Kolonia Consumer Cooperative Association v Federated States of Micronesia [1992] FMSC 24; 5 FSM Intrm. 375 (App. 1992) (9 November 1992)

[1992] FMSC 24; 5 FSM Intrm 375 (App 1992)

FEDERATED STATES OF MICRONESIA
SUPREME COURT APPELLATE DIVISION

FSM APPEAL CASE NO. P4-1991

KOLONIA CONSUMER COOPERATIVE ASSOCIATION
Appellant

V

FEDERATED STATES OF MICRONESIA
Appellee

OPINION: Argued: June 24, 1992 - Decided: November 9, 1992

BEFORE: Honorable Richard H. Benson, Associate Justice, FSM Supreme Court;
Honorable Martin Yinug, Associate Justice, FSM Supreme Court;
Honorable Arthur Ngiraklsong, Temporary Justice, FSM Supreme Court*

*Acting Chief Justice, Palau Supreme Court, Koror, Republic of Palau

APPEARANCES: For the Appellant: Roberta J. Lindberg, Esq. (on brief) and Delson Ehmes, Esq. (argued); For the Appellee: Douglas J. Juergens, Esq., Chief of Litigation, FSM Attorney General's Office

HEADNOTES

Administrative Law; Corporations
Regulations prescribed by the registrar of corporations have "the force and effect of law." KCCA v. FSM, [1992] FMSC 24; 5 FSM Intrm. 375, 377 (App. 1992).

Taxation
Where regulations existed referring to a patronage refund as a "bonus or refund" at the time Congress enacted the statute excluding refunds from the definition of gross revenue, the statute unambiguously excludes patronage refunds from gross revenue. KCCA v. FSM, [1992] FMSC 24; 5 FSM Intrm. 375, 379-80 (App. 1992).

Taxation
Patronage refunds are not voluntarily paid refunds because the regulations compel the allocation of patronage refunds. Therefore they are properly excludable from gross revenue. KCCA v. FSM, [1992] FMSC 24; 5 FSM Intrm. 375, 380 (App. 1992).

COURTS OPINION

RICHARD H. BENSON, Associate Justice:

54 F.S.M.C. 141 imposes a tax on the gross revenue of businesses. 54 F.S.M.C. 112(5) defines gross revenue and states that "refunds and rebates" (together with six other categories) are not included in gross revenue.

The appellant annually distributes refunds to its members in proportion to the value of business each member has transacted during the year.

The question of law before us is whether these "patronage refunds"^[1] are "refunds" as that term is used in 54 F.S.M.C. 112(5)(a). We conclude that they are. They are thus not included in gross revenue.

The action was brought in the trial division pursuant to 54 F.S.M.C. 156 to challenge the determination of the Secretary of Finance who, after a 1989 audit, disallowed the exclusion of the refunds for the years 1986, 1987, and 1988.

Kolonia Consumer Cooperative Association's motion for summary judgment was denied. Kolonia Consumers Coop. Ass'n v. Tuuth, 5 FSM Intrm. 68 (Pon. 1991). Judgment in favor of the Secretary was subsequently entered, and this appeal followed.

I.

Kolonia Consumer Cooperative Association (K.C.C.A.) is a cooperative association which was organized pursuant to the laws and regulations of the Trust Territory of the Pacific Islands.

K.C.C.A. was in existence when the gross revenue tax law became effective in 1971. Beginning in 1971 K.C.C.A. paid the gross revenue tax, deducting patronage refunds from the gross revenue. The government allowed the deduction for the years 1971 through 1985. Following a routine audit in 1989, the defendant Secretary of Finance disallowed the deductions taken in 1986, 1987 and 1988.

The Trust Territory Code provisions governing corporations, partnerships and associations appear in the 1966 Code. TTC 1115 et seq. (1966). They provide that the registrar of corporations may prescribe regulations which have "the force and effect of law." TTC 1115(b)(1966).

The regulations for cooperative associations filed May 23, 1969 provided for the allocation and distribution of net earnings in this order: not less than 10% to a reserve fund; to special funds as required by the High Commissioner, the Registrar of Corporations, by regulation, or by the cooperative's board of directors; to return on capital of the members; and the remainder to savings returns. "Savings returns" is defined in the regulations as "the amount returned to patrons in proportion to their patronage . . . ." Part 30.3(e).

Public Law 4-2, effective July 1, 1971, defined gross revenue and imposed a tax on gross revenue. The definition set out three categories that were not included in gross revenue; one was "refunds, rebates, and returns".

Thereafter the 1969 regulations were amended as reflected in Release No. 7-73, published in the Territorial Register, Volume 1, No. 1, August 15, 1974. These regulations govern cooperatives and remain in effect within the Federated States of Micronesia. Part 6.1(d) of the regulations provides for the allocation and distribution of net earnings in this order: not less than 20% to a mandatory reserve; to special reserves established by the Registrar of Corporations, the High Commissioner, regulations, or as recommended by the board of directors and approved by the general meeting of the members; to return on share capital not to exceed 6%; and the remainder allocated to members and to patrons eligible for and desiring membership, "a bonus or refund in proportion to the value of business each member or patron has transacted during the fiscal period in question . . . ." provided that:

Part 6.1(d)(l) through (4) are not pertinent to our inquiry.

Part 6.1(d)(5) (Inter alia, relates to payment of return on capital or patronage refund out of net earnings accumulated from previous fiscal periods).

These 1973 regulations state: "earnings returns means the amount returned to the patrons in proportion to their patronage . . . ." Part 1.3(d). This definition is almost identical to that in the 1969 regulations.

In 1981 Public Law 2-23 was enacted amending the definition of gross revenue to delete references to discounts and returns, and to add a new category not includible in gross revenue. This amendment changed the category of "refunds, rebates and returns" to "refunds and rebates."

II

An examination of the definition of gross revenue and of the language of the regulations governing cooperatives leads to our conclusion that patronage refunds are refunds within the category of items not included in gross revenue.

This is a summary of our holding:

l. The regulations governing cooperatives prescribed by the Registrar of Corporations during the Trust Territory administration are presently in effect.

2. The regulations in effect in 1986 and still in effect require the allocation of the remainder of net earnings after other allocations of "a bonus or refund in proportion to the value of business each member or patron has transacted. . . ."

3. Gross revenue, as defined in 1986 and as it is still defined, does not include "refunds and rebates." 54 F.S.M.C. 112(5).

4. The meaning of "refunds" in the foregoing section includes patronage refunds because patronage refunds are referred to in the regulations as refunds.

An examination of the problem in greater detail is appropriate because 1) patronage refunds were not described as refunds in the 1969 regulations, and 2) an amendment to the definition of gross revenue in 1981 deleted "returns" from the list of categories not included in gross revenue.

The changes in the regulations and the amendment of the definition is shown in the following tabulation.

REGULATIONS

1969 1973

35.1 6.1

"Shall apportion the net ". . . the net earnings

earnings: . . . shall be apportioned . . .

. . . . . .

(d) The remainder shall (d) The remainder shall

be allocated at the same be allocated . . . among

uniform rate to all patrons the members thereof, or

of the association in all patrons eligible for

proportion to their individual and desiring membership,

patronage:. . ." as a bonus or refund in

proportion to the value

of business each member

or patron has transacted

. . ."

30.3 (e) 1.3 (e)

"`Earnings returns' means "`Earnings returns'

the amount returned to the means the amount returned

patrons in proportion to their to the patrons in

patronage . . . ." proportion of their

patronage . . . ."

GROSS REVENUE DEFINITION

1971 1981

". . . Gross revenue shall ". . . Gross revenue

not include the following: shall not include

(a) refunds, rebates, and the following:

returns; . . ." (a) refunds and rebates;

. . ."

We observe that if an issue had arisen in 1971 as to whether patronage refunds are included in gross revenue, it seems the answer would be that they are not, because they are returns.

The 1973 regulations use two terms to mean patronage refunds, "earnings returns" and "bonus or refund". A hypothetical will again illustrate our reasoning: if the issue had arisen in 1974 as to whether patronage refunds are included in gross revenue, it appears that they would not be, because they are refunds and returns.

The issue before us arises from the state of the regulations and of the statute in 1986, 1987, and 1988, the years of the returns of KCCA that were audited by the government. Public Law 1-83 became effective in 1980. Its purpose was to make "necessary, technical amendments to Part I of Title 77 of the TT Code relating to rules and regulations governing the collection of taxes and the administration and management of the income tax law." SCREP No. 1-116, J. of 1st Cong., 2nd Reg. Sess. 234 (1979). This law reenacted the exclusion of "refunds, rebates and returns" from the definition of gross revenue.

Next, Public Law 2-23, effective in 1981, deleted "returns", as has been described already.

At the time of both these enactments Congress and the President had before them the 1973 regulations which refer to patronage refunds as "a bonus or refund". (Part 6.1 as summarized in part I above.) Additionally, Part 6.1(d)(5) refers to "patronage refunds", stating, "(5) the payment of a return upon share capital, or of patronage refund or refund upon the wages or products of each member, out of net earnings accumulated from previous fiscal periods, or from reserves, will only take place with the express approval of the Registrar in writing. . . ."

Because the regulations have the effect of law, had been in effect for many years before the enactment of the definition of gross revenue by the FSM, and identified patronage refunds as "refund", we feel compelled to conclude that patronage refunds are not to be included in gross revenue as it is defined in 54 F.S.M.C. 112(5). We find no ambiguity in the language of the definition.

III

On the issue presented on appeal the government's position only refers us to the opinion of the trial court, stating that it is correct. We briefly explain our departure from the reasoning of the trial court. The trial court found the meaning of "refunds" ambiguous. The court examined all categories of items not included in gross revenue in order to resolve the ambiguity. The only classification of categories into which "refunds" might fit was a category of "funds received by the taxpayer simply on behalf of another, or funds which the taxpayer was obliged to return." Kolonia Consumers Cooperative Association v. Tuuth, 5 FSM Intrm. 68, 71 (Pon. 1991) (citation omitted). The court concluded that this classification did not apply to "voluntarily paid refunds." Id.

In light of the regulations we do not find the term "refunds" in the statute ambiguous. We also conclude that there is compulsion to pay patronage refunds.

By regulation, the cooperative must allocate 20% of net earnings to a reserve. If the cooperative takes no other action to allocate to reserves or to a return on share capital, the remainder of the net earnings after the 20% must be allocated to patronage returns. We find compulsion in this.

We also find compulsion in the tax consequences of the taxpayer's allocations. If refunds are not included in gross revenue, the cooperative's lowest tax liability is by not making any allocation above the 20% to reserves and by not making a return to share capital. Any decision the taxpayer makes in respect to allocations increases its tax liability because reserves and dividends are included in gross revenue.

For the reasons stated the judgment of the trial court is reversed with directions to enter a new judgment in accord with our holding.

ENDNOTE:

¹The term "patronage refunds" is descriptive. It appears in the briefs and in the opinion below.

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^[1]The term "patronage refunds" is descriptive. It appears in the briefs and in the opinion below.