Markham & Brown, Inc. v. U.S.

• Decision Date: 25 June 1981
• Docket Number: Nos. 80-2106 and 81-1023,s. 80-2106 and 81-1023
• Citation: Markham & Brown, Inc. v. U.S., 648 F.2d 1043 (5th Cir. 1981)
• Parties: 81-2 USTC P 9518 MARKHAM & BROWN, INC., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee. Summary Calendar. . Unit A
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1043

648 F.2d 1043

81-2 USTC P 9518

MARKHAM & BROWN, INC., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

Nos. 80-2106 and 81-1023

Summary Calendar.

United States Court of Appeals, Fifth Circuit.

Unit A

June 25, 1981.

Gardere & Wynne, H. Martin Gibson, Joe B. Harrison, Gordon H. Rowe, Jr., Dallas, Tex., for plaintiff-appellant.

Martha Joe Stroud, Asst. U. S. Atty., Dallas, Tex., John F. Murray, Acting Asst. Atty. Gen., Michael L. Paup, Chief, Appellate Sect., Richard Farber, Richard N. Bush, Attys., Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellee.

Appeal from the United States District Court for the Northern District of Texas.

Before AINSWORTH, GARZA and SAM D. JOHNSON, Circuit Judges.

PER CURIAM:

The appellant, Markham & Brown, Inc. was of the opinion that its repurchase of stock was deductible as an ordinary and necessary business expense under 26 U.S.C. § 162 and that its unilateral allocation of amounts for covenants not to compete could be amortized. The Internal Revenue Service thought otherwise and denied Markham & Brown's claims for refunds. The district court affirmed. Contending that the district court had erred both on the facts and on the law, Markham & Brown sought relief in this court. Markham & Brown's briefs and arguments are capital, but so were its expenditures, thus disallowing the deductions. The district court's holding is affirmed.

The partnership of Markham & Brown was formed in the early 1930's. The business of the partnership involved river-related construction work. In the 1950's, Markham died, and M. J. Mitchell, an oil producer and banker, acquired Markham's interest in the partnership. Mitchell was never involved in the operations of the company, but rather served as an investor. In 1961, the partnership became a corporation with the name of Missouri River Constructors, Inc. The stock was distributed among three men. Ralph Brown and Mitchell each owned identical amounts of stock while the third stockholder, Charles Connor, owned a slightly lower percentage. The name was later changed to Markham and Brown, Inc.

In 1966, a buy-sell agreement was signed by the three stockholders. One provision of the agreement allowed any stockholder to demand that his stock be purchased by the corporation or the other shareholders. If none of these purchased the stock, the corporation was required to liquidate and dissolve. Another provision contained a covenant not to compete for five years following the sale of stock by a stockholder. Apparently, the business relationship between Mitchell and Brown began to deteriorate as early as 1969. In 1971, Connor sold his shares to the corporation, which shares were converted to treasury stock. This gave Brown and Mitchell, the only remaining shareholders, an equal number of shares in the corporation. Their relationship clearly worsened after Connor's departure. Brown alleged that Mitchell refused to talk to him and that an intermediary was necessary to communicate information between the two. Mitchell disagreed, stating that they continued to speak to each other. Mitchell was further under the impression that Brown, who was president of the corporation, was not doing an adequate job.

In 1972, an individual named Armstrong, who was executive vice-president of the corporation, resigned. Mitchell, believing that the company would be in serious trouble without the business acumen of Armstrong, demanded that his shares be purchased. The corporation agreed to purchase the stock but Mitchell did not agree with the appraisal of the value of the company. Mitchell filed suit on this matter, which eventually resulted in a settlement. The settlement agreement included a covenant not to compete clause which was more restrictive than the one found in the 1966 agreement. The second covenant not to compete clause forbade Mitchell from financing competitors of the corporation for five years. There was never any discussion concerning the allocation of any part of the purchase price as payment for the covenant not to compete.

The corporation realized a net operating loss in 1972 and carried this back to 1970 and 1971 and carried it forward to 1973 and 1974. It was around 1972 that the corporation's accountants noticed the covenant not to compete in the 1966 agreement. They believed that a certain amount of the purchase price of Connor's stock, as well as Mitchell's stock, should have been allocated to the covenant not to compete. Mitchell and Brown therefore allocated $60,000 out of the total purchase price to Connor of $600,000 as payment for the covenant not to compete. The corporation also allocated $155,000 out of a total purchase price to Mitchell of over $1,200,000 as payment for a covenant not to compete. Both these amounts were amortized pursuant to the federal tax laws. Additionally, the corporation deducted its payments to Mitchell as ordinary and necessary business expenses under 26 U.S.C. § 162. After disallowance of these deductions by the Internal Revenue Service, Markham and Brown filed two complaints in federal court. The first complaint involved its tax returns of 1970 and 1971. The second complaint concerned the tax years of 1973 through 1975. After losing in the district court and filing its notices of appeal, this court consolidated the two cases.

Expenses incurred in connection with the acquisition of corporate stock are usually nondeductible capital expenditures. Woodward v. Commissioner of Internal Revenue, 397 U.S. 572, 575, 90 S.Ct. 1302, 1304, 25 L.Ed.2d 577, 581 (1970); Jim Walter Corp. v. United States, 498 F.2d 631, 638 (5th Cir. 1974). An exception to this rule is found in Five Star Manufacturing Co. v. Commissioner of Internal Revenue, 355 F.2d 724 (5th Cir. 1966). In that case, two individuals, Kincade and Smith, purchased a patent for Five Star and later were sued by the inventor of the patent for failure to pay royalties. The apparent troubles of Five Star were attributable to the actions of Smith. The inventor agreed that Five Star could continue to use the patent provided that Smith would not be involved. Since the...