In the present case Barton was concededly an 80-percent or more shareholder of Barton-Naphtha. Whether his ownership of Barton-Solvents was also equal to or greater than 80 percent depends upon the treatment to be accorded the stock held by the employee-shareholders of that corporation other than Barton. If such stock is held to be excluded stock under section 1563(c)(2)(B), then Barton is regarded for purposes of this case as the sole shareholder of Barton-Solvents and accordingly petitioners must be classified as a controlled group of corporations. If the stock is not so excluded, Barton is then an owner of less than 80 percent of the stock of Barton-Solvents and the petitioners, lacking the necessary degree of common ownership, 1971 U.S. Tax Ct. LEXIS 145">*160 are not to be considered controlled corporations.

Respondent has taken the position that the stock owned by the employee-shareholders of Barton-Solvents, other than Barton himself, constituted "excluded stock" under section 1563(c)(2)(B). The conditions applicable to such stock by virtue of an endorsement on the face of the stock certificates extended to the corporation what is commonly referred to as the right of first refusal. Its provisions required shareholders desiring to sell their stock to first offer it for sale to the issuing corporation at book value, the corporation then having 30 days within which to accept such offer. The endorsement further granted the corporation a 30-day option to purchase the shares in the event of either the death of the employee or of his leaving the employ of the corporation. Respondent maintains that these conditions substantially restricted the right of the employees to dispose of their stock within the meaning of the statute. Since all other statutory requirements have clearly been satisfied under the facts of this case, it is the proper interpretation of the substantial-restriction requirements which underlies the present conflict.

In 1971 U.S. Tax Ct. LEXIS 145">*161 his contention that the restrictions herein satisfied the statutory requirements, respondent is firmly supported by the regulations. In 56 T.C. 107">*114 amplification of a statutory provision applicable to a parent-subsidiary group of corporations, similar to the provisions under consideration, section 1.1563-2(b)(2)(iii), Income Tax Regs., states:

In general, any condition which extends, directly or indirectly to the parent corporation or the subsidiary corporation preferential rights with respect to the acquisition of the employee's (or direct owner's) stock will be considered to be a condition described in the preceding sentence. It is not necessary, in order for a condition to be considered to be in favor of the parent corporation or the subsidiary corporation, that the parent or subsidiary be extended a discriminatory concession with respect to the price of the stock. For example, a condition whereby the parent corporation is given a right of first refusal with respect to any stock of the subsidiary corporation offered by an employee for sale is a condition which substantially restricts or limits the employee's right to dispose of such stock and runs in favor of the parent corporation. 1971 U.S. Tax Ct. LEXIS 145">*162 * * * [Emphasis supplied.]

These principles are expressly made applicable to brother-sister corporations by section 1.1563-2(b)(4)(ii), Income Tax Regs. Thus, a right of first refusal is considered to satisfy the statutory requirements of section 1563(c)(2)(B) in the case of brother-sister controlled groups. The above regulations echo the committee reports accompanying the enactment of the statute which explicitly treats a right of first refusal as a substantial restriction within the contemplation of the statute. See H. Rept. No. 749, 88th Cong., 1st Sess. 1964-1 C.B. (Part 2) 452. Thus, under both the regulations and the committee reports, petitioners constituted a controlled group of corporations within the meaning of section 1563.

In an effort to extricate themselves from the embrace of the unfavorable statutory provisions, petitioners argue: (1) That even if literally applicable, it was not the purpose of the statute to disallow a multiple surtax exemption in the present circumstances; (2) that under the facts of the case the restrictions contained on the face of the certificates were not substantial restrictions within the meaning of the statute; 1971 U.S. Tax Ct. LEXIS 145">*163 and (3) that, in any event, such restrictions were unenforceable under Iowa law.

We consider each of these contentions in order. The first contention of petitioners relates to the purpose of enactment of the provisions excluding certain stock owned by employees. Such purpose, petitioners claim, is to preclude the transfer of stock to employees for purposes of avoiding the provisions of section 1561. Thus, it is argued, the question of whether the statute is held applicable to a particular situation should depend upon the existence of improper motives. In the present case, since in petitioners' view the issuance of stock to the employees was motivated by legitimate business reasons rather than tax avoidance, petitioners maintain that no denial of multiple surtax exemptions was intended.

56 T.C. 107">*115 We note at the outset that the limitation upon the statutory provisions proposed by the petitioners is without authority in the statute. While congressional intent is frequently resorted to in ascertaining the proper meaning of unclear statutory provisions, it is the statutory language upon which such a determination must ultimately reside. In the present case, the statutory provisions1971 U.S. Tax Ct. LEXIS 145">*164 are clear and intimate no dependency upon the existence of tax-avoidance motives. By force of such provisions alone, therefore, petitioners' contention must be rejected. However, even looking to the legislative history, as petitioners urge, we can find no support for petitioners' contention.

The enactment in 1964 of sections 1561 through 1563 limiting the number of surtax exemptions in the case of controlled corporations coincided with the reduction of the tax on the first $ 25,000 of corporate income from 30 to 22 percent. The general purpose of enactment of these restrictions is revealed in the following excerpt of the committee reports accompanying such legislation:

While your committee recognizes the importance to small business of reducing the tax on the first $ 25,000 of income from 30 to 22 percent, it also recognizes that this substantial reduction should not provide added inducement to existing medium and large corporations to split up into multiple corporations. * * *

* * * *

your committee believes, as it has in the past, that, where corporations owned and controlled by the same interests engage in different businesses in the same area or conduct the same type business1971 U.S. Tax Ct. LEXIS 145">*165 in different geographical locales, there are legitimate business reasons for use of separate corporations and, therefore, the separate corporations should generally be recognized as separate taxpayers, retaining the benefit of use of multiple surtax exemptions. However, your committee does not intend to encourage the formation of these multiple corporations and therefore proposes to apply higher tax rates to corporations which are members of an affiliated group of corporations. * * * [H. Rept. No. 749, 88th Cong., 1st Sess. (1963), 1964-1 C.B. (Part 2) 241-242. ³]

The inclusion of the provisions relating to the exclusion of certain stock owned by employees in determining the percentage of common control is explained in the following manner:

certain outstanding stock, although owned by separate persons, could, unless neutralized for purposes1971 U.S. Tax Ct. LEXIS 145">*166 of determining control, be used by some owners as a means of divesting themselves of sufficient stock to avoid the application of this section without, as a practical matter, divesting themselves of the benefits of ownership of a corporation. Therefore * * * stock of a subsidiary corporation owned by * * * employees of the corporation, if the stock is subject to conditions * * * will not be treated as outstanding stock * * * [H. Rept. No. 749, 88th Cong., 1st Sess. (1963), 1964-1 C.B. (Part 2) 243. ⁴]

As indicated above the purpose of section 1561 is to limit the number of surtax exemptions available to corporations owned by the same 56 T.C. 107">*116 interests. While use of multiple corporations as a method of conducting business may comport with bona fide business requirements, the allowance of a surtax exemption to each corporation confers unwarranted tax benefits upon the common shareholder. It is this duplication of surtax exemptions which prompted the enactment of 1971 U.S. Tax Ct. LEXIS 145">*167 sections 1561 through 1563. We think it clear, and petitioner has not contended otherwise, that the general application of these sections does not depend upon the existence of tax-avoidance motives. This is particularly apparent when such sections are contrasted with the related provisions of sections 269 and 1551, both of which focus upon the taxpayer's intentions. The present statute, on the other hand, establishes objective criteria based solely upon the presence of the requisite degree of common control. Any doubt as to the proposition that tax-avoidance motives are irrelevant to the operation of sections 1561 et seq. is eliminated by the committee reports quoted above which state that the alternative 6-percent additional tax provided by section 1562 was included in recognition of the frequently legitimate use of the multiple corporate form of conducting business. Thus, it is clear that the absence of tax-avoidance motives constitutes no bar to the denial of multiple surtax exemptions to controlled corporations under section 1561.

By the same token, we think the specific provision in question excluding certain stock held by employees from the determination of stock ownership1971 U.S. Tax Ct. LEXIS 145">*168 does not require the existence of tax-avoidance motives. The exclusion of such stock is no more than a special refinement upon the 80-percent common ownership requirement designed to assure the denial of multiple surtax exemptions where the common shareholder owns less than 80 percent of the stock but enjoys the prohibited degree of control as a result of restrictions applicable to the stock held by outsiders. Given the presence of such control, we think that the statute mandates the denial of multiple exemptions for the same reasons generally applicable to controlled corporations, irrespective of the absence of tax-avoidance motives. Any contrary interpretation of the statute would permit a shareholder possessing the prohibited degree of control to derive precisely the unwarranted benefits from multiple incorporation which the statute was intended to defeat.

Petitioners next contend that the restrictions applicable to the employees' stock in the present case were not substantial within the contemplation of the statute. The restrictive endorsement herein granted a right of first refusal to the corporation requiring the corporation to pay book value upon its purchase of the stock. 1971 U.S. Tax Ct. LEXIS 145">*169 Petitioners take the position that since the book value was equal to fair market value, the restriction did not substantially inhibit the proprietary interests of the employees in the stock. As petitioners interpret the statutory provisions, only such restrictions which have a material effect upon the voting or dividend rights, value, or other incidents of 56 T.C. 107">*117 ownership of the stock, are to be considered substantial within the meaning of the statute. In light of the statutory purposes and legislative history, described above, we think petitioners misconstrue the provisions in question.

The purpose of excluding stock owned by employees, subject to restrictions upon their right of disposition, has been described above. In emphasizing such attributes of ownership as voting and dividend rights or the shareholder's ability to realize full market value on the sale of stock, petitioners ignore the critical requirement that the restrictions relate to the right of disposition, rather than incidents of ownership, of the employees. In this connection we note that the statute does not treat stock subject to substantial restrictions as if owned by the common shareholder. Instead the1971 U.S. Tax Ct. LEXIS 145">*170 stock is "neutralized" for purposes of determining stock ownership by regarding such stock as nonexistent. Such treatment of excluded stock is to be contrasted with the constructive ownership provisions of subsection (e) which attribute the ownership of stock by one individual to another. It is plainly the use of substantial restrictions as a method of retaining the reins of corporate control which is the sole concern of the statute. Accordingly, in determining what constitutes a substantial restriction, the focus of inquiry is properly upon the rights reserved to the common shareholder (or corporation) rather than the contraction of the employee's incidents of ownership. The right of first refusal in favor of the corporation involved in the present case clearly augmented the degree of control enjoyed by the common shareholder. Indeed it appears that such a restriction, cited by both the committee reports and the regulations as an illustration of a substantial restriction, is precisely the situation envisioned by Congress. We therefore regard the conditions applicable to the stock of the employees herein as a substantial restriction within the meaning of section 1563(c)(2)(B).

1971 U.S. Tax Ct. LEXIS 145">*171 Petitioners' final contention is that the restrictive endorsement applicable to the stock of the employees was invalid under local law. Accordingly, petitioners maintain that the stock was not in fact restricted for Federal tax purposes. Respondent's position is that the restrictions were valid.

It is well settled under the law of Iowa that reasonable restrictions upon the sale of stock are valid. McDonald v. Farley & Loetscher Mfg. Co., 226 Iowa 53">226 Iowa 53, 283 N.W. 261">283 N.W. 261 (1939); Elson v. Security State Bank of Allerton, 246 Iowa 601">246 Iowa 601, 67 N.W.2d 525 (1954). Moreover, prohibition upon the transfer of a corporation's stock to an outsider until the corporation has been given an opportunity to purchase such stock has been held to be a reasonable restriction. 226 Iowa 53">McDonald v. Farley & Loetscher Mfg. Co., supra.However, it is petitioners' position that such a restriction must be contained in either the articles of incorporation or bylaws of the corporation. In support of this assertion petitioners 56 T.C. 107">*118 cite Iowa Code Ann. sec. 491.5 and several1971 U.S. Tax Ct. LEXIS 145">*172 Iowa cases. The cited statute provides as relevant hereto:

Sec. 491.5 Articles adopted and recorded.

Before commencing any business except their own organization, they must adopt articles of incorporation, * * *

Such articles shall contain:

* * * *

3. The amount of authorized capital stock, the classes of stock and number of shares authorized, with the par value and conditions of each class of such shares, and the time when and conditions under which it is to be paid in.

Petitioners understand this provision to require the inclusion in the articles of incorporation of the restrictions upon disposition applicable to such stock. However, they cite no cases to support this construction of the statute. We are inclined to the view that the Iowa statute, in requiring the description of classes of stock and conditions of each class in the articles, does not refer to mere restrictions upon disposition applicable to some portion of a single class of stock. This conclusion we believe is compelled by the case of 246 Iowa 601">Elson v. Security State Bank of Allerton, supra, in which the court upheld the validity of a bylaw imposing restrictions 1971 U.S. Tax Ct. LEXIS 145">*173 upon the sale of stock, although the articles of incorporation were silent in this respect. The clear inference of such a holding is that the validity of restrictions upon the disposition of stock does not depend upon their inclusion in the articles of incorporation.

Petitioners also cite 226 Iowa 53">McDonald v. Farley & Loetscher Mfg. Co., supra, and Mason v. Mallard Telephone Co., 213 Iowa 1076">213 Iowa 1076, 240 N.W. 671">240 N.W. 671 (1932), for the proposition that restrictions which are outside the articles or bylaws are invalid. Each of the cited cases upheld the validity of reasonable restrictions upon alienability of stock which are contained in the articles of incorporation, the former dealing with a right of first refusal and the latter with a provision requiring the transfer of stock to be approved by two directors of the corporation. Petitioners would infer from these cases that restrictions which are not contained in the articles are invalid. However, what has been stated with reference to a similar inference from the Iowa statute is equally applicable here. Nothing in the cited cases suggests that the restrictions1971 U.S. Tax Ct. LEXIS 145">*174 must arise from provisions in the articles of incorporation. Clearly the import of these decisions is not to limit the validity of restrictions to those contained in the articles of incorporation since the Elson case establishes the enforceability of bylaw restrictions as well. Thus, the cited cases must be understood as establishing the validity of reasonable restrictions rather than the formalities necessary to create such restrictions.

The question of the validity of reasonable restrictions contained exclusively in the certificate representing the stock has not been specifically treated in any Iowa cases that have come to our attention. 56 T.C. 107">*119 However, there is nothing in the cases cited by petitioners which suggests that such restrictions would not be upheld as a contract between the corporation and shareholders or between the shareholders inter se. The cases of other jurisdictions do in fact recognize the validity of such contractual restrictions. Thus, in Doss v. Yingling, 95 Ind. App. 494">95 Ind. App. 494, 172 N.E. 801">172 N.E. 801 (1930), a restriction contained in an invalid bylaw was upheld on the basis that the bylaw evidenced an effective1971 U.S. Tax Ct. LEXIS 145">*175 agreement between the shareholders and the corporation. To the same effect see Krauss v. Kuechler, 300 Mass. 346">300 Mass. 346, 15 N.E.2d 207 (Sup. Jud. Ct. 1938).⁵ In the instant case the certificates of stock issued by the corporation to the employees as part of the original issue expressly stated that it was subject to specified conditions. Under such circumstances we believe that the courts of Iowa would enforce such restrictions on a contractual basis although the instructions were stated neither in the articles nor the bylaws of the corporation. It is significant, in this respect, that the Iowa cases of 213 Iowa 1076">Mason v. Mallard Telephone Co., supra, and 226 Iowa 53">McDonald v. Farley & Loetscher Mfg. Co., supra, adopt a contractual theory as the underlying basis of the validity of reasonable restrictions upon transfers contained in articles or bylaw provisions.

1971 U.S. Tax Ct. LEXIS 145">*176 Respondent has advanced an alternative argument in support of the deficiencies based upon the petitioners' filing of an election pursuant to section 1562. It is respondent's position that such filing establishes the status of petitioners as a group of controlled corporations since withdrawal of such an election requires the Commissioner's consent. While we are inclined toward the posture of petitioners that such an election is effective only if petitioners are in fact a group of controlled corporations, in view of our conclusions as to the merits of petitioners' claim we do not reach such issue.

Decisions will be entered under Rule 50.