fact that the property in the grain and the proceeds
therefrom vested in the co-operative and did not remain with the
member. Lamont J., who delivered the judgment of the Court, stated:
… the marketing agreement and the confirming Act do more than simply
create the relationship of principal and agent, or mercantile agent, in
the ordinary sense, between the growers and the Association. That
relationship the agreement, without doubt, creates, but, in addition
thereto, the property in the grain and in the proceeds is vested in the
Association and all rights of ownership thereto without limitation are
exercisable by it, for all or any of the purposes set out in the agreement. 14
“1 Ibid., 408 and 53, where the Court stated: “The only distribution that has
been made of the principal moneys of the two reserves has been in cases
where the grower, [member], died, leaving his family in not very affluent
circumstances”.
12Ibid., 416 and 59.
Is R.S.C. 1927, c.97.
14 Supra, f.n.9, 409 and 53.
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Without expressly referring to it, Lamont J. here is perhaps finding
the relationship between the co-operative and member-grower to be
one more akin to a trust relationship than an agency relationship,”,
In either case, however, the co-operative would be considered to be
the non-income type as the surplus retained by it is held for the
benefit of its members.
However, it must be noted that in the Saskatchewan Wheat Pool
case there was no obligation upon the co-operative to distribute the
reserves among the members. Notwithstanding the fact that it was in
the absolute discretion of the directors to make such a distribution,
the surplus placed in reserve was held not to be a profit of the
co-operative. The Court met this point by stating:
… there is no necessity for any contractual or statutory obligation. As
the growers who contribute the reserves have, in their capacity as share-
holders who elect the directors, the absolute control and management
of the Association, it must be amenable to their will without any express
provision to that effect.16
This statement, it is submitted, does not recognize the separation
of ownership and control which exists in large corporations whether
they be co-operatives or ordinary business corporations.17 It seems
to be a sanguine expectation which bears little relevance to the
practicalities of the situation. Although ultimate authority may exist
with the member qua shareholder, is it reasonable to suggest that
the corporate entity, although a co-operative in form, should not be
taxable on funds used for expansion purposes, especially where the
members have no right to receive or claim the amounts that are
ostensibly held on their behalf? The question may be asked whether
co-operatives in reality are in a different position from ordinary
business corporations in this respect.
The Saskatchewan Wheat Pool case recognizes that co-operatives
can arrange their affairs so that all of the surplus from operations
will belong to the members. However, as was indicated by the
15 Although agents and trustees are both fiduciaries, there are certain usual
differences, e.g., the trustee usually has legal title to the property with which
he is dealing whereas the agent usually does not have title; see further for a
comparison of the two relationships S.J. Stoljar, The Law of Agency (1961),
10; R.H. Maudsley, Hanbury’s Modern Equity (1969), 87; G.H.L. Fridman,
The Law of Agency (1971), 15.
I’6 Supra, f.n.9, 415 and 59.
17 See generally, AA. Berle, Property, Production and Revolution (1965) 65
Colum.L.Rev. 1; E. Rostow, “To Whom and For What Ends is Corporate
Management Responsible?”, in E.S. Mason (ed.), The Corporation in Modern
Society (1970), ch. 3; A.A. Berle and G.C. Means, The Modern Corporation and
Private Property (1933).
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TAXATION OF CANADIAN CO-OPERATIVES
Supreme Court of Canada, “each case must depend upon its parti-
cular facts”.’ 8 In this case three factors deprived the surplus of its
character as income in the hands of the co-operative: (1) the articles
provided that no profit would be taken by the co-operative and no
dividend would be paid on the shares; (2) the reserve funds were
credited on the books of the corporation to the members; (3) the
marketing agreement that each member had with the co-operative
created a principal-agent relationship between member and co-
operative.
It is interesting that the same Court one year earlier reached an
opposite conclusion on similar facts. In Fraser Valley Milk Producers’
Association v. M.N.R.19 reserves retained by the co-operative were
also in question. Here, however, the amounts had been returned
to the members, yet were held to be taxable. The agency argument
was put forth by the co-operative but with no success. The dividends
were not paid on the basis of patronage but on the basis of paid-up
capital and therefore the Court refused to treat the co-operative any
differently than an ordinary business corporation. Herein lies the
distinction between the two decisions: in the Saskatchewan Wheat
Pool case the amounts credited to the shareholders were in propor-
tion to business contracted with the co-operative, whereas in the
Fraser Milk case the dividend was simply a return on capital.2 0
If the surplus is credited or paid to the member in his capacity as
shareholder, the amounts are considered income of the co-operative
and are therefore taxable as such. However, if the surplus is credited
or paid to the member in his capacity as patron, then the amounts
may never be considered as income of the co-operative; this is
contingent upon a finding in each particular case that the member
has a legal right to the surplus. As we have seen, the Court referred
to this relationship as one of agency in the Saskatchewan Wheat
Pool case. The agency was based on the particular marketing
contract in that case, but perhaps the same type of relationship
could be created by statute or by the corporate constitution.
In the Fraser Milk case the Court appeared to place reliance on
certain provisions of the British Columbia Co-operative Associations
Act under which the co-operative had been incorporated.2 ‘ The
statute used the word “profit” in describing the surplus of the
association and the Court concluded that a “profit-making concern”,
18 Supra, f.n.9, 415 and 59.
19 [1929] S.C.R. 435, [1928-34] C.T.C. 22.
20 Ibid., 438 and 25.
21 Ibid., 439 and 27.
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was contemplated, apparently placing some reliance upon this ter-
minology in holding the surplus to be taxable. It is interesting to note
that the British Columbia statute now avoids the use of the word
“profit”, simply using the neutral word “surplus”. 22
The agency principle enunciated in the Saskatchewan Wheat Pool
case has been followed often in cases involving marketing co-
operatives. The Tax Appeal Board in 1952 held that a Manitoba
dairy co-operative was exempt from taxation under the Income War
Tax Act on the basis that the co-operative was acting as a mere
“conduit pipe” of the members for the profits from the creamery
operations.2 The Board felt that the case was clearly governed by the
Saskatchewan Wheat Pool case although the reasons for finding the
agency relationship were not as compelling. There was no contract
existing between the member and the corporation which expressly
created the agency relationship. The by-laws, however, provided for
the surplus to be paid on the basis of patronage. This appeared to be
the salient feature rendering the surplus non-assessable. The Board
concluded:
On the facts of this case… it is governed by the decision of the Supreme
Court of Canada in The Minister of National Revenue v. The Saskatchewan
Co-operative Wheat Producers Ltd …..
In the present instance, the ap-
pellant company is merely acting as the agent for its patrons in the
purchase from them of their cream… with any profit that may be
made on the transaction being credited in the books of the company
to the individuals who supplied the cream, such credit being computed
according to the butter fat content of that cream. Therefore the appellant
is not deriving profit for itself, but is merely acting, on behalf of its
patrons, as a conduit pipe for the profits from the conduct of the
creamery operations 4
Later decisions articulated more accurately the relationship that
must exist between the potential taxpayer and the surplus. In
Canadian Fruit Distributors Ltd. v. M.N.R. 5 Thorson P. adopted for
the second time a “quality of income” test to determine the income
tax status of reserves deducted by a co-operative. The test, which
was originally formulated by Brandeis J. of the United States
Supreme Court in 1933,26 was said to be as follows:
Is his right to it absolute and under no restriction, contractual or other-
wise, as to its disposition, use or enjoyment? To put it another way,
can an amount in a tax-payer’s hands be regarded as an item of profit
or gain from his business, as long as he holds it subject to specific and
22R.S.B.C. 1960, c.77, s.1.
23 Vita Co-operative Limited v. M.N.R. (1952) 6 D.T.C. 43, 5 Tax A.B.C. 351.
24 Ibid., 45 and 355-6.
25 [1954] Ex. C.R. 551, [1954] C.T.C. 284.
26 Brown v. Helvering 291 U.S. 193, 199 (1933).
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TAXATION OF CANADIAN CO-OPERATIVES
unfulfilled conditions and his right to retain it and apply it to his own
use has not yet accrued, and may never accrue? 27
The taxpayer, of course, is the co-operative; thus, if it does not have
an absolute right to the surplus retained, then the surplus lacks the
“quality of income” that is necessary to bring it within the taxing
statute.
The most complete review of the principles involved in deter-
mining the quality of income was made by the President of the
the Horse Co-operative Marketing
Exchequer Court in 1956. In
Association Ltd. v. M.N.R.28 Thorson P., again applying the Brandeis
formula,2 9 found that the surplus in question did not meet the test
and thus was not subject to taxation. In applying the test as to the
right of the co-operative to the funds, several illuminating statements
were made:
… the presence or absence of an intention to make a profit is not con-
clusive of taxability or otherwise, the absence of an intention to make
a profit is a factor to be taken into account. Nor does the mere fact
that the word “Co-operative” is part of the appellant’s name indicate
absence of tax liability in respect of its activities. The important thing
to determine is the true character of the amounts in dispute 3 0
In determining the true character of the amounts in dispute, the
Court looked to several factors, making the following observations:
The provisions of the Income War Tax Act relating to patronage dividends
have no bearing in this case. And the corporate set-up of the appellant
did not permit any declaration of dividends in respect of its transactions
with its members.
. They were entitled to the amounts credited to them in their own
individual rights under the conditions subject to which they had deliv-
ered their horses to the appellant for co-operative marketing or processing
by it.
… [T]he fact that the moneys to which the members were entitled were
not actually paid to them is immaterial. The effect of what the appellant
did was exactly the same as if it had paid the members the amounts to
which they were severally entitled and then borrowed such amounts from
them.s’
Then, referring again to the agency relationship, Thorson P. went on
to state:
When the appellant received the horses it did so as agent for the members
and was accountable to them for the net proceeds from their marketing
to the
or the sale of the processed products. The initial payments
27 Robertson Limited v. M.N.R. [1944] Ex. C.R. 170, 182-3, [1944] C.T.C. 75, 91.
28 [1956] Ex. C.R. 393, [1956] C.T.C. 115.
29 Supra, fm.26.
30 Supra, f.n.28, 411 and 133.
31 Ibid., 412 and 134.
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members were really advances to them on account of the total to which
they were severally entitled. Thus, the surplus of the appellant’s receipts
over its expenditures did not belong to the appellant as its profits or
gains but belonged to the members in their own individual rights and
was held by it on their own behalf. 2
Therefore, the quality of income test is failed if it can be shown
that the sums held by the co-operative do not in fact belong to it.
If it can be shown that the co-operative is the agent of the members
(“agent” perhaps not always used in its strict legal sense), then the
surplus is not taxable because the co-operative’s right to it is not
“unrestricted”. Factors which are looked at in determining whether
the necessary relationship exists include the intention, or absence
of the same, to make a profit on behalf of the co-operative in its
own right, and a corporate set-up prohibiting the declaration of
dividends otherwise than on a patronage basis. It is unimportant that
the surplus is retained by the co-operative and is never actually
paid to the member; all that is necessary is the credit entry in the
books of the co-operative.
It will be recalled that in the Saskatchewan Wheat Pool case88
a similar result was reached on similar principles. However, in
that case the agency relationship was based largely on a marketing
agreement which each member had with the co-operative, while in the
Horse Marketing case no such contract existed. After finding the
relationship between member and co-operative to be one of agency,
the Court stated:
The correctness of this conclusion is not affected by the fact that there
were no individual contracts between the appellant and its members on
which they could sue the appellant for the amounts to which they were
so entitled. They did not need contracts in order to become so entitled.8 4
The Court then cited section 10 of The Co-operative Marketing
Associations Act of Saskatchewan, under which the appellant had
been incorporated, which had the effect of rendering the memo-
randum of association and by-laws of the co-operative a binding
contract between the members inter se and the co-operative. The by-
laws provided for the deduction of certain amounts from the gross
surplus, with a contractual effect identical to individual contracts
with each member. Therefore, the agency relationship may be created
by a combination of the incorporating statute and the by-laws of
the particular association. Most jurisdictions now have a provision
22 Ibid., 414 and 135.
33Supra, f.n.19.
34 Supra, f.n.28, 412 and 134.
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similar to section 10 of The Co-operative Marketing Associations Act
of Saskatchewan 5
These principles were applied in several other cases involving
marketing co-operatives, with similar resultsY0
It is possible, how-
ever, for a marketing co-operative to earn income on its own account.
In a 1957 decision 3 7 the Exchequer Court held that reserves deducted
from the gross earnings of milk shippers by the marketing asso-
ciation were taxable. The method of operation of the association
varied slightly from those cases referred to above: there was a
marketing agreement signed by the co-operative with each member
which enabled the co-operative to deduct certain amounts as a
“commission”; the deductions were not credited to the members on
the co-operative’s books. The Court felt that the quality of income
test as applied in the Horse Marketing case had been met. It held
that the co-operative possessed a sufficient property interest in
the surplus for it to be taxable in its hands, notwithstanding the
fact that the co-operative lacked the intent to earn a profit but was
a mere service organization. On this point Kearney J. stated:
… I do not think that the lack of intent to make a profit is a sufficiently
weighty factor to enable the appellant to escape the incidence of income
tax.ss
3 5 E.g., R.S.B.C. 1960, c.77, s.21(3) which states:
The memorandum and rules bind the association and its members to the
same extent as if they had been respectively signed and sealed by each
member and contained covenants on the part of each member, his heirs,
executors, and administrators, to observe all the provisions of the memo-
randum and rules, subject to the provisions of this Act.
See also R.S.S. 1965, c246, s.13 and the Canada Co-operative Associations
Act, S.C. 1970, c.17, s.39(6). Jurisdictions which incorporate by issuance of
letters patent also contain similar provisions in their Acts with respect to
co-operatives; see R.S.O. 1970, c.89, s.156(2) and R.S.M. 1970, c.160, s.413(4):
these provisions in the letters patent jurisdictions only apply to co-operatives
incorporated under the respective Acts and not to ordinary business corpor-
ations. For a general discussion of the binding effect of by-laws in a letters
patent jurisdiction, see: S. Beck, “An Analysis of Foss v. Harbottle”, in J.
Ziegel (ed.), Studies in Canadian Company Law (1967), 545, 581.
36 See M.N.R. v. La Socidtd Coopgrative Agricole de la Vallde d’Yamaska
[1957] Ex. C.R. 65, [1957] C.T.C. 132; Manitoba Dairy and Poultry Co-operative
Ltd. v. M.N.R. (1957) 11 D.T.C. 1278, [1957] C.T.C. 401 (Exch.); Saskatchewan
Approved Flock Co-operative Hatchery Marketing Association Limited v.
M.N.R. (1955) 9 D.T.C. 586, 14 Tax A.B.C. 65.
3 7 Montreal Milk Producers’ Co-operative Agricultural Association v. M.N.R.
[1958] Ex. C.R. 19, 12 D.T.C. 1010.
38 Ibid., 27 and 1014.
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It must also be noted that nowhere in the corporate constitution
was the association prohibited from declaring a dividend,3 unlike
the situation in the Saskatchewan Wheat Pool and Horse Marketing
cases. This again was a factor in arriving at a conclusion contrary
to the results in those two cases.40
All the cases which have held that the co-operative has had
no income have involved marketing co-operatives. The marketing
co-operative lends itself readily to the agency type of relationship.
If it receives the member’s product, sells it, and transfers the pro-
ceeds, it is clearly arguable that the co-operative itself has no income.
Although the transaction is rarely this simple, the courts have been
ready to find the relationship of principal and agent. No Canadian
decision, is reported in which a purchasing co-operative, as opposed
to a marketing co-operative, has escaped the incidence of taxation
because it operated on an agency basis. The issue arose in M.N.R. v.
Davidson Co-operative Association Limited 41 where it was found
that the nature of the co-operative’s business was not substantially
different than that of any other businessman in a similar trade.
The co-operative purchased goods on its own account and not simply
to fulfill previous orders. As well, it sold at regular retail prices.
Although the surplus or profit earned after expenses was credited
as a patronage dividend, it was held to be taxable in the hands of
the co-operative. The co-operative was not merely the agent of the
members, although that possibility was not excluded outright by the
Exchequer Court. Fournier J. stated:
There is no evidence before the Court that there exists any agency
contract between the respondent and its individual members to act as
their purchasing agent. Furthermore, the respondent is not the agent
of a number of persons who have joined together to further a common
purpose of protection and have contributed to a common fund to that
end.42
39 Ibid., 23 and 1012.
40 It has been held that even though a part of a co-operative’s income was
obtained as a result of its own activities, the whole of the operation must be
considered as one business and no part of its “income” was taxable. The fact
that the co-operative’s expenses were paid from profits from an activity
outside its marketing activities did not render the surplus taxable: see The
Vernon Fruit Union v. M.N.R. (1956) 10 D.T.C. 43, 14 Tax A.B.C. 209; see also
Associated Growers of British Columbia Limited v. M.N.R. (1956) 10 D.T.C.
10, 14 Tax A.B.C. 199.
41 [1956] Ex. C.R. 138, [1956] C.T.C. 26,
427 bid., 156-7 and 43-44,
1975]
TAXATION OF CANADIAN CO-OPERATIVES
The possibility of agency contracts is therefore implied but the
facts of the case did not support the conclusion of an agency
relationship#3
Also, the Court emphasized the fact that the co-operative was
a separate entity earning a profit in its own right, separate and apart
from its members. 4 This raises the question of whether there
was a piercing of the corporate veil45 in all the cases where the
agency relationship was upheld. It seems arguable that, in the cases
where no separate contract existed between the members and the
corporate body, any finding that the co-operative was a mere “conduit
pipe”46 or mere “machinery” 47 for the purposes of the members
amounts to a finding that there has been a lifting of the corporate
veil. However, it appears that a distinction can be drawn between
these cases and those where individual marketing contracts existed,
such as the Saskatchewan Wheat Pool case. It is submitted that there
would be no infringement of the basic principles of company law
in allowing a principal-agent relationship to exist between a
company and its shareholders if the same is expressly provided
for.
48
43The decision of the Tax Appeal Board being appealed from found in
favour of the agency relationship: (1954) 8 D.T.C. 19, 20. The Board stated: “The
situation may be summed up briefly by saying that the appellant claims to
have nothing of its own and that everything it possesses is owned by the
numerous patrons collectively, whose agent it is in carrying on the business
mentioned”.
44 Supra, f.n.41, 145 and 33; see also, e.g., The Fraser Valley Milk Producers
Association v. M.N.R., supra, f.n.19, 435 and 22:
The sums acquired by the company and distributed as dividend, or
otherwise dealt with, are in their nature undistinguishable from the profits
and gains of ordinary traders and are therefore a fit subject for taxation.
The company is an independent entity in itself and has realized excess
profits over expenditures which are identical with all other traders’ profits.
The profit distributed is the difference between the cost of production
and the price realized.
45See generally, M. Woods, Lifting the Corporate Veil in Canada (1957) 35
Can. Bar Rev. 1176; I. Feltham, Lifting the Corporate Veil (Law Society of
Upper Canada Special Lectures, 1968), 305.
46 Supra, f.n.24.
47Supra, f.n28, 415 and 136, where Thorson P. states: “The conclu-
sion that the members established the appellant as the means or machinery
for accomplishing their purpose of disposing of their surplus horses is not
affected by the fact that it is a corporation…”.
48 See Rainham Chemical Works, Limited v. Belvedere Fish Guano Company,
Limited [1921] 2 A.C. 465, 90 LJ.K.B. 1252. It has been argued that in each
of these cases the courts have ignored the corporate entity to a greater or
lesser extent; see M. Woods, Federal Taxation of Income of Cooperative
Trading Corporations in the United States and Canada (1962), 54. However,
it is submitted that where a separate marketing contract exists, it is not a
McGILL LAW JOURNAL
[Vol. 21
The Canadian courts have tended to ignore any hinderances
in connection with the lifting of the corporate veil4 The following
indicates the philosophy that has been adopted:
It is essential in a case such as this that regard should be had to the
substance of the transaction under consideration rather than its form. ….
Thus, it is the true nature of the appellant association that falls to be
determined. 0
The cases indicate that the courts will not allow the corporate veil
to frustrate a decision as to the true ownership of funds which are
sought to be taxed.
To summarize briefly, the courts often regard the co-operative as
being in a representative or fiduciary capacity5 1 vis-&-vis the member
and thus accountable to the member for the proceeds or surplus
of its operation . 2 Where such a relationship is found the co-operative
is deemed to be of the non-income type and operates outside the
piercing of the corporate veil if the contract sets up the principal-agent
relationship between member and co-operative.
49 The problem of the corporate veil has caused Canadian courts little
consternation in tax matters, e.g., William Slater v. M.N.R. (1964) 18 D.T.C.
513 (Tax. App. Bd.).
50 Manitoba Dairy and Poultry Co-operative Ltd. v. M.N.R., supra, f.n.36, 1285
and 414.
51 The courts have not always used the terms “agency” and “trust” in this
respect as words of art: supra, text at f.n.14. No Canadian court has relied
solely on the trust relationship in defining the relationship between member
and co-operative, but some cases in the United States have relied solely on
the trust concept: see I. Packel, The Organization and Operation of Co-
operatives 3d ed. (1970), 142. Also see Woods, supra, f.n.48, 41, where it is
stated that the Exchequer Court in M.N.R. v. La Socigt9 Coopdrative Agricole
de la Vallde d’Yamaska, supra, f.n.36, referred to a co-operative as “trustee
or agent”.
This interpretation is based on a translation of the French judgment of
Fournier3. at 76 where he stated: “… recevait livraison de leur produit
comme consignataire, elle proc6dait, comme mandataire ou agent, aux opera-
tions n6cessaires…”. Woods translates these words as follows: “… received
delivery of their products as consignee, it proceeded as trustee or agent, to
conclude the operations…”. It is submitted that the word “mandataire” does
not denote a “trustee” in the Anglo-Canadian common law sense but is used
by Fournier 3. as being nearly synonymous with “agent”. In Quebec civil law
the trust concept is less developed than in common law; however, the word
“fiduciaire” would denote something closer to a “trustee” as opposed to
“mandataire”. Indeed, often the trust concept
is simply translated into
French as “un trust” with the word “mandataire” meaning simply an agent.
52 A “price adjustment” theory of the operations of co-operatives has also
been alluded to in Canadian jurisdictions. This theory is based on the premise
that a true co-operative is intended only to provide goods and services to
members at cost rather than to produce a profit. Patronage dividends paid out
19751
TAXATION OF CANADIAN CO-OPERATIVES
relevant sections of the Income Tax Act. If a co-operative is deemed
to have an income, then it is taxable as is any other taxpayer.
However, certain sections of the Income Tax Act come to the co-
operative’s aid in reducing that income.
III. TAXATION OF CO-OPERATIVE INCOME
If it is accepted that a co-operative is capable of earning an
income in its own right, the question of the taxation of that income
then arises where the particular co-operative is deemed not to be
of the non-income type. The characteristics that must exist to make
this determination have been analysed above. Taxation of co-opera-
tives having income will now be considered.
A. Background: The Income War Tax Act, 1917-1946
The Income War Tax Act of 1917, which introduced the first
taxation of income in Canada, contained an obscure provision
exempting from taxation
… the incomes of mutual corporations not having a capital represented
by shares, no part of the income of which inures to the profit of any
member thereof… .53
It was unclear whether a co-operative was a “mutual corporation”
within the meaning of the Act, although the exemption clearly seemed
inapplicable to such a corporation with share capital. In the decade
following 1917, no serious effort appears to have been made to levy
tax upon co-operatives with or without share capital. However,
certain factors may have contributed to this lack of interest by the
taxing authorities. Co-operatives were of relatively recent vintage as
of surplus are deemed to be merely a price adjustment in arriving at this
fundamental objective. See Manitoba Dairy and Poultry Co-operative Ltd. v.
M.N.R. supra, fn.36, 1286 and 316, where it is stated:
In the alternative… if it should be considered that the member’s delivery
of his produce to the association constituted a sale of it by him to it, it is
manifest that it was a condition of such sale that the amount paid on the
delivery of the produce was only a first payment on account and that the
balance was to be paid after the close of the year’s operations… .In that
view of the transaction between the members and the association the
amounts credited to the members.., would be part of the cost of the
produce to the appellant association and there would not be anything
left to constitute profit to it or taxable income in its hands.
See also Saskatchewan Approved Flock Co-operative Hatchery Marketing
Association Limited v. M.N.R., supra, f.n.36, 588 and 69. This is the theory
that direct charge co-operatives operate on: see supra, f.nA, 89.
53 S.C. 1917, c.28, s.5(f).
McGILL LAW JOURNAL
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a type of business enterprise in Canada and generated a small
amount of business activity 5 in these early years; thus, the actual
loss of revenue to the government was minimal. This was especially
so when one considers that the corporate rate of taxation prescribed
by the Act was initially only four per cent on earnings over $3,000.1
Also, a common view at the time was that a “true co-operative”
by its very nature and mode of operation had no income of its own.
This view was based on a number of theories, one being that the
co-operative acted as an agent for its members. Another, not totally
distinct from the first, was that a co-operative was intended only
to provide goods and services to members at cost rather than to
produce a profit. Thus, any surplus resulting from its operations
was merely an adjustment in arriving at this fundamental object
and was not income as such.50
Co-operatives, especially the grain marketing co-operatives of
Western Canada, began expanding economically in the latter part of
the 1920’s.57 This precipitated a change of attitude in the Department
of National Revenue, which sought to assess the “income” of some
of the more prosperous co-operatives. This resulted in two cases
ultimately being determined by the Supreme Court of Canada in
1929 and 1930.58 Both the Saskatchewan Wheat Pool case and the
Fraser Milk case, discussed above, involved co-operatives with share
capital but, as already seen, the Court came to different conclusions
regarding the taxability of the co-operatives’ surplus under the
Income War Tax Act.
Although these two early decisions can be distinguished on the
facts, Parliament shortly thereafter attempted to clear up any con-
fusion that may have existed. Section 4(p) was added to the
Income War Tax Act, which removed from tax liability:
livestockmen’s,
income of farmers’, dairymen’s,
The
fruit growers’,
poultrymen’s, fishermen’s and other like co-operative companies and asso-
ciations, whether with or without share capital, organized and operated
on a co-operative basis, which organizations
(a) market the products of the members or shareholders of such co-
operative organizations under an obligation to pay to them the proceeds
from the sales on the basis of quantity and quality, less necessary ex-
penses and reserves;
54See Report of the Royal Commission on Co-operatives (McDougall Com-
mission, Can. 1945), 134 et seq.
55 Supra, f.n.53, ss.4(1)(a), 4(2).
56 Supra, fn.52.
57Supra, f.n.54.
58Fraser Valley Milk Producers’ Association v. M.N.R., supra, f.n.19; M.N.R.
v. The Saskatchewan Co-operative Wheat Producers Ltd., supra, f.n.9.
1975]
TAXATION OF CANADIAN CO-OPERATIVES
(b) purchase supplies and equipment for the use of such members
under an obligation to turn such supplies and equipment over to them
at cost, plus necessary expenses and reserves.
Such companies and associations may market the produce of, or purchase
supplies and equipment for non-members of the company or association
provided the value thereof does not exceed twenty per centum of the
value of produce, supplies or equipment marketed or purchased for the
members or shareholdersfi9
The new section was of little improvement. The ambiguous wording
caused problems of application. No definition of “co-operative” or
“co-operative basis” was included in the provision.” What was the
meaning of “like co-operative companies or associations”?
The confusion led to the establishment of a Royal Commission on
Co-operatives6 ‘ to study the taxation of co-operatives prior to the
resolution of the various problems in the courts 2 The Royal Commis-
sion (McDougall Commission) had a broad mandate to determine
what was the most just and equitable means of taxing co-operatives. 3
One important finding of the Commission was that co-operatives
could indeed earn income and thus become liable to pay tax on the
same.r’ A co-operative was an entity unto itself, whica of course is
the necessary consequence of incorporation, and not merely a “price
adjustment” agency 5 However, it was recognized that dividends
which were paid to members by a co-operative could not be treated
in the same way as profits of an ordinary business corporation. The
Commission stated:
In a competitive situation… most of the economies which ordinary
companies secure tend to be passed on to their customers in the form
of lower prices. The taxable income of the companies, however, depends
on the prices actually charged. Similarly, if a co-operative association
effects economies and passes these on to its customers, we are of the
59 An Act to amend the Income War Tax Act, S.C. 1930, c.24, s2.
0 See supra, f.n.4.
61 The Royal Commission was established by Order in Council on November
16, 1944. The Honourable Mr Justice McDougall, Court of King’s Bench,
Quebec, was named chairman of the Commission; supra, f.n.54.
62 See R.C. McIvor, The Post-War Taxation of Canadian Co-operatives (1959,
Can. Tax Papers #17, Can. Tax Foundation), 11.
6 3 Supra, f.n.54, 3. The Order in Council empowered the Commission to
inquire into and report on “all facts which appear to them to be pertinent for
determining what would, in the public interest, constitute a just, fair and
equitable basis for the application of the Income War Tax Act … and to
make such recommendations for the amendment of existing laws as they
consider to be justified in the public interest”.
04 Ibid., 31-32.
65 Supra, f.n.52; but note that this finding does not prevent a co-operative
from being the agent of its members: see supra, Part II, esp. text at f.nA8.
McGILL LAW JOURNAL
[Vol. 21
opinion that it should not be taxed as though it did not adopt this
practice.0 6
The main recommendation of the Commission was that the then
existing provision of the Income War Tax Act, which ostensibly
exempted co-operatives from taxation, be repealed and the Act be
amended to provide for the taxation of co-operatives on the same
basis as other taxpayers.7 However, it was further recommended
that all taxpayers be allowed to deduct patronage dividends “which
are paid or credited to their customers in proportion to the quantity,
quality or value of goods acquired, marketed, or sold or services
rendered”.’ Then certain provisos were set out which were to be
complied with before patronage dividends could be deducted. It is
important to note that no attempt was made to place co-operatives
in a privileged position in this respect; the deductions were available
to all taxpayers, including partnerships and ordinary business cor-
porations. 9 The one overt major concession made to co-operatives
was that newly formed co-operatives in their first three years of
operation would obtain a complete exemption from taxation. The
rationale behind this proposal was that it was in the public interest
to favour fledgling co-operatives, whose mortality rate had been
high in the early years of operation because of their inherent
inability to attract capital.7 0
In 1946 Parliament enacted most of the McDougall Commission
recommendations. 71 The treatment of co-operatives for taxation pur-
e6 Supra, f.n.54, 34.
67 Ibid., 41-45.
68 Ibid., 44.
09 Ibid., 43, where it is stated:
We are also of the opinion that where ordinary companies, partnerships
or individual business enterprises hold forth, to their customers, that
they will distribute among them on a patronage basis a portion of the
surplus earnings, they should be allowed to deduct such payments before
arriving at taxable income.
70 Ibid., 43, where it is stated:
It has been pointed out to us on numerous occasions that co-operative
associations are difficult to organize and that their rate of mortality is
high, especially in their earlier years. They are not in a position to attract
capital for investment purposes, except in small amounts. Moreover, they
are apt to find it difficult to finance the employment of the necessary
managerial personnel. In addition, there is a pronounced tendency to
organize co-operatives in times of economic stress. We are, therefore, of
the opinion that in the public interest, co-operative associations, upon
consent of the Minister, should be exempt entirely from income tax during
the first few years of their operations.
71 An Act to amend the Income War Tax Act, S.C. 1946, c.55, s.3(3).
19751
TAXATION OF CANADIAN CO-OPERATIVES
poses has remained substantially the same since that time.72 The
existing provisions will now be discussed in detail.
B. The Present Income Tax Act
1. Deduction of Patronage Dividends
The question of deductibility of patronage dividends only arises
if the co-operative has failed to show that the sums in question are
not income belonging to it.73 If it has failed in this respect, it
will seek to deduct patronage dividends from income.
The Income Tax Act 74 provides that any taxpayer may deduct in
computing income “the aggregate of the payments made, pursuant
to allocations in proportion to patronage.. .”.” As recommended
by the McDougall Commission, this provision is not limited to
co-operatives but applies to any taxpayer.76 However, in order that
a taxpayer be allowed to make this deduction, the Act sets out
certain requirements that must be met.
The first requirement is that any payments must be made (or
credited) 77 within the taxation year or within twelve months
thereafter.8 Secondly, the “allocation in proportion to patronage”1 9
referred to in the principal deduction section
… means an amount credited by a taxpayer to a customer of that year
on terms that the customer is entitled to or will receive payment thereof,
72 The 1946 amendments to the Income War Tax Act, ibid., pertaining to
co-operatives were included in the Income Tax Act, S.C. 1948, c-52, ss.66, 68,
and were continued in the statutory revisions, i.e., R.S.C. 1952, c.148, ss.73, 75
and R.S.C. 1970, c.148, ss.85, 87; however, by S.C. 1970-71-72, c.43 the Income Tax
Act, R.S.C. 1970, c.148, is deemed not to be in effect and the Act contained in
R.S.C. 1952 is to continue in effect subject to amendments; in S.C. 1970-71-72, c.63,
some changes were made. Although the provisions remain substantially the
same, the changes include (1) removal of the 3 years exemption for new co-
operatives, (2) removal of the capital employed provisions, (3) enacting a 15%
withholding tax on patronage dividends. These changes are discussed in more
detail below.
73See supra, Part II.
74 S.C. 1970-71-72, c.63.
75 Ibid., s.135(1).
70 Supra, f.n.69.
77See infra, text, regarding meaning of “payment”.
78 Supra, f.n.74, ss.135(1), 135(4)(a)(i)(A); the McDougall Commission re-
commended that patronage dividends be paid in cash or credited to each
customer within six months after the annual meeting of the relevant fiscal
period, but the 1946 enactment contained the twelve month provision: S.C.
1946, c.55, s.4(13).
79 Supra, frn.75.
McGILL LAW JOURNAL
(Vol. 21
computed at a rate in relation to the quantity, quality or value of the
goods or products acquired, marketed, handled, dealt in or sold, or
services rendered by the taxpayer from, on behalf of or to the customer,
whether as principal or agent of the customer or otherwise, with appro-
priate differences in the rate for different classes, grades or qualities
thereof … 80
Thus some flexibility is allowed in the computation of the patronage
dividend; that is, differences in classes, grades or qualities of the
goods or products dealt with may be taken into account. Also it may
be noted that the Act contemplates a possible principal –
agent
relationship, yet allows for the deduction to apply.
However, three provisos are included in the definition of “alloca-
tion in proportion to patronage”. As already seen, the amount must
be credited within the taxation year or within twelve months there-
after.81 Also (allowing for the appropriate differences in classes,
grades or qualities), all customers, whether members 82 or non-
members, must be credited at the same rate.8 3 If allocations are
not made to all customers at an equal rate, the Act imposes a
limitation on the amount that may be deducted. The deduction is
limited to the lesser of:
income for
business done with members and allocations to non-members for
the taxation year.84 This, in effect, prevents a co-operative from
paying out all of its surplus to its members by way of deductible
patronage dividends unless the surplus was earned as a result of
business done only with those members. Thus, a co-operative’s
taxable surplus will never be less than the surplus earned from
non-member transactions that is not distributed
to those non-
members.
(1) all deductions and; (2)
In addition, in order for the patronage dividends to be deductible,
the taxpayer must have held forth to customers the prospect that
amounts would be credited according to patronage., Such prospect
is deemed to have been held forth if:
(a) throughout the year the statute under which the taxpayer was in-
corporated or registered, its charter, articles of association, or by-laws
or its contract with the customer held forth the prospect that amounts
would be so credited to customers who are members or non-member
customers, as the case may be, or
80 Supra, fro.74, s.135(4)(a).
s Supra, faa.78.
82 Supra, fn.74, s.135(4) (e) defines “member” as “a person who is entitled
as a member or shareholder to full voting rights in the conduct of the affairs
of the taxpayer (being a corporation) ….
83 Ibid., s.135(4) (a) (i) (B).
84 Ibid., s.135(2).
sr Ibid., s.135(4) (a) (ii).
1975]
TAXATION OF CANADIAN CO-OPERATIVES
(b) prior to the commencement of the year or prior to such other
day as may be prescribed for the class of business in which the taxpayer
is engaged, the taxpayer has published an advertisement in prescribed
form in a newspaper or newspapers of general circulation throughout
the greater part of the area in which the taxpayer carried on business
holding forth that prospect to customers who are members or non-
member customers, as the case may be, and has filed copies of the
newspapers with the Minister before the end of the 30th day of the
taxation year or within 30 days from the prescribed day, as the case
may be.8 6
The allowing of the holding forth of the prospect by advertising in
a newspaper permits ordinary business corporations to qualify for
the deductions without having to alter their corporate documents or
to enter into individual contracts with customers.8 1
Payments must be made within twelve months after the taxation
year but some flexibility is given as to what constitutes a payment.
“Payment” includes the issuing of a certificate of indebtedness or
shares of the co-operative. This allows the co-operative to deduct
patronage dividends which are in effect retained by the co-operative
under a revolving fund plan.8 8 However, the Act provides that
payment may be made by this means only if:
… the taxpayer… has in the year or 12 months thereafter disbursed
an amount of money equal to the aggregate face value of all certificates
or shares so issued in the course of redeeming or purchasing certificates
of indebtedness or shares of the taxpayer… previously issued…
9
Payment also includes:
… the application by the taxpayer of an amount to a member’s liability
to the taxpayer (including, without restricting the generality of the fore-
going, an amount applied in fulfilment of an obligation of the member
to make a loan to the taxpayer and an amount applied on account of
payment for shares issued to a member) pursuant to a by-law of the
taxpayer, pursuant to statutory authority or at the request of the
member… 90
This allows for a set-off of a member’s liability to the co-operative.
This liability arises by statute, the corporate constitution or indivi-
dual agreement with members imposing an obligation on the mem-
bers to lend patronage dividends to the co-operative or to apply
them toward the purchase of shares.
In addition to the limitation on the extent to which income
can be reduced by payment of patronage dividends, 9′ there exists
86 Ibid., s.135(5).
87 See Woods, supra, f.nA8, 278.
8 8 See, for a description of a revolving fund plan, Report on Co-operatives,
supra, f.n.4, 65.
89 Supra, f.n.74, s.135(4)(g)(i).
80 Ibid., s.135(4) (g) (ii).
91 Supra, f.n.84.
McGILL LAW JOURNAL
[Vol. 21
another limitation. Certain provincial incorporating statutes require
that co-operatives set aside each year a percentage of their surplus
as a reserve 2 This unallocated reserve becomes subject to taxation;
thus, the provincial statutes which require a mandatory reserve
effectively impose a minimum upon which income tax must be paid.
There formerly existed a third limitation or restriction which
prevented a co-operative from reducing its taxable income below a
minimum amount by payment of patronage dividends. The Income
Tax Act provided that the taxpayer’s (co-operative’s) taxable income
could not be reduced below an amount equal to “3% of the capital
employed in the business at the commencement of the year” 03 less
“the interest, if any, paid on borrowed moneys … and deductible in
computing his income for the year”. 4 The effect of this limitation
was to prevent a co-operative from escaping taxation completely by
paying out its entire surplus by way of patronage dividends 0
However, it also had the obvious effect of forcing co-operatives to
pay income tax even though no surplus may have accrued throughout
the year. This limitation no longer exists in the Act.””
Co-operatives therefore must pay tax under the Income Tax Act
on whichever is the greater of: (1) total unallocated surplus, even
92 E.g., R.S.B.C. 1960, c.77, s.12; R.S.Q. 1964, c.292, s.82.
93R.S.C. 1952, c.148, s.75(3)(a).
94Ibid.
Or The “capital employed” provision first appeared in the 1946 amendments
to the Income War Tax Act, S.C. 1946, c.55, although the McDougall Commission
contained no recommendations to that effect; see McIvor, supra, f.n.62, 16,
where, referring to the “capital employed” provision, he states:
This provision was nowhere recommended in the Commission’s report
and it appears to have been enacted, following representations from the
competitors of the co-operatives, as a sort of compromise measure charac-
teristic of the democratic political process … . The choice of the “three
per cent” figure presumably reflects what was considered to be a fair
rate of return on capital during the war years when one major objective
of government monetary policy was to maintain interest at relatively low
levels. However, when viewed within the overall context of the Commis-
sion’s report, the rationale of section 75(3) is by no means clear.
96 It is interesting to note that in Bill C-259, An Act to Amend the Income
Tax Act, the 3% minimum on capital employed was raised to 5%: s.135(3);
however, in the Act that was passed by Parliament, S.C. 1970-71-72, c.63, the
entire section had been dropped. In the interim much pressure was exerted
on the government by the co-operative movement to have the provision re-
pealed; see, e.g., Joint Submission to the Minister of Finance by the Co-oper-
ative Union of Canada and Le Conseil Canadien de la Coopgration in the matter
of Co-operatives and in the matter of Sections 135 and 136 of Bill C-259
(August 1971).
19751
TAXATION OF CANADIAN CO-OPERATIVES
though this surplus might be in the form of a mandatory reserve as
required by provincial legislation; 97 and (2) the surplus that arises
from non-member business that is not distributed to non-members.8
The deduction of patronage dividends to reduce taxable income
is open to ordinary business corporations as well as co-operatives;
however, as a practical matter it is clear that co-operatives are the
principal beneficiaries of such provisions because of the coincidence
of ownership and patronage. Because of the investment role that
capital plays in co-operatives, large scale use of dividends accrues
directly to the owners of the business, whereas in ordinary business
corporations, payment of patronage dividends in effect reduces
the equity of the owners. Therefore, although oni the surface of the
legislation there appears to be no discrimination between the two
types of enterprise, a closer look reveals a discrimination in fact.
2. Exempt Co-operatives
Another possibility exists for co-operatives which can be brought
within certain exemptive provisions of the Income Tax Act. Section
149(1) of the Act states:
No tax is payable.., upon the taxable income of a person for a period
when that person was …
(e) an agricultural organization, a board of trade or a chamber of
commerce, no part of the income of which was payable to, or was other-
wise available for the personal benefit of, any proprietor, member or
shareholder thereof: …
(1) a club, society or association organized and operated exclusively
for social welfare, civic improvement, pleasure or recreation or for any
other purpose except profit, no part of the income of which was payable
to, or was otherwise available for the personal benefit of, any proprietor,
member or shareholder thereof….
Attempts have been made by commercial co-operatives to -come
within these provisions although it appears that the exemptions are
intended to apply to associations of a non-commercial nature. – Thus,
co-operatives which are organized to promote educational or charita-
ble purposes would clearly be exempt from paying taxes. on any
profits that might accrue. 9
97 Supra, fro.92.
98Supra, f.n.84.
9 See Francis, supra, fm.1, 208-9, where a precedent of a by-law is reproduced,
approved by the Department of National Revenue, which will allow co-oper-
atives of the non-profit or charitable type to obtain exempt status under the
Act. The by-law states:
The net income of the association shall be retained as a reserve and used
only for educational or charitable purposes and no part of the income
McGILL LAW JOURNAL
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The exemption provisions were applied by the Tax Appeal Board
in a case involving a co-operative organized to market agricultural
products of its members. In Edmonton District Milk and Cream
Producers Association Limited v. M.N.R. 10
the memorandum of
association empowered the co-operative to “carry on all kinds of
businesses or operations connected with marketing, selling.., of any
agricultural product, produced or delivered to it by its mem-
bers…,,101 In fact the co-operative did no buying or selling of
products but merely bargained on behalf of its members to get the
best prices for milk. The dairies to which the members delivered the
milk deducted a certain percentage on a volume basis, turning this
amount over to the co-operative association. Expenses were paid out
of this sum, 10% placed in a reserve, and the balance was credited
to members. The Board held the co-operative to be a service organi-
zation and bargaining agency, and thus exempt under the provisions
of the existing Act.102
Counsel for the Minister argued that since the memorandum of
association stated the objects of the co-operative to be of a business
nature, the association was more than a service organization and
bargaining agency for its members. However, the Board indicated
that substance rather than form was the important consideration
and quoted from English authority to the following effect:
… the question is not what business does the taxpayer profess to carry
on, but what business does he actually carry on.10 3
This de-emphasis on the professed objects as stated in the corporate
constitution was not adhered to in a later decision of the Supreme
or reserve shall be payable to or otherwise available for the personal
benefit of any member. The association shall not declare any dividend
or distribute any of its property among its members during the existence
of the association or upon its winding up or dissolution. On the winding
up of the association the surplus, if any, shall be used for charitable or
educational purposes as the members may determine by resolution and
not for the personal benefit of any member.
109 (1953) 7 D.T.C. 282, 8 Tax A.B.C. 432.
101 Ibid., 283 and 434.
102 Because the taxation years in question were 1948, 1949 and 1950, the
provisions of the Income War Tax Act and the Income Tax Act, 1948 both
had to be considered. The relevant section in the latter Act was identical to
s.149(1)(1) of the present Act. The relevant section in the former Act read:
The following incomes shall not be liable to taxation.., income of clubs,
societies and associations organized and operated solely for social wel-
fare … or other non-profitable purposes, no part of the income of which
inures to the benefit of any stockholder or member.
103 Inland Revenue Commissioners v. The Hyndland Investment Company,
Limited (1929) 14 T.C. 694, 699.
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TAXATION OF CANADIAN CO-OPERATIVES
Court of Canada. In M.N.R. v. St. Catherines Flying Training School
Limited 104 the Court was called upon to determine whether profits
of a company incorporated with share capital under the Companies
Act 1 4a were exempt from taxation on the ground that the corporation
was being operated for non-profitable purposes. Locke J., delivering
the judgment of the Court, stated:
The question of the liability of the respondent to taxation depends, not
upon the intention of the promoters or the shareholders as to the dis-
position to be made of the profits but rather upon consideration of the
terms of the letters patent, the nature of the business authorized to be
carried on and of the business which was carried on which resulted in
the earning of the income. …
If the company had succeeded in obtaining
letters patent which prohibited the payment of dividends completely and,
in addition, the retention of any earned income by the company, different
considerations, which need not here be considered, would arise. 105
This part of the judgment indicates that the provisions of the
corporate constitution, that is, the letters patent, memorandum of
association or by-laws, rather than the actual operations of the
company, determine whether a company, be it a co-operative or
otherwise, will get tax exempt status. In this respect, then, the
decision of the Tax Appeal Board in the Edmonton Milk ’06 case can
no longer be considered good authority.
These cases must be distinguished from those previously dis-
cussed where it has been held that the co-operative had no income
whatever in its own right. In the cases presently under discussion,
the co-operative or association does have an income, but that
income may be exempt from taxation because the association is not
organized and operated for profit. To speak of the organizations
seeking exemption under section 149(1) of the Income Tax Act as
non-profit organizations is somewhat misleading. The position has
been summarized as follows:
Thus, it is essential to distinguish between purposes which are non-profit
in nature and the results of carring out these non-profitable purposes.
That is, it may be that the results of carrying out the non-profitable
purposes are that profit is made; however, so long as the club, society
or association is organized and operated exclusively for purposes except
profit the fact that profit or income may result will not affect the status
of the organization.1 0T
104 (1955) 9 D.T.C. 1145, [1955] C.T.C. 185 (S.C.C.), [1955] S.C.R. 738.
104a 24-25 George V, R.S.C. 1934, c.27.
105 Supra, frn.104, 1148, 190 and 743.
10 Supra, fn.100.
107 V. Peters and F. Zaid, The Present and Proposed Taxation of Non-Profit
Organizations (1971) 9 Osgoode Hall E..
359, 366.
McGILL LAW JOURNAL
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The distinction between the non-income co-operative and the
exempt co-operative was made clear by the Exchequer Court in
Montreal Milk Producers’ Co-operative Agricultural Association v.
M.N.R.,0 8 where a claim for exemption was made under section
4(h) of the Income War Tax Act.0 9 The Court held that, to accord
with the words of the statute, an organization had to be organized
and operated solely for non-profitable purpose to obtain the exemp-
tion. It was pointed out that the objects of the co-operative were
of a commercial nature with no provision excluding the objective of
pecuniary gain; nor was the declaring of dividends or the distributing
of profits prohibited. The Court went on to state:
Even if it be true, as claimed by the appellant, that it did not pursue
some of its stated objects of a commercial and gainful nature… never-
theless because it had declared objects of such nature, the Association
cannot… qualify as a company organized exclusively for purposes other
than profit… . [T]he facts of the case, and particularly the evidence
concerning the profits made.., prove beyond question that the Associa-
tion was not operated exclusively for purposes other than profit.110
Again the corporate constitution was determinative of the issue,
unlike the Edmonton Milk case. It seems, therefore, safe to say
that in order to come within the exemptive provisions of section
149(1) of the Act, merely operating as a “non-profit” organization”‘
is not sufficient. The co-operative must also be organized so that
“no part of the income . . . [is] payable to, or [is] otherwise
available for the personal benefit of, any proprietor, member or
shareholder thereof…”.1 2
If a co-operative is organized and operated as a non-profit
organization, it may fall clearly within section 149(1) and be tax
exempt, depending on its objects. The section enumerates various
types of organizations, but the broadest provision is in section 149
(1) (1), referring to “any other purpose except profit”. Co-operatives
subject to the proper organization and operation may thus seek
the benefit of this provision.” 3 Also section 149(1) (e), referring to
108 [1958] Ex. C.R. 19, 24, 58 D.T.C. 1010, 1012.
109 See the similar provision supra, fmn.102.
110 Supra, f.n.108, 24 and 1012.
1 It is recognized that to speak of the taxation of the income of non-profit
entities is in itself a contradiction in terms; hence, the term non-profit organ-
ization is used in this qualified sense; see supra, fmn.107, 359.
,2 Supra, f.n.74, s.149(1)(1).
11. If a co-operative is organized for some purpose contemplated by the
other subsections of s.149(1), nothing of course prevents it from qualifying
for the exemption on that ground, e.g., a co-operative may come within
s:149(1)(i) regarding low cost housing for the aged; see Campus Co-operative
(1963) 17 D.T.C. 857, 33 Tax A.B.C. 305,
Residence, Incorporated v. M.N.R.
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TAXATION OF CANADIAN CO-OPERATIVES
agricultural organizations, is of importance to co-operatives.114 How-
ever, as seen above, organizations seeking the benefit of the exemp-
tion, whether they be co-operatives or otherwise, must be bona fide
non-profit organizations. Therefore, the application of the exemption
provisions is rightfully quite restricted and will not apply to the
ordinary trading co-operative.
Until recently there existed provisions exempting co-operatives
from taxation during their first three years of operation.115 The
exemption was broad in application, encompassing nearly all fled-
gling co-operatives. This exemption was recommended by the Mc-
Dougall Commission 116 and enacted shortly thereafter by Parlia-
ment. 117 The need for such an exemption was ouestionable. If a
co-operative in its first few years was having financial difficulty,
no surplus presumably would accrue and the question of taxation
would never arise. If the new co-onerative did earn an income, it
could be argued that tax should be paid on that income as this
would prima facie be evidence of some financial stability, rendering
the policy considerations behind the exemption meaningless. The
only function the exemption provisions may have performed was
to prevent new co-operatives not earning an income ‘from having
to pay a tax under the “capital employed” provisions that existed
at the same time. 18 However, since the latter provisions have been
removed from the Act, the removal of the three year exemption
was a logical step.
C. Taxation of the Co-operative Customer on Patronage Dividends
The Income Tax Act provides that patronage dividends shall be
included in the income of the recipient in the year in which the
payment was received. 1 9 An exception is made with regard to allo-
where it was argued unsuccessfully that a student housing co-operative should
qualify under s.62(1)(e) of the Act, now s.149(1)(f), as a charitable organiza-
tion.
1141n Ontario Hog Producers’ Co-operative v. M.N.R. (1962) D.T.C. 322, 29 Tax
A.B.C. 266, an agricultural co-operative was exempted from tax under s.62(1)(d)
of the Act, now s.149(l)(e); however, the Tax Appeal Board seems to
have followed reasoning similar to that in the Edmonton Milk case rather
than the Montreal Milk case, for it does not appear that the co-operative here
was organized on a non-profit basis though perhaps operated that way.
115R.S.C. 1952, c.148, s.73; repealed by S.C. 1970-71-72, c.63.
116 Supra, f.n.70.
117 S.C. 1946, c.55
118Supra, f.n.93.
119 Supra, f.n.74, s.135(7).
McGILL LAW JOURNAL
[Vol. 21
cations in respect of consumer goods or services and these are
defined as follows:
… goods or services the cost of which was not deductible by the taxpayer
in computing the income from business or property. 2 0
Thus, if patronage dividends are received by a taxpayer from
a marketing or purchasing co-operative as a result of trading in his
business, they must be included in his income. In the marketing
co-operative the patronage dividend is essentially a belated payment
for his product, therefore amounting to an increased price received
for his product. In the purchasing co-operative the patronage
dividend represents a decrease in operating costs, which will be
reflected in the operations of the business. Amounts deducted
from income must be included in income when collected or recovered
later by way of patronage dividend . 21 However, if the goods or
services are of the consumer type so that the cost is not deductible
by the taxpayer in computing income from his business, the patron-
age dividends received by him can be ignored for income tax
purposes.
If the payment of the patronage dividend is not in cash but by
issuing a certificate of indebtedness or shares, 22 the amount of the
payment by virtue of such issue must be included in computing the
recipient’s income.’2 The payment of the dividend by this means
does not have the effect of granting a tax deferral to the recipient.
It may also be noted that all patrons, whether members or non-
members, are treated similarly with regard to the taxability of
patronage dividends.
The recent amendments to the Act now require the co-operative
which pays the patronage dividend to withhold an amount equal
to 15% of such payment exceeding $100.124 The withholding tax is
credited toward the recipient’s personal tax. If the recipient is not
120 Ibid., s.135(4) (b).
121 See Pope v. Beaumont [1941] 2 K.B. 321, [1941] 3 All E.R. 9, where a
dividend from a co-operative on trade purchases was held to be a trade receipt.
There appear to be no reported Canadian cases interpreting these provisions,
but perhaps an analogy can be drawn between patronage dividends repre-
senting a price adjustment and foreign exchange profits, the latter having been
held to be a revenue receipt and therefore taxable: see M.N.R. v. Tip Top
Tailors Limited [1957] S.C.R. 703, 11 D.T.C. 1232; Eli Lilly and Company
(Canada) Limited v. M.N.R. [1953] Ex. C.R. 269, 7 D.T.C. 1252. The U.S. position
seems to be similar to that of Canada: see Packal, supra, f.n.51, 268; also see
Woods, supra, f.nA8, 290.
122Supra, f.n.74, s.135(4)(g)(i).
123 Ibid., s.135(7).
124 Ibid., s.135(3).
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TAXATION OF CANADIAN CO-OPERATIVES
taxable, presumably the tax would be returned to him upon filing
the usual tax return.125
IV. OBSERVATIONS AND PROPOSALS
As we have seen, co-operatives can be broadly divided into two
categories for tax treatment, that is, the non-income co-operative and
co-operatives with income. A third category of lesser import was also
discussed, that is, the non-profit or exempt co-operative. Some
observations must now be made regarding the tax position of these
various types of co-operatives as compared to other corporate
taxpayers. The issues must be evaluated to determine whether the
present system of taxation is fair or, to use the terminology of the
Carter Commission, whether equity and neutrality are achieved. 26
If it cannot be said that the system treats co-operatives and their
competitors equally, are there justified policy reasons for this
discrimination? There are numerous examples in our present tax
system of preferential treatment based on policy considerations; 1
7
are co-operatives treated preferentially and, if so, what are the
policy reasons for so doing?
2
A. The Non-profit Co-operative
The exemption that obtains under section 149 of the Income
Tax Act to certain non-profit organizations applies equally to co-
operatives which fall within one of the various categories set out
therein. The exemptions apply to organizations of a charitable nature
or organizations which perform a function which is deemed to be in
the public interest. The reason for exempting co-operatives from
paying income tax, if they fall within one of the categories of
section 149, is not because of their co-operativeness per se but
because of the function they perform in society. The rationale” of
the exemptive provisions lies on the broad base of social policy.
u5sThe withholding tax was proposed by the co-operative movement as a
compromise for repealing the capital employed provisions in the Act; see
Joint Submission, supra, fn.96, 6. The withholding tax was not included in
Bill C-259 but appeared in the Act as passed, and the capital employed pro-
visions were removed. Originally the 15% withholding tax had been pro-
posed by the Carter Commission: see Report of the Royal Commission on
Taxation (Carter Commission, Can. 1966, v.4), 105.
12 Ibid., 3.
127 See, e.g., supra, f.n.74, s.149(1) exempting certain charitable type organiza-
tions and s.125 allowing special deductions for Canadian controlled private
corporations.
McGILL LAW JOURNAL
[Vol. 21
The present taxation status of non-profit organizations has been
criticized on the ground that certain entities, although of doubtful
public benefit, in effect receive a public subsidy and an unfair
competitive advantage by reason of their qualifying for exempt
status 28 Co-operatives should also be required to meet a “public
benefit” test to be exempt. It seems completely untenable that
the provisions of section 149 should apply to co-operatives of a
commercial nature.2 9 If no profits of the organization are received
by the members, they should not be taxed on them, but this does
not justify exempting the organization itself. 30 The only justifiable
reason for awarding exempt status to any organization is that
of public benefit. No policy reasons exist to exempt from taxation
entities which are organized and operated on a non-profit basis
but perform services of a non-charitable nature for a select few
individuals. 31 Surely only organizations of a charitable nature, in-
terpreted quite broadly, should benefit from this preferred treat-
ment under our tax system. Other entities which earn an income
should be taxed as any other taxpayer.
B. The Non-income Co-operative
One argument used successfully by co-operatives
to support
non-payment of taxes is that they are agents of their patron-mem-
bers and have no taxable income. The result is that funds received by
co-operatives in the course of operation are not deemed to be in-
come of the co-operative at all.
There appears to be a legal inconsistency in treating the mem-
ber-co-operative relationship as one of principal and agent on the
one hand, while recognizing the separate legal entity of the co-
operative on the other. It has been noted earlier that nothing
prevents an incorporated body from entering into an agency agree-
ment with its shareholders. 2 However, allowing the agency rela-
tionship to arise in circumstances short of an express agreement
to that effect seems to be giving co-operative members the best of
both worlds. They claim that income or surplus received by the
‘128 See, e.g., Peters and Zaid, supra, frn.107, 379.
129 Edmonton District Milk and Cream Producers Association Limited V.
M.N.R., supra, frn.100; Ontario Hog Producers’ Co-operative v. M.N.R., supra,
f.n.114.
130 Peters and Zaid, supra, f.n.107, 380.
‘3 1 E.g., Edmonton Milk case, supra, frn.100.
‘132 -Supra, f.n.48; see also, Apthorpe v. Peter Schoenhofen Brewing Co. (1899)
4,T.C. 41, 80 L.T.- 395 (C.A.); Southern v. Watson [1940] 3 All E.R. 439, 85 S.J. 8
(CA).
19751
TAXATION OF CANADIAN CO-OPERATIVES
co-operative entity is not taxable in its hands because it does not
truly belong to the co-operative, yet they are protected by the
principle of limited liability which is obtained with incorporation.
The nature of the agency relationship is such that the agent is in
a position of acting so as to affect the principal’s legal position
with regard to third parties; 33 but because virtually all co-operatives
are incorporated for these precise reasons, the member (principal)
is shielded from liability to third parties. Thus the inconsistency:
the benefits of the principal-agent relationship accrue wthout the
detriment that might ordinarily arise because of the usual power of
an agent to bind his principal.
Agents are subject to the control of their principal
and are
under a duty to pay over to the principal all money received
on the principal’s behalf. ~ 5 When applied to the co-operative-mem-
ber situation, perhaps these two principles of agency suffer some
erosion. Although the payment is made to the member, it is not
usually in cash but is a mere journal entry in the books of the
co-operative. 36 But more significant is the fact that the member
has no control over how or when the actual payment to him will
be made. This is a matter usually reserved for the discretion of
the board of directors of the co-operative.’3 7 The direct control
that a principal usually has over his agent is absent. The courts
have overcome this hurdle by finding that ultimate control rests
with the members by reason of their power to elect the board
of directors; 38 this allows the principal to exert control over his
agent only by means of a two step process. Although ultimate
control over the agent (co-operative) lies in theory with the prin-
133 Agency has been defined as:
… the relationship that exists between two persons when one, called the
agent, is considered in law to represent the other, called the principal,
in such a way as to be able to affect the principal’s legal position in
respect of strangers to the relationship by the making of contracts or the
disposition of property.
(G.H.L. Fridman, The Law of Agency 3d ed. (1971), 8).
134 Restatement of the Law of Agency 2d (1958), 7, defines agency as “the
fiduciary relation which results from the manifestation of consent by one
person to another that the other shall act on his behalf and subject to his
control…” (italics added); see also Bowstead on Agency (1968), 1.
135 Fridman, supra, frn.133, 132.
136 E.g., The Horse Co-operative Marketing Association, Limited v. M.N.R.,
supra, f.n.28.
137 Ibid., 406 and 126.
138 M.N.R. v. The Saskatchewan Co-operative Wheat Producers Ltd., supra,
f.n.133, 415, [1928-34] C.T.C. 47, 59.
McGILL LAW JOURNAL
[Vol. 21
cipal (member), it is perhaps too remote to meet the requirements
of a strict legal agency relationship. Also, this ultimate power or
control does not arise by reason of the principal-agent relationship
but by reason of the shareholder status of the member. The fol-
lowing observation has been made on this point by an American
writer:
While the patrons could change the distribution policies of the co-operative
by electing a new board of directors, the new policy would result from
the patrons’ ownership capacity, not from a principal-agent relation-
ship.139
Further considerations which indicate the absence of a true
agency is that the co-operative usually conducts business in
its
own name, holds title to property and employs its own people.
These factors all must be considered in characterizing the rela-
tionship; although none of these factors individually is sufficient
to be determining, it has been held that the cumulative effect is
a strong indication of the absence of an agency relationship.1 40
Although it has often been held that co-operatives did not earn
income because they were acting as agents for the members, the
actual impact of these decisions has been minimal. One commentator
in 1959 wrote:
It is not unreasonable to assume the recent court decisions may encourage
a substantial shift toward the establishment of many more agency-type
“non-income” co-operatives. If such is the case, the social interest may
be significantly affected by the adverse repercussions on the national
treasury, a circumstance which could conceivably necessitate a recon-
sideration of their tax position.141
The decisions referred to did not have the effect contemplated.
In fact, the point appears not to have arisen in any reported
Canadian case since that time,1′
and no legislation has been
passed that affects the findings in the “non-income” co-operative
cases.
139 M.M. Caplin, Taxing the Net Margins of Cooperatives (1969) 58 Geo. Lj.
6, 26.
140 Firestone Tire and Rubber Co. Ltd. v. Commissioner of Income Tax [1942]
S.C.R. 476, [1942] 4 D.L.R. 433.
141 McIvor, supra, f.n.62, 68.
342 The agency argument has not arisen in any recent cases. There were
several cases involving the issue in the mid-1950s: see supra, Part II. The last
decision in which it was argued (unsuccessfully) was Montreal Milk Producers’
Co-operative Agricultural Association v. M.N.R., supra, f.n.37.
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TAXATION OF CANADIAN CO-OPERATIVES
C. The Income Earning Co-operative
Most co-operatives operate not as non-profit organizations nor
as agents of their members but are of the income earning type.
The provisions in the Income Tax Act which allow deduction of
patronage dividends from taxable income have caused the most
controversy in the area of co-operative taxation. Although, as pre-
viously indicated, the provisions do not only apply to co-operatives,
it is they that benefit primarily from them. The main objection
of the private sector is that while patronage dividends are de-
ductible, corporate dividends are not. 4 Secondly, the form of pay-
ment has given rise to objections since the effect of paying patronage
dividends in a form other than cash (such as the issuing of new
shares and a setting off against a member’s obligation to loan money
to the co-operative) is to allow co-operatives to generate internally a
major source of capital upon which tax has not been paid. The private
sector has vigorously opposed this obvious advantage bestowed on
co-operatives and has pointed to this preferred tax treatment as
a main reason for rapid co-operative expansion.144 The net result
of the present treatment of patronage dividends as deductible is
in fact to favor the co-operative form over the ordinary business
corporation.
The effect of allowing co-operatives to reduce their taxation
while not truly awarding the same benefit to other taxpayers is,
in essence, to subsidize them at the expense of other taxpayers.
The co-operative does not have the additional expense of paying
tax on the amounts deducted and the loss of revenue resulting
must be made up by requiring other taxpayers to pay more. Also,
the preferred treatment of co-operatives gives them an unfair ad-
vantage over their competitors, which results in providing more tax
free dollars to the co-operative than to the ordinary business cor-
poration.
143 Non-co-operative competitors of co-operatives have always argued that
co-operatives were treated preferentially in the Income Tax Act. The contro-
versy has thrived for many years; see, e.g., Report of the Royal Commission
on Co-operatives, supra, fmn.54, 37 et seq. and submissions to the McDougall
Commission; Carter Commission, supra, f.n.125, 108, and submissions thereto,
esp. submission of The Equitable Income Tax Foundation; I.H. Asper, The
Carter Report: Taxation of Co-operatives (The Equitable Income Tax Founda-
tion). The United States has had similar activity in this area: see Tax Treat-
ment of Earnings of Co-operatives, Hearings Before the Committee on Ways
and Means (House of Representatives, U.S. 1960); Caplin, supra, f.n.139.
144 Carter Commission, ibid.; Mutual and Tax-Exempt Organizations (Report
of Proceedings of the 19th Tax Conference, 1967), 137, 148.
McGILL LAW JOURNAL
[VoL. 21
If it is accepted that discrimination exists in the present tax
system in favor of co-operatives,1 45 the question that must then
be asked is whether such discrimination is justified. Are there
public policy reasons which indicate co-operatives should be treated
differently from ordinary business corporations? Co-operatives to-
day are big business; in 1972 the gross business volume of mar-
keting and purchasing co-operatives in Canada exceeded $2 bil-
lion.’ 46 The earlier arguments favouring a special treatment for
co-operatives on the ground of encouraging agriculturalists to or-
ganize have lost some of their validity. On the whole, co-operatives
perform the same function in Canadian society as ordinary busi-
nesses do; there appears to be no reason to grant them tax ad-
vantages en blanc that do not apply, for whatever reasons, to
the ordinary business corporation. However, certain exceptions may
be made for particular co-operatives which perform a service to
society that is recognized to be beneficial. In this category may
fall most consumer co-operatives. Consumer co-operatives which
supply goods and services could justifiably be allowed to reduce
taxable income by the amounts of savings (patronage dividends)
which are passed on to members.147 The same considerations do
not apply to co-operatives which are mere vehicles to aid in the
carrying on of the members’ business; these deserve no special
treatment.
Several possibilities present themselves
in considering what
course should be followed in taxing co-operatives. The ideal would
be to tax co-operative earnings at the same rate and on the same
basis as the earnings of ordinary business corporations 148 with ex-
ceptions made for consumer co-operatives. Patronage dividends,
under this proposal, would not be deductible by any taxpayer save
the excepted co-operatives. Thus, there would be no discrimination
between the two’business forms in fact as well as in law. The
145The co-operative movement does not accept that discrimination exists
in their favor. It is argued that the deduction of patronage dividends is
available to all corporations. This is formally correct but does not accurately
reflect the true position; see supra, text following f.n.98; see also R.C. McIvor,
Recent Growth in Canadian Co-operatives (1962, Can. Tax Papers #28, Can.
Tax Foundation), 27.
146 Supra, f.n.5; the statistics for 1972 are the latest available.
147A recent report indicated that a Canadian food co-operative in one city
has returned by way of patronage dividends 4% of sales. It is thought that
co-operatives play a role in the consumer’s fight against inflation; see
Financial Post, May 26, 1973, p.5 .
148 This has always been proposed by the private sector, e.g., Asper, supra,
f.n.143, 13.
19751
TAXATION OF CANADIAN CO-OPERATIVES
privilege granted to consumer co-operatives would be strictly on a
policy basis, since a recognized benefit to society accrues as a
result of the passing on of savings to consumers. Organizations
qualifying for the deductions would have to be strictly defined.
The Carter Commission recognized the fact that co-operatives
obtained an advantage under the present system. 4 9 Referring to
deduction of patronage dividends, the Commission stated:
… co-operatives have had a distinct advantage over corporations, because
the equivalent treatment of a corporation would be the allowance of the
deduction of interest and dividends in the determination of income.’ 50
Again referring to the “forced loan” effect of non-cash dividends,
the Commission said:
… the ordinary corporation is at a significant disadvantage because of
the immediate withdrawal by the government of one half of the income
before any distributions to shareholders …. 151
Consistent with its view that “if the economic position of the
members is improved as a result of the activity, the economic gain
is a proper subject for taxation”,5 2 the Commission recommended
that co-operatives be treated like ordinary business corporations.
The effect of the recommendations would be to give no prefer-
ence to co-operatives and to provide for full integration of share-
holder and corporation income taxes and member and co-operative
income taxes. However, none of the Carter Commission recom-
mendations has been implemented with respect to co-operatives,
and there is little likelihood of change at this time.
Since much of the controversy surrounds the method of pay-
ment, it would seem that a compromise position could be reached.
If only dividends that were paid in cash would be allowable
deductions, the objection to co-operatives utilizing tax free dollars
for capital expenditures would be met. The McDougall Commission
made a similar recommendation in 1945, suggesting that payment
be made in cash within six months after the relevent business period,
or that patronage dividends be
… credited within the same period to each customer and exigible by
him on giving such notice as may be deemed reasonable. 53
However, such requirements were never included in the legislation
and “forced loans” resulted.
149 Although the Carter Commission proposals were aimed at the tax system
as it existed in 1966, it has not changed substantially since that time regarding
co-operatives.
150 Supra, f.n.125, vol. 4, 102.
151 Ibid., 113.
152 Ibid., 109.
153 Supra, f.n.54, 44.
McGILL LAW JOURNAL
[Vol. 21
One final possibility would be to set a minimum limit to con-
trol business conducted with non-members. It could be required
that 90% of a co-operative’s business must be with members before
patronage dividends would be deductible. This would limit the
ability of co-operatives to conduct business on a par with ordinary
business corporations as regards members of the general public.
This would require co-operatives to truly become service organiza-
tions for the owners of the co-operative.
D. Conclusion
It
is clear that co-operatives do earn an income and thus
should be taxable on the same basis as are other intermediaries under
our tax system. A further evaluation of the present system should
be made and changes introduced to equalize the treatment received
by co-operative and non-co-operative taxpayers.
Co-operatives
today are large business ventures permeating
virtually all possible markets. Preferential tax treatment that ef-
fectively amounts to a public subsidy of co-operatives allows them
an unfair competitive advantage over non-co-operative taxpayers in
similar businesses. Such differential
tax treatment of business
forms performing similar functions cannot be said to be equitable
and neutral and should not subsist.
