Forward Communications Corp. v. United States

Citation608 F.2d 485
Decision Date17 October 1979
Docket NumberNo. 332-74.,332-74.
CourtCourt of Federal Claims


William A. Cromartie, Chicago, Ill., attorney of record, for plaintiff. Michael M. Conway and Hopkins, Sutter, Mulroy, Davis & Cromartie, Chicago, Ill., of counsel.

Iris J. Brown, Washington, D. C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D. C., for defendant. Theodore D. Peyser, Jr., and Donald H. Olson, Washington, D. C., of counsel.

Before FRIEDMAN, Chief Judge, and DAVIS and KASHIWA, Judges.



This is an action for the recovery of federal income taxes plus interest claimed to have been overpaid for the taxable years ending June 30, 1962 through 1968. Timely claims for refund were disallowed, and this suit was timely brought thereafter.

Plaintiff, Forward Communications Corporation (Forward), is a corporation with principal place of business in Wausau, Wisconsin. For the taxable years in issue, plaintiff and its subsidiaries were engaged in the business of radio and television broadcasting and newspaper publishing.

On December 1, 1965, plaintiff purchased all of the assets of Station KVTV, Sioux City, Iowa, from Peoples Broadcasting Company (Peoples).1 The questions presented for determination in this case with regard to the KVTV purchase are:

(1) May plaintiff deduct annually part of the price for the amortization of a 5-year covenant by the seller not to compete?

(2) May plaintiff deduct annually part of the price for the amortization of the Federal Communications Commission (FCC) license it acquired?

(3) May plaintiff deduct as a 1967 loss a portion of the price it paid attributable to a primary Columbia Broadcasting System (CBS) network affiliation contract which it terminated after entering into a new American Broadcasting Company (ABC) network affiliation contract in September 1967?

(4) May plaintiff deduct in 1966 and 1967 against the income from the performance of advertising contracts an allocated portion of the purchase price attributable to such contracts?

(5) Is plaintiff entitled to establish an increased basis for the depreciation of its tangible operating equipment in the absence of such a contention in its claims for refund?

Between October 30, 1964 and September 1, 1967, plaintiff acquired all of the stock of the News Publishing Company of Marshfield, Wisconsin, which published the Marshfield News-Herald, a daily newspaper. On September 30, 1967, plaintiff liquidated the News Publishing Company and received all of its assets under a plan of liquidation qualifying under section 334(b)(2) of the Internal Revenue Code.2 The issues presented with regard to the newspaper acquisition are the fair market value of (1) the machinery and equipment, and (2) the newspaper's goodwill on September 30, 1967.

Although all of the significant events necessary to determine the issues took place from and after 1965, the taxable years 1962 through 1964 are also involved due to loss carrybacks and unused investment credits.

I. Covenant Not To Compete

In 1965, there were only two television stations in Sioux City, Iowa: KVTV, which had a primary CBS-network affiliation, and KTIV, which had a primary National Broadcasting Company (NBC) network affiliation. Both were VHF (very high frequency) stations. Although the FCC had allocated a UHF (ultra high frequency) channel to the Sioux City area as far back as 1952, up through the end of 1965 no one had thought it sufficiently worthwhile to apply for it.

Station KVTV was owned by Peoples Broadcasting Company, a subsidiary of a large insurance company with headquarters at Columbus, Ohio. In March 1965, plaintiff began negotiations with Peoples to purchase that station. From the start, Peoples indicated that it would not sell the station for less than $3.5 million, and plaintiff acquiesced in that basic price. The negotiations thereafter related largely to the clauses which plaintiff desired to include in the agreement of sale.

One of the clauses which plaintiff proposed was a covenant by Peoples that it would not compete with plaintiff in Sioux City for a period of 5 years. The 5-year period was chosen because plaintiff felt that after that period Peoples would lose its effectiveness in the Sioux City market.

On April 26, 1965, Peoples forwarded to plaintiff its draft of the sale contract. The contract set forth the agreed upon $3.5 million price plus reimbursement of Peoples' share of the cost of a new tall transmission tower then under construction for joint use by both Sioux City television stations. Although the parties had discussed the covenant not to compete, the draft agreement did not contain one. After plaintiff conveyed to Peoples its insistence that there be such a covenant, Peoples supplemented its draft by adding a 5-year covenant but did not change the price.

The final contract was executed July 16, 1965. Section 1, entitled "Sale, Assignment and Delivery of Assets", provided for the conveyance by Peoples to plaintiff of the FCC license, the call letters KVTV, the tangible assets and the leases, agreements and contracts pertaining to the business of the station. Section 3, entitled "Purchase Price and Terms of Payment", provided that "the purchase price for the assets purchased hereunder" was $3.5 million plus the seller's costs and expenses incurred up to the closing date in connection with the new tall tower and related facilities. It recited that $150,000 was paid by plaintiff on the execution of the contract, to be held in escrow, and the remainder was due at the closing. The final section of the contract provided in full:

Section 25. Covenant not to Compete. Seller agrees not to engage, directly or indirectly, in the business of operating a television station in Sioux City, Iowa, for a period of five years from the Closing Date.

There was no provision in the contract for payment or for any allocation of the purchase price for the covenant not to compete.

At closing, on December 1, 1965, plaintiff paid Peoples a total of $3,928,033.11 in the form of three bank cashier's checks as follows:

                First National Bank of Chicago                                $3,200,000.00
                First National Bank of Chicago                                   250,000.00
                Continental Illinois National Bank
                 and Trust Co. of Chicago                                        478,033.11

The $478,033.11 check represented reimbursement for Peoples' outlays in connection with the new tall transmission tower.

Although the $250,000 check then contained no notation as to what it represented, plaintiff's president, Richard Dudley, and its attorney, Stanley Staples, for the first time orally informed Peoples' representatives that the amount on the separate check was what plaintiff was paying for the covenant not to compete. Peoples' representatives were noncommittal. Neither Dudley nor Staples was willing to testify that Peoples agreed to the proposal. Indeed, Staples testified, "I certainly would not be correct if I stated that the sellers accepted our allocation." Although no representative of Peoples testified at trial, in its income tax return Peoples treated the entire purchase price as the proceeds from the sale of capital assets.

The $3,200,000 represented the remainder of the purchase price.3

Plaintiff urges that irrespective of the contract provisions, $250,000 of the $3,928,033.11 is allocable to Peoples' covenant not to compete and that it is amortizable over the 5-year life of the covenant. Defendant, on the other hand, contends that since the entire contract price was paid for the transferred assets nothing was paid by plaintiff for Peoples' covenant not to compete, and, hence, there was no cost to amortize.

A covenant by the seller of a business that he will not compete with the purchaser for a limited period after the sale is often merely a protective device to insure the conveyance of goodwill. In that event, the entire sum received by the seller represents the proceeds from the sale of his capital assets, and correspondingly the purchaser's investment in such assets. On the other hand, where the parties agree that the seller should be separately compensated for his loss of earnings (not from the transferred business but from other sources) for a limited period, where the parties bargain in good faith as to the sum to be paid therefor, and the amount agreed upon has economic reality, then other tax consequences may ensue. The seller may be required to treat the substituted earnings as ordinary income, and correspondingly the buyer may become entitled to deduct them from ordinary income as business expenses. See Davee v. United States, 444 F.2d 557, 195 Ct.Cl. 184 (1971), cert. denied sub nom. Lea Associates, Inc. v. United States, 425 U.S. 912, 96 S.Ct. 1507, 47 L.Ed.2d 762 (1976); and Ullman v. Commissioner, 264 F.2d 305, 307-08 (2d Cir. 1959).

In determining whether the amount may be separately allocated to a covenant not to compete, the courts have applied at least four tests, the importance of each varying with the context in which the issue arises — i. e., whether the covenantor is taxable upon part of the proceeds as ordinary income, or whether the covenantee is entitled to deduct part of the payment as an actual or amortizable expense, and whether the taxpayer or the Commissioner is challenging the form of the agreement.

The first of these tests is whether the compensation paid for the covenant is separable from the price paid for the goodwill. This test is aptly stated in Ullman v. Commissioner, supra at 307-08:

It is well established that an amount a purchaser pays to a seller for a covenant not to compete in connection with a sale of a business is ordinary income to the covenantor and an

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