OPINION
Raum, Judge:
Section 1561(a), I.R.C. 1954,4 provides that if a group of corporations constitutes a “controlled group of corporations” on a December 31, the component members of such group are entitled to only one surtax exemption of $25,000 to be apportioned among them for their respective taxable years which include such December 31. The Commissioner contends that petitioners constituted a “controlled group of corporations” in accordance with section 1563 (a) (2),5 which in substance defines that term to include a “brother-sister controlled group,” and that definition in turn is applicable here by its terms if A. E. Huckins owned, directly or constructively, at least 80 percent of the outstanding stock of all three petitioners on December 81 of 1966, 1967, and 1968. In the absence of petitioners’ consent to a plan for an uneven apportionment of such exemption, the Commissioner has allocated one-third of $25,000 to each petitioner for each of the years at issue. The petitioners object to the Commissioner’s determination that A. E. Huckins owned more than 80 percent of each company’s stock. We think that his determination must be approved.
■Section 1563 (e) 6 prescribes a set of attribution rules for determining whether one person possesses the requisite 80-percent ownership in several corporations which qualifies them as component members of a brother-sister controlled group. These rules are made applicable to section 1563 (a) (2) by section 1563(d) (2).7 There is no dispute that A. E. Huckins is deemed to have owned his wife’s interest in the couple’s commonly held stock in Redding and Chico (2,070 and 2,750 shares, respectively), pursuant to section 1563(e)(5). In addition, under sections 1563(e) (6) (B) and 1563(f) (2) (A),8 Huckins constructively owned the shares belonging to his adult children, Diann Huckins Allen and D. Pete Pluckins, which amounted to 300 shares of Redding Co. stock and 400 shares of Chico Co. stock. Thus, A. E. Huckins is treated as owning at least 79 percent ((2,070 + 300)/3,000) and 78.75 percent ((2,750+400)/4,000) of the total number of outstanding shares of the Redding and Chico companies, respectively, on December 31 of 1966, 1967, and 1968. Since these companies each owned 50 percent of the outstanding stock of the Marysville Co., the ownership of at least 78.88 percent (l/2 X (79 percent+78.75 percent)) of that company’s stock is also attributed to A. E. Huckins under section 1563 (e) (4). This much of the computation is not in dispute.
However, section 1563(c)(1)(C)9 provides in substance that, for the purpose of determining whether several corporations constitute a controlled group, certain stock is to be treated as “excluded stock” and not counted in computing a common owner’s percentage of ownership in such corporations. Prior to its amendment by section 401(d) (2) of the Tax Reform Act of 1969, 83 Stat. 487, section 1563(c) (2) (B) provided as follows in respect of such excluded stock:
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.10 The petitioners argue, however, that these employee-owned shares are not to be treated as “excluded” under section 1563 (c) (2) (B) (ii). They rely upon either of two grounds: (1) That the right of first refusal did not substantially restrict or limit the employees’ rights to dispose of their stock; and (2) that the right of first refusal was “a bona fide reciprocal stock purchase arrangement” within the meaning of the second sentence of section 1568(c) (2) (B) (ii), which precluded the classification of such stock as excluded stock. We think that neither of these positions is sound.
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.11 (applied to brother-sister groups through sec. 1.1563-2 (b) (4) (ii), Income Tax Pegs.); Pev. Pul. 70-170,1970-2 C.B. 182. We hold that the right of first refusal that attached to the employees’ stock in this case was one that substantially restricted or limited their right to dispose of the stock within the meaning of section 1563 (c) (2) (B) (ii).
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.
Free access — add to your briefcase to read the full text and ask questions with AI
OPINION
Raum, Judge:
Section 1561(a), I.R.C. 1954,4 provides that if a group of corporations constitutes a “controlled group of corporations” on a December 31, the component members of such group are entitled to only one surtax exemption of $25,000 to be apportioned among them for their respective taxable years which include such December 31. The Commissioner contends that petitioners constituted a “controlled group of corporations” in accordance with section 1563 (a) (2),5 which in substance defines that term to include a “brother-sister controlled group,” and that definition in turn is applicable here by its terms if A. E. Huckins owned, directly or constructively, at least 80 percent of the outstanding stock of all three petitioners on December 81 of 1966, 1967, and 1968. In the absence of petitioners’ consent to a plan for an uneven apportionment of such exemption, the Commissioner has allocated one-third of $25,000 to each petitioner for each of the years at issue. The petitioners object to the Commissioner’s determination that A. E. Huckins owned more than 80 percent of each company’s stock. We think that his determination must be approved.
■Section 1563 (e) 6 prescribes a set of attribution rules for determining whether one person possesses the requisite 80-percent ownership in several corporations which qualifies them as component members of a brother-sister controlled group. These rules are made applicable to section 1563 (a) (2) by section 1563(d) (2).7 There is no dispute that A. E. Huckins is deemed to have owned his wife’s interest in the couple’s commonly held stock in Redding and Chico (2,070 and 2,750 shares, respectively), pursuant to section 1563(e)(5). In addition, under sections 1563(e) (6) (B) and 1563(f) (2) (A),8 Huckins constructively owned the shares belonging to his adult children, Diann Huckins Allen and D. Pete Pluckins, which amounted to 300 shares of Redding Co. stock and 400 shares of Chico Co. stock. Thus, A. E. Huckins is treated as owning at least 79 percent ((2,070 + 300)/3,000) and 78.75 percent ((2,750+400)/4,000) of the total number of outstanding shares of the Redding and Chico companies, respectively, on December 31 of 1966, 1967, and 1968. Since these companies each owned 50 percent of the outstanding stock of the Marysville Co., the ownership of at least 78.88 percent (l/2 X (79 percent+78.75 percent)) of that company’s stock is also attributed to A. E. Huckins under section 1563 (e) (4). This much of the computation is not in dispute.
However, section 1563(c)(1)(C)9 provides in substance that, for the purpose of determining whether several corporations constitute a controlled group, certain stock is to be treated as “excluded stock” and not counted in computing a common owner’s percentage of ownership in such corporations. Prior to its amendment by section 401(d) (2) of the Tax Reform Act of 1969, 83 Stat. 487, section 1563(c) (2) (B) provided as follows in respect of such excluded stock:
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.10 The petitioners argue, however, that these employee-owned shares are not to be treated as “excluded” under section 1563 (c) (2) (B) (ii). They rely upon either of two grounds: (1) That the right of first refusal did not substantially restrict or limit the employees’ rights to dispose of their stock; and (2) that the right of first refusal was “a bona fide reciprocal stock purchase arrangement” within the meaning of the second sentence of section 1568(c) (2) (B) (ii), which precluded the classification of such stock as excluded stock. We think that neither of these positions is sound.
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.11 (applied to brother-sister groups through sec. 1.1563-2 (b) (4) (ii), Income Tax Pegs.); Pev. Pul. 70-170,1970-2 C.B. 182. We hold that the right of first refusal that attached to the employees’ stock in this case was one that substantially restricted or limited their right to dispose of the stock within the meaning of section 1563 (c) (2) (B) (ii).
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,12 had the power under California law to eliminate the restrictions from the bylaws at will, thereby removing any impediment against transfer by him whenever he might desire to dispose of his stock. If Huckins in fact had such power, then the “reciprocal” aspect of the arrangement becomes illusory, and we would conclude that there was not any “bona fide reciprocal stock purchase arrangement” within the meaning of the statute. As we view California law, we think that the Commissioner is correct.
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.”13 Thus, under these provisions, a stockholder with voting control has it within his power unilaterally to amend the bylaws so as to impose new restrictions against transfer where none were previously in effect, or by parity of reasoning, to remove existing restrictions from the bylaws. This, we think, is clearly the law of California,14 as set forth by its Supreme Court in Tu-Vu Drive-In Corp. v. Ashkins, 61 Cal. 2d 283, 391 P. 2d 828, 38 Cal. Rptr. 348.
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) ,15
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.16 While it is undoubtedly time that a majority stockholder may be under a fiduciary duty (see Jones v. H. F. Ahmanson & Co., 1 Cal. 3d 93, 460 P. 2d 464, 81 Cal. Rptr. 592; Pepper v. Litton, 308 U.S. 295), the elimination of restrictions against transfer would be no more a violation of that duty than the imposition of such restrictions, which were approved by the Supreme Court of California in Tu-Vu.
In view of our conclusion that Huckins had the power to remove the restrictions at will,17 it is a matter of no moment that there were undoubtedly valid business reasons for imposing such restrictions in the first instance, as shown by the testimony of Donald Pluckins and that of A. E. Huckins himself. The point is that the restrictions were applicable to the minority stockholder-employees, but that A. E. Huckins could remove them at will in the event that he wished to dispose of his stock. In the circumstances, the “bona fide reciprocal” character of the arrangement becomes illusory.
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),18 they are entitled to multiple surtax exemptions for the year 1968 but are liable for the additional tax imposed by section 1562(b) (l).19
Decisions will be entered wider Rule 50.