1972 U.S. Tax Ct. LEXIS 68 | Tax Ct. | 1972
Lead Opinion
OPINION
Section 1561(a), I.R.C. 1954,
■Section 1563 (e)
However, section 1563(c)(1)(C)
SEC. 1563. DEFINITIONS AND SPECIAL RULES.
(e) Certain Stock Excluded.—
*******
(2) Stock treated as “excluded stock”.—
*$$$$**
(B) Brother-sister controlled group. — -For purposes of subsection (a) (2), if a person who is an individual, estate, or trust (referred to in this paragraph as “common owner”) owns (within the meaning of subsection (d) (2)), 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock in a corporation, the following stock of such corporation shall be treated as excluded stock—
*******
(ii) stock in such corporation owned (within the meaning of subsection (d) (2)) by an employee of the corporation if such stock is subject to conditions which run in favor of such common owner (or such corporation) and which substantially restrict or limit the employee’s right (or if the employee constructively owns such stock, the direct owner’s right) to dispose of such stock. If a condition which limits or restricts the employee’s right (or the direct owner’s right) to 'dispose of such stock also applies to the stock held by the common owner pursuant to a bona fide reciprocal stock purchase arrangement, such condition shall not be treated as one which restricts or limits the employee’s right to dispose of such stock * * *.
The Commissioner contends that stock of the Redding and Chico companies which was owned by employees of those companies was “subject to conditions which [ran] in favor of [the respective corporations] and which substantially restricted] or limit[ed] the employee [s’] right * * * to dispose of such stock,” by reason of article YI, section 3, of the bylaws, which was reproduced on the stock certificates and which in substance prohibited the sale of the stock without first offering it to the company and thereafter to the other shareholders in the event that the company did not exercise its option to purchase. If the Commissioner is correct in his contention that the minority employee-owned shares (220 in Redding and 750 in Chico) must be excluded, then it is undisputed that A. E. Huckins’ percentage interests in all three corporations exceeded 80 percent.
1. Petitioners’ first contention calls for only brief comment. The same argument was made and rejected in Barton Naphtha Co., 56 T.C. 107. Petitioners have not been able to offer any satisfactory distinction between the present case and Barton Naphtha; we follow it here. See also sec. 1.1563-2(b) (2) (iii), Income Tax Pegs.
2. Nor do we agree with petitioners’ second contention that the employees’ stock may not be treated as “excluded stock” by reason of a purported “bona fide reciprocal stock purchase arrangement” under which the restrictions affecting the employees’ stock were equally applicable to the stock of the common owner, A. E. Huckins. To be sure, the same restrictions upon transfers of stock which were imposed by the bylaws in respect of the minority employee-owned stock were in form equally applicable to the stock owned by Huckins. And if such restrictions were irrevocably binding upon him, we would sustain petitioners’ position. But the Commissioner argues that Huckins, as the controlling stockholder,
Section 500 of the California Corporations Code (1947) provides that bylaws may be “amended, or repealed by the vote or the written assent of shareholders entitled to exercise a majority of the voting-power of the corporation.”
In the Tu-Vu case, the owner of 54 percent of a corporation’s stock effected a change in the bylaws, requiring for the first time that the corporation’s shares could be transferred to an outsider only if the owner first offered them to the other shareholders or the corporation. In an action to enforce these new restrictions against a nonconsenting stockholder owning 39 percent of the outstanding stock, the Supreme Court of California held the amended bylaws valid. In response to the argument that the amendment to the bylaws impaired the minority stockholder’s “contract” with the corporation, the court held that insofar as the corporate bylaws constituted a contract between the stockholders and the corporation, such contract was subject to the legislature’s power to regulate the rights of corporate stockholders and was therefore subject to the corporation’s power to amend its bylaws pursuant to statutory authority. Therefore, even if petitioners’ bylaws were also regarded as an agreement between the stockholders inter sese, their agreement must likewise have been subject to the relevant provisions of the California Corporations Code, which did not require all stockholders to consent to the repeal or amendment of a bylaw. See also Wilson v. Cherokee Drift Mining Co., 14 Cal. 2d 56, 58, 92 P. 2d 802, 803; Silva v. Coastal Plywood & Timber Co., 124 Cal. App. 2d 276, 278, 268 P. 2d 510, 512 (approving a nonunanimous repeal of a bylaw which restricted the transfer of shares) ,
Thus, if a majority stockholder could unilaterally amend the bylaws so as to impose restrictions upon the disposition of the corporation’s stock, it would seem that it would similarly be within his power to remove existing restrictions of a like nature — ordinarily, a less drastic action. We are unable to discern any critical difference between the two situations, and, in our judgment, Huckins had the power to modify the bylaws at will so as to remove the restrictions against disposition.
In view of our conclusion that Huckins had the power to remove the restrictions at will,
We hold that petitioners’ employee-owned stock, apart from that held by A. E. Huckins, must be treated as “excluded stock” under section 1563(c) (2) (B) (ii) and that Huckins’ extent of control over each of the petitioners therefore exceeded 80 percent. Cf. Rev. Rul. 70-252, 1970-1 C.B. 186. As a component member of a brother-sister controlled group of corporations, each petitioner was entitled under section 1561 (a) to only one-third of a full $25,000 surtax exemption for each of the years 1966 and 1967. Pursuant to their timely filed election under section 1562(a) (1),
Decisions will be entered wider Rule 50.
In respect of the years at issue herein, sec. 1561(a) provides as follows : SEC. 1561. SURTAX EXEMPTIONS IN CASE OF CERTAIN CONTROLLED CORPORATIONS.
(a) General Rule. — If a corporation is a component member of a controlled group of corporations on a December 31, then for purposes of this subtitle the surtax exemption of such corporation for the taxable year which includes such December 31 shall be an amount equal to—
(1) $25,000 divided by the number of corporations which are component merdbers of such group on such December 31, or
(2) if all such component members consent (at such time and in such manner as the Secretary or his delegate shall by regulations prescribe) to an apportionment plan, such portion of $25,000 as is apportioned to such member in accordance with such plan.
The sum of the amounts apportioned under paragraph (2) among the component members of any controlled group shall not exceed $25,000.
As it applied to the years In Issue, prior to its amendment by section 401 (c) of the Tax Reform Act of 1969, 83 Stat. 487, sec. 1563 (a) (2) read as follows:
SEC. 1563. .DEFINITIONS AND SPECIAL RULES.
(a) Controlled Group op Corporations. — For purposes of this part, the term “controlled group of corporations” means any group of—
»*•*•**
(2) Brother-sister controlled group. — Two or more corporations if stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each of the corporations is owned (within the meaning of subsection (d) (2i)) by one person who is an individual, estate, or trust.
SEC. 1563. DEFINITIONS AND SPECIAL RULES.
(e) Constructive Ownership.—
*******
(4) Attribution from corporations. — Stock owned, directly or indirectly, by or for a corporation shall be considered as owned by any person who owns (within the meaning of subsection (d)) 5 percent or more in value of its stock in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation;
(5) Spouse. — An individual shall be considered as owning stock in a corporation owned, directly or indirectly, by on for his spouse » * *, except in the case of a corporation with respect to which each of the following conditions is satisfied for its taxable year—
(A) The individual does not, at any time during such taxable year, own directly any stock in such corporation;
(B) The individual is not a director or employee and does not participate in the management of such corporation at any time during such taxable year;
(C), Not more than 50 percent of such corporation’s gross income for such taxable year was derived from royalties, rents, dividends, interest, and annuities; and
(D) Such stock in such corporation is not, at any time during such taxable year, subject to conditions which substantially restrict or limit the spouse’s right to dispose of such stock and which run in favor of the individual or his children who have not attained the age of 21 years.
(6) Children, grandchildren, parents, and grandparents.—
* * * * * * *
(B) Adult children and grandchildren. — An individual who owns (within the meaning of subsection (d)(2), but without regard to this subparagraph) more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock in a corporation shall be considered as owning the stock in such corporation owned, directly or indirectly, by or for his parents, grandparents, grandchildren, and children who have attained the age of 21 years.
SEC. 1563. DEFINITIONS AND SPECIAL RULES.
(<j) Rules for Determining Stock Ownership. — - *******
(2) Brother-sister controlled group. — For purposes of determining whether a corporation is a member of a brother-sister controlled group of corporations (within the meaning of subsection (a)(2)), stock owned by a person who is an individual, estate, or trust means—
(A) stock owned directly by such person, and
(B) stock owned with the application of subsection (e).
SEC. 1563. DEFINITIONS AND SPECIAL RULES.
(f) Other Definitions and Rules. — •
*******
(2) Operating rules.—
(A) In general. — * * * stock constructively owned by a person by reason of the application of paragraph (1), (2), (3), (4), (5), or (6) of subsection (e) shall, for purposes of applying such paragraphs, be treated as actually owned by such person.
SEC. 1563. DEFINITIONS AND SPECIAL RULES.
(e) Certain Stock Excluded.—
(1) General rule. — For purposes of this part, the term “stock” does not include— * * * * ' * * *
(C) stock which is treated as “excluded stock” under paragraph (2).
The computations are as follows:
[[Image here]]
[[Image here]]
[[Image here]]
These regulations provide that a condition whereby the corporation “Is given a right of first refusal with respect to any stock * * * offered by an employee for sale is a condition which substantially restricts or limits the employee’s right to dispose of such stock.” In accord with established law these regulations are valid unless plainly inconsistent with the statute. See Commissioner v. South Texas Co., 333 U.S. 496, 501; Bingler v. Johnson, 394 U.S. 741, 749-750; Regal, Inc., 53 T.C. 261, 263, affirmed 435 F. 2d 922 (C.A. 2). No such inconsistency has been shown here. To the contrary, the legislative history of the statute clearly demonstrates that the House Ways and Means Committee regarded a “right of first refusal” as “[a]n example of a condition which substantially restricts or limits an employee’s right to dispose of his stock." H. Rept. No. 749, 88th Cong., 1st Sess., p. A204.
He and his wife owned 2,070 out of the 3,000 outstanding shares of Redding and 2,750 out of the 4,000 outstanding shares of Chico. ’Such shares were held as community property, and Huckins possessed the power to vote them, pursuant to sec. 172 of the California Civil Code (now codified in Cal. Civ. Code sec. 5125 (1970)), which provides that “the husband has the management and control of the community personal property.”
Pursuant to that section bylaws may also be amended or repealed by the board of directors, but its power in this respect is made explicitly “[s]ubjeet to the right of the shareholders to * * * amend, or repeal” the bylaws.
Several cases cited by petitioners suggest that the law may be otherwise in one or two other States.
Casady v. Modern Metal Spinning & Manufacturing Co., 188 Cal. App. 2d 728, 10 Cal. Rptr. 790, also relied upon by petitioners, entirely faUed to consider the possibility that the shareholders’ contract arising from the bylaws incorporated the amendatory provisions of the statute. Moreover, the court’s description of the bylaws as a contract between the stockholders inter sese, was characterized as dictum and questioned in Scott v. Lee, 208 Cal. App. 2d 12, 14-15, 24 Cal. Rptr. 824, 826. Finally, the Oasady case was heavily Telied on in the appellate court’s opinion in Tu-Vu Drive-In ease, 34 Cal. Rptr. 622, 623 (Dist. Ct. App. 4th Dist.), which was reversed by the California Supreme Court.
The fact that the applicable provisions of the bylaws were quoted in the certificates adds nothing to petitioners' case. Such endorsements merely operated to bring the certificates into conformity with the disclosure requirements of secs. 2403(c) and 2404 of the California Corporations Code, and if the bylaws were modified, there would not appear to be any difficulty in obtaining the California corporations commissioner’s permission to replace the original stock certificates with certificates not containing the restrictive legend. Cf. Tu-Vu Drive-In Corp. v. Ashkins, 61 Cal. 2d 283, 285, 391 P. 2d 828, 829, 38 Cal. Rptr. 348, 349.
To be sure, as majority stockholder, he could also have obtained a modification of the bylaws in another manner, namely, by selecting a sufficient number of compliant directors who could be counted upon to amend the1 bylaws in accordance with his wishes. We need not decide whether this ground alone would be sufficient to support our conclusion in the light of United States v. Byrum, 408 U.S. 125, for Huckins had the right as stockholder to amend the bylaws without any participation by the directors — a right which he could exercise in his favor under California law pursuant to the rationale of the Tu-Vu case. Moreover, even if that right was subject to some restriction based upon a fiduciary obligation, it is obvious that he certainly could exercise his right at least within a broad range as exemplified by Tu-Vu, whereas the minority stockholders had no such right at all. Accordingly, there is here absent the “reciprocal stock purchase arrangement” required by the statute. No such provisions were involved in Byrum.
SEC. 1562. PRIVILEGE OP GROUPS TO ELECT MULTIPLE SURTAX EXEMPTIONS. (a) Election of Multiple Surtax Exemptions.—
(1) In general. — A controlled group of corporations shall (subject to the provisions of this section) have the privilege of electing to have each of its component members make its returns without regard to section 1561. Such election shall be made with respect to a specified December 31 and shall be valid only if—
(A) each corporation which is a component member of such group on such December 31, and
(B) each other corporation which is a component member of such group on any succeeding December 31 before the day on which the election is filed, consents to such election.
SEC. 1562. PRIVILEGE OF GROUPS TO ELECT MULTIPLE SURTAX EXEMPTIONS. (b) Additional Tax Imposed.—
(1) General rule. — If an election under subsection (a) (3) by a controlled group of corporations is effective with respect to the taxable year of a corporation, there is hereby imposed for such taxable year on the taxable income of such corporation a tax equal to 6 percent of so much of such corporation’s taxable income for such taxable year as does not exceed the amount of such corporation’s surtax exemption for such taxable year. * * *