35 T.C.M. (CCH) 843
VERONICA ADSHEAD, Transferee, ET AL., Petitioners
COMMISSIONER OF INTERNAL REVENUE, Respondent
Nos. 3263-72, 2399-74, 2430-74.
United States Tax Court
June 17, 1976
A corporation sold its assets as a going concern pursuant to a plan of complete liquidation under sec. 337. A separate provision in the contract for sale provided that the corporation and its sole shareholder would not compete with the buyers for a period of 10 years. The contract allocated $250,000 of the purchase price to the covenant which was executed by both the corporation and its sole shareholder. Held: The covenant has a basis in economic reality. The portion of the purchase price attributable thereto is therefore amortizable by the purchaser and is taxable to the seller as ordinary income. Held further: Since the transferee of the seller put the year in which the sale occurred at issue for the first time on brief and since consideration of such issue would result in substantial prejudice to respondent, we decline to decide this issue. Held further: Respondent's disallowance of depreciation deductions sustained. Held further: The selling corporation is not entitled to deductions for expenses incurred in connection with the sale of capital assets. Held further: The allocation of the consideration for the covenant between the selling corporation and its sole shareholder, in her individual capacity, determined. Held further: The amount of the consideration for the covenant attributable to the selling corporation which is properly accruable in the year of sale determined.
George McMillan, Russell L. Forkey, and Bernard A. Jackvony, for petitioner in docket No. 3263-72.
Richard J. Bischoff, Richard H. Hunt, Samuel C. Ullman, and Leon O. Stock, for petitioners in docket Nos. 2399-74 and 2430-74.
Paul R. Stanton, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined deficiencies in petitioners' federal income taxes as follows:
|| Year Ended
| Veronica Adshead[*]
|| $ 1,195.00
| National Food Services, Inc.
| National Food Services, Inc.,
| Willoughby's Restaurant, Inc.
The issue in controversy common to these cases is whether a portion of the consideration paid by National Food Services, Inc. under a contract for purchase of a restaurant owned by 721969 Corporation, formerly Captain's Table, Inc., in fact represents payment for a covenant not to compete executed by the seller and its then president, Victoria Adshead, or in contradistinction represents payment for the goodwill and the trade name of the seller. The contract sets forth an allocation of the purchase price among the various assets sold and further states that $250,000 of the total consideration represents payment for the aforenoted covenant not to compete. Concomitant with the sale the 721969 Corporation adopted a plan of complete liquidation under the provisions of section 337. With respect to this issue respondent has taken inconsistent positions. In the Adshead case he determined that the portion of the payments contractually allocated to the covenant not to compete is in fact bona fide consideration for the covenant and is therefore taxable as ordinary income. In the National Food Services, Inc. cases he determined that the same sum represents a capital expenditure for goodwill and denied the amortization deductions taken with respect thereto. Despite the inconsistent positions contained in his notices of deficiency, respondent merely seeks uniform treatment of the $250,000 and does not argue that we should sustain his determinations on this issue as to all parties. On brief, however, he has advanced as his preferred position the stance that the $250,000 was in reality for the covenant as set forth in the contract for sale. With respect to the Adshead case certain other issues are presented for our consideration. These are: (1) Whether the sale of the restaurant took place in 1968 or in 1969; (2) Whether the Corporation is entitled to deductions for depreciation for its taxable year ended August 31, 1969; (3) Whether the Corporation is entitled to deduct expenses incurred in connection with the sale of the restaurant; (4) Whether respondent erred in determining that the consideration for the covenant was taxable to the Corporation rather than to Adshead in her individual capacity, and (5) Whether the consideration for the covenant was properly accruable in 1969. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, and the exhibits attached thereto, are incorporated herein by this reference. Petitioner, Veronica Adshead (hereinafter Adshead), formerly Veronica Hagmann, resided in Ft. Lauderdale. Florida at the time she filed her petition herein. In his notice of deficiency to Adshead, respondent determined that she was liable, as transferee of the assets of 721969, Incorporated, formerly Captain's Table, Inc. (hereinafter the Corporation) for deficiencies in income taxes determined to be due from the Corporation for its calendar years 1965
and 1968 and for its taxable year ended August 31, 1969. The Corporation, prior to its dissolution, was a Florida corporation with its principal place of business in Deerfield Beach, Florida. It filed its corporate income tax return for its taxable year ended August 31, 1969 with the southeast service center, Chamblee, Georgia on February 16, 1970. The record does not disclose where it filed its returns for the calendar years 1965 and 1968. The Corporation, the transferor, was liquidated on August 28, 1969 and thereupon transferred all its assets to Adshead. The parties in the Adshead case agree that the fair market value of the assets so transferred exceeds the deficiency (including interest) determined to be due from the Corporation; that Adshead is a transferee of assets within the meaning of section 6901; and that she is liable as such for any deficiency (including interest) we find to be due from the Corporation. Petitioner National Food Services, Inc. (hereinafter NFS) is a Florida corporation with its principal place of business in Deerfield Beach, Florida. Its corporate income tax return for its taxable year ended September 30, 1970 was prepared and filed on the accrual method of accounting with the district director of internal revenue, Jacksonville, Florida. 1755 Corporation and Willoughby's Restaurant, Inc. (hereinafter Willoughby's) are Florida corporations which at all times pertinent to this case were wholly-owned subsidiaries of NFS. NFS, 1755 Corporation, and Willoughby's filed a consolidated corporate income tax return for their taxable year ended September 30, 1971 with the district director of internal revenue, Jacksonville, Florida. From 1956 until September 6, 1968 the Corporation operated Pal's Captain's Table Restaurant (hereinafter the restaurant) in Deerfield Beach, Florida, the operation of which was handled by Hank Hagmann until his death on November 8, 1965.
Hank Hagmann, Adshead's late husband, was a man of considerable experience in the restaurant business having owned and operated five such enterprises during his 20 years in the restaurant field. Over the years he acquired a reputation as an excellent operator and his name was well-known among restaurateurs in the Deerfield Beach area. During the period in which he operated the restaurant he spent nearly every evening there and frequently greeted customers, many of whom knew him by sight if not by name.
Adshead, on the other hand, did not participate in, and knew very little about the operation of the restaurant prior to Hank Hagmann's death. Upon Hank Hagmann's death Adshead became the sole shareholder of the Corporation and remained so until August, 1969 when the Corporation was liquidated.
Rather than attempt to run the restaurant herself, she entrusted its operation to her son who had worked there approximately 1 year in the capacity as doorman. Subsequently in December 1967, she dismissed her son for lack of experience and retained a new manager whom she fired 6 weeks later. Adshead then proceeded to manage the restaurant herself, began to come to the restaurant daily, and made it her practice to greet customers. However, the restaurant, despite increasing sales, was experiencing financial difficulty and Adshead realized that she was not capable of operating it. In early 1968 she decided to dispose of the restaurant and authorized David Graham (hereinafter Graham), an attorney, to find a suitable buyer. Graham had previously become acquainted with Adshead in September or October of 1967 when she retained him with respect to certain collection matters. When she requested his assistance in selling the restaurant he found it necessary to ‘ hold off’ creditors until a sale could be consummated. After an examination of the Corporation's books, which revealed that the restaurant had a large gross volume notwithstanding its operating deficit, Graham decided that the cash flow of the restaurant warranted its continued operation until it could be sold. Bert T. Laacks (hereinafter Laacks), presently a director, shareholder, and president of NFS,
is a man of considerable experience in the restaurant field having been engaged in that business for approximately 20 years. In July, 1968, he learned that the restaurant was for sale, and contacted Graham for the purpose of negotiating a purchase...