FSM SUPREME COURT
TRIAL DIVISION
Cite as Kolonia Consumers' Cooperative Association vs. Tuuth,
5 FSM Intrm. 68 (Pon. 1991)

[5 FSM Intrm. 68]

KOLONIA CONSUMERS'
COOPERATIVE ASSOCIATION,
Plaintiff,

v.

ALOYSIUS J. TUUTH, in his capacity
as Secretary of Finance,
Federated States of Micronesia,
Defendant.

FSM Civ. 1990-026

OPINION

Edward C. King
Chief Justice
Hearing:  October 9, 1990
Decision:  May 14, 1991

APPEARANCES:
For the Plaintiff:          Roberta Lindberg
                                     Attorney-at-Law
                                     Micronesian Legal Services Corp.
                                     P.O. Box 129
                                     Kolonia, Pohnpei, FM  96941

For the Defendant:     David Webster
                                     Chief, Division of Litigation
                                     Office Attorney General
                                     Federated States of Micronesia
                                     P.O. Box PS-105
                                     Palikir, Pohnpei  FM   96941

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HEADNOTES
Taxation
     In the Federated States of Micronesia Income Tax Law, 54 F.S.M.C. 111 et seq., cooperatives are not singled out in any way within the definition of business and there is no indication in the tax law that cooperatives are to be treated differently than corporations or any other forms of businesses.KCCA v. Tuuth, 5 FSM Intrm. 68, 70 (Pon. 1991).
 
[5 FSM Intrm. 69]

Taxation
     Each exclusion from the definition of "gross revenue" in 54 F.S.M.C. 112(5) seems to represent one or another of three possible purposes: to prevent dual taxation of revenue of a single taxpayer, to make allowances for special situations, or to exclude funds received by the taxpayer on behalf of another such as refunds and rebates, moneys held in a fiduciary capacity, cash discounts taken on sales, or proceeds of sales of goods returned by customers when the sale price was refunded in cash or by credit.  KCCA v. Tuuth, 5 FSM Intrm. 68, 70-71 (Pon. 1991).

Taxation
     Patronage refunds paid by a cooperative to its members are not refunds within the meaning of 54 F.S.M.C. 112(5)(a) and are not excludible from gross revenue under the FSM Tax Law.  KCCA v. Tuuth, 5 FSM Intrm. 68, 71 (Pon. 1991).

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COURT'S OPINION
EDWARD C. KING, Chief Justice:
     This action is brought by Kolonia Consumers' Cooperative Association (KCCA) to challenge the determination, arrived at by the Secretary of Finance of the Federated States of Micronesia in 1989, that in calculating taxable gross revenue KCCA may not deduct "patronage refunds" paid by KCCA to its cooperative members out of those revenues.  Now before the Court is KCCA's motion for summary judgment which, for the reasons stated here, is denied.
 
I.
     There is no dispute as to the following facts.  KCCA, which operates a grocery and general store in Kolonia, is a consumer cooperative, associated and carrying on business under chapter 7 of the Corporations, Partnerships and Associations Regulations (the C.P.A. Regs) set out in volume I of the FSM regulations.1

     To become a patron, or member, of KCCA, one must pay a membership fee. Members pay KCCA the same prices for groceries and commodities as do

[5 FSM Intrm. 70]

nonmembers who make purchases there.  Throughout the year, the purchases of members are recorded and tallied.

     At the end of each year, KCCA's net earnings for the year are determined.  Under the governing regulations, at least twenty percent of the net earnings must be retained as a mandatory reserve.  A limited amount, up to six percent of their investment, may be paid to members as a return upon share capital.  The board may also allocate any or all of the remainder to special reserves.  C.P.A. Regs, Part 6, 6.1(a) to (c).

     It is possible that all net earnings could be employed for the above purposes and, until the board of directors has made those allocations, KCCA has no obligation to pay any bonus or refund to the members.  However after KCCA's board of directors has made those other allocations, the remaining net profits must be distributed to members, as patronage refunds.  Id., 6.1(d).  These patronage refunds are distributed among the members in proportion to their respective aggregate purchases throughout the year.  For the three tax years involved in this action, 1986 through 1988, the Board determined that one-half of each patronage refund would be paid in cash, with the other half of the refund credited to each member's share account, as added investment in KCCA.

II.
     The Federated States of Micronesia Income Tax Law, 54 F.S.M.C. 111 et seq., imposes a tax on gross revenue realized by businesses subject to the tax.  54 F.S.M.C. 141.  KCCA falls within the Income Tax Law's definition of "business," which includes "any . . . undertaking carried on...within the Federated States of Micronesia for economic benefit either direct or indirect . . . ."  54 F.S.M.C. 112(1) (1987 Supp.).  Cooperatives are not singled out in any way within the definition of business and there is no indication in the tax law that cooperatives are to be treated differently than corporations or other forms of businesses.  The broad definition of gross revenue, 54 F.S.M.C. 112(5), indisputably reaches all revenue realized by KCCA unless patronage refunds fall within any of the exclusions enumerated in that subsection.

     Each exclusion identified in subsection 112(5) seems to represent one or another of three possible purposes.  One purpose is to prevent dual taxation of revenue of a single taxpayer.  Thus, wages and salaries are excluded from gross revenue.   112(5)(c); see also the last clause of 112(5)(f).  KCCA does not claim that the Secretary's refusal to permit deduction of patronage refunds would result in double taxation of KCCA.

     Another purpose apparent within the exemptions is to make allowances for special situations.  Sections 112(5)(d) and (e) exclude from gross revenue amounts received as sale and rental payments for commercial aircraft if certain conditions are met.  Under section 112(5)(g), foreign aid which by

[5 FSM Intrm. 71]

agreement of the national government is not to be subject to taxation by the Federated States of Micronesia, is excluded from taxable gross revenue.  Surely, there are policy considerations which may be seen as justifying encouragement of cooperatives over other forms of business.  If Congress wanted to make special allowances or provisions for patronage refunds paid by cooperatives, it would be expected that a specific exclusion would be set out in section 112.  This, however, has not been done.

     The remaining section 112(5) exclusions are: "(a)  refunds and rebates; (b) moneys held in a fiduciary capacity; and (f)  cash discounts allowed and taken on sales, the proceeds of sale of goods, wares, or merchandise returned by customers when the sale price is refunded in cash or by credit . . . ."  These all may be seen as excluding either funds received by the taxpayer simply on behalf of another, 112(5)(b), or funds which the taxpayer was obliged to return, for legal or business reasons arising out of the transaction which produced the revenue.  All of the revenues excluded from taxation are received by the taxpayer subject to claims of another party.

     KCCA argues that its patronage refunds are included among the kinds of refunds referred to in 54 F.S.M.C. 112(5)(a).  It is of course possible that the term "refund", viewed by itself, could be seen as sufficiently broad to cover any repayment or return of money regardless of whether the repayment is voluntary or legally required.  See H. Black, Black's Law Dictionary 1152 (5th ed. 1979).  Indeed, the C.P.A. regulations refer to a patronage refund as a "bonus or refund."  C.P.A. Regs, Part 6, 6.1(d).

     However, nothing in the FSM Income Tax Law or in the statute's legislative history suggests that the term "refund" as it is used in 54 F.S.M.C. 112(5) was intended to refer to patronage refunds paid by a consumer cooperative to its members. Moreover, an exclusion of voluntarily paid refunds would be strange indeed in a tax code, for such an exclusion would place in the taxpayer an ability to alter its own tax liability artificially through refunds or repayments having no business purpose or other legal justification whatever.  Finally, such an interpretation of the word "refund" would be asymmetrical, establishing a broad exclusion outside of any of the general purposes apparent in the other exclusions.  The Court concludes that voluntary refunds are not excluded from gross revenue.

     It follows that the patronage refunds paid by KCCA to its members in the years in question are not refunds within the meaning of 54 F.S.M.C. 112(5)(a) and are not excludible from gross revenue.  In each of 1986 through 1988, KCCA had no legally enforceable obligation to pay any specific amount, nor indeed to pay any patronage refund at all, when the revenues were received.  Instead, the revenues were property of KCCA to be used for any purposes determined by the board of directors.  Only at the end of the fiscal year, after net earnings had been determined and when the board of directors declared a patronage refund, did a legal obligation arise.

     These patronage refunds, then, were not based upon legal liabilities which pre-existed or coincided with KCCA's receipt of the gross revenue nor did they somehow arise out of the generation of the revenue itself.  Instead,

[5 FSM Intrm. 72]

they arose after receipt of the funds through voluntary action of the taxpayer's board of directors after net earnings had been calculated.  The patronage refunds were in fact distributions of earnings, akin to dividends.  The government's position that patronage refunds are not entitled to exclusion from KCCA's gross revenues for tax purposes is the more reasonable interpretation of the statutory language.  Thus, plaintiff's motion for summary judgment must be denied.

III.
     If we were writing on a clean slate and if this were the first implementation of 54 F.S.M.C. 112(5), this Court would uphold the position of the government without reservation.  Here, however, KCCA points out that for almost 20 years, since the original Trust Territory income tax law went into effect in 1971, all the way up until 1989, tax authorities allowed deductions of patronage refunds such as those in issue now.

     Throughout those 18 years, the actions of taxing authorities presumably reflected an administrative interpretation as to the meaning of the term "refund" as it now appears in 54 F.S.M.C. 112(5)(a).  This Court has significant reservations about the legal propriety of a sudden retroactive change of interpretation, announced after the tax years in question, which could lead to assessments of penalty and interest against a taxpayer who has acted in conformity with then existing administrative interpretations.

     Therefore as proceedings in this case continue, the focus will be on whether, without any change in the relevant statutory language or in the regulations, the government may announce reversal of its prior interpretations, and then employ the new interpretation retroactively as a basis for collecting interest and penalties from the taxpayer.   Cf. Ponape Federation of Cooperative Associations v. Federated States of Micronesia, 2 FSM Intrm. 124, 128 (Pon. 1985).

IV.
     The plaintiff's motion for summary judgment is denied.  Proceedings shall continue as to retroactive application of the government's new interpretation.
 
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Footnote:
 
1. A consumers' cooperative is a form of business association designed to enable consumers, who may participate as members of the association, to pool their purchasing power.  The basic theory is that the cooperative will be able to buy in greater quantities, and therefore more cheaply and efficiently, than could individual members through their own separate efforts.  Cooperatives also seek to reduce costs through elimination of the "middleman's" profit.