dissenting: With respect to the first issue, the problem presented for our decision is whether certain obligations denoted as debt, in fact, represent an equity interest and, if so, whether said equity interest results in the issuing corporation having more than one class of stock. I would give an affirmative answer to both questions and hence nullify the corporation’s election to be taxed as a subchapter S corporation. Sec. 1371 (a) (4).
It seems evident, in weighing the indicia of debt and equity of the obligations, that the latter predominate: (1) The notes were not interest bearing; (2) the debt-equity ratio was 1080:1 (without the inclusion of indebtedness owed to outsiders); (3) an outside investor would not have made advances under the same terms as those accepted by the petitioner; (4) repayment of principal was to be made out of earnings only;1 and (5) as was said in 2554-58 Creston Corp., 40 T.C. 932, 935 (1963) : “A stockholder [in contrast to a creditor] * * * intends to make an investment and take the risks of the venture.”
Since I do not understand the majority seriously to contest the fact that for all other purposes of the Code the obligations at issue would be deemed equity, there is no need to belabor this conclusion.
What is worth emphasizing is the fact that the majority would apply a special rule to the subchapter S situation. This I would not do and, in so holding, am reminded of this Court’s opinion in Edwin C. Hollenbeck, 50 T.C. 740, 747 (1968), wherein we said:
The debt-equity inquiry is essentially the same in all areas. Tlie precise determination to be made — is there more than one class of stock, are notes bona fide indebtedness, etc., varies from case to case, but the basic standards remain the same in all cases where the respondent seeks to reclassify debt or equity. * * * [Emphasis supplied.]
The above quotation is singularly appropriate here for it was made in the context of a determination under section 1244 of the Code.
Furthermore, we said in another case involving section 1244, Wesley H. Morgan, 46 T.C. 878, 889 (1966):
but section 1244 being designed to provide a tax benefit to a rather limited group of taxpayers as it is, we feel that qualification for those benefits requires strict compliance with the requirements of the law and the regulations promulgated pursuant to the specific instructions therefor included in section 1244(e). [Emphasis supplied.]
The common goals of section 1244 and subchapter S make the above cases particularly pertinent. Section 1244 and subchapter S were both enacted as part of Pub. L. 85-866 which was approved on September 2, 1958. Section 1244 is entitled “Losses on Small Business Stock” and subchapter S is entitled “Election of Certain Small Business Corporations as to Taxable Status.” There is no doubt that the two were enacted for largely overlapping purposes, namely, to aid small business.
Since it is my view, in concert with the foregoing authorities, that the obligations in issue represent an equity interest, then the question must be faced as to whether said equity interest results in the corporation having more than one class of stock.
Income Tax Begs, section 1.1371-1 (g) provides in part as follows:
(g) Glasses of stock. A corporation having more than one class of stock does not qualify as a small business corporation. * * * Obligations which purport to represent debt but which actually represent equity capital will generally constitute a second class of stock. However, if such purported debt obligations are owned solely by the owners of the nominal stock of the corporation in substantially the same proportion as they own such nominal stock, such purported debt obligations will be treated as contributions to capital rather than a second class of stock. * * * [Emphasis supplied.]
The above regulation is consistent with our comment in W. C. Gamman, 46 T.C. 1, 9 (1966) :
we must also look to the realities of the situation to determine whether the instruments, even though they might represent equity capital, actually gave the holders thereof any rights and interests in the corporation different from that owned by the holders of the nominal stoek. We do not think they did under the circumstances here present, because the advances were made and the notes were held by the stockholders in direct proportion to their stockholdings. * * * [Emphasis supplied.]
It will be recalled that the so-called debt obligations were held by the shareholders in disproportionate amounts to their stockholdings, a fact of which petitioners make much in support of their debt argument. However, once it is decided that the obligations in fact represent an equity interest, petitioners are hoisted on their own petard. It seems indisputable that, upon liquidation, distribution of the assets would first have to be made with respect to the so-called debt obligations with any excess thereof being distributed according to the nominal stockholdings. Further, since the face amount of the alleged indebtedness is only payable out of earnings or profits, the holders of the alleged indebtedness are also entitled to a priority in the profits. This being so, the alleged debt instruments must represent at least a second class of stock. The general rule set forth in the regulations quoted above seems clearly applicable.
In reaching an opposite conclusion the majority necessarily invalidates the regulation quoted above. It seems to me that in so doing the majority is ignoring the following oft-quoted language of the Supreme Court in Commissioner v. South Texas Co., 333 U.S. 496, 501 (1948):
This Court has many times declared that Treasury regulations must be sustained unless unreasonable and plainly inconsistent with the revenue statutes and that they constitute contemporaneous constructions by those charged with administration of these statutes which should not be overruled except for weighty reasons. ⅜ * *
See also Bingler v. Johnson, 394 U.S. 741, 749-750; Fawcus Machine Co. v. United States, 282 U.S. 375, 378; Boske v. Comingore, 177 U.S. 459, 470; Brewster v. Gage, 280 U.S. 327, 336; Textile Mills Corp. v. Commissioner, 314 U.S. 326, 336-339; Colgate Co. v. United States, 320 U.S. 422, 426; William F. Sanford, 50 T.C. 823, 832, affd. 412 F.2d 201 (C.A. 2), certiorari denied 396 U.S. 841. I fail to see how the regulations can be deemed “unreasonable and plainly inconsistent” with the applicable statute.
The majority’s case rests primarily on the view that Congress had the more traditional concepts of stock in mind when it prohibited a sub-chapter S corporation from having more than one class of stock. The difficulty with this view is that it is impossible to give it any direct support from the subchapter’s legislative history. Hence, it rests on speculation which may be reasonable or unreasonable. However, even reasonable speculation, by any other name, remains speculation. I do not feel that we are justified in invalidating the Commissioner’s regulation based upon speculation, particularly in light of the Supreme Court’s opinions relating to the sanctity of regulations.
The majority cites section 1376 (b)2 as proof of the fact that sub-chapter S contemplates that a shareholder may also make loans to his corporation. The short answer to that is, of course. But, that fact is of no assistance to us here in determining whether the particular obligation at issue represents a debt or equity interest.
The significance of section 1376 (b) is limited to the fact that the pass-through provisions of subchapter S obviously necessitated a further provision which would provide the manner in which the amounts passed, through should be treated on each shareholder’s individual income tax return. This significance or fact is, however, irrelevant to the problem at hand.
For all of the foregoing reasons I respectfully dissent from the majority opinion.
TietjeNs, Naum, AtkiNS, Forkestek, and SimpsoN, //., agree with this dissent.Having heard all of the testimony and having examined the documentary evidence, It would be my finding that the notes in question were to he repaid from only earnings or profits on a monthly basis over the life of the lease. Compare the opinion of the majority, supra at 229. Since the business was that of operating a driving range and small golf course at a particular location, presumably the business would be terminated upon expiration of the lease.
With respect to the majority’s comment that no foreseeable tax benefit results from the application of section 1376, see R. Anthoine, “Federal Tax Legislation of 1958: The Corporate Election and Collapsible Amendment,” 58 Colum. L. Rev. 1146, 1161-1162.