Patronage Refund: Another Way to Share

By Art Godin, Councilmember and Treasurer

The creation of the cooperative as an economic model is generally attributed to a group of weavers in Rochdale, England who, in 1844, devised a set of cooperative business principles designed to raise them from their poverty. These principles, in slightly modified form, provide the underpinnings of cooperative organizations to this day. (They are printed on page 11 of each issue of GreenLeaf.)

One key principle established by the Rochdale pioneers is that net income generated by a cooperative is used:

• to provide common services;

• to develop the business, and;

• to benefit members in proportion to their transactions.

These points remain a good prescription for the prudent handling of a cooperative’s net income. Let’s examine what they mean for GreenStar as a retail food cooperative.

1. A portion of net income must be available for short-term needs. Working capital is required to contend with the ebb and flow of cash reserves, to guard against unforeseen losses and to provide ongoing services to members. While GreenStar still has a strong balance sheet, the slim profits of recent years, along with a net loss in 2005, are not sufficient to ensure continued financial vitality.

2. A portion of net income must be available for long-term needs. A strong reserve fund is needed to capitalize improvements to our physical plant, to provide funds for special projects and to ready ourselves for any expansion opportunity that might present itself.

3. A portion of net income must be returned to members. GreenStar’s policy of granting members a 2% discount on all purchases does benefit members in proportion to their transactions, or patronage. It could be considered an “advance” of net income anticipated. But in recent years these discounts have far exceeded net income, leaving little or none to meet GreenStar’s other needs listed above.  A patronage refund system of the sort increasingly used by co-ops nationwide distributes net income to members in proportion to their patronage after the close of the year when the amount of net income realized is actually known.

At its March 2008 meeting, GreenStar’s Council approved a proposal to begin an exploratory dialogue with members regarding the possibility of adopting such a patronage refund system for distributing net income to its members in place of the current up-front 2% discount. Council also approved funds for securing legal assistance in assessing the related changes needed to GreenStar’s Certificate of Incorporation and Bylaws. After the requirements and effects of the new system have been fully explained to members, a Member Referendum will be held and members will vote on whether or not to adopt the new system.

IRS tax regulations established for cooperatives are quite favorable, but only for cooperatives which have adopted a patronage refund system, around which the regulations were designed. By following exacting but clear guidelines, a cooperative is exempt from tax on net income derived from sales to its members if that net income is refunded to its members in proportion to their transactions, or patronage. Furthermore, the cooperative may pay out a portion of the refund in cash and retain a portion of the refund for providing capital for ongoing services and business development. Finally, members of the cooperative are also exempt from taxation on any refund they receive if it’s based on purchases of “personal, living or family items,” as is almost always the case for GreenStar members.

GreenStar has not taken advantage of these tax benefits allowable under IRS regulations. In robust years GreenStar has paid taxes on member-generated net income that would have been exempt under a patronage refund system. In lean years, by granting an up-front 2% discount on all sales to members, it has eliminated most or all of the net income needed for its operation and development. 

Here’s how a patronage refund system could work at GreenStar:

• Throughout the year members pay the prices marked on the shelves minus any discount they currently receive (staff, working member, super-worker) except for the 2% member discount portion.

• Each member’s purchases are tallied in GreenStar’s new point of sale (POS) system.

• At the end of the year, GreenStar’s sales and before-tax net income is determined. Let’s say sales were $10 million and net profit was $200,000, or 2%.

• The portion of net income from member sales is determined. Since GreenStar’s sales are about 70% to members, member sales totaled $7,000,000.  Net income from member sales was 2% of $7,000,000, or $140,000.

• Each member’s share of total member purchases is calculated. Let’s say Xavier’s purchases totaled $7000 over the year. His share of total member purchases is $7000/7,000,000, or .1%, so Xavier is entitled to .1% of the $140,000 of member-generated net income, or $140.

• Council determines what percentage of that year’s patronage refund to return to Xavier (and every other member) in the form of cash, and what percentage to retain in Xavier’s retained patronage account. Let’s say Council decides to pay out 50% and retain 50%.

• A $70 store certificate is issued in Xavier’s name. The certificate explains that by using it to buy groceries, or by redeeming it for cash, Xavier declares his acceptance of the entire $140 patronage refund, which includes the $70 retained in his name by GreenStar.

• Xavier’s acceptance of the patronage refund permits GreenStar to exempt Xavier’s portion of its net income from tax. Xavier’s retained $70 of capital appears on GreenStar’s balance sheet as owner equity, the portion of GreenStar’s assets owned by its members.  The retained portions of Xavier’s and Yvonne’s and Zachary’s patronage refunds combine to strengthen GreenStar’s daily operations and long-term development.

• If Council later determines that the retained portion of Xavier’s refund is not needed, it may return the other 50% to Xavier in the form of a store certificate or cash.

One requirement of a patronage refund system is that it be established as a “pre-existing obligation” prior to the first fiscal year in which it’s used. In order for the patronage refund system to go into effect in 2009, the year targeted by the Finance Committee and managers for its adoption, members would need to approve the required bylaws changes before the end of 2008.

A discussion of patronage refunds is planned for the April 24 Membership Meeting.  Materials will be distributed throughout 2008 to inform members about how the system will work, and other opportunities for discussing the system will be created. Finally, members will decide through a Member Referendum whether or not to formally adopt this important policy change.