Lumbard, Chief Judge, Friendly, Circuit Judge, and Judd, District Judge.*fn*
This petition to review a decision of the Tax Court raises a close question concerning the interpretation of § 1244 of the Internal Revenue Code of 1954, which provides that up to certain maxima, a loss on "§ 1244 stock" is deductible as an ordinary rather than a capital loss. The sole issue is whether certain of the taxpayers' stock satisfied the requirements of § 1244(c)*fn1 and the Commissioner's regulations thereunder.*fn2
On October 25, 1960 the taxpayer, Pierre Godart, TSM Corporation of which he was president and sole stockholder, and S. Stroock & Co., Inc. entered into a Lease and License Agreement. This provided that they would organize a New York company, with a certificate of incorporation substantially in a form attached, and would cause it "on or prior to the date of closing" to issue 1250 shares for $125,000 to Stroock and 2500 shares for $250,000 to Godart and TSM, which the parties agreed to purchase. No stock other than three directors' qualifying shares was to be issued prior to the closing date, but the Agreement was silent about issuances on that date. The new company was to take over the woolen weaving business of Stroock and to sell notes in specified amounts to Stroock and to Rusch & Co., a commercial banker and factor. Stroock agreed to proceed as promptly as practicable to hold a stockholders' meeting to obtain all needed authorization. The closing was to "take place as soon as practicable, but in any event not later than the first day of the first month after the approval by the stockholders of Stroock of the transactions contemplated." At the closing the notes and any of the 3750 shares of stock which remained unissued were to be issued and paid for, and certain other transactions were to be carried out.
The parties proceeded to incorporate The French-American-British Woolens Corporation (FAB) with authorized capital stock of $1,000,000 consisting of 10,000 shares of common stock of a par value of $100. On December 22, 1960, the Stroock stockholders granted approval. Eight days later the directors of FAB held their first meeting. Resolutions were adopted authorizing the issuance of 1250 shares of common stock to Stroock, 1500 to TSM, and 1000 to Godart, at $100 per share; the officers were authorized and directed to issue the stock on the acceptance of such offers and payment in cash. The chairman presented to the meeting the Lease and License Agreement together with all its exhibits and schedules. The directors then approved various transactions therein contemplated, including the Main Lease from Stroock, a Store Lease, a License Agreement, an assumption of the Stroock Pension Plan and an implementing Trust Agreement so that its benefits would continue to be available to employees of Stroock when they became employees of FAB or its affiliates, and an assumption of a collective bargaining agreement between Stroock and the Textile Workers Union and a related pension agreement. After the FAB directors' meeting ended, the closing under the Lease and License Agreement began. It was completed early in the afternoon of December 30, 1960.
FAB sustained heavy losses in 1961 and still heavier ones in the early months of 1962, and Godart's stock concededly became worthless during the latter year. The Godarts' joint return for 1962 showed this loss as a long-term capital loss, but after the Commissioner made other adjustments and determined a deficiency, they contended that the stock was § 1244 stock and that they were entitled to an ordinary loss deduction to the extent of $50,000. The Commissioner disagreed, the Tax Court sustained him, 51 T.C. 937, and this petition for review followed. Although we consider the case much closer than did the Tax Court and find some of its discussion open to serious question, we affirm the judgment.
The Tax Court assumed arguendo that if the Lease and License Agreement and the corporate minutes, read together, contained all the elements of a "plan" required by § 1244(c), that would satisfy the requirement in Regulations § 1.1244(c)-1(c) (1) that the plan be written. Nevertheless, it found the "plan" deficient in two fundamental respects. First, it did not specify a time within which the stock would be offered, since the term "closing date" was not understandable without further explanation and reference to outside events. Second, the plan did not specifically state the maximum amount to be received by the corporation in consideration for the stock to be issued pursuant thereto, since in addition to the $375,000 of stock mentioned in the alleged plan the corporation could have issued the remaining 6250 authorized shares on the date of closing. The Tax Court found that the stock failed to qualify under § 1244(c) in other respects, but these were largely dependent on the correctness of the above conclusions.
Counsel for Godart strenuously disputes both these conclusions. The first step for the argument is supplied by our decision in Eger v. C.I.R., 393 F.2d 243, 246 (1968), that corporate minutes may be a sufficient writing to meet the statutory requirements for a plan. The FAB directors' minutes of December 30, 1960, when read with the Lease and License Agreement to which they refer, are claimed to contain the essentials. The requirement that the offering shall be "during a period specified in the plan ending not later than two years after the date the plan is adopted," is allegedly met by the provision in the Lease and License Agreement that the closing shall take place not later than the first day of the first month after approval by Stroock stockholders. A fair reading of the minutes, it is argued, shows that this had already been given, and the closing thus had to occur by January 1. 1961 -- two days after the plan rather than the two years the statute permits.
The requirement that the plan set a limit on the maximum to be received for the stock to be issued thereunder is claimed likewise to have been satisfied. The only issuance of stock contemplated by the plan was the 3750 shares for which an amount was specified. While conceding that nothing in the plan prevented the corporation from issuing additional stock on the date of closing, counsel asserts that such stock would not be issued "pursuant to the plan," and the only consequence of issuance would be that the stock so issued and any stock subsequently issued pursuant to the plan would not qualify under § 1244(c). See Regulations § 1.1244(c)-1(h). He points out that any provision in the plan purporting to limit other stock issuances during the period of the plan would be mere verbiage, since the corporation could always abrogate it, and argued that the Regulations ought not to be read to require such a useless act.
These arguments have much weight in the abstract but, so far as we can see, their acceptance without more would mean that the first $500,000 of common stock in any new corporation would qualify for ordinary loss treatment, provided only that the initial issue or issues were kept below that figure and one could spell out from the minutes and documents mentioned in them that the stock was to be issued within two years. While the statute is poorly drafted,*fn3 and it may well be that by careful tax planning any new corporation could achieve § 1244 status for its initial stock issuance, we find no indication in the statute or the legislative history, see H.R. Rep. No. 2198, 85th Cong., 1st Sess., reprinted in 1959-2 Cum. Bull. 709,*fn4 that any such consequences were intended or foreseen. Rather the House Report stressed that budgetary considerations required that any tax reductions accorded small businesses be kept at a minimum and that other desirable reforms be postponed. Id. at 710.
It is not easy to reconcile the potentially broad language of the section with the limited effect Congress envisioned, but a clue is given by the stated purpose of this portion of the bill: "to increase the volume of outside funds which will be made available for the financing of small business" by according ordinary loss treatment to "investments in small business which do not prove to be successful." Id. While one could not sustain the position that Congress meant the benefits of § 1244 to be given only to taxpayers who would not have invested without the promise of them, it is hard to see how its purpose would be served by according its benefits in cases where there is no indication that at the time the alleged plan was adopted the corporation had any awareness of the section or any intent to make its extraordinary tax advantages available to investors in the corporation.
The cases seem to reflect this view. In upholding the taxpayer in Eger v. C. I.R., supra, 393 F.2d at 246, we stressed that "the very formation of the corporation and issue of its stock was expressed to be in conformity with and limited to the conditions required by section 1244 * * *," and we distinguished four Tax Court decisions denying ordinary loss treatment, relied on by the Commissioner, in large part on the basis of lack of reference to § 1244 in the minutes. Id. at 246-247. In Childs v. C.I.R., 408 F.2d 531, 533 (3 Cir. 1969), the court stressed the absence of any reference to the section in the corporate minutes. See also Spillers v. C.I.R., 407 F.2d 530 (5 Cir. 1969).
It is true enough that tax consequences generally depend on what people do and not on what they say. But Congress, if it chooses, may condition tax incentives both on doing certain things and on showing in an objective way that they were done with an intention of realizing the benefits Congress had afforded.*fn5 We do not mean either that ritualistic reference to § 1244 is essential or that such a reference will save a plan that does not meet the statutory tests. We do mean that there must be some substantially contemporary objective evidence that the plan ...