*154 Decisions will be entered under Rule 155.
An incorporator irrevocably contracted, as part of the incorporation transaction, to sell to a third party 50 percent of the stock the incorporator received in exchange for his transfer to the corporation of all its property. Held, the incorporator did not "control," within the meaning of sec. 368(c), I.R.C. 1954, the requisite percentage of stock immediately after the exchange for the incorporation to be a tax-free exchange under sec. 351(a), I.R.C. 1954.
*1025 Respondent determined deficiencies in petitioners' income taxes as follows:
| TYE June 30 -- | Amount |
| 1965 | $ 9,192.50 |
| 1967 | 97,022.41 |
| 1968 | 615,494.35 |
| 1969 | 125,706.11 |
| 847,415.37 |
The cases were consolidated for trial, brief, and opinion. The *156 only issue for decision is whether a certain corporate formation was nontaxable under section 351(a). 1 This depends solely upon whether the primary incorporator had "control" of the requisite percentage of stock immediately after the exchange within the meaning of section 368(c).
FINDINGS OF FACT
Petitioners are the Intermountain Co., previously known as Intermountain Lumber Co., and its affiliates (hereinafter collectively referred to as Intermountain or petitioner). *1026 Petitioner filed consolidated income tax returns for fiscal years ending June 30, 1967 and 1968, with the District Director of Internal Revenue, Helena, Mont., and filed such returns for fiscal years ending June 30, 1969 and 1970, with the service center at Ogden, Utah. Intermountain Lumber Co. and Tree Farmers, Inc., each filed a separate income tax return for the fiscal year ending June 30, 1965, with the District Director of Internal Revenue, Helena, Mont.
Intermountain's*157 principal place of business during the years in controversy and until 1973, when it merged with Hoerner Waldorf Corp., was located in Missoula, Mont. Hoerner Waldorf Corp.'s principal place of business is located in St. Paul, Minn.
From 1948 until March of 1964, Mr. Dee Shook (hereinafter Shook) individually owned a sawmill at Conner, Mont. During that time Mr. Milo Wilson (hereinafter Wilson) had logs processed there into rough lumber for a fee. Shook owned the remaining logs processed at the sawmill, which constituted about half of all the logs processed there.
From 1954 until March of 1964, rough lumber from the sawmill was processed into finished lumber at a separate finishing plant which Shook and Wilson owned as equal shareholders.
In March of 1964, fire damaged the sawmill. Shook and Wilson wanted to replace it with a larger one so that the finishing plant could operate at full capacity. Shook was financially unable, however, to do so. He accordingly induced Wilson to personally coguarantee a $ 200,000 loan to provide financing. In return, Wilson insisted upon an equal voice in rebuilding the sawmill and upon an opportunity to become an equal shareholder with Shook in*158 the new sawmill.
On May 28, 1964, Shook, Wilson, and two other individuals, all acting as incorporators, executed articles of incorporation for S & W Sawmill, Inc. (hereinafter S & W). The corporate name, S & W, was derived from the names Shook and Wilson.
Minutes of the first stockholders meeting on July 7, 1964, stated in part that "Mr. Shook informed the meeting that a separate agreement was being prepared between he and Mr. Wilson providing for the sale of one-half of his stock to Mr. Wilson." Also on that date, 1 share was issued to each of the other two incorporators.
*1027 Shook executed a bill of sale for his sawmill equipment and deeded his sawmill site to S & W on July 15 and 16, 1964, respectively. In exchange, Shook received 364 S & W shares on July 15, 1964. Shook and Wilson also received 1 share each as incorporators. The 364 shares and the 4 incorporation shares constituted all outstanding capital stock of S & W on July 15, 1964.
Also on that date, minutes of a special meeting stated in part that "The President, Dee Shook, announced that he and Milo E. Wilson had entered into an agreement whereby Mr. Wilson was to purchase 182 shares of Mr. Shook's stock." *159 That agreement, dated July 15, 1964, and entitled "Agreement for Sale and Purchase of Stock" (hereinafter agreement for sale) provided in part as follows:
it is the intention of all the incorporators that Shook and Wilson are to be the owners of the majority of the stock of said corporation;
* * *
And Whereas, it is the desire and plan of both parties hereto that a sufficient number of shares of stock be sold by Shook to Wilson so that eventually the stock ownership would be equal;
And Whereas, the purchase of said shares of stock by Wilson from Shook is to be financed by a series of payments;
It Is Therefore Agreed, That for and in consideration of the covenants to be performed and the payments to be made as hereinafter set forth, the sale and purchase of said stock is to be as follows:
1. Dee Shook is to sell to Milo E. Wilson 182 shares of stock in S & W SAWMILL, INC. for the agreed price of $ 500.00 per share.
2. Wilson is to pay Shook for said stock as follows:
Interest on unpaid balance due is to be paid annually at 3% per annum from August 1, 1964 to July 31, 1968.
Interest on unpaid balance due is to be paid annually at 4% per annum from August 1, 1968, to July 31, 1970.
*160 Interest on unpaid balance due is to be paid annually at 5% per annum from August 1, 1970, until entire balance is paid in full.
In addition to interest $ 6,000.00 on the principal is due November 1, 1969.
In addition to interest, $ 15,000.00 on the principal is due annually, beginning Nov. 1 1970, and continuing until the entire purchase price is paid. The payments may be made in advance at any time and in any amount.
3. As each principal payment is made the proportionate number of shares of stock are to be transferred on the corporate records and delivered to Wilson.
4. In the event any payment of principal is not made on the due date, or within 90 days thereafter, Wilson thereby forfeits and loses his right to purchase that proportionate number of shares of stock; Provided However, That nevertheless any subsequent, or later payment of principal may be made according to the above payment schedule, and thereupon Wilson will be entitled *1028 to the proportionate number of shares of stock as represented by such payment. Interest payment must always be kept current before any delivery of stock is to be made resulting from a payment of principal.
5. For the period of one year*161 from the date hereof Wilson is to have the full power to vote all of the stock herein agreed to be sold to him by Shook. Thereafter the voting rights of the stock is [sic] to be determined by the stock ownership records of the corporation.
On July 15, 1964, Shook also executed an irrevocable proxy granting to Wilson voting rights in 182 shares until September 10, 1965. Two other documents also executed on that date related to share ownership between Shook and Wilson. One, entitled "S & W Sawmill, Inc. Stockholders' Restrictive Agreement," provided in part as follows:
such provisions [against stock transferability] do not apply to the presently existing Agreement for Sale and Purchase of Stock entered into between Dee Shook and Milo E. Wilson, dated the 15th day of July, 1964, and providing for the purchase by Milo E. Wilson of 182 shares of stock in the company.
It Is The Intention and Purpose of the incorporators that the majority of the ownership of the corporation is to be held by Dee Shook and Milo E. Wilson on an equal share basis when Milo E. Wilson completes the purchase of the stock certificates which are the subject of said purchase agreement.
The other, entitled *162 "Option To Buy Stock Forming Part Of Stockholders' Restrictive Agreement," provided in part that "the ownership of shares in S & W Sawmill, Inc., as the same now stands, to-wit: Dee Shook 365 shares, Milo E. Wilson 1 shares [sic] * * * shall continue."
In connection with the agreement for sale, Shook deposited stock certificates representing 182 shares with an escrow agent on July 17, 1964.
On August 19, 1964, S & W borrowed $ 200,000, in part upon the personal guarantees of Shook, Wilson, and their wives. The loan agreement referred to Shook and Wilson as "the principal officers and stockholders" of S & W. S & W agreed therein to insure the lives of Shook and Wilson for $ 100,000 each.
On March 19, 1965, Shook and Wilson agreed to purchase additional shares from S & W in an agreement which provided in part as follows:
Witnesseth
That Whereas, Prior to this date stock in the Corporation had been purchased by the Stockholders and a number of said shares are subject to an escrow agreement at Citizens State Bank, Hamilton, Montana, providing for the purchase by Milo E. Wilson of a certain number of shares of such stock from *1029 Dee Shook; that the purpose of said escrow arrangement*163 is to provide for an equal ownership of the stock of said Corporation by Milo E. Wilson and Dee Shook;
That Whereas, it is the desire of all parties at this time that each of the Stockholders purchase an additional One Hundred Shares of Stock at Five Hundred Dollars ($ 500.00) per share, and payment for the same having been made to the Corporation;
Now, Therefore, for and in consideration of the mutual benefits to be derived by all parties hereto, It Is Hereby Agreed as Follows:
That each of the Stockholders are to purchase One Hundred Shares of stock of the Corporation at Five Hundred Dollars ($ 500.00) per share;
That, as well as with other stock purchases, it is the desire of the Stockholders that stock ownership held by Dee Shook and Milo E. Wilson are to remain equal; that any stock purchased or issued as a result of this agreement is to be regulated accordingly * * *
Wilson made all payments in 1965 and 1966 specified in the agreement for sale and accordingly claimed interest deductions on his Federal income tax returns for those years.
On July 1, 1967, before principal payments were required by the agreement for sale, petitioner purchased all outstanding S & W stock. In anticipation*164 of this purchase, a letter to petitioner dated May 3, 1967, and signed by Shook and Wilson stated as follows:
To have it in the record, Milo E. Wilson owes Dee Shook $ 91,000 for 182 shares of S & W Sawmill Inc. stock in escrow at Citizens State Bank Hamilton Montana. On the purchase contract, Intermountain Lumber Co. would pay Dee Shook $ 91,000.00 more over the 14 yrs. than Milo E. Wilson.
OPINION
Section 351 provides, in part, that no gain shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control of the corporation. 2*165 "Control" is defined for this purpose in section 368(c) as ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation. 3
*1030 In this case, respondent is in the unusual posture of arguing that a transfer to a corporation in return for stock was nontaxable under section 351, and Intermountain is in the equally unusual posture of arguing that the transfer was taxable because section 351 was inapplicable. The explanation is simply that Intermountain purchased all stock of the corporation, S & W, from its incorporators, and that Intermountain and S & W have filed consolidated income tax returns for years in issue. Accordingly, if section 351 was applicable to the incorporators when S & W was formed, S & W and Intermountain must depreciate the assets of S & W on their consolidated returns on the incorporators' basis. Sec. 362(a). *166 4 If section 351 was inapplicable, and the transfer of assets to S & W was accordingly to be treated as a sale, S & W and Intermountain could base depreciation on those returns on the fair market value of those assets at the time of incorporation, which was higher than the incorporators' cost and which would accordingly provide larger depreciation deductions. 5Secs. 167(g), 1011, and 1012. 6
*167 Petitioner thus maintains that the transfer to S & W of all of S & W's property at the time of incorporation by the primary incorporator, one Dee Shook, was a taxable sale. It asserts that *1031 section 351 was inapplicable because an agreement for sale required Shook, as part of the incorporation transaction, to sell almost half of the S & W shares outstanding to one Milo Wilson over a period of time, thereby depriving Shook of the requisite percentage of stock necessary for "control" of S & W immediately after the exchange.
Respondent, on the other hand, maintains that the agreement between Shook and Wilson did not deprive Shook of ownership of the shares immediately after the exchange, as the stock purchase agreement merely gave Wilson an option to purchase the shares. Shook accordingly was in "control" of the corporation and the exchange was thus nontaxable under section 351.
Respondent has abandoned on brief his contention that Wilson was a transferor of property and therefore a person to also be counted for purposes of control under section 351. Respondent is correct in doing so, since Wilson did not transfer any property to S & W upon its initial formation in July of*168 1964. Wilson's agreement to transfer cash for corporate stock in March of 1965 cannot be considered part of the same transaction.
Since Wilson was not a transferor of property and therefore cannot be counted for control under section 351, William A. James, 53 T.C. 63">53 T.C. 63, 69 (1969), we must determine if Shook alone owned the requisite percentage of shares for control. This determination depends upon whether, under all facts and circumstances surrounding the agreement for sale of 182 shares between Shook and Wilson, ownership of those shares was in Shook or Wilson.
A determination of "ownership," as that term is used in section 368(c) and for purposes of control under section 351, depends upon the obligations and freedom of action of the transferee with respect to the stock when he acquired it from the corporation. Such traditional ownership attributes as legal title, voting rights, and possession of stock certificates are not conclusive. If the transferee, as part of the transaction by which the shares were acquired, has irrevocably foregone or relinquished at that time the legal right to determine whether to keep the shares, ownership in such shares*169 is lacking for purposes of section 351. By contrast, if there are no restrictions upon freedom of action at the time he acquired the shares, it is immaterial how soon thereafter the transferee elects to dispose of his stock or whether such disposition is in accord with a preconceived plan not amounting *1032 to a binding obligation. Stephens, Inc. v. United States, 464 F.2d 53">464 F. 2d 53, 66-67 (8th Cir. 1972), cert. denied 409 U.S. 1118">409 U.S. 1118 (1973); Barker v. United States, 223">200 F. 2d 223, 229 (9th Cir. 1952); S. Klein on the Square, Inc., 14 T.C. 786">14 T.C. 786, 789-790 (1950), affd. 188 F. 2d 127, 129 (2d Cir. 1951), cert. denied 342 U.S. 824">342 U.S. 824 (1951); American Bantam Car Co., 11 T.C. 397">11 T.C. 397, 404-408 (1948), affd. per curiam 177 F. 2d 513 (3d Cir. 1949), cert. denied 339 U.S. 920">339 U.S. 920 (1950); Wilgard Realty Co., 43 B.T.A. 557">43 B.T.A. 557, 561 (1941), affd. 127 F. 2d 514, 516 (2d Cir. 1942), cert. denied 317 U.S. 655">317 U.S. 655 (1942);*170 Schumacher Wall Board Corp., 33 B.T.A. 1211">33 B.T.A. 1211, 1214 (1936), affd. 93 F. 2d 79, 81 (9th Cir. 1937); Wilbur F. Burns, 30 B.T.A. 163">30 B.T.A. 163, 171-172 (1934), affd. sub nom. Bassick v. Commissioner, 85 F. 2d 8, 10 (2d Cir. 1936), cert. denied 299 U.S. 592">299 U.S. 592 (1936); Federal Grain Corp., 18 B.T.A. 242">18 B.T.A. 242, 248-249 (1929).
After considering the entire record, we have concluded that Shook and Wilson intended to consummate a sale of the S & W stock, that they never doubted that the sale would be completed, that the sale was an integral part of the incorporation transaction, and that they considered themselves to be coowners of S & W upon execution of the stock purchase agreement in 1964. These conclusions are supported by minutes of the first stockholders meeting on July 7, 1964, at which Shook characterized the agreement for sale as a "sale"; minutes of a special meeting on July 15, 1964, at which Shook stated Wilson was to "purchase" half of Shook's stock; the "Agreement for Sale and Purchase of Stock" itself, dated July 15, 1964, *171 which is drawn as an installment sale and which provides for payment of interest on unpaid principal; Wilson's deduction of interest expenses in connection with the agreement for sale, which would be inconsistent with an option; the S & W loan agreement, in which Shook and Wilson held themselves out as the "principal stockholders" of S & W and in which S & W covenanted to equally insure Shook and Wilson for $ 100,000; the March 1965 stock purchase agreement with S & W, which indicated that Shook and Wilson "are to remain equal" (emphasis added) shareholders in S & W; the letter of May 1967 from Shook and Wilson to Intermountain, which indicated that Wilson owed Shook the principal balance due on the shares as an unpaid obligation; and all surrounding facts and circumstances leading to corporate formation and execution of the above documents. Inconsistent and self-serving testimony of Shook and Wilson *1033 regarding their intent and understanding of the documents in evidence is unpersuasive in view of the record as a whole to alter interpretation of the transaction as a sale of stock by Shook to Wilson.
We accordingly cannot accept respondent's contention that the substance*172 varied from the form of this transaction, which was, of course, labeled a "sale." The parties executed an "option" agreement on the same day that the "agreement for sale" was executed, and we have no doubt that they could and indeed did correctly distinguish between a sale and an option.
The agreement for sale's forfeiture clause, which provided that Wilson forfeited the right to purchase a proportionate number of shares for which timely principal payments were not made, did not convert it into an option agreement. Furthermore, the agreement for sale made no provision for forgiving interest payments on the remaining principal due should principal payments not be made on earlier dates; indeed, it specifically provided that "Interest payment must always be kept current before any delivery of stock is to be made resulting from a payment of principal."
We thus believe that Shook, as part of the same transaction by which the shares were acquired (indeed, the agreement for sale was executed before the sawmill was deeded to S & W), had relinquished when he acquired those shares the legal right to determine whether to keep them. Shook was under an obligation, upon receipt of the shares, *173 to transfer the stock as he received Wilson's principal payments. Cf. S. Klein on the Square, Inc., 14 T.C. 786">14 T.C. 786, 790 (1950), affd. 188 F. 2d 127 (2d Cir. 1951), cert. denied 342 U.S. 824">342 U.S. 824 (1951). We note also that the agreement for sale gave Wilson the right to prepay principal and receive all 182 shares at any time in advance. Shook therefore did not own, within the meaning of section 368(c), the requisite percentage of stock immediately after the exchange to control the corporation as required for nontaxable treatment under section 351.
We note also that the basic premise of section 351 is to avoid recognition of gain or loss resulting from transfer of property to a corporation which works a change of form only. See Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 3.01, p. 3-4 (3d ed. 1971). Accordingly, if the transferor sells his stock as part of the same transaction, the transaction is taxable because there has been more than a mere *1034 change in form. See, e.g., Wilbur F. Burns, 30 B.T.A. 163">30 B.T.A. 163 (1934), affd. sub nom. Bassick v. Commissioner, 85 F. 2d 8 (2d Cir. 1936),*174 cert. denied 299 U.S. 592">299 U.S. 592 (1936). In this case, the transferor agreed to sell and did sell 50 percent of the stock to be received, placed the certificates in the possession of an escrow agent, and granted a binding proxy to the purchaser to vote the stock being sold. Far more than a mere change in form was effected.
We accordingly hold for petitioner. Because of concessions of other issues,
Decisions will be entered under Rule 155.
Footnotes
1. Statutory references are to the Internal Revenue Code of 1954.↩
2. SEC. 351. TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.
(a) General Rule. -- No gain or loss shall be recognized if property is transferred to a corporation * * * by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)↩) of the corporation. * * *
3. SEC. 368. DEFINITIONS RELATING TO CORPORATE REORGANIZATIONS.
(c) Control. -- For purposes of * * * this part [including sec. 351↩], the term "control" means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.
4. SEC. 362. BASIS TO CORPORATIONS.
(a) Property Acquired by Issuance of Stock or as Paid-In Surplus. -- If property was acquired on or after June 22, 1954, by a corporation
(1) in connection with a transaction to which section 351 (relating to transfer of property to corporation controlled by transferor) applies, or
(2) as paid-in surplus or as a contribution to capital,↩
then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain recognized to the transferor on such transfer.5. Petitioner would also benefit from increased net operating loss deductions and increased investment credits.↩
6. SEC. 167. DEPRECIATION.
(g) Basis for Depreciation. -- The basis on which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 1011 for the purpose of determining the gain on the sale or other disposition of such property.
SEC. 1011. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis (determined under section 1012 or other applicable sections of this subchapter * * *
SEC. 1012. BASIS OF PROPERTY -- COST.
The basis of property shall be the cost of such property * * *↩