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Santel Communications Cooperative, Inc. v. United States

March 12, 2010


The opinion of the court was delivered by: Karen E. Schreier Chief Judge


Plaintiff, Santel Communications Cooperative, Inc., filed and served a complaint on defendant, United States of America, seeking to recover $1,126,675 or such amount as is legally recoverable, plus applicable interest, on the basis that the United States improperly collected and retained it. (Docket 1). United States moves to dismiss Santel's claim on the ground of lack of subject matter jurisdiction. (Docket 24). United States's motion to dismiss is granted.


Santel is a rural-telephone cooperative headquartered in Woonsocket, South Dakota. Santel was founded in 1951 and has operated continuously as a rural-telephone cooperative since that time. In general, nonexempt cooperatives have been governed since the Revenue Act of 1962 by subchapter T of the Internal Revenue Code, see generally Farmers Coop. Co. v. Birmingham, 86 F. Supp. 201 (N.D. Iowa 1949), but Santel is a rural-telephone cooperative and is therefore specifically excluded from the statute.

See 26 U.S.C. § 1381(a)(2)(C) (explicitly excluding from subchapter T any organization "which is engaged in furnishing electric energy or providing telephone service to persons in rural areas"). As explained in the committee reports to the Revenue Act of 1962, the nonexempt cooperatives engaged in providing telephone services to rural areas "will continue to be treated the same as under present law." H.R. Rep. No. 87-1447 (1962); S. Rep. No. 87-1881 (1962); see also Clayton S. Reynolds, Patronage-Sourced Income: An Expanding Universe, 58 Tax Law. 479, 481 n.11 (Winter 2005). Therefore, the law prior to 1962 continues to govern the taxation of Santel.

Santel provides telephone services to approximately 2,500 members; by agreeing to purchase services from Santel, a person automatically becomes a member of the cooperative and is thereafter entitled to one vote. Santel's bylaws also provide that a member is entitled to a share of the cooperative's "patronage-sourced income," which is income that Santel earns from conducting business with its patrons, in proportion to the purchases of the cooperative's services made by the member. Santel's bylaws mandate that all patronage-sourced income be allocated to its patrons on a patronage basis.

In 1989, Santel purchased cellular FCC licenses and formed three corporations to hold the licences. Santel made this purchase in order to meet the needs of its rural customers and to protect itself from emerging competitors. Santel owned 16 percent, 20 percent, and 25 percent, respectively, of the three corporations.

In 1998, Santel sold its interest, or stock, in the three corporations, leading to a taxable capital gain of $5,256,536. Santel realized the capital gain in 1998. At that time, the IRS maintained the position that capital gains were not patronage-sourced income. See sec. 1.1382-3(c)(2), Income Tax Regs. Santel did not distribute or allocate the proceeds that arose from this capital gain as a patronage dividend in 1998.

Santel paid the estimated tax on its 1998 taxable income on March 15, 1999, and filed its 1998 corporate income tax return on May 25, 1999. The 1998 corporate income tax return reported the $5,256,536 proceeds from the 1998 sale of stock as taxable capital-gain income.

In 1999, the United States Tax Court issued an opinion finding that, in appropriate circumstances, income from the sale or exchange of capital assets could be patronage-sourced income. Farmland Indus. v. Commissioner, 78 T.C.M. (CCH) 846 (1999). On March 27, 2001, the IRS issued a formal memorandum announcing the IRS's acquiescence in the tax court's finding in Farmland Industries. Id., action on dec. 2001-003 (Mar. 28, 2001). Specifically, the IRS stated that it will determine whether each item of income is patronage or nonpatronage sourced by considering the circumstances and analyzing "the relationship of the activity producing the income or loss to the cooperative's business of serving its patrons." AOD 2001-003, at 2.

On September 14, 2001, in light of the IRS's change in position, Santel allocated $3.9 million of the proceeds from the 1998 sale of stock to its patrons' accounts. Santel excluded or deducted from its 2000 gross income the amount of the proceeds, and thereafter reported a net operating loss in the amount of $3,713,428 for the 2000 taxable year in an amended 2000 corporate income tax return.

On September 6, 2002, Santel filed a claim for refund with the IRS by filing an amended 1998 income tax return. The refund claim was in the amount of $1,126,975. Santel asserted that this refund was due to a carryback to 1998 of the 2000 net operating loss.

The IRS denied Santel's refund claim, and Santel now ...

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