*2086 1. Cost of a contract and an exhaustion allowance based thereon determined.
2. Ira L. Henry Co. followed in regard to the year in which Wisconsin taxes may be deducted.
*256 The Commissioner determined a deficiency of $63.61 in the petitioner's income-tax liability for the calendar year 1922. The petitioner assigns as errors (a) the failure of the Commissioner to allow as a deduction 20 per cent of the cost to the petitioner of a certain contract with Martin Christensen, that the latter would not compete in any way with the petitioner for a period of five years and would hold his services for certain purposes available to the petitioner for a like period; (b) failure of the Commissioner to allow as a deduction an amount of $987.73 for the Wisconsin state income taxes accrued within the year.
Counsel for the parties entered into a stipulation which we have incorporated in our findings of fact.
FINDINGS OF FACT.
The taxpayer, the Christensen Machine Company, was incorporated under the laws of the State of Wisconsin in the year 1912.
*2087 The said taxpayer corporation is at present, and was at all times herein material, engaged in the business of manufacturing and selling book stitcher feeding machinery and machinery and devices adapted for use in connection with the book stitching operation.
On February 21, 1920, the taxpayer's outstanding capital stock had a par value of $25,000.00. Based upon all of the assets of the company the book value of its stock was $206.38 per share, on February 21, 1920. The par value was $100.00 per share. Of the outstanding stock, one, F. J. Greene, owned $12,500.00 par value and one, Martin Christensen, owned a like amount of the same par value.
On February 21, 1920, the Christensen Machine Company, F. J. Greene and Martin Christensen entered into a contract, a copy of which will be introduced *257 into the record as petitioner's Exhibit "A," under which there was paid to Martin Christensen the sum of $60,000.00 in consideration of the following engagements on the part of the said Martin Christensen: (a) that he would transfer to the Christensen Machine Company his stock of the par value of $12,500.00, as aforesaid; (b) that he would abstain from competing with the*2088 taxpayer for a period of five years from February 21, 1920; (c) that he would assist the taxpayer in perfecting its applications and expected applications for patents and in perfecting the patents themselves; (d) that he would undertake the invention of new machines should the machines owned by the taxpayer be found to infringe upon prior patents issued to others. It was provided in the contract that all expenses in connection with the engagements referred to in clauses (c) and (d) above should be borne by the taxpayer.
Pursuant to the contract and the payment thereunder of $60,000.00 on February 21, 1920, the said Martin Christensen transferred his certificates of stock representing the ownership of shares with a par value of $12,500.00, and abstained from competing with the taxpayer for the specified five year period.
Of the sum of $60,000.00 paid to the said Martin Christensen, the portion representing the fair market value of the stock on February 21, 1920, was in consideration of the 125 shares of stock in the taxpayer corporation. The remainder of the $60,000.00 was paid in consideration of Martin Christensen's agreement not to compete and to render taxpayer such services*2089 as it might possibly require to clear its patents.
During the year 1925 at about the time of the expiration of the aforesaid five year contract, the said Martin Christensen threatened to engage in business in competition with the taxpayer, whereupon a second contract was entered into pursuant to which the sum of $11,000.00 was paid to Martin Christensen by the taxpayer specifically in consideration of the former's agreement not to compete for a further period of fifteen years.
The respondent in his deficiency notice from which this appeal was taken allowed no portion of the aforesaid $60,000.00 payment under the contract as a deduction from the taxpayer's gross income for the year 1922.
The following taxes were imposed by the State of Wisconsin upon the taxpayer's net income for the year 1922:
| Income tax | $760.76 |
| Soldiers' educational surtax | 109.28 |
| Teachers' retirement fund surtax | 114.29 |
| Total | 984.33 |
The taxpayer paid the soldiers' educational surtax and the teachers' retirement fund surtax in full in the year 1924. Of the income tax, the taxpayer paid in 1924 the sum of $638.71, the balance of $122.05 being credited with the amount of personal property*2090 tax paid.
In his notice of deficiency the respondent has not allowed any portion of the Wisconsin taxes described in paragraph "9" above as a deduction from the taxpayer's gross income for the year 1922.
The taxpayer maintained its books of account, and reported income during all years herein material, upon the accrual basis.
Fred J. Greene has been president of the petitioner since its incorporation. He drew no salary from it until 1919. Martin Christensen developed and invented certain machinery to be used in connection with the binding of books. He had some of these machines *258 manufactured at Greene's machine shop. Thereafter, these two men formed a partnership for the manufacture of these machines. Christensen had all the dealings with the trade, and Greene's connection with the business was to advance capital from time to time and to manufacture the machines at his machine shop. In 1917 the petitioner bought its own machinery and equipment, rented space in a building owned by Greene, and Christensen from then on had full charge of the sales and of the manufacture of the machines.
In 1912 they formed the petitioner corporation and each took one-half*2091 of its stock. They held this stock in this proportion until February 21, 1920, when the petitioner for and on its own account, paid Christensen $60,000 in accordance with the terms of the contract above mentioned, and thereafter Christensen had no further connection with the petitioner or with its business, and was never afterward called upon to do anything for it under the contract. Christensen's stock was thereafter held as treasury stock. There were no other sales of the petitioner's stock in February, 1920. No other offers were ever made to buy or sell stock in the petitioner.
Beginning in 1915 and running through 1916 and 1917, a new machine was produced by a competing company which was superior to the machines manufactured by the petitioner and which threatened to completely destroy the business of the petitioner. Christensen then started work on the invention of a new machine, which he completed in the latter part of 1918. The petitioner began to make deliveries on this machine in the last month in 1918, and then made regular deliveries on it through the year 1919, selling 70 of the machines. During 1919 it made no other machines. From January 1, 1920, to February 21, 1920, it*2092 sold about 15 of the new machines.
In 1919 some disagreement arose between Greene and Christensen, as a result of which the contract of February 21, 1920, was entered into. At this time Greene was not known to the trade, neither was he in close touch with the manufacturing end of the petitioner's business. Christensen was the petitioner's only salesman and demonstrator. Up to this time Greene had only devoted about one-third of his time to the petitioner's business.
The petitioner's income for the various years was as follows:
| Year | Income |
| 1912 | $1,120.65 |
| 1913 | 3,691.66 |
| 1914 | 4,693.07 |
| 1915 | 1,242.75 |
| 1916 | 1,029.21 |
| 1917 (loss) | 368.07 |
| 1918 | 3,963.50 |
| 1919 | 18,731.49 |
*259 The value of its tangible assets on various dates prior to February 21, 1920, was as follows:
| December 31, 1916 | $11,852.02 |
| December 31, 1917 | 24,767.69 |
| December 31, 1918 | 31,479.59 |
| December 31, 1919 | 90,531.18 |
Its balance sheet as of December 31, 1919, was as follows:
| Assets | Liabilities and capital | ||
| Cash | $6,344.25 | Accounts payable | $23,284.08 |
| Accounts receivable | 48,022.28 | Bills payable | 21,899.98 |
| Bills receivable | 3,520.00 | Accrued wages | 3,263.64 |
| Inventory | 10,004.52 | Accrued State income tax | 327.34 |
| War savings stamps | 841.26 | Accrued Federal income taxes | 3,457.75 |
| Machinery | 11,674.19 | Depreciation reserve | 7,423.64 |
| Shop equipment | 1,200.54 | Capital stock | 25,000.00 |
| Power equipment | 1,347.33 | Surplus | 17,378.25 |
| Jigs and dies | 3,663.35 | ||
| Patterns | 7,324.51 | ||
| Patents | 3,079.86 | ||
| Drawings | 918.53 | ||
| Office furniture & fixtures | 500.85 | ||
| Small tools | 3,593.21 | ||
| Total | 102,034.68 | Total | 102,034.68 |
*2093 The fair market value on February 21, 1920, of Christensen's stock in the petitioner of the par value of $12,500 was not more than $30,000.
OPINION.
MURDOCK: There is clear and convincing evidence in this case that by the contract of February 21, 1920, the petitioner secured two things of considerable value - one was 125 shares of its stock, and the other was Christensen's agreement to refrain from engaging in the book stitcher machine business for a period of five years. The other engagements of Christensen were only incidental and precautionary so far as Greene and the petitioner were concerned.
There were no sales, no offers or bids to guide us in determining the value of the stock, and yet probably all of the available evidence which might help us to determine this value has been presented. The petitioner contends that the fair market value of the stock was not in excess of its book value of $25,797.50. Earnings of the company up to 1919 probably do not indicate a higher value, but 1919 was a banner year and on February 21, 1920, the prospects for business in 1920 were good. On the other hand, Christensen was leaving. He had been the most important person in the*2094 business. He had invented the machines, he had manufactured them and had sold them. Greene knew but little about conducting the business, but before he agreed to the purchase of this stock, which was to make him sole owner of the corporation, he made an extensive investigation *260 to learn just what he would have, how much he could reasonably expect to make out of it and how much the stock was worth. He then came to the conclusion that if Christensen would agree not to compete for five years, the stock would be worth about its book value. He was of the opinion that without such an agreement the business in his hands would be a failure. There had been competition in the past, the market was small, and Christensen was in a splendid position to compete, for he knew more about the business than anyone else. We believe that it is fair and just to allocate one-half of the $60,000 to each of the two principal things purchased.
We have now found that the petitioner paid $30,000 for Christensen's agreement not to compete for a period of five years, but the question remains whether or not the petitioner is entitled to deduct a reasonable amount representing the exhaustion of*2095 this contract as property used in a trade or business. This question is one that is not altogether free from doubt. In a number of cases the Board has not allowed deductions for somewhat similar contracts, but in each instance it was either because the cost of the contract had not been proven or because the contract had an indefinite life. See ; ; ; . , is a case closely analogous to the present one. There, the petitioner paid $200,000 to two individuals to secure their resignation as trustees and thus permit him to have the sole control and management of the trust estate, of which he was the sole beneficiary. At that time the trust was to continue for twelve years, and although the life expectancy of one of the trustees was at least twelve years and the life expectancy of the other was only 5.1 years, and although the one whose life expectancy was twelve years died within five years and the one whose life expectancy was*2096 5.1 years lived much longer and was still living at the time of the hearing, the petitioner was allowed to deduct one-twelfth of $200,000 in the year before the Board. We there said:
What the taxpayer gave $200,000 for in 1919 was the right to exercise exclusive control of all the properties which might remain in the trust from 1919 until 1931 when the trust would terminate. He was interested in acquiring this right without regard to the possibility that one or both of the trustees might die, or, for reasons of their own, resign before 1931, and without regard to the fact that there was a likelihood of his being in control of some of the corporations before 1931. He bought a right - which, except for the purchase of it, he might never have acquired - to act as sole trustee without any interference by any other trustee over a period of 12 years, and we think the investment thus made is properly recoverable by him out of income over the entire 12-year period, and not over any shorter period.
*261 The petitioner for $30,000 secured Christensen's agreement that he would not compete for a period of five years. It thus obtained the right to conduct its business free from*2097 Christensen's competition during a period when it was not in a strong position. This was a valuable asset in the hands of the petitioner, the benefits of which would continue over a period which would not necessarily be coextensive with the five-year period provided in the agreement. To illustrate, the petitioner in two years' time might have so strengthened its position that Christensen's competition could not affect it, or in the five years it might have so strengthened its position that as a consequence for one or more years thereafter Christensen's competition would be less severe than it otherwise would have been. The fact remains, however, that as each year passed, the time was that much nearer when the benefits derived from the contract would be completely exhausted. We will not attempt to give an opinion as to when that time would be, but it is our opinion that $6,000 is a reasonable allowance for the exhaustion of the property in question for the taxable year which is before us.
The question of the deductibility of the taxes imposed by the State of Wisconsin upon the petitioner's net income for the year 1922 is similar to the question which was decided by this Board*2098 in . Following the reasoning in that case. our judgment on this point is for the petitioner.
Judgment will be entered under Rule 50.