Cooperative firms return profits to their member-owners in proportion to their use of the firm. Those profit distributions are referred to as “patronage refunds”. In contrast, most other corporations distribute profits in proportion to investment. Cooperative members may be somewhat familiar with patronage refunds but often do not understand all of the structures and issues. Producers who are not a member of a cooperative may wonder what they are missing. Patronage refunds are the most unique and, perhaps, the most interesting feature of cooperatives.
In cooperative terminology, a patron is a cooperative customer who qualifies to receive patronage refunds. That typically means that they are a member of the cooperative. Patronage refunds are profits that are distributed in proportion to use. Usage can be measured in multiple ways. Patronage can be based on the dollar amount of purchases or commodity payments or on physical units such as bushels or tons. A cooperative can track member use as a single patronage pool, or as multiple pools reflecting separate commodities, products or departments. Each cooperative selects the patronage base that most fairly represents member use.
Cooperatives can pay patronage as a combination of cash and equity. Equity patronage is eventually redeemed into cash and, for that reason, is often called “revolving equity”. Equity patronage has two functions. First, it allows members to build ownership without an out-of-pocket investment. Second, it capitalizes the cooperative, funding the property, plant and equipment.
Patronage refunds have tax implications. Cooperatives are taxed as corporations but are allowed to deduct patronage distributions. Those patronage refunds become taxable income for the patrons. Cash patronage is immediately taxable to the patron but equity patronage can be structured to be taxable when issued or taxed at the later date when it is redeemed into cash.
Many local cooperatives are in turn members of regional cooperatives. Those regional cooperatives issue patronage refunds to the local cooperatives, which becomes part of the local cooperative’s net income. Therefore, the patronage refunds that producers receive from their local cooperative reflects both the local cooperative’s profits and the pass through share of the regional cooperative’s profits.
Many younger producers wonder why a cooperative cannot simply offer more favorable prices (more than what competition might dictate) in lieu of paying patronage refunds. There are some very good reasons. Equity patronage capitalizes the cooperative. One way to think of equity patronage is that the members are receiving their share of the total profits and then temporarily reinvesting a portion of those profits in the cooperative. The second rationale for not substituting favorable prices for patronage is the danger of misestimating costs and creating a loss. Finally, favorable prices would result in zero profits and zero return on assets and equity. Basically, profits have been given away in the form of prices. Many members will not perceive the price benefit and conclude that the cooperative is poorly managed. By setting prices at market level, generating profits and then returning those profits as patronage refunds, members can observe the cooperative’s performance and appreciate its benefit, and the cooperative will be capitalized and able to respond to member needs.
Most producers wish they could purchase their inputs a little cheaper and sell their commodities at a slightly higher price. Most producers would also like to invest for the future. Producers can achieve all of the goals with no out-of-pocket investment by joining and patronizing their local cooperative. When you are a cooperative patron, the check really is in the mail!