Petition — United States v. Vogel Fertilizer Co.

Office-Supreme Court, U.S.

FILED

;

|

| 80-1251 i JAN 23 1961

ALEXANDER L. STEVAS,

a

In the Suprene Court of the United Strtes

OCTOBER TERM, 1980

UNITED STATES OF AMERICA, PETITIONER

v.

VOGEL FERTILIZER COMPANY

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF CLAIMS

WADE H. McCREE, JR.

Solicitor General

JOHN F. MURRAY

Acting Assistant Attorney General

STUART A. SMITH

Assistant to the Solicitor General

ERNEST J. BROWN

WILLIAM A. FRIEDLANDER

Attorneys

Department of Justice

Washington, D.C. 20530

(202) 633-2217

In the Suprene Court of the Hnited States

OCTOBER TERM, 1980

No.

UNITED STATES OF AMERICA, PETITIONER

U.

VOGEL FERTILIZER COMPANY

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF CLAIMS

QUESTION PRESENTED

Section 1561(a) of the Internal Revenue Code of

1954 (26 U.S.C.) provides that a “controlled group of

corporations” shall be limited to a single corporate sur-

tax exemption. Under Section 1563(a) (2), a “controlled

group of corporations” includes a “brother-sister

group,” which is defined as “[t]wo or more corpora-

tions if 5 or fewer persons who are individuals

“= * own * © * stock” possessing two prescribed and

differing percentages of the total combined voting

power of all classes of voting stock or of the total value

of all classes of the stock of each corporation.

The question presented is whether the statutory

definition is met if the “5 or fewer persons” own the

prescribed stock singly or in combination, as the gov-

erning Treasury Regulations provide, or whether each

person whose stock is to be taken into account must

own stock in each corporation of the group, as the de-

cision below held.

Ill

TABLE OF CONTENTS

Page

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Statute and regulations ............ceseeeeees 1

IND Shh ious 6 bu caeWahew tides vukbeweses 1

Reason for granting the petition .............. 5

PRL. stpelbavvesskeebenes thebawu eit 14

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NCEE occ nescence seavnsscvedvstsdedesses 45a

TABLE OF AUTHORITIES

Cases:

Allen Oil Co. v. Commissioner, 614 F.2d

$86, rev’g 38 T.C.M. 356 ......ccccccess 3, 5

Bingler v. Johnson, 394 U.S. 741......... 12

Commissioner v. South Texas Lumber Co.,

PE ME So tiacescaceasstcckaanenve 12

Delta Metalforming Co. v. Commissioner,

No. 78-3699 (Dec. 8, 1980) ............. 6

Fairfax Auto Parts of Northern Virginia,

Inc. v. Commissioner, 548 F.2d 501,

rev'g 65 T.C. 798, cert. denied, 434 U.S.

Dae chL ASG Ns bow eaen sci bau eens 3, 5,9

Fulman v. United States, 434 U.S.

Mierke iecbacceei ct ccrurticrenes 4 12-13

National Muffler Dealers Assn. v. United

SE BOs OED Cass kab on subse uens 13

T. L. Hunt, Inc. v. Commissioner, 562

F.2d 532, rev’g 35 T.C.M. 966 .......... 3, 5

United States v. Correll, 389 U.S. 299 .... 13

IV

Statutes and regulation:

Internal Revenue Code of 1954 (26 U.

(1970 ed.):

ee oda wean es

EOEGNOUD MEN Ks o's cack vce ccabers

Page

S.C.

eee

Internal Revenue Code of 1954 (26 U.S.C.):

SE as oc ac bak keawes 1, 2, 7, 45a

SUCRE UNE. Sirs ob cn beadveceeanese 6

NIE Spb 6 4-6-0. 0d 0's 00 deed oe ween 6

| | ne es eee 6

Section 404(aX(1NKC).... 2... ecw ec eenes 6

ae oe duh ee 6

I goons void le nnceeawabae-s 6

ok re 6

Section S00(d)(10) .......cceccccccces 6

ERP arerrer errr ere 7, 45a

IED fc hon occocacvckwcneaes l

EOCGENET SUMMED boon ccacecoucusecn 2

Section 1563(a) ........cccceee 5, 7, 10, 12

Section 1563(aX2) .......cccceees 1, 2, 3,

6, 7, 10,

12, 46a-47a

Section 1563(a)(2)(A) ............ a 4,-7.

: 8, 9, 47a

Section 1563(a)(2)(B)............. 4, 7, 8,

9, 10, 47a

RE RD io ina cade cderabaa 2

Revenue Act of 1964, Pub. L. No. 88-272,

Section 235(a), 78 Stat. 120............. 10

Tax Reform Act of 1969, Pub. L. No. 91-

172, Section 401(c), 83 Stat. 602 ........ 10

Treasury Regulations on Income Tax, 126

Lae sas LR 60s oc iN vecease ie ef

Miscellaneous: Page

Tax Reform, 1969: Hearings Before the

House Comm. on Ways and Means, 91st

Cong., Ist Sess. (10GB) .....ccccccsees (10-11

The Solicitor General, on behalf of the United States

of America, petitions for a writ of certiorari to review

the judgment of the United States Court of Claims in

this case.

OPINION BELOW

The opinion of the Court of Claims (App. A, infra,

la-42a) is not yet reported.

JURISDICTION

The opinion of the Court of Claims was filed on Au-

gust 13, 1980. The order denying rehearing en banc

was entered on October 3, 1980. (App. B, infra, 48a).

The judgment of the Court of Claims was entered on

November 28, 1980 (App. C, infra, 44a). The jurisdic-

tion of this Court is invoked under 28 U.S.C. 1255.

STATUTE AND REGULATIONS

The relevant provisions of Sections 11(d), 1561(a)

and 1563(a) (2) of the Internal Revenue Code of 1954

(26 U.S.C.), and of Treasury Regulations, Section

1.1563-1(a)(3)(26 C.F.R.), are set forth at App. D,

infra, 45a-48a.

STATEMENT

1. Respondent Vogel Fertilizer Company is an lowa

corporation in the business of selling farm fertilizer

products at retail to local customers. During 1973-

1975, respondent had only common stock issued and

outstanding, which was owned by Arthur Vogel

(113,575 shares—77.49%) and Richard Crain (33,000

shares— 22.51%) (App. A, infra, 2a).

Vogel Popcorn Company is a separate corporation

engaged in a business unrelated to respondent. During

1

2

1973-1975, Vogel Popcorn had issued and outstanding

440,062 shares of common stock, all of which was

owned by Arthur Vogel, and 62,866 shares of voting

preferred stock, all of which was held by Arthur Vogel

as trustee of the Alex Vogel Family Trust. As a result,

Arthur Vogel owned 87.5% of all classes of Vogel Pop-

corn stock entitled to vote. The Alex Vogel Trust in

turn owned 12.5% of such stock (App. A, infra, 2a).

In its corporate income tax returns for the taxable

years 1973-1975, respondent originally treated itself

and Vogel Popcorn as members of a brother-sister con-

trolled group of corporations as defined by Section

1563(a) (2). This position was in accord with the gov-

erning Treasury Regulations (Section 1.1563-1(a) (3)),

which provides that the term “brother-sister con-

trolled group” means two or more corporations if the

same five or fewer shareholders own, either singly or

in combination, stock possessing—(A) at least 80% of

the total combined voting power of all classes of voting

stock of each corporation; and (B) more than 50% of

the total combined voting power of all classes of voting

stock or more than 50% of the total value of all classes

of stock of each corporation, taking into account the

stock ownership of each person only to the extent such

stock ownership is identical with respect to each such

corporation (App. A, infra, 2a, 4a-5a).

Because it treated itself as a member of a controlled

group of corporations, respondent did not claim the full

corporate surtax exemption provided by Section 11(d)

of the Internal Revenue Code of 1954. For its taxable

years ended November 30, 1973 and 1974, respondent

elected to utilize the multiple surtax exemption under

Sections 1562 and 1564(a) and to pay the multiple sur-

tax penalty imposed by Section 1562(b). For the tax-

able year ended November 30, 1975, respondent

elected under Section 1561(a) (2) to allocate the single

3

surtax exemption then allowed to members of a con-

trolled group of corporations entirely to Vogel Popcorn

(App. A, infra, 3a).

Respondent thereafter filed timely claims for refund

for each of the years in question. In such claims, re-

spondent took the position that it and Vogel Popcorn

were not members of a controlled group of corpora-

tions and that therefore it was entitled to a full surtax

exemption for each taxable year. After the Internal

Revenue Service disallowed respondent’s claims, it

commenced this refund suit in the United States Court

of Claims (App. A, infra, 3a).

2. A divided panel of the Court of Claims upheld re-

spondent’s claims (App. A, infra, la-36a). It first

pointed out that the dispute between the parties in-

volved only the 80% test of Section 1563(a) (2)(A).

Specifically, the question presented was whether

Richard Crain, who held no stock in Vogel Popcorn,

could be counted as one of the five or fewer persons

who held 80% of the stock of each corporation. In ar-

guing that Richard Crain could not be so counted, re-

spondent conceded that the governing Regulations

(Section 1.1563-1(a) (3) (ii)) explicitly provided that

“the five or fewer persons” can own 80% of the stock of

each corporation, singly or in combination, and in-

cluded an example corresponding exactly to this case

(App. A, infra, 6a).

After noting that three circuits had upheld the va-

lidity of the Regulation which was the basis of the

government’s position,! the Court of Claims struck

down the Regulation and instead approved “the

statutory construction made by the Tax Court in

1 Fairfax Auto Parts of Northern Virgina, Inc. v. Commis-

sioner, 548 F.2d 501 (4th Cir.), cert. denied, 434 U.S. 904

(1977); Allen Oil Co. v. Commissioner, 614 F.2d 336 (2d Cir.

1980); T.L. Hunt, Inc v. Commissioner, 562 F.2d 532 (8th Cir.

1977).

4

Fairfax Auto Parts of Northern Virginia, Inc. v.

Commissioner, * * * 65 T.C. [798] at 802-803 [(1976),

rev'd, 548 F.2d 501 (4th Cir.), cert. denied, 434 U.S.

904 (1977) as] the most careful and best analysis of the

statute to date” (App. A, infra, 8a; footnote omitted).

In the Court of Claims’ view, the statutory term “each

such person” in the 50% test of Section 1563(a) (2) (B)

applies as well with respect to the 80% test of Section

1563(a) (2) (A). As a result, the court concluded that

for a person’s stock ownership to be taken into account

for purposes of the 80% test, that person must own

stock in each member of the brother-sister controlled

group (App. A, infra, 10a).

In so holding, the Court of Claims admitted that

“the different view taken by Treas. Reg. § 1.1563-1(a)

(3) is not wholly unreasonable as a construction of the

words appearing in section 1563(a) (2)” (App. A, infra,

12a). However, the court ruled that the Regulation

was inconsistent with the legislative history and was

unreasonable (App. A, infra, 10a).

3. The dissenting judge would have upheld the va-

lidity of the Regulation (App. A, infra, 36a-42a). As

he saw the matter, “the issue is not whether [respond-

ent’s] interpretation is as reasonable as [the govern-

ment’s]; clearly that will be true in certain given fac-

tual situations. The issue is whether [respondent] has

carried its heavy burden of showing the regulation to

be unreasonable and plainly inconsistent with the

statute (emphasis in original)” (App. A, infra, 38a).

In the dissenting judge’s view, respondent did not

meet this burden. Addressing the facts of this case,

the dissent noted that during the years at issue, Ar-

thur Vogel owned 77.4% of the only class of stock of

Vogel Fertilizer Company. During the same years, he

had 87.5% of Vogel Popcorn. Hence, using his stock

alone, Arthur Vogel had the “power to direct the op-

5

erations of both corporations and to cause the corpora-

tions to operate as a unified economic enterprise”

(App. A, infra, 41a). Although Section 1563(a) was di-

rected at precisely such a case, “[ylet the majority

holds that the two corporations were not brother-

sister and, hence, were each entitled to a full surtax

exemption” (ibid.)

The dissent further noted that, if Richard Crain

owned but a single share of stock in Vogel Popcorn,

then the two corporations would have constituted a

brother-sister group even under the majority’s in-

terpretation (App. A. infra, 4la). Absent any proof

“that Congress intended the mechanical test which the

majority has in mind and which leads to the unreason-

able results just described” (App. A, infra, 42a), the

dissent would have disallowed respondent’s claim on

the authority of the Regulation.

REASONS FOR GRANTING THE PETITION

1. In holding that respondent and Vogel Popcorn

were not members of a “brother-sister” controlled

group of corperations within the meaning of Section

1563(a) of the Internal Revenue Code because the

same persons were not shareholders in both corpora-

tions, the Court of Claims acknowledged that its deci-

sion squarely conflicted with Fairfax Auto Parts of

Northern Virginia, Inc. v. Commissioner, 548 F.2d

501 (4th Cir. 1977), rev’g 65 T.C. 798 (1976), cert. de-

nied, 434 "J.S. 904 (1977); Allen Oil Co. v. Commis-

sioner, 614 F.2d 336 (2d Cir. 1980), rev’g 38 T.C.M. 355

(1979); and 7.L. Hunt, Inc. v. Commissioner, 562

F.2d 532 (8th Cir. 1977), rev’g 35 T.C.M. 966 (1976).

Subsequent to the decision below, the Fifth Circuit has

aligned itself with the Court of Claims. See Delta

Metalforming Co. v. Commissioner, No. 78-3699

(Dec. 8, 1980).

6

Hence, as matters now stand, the Second, Fourth,

and Eighth Circuits have upheld the government’s po-

sition, which finds explicit support in the Treasury

Regulations (Section 1.1563-1(a) (3) and Example (1)),

that two corporations constitute a brother-sister con-

trolled group as long as five or fewer shareholders own

the statutorily prescribed percentage of stock, singly

or in combination. On the other hand, the Tax Court,

the Court of Claims in the decision below, and the

Fifth Circuit have taken the contrary position and

have held the governing Treasury Regulation to be in-

valid. This Court should resolve the conflict and estab-

lish a vniform rule for the proper administration of the

revenue laws.

Moreover, the question presented has considerable

administrative importance. We are advised by the

Internal Revenue Service that there are currently 223

cases pending in the courts involving approximately

$3.5 million. Two of these cases are awaiting argument

in the courts of appeals.? And apart from the applica-

tion of Section 1563(a)(2) itself, the issue of multiple

corporate surtax exemptions materially affects a host

of other provisions of the Internal Revenue Code. See

Sections 535(c) (accumulated earnings tax credit),

894(a)(3) and 809(d)(10) (limitation on small business

deduction of life insurance companies), Sections

404(a)(1)(C) and 414(b) (deduction by employers for

contributions to stock bonus, revision, profit-showing

or annuity plans), Section 46(a)(6) (computation of re-

fund limitation on investment credit), Section 58(b)

(apportionment of exemption from minimum tax), and

Section 179(d) (7) (limitation on additional first-year

depreciation). Thus, the fiscal significance of the ques-

2 Baloian v. Commissioner, Nos. 78-2438 and 78-2508 (9th

Cir.); Davidson Chevrolet Co. v. Commissioner, No. 80-1041

(6th Cir.).

7

tion presented cannot be limited to Section 1563(a)

alone. —

2.a. Section 1561 of the Code (App. D, infra, 45a)

provides that the members of a “controlled group of

corporations” shall be limited to a single surtax

exemption under Section 11(d). Section 1563(a)(2)

(App. D, infra, 46a-47a) defines the terms “controlled

group of corporations” as follows:

(a) CONTROLLED GROUP OF CORPORA-

TIONS—For purposes of this part, the term “con-

trolled group of corporations” means any group

of —

* * X* * *

(2) BROTHER-SISTER CONTROLLED

GROUP—Two or more corporations if 5 or fewer

persons who are individuals, estates, or trusts

own (within the meaning of subsection (d)(2))

stock possessing—

(A) 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 the stock of each corporation, and

(B) 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 of each corporation,

taking into account the stock ownership of each

such person only to the extent such stock owner-

ship is identical with respect to each such corpo-

ration (Emphasis supplied).

Under the statute, subparagraphs (A) and (B) set

forth an 80% test and a 50% test. The only substantive

difference between the two tests is the italicized lan-

guage of subparagraph (B), which introduces a limita-

8

tion not applicable to the 80% test. Thus, the stock

owned by any or all of the five persons may be taken

into account in determining whether the 80% test has

been met. On the other hand, in determining whether

the 50% test has been satisfied, it is necessary to as-

certain which of such persons owns stock in both of the

corporations and how much each of them owns. Only to

the extent that a person owns stock in each of the cor-

porations is his stock taken into account for purposes

of the 50% test. Accordingly, a person who owned no

stock in one of the corporations would be excluded

from consideration for purposes of that test. That is

the import of the italicized language of subparagraph

(B)—“taking into account the stock ownership of each

such person only to the extent such stock ownership is

identical with respect to each such corporation.”

Applying the statute to the facts of the instant case,

Arthur Vogel owned 77.49% of the voting stock of re-

spondent Vogel Fertilizer and 87.5% of the voting

stock of Vogel Popcorn. Richard Crain owned the re-

maining 22.51% of respondent Vogel Fertilizer’s voting

stock. Hence, using the figure 77.49% as the identical

stock ownership of Arthur Vogel, it is clear that “5 or

fewer persons” owned more than 50% of the voting

stock of both corporations. Since it can hardly be dis-

puted that “5 or fewer persons” owned at least 80% of

the voting stock of each corporation—unless one adds

unstated conditions to Section 1563(a)(2)(A)—the

Commissioner properly determined that respondent

and Vogel Popcorn were entitled to only one surtax

exemption, as originally reported on their returns.

The foregoing analysis is squarely supported by

Treasury Regulations, Section 1.1563-1(a)(3) (26

C.F.R.) (App. D, infra, 47a-48a), which provides that

“(tlhe term ‘brother-sister controlled group’ means

two or more corporations if the same five or fewer

persons who are individuals * * * own * * * singly or

9

in combination, stock possessing * * “ [the requisite

voting power]” (emphasis added). Indeed, the Regula-

tions (Section 1.1563-1(a)(3)(ii) ) set forth the following

example, which demonstrates that the 50% test may

be satisfied even though each of the “5 or fewer per-

sons” does not own stock in each corporation.

Example (1). The outstanding stock of corpora-

tions P, Q, R, S, and T, which have only one class

of stock outstanding, is owned by the following

unrelated individuals:

Identical

Individuals Corporations Ownership

P Were one

i -cvbanensaGeneewns 60% 60% 60% 60% 100% 60%

i Whcdh 6aenhanabeas 4o—- — —-— a

Es Shade saueneeoes os — 4% —

DP sucedvasesboaecas —- — 4% —

DP nbssvechanssdsern —- — — 4% — ime

Total 100% 100% 100% 100% 100% 60%

Corporations P, Q, R, S, and T are members of

a brother-sister controlled group.

b. In holding that the 50% test of subparagraph (A)

is not satisfied unless each of the “5 or fewer persons”

owns stock in each corporation, the Court of Claims

relied upon the phrase “each such person” in subpara-

graph (B) and concluded that the phrase refers to the

“5 or fewer persons” for purposes of both the 80% and

50% tests (App. A, infra, 10a). Quoting with approval

from the Tax Court’s opinion in Fairfax Auto Parts of

Northern Virginia, Inc. v. Commissioner, supra, 65

T.C. at 802-803, the Court concluded that the statute

“requires the same persons to be in the group of con-

trolling stockholders used in both tests” (App. A,

infra, 10a-11a).

But the fundamental error of the Court of Claims (as

well as the Tax Court) in interpreting Section

10

1563(a)(2) was to ignore the fact that the phrase “each

such person” is found only in subparagraph (B) with

respect to the 50% test. Thus, the natural reading of

“each such person” is that it refers only to those per-

sons owning more than 50% of the voting stock of each

corporation, in subparagraph (B), rather than modify-

ing the “5 or fewer persons” set forth in the prefatory

part to paragraph (2). Indeed, if such were not the

case, one could well conclude (contrary to even the de-

cision below) that the entire italicized portion of sub-

paragraph (B) refers to the “5 or fewer persons” with

the result that the 80% test would be met only if each

of the “5 or fewer persons” owned stock in both corpo-

rations.

The legislative history of Section 1563(a) confirms

the correctness of our submission that the 80% test

and the 50% test are independent parts of the statute.

The 80% test antedated the 50% test. As originally

enacted by the Revenue Act of 1964, Pub. L. No. 88-

272, Section 235(a), 78 Stat. 120, Section 1563(a)(2)

defined a brother-sister controlled group to be two or

more corporations, if 80% of the total combined voting

power or value of the shares was owned by one person.

Because that rule failed to prevent the abuse of a

group of corporations operated as a single economic

entity claiming multiple surtax exemptions, Congress

expanded the definition of a controlled group in the

Tax Reform Act of 1969, Pub. L. No. 91-172, Section

401(c), 83 Stat., 602. To make the rule applicable in

more situations, the stock ownership of up to five per-

sons was to be taken into account. However, Congress

added the 50% test to assure that there would be

common control of each of the corporations by some of

the group. As the Treasury’s General Explanation con-

tained in the Tax Reform, 1969: Hearings Before the

House Comm. on Ways and Means, 91st Cong., Ist

Sess. 5394 (1969), states—

11

However, in order to insure that this expanded

definition of brother-sister controlled group

applies only to those cases where the five or fewer

individuals hold their 80 percent in a way which

allows them to operate the corporations as one

economic entity, the proposal would add an addi-

tional rule that the ownership of the five or fewer

individuals must constitute more than 50 percent

of the stock of each corporation considering, in

this test of ownership, stock of a particular person

only to the extent that it is owned identically with

respect to each corporation.

This explanation supports the provision of the Reg-

ulations that the 80% test will be met if the “5 or fewer

persons” own stock of both corporations, either singly

or in combination. The juxtaposition of the phrase re-

ferring to stock of “a particular person” (for purposes

of the 50% test) to “the five or fewer individuals” (as to

which the 80% test is applied) makes it clear that dif-

ferent persons may be taken into account in applying

the 80% and the 50% tests and that the common own-

ership requirement applies only to the 50% test. In

short, the 80-percent and 50-percent tests are separate

parts of the statute that are to be independently

applied. Hence, there is no basis for the importation of

the phrase “each such person” from the 50% test inte

the 80% test, as the decision below construed the stat-

ute.? Indeed, as the dissenting judge pointed out (App.

%The Court of Claims addressed the Treasury’s General Ex-

planation but concluded that it undermined the Regulation be-

cause of the references in the Treasury document to “the same

five or fewer persons” owning at least 80% of “each corporation”

and “these five or fewer individuals” owning at least 50% of the

stock of each corporation (see App. A, infra, 2la). But these

references simply underscore the fact that the same group of

five or fewer persons, rather than a different group, is to be

considered in applying both the 80% and oO, 7241

' 12

A, infra, 40a-42a), the majority’s gloss upon Section

1563(a) would impede the legislative purpose of deny-

ing multiple surtax exemptions to those corporations

which are operated as a single economic entity. Here,

it is clear that Arthur Vogel—owning 77.49% of re-

spondent’s voting stock and 87.5% of Vogel Popcorn’s

voting stock—had the power to operate both corpora-

tions as a single economic entity. But under the

majority’s view, the corporations were not brother-

sister and were therefore entitled to two surtax

exemptions, a result that would be changed if Richard

Crain owned a single share of Vogel Popcorn. It is dif-

ficult to imagine that Congress intended the statute to

turn upon such minute distinctions which make no eco-

nomic difference.

3. While we believe that the language of Section

1563(a)(2) and its legislative history support the con-

clusion that the 50% test is satisfied if the “5 or fewer

persons” own stock in each corporation either singly or

in combination, the question in this case is not whether

the Court of Claims has reached a more reasonable in-

terpretation of the statute. Given the existence of a

controlling Treasury Regulation, the question is

whether the Regulation is @ reasonable interpretation

of the statute. This Court has repeatedly ruled that

Treasury Regulations must be upheld if they are not

plainly inconsistent with the statute and if they im-

plement the statute in a reasonable way. See, ¢.@.,

Commissioner v. South Texas Lumber Co., 333 U.S.

496, 501 (1948); Bingler v. Johnson, 394 U.S. 741,

749-750 (1969); Fulman v. United States, 434 U.S.

528, 533 (1978); National Muffler Dealers Assn. v.

United States, 440 U.S. 472 (1979).

Here, it cannot be disputed that the controlling

Treasury Regulation interprets the statutory language

in a reasonable manner. Indeed, apart from the three

13

circuits that have upheld the Regulation, even the

Court of Claims “admitted that the different view

taken by Treas. Reg. § 1.1563-1(a)(3) is not wholly un-

reasonable as a construction of the words appearing in

section 1563(a)(2)” (App. A, infra, 12a). And, as we

have shown, that construction is consistent with the

legislative history and purpose of the pertinent statu-

tory provisions. It was, therefore, not open to the

court to adopt an interpretation at variance with the

Regulation even though it believed that its reading of

the statute was equally or even more reasonable. In

short, a court cannot set a reasonable Treasury Regu-

lation aside in favor of another interpretation that it

deems preferable. In this respect, this Court’s admoni-

tion in United States v. Correll, 389 U.S. 299 (1967),

is particularly appropriate. In upholding the Commis-

sioners’ overnight rule concerning the deductibility of

meals consumed during business travel, the Court

there stated, in terms equally applicable to this case

(id. at 306-307):

Alternatives * * * are of course available. Im-

provements might be imagined. But we do not sit

as a committee of revision to perfect the adminis-

tration of the tax laws. Congress has delegated to

the Commissioner, not to the courts, the task of

prescribing ‘all needful rules and regulations for

the enforcement’ of the Internal Revenue Code.

* * * The role of the judiciary in cases of this sort

begins and ends with assuring that the Commis-

sioner’s regulations fall within his authority to im-

plement the congressional mandate in some rea-

sonable manner.

14

CONCLUSION

The petition for a writ of certiorari should be

granted.

WADE H. McCREE, JR.

Solicitor General

JOHN F. MURRAY

Acting Assistant Attorney General

STUART A. SMITH

Assistant to the Solicitor General

ERNEST J. BROWN

WILLIAM A. FRIEDLANDER

Attorneys

JANUARY 1981

APPENDIX A

In the United States Court of Claims

No. 69-78

(Decided August 13, 1980)

VOGEL FERTILIZER COMPANY

Uv.

THE UNITED STATES

Before FRIEDMAN, Chief Judge, BENNETT and

SMITH, Judges.

ON DEFENDANT'S MOTION FOR SUMMARY JUDGMENT

AND PLAINTIFF'S CROSS-MOTION

FOR SUMMARY JUDGMENT

BENNETT, Judge, delivered the opinion of the court:

The issue in this case is the validity of Tres. Reg.

§ 1.1563-1(a)(3) (1972), which defines the term

“brother-sister controlled group” for the purposes of

the limited surtax exemption available to multiple cor-

porations. Plaintiff has filed suit for the refund of in-

come taxes for the taxable years ended November 30,

1973, 1974, and 1975. The case is now before the court

on the parties’ cross-motions for summary judgment.

We hold that the regulation is an overly expansive in-

terpretation of I.R.C. § 1563(a)(2) and that plaintiff is

not a member of a “brother-sister” controlled group”

as that term is used in the statute. Therefore, we

grant plaintiff's motion for summary judgment.

la

2a

Plaintiff, Vogel Fertilizer Company, is an Iowa cor-

poration in the business of selling farm fertilizer prod-

ucts at retail to local customers. Plaintiff has only

common stock issued and outstanding, and for all rel-

evant periods, Arthur Vogel held 113,575 shares (77.49

percent) and Richard Crain held 33,000 shares (22.51

percent) of such stock.

Vogel Popcorn Company (hereinafter Vogel Pop-

corn) is also an Iowa corporation, which is engaged in a

business unrelated to plaintiff's. For all relevant

periods, Vogel Popcorn had issued and outstanding

440,062 shares of common stock, all of which was held

by Arthur Vogel, and 62,866 shares of voting pre-

ferred stock, all of which was held by Arthur Vogel as

trustee of the Alex Vogel Family Trust. The relative

value and voting power of this stock were as follows:

Voting %

of All Percent of Value of All

Classes Classes of Stock

Entitled

Shareholder No. of Shares to Vote 1973 =1974 1975

Arthur Vogel, 440,062 87.5 90.66 91.42 93.42

individually Common Stock

Arthur Vogel, 62,866 Voting 12.5 9,34 8.58 6.58

as trustee Preferred

Stock

Richard Crain is not related to Arthur Vogel in

any manner. Defendant makes no contention that the

stock owned by either person may be attributed under

I.R.C. § 1563(d) to the other. Moreover, defendant has

expressly conceded that under the attribution rules

Arthur Vogel could not be considered the constructive

owner of the shares held by him as trustee.

Plaintiff timely filed corporate income tax returns

for the years in question. In accordance with Treas.

Reg. § 1.1563-1(a)(3), plaintiff originally treated itself

and Vogel Popcorn as members of a controlled group

3a

of corporations. Plaintiff therefore did not claim the

full surtax exemption provided by I.R.C. § 11(d). For

the taxable years ended November 30, 1973 and 1974,

plaintiff elected to utilize the multiple surtax exemp-

tion under I.R.C. §§ 1562 and 1564(a) and to pay the

multiple surtax penalty imposed by I.R.C. § 1562(b).!

For the taxable year ended November 30, 1975, plain-

tiff elected under I.R.C. § 1561(a)(2)? to allocate the

single surtax exemption then allowed to members of a

controlled group of corporations entirely to Vogel Pop-

corn.

On November 25, 1976, plaintiff filed timely claims

for refund for each of the years in question. Plaintiff

asserted that it and Vogel Popcorn were not members

of a controlled group of corporations and that, there-

fore, plaintiff was entitled to a full surtax exemption

for each taxable year. After plaintiff's claims were dis-

allowed in full by the Internal Revenue Service, plain-

tiff timely filed suit in this court.

The legal question presented by this case is whether

plaintiff and Vogel Popcorn are a “brother-sister con-

trolled group” under section 1563(a)(2). If they are a

controlled group, it is undisputed that the limitations

imposed by sections 1561 through 1564 would prevent

plaintiff from claiming a full surtax exemption.

' During these years the benefits of multiple surtax exemp-

tions were being gradually phased out. Section 1562 was re-

pealed effective December 31, 1974, by sections 401(a)(2) and

(h)(1) of the Tax Reform Act of 1969, Pub. L. No. 91-172, 83

Stat. 600, 604.

2 Section 1561(a) was amended effective December 31, 1974,

by sections 401 (a)(1) and (h)(1) of the Tax Reform Act of 1969,

supra, 83 Stat. 599, 604.

4a

Section 1563(a)(2) provides that the term “controlled

group of corporations” includes:

(2) BROTHER-SISTER CONTROLLED GROUP—

Two or more corporations if 5 or fewer persons

who are individuals, estates, or trusts own (within

the meaning of subsection (d)(2)) stock

possessing —

(A) at least 80 percent of the total combined

voting power of all cases of stock entitled to vote

or at least 80 percent of the total value of shares of

all classes of the stock of each corporation, and

(B) 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 of each corporation,

taking into account the stock ownership of each

such person only to the extent such stock owner-

ship is identical with respect to each such corpora-

tion.

Treas. Reg. § 1.1563-1(a)(3) explains the statute as

follows:

(3) Brother-sister controlled group. (i) The term

“brother-sister controlled group” means two or

more corporations if the same five or fewer per-

sons who are individuals, estates, or trusts own

(directly and with the application of the rules con-

tained in paragraph (b) of § 1.1563-3), singly or in

combination, stock possessing—

(a) 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 the stock of each corporation; and

(b) 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

5a

shares of all classes of stock of each corporation,

taking into account the stock ownership of each

such person only to the extent such stock owner-

ship is identical with respect to each such corpora-

tion.

(ii) The principles of this subparagraph may be

illustrated by the following examples:

Example (1). The outstanding stock of corpora-

tions P,.Q, R, S, and T, which have only one class

of stock outstanding, is owned by the following

unrelated individuals:

Corporations Identical

Individuals owner-

P Q R 8 T ship

DIR Gaauenensuesaee 60% 60% 60% 60% 100% 60%

es UGUGGseenceteres ina c.bees Btcdau seas: soaceadiues

te eres cat's S40k 0s MY 1 Padaete. Seuwun’ Senesd- oe cad busses

DEMURE NOV aUNENGAA cee trovisévcect ens). savakh Swesed eeiesaeeake

SUNG U Elana lapwies anesse .ecnnce Wee.l) cca cetnsabaiee

Es kdecetnes 100%) — 100%) 100%) 100% 100% 60%

Corporations P, Q, R, S, and T are members of a

brother-sister controlled group.

* * * *

Thus, the regulation for the most part restates the

statute. The regulation does, however, add that the

stock ownership of the “same” five or fewer persons

should be considered “singly or in combination.”

Example (1) of the regulation illustrates the meaning

of this addition. The example indicates that for the

purposes of the 80-percent test a person can be consid-

ered as one of the five or fewer members of the group

controlling shareholders even though such person

holds stock only in one corporation.

6a

In this case, there is no question that the 50-percent

test in section 1563(a)(2)(B) is met. Arthur Vogel held

77.49 percent of the stock of plaintiff and 87.5 percent

(in terms of voting power) of the stock of Vogel Pop-

corn. The stock ownership is taken into account to the

extent that it is identical, i.e., 77.49 percent, which is

more than the 50 percent required by section

1563(a)(2)(B).

The dispute here involves only the 80-percent test

and specifically whether Richard Crain who holds no

stock in Vogel Popcorn can be counted as one of the

five or fewer persons who hold 80 percent of the stock

of each corporation. Plaintiff concedes that if Example

(1) of Treas. Reg. § 1.1563-1(a)(3)(ii) is valid, then

Richard Crain’s stock can be counted toward the re-

quired 80 percent. Plaintiff, however, argues that the

regulation is unreasonable and clearly inconsistent

with the statute. A person must hold some stock in

both corporations, plaintiff contends, before his stock

in any corporation can be counted in the 80-percent

test.

The validity of Treas. Reg. § 1.1563-1(a)(3) has al-

ready been extensively litigated. The first case

brought under the regulation was Fairfax Auto Parts

of Northern Virginia, Inc. v. Commissioner, 65 T.C.

798 (1976). The regulation was found to be invalid in a

decision reviewed by the full Tax Court with four

judges dissenting. The United States Court of Appeals

for the Fourth Circuit reversed the Tax Court in a

short per curiam opinion agreeing with the four dis-

senting judges. 548 F.2d 501, cert. denied, 434 U.S.

904 (1977). The Tax Court has reaffirmed its majority

view in a second court-reviewed decision, Charles

Baloian Co. v. Commissioner, 68 T.C. 620 (1977), and

has continued to apply section 1563(a)(2) without re-

gard to the regulation in several cases. See, for eram-

Ta

ple, Davidson Chevrolet Co. v. Commissioner, No.

2619-78, T.C. Memo. 1979-414 (Oct. 2, 1979); Delta

Metalforming Co. v. Commissioner, 37 T.C.M. (CCH)

1485 (1978). Two other courts of appeals have sub-

sequently reversed Tax Court decisions and have up-

held the regulation. Allen Oil Co. v. Commissioner,

614 F.2d 336 (2d Cir. 1980), rev’g 38 T.C.M. (CCH)

355 (1979); T.L. Hunt, Ine. v. Commissioner, 562

F.2d 532 (8th Cir. 1977) (2-1 opinion), rev’g 35 T.C.M.

(CCH) 966 (1976). Appeals from the Tax Court are

now pending before several circuits.

Although the parties agree on the mechanical opera-

tion of the 50-percent test, plaintiff and defendant

have very different views on the importance of the

50-percent test relative to the 80-percent test.

In defendant’s view, the 80-percent test only meas-

ures the closely held nature of the corporations. Thus,

if 80 percent of each corporation is held by iive or

fewer individuals, the 80-percent test is met regard-

less of whether all of the five or fewer individuals hold

stock in only one corporation. Only the 50-percent test

measures whether the corporations are in any way re-

lated through common stockholders. Under defend-

ant’s interpretation, the 80-percent test standing alone

has no significance; it only has meaning as one part of a

two-pronged test.

Plaintiff believes that defendant's interpretation ac-

cords too little scope to the 80-percent test. The 80-

percent test, plaintiff argues, is the more important of

the two tests, and the proper role of the 50-percent

test is subordinate, not superior, to the 80-percent

test. Thus, each of the five or fewer persons consid-

ered in the 80-percent test must own some stock in

8a

both corporations, and the function of the 50-percent

test is to treat corporations as separate entities if the

80 percent is held in such differing proportions with

respect to each corporation that the corporations can-

not effectively be controlled as one.*

The statute itself has been fairly criticized as being

open to at least four different constructions. Libin &

Abramowitz, Multiple Corporations: A Surprising

Interpretation of Sec. 1563(a)(2) in Temporary Regu-

lations, 2 TAX ADVISER 326, 327-28 (1971). We agree

that the correct interpretation of section 1563(a)(2)

cannot be resolved solely by reference to the statutory

language. Nevertheless we do believe that the statut-

ory construction made by the Tax Court in Fairfar

Auto Parts of Northern Virginia, Inc. v. Commis-

sioner, supra, 65 T.C. at 802-03, is the most careful

and best analysis of the statute to date. There the

®* The most obvious example is where the stock of one corpora-

tion is held 50 percent by A and 20 percent by B while the stock

of another corporation is held 20 percent by A and 80 percent by

B. The 80-percent test would be met regardless of which in-

terpretation is correct. The 50-percent test would net be met

because the holdings are considered only to the extent that they

are identical with respect to each corporation, /.¢., 20 percent

each for A and B for a total of 40 percent. See TECHNICAL EX-

PLANATION OF TREASURY TAX REFORM PROPOSALS in Hearings

on the Subject of Tax Reform Before House Comm. on Ways

and Means, 91st Cong., Ist Sess. 5170 (1969). Because each

stockholder has a much greater investment in one of the corpo-

rations, the interests of the stockholders and the corporations

are quite distinct.

* This construction of the statute was first suggested in

Thomas, Brother-Sister Multiple Corporations —The Tax Re-

form Act of 1969 Reformed by Regulation, 28 Tax L. Rev. 65,

77-79 (1972).

Tax Court stated:

The key words of the statute relevant to an

analysis of the issue are:

if 5 or fewer persons * * * own * * *

(A) at least 80 percent * * * of each corpo-

ration, and

(B) more than 50 percent * * * of each cor-

poration, taking into account the stock owner-

ship of each such person only to the extent

such stock ownership is identical with respect

to each such corporation. [Sec. 1563(a)(2).

Emphasis supplied. }

Since the “five or fewer persons” is the conjunc-

tive subject of both the 80-percent test and the

50-percent test, it cannot be gainsaid that both

tests must be satisfied by the same ownership

group. However, to gain entrance into the owner-

ship group for purposes of the 50-percent test one

must possess stock in each corporation involved

since an absence of such stock ownership produces

an identical stock ownership of zero or, put

another way, no stock ownership at all. If owner-

ship of stock in each corporation involved is a pre-

condition to membership in the ownership group

for purposes of the 50-percent test, and the own-

ership groups for the 50-percent test and 80-

percent test are one and the same, it follows in our

mind that one must own stock in each corporation

before his stock can be taken into account for pur-

poses of the 80-percent test.

Furthermore, the language of the 50-percent

test comports with this analysis. The words “each

such person” appearing therein refer to the “five

or fewer persons” constituting the ownership

group, for purposes of both the 80-percent and

10a

50-percent tests. The import of such usage is that

each person—and not just some of the persons—

counted for purposes of the 80-percent test must

be also counted for purposes of the 50-percent

test. To interpret the statutory language as re-

spondent has done in his regulation is plainly in-

consistent with the tirust of the statutory lan-

guage. Hence, we hold that for a person’s stock

ownership to be taken into account for purposes of

the 80-percent test that person must own stock in

each member of the brother-sister controlled

group.* * *

Defendant takes exception to the Tax Court’s analy-

sis and noies ° iat while the 50-percent test specifically

provides for “taking into account the stock ownership

of each such person only to the extent such stock own-

ership is identical with respect to each such corpora-

tion,” the 80-percent test contains no such language.

Thus, defendant concludes that there is no specific re-

quirement in the 80-percent test that a person own

stock in more than one corporation. Defendant further

argues that under the Tax Court’s interpretation the

50-percent test would serve no function since it would

necessarily be satisfied in any situation in which the

80-percent test was met. This argument attempts to

blur the important distinction drawn by the Tax Court

between the overlapping ownership required by the

80-percent test and the identical overlapping owner-

ship required by the 50-percent test.5 Contrary to de-

fendant’s contentions, the Tax Court’s interpretation

does not import the requirement of identical ownership

into the 80-percent test; it merely requires the same

5 The example given in note 3, supra, demonstrates a situa-

tion where the 80-percent test, but not the 50-percent test, is

met.

lla

persons to be in the group of controlling stockholders

used in both tests.

Defendant further relies upon the “last antecedent”

doctrine to dispute that the phase “each such person”

in the 50-percent test refers to the “5 or fewer per-

sons” who are the subject of both tests. This doctrine

requires that qualifying words, phrases, and clauses in

a statute are to be applied to the words or phrase im-

mediately preceding and are not to be construed as ex-

tending to and including others more remote. Azure v.

Morton, 514 F.2d 897, 900 (9th Cir. 1975); Quindlen v._

Prudential Ins. Co. of America, 482 F.2d 876, 878 (5th

Cir. 1973). Defendant misunderstands the function of

this doctrine, which, for example, would establish (in

the absence of clarifying indentation) that the qualify-

ing clause “taking into account the stock ownership of

each such person only to the extent such stock owner-

Defendant further argues that, even assuming arguendo that

there may be isolated instances in which the 80-percent but not

the 50-percent test would be satisfied under the Tax Court’s in-

terpretation, in the vast majority of stock ownership patterns,

the Tax Court’s common ownership requirement for the 80-

percent test would come close to eliminating the 50-percent test

despite Congress’ intent to have two separate tests. As dis-

cussed in part II of this opinion, supra, regardless of the in-

terpretation chosen, one of the two tests will play a far more

significant role than the other. Based on the legislative history

and purpose of section 1563(a)(2) discussed in parts IV and VI of

this opinion, infra, we have concluded that the 80-percent test

was intended to be the primary test and must be so treated if it

is to have any significance at all. While we disagree with de-

fendant’s unsupported factual assertions with respect to the

“vast majority” of stock ownership patterns, we do agree that

under our interpretation the 50-percent test by itself would re-

sult in the exclusion of a group of corporations from treatment

as a brother-sister controlled group only in an atypical stock

ownership arrangement. This, in our opinion, is precisely what

the 50-percent test was intended to do.

12a

ship is identical with respect to each such corporation”

only applies to the immediately preceding 50-percent

test and not to the more remote 80-percent test. The

phrase “5 or fewer persons” is the most immediately

preceding reference to “persons” prior to the phrase

“each such person.” As such, both common English

usage and the “last antecedent” doctrine support the

Tax Court’s interpretation.

Despite the better reasoned construction of the

statutory language by the Tax Court, it must be ad-

mitted that the different view taken by Treas. Reg.

§ 1.1563-1(a)(3) is not wholly unreasonable as a con-

struction of the words appearing in section 1563(a)(2).

The regulation is, however, clearly inconsistent with

the legislative history and unreasonable when the pur-

pose, as well as the bare words, of the statute are con-

sidered.

IV

In order to understand the legislative history of sec-

tion 1563(a)(2), it is necessary to begin with earlier

congressional attempts to deal with the tax abuses of

multiple corporations. Prior to the Revenue Act of

1964, Pub. L. No. 88-272, 78 Stat. 19, the Commis-

sioner of Internal Revenue had fairly limited powers to

curb multiple incorporation for the purpose of claiming

extra surtax exemptions. The only provision of the

Internal Revenue Code specifically aimed at multiple

surtax exemptions was section 1551.® Prior fo 1964,

® The Commissioner could also employ more general powers

under section 269 to disallow tax benefits resulting from the ac-

quisition of control of a corporation where the principal purpose

of such acquisition is the evasion or avoidance of federal income

tax or under section 482 to reallocate deductions, credits, or al-

lowances between two corporations owned or controlled by the

13a

section 1551 disallowed the surtax exemption of a

transferee corporation in certain cases if the corpora-

tion failed to establish by a preponderance of the evi-

dence that the securing of the exemption was not a

major purpose of the transfer. Section 1551 applies to

situations where a corporation transferred part or all

of its property (other than money) to another corpora-

tion created to acquire such property, or not actively

engaged in business at the time of the transfer, if

there was common control of the two corporations.

The Revenue Act of 1964 expanded the Commis-

sioner’s power to deal with multiple surtax exemptions

in two ways.

First, sections 1561 through 1563 were added to the

Code. These new provisions limited in one of three al-

ternative ways the surtax exemptions available to a

“controlled group of corporations.” Sections 1561-1563

established a mechanical test relating to stock owner-

ship, and once it was met, the sanctions would apply

regardless of any legitimate nontax purposes for the

use of more than one corporation.? A “brother-sister

controlled group” was defined in the 1964 Act as

existing where a single individual, trust, or estate

owned at least 80 percent of the total combined voting

power or value of all classes of stock of each of two or

same interest where necessary to prevent the evasion of taxes

or clearly to reflect the income of the corporations.

7 The mechanical application of sections 1561-1563 is by far

the most significant change from the approach taken in section

1551. In Thomas, Brother-Sister Multiple Corporations —The

Tar Reform Act of 1969 Reformed by Regulation, 28 TAX L.

REV. 65, 69 (1972), it is noted that virtually every litigated case

under the older section 1551 was decided by a determination of

the taxpayer’s purpose or motive and that not one case can be

found that seriously raised any question as to the control re-

quirements under that statute.

l4a

more corporations.* See H. REP. No. 749, 88th Cong.,

Ist Sess. (1963), reprinted in [1964] U.S. CODE CONG.

& AD. NEWS 1313, 1428, 1624, 1964-1 C.B. (Part 2)

125, 243, 446; S. REP. No. 830, 88th Cong., 2d Sess.

(1964), reprinted in [1964] U.S. CopE Conc. & AD.

NEWS 1673, 1825, 1964-1 C.B. (Part 2) 505, 655.

Second, section 1551 was retained and expanded in

scope. One of the changes was to apply section 1551 to

transfers by an individual (as well as a corporation) to

a controlled corporation. Under section 1551(b)(2),

§ It is worth noting that in PRESIDENT’S 1963 TAX MESSAGE

in Hearings on the President's 1963 Tax Message Before the

House Comm. on Ways and Means, 88th Cong., lst Sess. 77

(1963), the Treasury Department originally proposed to define a

brother-sister controlled group less stringently than in Treas.

Reg. § 1.1563-1(a)(3) under the 1969 change in section

1563(a)(2). Under the proposal, a brother-sister affiliated group

would have included any group of two or more corporations if (1)

at least 80 percent of the value or voting power of the stock of

each of the corporations was owned by not more than five indi-

viduals, (2) each of the individuals owned 5 percent or more of

the value or voting power of the stock of at least one of the

corporations, and (3) each of the individuals owned substantially

the same proportion of the voting power or value of the stock of

each of the corporations. In determining whether there existed

80-percent common ownership in each of two brother-sister-type

corporations in substantially the same proportion, an indi-

vidual’s stock ownership in one corporation would not hove been

taken into account to the extent it exceeded twice the percent-

age of his stock ownership in the other corporation.

Thus, it is clear that under the first part of the 1963 proposal

an 80-percent overlap of ownership was required. There is no

equivalent in the 1969 statute to the second part of the 1963

proposal, but the third part has a very similar function to the

50-percent test in the 1969 statute as construed by plaintiff and

this court. Neither one erases the requirement of an 80-percent

overlap, and both measure whether the 89 percent is held to a

large extent in identical proportions with respect to each corpo-

ration.

l5a

control was deemed to exist where the individual who

made the transfer, together with no more than four

individuals, owned at least 80 percent of the value or

voting power of the stock in two or more corporations,

one of which was the trunsferee corporation, and

where the same individuals owned more than 50 per-

cent of the value or voting power of the stock in each

corporation (only taking into account identical stock-

holdings) after the transfer. See H. REP. No. 749,

supra, [1964] U.S. CoDE Conc. & AD. NEWS at 1432,

1638-39, 1964-1 C.B. (Part 2) at 247, 460-61; S. Rep.

No. 830, supra, [1964] U.S. CoDE Conc. & AD. NEws

at 1829, 1964-1 C.B. (Part 2) at 659. There are no re-

ported court decisions under section 1551(b)(2) which

construe the meaning of this control test.

In 1969, the Treasury Department made several fur-

ther proposals relating to multiple corporations. One of

these was to expand the definition of a brother-sister

controlled group in section 1563(a)(2) to consider the

stockholdings of up to five persons instead of only one.

The Treasury proposal to modify section 1563(a)(2) to

apply the same test as section 1551(b)(2) was adopted

without change by the Congress. See the Tax Reform

Act of 1969, Pub. L. No. 91-172, § 401(c), 88 Stat. 602.

Therefore, the committee reports on this aspect of the

bill are very cursory.® The only significant contem-

® The General Explanation in H. Rep. No. 91-413 (Part 1,

9ist Cong., Ist Sess. 99 (1969), reprinted in [1969] U.S. Cope

ConG. & AD. NEWS 1645, 1747-48, 1969-3 C.B. 200, 262, only

states:

“The bill also modifies the present definition of a

brother-sister controlled group—i.e., two or more corpo-

rations 80 percent or more of the stock of which is owned

(by voting power or value) by one individual, estate, or

trust. This bill expands this definition to include two or

more corporations which are owned 80 percent or more (by

16a

poraneous legislative material in the 1969 change in

section 1563(a)(2) is the Treasury Department’s expla-

nation of its proposal. The relevant portions of the

TECHNICAL EXPLANATION and the GENERAL EXPLA-

NATION OF TREASURY TAX REFORM PROPOSALS in

Hearings on the Subject of Tax Reform Before House

Comm. on Ways and Means, 91st Cong., Ist Sess.

5168-70, 5394-96 (1969), state:

(b) Brother-sister controlled group. Present law

defines a brother-sister controlled group as a

group of corporations in which the voting stock or

value of shares of each member is owned 80 per-

cent by the same person (i.e., individual, estate or

trust). Under the proposal, the present definition

would be changed so that a group of corporations

would constitute a brother-sister controlled group

if (1) the same five or fewer persons own at least

voting power or value) by five or fewer persons (individu-

als, estates, or trusts) provided that these five or fewer

persons own more than 50 percent of each corporation

when the stock of each person is considered only to the

extent it is owned identically with respect to each corpora-

tion. In other words, a person who owns 70 percent of one

corporation and 30 percent of another corporation is to be

treated as owning only 30 percent of each corporation iden-

tically. It is only this amount which would be taken into

account in applying the 50-percent test.”

The Technical Explanation in H. REP. No. 91-413 (Part

II), supra, at 76, [1969] U.S. Cope Conc. & AD. NEws at

1956, 1969-3 C.B. 384, only adds: “Subsection (c) of section

401 of the bill amends section 1563(a)(2) of the code to ex-

pand the definition of a brother-sister controlled group of

corporations. The stock ownership test would be the same

test employed in section 1551(b)(2) of the code.”

The relevant portion of S. REP. No. 91-552, 91st Cong., Ist

Sess. 135 (1969), reprinted in [1969] U.S. Cope Conc. & Ap.

NEWS 2027, 2167, 1969-3 C.B. 423, 510, is substantially the

same as the General Explanation in the House report.

17a

80 percent of the voting stock or value of shares of

each corporation, and (2) these five or fewer indi-

viduals own more than 50 percent of the voting

power or value of shares of each corporation con-

sidering a particular person’s stock only to the ex-

tent that it is owned identically with respect to

each corporation. This definition is the same as

that under section 1551 (relating to the disallow-

ance of surtax exemptions and accumulated earn-

ing credits in cases of transfers in order to secure

the exemption or credit).

Part (1) of this test is satisfied if the group of

five or fewer persons as a whole owns at least 80

percent of the voting stock or value of shares of

each corporation, regardless of the size of the in-

dividual holdings of each person. Thus, for exam-

ple, part (1) (but not necessarily part (2)) is met

whether one person owns 80 percent of the voting

stock of each corporation, four persons each own

20 percent of the voting stock of each corporation,

or one person owns 60 percent of the voting stock

of one corporation and 40 percent of another, and

another person owns 40 percent of the voting

stock of the first and 60 percent of the second.

Part (2) of the test is satisfied only if the same

five or fewer persons own more than 50 percent of

the voting stock or value of shares of each corpo-

ration, considering stock owned by a particular

person only to the extent that it is owned identi-

cally in each of the corporations. Thus, for exam-

ple, a person who owns 80 percent of the voting

stock of one corporation and 30 percent of another

would be considered as owning 30 percent of both

corporations for purposes of part (2) of the test.

18a

The following two examples illustrate the opera-

tion of this two-part test:

Example 1

Percent of stock Percent of Identical

Ownership (pt. 1) Ownership (pt. 2)

Corp. Corp. Corp. Corp.

No. 1 No. 2 No. 1 No, 2

Shareholders:

Be nkvexavess 30 75 30 30

De - ccervvasks 70 25 25 25

BOER seciane 100 100 55 55

Example 2

Percent of stock Percent of Identical

Ownership (pt. 1) Ownership (pt. 2)

Corp. Corp. Corp. Corp.

No. 1 No. 2 No. 1 No. 2

Shareholders:

Wi ceucheces 80 20 20 20

Dr we isecke css 20 80 20 20

ONE cdcres 100 100 40 40

In both examples, individuals A and B together

own 100 percent of both corporations. Thus, part

(1) of the test is met. However, under part (2) of

the test, the stock holdings of A and B are re-

stricted to the lowest percentage of any member

to be included in the group. Thus, in Example 1,

because stockholder A owns only 30 percent of

Corporation No. 1 he is considered to own only 30

percent of Corporation No. 2. Part (2) of the test

is satisfied in Example 1, but not in Example 2.

Consequently, the corporations in Example 1

would constitute a brother-sister controlled group

while those in Example 2 would not.

a K ae * *

19a

(2) Brother-sister groups. —A group of corpora-

tions in which five or fewer persons’ own, to a

large extent in identical proportions, at least 80

percent of the stock of each of the corporations.

This provision expands present law by considering

the combined stock ownership of five individuals,

rather than one individual, in applying the 80-

percent test. Even the mild 6-percent penalty

under existing law for brother-sister corporations

claiming multiple surtax exemptions is largely in-

effectual because of the present requirement that

one person own 80 percent of the stock of each

corporation before the group of corporations is

subject to the penalty.

However, in order to insure that this expanded

definition of brother-sister controlled group

applies only to those cases where five or fewer in-

dividuals hold their 80 percent in a way which al-

lows them to operate the corporations as one eco-

nomic entity, the proposal would add an additional

rule that the ownership of the five or fewer indi-

viduals must constitute more than 50 percent of

the stock of each corporation considering, in this

test of ownership, stock of a particular person

only to the extent that it is owned identically with

respect to each corporation.

Thus, even where the 80 percent ownership test

is met, the brother-sister definition will not apply

unless the stockholdings of the individuals in the

various corporations also meet the 50-percent

identical ownership test.

a“Persons” in this discussion refers to individuals, estates,

or trusts.

20a

For example, if A owns 55 percent of Corpora-

tion Y and 45 percent of Corporation Z, and B

owns 35 percent of Y and 40 percent of Z, the two

tests would apply as follows:

Percent of stock Percent of identical

ownership ownership

Corporation Corporation

. Z Z Z

Shareholder:

Mi tanswstchat 55 45 45 45

Oe whavies aa 35 40 35 35

WN kckaean 90 85 80 80

“As the table illustrates, A and B together own

90 percent of Y and 85 percent of Z. Thus, the

basic 80 percent ownership test is met. However,

since A owns 55 percent of Y but only 45 percent

of Z, his stockholdings in the two are identical

only to the extent of 45 percent. Similarly, B’s

stockholdings are identical only to the extent of 35

percent. Together A and B hold 80 percent each of

Y and Z and the 50-percent test is met. Thus, in

this example, Y and Z are members of a brother-

sister controlled group.

Expanding the 80-percent ownership test from

one person to five will close the present opportu-

nity for easy avoidance of that 80-percent test.

However, adding the 50-percent identical owner-

ship test will insure that the new expanded defini-

tion is limited to cases where the brother-sister

corporations are, in fact, controlled by the group

of stockholders as one economic enterprise.

After having read the entire Treasury explanation,

we fail to understand how this document has been con-

strued as supporting, or at least not contradicting, the

2la

interpretation of section 1563(a)(2) made by Treas.

Reg. § 1.1563-1(a)(3). Nevertheless, various courts

have construed it in this manner.'® Therefore, we will

discuss in detail how the Treasury explanation clearly

indicates that each of the five or fewer persons consid-

ered under the 80-percent test must hold some stock in

each corporation in the controlled group.

First, and foremost, the Treasury explanation di-

rectly states this very proposition:

* * * Under the proposal, the present definition

would be changed so that a group of corporations

would constitute a brother-sister controlled group

if (1) the same five or fewer persons own at least

80 percent of the voting stock or value of shares of

each corporation, and (2) these five or fewer indi-

viduals own more than 50 percent of the voting

power or value of shares of each corporation con-

sidering a particular person’s stock only to the ex-

tent that it is owned identically with respect to

each corporation. [Emphasis added in part. ]

The use of the word “same” in the above sentence re-

moves any possible ambiguity and establishes that the

same persons must own some stock in each corpora-

tion. Moreover, the use of the words “these five or

fewer individuals” supports the construction of the

statute by the Tax Court in Fairfax Auto Parts to the

effect that the same persons, with no additions or sub-

tractions, must be considered in both the 80-percent

and the 50-percent tests.!!

1° See Allen Oil Co. v. Commissioner, supra, 614 F.2d at

339; T. L. Hunt, Inc. v. Commissioner, supra, 562 F.2d at 535;

Fairfax Auto Parts of Northern Virginia, Inc. v. Commis-

sioner, supra, 65 T.C. at 809-10 (dissenting opinion), 548 F.2d

at 503.

'! Similar language is also found in H. REP. No. 91-413 and S.

REP. No. 91-552, supra note 9, with respect to the amendment

22a

Second, if the regulation’s interpretation of section

1563(a)(2) is correct, the most significant change made

to that section is not the expansion of the number of

stockholders considered from one to five but rather the

removal of the requirement in the prior version of the

80-percent test that each stockholder must own some

stock in each corporation. In effect, the amended sec-

tion as interpreted by the regulation would reduce the

required overlap of ownership from 80 to 50 percent.

Yet, the Treasury explanation says only that present

law is expanded “by considering the combined stock

ownership of five individuals, rather than one indi-

vidual, in applying the 80-percent test.” To paraphrase

Judge Webster’s dissent in 7.L. Hunt, Inc. v. Com-

missioner, supra, 562 F.2d at 537, the prior version of

the 80-percent test required both sameness and small-

ness. The Treasury explanation indicates that the

number constituting smallness would be increased, but

there is absolutely no indication that the requirement

of sameness would be removed.

Moreover, if the Treasury was indeed proposing to

remove the requirement of sameness in the 80-percent

test, it is scarcely credible that an example to illus-

trate this important change would not have been

given. In every example in the Treasury explanation

involving the 80-percent test, the persons mentioned

own some stock in each corporation.'!? The explanation

of section 1563(a)(2) and in H. REP. No. 749 and S. REP. No.

830, supra, with respect to the enactment of section 1551(b)(2).

‘2 No examples are provided in the committee reports on the

amendment of section 1563(a)(2). However, the example in the

House committee report on the original enactment of the same

statutory language as section 1551(b)(2) involves persons who

own stock in each corporation. H. REP. No. 749, supra, [1964]

U.S. CopE Conc. & AD. NEWS at 1638-39, 1964-1 C.B. (Part 2)

at 460-61.

23a

even states in detail that the 80-percent test is met

“whether one person owns 80 percent of the voting

stock of each corporation, four persons each own 20

percent of the voting stock of each corporation, or one

person owns 60 percent of the voting stock of one cor-

poration and 40 percent of another, and another per-

son owns 40 percent of the voting stock of the first

and 60 percent of the second.” [Emphasis supplied. }

Third, the Treasury explanation indicates in several

ways that the 80-percent test was envisioned as a test

of independent significance, in fact a test of greater

significance than the 50-percent test. The explanation

states in two places that the 50-percent test is added

to “insure” that the corporations are in fact “con-

trolled” by the group of stockholders as one economic

entity or enterprise. The use of the word “insure” indi-

cates that the 80-percent test also measures to some

degree whether the corporations can be considered one

economic entity. The 80-percent test therefore must

measure substantial overlapping financial interests.

The 50-percent test was added to “insure,” not to es-

tablish, the unity of economic enterprise by measuring

whether overlapping control exists.

Similarly, the explanation states: “Thus, even where

the 80 percent ownership test is met, the brother-

sister definition will not apply unless the stockholdings

of the individuals in the various corporations also meet

the 50-percent identical ownership test.” The emphasis

of the sentence on the 80-percent test as the primary

requirement belies the notion that the 80-percent test

was intended to measure only the number of stock-

holders and not the extent of overlapping stock owner-

ship. The Treasury explanation is totally inconsistent

with the relatively minor role relegated to the 80-

percent test by Treas. Reg. § 1.1563-1(a)(3).

24a

In conclusion, we find no ambiguity whatsoever in

the Treasury explanation and other legislative mate-

rial when they are read in their entirety. It would be a

gross usurpation of the power of Congress to draft tax

statutes to allow the Treasury to explain a legislative

proposal in one way and then to interpret it after

enactment ina far more expansive fashion. Since it

was understood at all times during the legislative con-

sideration of the Tax Reform Act of 1969 that the pro-

posal would track the language of section 1551(b)(2),

there can be no doubt that Congress was enacting pre-

cisely what it understood the Treasury to be propos-

ing.

v

Defendant relies upon two similar arguments to

support its interpretation of section 1563(a)(2). First,

since section 1563(a)(2) of the Code (section 401(c) of

the Tax Reform Act of 1969, supra) contains language

identical to the previously enacted section 1551(b)(2),

Congress must have intended to adopt the interpreta-

tion of this language made in Treas. Reg. § 1.1551-1

(1967). Second, the Employee Retirement Income Se-

curity Act of 1974 (ERISA), Pub. L. No. 93-406,

$§ 1013(c)(1) and 1015, 88 Stat. 921, 925, incorporated

section 1563(a) by reference in sections 404(a)(1)(C)

and 414(b) of the Internal Revenue Code at a time

when Treas. Reg. § 1.1563-1(a)(3) had already been

published. Therefore, defendant argues that Congress

necessarily approved the interpretation of section

1563(a)(2) made by the regulation.

While it is clear that Congress intended the same

statutory tests to be applied in all of the above in-

stances, there is no indication in the legislative history

of either the Tax Reform Act of 1969 or ERISA that

25a

Congress was aware of or approved any regulation in-

terpreting the control requirements for the brother-

sister corporations. According to 1 MERTENS’ LAW OF

FEDERAL INCOME TAXATION ¢ 3.24 (1974 rev. ed.),

the rule relating to implied congressional approval of

an administrative construction through statutory

reenactment is an anachronism left over from earlier

days in which statutes were briefer, were seldom

reenacted or amended, and where administrative in-

terpretation was far simpler. Reenactment—par-

ticularly without the slightest affirmative indication

that Congress ever had before it the particular con-

struction in question—is an unreliable indicium at

best. Commissioner v. Glenshaw Glass Co., 348 U.S.

426, 431 (1955).

In addition to the general unreliability of the doc-

trine of statutory reenactment, the doctrine has been

found particularly inappropriate where the prior con-

struction is not of long standing. In United States v.

Calamaro, 354 U.S. 351, 358-59 (1957), the Supreme

Court refused to give any significance to the reenact-

ment of a provision as a part of the 1954 Code only 3

years after the issuance of the regulation in question.

Accord, Commissioner v. Sun Pipe Line Co., 126

F.2d 888, 892 (3d Cir. 1942); Commissioner v. F.H.E.

Oil Co., 102 F.2d 596, 598 (5th Cir. 1939), aff'd, 308

U.S. 104 (1939); see also Eastman Kodak Co. v.

United States, 99 Ct. Cl. 569, 572, 48 F.Supp. 357, 359

(1943). Because of the short periods between the

publication of each regulation and the enactment of the

subsequent statute (22 months in the case of the regu-

lations under section 1551(b)(2) and 29 months in the

case of Treas. Reg. § 1.1563-1(a)(3)), congressional

approval of the regulations cannot be implied.

Finally, defendant’s first argument must also be re-

jected because the regulations under section 1551(b)(2)

26a

did not unambiguously establish the interpretation

which, according to defendant, Congress approved.

Any implied congressional approval must necessarily

be limited to the Jiteral wording of the regulations and

cannot be extended to a possible inference or interpre-

tation. Montana Power Co. v. United States, 232 F.2d

541, 549 (3d Cir.), cert. denied, 352 U.S. 843 (1956).

In drafting Treas. Reg. § 1.1551-1, the Treasury did

not add the words “singly or in combination” to the

statutory language as it did to the same language in

Treas. Reg. § 1.1563-1(a)(3). Furthermore, the

Treasury did not provide an explicit example such as

Treas. Reg. § 1.1563-1(a)(3)(ii), Example (1), to show

that persons owning stock in only one corporation can

be counted in the 80-percent test. The examples pro-

vided in Treas. Reg. § 1.1551-1 are capable of more

than one interpretation.

One example, Treas. Reg. § 1.1551-1(f)(2), Example

(2), involves individual A who owns all of the stock of

corporation X. Individual A transfers property to cor-

poration Y in exchange for 60 percent of the voting

stock of Y. During a later taxable year of Y, A ac-

quires an additional 20 percent of Y’s voting stock. The

example concludes that section 1551(a)(3) is applicable

beginning in the taxable year in which the later ac-

quisition of stock occurred. The inapplicability of sec-

tion 1551(a)(3) to the earlier taxable years can only be

explained in one of two ways. First, the Treasury then

considered that the 80-percent test would only apply to

persons who owned stock in both X and Y. Alterna-

tively, the 40 percent of Y’s stock not owned pre-

viously by A could have been so diversely held that no

four other stockholders would own as much as 20 per-

cent. This alternative explanation is unlikely because

it assumes that the drafters of the regulation com-

mitted a cardinal error in writing an example by failing

27a

to provide all of the facts necessary to understand the

example.

Another example, Treas. Reg. § 1.1551-1(g)(4),

Example (4), on which defendant relies, may indicate a

contrary proposition. In this example, individual A

owns 55 percent of the stock of corporation X. Another

25 percent of the stock of X is owned in the aggregate

by individuals B, C, D, and E. Individual A transfers

property to corporation Y in exchange for 60 percent

of the stock of Y, and B, C, and D acquire all of the

remaining stock of Y. The example concludes, without

providing any rationale, that the transfer is within the

scope of section 1551(a)(3). Defendant argues that the

example demonstrates that owning stock in both cor-

porations is not a requirement of the 80-percent test.

However, the examples under paragraph (g) of Treas.

Reg. § 1.1551-1 are intended as illustrations of the na-

ture of the transfer required under that paragraph

rather than as illustrations of the meaning and applica-

tion of the term “control” discussed in paragraph (e).

It has been suggested that the example merely illus-

trates that a transfer can be made by one, rather than

all, of the individuals in control of the transferor cor-

poration or that the controlling stockholders of the

transferee corporation must come from the group of

five or fewer stockholders of the transferor but need

not include all of the members of that group. Bonovitz,

Brother-Sister Controlled Groups under Section 1563:

The 80 Percent Ownership Test, 28 TAX LAWYER 511,

524-28 (1975). These suggested constructions of the

example would not conflict with our interpretation of

section 1563(a)(2) and are just as likely to be the

proper construction of an ambiguous example as that

of defendant’s.

Thus, we hold that no definite conclusions with re-

spect to the proper interpretation of section 1563(a)(2)

28a

can be drawn from the .regulations under section

1551(b)(2) or from the later enactment of ERISA.

Vi

In addition to concluding that Treas. Reg.

§ 1.1563-1(a)(3) is inconsistent with Congress’ intent

as evidenced by the legislative history, we have fur-

ther determined that the regulation is an unreasonable

interpretation of the statute. Under the regulation,

the 80-percent test measures nothing of significance

when the purpose of the statute is considered.

The purpose of the tests in section 1563(a)(2) is to

measure whether there is such a substantial identity

between the stockholdings of two or more corporations

to warrant treating them as one entity limited to one

surtax exemption.'!* The percentage of overlapping

stockholdings that constitutes such a substantial iden-

tity is necessarily a somewhat arbitrary figure.'* Con-

13 The same tests of control also affect the amounts allowed in

computing the accumulated earnings credit under section

535(c)(2) and (3) of the Code and the limitation on the small

business deduction of life insurance companies under sections

804(a)(3) and 809(d)(10). See section 1561(a)(2) and (3). As dis-

cussed in part V of this opinion, supra, the same definition of

the term “controlled group” is adopted with respect to pension

and profit-sharing plans in sections 404(a)(1)(C) and 414(b) of

the Code by ERISA. Other cross-references in the Code to sec-

tion 1563(a) are found in section 46(a)(6) relating to the $25,000

refund limitation on the investment tax credit, in section 58(b)

relating to the $10,000 exemption from the minimum tax on

preference items, and in section 179(d)(6) relating to the $10,000

limitation on additional first-year depreciation for small busi-

ness.

14 Thus, even if one person owns 100 percent of the stock of

one corporation and 79.9 percent of the stock of a second corpo-

ration, the two co#porations would not be a controlled group.

While this may seem to some to permit abusive situations, it is

29a

gress could, if it wished to do so, set the minimum per-

centage of overlap at 50 percent, but if it did, it would

not have included a superfluous 80-percent test. As

Judge Webster states in his dissenting opinion in 7. L.

Hunt, Inc. v. Commissioner, supra, 562 F.2d at 537:

* * * There is nothing in the legislative history

to suggest that Congress intended to penalize

companies in which there were five or fewer

shareholders. It is not the smallness of the

number of persons in each company that triggers

§ 1563; it is the sameness of that small number.

The 80 percent financial interest requirement is

meaningless unless it is the same group of five or

fewer persons that own 80 percent of each com-

pany within the controlled group. It is this re-

quirement of “economic entity” which is entirely

eviscerated by Reg. § 1.1563-1(a)(3). [Emphasis

in original. |

Futhermore, section 1563(a)(1) provides persuasive

evidence that Congress would require a significantly

greater overlap of stockholdings than 50 percent be-

fore it would treat two or more corporations as one

entity. Section 1563(a)(1) defines a “parent-subsidiary

controlled group” as existing where a parent corpora-

tion owns stock representing 80 percent of the value or

voting power of one or more subsidiary corporations

either directly or indirectly through a subsidiary. It

seem unlikely that Congress would require a lesser

identity of ownership between brother-sister corpora-

unquestionably Congress’ prerogative to choose the determina-

tive percentage, and in this case, it has choosen 80 percent. It is

certainly no more arbitrary to classify these two corporations as

not constituting a controlled group than it would be to hold

under the regulation that they were a controlled group even if

the stock held in the second corporation were only 50.1 percent.

30a

tions owned by up to five persons than between a more

centralized and more easily controlled parent-

subsidiary group.

The Second Circuit in Allen Oil Co. v. Commis-

sioner, supra, 614 F.2d at 340, has offered the follow-

ing explanation of the 80-percent test as interpreted

by Treas. Reg. § 1.1563-1(a)(3):

*** According to the Commissioner, the 80%

test is designed to assure that within the group of

five persons or fewer the overall control of or fi-

nancial interest in each of the corporations will

beyond question be substantially more than 50%

(i.e., 80%), * * *

*** it [the 80-percent test as interpreted by

the Commissioner] insures that the stock is closely

held. Thus, even though five or fewer persons

may satisfy the 50% control test, the tax exemp-

tion of a corporate member of the group is saved

only if shareholders who are not part of the group

of five or fewer own more than 20% of its stock.

The majority opinion in 7.L. Hunt, Inc. v. Com-

missioner, supra, 562 F.2d at 536 n.2, similarly states:

* * * The 80 percent test prevents the denial of

surtax exemptions in situations meeting the 50 per-

cent control test if five or fewer persons do not

meet the 80 percent financial interest test. The 80

percent test thus serves the purpose of saving the

tax exemption in situations where minority stock-

holders own a substantial amount of the stock.

These explanations are only a restatement of the

obvious implications of defendant’s interpretation of

the 80-percent test. Indeed, it does measure whether

80 percent of the stock of each corporation is closely

held and conversely whether many small stockholders

together own a substantial amount of stock, but no ex-

3la

planation is offered why these facts have any signifi-

cance to the question of whether the corporations are

“one economic entity.” No one has provided any

rationale for including in the number of stockholders

counted in the 80-percent test those stockholders who

only own stock in one of the corporations.

We do not believe that any reasonable purpose is

served by counting such persons. For example, sup-

pose that individual A owns 100 percent of the stock of

corporation X and 60 percent of the stock of corpora-

tion Y, that individuals B,C,D, and E (first group)

each own 5 percent of the stock of Y for a total of 20

percent, and that individuals F,G,H,I, and J (second

group) each own 4 percent of the stock of Y for a total

of 20 percent. Individual A owns in excess of 50 per-

cent of each corporation and therefore has undisputed

voting control of both. While we would hold that the

80-percent test was not met, defendant would maintain

that it would be met because the stock of the first

group could be added to A’s stock. We disagree be-

cause the members of the first group have nothing in

common with A which could logically cause them to be

included with A in a group of controlling stockholders

for the purpose of limiting the surtax exemptions of X

and Y. The interests of the first group are virtually

identical to those of the second group. They will suffer

the same as the second group if Y’s surtax exemption

is lost, and since they do not hold stock in X, they will

have done nothing more than the second group to trig-

ger such treatment of Y except for the ownership of

slightly more stock in Y.

While the above example represents an extreme

case clearly demonstrating the unreasonableness of

defendant’s position, we believe that the same princi-

ples would hold true if B owned 24 percent of the stock

of Y and stockholders C through J each owned 2 per-

32a

cent for a total of 16 percent. B would still have more

in common with the 2-percent stockholders than with

A. B would be just as much a “minority stockholder”

as they are.'5

_ Finally, defendant points out that if Richard Crain

held as much as one share of stock in Vogel Popcorn,

then section 1563(a)(2) would apply even under our in-

terpretation. Defendant contends that had Congress

intended to require common ownership as part of the

80-percent test, it would have provided for some

minimum and meaningful level thereof and would not

have left it to turn upon the happenstance of a sym-

bolic but factually meaningless ownership of a single

share. Defendant’s argument may seem valid in the

‘5 The dissent suggests that the purpose of the 80-percent

test under the position taken by the regulation is to insure that

the stockholders with overlapping 50-percent control of both

corporations can obtain 66%-percent or 75-percent voting con-

trol when necessary without experiencing the difficulty and at-

tendant delay of dealing with a large number of other stockhold-

ers. There is absolutely nothing in the legislative history to

suggest that the 80-percent test was intended to measure con-

trol. For the most part, the operation of two or more corpora-

tions as one economic entity can be secured by mere 50-percent

control. In enacting the 80-percent test, Congress obviously had

in mind something other than control. Eighty-percent owner-

ship was made relevant as a test of a substantial identity of

financial interest between the two corporations.

Moreover, assuming arguendo that the 80-percent test is a

“control” test, control would be relevant only to the extent that

it would allow the two or more corporations to be operated as

one entity. The stockholders with overlapping 50-percent con-

trol of both corporations would not be able to secure the agree-

ment of a stockholder in only one of the corporations to a pro-

posal that would be disadvantageous to his corporation. It is not

“control” if the majority stockholders have to negotiate with,

and make concessions to, the minority stockholders in order to

pass a proposal.

33a

abstract but it has no merit when the predictable ac-

tions of real taxpayers are considered. It might well be

appropriate not to consider the ownership of a token

amount of stock if taxes could be avoided by such

ownership. Here the ownership of a token amount of

stock would increase taxes, and Richard Crain would

be most ill advised to acquire one share of stock in

Vogel Popcorn and so cause the 80-percent test to be

satisfied. Presumably, Mr. Crain is aware of the tax

laws and would only acquire stock in Vogel Popcorn if

he wished to make an investment of sufficient mag-

nitude to compensate for the loss of a surtax exemp-

tion.

VII

Normally courts are reluctant to invalidate a Treas-

ury Regulation and will do so only if the regulation

clearly constitutes an impermissible expansion or con-

traction of the provision of the Internal Revenue Code

that it interprets and applies. The courts recognize the

broad discretion of the Commissioner by regulation to

give detailed content to, fill in the details of, and ex-

plain and define the various provisions of, the Code.

See, e.g., Bingler v. Johnson, 394 U.S. 741, 749-50

(1969); United States v. Correll, 389 U.S. 299, 305-06

(1967). If the meaning or application of the Code provi-

sion is unclear, the regulation ordinarily carries the

day.

The present case, however, is inappropriate for the

application of that principle, upon which the dissenting

opinion in the Tax Court in Fairfax placed great

weight. 65 T.C. at 807-08. The sole question here is

whether the 80-percent provision requires that the five

or fewer persons involved each hold stock in all of the

brother-sister corporations. The answer to that ques-

34a

tion turns upon the statutory language, the legislative

history, and the basic purpose and design of the legis-

lation.

If section 1563(a)(2)(B) applies only when each of the

stockholders holds stock in each of the corporations,

then the regulation is-invalid as an impermissible alt-

eration of the statute. If, on the other hand, the 80-

percent provision applies even where each of the per-

sons does not hold stock in each of the corporations,

that conclusion flows from the statute itself, without

regard to the regulation. In this case, therefore, the

regulation either adds nothing not already in the stat-

ute or is inconsistent with the statute. Accordingly,

the regulation here is not entitled to the significance

we otherwise would give it.

Conclusion

Accordingly, we hold Treas. Reg. § 1.1563-1(a)(3)

invalid to the extent that it counts stock held by a

shareholder in only one corporation of the group of

corporations toward the 80-percent requirement in

section 1563(a)(2)(A). Plaintiff's cross-motion for sum-

mary judgment is granted, and defendant’s motion for

summary judgment is denied. The case is remanded to

the trial division for a determination under Rule 131(c)

of the amount of plaintiff's recovery.

FRIEDMAN, Chief Judge, concurring:

Although I fully agree with everything in the court’s

opinion, I add the following comments:

As noted, in the 1964 statute a “brother-sister con-

trolled group” was defined as two or more corporations

in which a single individual owned 80 percent or more

35a

of the stock. Under that definition no question could

arise whether the same individual had to be a stock-

holder in all of the brother-sister controlled corpora-

tions.

When Congress in 1969 expanded the definition of

brother-sister controlled corporations to cover situa-

tions where up to five people owned 80 percent of the

stock, it is reasonable to assume that it intended to

build on the previous law, changing only the number of

persons whose stock interests would be considered and

not the nature of those interests. If, when Congress

broadened the number of persons from one to five, it

also intended to make the definition applicable even

where not all of those additional stockholders held

interests in all of the corporations, presumably it

would have explicitly so indicated—either in the lan-

guage of the statute or in its legislative history. It did

neither. Not only does the legislative history fail so to

indicate, but, as shown, whatever history there is on

this issue points in the opposite direction.

The defendant argues, however, that in the 50-

percent provision Congress has manifested its inten-

tion to change the character of the interlocking inter-

ests. The argument is that since only the latter provi-

sion contains language specifically recognizing that the

five or fewer stockholders must have stock in all of the

companies, the implication is that the 80-percent pro-

vision, which does not contain similar language, does

not include that requirement.

The language of the 50-percent provision upon which

the defendant relies, however, does not justify that

inference. It states that in determining whether five or

fewer persons own 50 percent of the stock, the stock

ownership of each such person is to be considered

“only to the extent such stock ownership is identical

36a

with respect to each such corporation.” The purpose of

this requirement is to insure that the same five or

fewer individuals together control (by ownership of a

majority of the stock) each of the brother-sister corpo-

rations. The situation to which this provision is ad-

dressed is illustrated in footnote 3 of the court’s opin-

ion: one person owns 80 percent of the stock in corpo-

ration A and 20 percent of the stock in corporation B, a

second person owns 80 percent of corporation B and

and 20 percent of corporation A. Although the 80-

percent test would be met, there would be no common

control. The 50-percent test was necessary to prevent

the two corporations in that situation from being

treated as under common control.

The congressional requirement that each member of

the control group must have an interest in each of the

corporations, and that the members of the group to-

gether must have more than 50 percent of the stock of

each corporation, cannot fairly be read as indicating a

congressional intent to permit the 80-percent test to be

applied to different groups of five or fewer stockhold-

ers whose only common bond is that together the

stockholders in each group own as least 80 percent of

the stock in their particular corporation.

SMITH, Judge, dissenting:

That Treas. Reg. § 1.1563-1(a)(3)(1972) must be

sustained unless it is “unreasonable and plainly incon-

sistent with” I.R.C. § 1563(a)(2) is incontrovertible.'

1Commissioner v. South Texas Lumber Co., 333 U.S. 496,

501 (1948). Hence, the issue in this case is not whether the

majority’s interpretation of section 1563(a)(2) is more reason-

able than the interpretation espoused by the regulation; the

issue is whether the regulation is a reasonable interpretation of

the statute.

37a

The majority admits that the interpretation of section

1563(a)(2) espoused by the regulation “is not wholly

unreasonable as a construction of the words appearing

in” the statute. Moreover, the majority acknowledges

that “[t]he statute itself has been fairly criticized as

being open to at least four different constructions.”

(Emphasis added.) Hence, the majority appears to

concede that the regulation is not plainly inconsistent

with the text of the statute. The majority believes,

however, that the regulation is “clearly inconsistent

with the legislative history [of the statute] and unrea-

sonable when the purpose as well as the bare words, of

the statute are considered.”

The “legislative history” which the majority has in

mind consists not of congressional committee reports

but of the two explanations prepared by the Treasury

Department to accompany its 1969 proposal to Con-

gress that section 1563(a)(2) be amended.? The major-

ity derives its holding that the regulation is invalid al-

most exclusively from its reading of these explanation.

Hence, assuming that the Treasury explanations are

more than a possible admission against interest, and

can be regarded as persuasive evidence of what Con-

gress intended the amended section 1563(a)(2) to

mean, the test of whether the majority is correct can

be stated as follows: Is the regulation plainly incon-

sistent with the meaning of the statute as that mean-

ing has been clarified by the Treasury explanations?

? TECHNICAL EXPLANATION and GENERAL EXPLANATION OF

TREASURY TAX REFORM PROPOSALS, Hearings Before the

House Comm. on Ways and Means on Tax Reform, 91st Cong.,

Ist Sess. 5168-70, 5394-96 (1969). It is recalled that Congress

enacted without change, as part of the Tax Reform Act of 1969,

the amendment of section 1563(a)(2) proposed by the Treasury

Department.

38a

I have read the Treasury explanations carefully. I

cannot say that they are contradicted by the regula-

tion.* Indeed, they can reasonably be read as suppor-

tive of the regulation. That being the case, the issue is

not whether plaintiffs interpretation is as reasonable

as defendant’s; clearly that will be true in certain given

factual situations. The issue is whether plaintiff has

carried its heavy burden of showing the regulation to

be unreasonable and plainly inconsistent with the stat-

ute. This plaintiff cannot do or at least has not done.

The regulation interprets the 80-percent test in sec-

tion 1563(a)(2)(A) to mandate only that the same group

of five or fewer persons own 80 percent of the stock of

each corporation. In other words, the regulation inter-

prets the 80-percent test not to require that each

member of the group have a stock interest in each cor-

poration. Support for the regulation’s interpretation

of the 80-percent test can be found in both of the

Treasury explanations. The Technical Explanation

states:

Part (1) of this test [namely, section 1563(a)

(2)(A)] is satisfied if the group of five or fewer

persons as a whole owns at least 80 percent of the

voting stock or value of shares of each corpora-

tion, regardless of the size of the individual hold-

ings of each person. Thus, for example, part (1)

(but not necessarily part (2) (the 50-percent iden-

tical ownership requirement of section

1563(a)(2)(B]) is met whether one person owns 80

percent of the voting stock of each corporation,

four persons each own 20 percent of the voting

stock of each corporation,* * * [Emphasis added. ]

3 In Ailen Oil Co. v. Commissioner, 614 F.2d 336 (2d Cir.

1980), the second circuit reached the same conclusion.

* The regulation is consistent with the text of section

1563(a)(2)(A). Nothing in the text thereof can be read to require

39a

The General Explanation states:

Expanding the 80-percent ownership test from

one person to five will close the present opportu-

nity for easy avoidance of that 80-percent test.

However, adding the 50-percent identical owner-

ship test will insure that the new expanded defini-

tion is limited to cases where the brother-sister

corporations are, in fact, controlled by the group

of stockholders as one economic enterprise. [Em-

phasis added. ]

The quoted portions of the Treasury explanations

suggest a reading of the explanations which is both

reasonable and harmonious with the regulation. The

suggested reading is as follows. The amendment of

section 1563(a)(2) was intended, with respect to the

80-percent test, to expand the reference point of vot-

ing control or financial interest from the same single

person to the same group of five or fewer persons. As

long as the same group of five or fewer persons pos-

sessed 80 percent voting control of or financial interest

in each corporation, the 80-percent test would be

satisfied regardless of whether each member of the

group had an interest in each corporation. However, to

insure that there would be adequate common owner-

ship of all the corporations, the more than 50 percent

identical ownership requirement was added. Its effect

would be (a) to insure that one or more members of the

group would be shareholders of all the corporations

and (b) to insure that these members’ aggregate iden-

tical stock interests in all the corporations would rep-

resent greater than 50 percent voting control of or fi-

nancial interest in each of the corporations.5

that each member of the group have an interest in each corpora-

tion.

5 Greater than 50 percent voting control provides, generally

speaking, the power to determine everyday corporate activities.

40a

Under this reading of the Treasury explanations,

the 80-percent test and the more-than-50-percent test

each have an independent significance. The more-

than-50-percent test insures that everyday control of

all the corporations emanates from the same source,

i.e., from the same shareholder or shareholders who

have a greater than 50 percent stock interest in all the

corporations. The 80-percent test insures that, in those

instances where a greater interest, as, for example,

66% percent or 75 percent voting control or financial

interest, is needed, the more-than-50-percent share-

holder control group can obtain this additional neces-

sary voting control or financial interest without ex-

periencing the difficulty and attendant delay of dealing

with a large number of other sharehulders.®

Even though a reasonable person can read the

Treasury explanations to impute the just described

meaning to the 80-percent and more-than-50-percent

tests and even though this meaning is the meaning of

the tests which is espoused by the regulation, the

majority holds the regulation invalid. The majority in-

terprets section 1563(a)(2) to require that each share-

holder counted in applying the 80-percent test have a

stock interest in each corporation. According to the

majority, the stock interest is not required to be any

specific minimum amount. Hence, the ownership of 1

share in a corporation would, as to that corporation

and as to the shareholder owning that 1 share, satisfy

the requirement.

The majority’s requirement gives rise in the instant

case to a result which is inconsistent with the purpose

® The 80-percent test insures, in short, that all the corpora-

tions are closely held. Their being closely held is important be-

cause it facilitates their operation as a unified economic enter-

prise.

4la

underlying section 1563(a)(2). Arthur Vogel owned

during the tax years in question 77.49 percent of the

only class of stock of Vogel Fertilizer Company. Dur-

ing the same years, his stock in Vogel Popcorn Com-

pany provided him with 87.5 percent voting control of

that corporation. Hence, using his stock alone, he

could muster at least 75 percent voting control of both

corporations.? Possessing this voting control, he had

the power to direct the operations of both corporations

and to cause the corporations to operate as a unified

economic enterprise. Yet the majority holds that the

two corporations were not brother-sister and, hence,

were each entitled to a full surtax exemption.

The majority’s requirement will give rise in other

situations to equally unreasonable and inconsistent re-

sults. Consider, for example, the situation in which X

owns 100 percent of the stock of corporation A and

79.9 percent of the only class of stock of corporation B.

The remaining 20.1 percent of the stock of B is owned

by Y. Under the majority’s interpretation of section

1563(a)(2), A and B are not brother-sister corporations

because the 80-percent test is failed. However, if this

example is changed merely by having X own all the

stock of A except 1 share and having Y own this 1

share, A and B are brother-sister corporations even

under the majority’s interpretation of section

1563(a)(2).

There is absolutely no rational basis for differ-

entiating the treatment to be accorded to A and B in

7 If he were to need 80 percent voting control of Vogel Fer-

tilizer Company, he could negotiate with a single shareholder,

Richard Crain, for the additional necessary voting power.

® Yet, using merely his stock, X has 75 percent voting control

of both corporations and, hence, can cause the corporations to

operate as a unified economic enterprise.

42a

the second example from the treatment to be accorded

to them in the first example.® Yet this is precisely

what the majority’s interpretation does. I realize, of

course, that section 1563(a)(2) is a mechanical test, but

unfortunately the proof does not exist that Congress

intended the mechanical test which the majority has in

mind and which leads to the unreasonable results just

described.

Therefore, I respectfully dissent.

® In both examples, the fact that A and B can be operated as a

single economic enterprise is attributable to the stockholdings of

X, not to those of Y. Thus, Y’s 1 share in A in the second exam-

ple should not be significant.

43a

APPENDIX B

In The United States Court Of Claims

No. 69-78

VOGEL FERTILIZER COMPANY

Uv.

THE UNITED STATES

[Filed Oct. 3, 1980]

Before FRIEDMAN, Chief Judge, BENNETT and

SMITH, Judges.

ORDER

This case comes before the court on defendant’s mo-

tion, filed September 12, 1980, for rehearing en banc

pursuant to Rules 7 (d) and 151 (b) with reference to

the decision entered herein on August 13, 1980. Upon

consideration thereof, together with the response in

opposition thereto, without oral argument, by the six

active Judges of the court (Judge Davis not par-

ticipating therein) as to the suggestion for reharing en

banc under Rule 7 (d), which suggestion is denied, and

further having been so considered by the panel listed

above as to the motion for rehearing under Rule 151

(b),

IT IS ORDERED that defendant’s said motion for

rehearing be and the same is denied.

BY THE COURT

DANIEL M. FRIEDMAN

Chief Judge

44a

APPENDIX C

In the United States Court of Claims

No. 69-78

VOGEL FERTILIZER COMPANY

Vv.

THE UNITED STATES

[Filed Nov. 28, 1980]

ORDER

On August 13, 1980, the court issued an opinion

holding that the plaintiff was entitled to recover and

entered judgment to that effect. Determination of the

amount of recovery was reserved pending further pro-

ceedings under Rule 131(c).

On November 24, 1980, the trial judge of this court

filed a memorandum report, herein adopted by the

court, recommending that, in accordance with the

opinion of the court and a stipulation of the parties,

judgment be entered for plaintiff for the successive tax

vears ending November 30, 1973, 1974, and 1975, in

the respective amounts of $4,000, $4,834, and $12,905,

together with interest as allowed by law.

It Is THEREFORE ORDERED that judgment be and

the same is entered for the plaintiff, for the tax years

ending November 30, 1973, 1974, and 1975, the respec-

tive sums of four thousand dollars ($4,000); four

thousand eight hundred thirty-four dollars ($4,834);

and twelve thousand nine hundred five dollars

($12,905), together with interest on these amounts as

allowed by law.

BY THE COURT

s

DANIEL M. FRIEDMAN

Chief Juda

45a

APPENDIX D

Internal Revenue Code of 1954 (26 U.S.C.):

SEC. 11 [as amended by Revenue Act of 1964,

Pub. L. No. 88-272, Section 121, 78 Stat.

25, and Tax Reform Act of 1969, Pub. L.

No. 91-172, Section 401(b)(2)(B), 83 Stat.

602]. TAX IMPOSED.

*# * * * *

(d) Surtax Exemption —For purposes of this

subtitle, the surtax exemption for any taxable

year is * * * , except that, with respect to a cor-

poration to which section 1561 or 1564 (relating to

surtax exemptions in case of certain controlled

corporations) applies for the taxable year, the sur-

tax exemption for the taxable year is the amount

determined under such section.

e Bo mK OK a

SEC. 1561 [as added by Revenue Act of 1964,

Pub. L. No. 88-272, Section 235 (a), 78

Stat. 116, and amended by Tax Reform Act

of 1969, Pub. L. No. 91-172, Section 401

(a)(1), 83 Stat. 599]. LIMITATIONS ON

CERTAIN MULTIPLE TAX BENEFITS

IN THE CASE OF CERTAIN CON-

TROLLED CORPORATIONS.

(a) General Rule. —The component members of

a controlled group of corporations on a December

31 shall, for their taxable years which include such

December 31, be limited for purposes of this subti-

tle to—

(1) one * * * surtax exemption under sec-

tion 11 (d),

46a

(2) one $100,000 amount for purposes of

computing the accumulated earnings credit

under section 535 (c) (2) and (3), and

(3) one $25,000 amount for purposes of

computing the limitation on the small business

deduction of life insurance companies under

sections 804 (a) (4) and 809 (d) (10).

The amount specified in paragraph (1) shall be di-

vided equally among the component members of

such group on such December 31 unless all of 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 providing for an unequal allocation of such

amount. The amounts specified in paragraphs (2)

and (3) shall be divided equally among the compo-

nent members of such group on such December 31

unless the Secretary or his delegate prescribes

regulations permitting an unequal allocation of

such amounts.

* ae *% * *

SEC. 1563 [as added by Revenue Act of 1964,

Pub. L. No. 88-272, Section 235 (a), 78

Stat. 120, and amended by Tax Reform Act

of 1969, Pub. L. No. 91-172, Section 401

(c), 83 Stat. 602}. DEFINITIONS AND

SPECIAL RULES

(a) Controlled Group of Corporations. — For

purposes of this part, the term “controlled group

of corporations” means any group of—

* * * * *

47a

(2) Brother-Sister-Controlled Group.—Two

or more corporations if 5 or fewer persons

who are individuals, estates, or trusts own

(within the meaning of subsection (d)(2)) stock

possessing —

(A) at least 80 percent of the total com-

bined 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

the stock of each corporation, and

(B) 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 of each corporation, tak-

ing into account the stock ownership of

each such person only to the extent such

stock ownership is identical with respect

to each such corporation.

* *# * # +

Treasury Regulations on Income Tax (26 C.F.R.):

§ 1.1563-1 Definition of controlled group of cor-

porations and component members.

(a) Controlled group of corporations.—(Q) In

general. For purposes of sections 1561 through

1563 and the regulations thereunder, the term

“controlled group of corporations” means any

group of corporations which is either a “parent-

subsidiary controlled group” (as defined in sub-

paragraph (2) of this paragraph), a “brother-sister

controlled group” (as defined in subparagraph 3 of

this paragraph, a “combined group” (as defined in

subparagraph (4) of this paragraph), or an “insur-

ance group” (as defined in subparagraph (5) of this

48a

paragraph). For the exclusion of certain stock for

purposes of applying the definitions contained in

this paragraph, see section 1563 (c) and

§ 1.1563-2.

a 8 He a 4

(3) Brother-sister controlled group. (i) The

term “brother-sister controlled group” means two

or more corporations if the same five or fewer

persons who are individuals, estates, or trusts

own (directly and with the application of the rules

contained in paragraph (b) of § 1.1563-3)

singly or in combination, stock possessing—

He eo 4E 4 4