Pine State By-Products, Inc. v. C. I. R., 062673 FEDTAX, 2276-71

Docket Nº:2276-71, 2277-71.
Opinion Judge:SCOTT, Judge:
Attorney:Gerald Gillerman and Steven R. Kaye, for the petitioners. A. W. Dickinson, for the respondent.
Case Date:June 26, 1973
Court:United States Tax Court

32 T.C.M. (CCH) 665







Nos. 2276-71, 2277-71.

United States Tax Court

June 26, 1973

Gerald Gillerman and Steven R. Kaye, for the petitioners.

A. W. Dickinson, for the respondent.


SCOTT, Judge:

Respondent determined a deficiency in the income tax of petitioner Pine State By-Products, Inc., in the amount of $15,287.67 for the taxable year ended December 31, 1967, and determined a deficiency in the amount of $3,940.74 in the income tax of petitioner York County Rendering Co. for its fiscal year ended January 31, 1968.

The issues for decision are (1) whether a $10,000 payment made by Pine State By-Products, Inc., to Roger Spada is deductible as amortization of a covenant not to compete under section 167, I.R.C. 1954, and (2) whether payments made by York County Rendering Co. to John P. Martin and Augustus Barber, pursuant to an agreement entitled a consulting and advisory contract, are deductible by that company as salaries under section 162(a) of the Code.


Some of the facts have been stipulated and are found accordingly.

Pine State By-Products, Inc. (Pine State), a corporation organized in 1965 under the laws of the State of Maine, had its principal office at South Portland, Maine, at the time it filed its petition in this case. Pine State engaged in the rendering business. Pine State filed its Federal income tax return for the taxable year 1967 with the district director of internal revenue in Augusta, Maine.

York Rendering Co. (York) which was also engaged in the rendering business, was organized under the laws of the State of Maine. Its office was located in South Portland, Maine at the time it filed its petition in this case. York filed its Federal income tax return for its fiscal year ended January 31, 1968, with the district director of internal revenue in Augusta, Maine.

Since its incorporation, Pine State has been engaged in the rendering of several types of byproducts. It converts fish hyproducts, known as gurry or cuttings, which are left over after the fish are filleted, into fish meal and fish oil. It converts fat, meat and bone byproducts which are picked up from wholesale butchers and from butcher stores into meat meal and tallow. It converts poultry byproducts, which are the poultry offal, or the innards of chickens, and chicken feathers, into feed products called poultry byproduct meal, poultry oil, and a feather meal. All these products are high protein supplements used by the animal feed industry.

Upon its organization in 1965, Pine State was owned one-third by its then vice president and general manager, Abraham Levovitz; one-third by Maplewood Poultry Company, Belfast, Maine; and one-third by Hillcrest Poultry Company, Lewiston, Maine. The two latter were in the business of processing chickens and purchased Pine State's products indirectly, through new England Feed Company, which they owned.

York was organized in 1962 by Augustus Barker, President of Barber Beef and Poultry Company, and John P. Martin, president of Martin Foods, a grocery supermarket chain, both of Portland, Maine. In 1962, the owner of the rendering business to which Martin and Barber sold the byproducts from their respective businesses had died, and another company, Consolidated Rendering (Consolidated) took over the territory. Dissatisfied with Consolidated's prices, Martin and Barber decided to start a rendering company of their own. They each became 25 percent owners in the newly formed company, York. The remaining 50 percent of York's stock was acquired by Roger Spada, who was to operate the plant. Barber and Martin were officers of York and large suppliers of raw material to York. However, they generally spent only an hour or so once or twice a week at the York plant.

York purchased second-hand equipment for its plant. This equipment was for use in a batch type of rendering system rather than the modern continuous system. When the batch system is used, the equipment is shut down after each 5,000 pounds is cooked and then that amount is pressed and this process repeated.

By 1966, York and Pine State were competitors in the Portland, Maine area. Pine State had designed and purchased a new type of equipment which provided a continuous rendering system, enabling Pine State to use the same equipment to process fish byproducts, meat byproducts and poultry byproducts without shutting down the cooking operation. At that time, most companies processed each of these separately. The new equipment gave Pine State a capacity to handle much more raw material than it then had available. Levovitz decided to ‘ go out and get’ additional raw material. Pine State approached York's customers and offered to pay them more for raw material than york was paying them. York met any price offered by Pine State and lost none of its customers to Pine State.

York was at this time handling about 5,000,000 pounds of material per year. In his program to outbid York for the material, Levovitz contemplated offering York's customers a penny a pound more. To meet this competition, it would have been necessary for York to expend an additional $50,000 per year to keep obtaining 5,000,000 pounds of materials a year.

William J. Mendelson, president of Hillcrest Poultry Company (a one-third owner of Pine State) learned of Levovitz's program to outbid York for the latter's customers. He held a meeting in December 1966 with Levovitz and Maxwell Wakely. Wakely, a C.P.A., was tax advisor and independent auditor for Pine State, Hillcrest, and Mendelson. Levovitz's program and its costliness were discussed.

Wakely advised Mendelson that Levovitz's aggressive price campaign was the wrong approach and that the right approach to acquiring York's accounts would be to meet with Martin and Barber and negotiate with them.

Mendelson agreed that Levovitz's program was not a prudent approach, mentioning that he, Mendelson, had close relationships with Martin and Barber. He suggested strongly that, rather than approach the situation as Levovitz had been doing, he and Levovitz should talk with Martin and Barber in an effort to work out an arrangement to acquire the raw material without destroying York. Levovitz agreed to this plan.

Levovitz was of the opinion that Pine State could not make use of York's plant, but that the people who knew York's customers might be of value to Pine State. It was Martin and Barber who had the contacts with York's suppliers. Levovitz discussed with Mendelson whether it would be possible to employ Martin and Barber as a means of keeping the York contacts.

Arrangements were made for a meeting of representatives of Pine State with Martin and Barber. The meeting was held on Thursday, January 12, 1967, at Lowiston, Maine, the headquarters of Hillcrest Poultry Company with Levovitz, Wakely, and Mendelson present on behalf of Pine State.

Levovitz, at the outset, told Martin and Barber that he was not really interested in the purchase of York as a going business because the York plant was of no value to him. He stated that he was only interested in York's contacts and would agree to pay York for its business only the amount that Pine State could realize from disposition of York's physical assets including equipment, land, and building, since Pine State could not use York's assets. Levovitz made an offer of $30,000 for York's plant, including inventory and equipment. Barber's initial reaction was that the offer was very low. He regarded York as a successful business and thought the price for York should be over $100,000. The meeting ended without agreement.

At about this time, barber after a study of York's figures, met with Spada, who had been working at York only Tuesday through Thursday of each week. He unsuccessfully tried to persuade Spada to stay a full week and to undertake a vigorous campaign to compete with Pine State. Martin and Barber then decided to look seriously into the possibility of merging with Pine State. Another meeting was held on Saturday, January 12, 1967, at Portland, Maine between Martin and Barber for York and Mendelson and Wakely for Pine State. Levovitz did not attend. Some progress was made toward an agreement for Pine State to purchase York's business assets.

Upon request of Wakely, Levovitz looked over York's plant, equipment and inventory to determine what Pine State would offer for these assets. Levovitz studied York's balance sheets, especially the balance sheet of March 31, 1967, which showed the following assets and liabilities:

Current assets:
Petty cash $ 25.00
Cash in banks 17,158.93
Accounts receivable-Trade 30,436.53
Accounts receivable-Employee 134.00
Inventroy-(at market) 18,943.68
Inventory-Supplies 893.94
Prepaid insurance 1,693.62
Prepaid auto and truck registrations 950.28 $ 70,235.98
Cash surrender value of life insurance 4,306.80
Fixed assets:
Land 1,895.74
Building $ 48,495.50
Fixtures and equipment 113,481.82
Autos and trucks 41,896.07
Less-Reserves for Depreciation 94,296.94 109,576.45 111,472.19
Goodwill 2,190.58
Current liabiltites
Accounts payable-Trade $11,048.09
Federal income tax payable-(Tax liability 5,142.62
as of January 31, 1967 for year then ended
Accrued and witheld payroll taxes 1,772.98 $ 17,963.69

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