SCOTUS Reports

Tag: Excluded Stock

  • Tribune Publishing Co. v. Commissioner, 79 T.C. 1029 (1982): When a Right of First Refusal Constitutes ‘Excluded Stock’ in Parent-Subsidiary Controlled Groups

    Tribune Publishing Co. v. Commissioner, 79 T. C. 1029 (1982)

    A right of first refusal in favor of a parent corporation can make stock owned by subsidiary employees ‘excluded stock’ for determining control in parent-subsidiary controlled groups under IRC § 1563.

    Summary

    Tribune Publishing Co. and News Review Publishing Co. were involved in a dispute over their classification as a controlled group under IRC § 1563. Tribune owned 70% of News’s stock and had a right of first refusal on the remaining shares owned by News’s employees. The court held that this right constituted a substantial restriction, making the employees’ stock ‘excluded’ for control calculations, thus classifying the companies as a parent-subsidiary controlled group. This decision impacts how similar corporate structures are analyzed for tax purposes, emphasizing the significance of rights of first refusal in determining control.

    Facts

    In 1967, Tribune purchased 100 of the 250 shares of News Review Publishing Co. and entered into an agreement granting it a right of first refusal on any sale of News’s remaining stock. By 1972, Tribune increased its ownership to 175 shares, with the remaining 75 shares owned by two News employees, William and A. J. Marineau. The agreement’s right of first refusal applied to the Marineaus’ shares, which were crucial in determining whether Tribune and News constituted a controlled group under IRC § 1563.

    Procedural History

    The Commissioner of Internal Revenue determined that Tribune and News were a controlled group and issued deficiency notices for the years 1976-1978. The companies contested this classification in the U. S. Tax Court, arguing that the Marineaus’ stock should not be treated as ‘excluded stock’ due to the right of first refusal.

    Issue(s)

    1. Whether the right of first refusal in favor of Tribune constituted a condition that substantially restricted the Marineaus’ right to dispose of their News stock under IRC § 1563(c)(2)(A)(iii).

    Holding

    1. Yes, because the right of first refusal was a condition running in favor of Tribune that substantially restricted the Marineaus’ right to dispose of their stock, making it ‘excluded stock’ under IRC § 1563(c)(2)(A)(iii).

    Court’s Reasoning

    The court applied IRC § 1563(c)(2)(A)(iii) and the corresponding regulation, which explicitly states that a right of first refusal in favor of the parent corporation constitutes a substantial restriction on an employee’s right to dispose of stock. The legislative history supported this interpretation, indicating that such a right qualifies as a substantial restriction. The court rejected the taxpayers’ argument that the reciprocal nature of the right of first refusal should exempt it from being considered a substantial restriction, as this exception applies only to brother-sister controlled groups, not parent-subsidiary groups. The court also dismissed the argument that the restriction was unenforceable under state law, finding that the shareholders’ agreement was valid and enforceable between the parties. The court emphasized that the tax code’s application does not depend on tax-avoidance motives but on the legal structure and agreements in place.

    Practical Implications

    This decision clarifies that a right of first refusal in favor of a parent corporation can be a significant factor in determining control under IRC § 1563 for parent-subsidiary groups. Legal practitioners should carefully review shareholder agreements for similar provisions when assessing corporate control for tax purposes. Businesses should be aware that such agreements can impact their tax liabilities by affecting their classification as a controlled group. Subsequent cases, such as Barton Naphtha Co. v. Commissioner, have reinforced this principle, emphasizing that tax-avoidance motives are irrelevant in applying these rules. This ruling underscores the importance of considering all aspects of corporate governance and shareholder agreements in tax planning and compliance.

  • Crow-Burlingame Co. of Pine Bluff, et al. v. Commissioner of Internal Revenue, 65 T.C. 785 (1976): Indirect Control and Excluded Stock in Controlled Groups

    Crow-Burlingame Co. of Pine Bluff, et al. v. Commissioner of Internal Revenue, 65 T. C. 785 (1976)

    Stock owned by employees and subject to a repurchase option can be considered “excluded stock” if the option indirectly favors the parent corporation, even if a third corporation holds the option.

    Summary

    Crow-Burlingame Co. sought to retain multiple surtax exemptions for its subsidiaries by selling stock to employees with a repurchase option held by C. B. Investment Co. (CBI). The Tax Court ruled that the subsidiaries formed a controlled group under IRC § 1563 because the stock was “excluded stock” due to the indirect control Crow-Burlingame exerted through CBI. The decision hinged on the repurchase option’s substantial restriction on the employees’ stock disposal rights, which indirectly favored Crow-Burlingame, requiring the application of a single surtax exemption across the group.

    Facts

    Crow-Burlingame Co. established subsidiaries to operate local automotive parts stores, retaining about 78% of each subsidiary’s stock and selling the rest to employees through CBI, which held a repurchase option on the sold shares. CBI was controlled by Crow-Burlingame, sharing the same office space and key officers. The repurchase option was triggered by events like the employee’s termination or death, ensuring the stock would not pass to outsiders and allowing Crow-Burlingame to maintain control over the subsidiaries.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in the subsidiaries’ income taxes for 1970, treating them as a controlled group under IRC § 1563. Crow-Burlingame contested this, leading to the case being heard by the U. S. Tax Court, which ruled in favor of the Commissioner.

    Issue(s)

    1. Whether the stock sold to employees of the subsidiaries and subject to a repurchase option held by CBI was “excluded stock” under IRC § 1563(c)(2)(A)(iii)?

    2. Did the repurchase option run in favor of Crow-Burlingame or its subsidiaries, indirectly or otherwise?

    Holding

    1. Yes, because the stock was subject to conditions that indirectly favored Crow-Burlingame, fulfilling the requirements of “excluded stock” under IRC § 1563(c)(2)(A)(iii).

    2. Yes, because Crow-Burlingame indirectly controlled CBI, and the repurchase option thus indirectly favored Crow-Burlingame, meeting the statutory criteria for excluded stock.

    Court’s Reasoning

    The court applied IRC § 1563, which defines a controlled group and specifies “excluded stock” as stock subject to conditions favoring the parent or subsidiary corporation. The court found that the repurchase option held by CBI was a substantial restriction on the employees’ disposal rights. Despite CBI being the nominal holder of the option, Crow-Burlingame’s control over CBI meant the option indirectly favored Crow-Burlingame. The court cited the Eighth Circuit’s decision in Mid-America Industries, Inc. v. United States, which supported the view that indirect benefits to the parent corporation from a repurchase option are sufficient to classify stock as excluded. The court emphasized that Crow-Burlingame’s dominance over CBI’s operations and the shared personnel and office space demonstrated this indirect control. The court also rejected the argument that CBI was an unrelated corporation, pointing to the substantial ownership of CBI’s stock by Crow-Burlingame’s employees, further solidifying the indirect control argument.

    Practical Implications

    This decision establishes that for tax purposes, indirect control through a third party can be as significant as direct control in determining the status of a controlled group. Companies must carefully structure employee stock ownership plans to avoid unintended tax consequences, especially when using options or restrictions that might be seen as favoring the parent corporation. This case has influenced how similar arrangements are analyzed, prompting businesses to ensure that any control mechanisms, whether direct or indirect, are structured in a way that does not trigger the controlled group provisions. Subsequent cases have referenced Crow-Burlingame to evaluate the indirect control aspect of excluded stock provisions, reinforcing the need for clear and separate corporate governance in such arrangements.