1932 BTA LEXIS 1498">*1498 The Board is unable to determine that the basis for loss on the disposition of an interest in a business was greater than that determined by the Commissioner.
25 B.T.A. 591">*591 The Commissioner determined deficiencies in the petitioner's income-tax liability for the years 1924 and 1925 of $3,132.73 and $599.41, respectively. The assignment of error as to the year 1924 is "that the petitioner was not permitted to take as a deduction from his income a loss which he sustained from the sale of an interest in a partnership." The assignment for 1925 has been disposed of by stipulation.
FINDINGS OF FACT.
The petitioner is an individual residing in New York City. On November 15, 1909, the petitioner and his brother, Sumner Ballard, became partners with D. S. Walton in a firm known as D. S. Walton & Company. The partnership continued the business of importing, manufacturing, and selling on commission and otherwise, paper, bags, packages and other related articles. This business had been in existence for over thirty years prior to November 15, 1909. The partnership1932 BTA LEXIS 1498">*1499 agreement entered into on that date was to terminate at noon on January 1, 1915, unless sooner dissolved. On July 3, 1914, 25 B.T.A. 591">*592 a new partnership agreement was entered into, whereby two sons of D. S. Walton joined the three old partners and a new partnership was to begin January 1, 1915, and to terminate at noon on January 1, 1920. The interests of the partners were the same as previously except that Walton gave each of his sons a one-sixteenth interest in the firm. On January 2, 1920, the same parties entered into a new partnership agreement, to begin January 1, 1920, and to terminate at noon January 1, 1925. The interests in this partnership were the same as in the previous agreement except that the petitioner obtained an additional one-sixteenth interest from his brother. This partnership agreement provided that the petitioner was to receive a salary of $1,500 a month. Each partnership agreement provided for the keeping of true and accurate books and for the payment of interest to each partner on his capital investment. Each agreement also provided that certain real estate, originally owned by Walton and used by the partnership, should remain the separate property1932 BTA LEXIS 1498">*1500 of Walton and not become a part of the property of the partnership.
There was no substantial change in the policy or conduct of the business from 1909 to 1925. Throughout this period the business was prosperous. There was never a distribution of any of the assets of the partnerships. The pfofits increased after 1913 and the assets were increased 25 per cent after 1913.
The partnerships imported a great deal of merchandise, being the second largest importers of wrapping paper in the United States. The merchandise was sold to thousands of customers all over the United States, many of whom had been customers of the partnerships for many years. The reputation of the business conducted by the partnerships was good. The different partnerships at various times entered into contracts with the Union Bag & Paper Company for the exclusive right to sell the articles of that company in New Jersey, New York, and Connecticut. Commissions on the sales of these articles in this territory ranged from $40,000 to $55,000 a year. There was such a contract in effect in 1913. In 1913 the partnership possessed a well known trade-mark, "Lunzoid," on an exclusive line of imported paper. This1932 BTA LEXIS 1498">*1501 trade-mark was registered in the United States and Sweden. The partnerships had the exclusive right to purchase and dispose of this paper in the United States. The books of the partnerships never carried any value for the trade-mark or contracts.
The petitioner was in poor health in the fall of 1924. He took no active interest in the business of the firm after December 24, 1924.
On December 24, 1924, the partners entered into the following contract:
The undersigned. D. S. Walton and R. L. Walton, hereby agree to pay to Charles W. Ballard and Sumner Ballard the sum of $106,000 in full settlement 25 B.T.A. 591">*593 and liquidation of all their right, title and interest in and to the assets of the firm of D. S. Walton & Co., a co-partnership, and to assume all the liabilities of the said co-partnership as of January 1, 1925. All the right, title and interest of the said Ballards in and to the said assets of every kind, nature and description, including name and good will and trademarks, is included, and the undersigned agree to assume all liabilities of the firm of D. S. Walton & Co. as existing on January 1, 1925, or to exist hereafter. Payment to be made in New York funds on1932 BTA LEXIS 1498">*1502 January 3rd, 1925, at New York City. Formal releases to be exchanged between the respective members of the said co-partnership, and bills of sale executed by the said Ballards on January 1, 1925. And the said Charles W. Ballard and Sumner Ballard agree to accept said amount.
On January 3, 1925, the following contract was entered into and acknowledged before a notary:
AGREEMENT made and entered into this 3rd day of January, One thousand nine hundred and twenty-five, between DAVID S. WALTON, HAROLD L. WALTON and RUDOLPH L. WALTON, parties of the first part, and CHARLES W. BALLARD and SUMNER BALLARD, parties of the second part.
WHEREAS, heretofore the parties hereto have been copartners in business under the firm name and style of "D. S. WALTON & COMPANY", pursuant to articles of copartnership dated January 2, 1920; and
WHEREAS the said partnership terminated and dissolved by limitation on January 1, 1925; and
WHEREAS said partners are possessed as their partnership property of certain assets, including cash, accounts receivable, merchandise, machinery, tools, equipment, trade marks, trade name and good will, etc.; and
WHEREAS the parties of the first part are desirous1932 BTA LEXIS 1498">*1503 of acquiring and obtaining all the interest of the parties of the second part in and to the said copartnership assets, and are to assume all the liabilities of said copartnership.
Now, THEREFORE, this agreement witnesseth that for and in consideration of the sum of One hundred and six thousand ($106,000) dollars paid by the parties of the first part to the parties of the second part, receipt of which is hereby acknowledged, and of the covenants herein contained, the said parties hereto agree as follows:
1. That the aforesaid partnership is hereby dissolved.
2. That the said parties of the second part have bargained and sold and by these presents do grant and convey unto the parties of the first part, their successors, administrators and assigns, the assets of said copartnership, including good will, trade name and trade marks, all monies in bank, accounts due or to become due, merchandise, machinery, and all assets of any and every kind, nature and description whatsoever, belonging to the said copartnership, and in consideration thereof the parties of the first part jointly and severally hereby agree to assume, pay and satisfy or cause to be paid and satisfied all debts and1932 BTA LEXIS 1498">*1504 other liabilities of the copartnership hereby dissolved as the same may now exist or which may hereafter exist.
3. The parties of the first part shall have the sole right to endorse or otherwise use the copartnership name in order to transfer or collect any checks or other obligations for the payment of money.
4. The said parties of the first part hereby release the parties of the second part, and the parties of the second part release the parties of the first part from all accounts, claims and demands relating to said copartnership and from all causes of action, agreements, matters or things arising out of or contained 25 B.T.A. 591">*594 in the said agreement of copartnership dated January 2, 1920, and from and by reason of any other matter, cause or thing whatsoever from the beginning of the world up to and including the date hereof, except that this release shall not prejudice or affect any of the covenants, agreements or provisions herein contained, or the rights or remedies of the respective parties hereunder.
The petitioner was paid and received his salary of $18,000 for the calendar year 1924. The books of the partnership were kept on the basis of a fiscal year ending July1932 BTA LEXIS 1498">*1505 31.
The petitioner made his return for the calendar year 1924 on an accrual basis and in it reported salary from D. S. Walton & Company for that year in the amount of $18,000 and took a capital loss of $24,375, representing a loss claimed on the sale of his interest in the partnership. The respondent denied this deduction and added to the petitioner's gross income for 1925 the sum of $4,500 as his share of the profits of the partnership profits for the six months ended January 1, 1925.
The following facts were stipulated:
1.
The petitioner, Charles W. Ballard had a cash investment in the copartnership of D. S. Walton and Company on March 1, 1913 of forty thousand dollars ($40,000.00) representing an interest in the firm of twelve and one-half per cent (12 1/2%), such interest in tangible assets having a fair market value as at that date of $40,000.00.
2.
On January 2, 1920, the petitioner acquired from his brother Sumner Ballard an additional six and one-quarter per cent (6 1/4%) interest in the firm of D. S. Walton & Company for the sum of twenty-five thousand dollars ($25,000.00) paid in cash. Six and one quarter (6 1/4%) of the book value of net tangible assets1932 BTA LEXIS 1498">*1506 on the partnership books as at January 2, 1920 amounted to approximately $25,000.00.
3.
At the date of sale by the petitioner of his interest in the copartnership, his interest had been further increased by the sum of fourteen thousand five hundred dollars ($14,500.00) representing his undistributed share in firm profits credited to his capital account. Of this amount, ten thousand dollars (10,000.00) represents profits taxed for Federal income tax in 1914 which were credited to the petitioner's account during the fiscal year ended July 1, 1914 and left in the business. The remainder, four thousand, five hundred, dollars ($4,500.00) represents petitioner's share of firm profits for the period ended January 1, 1925 which the respondent has included in the petitioner's taxable income for 1925.
4.
The basis, to be used, exclusive of any goodwill value, for the computation of gain or loss on the sale of petitioner's interest, for Federal income tax purposes is $79,500.00 consisting of cash investment by petitioner of $65,000.00 and his share of accumulated profits amounting to $14,500.00.
25 B.T.A. 591">*595 5.
At the date of sale, the petitioner held an interest in the firm1932 BTA LEXIS 1498">*1507 equal to eighteen and three-quarter percent (18 3/4%) for which the petitioner received from D. S. Walton, Harold F. Walton and Rudolph F. Walton as and for his share and interest, the sum of Seventy-nine thousand, five hundred dollars ($79,500.00).
6.
The net profits of the partnership of D. S. Walton & Company for the period July 1, 1909 to February 28, 1913, after deducting all expenses, including salaries of partners and depreciation were:
| July 1, 1909 to July 1, 1910 | $56,643.89 |
| July 1, 1910 to July 1, 1911 | 42,099.40 |
| July 1, 1911 to July 1, 1912 | 86,139.73 |
| July 1, 1912 to Feb. 28, 1913 | 82,922.07 |
| Total net profits | $267,805.09 |
or an average net profit for such period of $73,036.84.
The value of the net tangible assets of the partnership for the period July 1, 1909 to February 28, 1913 was $350,000.00 for each year or an average of $350,000.00 for the entire period.
OPINION.
MURDOCK: The petitioner contends that he sold his interest in the partnership of D. S. Walton & Company in 1924 and thereby suffered a loss. In his return he took a deduction of $24,375 representing this loss. In the petition he claims that the loss amounted to $28,417.10, 1932 BTA LEXIS 1498">*1508 while in his brief he computes the loss at $37,530.70. In his computations the amount of the loss depends upon the March 1, 1913, value of his share of the intangible assets of the firm. The Commissioner not only denied the loss, but he also denied that the sale occurred in 1924. The parties have stipulated that the petitioner on March 1, 1913, had in the firm then existing a cash investment of $40,000, representing a one-eighth interest, and that such interest in the tangible assets had a fair market value at that date of $40,000. The petitioner has sought to prove in addition that his one-eighth interest had a fair market value on March 1, 1913, in excess of $40,000.
The partnership which existed on March 1, 1913, was not the same partnership that existed in 1924 and up to noon of January 1, 1925. Several partnership agreements had been entered into in the meantime. The business carried on by these various partnerships had remained much the same. There might be some question as to whether the March 1, 1913, value has any bearing upon the present question of the gain or loss from the sale in 1924 or 1925, although it is possible that the petitioner, after March 1, 1913, made1932 BTA LEXIS 1498">*1509 a number of nontaxable exchanges so that the fair market value of what he owned 25 B.T.A. 591">*596 on March 1, 1913, is the basis for gain or loss upon the sale of what he had at the end of 1924. The petitioner contends that the value of the good will and other intangible assets on March 1, 1913, had dwindled to nothing and disappeared by the time the petitioner sold his interest in the firm. If this were true it might raise some other questions. Since, however, we can not determine the basis, it becomes unnecessary to decide any other question, including the question of when the sale took place. We are satisfied, however, that the sale did not take place in 1924. ; ; affd. sub nom. ; Williston on Sales, 2d ed., vol. 1, p. 1. Cf. ; affd., ; . The petitioner has not sought any relief in case we find that the sale took place in 1925.
The petitioner1932 BTA LEXIS 1498">*1510 was the only witness. He gave his opinion as to the fair market value on March 1, 1913, of the intangible assets of the firm which existed on that date. But the basis for his opinion and the method of reasoning used by him in arriving at this opinion were such as to cause his own counsel to admit that his opinion was worthless and should be ignored. We agree that his opinion should be disregarded. . He testified, however, as to certain facts and other facts were stipulated. His counsel argues that the only method available for the computation of the fair market value of the good will of the partnership on March 1, 1913, is by use of a formula described as the third method in A.R.M. 34, C.B. No. 2, p. 31. This memorandum discloses that the Committee found itself unable to lay down any general rule for the determination of the fair market value of intangibles. It only suggested the method as one which might be utilized broadly to check upon the soundness and validity of a taxpayer's claims. To apply the formula, average earnings for a period prior to March 1, 1913, preferably not less than five years, were1932 BTA LEXIS 1498">*1511 required. Abnormal years should be eliminated. There were variables in the formula suggested which depended upon circumstances. The memorandum concluded as follows:
In any or all of the cases the effort should be to determine what net earnings a purchaser of a business on March 1, 1913, might reasonably have expected to receive from it, and therefore a representative period should be used for average actual earnings, eliminating any year in which there were extraordinary factors affecting earnings either way. Also, in the case of the sale of good will of a going business the percentage rate of capitalization of earnings applicable to good will shown by the amount actually paid for the business should be used as a check against the determination or good will value as of March 1, 1913, 25 B.T.A. 591">*597 and if the good will is sold upon the basis of capitalization of earnings less than the figure above indicated as the ones ordinarily to be adopted, the same percentage should be used in figuring value as of March 1, 1913.
It will be noted at the outset that all of the sales of interests in the partnerships in this case of which we have any knowledge were made at book value, which1932 BTA LEXIS 1498">*1512 included nothing for intangibles. Earnings for a period of only three years and eight months prior to March 1, 1913, have been shown. In this short period the earnings fluctuated greatly, but we have not been told whether or not the period included any abnormal year. Furthermore, our knowledge of the risks of the business is not sufficient to enable us to determine intelligently the percentages to be used in applying the formula. Cf. ; ; affd., ; certiorari denied, . If we were to use the formula we would not know what part of the average earnings to attribute to the tangibles or what additional part, if any, to attribute to good management, location, firm name, and the presence and activity of the partners themselves in the business. Fair market value has been defined as the price likely to be agreed upon by a willing buyer and a willing seller, neither forced to buy or sell, but both having knowledge of the facts. Had the petitioner sold his interest on March 1, 1913, his connection with the business would have1932 BTA LEXIS 1498">*1513 ceased together with any benefit which the business had theretofore derived from such connection. We do not know that the amount designated "salary" was a proper measure of his value to the business of the firm. The partnership agreement in effect on March 1, 1913, was to remain in effect only until noon of January 1, 1915. A purchaser of the petitioner's interest on March 1, 1913, would not only have taken into consideration this circumstance, but also the fact that the partnership would have been dissolved immediately by the petitioner's withdrawal from the firm. The location of the business, the name of H. S. Walton, and the benefit of Walton's association with firm might all have been lost to a prospecitve purchaser on March 1, 1913. We do not know how valuable to the firm was the location at which it transacted its business or the name under which it transacted its business, but the location and the name gave little value to the petitioner's interest on March 1, 1913, since Walton could have used both after the partnership then existing was dissolved. We do not know how valuable Walton was to the firm, but if any part of the earnings over and above the normal return on tangibles1932 BTA LEXIS 1498">*1514 was attributable to Walton, such value would have to be discounted in determining the fair market value of the petitioner's interest on March 1, 1913. Cf. . A purchaser of the petitioner's 25 B.T.A. 591">*598 interest on March 1, 1913, would have realized that he could gain nothing from any intangible asset such as good will unless he should be permitted to share in some way in a continuation of the going business. He would know also that in a partnership there is delectus personae. Thus, the value of the intangibles, in his opinion, would have depended to a very large extent upon the willingness or unwillingness of the other partners to accept him as a member of the new firm to carry on the business. This feature of a partnership makes any valuation extremely difficult. Walton and the petitioner had been associated with the business for many years prior to March 1, 1913; the firm enjoyed a good reputation in the trade; and the average earnings for the period of three years and eight months prior to March 1, 1913, probably exceeded a normal return on the tangible assets of the firm. Nevertheless, we are unable to determine from1932 BTA LEXIS 1498">*1515 the facts in the record that the petitioner's one-eighth interest in the partnership had a value on March 1, 1913, in excess of $40,000. That is, we can not translate any excess earnings of the firm into value of the petitioner's interest.
The petitioner contends that the firm also had valuable contracts on March 1, 1913, particularly one with the Union Bag & Paper Company. He was quite vague as to the date, duration, and terms of the contract with the Union Bag & Paper Company in effect on March 1, 1913, but it seems to have been for a short term. So far as we can see it was entered into at arm's length and we can not find any justification for concluding that it gave the partnership any more than fair compensation for services rendered. The petitioner claimed that neither his original acquisition of a partnership interest nor his final disposition of his partnership interest was an arm's-length transaction which would indicate the fair market value of the subject matter. He stated that he acquired his interest at a very low price because Walton was anxious to have him continue in the business, and he sold out at a very low price because of ill health. It appears, however, 1932 BTA LEXIS 1498">*1516 that the petitioner's brother acquired his interest at the same time the petitioner acquired his and that the brother sold at the same time the petitioner sold, but there is no reason to believe that Walton made any reduction in price in order to get the brother to come into the firm. The brother did not sell his interest because of ill health. The books never reflected any value for intangibles and, as we have heretofore pointed out, each of the sales of interests in the partnerships was made at book value. We are unable to say that the basis for gain or loss from the sale of the petitioner's interest was any larger than the amount determined by the Commissioner. The latter made an alternative contention in case we disturbed his determination as to either year. Since we do not disturb his determination 25 B.T.A. 591">*599 as to either year, we need not discuss this alternative contention.
Judgment will be entered for the respondent.