Ullman v. CIR

Decision Date04 March 1959
Docket NumberDocket 25068-25071.,No. 103-106,103-106
PartiesDavid H. ULLMAN and Claire W. Ullman (husband and wife), Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. David H. ULLMAN, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Benjamin ULLMAN, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Benjamin ULLMAN and Anna Ullman (husband and wife), Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Court of Appeals — Second Circuit

Philip A. Brenner, New York City (Philip A. Brenner, Julius Kuschner, of counsel), for petitioners.

Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Melva M. Graney, Joseph Kovner, Attorneys, Dept. of Justice, Washington, D. C., for respondent.

Before CLARK, Chief Judge, WATERMAN, Circuit Judge, and GALSTON, District Judge.

WATERMAN, Circuit Judge.

Petitioners appeal from a decision of the Tax Court, 29 T.C. 129, upholding a determination by the Commissioner that $350,000 received by petitioners and another in connection with the sale of the capital stock of three linen supply corporations was received by them in consideration for their covenants not to compete with the purchasers, and hence was taxable as ordinary income. The facts are fully set forth in the Tax Court's opinion, and we state only those we deem necessary for the purpose of disposing of the questions presented to us.

Petitioners David Ullman and Benjamin Ullman together with their brother Richard (not a party to this appeal) had been engaged in the operation of a number of laundries and linen supply companies for some years when they began negotiations in August 1945 to sell to Consolidated Laundries Corporation the entire capital stock of three linen supply companies of which they, in varying proportions, were the sole stockholders.1 About a year later, on August 8, 1946, written agreements of purchase and sale were entered into. The sale of the corporate stock in each of the three companies was the subject of a separate agreement and the sums that Consolidated paid in each case were paid to the Ullmans in direct proportion to their respective stock interests in each corporation. Each agreement provided that a sum of money, to be paid over at the time of closing, represented the sale price of the corporate stock. Each agreement also provided that an additional sum of money, one-fifth of which was to be paid at closing, two-fifths payable in 1947, and two-fifths payable in 1948, was being paid in consideration of agreements on the part of the Ullmans to execute and deliver to Consolidated covenants not to compete with Consolidated.2 On the same day, August 8, 1946, each of the Ullmans executed a separate agreement labeled "Restrictive Covenant" containing several carefully delineated commitments on each of their parts. These commitments included promises that for a period of seven years within competitive areas the Ullmans would not solicit present or former customers of the linen supply companies Consolidated was acquiring that day, and would not assist financially, engage in, or be interested in any similar business that could compete with the linen supply companies so being acquired, or with Consolidated itself; provided, however, that the Ullmans could continue their present stockholdings or connections in six other linen supply companies operating in competitive areas upon condition that these six companies did not solicit customers of the three companies Consolidated was acquiring. Also on the same day, August 8, 1946, the Ullmans executed a document labeled "Guaranties" whereby they agreed, among other things, to pay Consolidated "the sum of thirty dollars per dollar of the weekly average sales for any customer" of the three companies then being sold if such customer should thereafter cease to be such and thereafter received linen services from any one of the six companies in which the Ullmans were permitted to continue to have business interests.

There were other documents also executed on August 8, 1946, some by the three Ullmans and others by an individual Ullman. These are set forth in the Tax Court findings of fact and opinion, but their contents have no direct bearing on the questions before us, except the obvious one that all the documents and agreements executed on August 8, 1946 were part of the same over-all transaction.

Some time after the original negotiations began in August 1945 the parties arrived at a price formula of "forty dollars per dollar of weekly collections from customers taking linen service, such collections being in excess of $2,500 per week." Accountants and financial men acting for the parties were called upon to determine the weekly sales of each of the linen supply corporations, the manner in which the total sums Consolidated was to pay were to be allocated among the different companies sold, and the details of the payments to the stockholders. Their computation resulted in a round figure of approximately one million dollars to be paid to the stockholders of the Ullman corporations. Several weeks before the legal documents relating to the sales transaction were executed the question of assigning a certain amount of money for restrictive covenants came up for consideration. Originally Consolidated wanted $400,000 set aside for this purpose out of the agreed over-all price, but after this was discussed with the sellers this sum was reduced to $350,000. The gross sum the stockholders received under the three purchase agreements that was stated in the agreements to be for the corporate stock was $647,000, all to be paid in 1946. The gross sum the stockholders received that was stated in the three purchase agreements to be received for the covenants not to compete was $350,000, of which $70,000 was paid in 1946, and $140,000 was payable in each of the years 1947 and 1948.

The petitioners treated their shares of the entire $997,000 received from the transaction as the price received for the sale of their capital stock, allocating nothing whatever separately to their covenants not to compete. Consolidated contrariwise recorded $350,000 on its books as a separate expense item attributable to the covenants and amortized this cost over a seven-year period.

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 amortizable item for the covenantee unless the covenant is so closely related to a sale of good will that it fails to have any independent significance apart from merely assuring the effective transfer of that good will.3 Petitioners do not contest the soundness of that rule. They insist to us that the Tax Court's determinations that the covenants were separate items apart from the transferred good will and that the $350,000 was given in specific payment therefor were clearly erroneous. They argue that the price of the covenants as stated in the contract was simply a fictitious allocation designed to benefit the tax position of the buyer, the true value of the covenants being inconsequential or at least being much less than the $350,000.

The burden of proof in the Tax Court...

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