The Commissioner takes the position that the petitioner retained a prohibited interest in the corporation within the meaning of section 302(c)(2)(A)(i). First, he maintains that the petitioner continued to be a paid employee of the corporation after the redemption, that the petitioner continued to have access to substantial corporate benefits, and that the petitioner continued to participate in the corporation's day-to-day business affairs in a position from which he could exercise influence.

Section 302(c)(2) was enacted as part of the Internal Revenue Code of 1954 to provide that when there is a bona fide severance of a shareholder's interest in a corporation, he will receive capital gains treatment. H. Rept. 1337, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. 36 (1954); 1984 U.S. Tax Ct. LEXIS 21">*39 S. Rept. 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. 45 (1954). We have previously stated that it is reasonable to infer from the legislative history that in enacting section 302(c)(2)(A), Congress was primarily concerned with a situation where a redeeming shareholder retained a financial stake in the corporation or continued to control the corporation and benefit by its operations after making only a nominal transfer of his stock. Seda v. Commissioner, 82 T.C. 484">82 T.C. 484, 82 T.C. 484">488 (1984); 83 T.C. 597">*605 Estate of Lennard v. Commissioner, 61 T.C. 554">61 T.C. 554, 61 T.C. 554">561 (1974); Lewis v. Commissioner, 47 T.C. 129">47 T.C. 129, 47 T.C. 129">136 (1966) (Simpson, J., concurring). Immediately after the enactment of the 1954 Code, it was recognized that section 302(c)(2)(A)(i) did not prohibit office holding per se, but was concerned with a retained financial stake in the corporation, such as a profit-sharing plan, or in the creation of an ostensible sale that really changed nothing so far as corporate management was concerned. 47 T.C. 129">Lewis v. Commissioner, supra at 137-138 (Simpson, J., concurring), citing1984 U.S. Tax Ct. LEXIS 21">*40 Bittker, "Stock Redemptions and Partial Liquidations under the Internal Revenue Code of 1954," 9 Stan. L. Rev. 13, 33 n. 72 (1956). See also Bittker, "The Taxation of Stock Redemptions and Partial Liquidations," 44 Cornell L. Q. 299, 316 (1959). Thus, in determining whether a prohibited interest has been retained under section 302(c)(2)(A)(i), we must look to whether the former stockholder has either retained a financial stake in the corporation or continued to control the corporation and benefit by its operations. 82 T.C. 484">Seda v. Commissioner, supra at 488; Chertkof v. Commissioner, 72 T.C. 1113">72 T.C. 1113, 72 T.C. 1113">1124-1126 (1979), affd. 649 F.2d 264">649 F.2d 264 (4th Cir. 1981); 61 T.C. 554">Estate of Lennard v. Commissioner, supra at 560-562; B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 9.23, at 9-26 to 9-27 (4th ed. 1979). In particular, where the interest retained is not that of an officer, director, or employee, we must examine the facts and circumstances to determine whether a prohibited interest has been retained1984 U.S. Tax Ct. LEXIS 21">*41 under section 302(c)(2)(A)(i). Seda v. Commissioner, 82 T.C. 484">82 T.C. 491 (Whitaker, J., concurring); ²Chertkof v. Commissioner, 72 T.C. 1113">72 T.C. 1124-1126; 61 T.C. 554">Estate of Lennard v. Commissioner, supra.

The Commissioner's argument that the petitioner retained a financial stake in the corporation is based largely on his contention that the petitioner was an employee of the corporation after the redemption. The petitioners, on the other hand, argue that pursuant to the consulting agreement, the1984 U.S. Tax Ct. LEXIS 21">*42 petitioner's relationship with the corporation was that of an independent 83 T.C. 597">*606 contractor. Where previously we have been required to determine whether an individual was an independent contractor or an employee for purposes of section 302(c)(2)(A), we have looked to whether the individual was subject to the control of the corporation. Estate of Lennard v. Commissioner, 61 T.C. 554">61 T.C. 561; see sec. 31.3401(c)-1(b), Employment Tax Regs.

In the present case, the petitioner was not subject to the control of the corporation. Immediately after the redemption, he chose to go to the office daily, but as time passed, he appeared less often. Approximately a year after the redemption, he went to the office only about once or twice a week, and sometimes he had no contact with the corporation for weeks at a time. Moreover, the evidence in the record establishes that he, himself, determined when he would be at the corporation's offices and what he would do there. Indeed, on a number of occasions, the petitioner, when requested by the corporation to perform consulting services, informed the corporation that he was not available. The petitioner did perform consulting1984 U.S. Tax Ct. LEXIS 21">*43 services with respect to the layout of the corporation's yard in San Marcos, and he did advise the corporation with respect to its acquisition and standardization of the 13 used pipe machines. However, such activities are consistent with the petitioner's status as an independent contractor. The corporation never withheld any payroll taxes from the payments it made to the petitioner under the consulting agreement. After the redemption, the petitioner did continue to be covered by the corporation's group health insurance policy and its medical reimbursement plan, but although that coverage tends to indicate that he was treated as an employee for some purposes, we have concluded that the weight of the evidence establishes that he was not an employee of the corporation after the redemption.

In light of such conclusion, it is clear that we must examine all the surrounding facts and circumstances to determine whether the petitioner retained a financial stake in the corporation or continued to control the corporation after the redemption of his stock. The record shows that the petitioner did not have a financial stake in the corporation after the redemption. The payments which the petitioner1984 U.S. Tax Ct. LEXIS 21">*44 received pursuant to the consulting agreement were in no sense contingent on the profitability or the future operations of the 83 T.C. 597">*607 corporation. Indeed, while the corporation continued to be profitable after the redemption, the payments to the petitioner under the consulting agreement were reduced by one-half approximately 1 year after the redemption by the mutual assent of the parties, and 1 year prior to the end of the consulting agreement, such payments, also by the mutual assent of the parties, were terminated altogether. Nor were the benefits received by the petitioner sufficient to give him a financial stake in the corporation. Compare Lewis v. Commissioner, 47 T.C. 129">47 T.C. 135. ³ The petitioner was covered under the corporation's group health insurance policy, and the corporation paid $ 4,487.54 for such coverage after the redemption. Both petitioners were covered under the corporation's medical reimbursement plan, but they received only a total of $ 96.05 under such plan after the redemption. Lastly, the corporation provided the petitioner with the use of a pickup truck. In summary, the payments under the consulting agreement, together1984 U.S. Tax Ct. LEXIS 21">*45 with the other benefits received by the petitioner, were in no way contingent on the future profitability of the corporation, and in the aggregate, they did not constitute a significant or substantial interest in the continued success of the business.

The evidence also shows that after the redemption the petitioner made no effort to continue to control the corporation. The petitioner's son, Gilbert, had for sometime prior to the redemption begun to assume more and more managerial responsibility for the affairs of the corporation. It was Gilbert who believed that the corporation needed to diversify and to get into the construction business in order to continue to be profitable. Based on the record before us, we conclude that Gilbert, as of the redemption, both nominally and in fact, assumed complete control over the corporation. After the redemption, the petitioner may have given Gilbert some advice with respect to the affairs 1984 U.S. Tax Ct. LEXIS 21">*46 of the corporation, but advice alone is not prohibited. Estate of Lennard v. Commissioner, 61 T.C. 554">61 T.C. 561. Moreover, the employees of the corporation who continued to work for the corporation after the redemption, had sufficient technical expertise to carry on the operations of the corporation.

83 T.C. 597">*608 In the present case, the Commissioner has not argued that after the redemption of his stock, the petitioner continued to control the corporation. Rather, the Commissioner's argument is that after the redemption, the petitioner remained in a position from which he could exercise influence over the affairs of the corporation. Cf. Chertkof v. Commissioner, 72 T.C. 1113">72 T.C. 1124-1126. We do not believe that what the petitioner might have done is controlling. The evidence in the record establishes that in fact Gilbert, and not the petitioner, controlled the corporation after the redemption. For such reasons, we conclude that the petitioner did not retain control of the corporation after the redemption. ⁴

1984 U.S. Tax Ct. LEXIS 21">*47 Second, the Commissioner argues that the petitioner retained a prohibited interest within the meaning of section 302(c)(2)(A)(i) because the note received by the petitioner upon the redemption of his stock was more in the nature of a retained equity interest than an interest as a creditor. He bases his contention on the fact that subsequent to the redemption, the petitioner agreed to subordinate the note to enable the corporation to take advantage of an opportunity to expand and to gain a competitive advantage. The petitioners contend that under section 1.302-4(d) of the Income Tax Regulations, the subordination agreement should not cause the petitioner's claim against the corporation to be treated as an equity interest.

Section 1.302-4(d), Income Tax Regs., provides:

(d) For the purpose of section 302(c)(2)(A)(i), a person will be considered to be a creditor only if the rights of such person with respect to the corporation are not greater or broader in scope than necessary for the enforcement of his claim. Such claim must not in any sense be proprietary and must not be subordinate to the claims of general creditors. An obligation in the form of a debt may thus constitute a proprietary1984 U.S. Tax Ct. LEXIS 21">*48 interest. For example, if under the terms of the instrument the corporation may discharge the principal amount 83 T.C. 597">*609 of its obligation to a person by payments, the amount or certainty of which are dependent upon the earnings of the corporation, such a person is not a creditor of the corporation. Furthermore, if under the terms of the instrument the rate of purported interest is dependent upon earnings, the holder of such instrument may not, in some cases, be a creditor.

Initially, we observe that the examples contained in such regulations which evince that the distributee is not merely a creditor are not applicable in the present case. Here, the corporation's obligation under the note as to the amount or certainty of the required payments was not dependent upon the earnings of the corporation; nor was the interest rate to be paid under the note dependent upon earnings.

We have previously held that subordination, if it exists, is only one of several factors to be taken into account in determining whether a particular interest is other than that of a creditor. Dunn v. Commissioner, 70 T.C. 715">70 T.C. 715, 70 T.C. 715">727 (1978), affd. 615 F.2d 578">615 F.2d 578 (2d Cir. 1980);1984 U.S. Tax Ct. LEXIS 21">*49 Estate of Lennard v. Commissioner, 61 T.C. 554">61 T.C. 563. Thus, subordination alone is not sufficient for us to find that the petitioner retained an interest other than as a creditor. The applicable regulations state that the shareholder's "claim must not in any sense be proprietary and must not be subordinate to the claims of general creditors." Sec. 1.302-4(d), Income Tax Regs.; emphasis added. In the present case, the petitioner's interest in the corporation after the redemption cannot fairly be characterized as "proprietary." We have already determined that he did not retain a financial stake in the corporation, nor did he retain control of the corporation after the redemption. Moreover, the payments to the petitioner under the note were not contingent on the future profitability or operations of the corporation. Finally, the corporation's obligation to the petitioner under the note was not subordinated to the general creditors of the corporation; rather, such obligation was subordinated to a single creditor. Also, the bank acquired a security interest in the corporation's equipment, which had an appraised value of $ 985,000, so that there may 1984 U.S. Tax Ct. LEXIS 21">*50 have been little risk to the petitioner in agreeing to the subordination of his note. Under such circumstances, we believe that the subordination agreement, when considered in conjunction with the other facts in the present case, did not cause the petitioner's claim as a creditor to become an equity interest.

83 T.C. 597">*610 Third, the Commissioner argues that the pledge agreement entered into between the petitioner and Gilbert demonstrates that the note was more in the nature of a retained equity interest than an interest as a creditor. In support of his contention, the Commissioner relies upon section 1.302-4(e), Income Tax Regs., which provides:

(e) In the case of a distributee to whom section 302(b)(3) is applicable, who is a creditor after such transaction, the acquisition of the assets of the corporation in the enforcement of the rights of such creditor shall not be considered an acquisition of an interest in the corporation for purposes of section 302(c)(2) unless stock of the corporation, its parent corporation, or, in the case of a redemption of stock of a parent corporation, of a subsidiary of such corporation is acquired.

In our view, such regulations have no applicability in1984 U.S. Tax Ct. LEXIS 21">*51 the present case. By its own terms, section 1.302-4(e), Income Tax Regs., pertains to the enforcement of a creditor's rights. Such regulations provide that if, in the enforcement of his claim as a creditor, a stockholder acquires the assets of the corporation, the acquisition of such assets will not be considered an acquisition of an interest in the corporation for purposes of the applicability of the attribution rules under section 302(c)(2), but the regulations imply that if the stockholder acquires stock, the acquisition of such stock will constitute a prohibited interest. T. Ness & E. Vogel, Taxation of the Closely Held Corporation, sec. 10.4(b), at 10-39 n. 20 (3d ed. 1983). However, the petitioner did not in fact acquire either the assets or the stock of the corporation. He had merely a right to acquire such stock in the event of a default by the corporation, and the regulations do not deal with that security interest. The holding of such a security interest is common in sales agreements, and in our judgment, it is not inconsistent with the interest of a creditor. See Lewis v. Commissioner, 47 T.C. 129">47 T.C. 131, 133. Having not been convinced 1984 U.S. Tax Ct. LEXIS 21">*52 by any of the Commissioner's arguments, we conclude and hold that the petitioner did not retain a prohibited interest within the meaning of section 302(c)(2)(A).

The Commissioner also takes the position that the attribution rules are applicable by reason of the provisions of section 302(c)(2)(B). He contends that the transfer of stock to Gilbert had as one of its principal purposes the avoidance of Federal income tax within the meaning of section 302(c)(2)(B)(ii). 83 T.C. 597">*611 Under such provision, the attribution rules of section 318(a) are applicable in determining whether there has been a complete redemption of a shareholder's interest in a corporation if:

(ii) any person owns (at the time of the distribution) stock the ownership of which is attributable to the distributee under section 318(a) and such person acquired any stock in the corporation, directly or indirectly, from the distributee within the 10-year period ending on the date of the distribution, unless such stock so acquired from the distributee is redeemed in the same transaction.

However, section 302(c)(2)(B) also provides that such restriction "shall not apply if the * * * disposition * * * by the distributee did 1984 U.S. Tax Ct. LEXIS 21">*53 not have as one of its principal purposes the avoidance of Federal income tax." Thus, under the statute, the transaction to be examined for tax avoidance is the transfer of stock from the petitioner to Gilbert. B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 9.23, at 9-28 to 9-29 (4th ed. 1979); T. Ness & E. Vogel, Taxation of the Closely Held Corporation, sec. 10.4(b), at 10-40, S.10-12 to S.10-13 (3d ed. 1983, and 1984 Cumm. Supp.).

The Commissioner's argument is, by his own admission, circumstantial. He does not contend that the transfer of the 50 shares of stock to Gilbert alone demonstrates a tax-avoidance motive. Rather, he argues that the cumulative weight of the evidence demonstrates that avoidance of taxes was one of the principal purposes for each of the steps undertaken by the parties in the redemption transaction, including the step which involved the transfer of 50 shares of stock to Gilbert. The Commissioner's contention is that the petitioner, through a series of relatively sophisticated transactions, secured a distribution of the corporation's retained earnings and profits and sought to avoid paying a tax on such retained 1984 U.S. Tax Ct. LEXIS 21">*54 earnings and profits at ordinary income rates. The petitioners, on the other hand, argue that the transfer of the 50 shares of stock to Gilbert was intended in conjunction with the redemption to transfer ownership of the corporation from the petitioner to Gilbert. They recognize that the transfer to Gilbert may be 83 T.C. 597">*612 viewed as a gift to him, ⁵ but they claim that there was no tax-avoidance purpose in such transfer.

Based on the record before us, we are convinced that the transfer by the petitioner to Gilbert prior to the redemption did not have as one of its principal purposes the avoidance of Federal income tax. We find the Commissioner's argument on this question to be convoluted as well as circumstantial. The evidence establishes that the petitioner, in transferring the 50 shares of stock to Gilbert and thereafter redeeming his remaining shares, sought to 1984 U.S. Tax Ct. LEXIS 21">*55 transfer ownership of the corporation to Gilbert. We do not find a tax-avoidance purpose in the transfer. The purpose of the transfer to Gilbert, and the sole purpose for that transfer, was to effect the eventual transfer of the ownership of the corporation to Gilbert. Moreover, the fact that the petitioner's redemption of his stock will be treated as a sale or exchange of such stock and that he will thereby obtain long-term capital gain treatment of the proceeds of the redemption does not establish a tax-avoidance motive. Section 302 provides for such treatment if the requirements of section 302(b) are met.

The Commissioner's final argument is that the price which the corporation paid for the petitioner's stock was unjustifiably inflated, reflecting the fact that the parties to the redemption were not dealing with each other at arm's length, and that thus there was no bona fide sale or exchange of the petitioner's stock which would justify capital gains treatment. The petitioners point out that the Commissioner is attempting, in his brief, to interject a new theory into the present case. They contend that the Commissioner bears the burden of proof with respect to such argument1984 U.S. Tax Ct. LEXIS 21">*56 pursuant to Rule 142(a), Tax Court Rules of Practice and Procedure, and that the Commissioner's argument is not supported by the record.

It is well settled that the Commissioner may not raise a new theory for the first time on brief where the petitioner had no opportunity to address such theory at trial and where he is prejudiced by the lack of such opportunity. Riss v. Commissioner, 57 T.C. 469">57 T.C. 469, 57 T.C. 469">472-474 (1971) (Supplemental Opinion), affd. on this issue sub nom. Commissioner v. Transport Mfg. & Equip. Co., 478 F.2d 731">478 F.2d 731, 478 F.2d 731">734-736 (8th Cir. 1973); Theatre 83 T.C. 597">*613 , 29 T.C. 754">29 T.C. 754, 29 T.C. 754">760-761 (1958); Tully v. Commissioner, 28 T.C. 265">28 T.C. 265, 28 T.C. 265">269 (1957). The present case falls within such rule. The petitioners were not informed that the Commissioner intended to argue that the redemption of the petitioner's stock was not a bona fide sale or exchange because the price paid for such stock was inflated until such argument was advanced in the Commissioner's brief. Accordingly, at trial, the petitioners did not seek to introduce evidence concerning1984 U.S. Tax Ct. LEXIS 21">*57 how the price paid by the corporation for the petitioner's stock was determined. Since the Commissioner's theory was presented for the first time in his brief, we will not consider such theory.

In conclusion, we hold that the redemption of all of the petitioner's stock in the corporation is taxable as long-term capital gain under section 302(a).

Decision will be entered under Rule 155.