*911 Contracts for the purchase of competitors' businesses included convenants to refrain from competition for definite periods. Upon the proof of the relative value of those covenants to other properties acquired under the contracts, it is held that an equal portion of the total price paid in each case is exhaustible over the period during which the covenant to refrain from competition was effective.
*693 In this proceeding petitioners contest a deficiency in income tax determined by the respondent in the amount of $732.36 for the calendar year 1930 and claim an overpayment in the amount of $6,806.90. The sole issue is whether the petitioners, who purchased the businesses of three competitors, are entitled to deduct an allowance for depreciation with respect to amounts alleged to have been paid for trade brands and trade-marks and for the vendors' agreements to refrain from competition for a period of years.
FINDINGS OF FACT.
B. T. Babbitt, Inc. (New York), is a New York corporation having its principal office at 386 Fourth Avenue, New*912 York City. B. T. Babbitt, Inc. (Delaware), has its principal office in the State of Delaware and is a subsidiary of the New York corporation.
Petitioners (hereinafter referred to as "Babbitt") are manufacturers and packers of lye, and related products, sold throughout the United States. Lye is not manufactured under any secret formula and is not a patented article. Prior to 1922 the trend in the volume of lye sales was upward. The peak year was 1922, and thereafter both the volume of sales and the price decreased. The decrease in the Babbitt brands is shown by the following tabulation, in which 100 is used as the volume of sales index figure for 1922.
| Year | Volume of sales | Average sale price per case |
| 1922 | 100 | $4.684 |
| 1923 | 94 | 4.43 |
| 1924 | 94 | 4.138 |
| 1925 | 85 | 4.179 |
| 1926 | 74 | 1 4.168 |
| 1927 | 83 | 3.994 |
| 1928 | 73 | $4.056 |
| 1929 | 72 | 3.99 |
| 1930 | 65 | 3.867 |
| 1931 | 63 | 3.786 |
| 1932 | 60 | 3.541 |
*694 The decrease in sales, which was general throughout the lye industry, was due to several factors. One of these was the increase in production of other substances, such as water softeners, *913 varnish removers, and drain pipe cleaners which perform the same functions as lye and are not so dangerous to handle. Another factor was the increase in the use of aluminum, on which lye can not be used. Another, the statutory requirement of labeling lye with the word "Poison" in conspicuous letters and the requirement of some states that labels bear a skull and cross bones and the word "caustic."
Sales volume in the lye industry is not dependent to any great extent on trade brands or trade-marks. It is largely dependent on the personal contact of the manufacturers with wholesalers of the product.
In order to eliminate competitors from Babbitt's field and also to acquire new territory, thereby bringing up its sales volume, Babbitt entered into several contracts with competitors hereinafter more fully described.
By contract of December 22, 1925, with Harry V. Hall, Jane R. Robbins, and Elizabeth N. Todd, Babbitt acquired the lye business of Hall & Co. and the New York Lye Co. The three individuals named comprised a partnership which operated these two companies. The partnership was the owner of a brand known as "Star Lye."
By agreement dated April 10, 1926, with William*914 Schield and Albert Schield, Babbitt acquired their lye business. These individuals were partners operating under the name of Wm. Schield Mfg. Co. This partnership marketed lye under several trade names, treated herein collectively as the "Schield brands."
By agreement of July 21, 1930, with the J. B. Ford Co., a Michigan corporation, Babbitt acquired the lye business of that corporation.
In each of the above contracts known, respectively, as the Hall, Schield, and Ford contracts, it was provided that the vendor "agrees to sell and Babbitt agrees to buy all the business and the good will of the business", together with all trade-marks, trade names, brands, labels, copyrights, and processes of the vendors. In the Schield contract Babbitt acquired the right to use the name of "Wm. Schield Mfg. Co." solely in connection with the formula "Successor to Wm. Schield Mfg. Co." for a period of five years. In the Schield and Ford contracts Babbitt also acquired dies, plates, and cuts for use in connection with the various brands of the vendors. In each case there was a specific consideration named for the above assets, namely, Hall, $110,000; Schield, $600,000; Ford, $1,150,000. The*915 recited consideration was paid in each case.
Under each contract Babbitt purchased certain merchandise on hand and assumed certain contracts and obligations of the vendors. The consideration for these was separately provided for and is not material here. In each case the vendors agreed to transfer to Babbitt, *695 without charge, all their records and books of account pertaining to the lye business, and in each case Babbitt agreed to use its best efforts to collect outstanding accounts and to account therefor to the vendors.
Each contract contained the further provision "that in consideration of the premises and of the payment by Babbitt of the considerations hereinbefore expressed and for the purpose of enabling Babbitt * * * to acquire * * * and carry on the aforesaid business * * *", the vendors would not, directly or indirectly, except as employees of Babbitt, engage in the lye business. In the case of Hall this restriction was to be effective for 25 years; in the case of Schield, 15 years; and in the case of Ford, 20 years.
In the Schield case, two of the Schield employees had been active in selling lye and Babbitt obtained from them written agreements to refrain*916 from engaging in the lye business for a period of 15 years. In each case Babbitt employed one or more of the salesmen of the vendors. One of the Ford salesmen was employed under a written contract whereby he agreed that in the event of termination of employment by Babbitt he would not engage in the lye or chlorinated lime business for a period of five years.
Babbitt would not have entered into the above purchase contracts without the covenants therein to refrain from competition. In the Schield case the negotiations were at one time brought to a standstill by the refusal of the two Schield employees mentioned above to agree to refrain from competition. Babbitt refused to purchase the Schield business until these employees signed the agreement.
The value of the convenant to refrain from competition in each case represented not less than 85 percent of the value of the business acquired, exclusive of equipment and inventories acquired for separate considerations.
OPINION.
ARUNDELL: The pleadings herein raise issues as to deductions for depreciation and obsolescence of trade brands and trade-marks, and amortization of contracts to refrain from competition. There is no*917 evidence concerning the basis or rate of exhaustion of the trade brands or trade-marks and we assume that issue has been abandoned by petitioner. See , holding that trade-marks and not susceptible of exhaustion by the passage of time, nor wear and tear by use in the business.
Petitioners' present claim is for deductions for the amortization of the contracts to refrain from competition which were part of the agreements whereby the businesses of competitors were acquired. The theory of petitioners is that the convenants to refrain from competition constituted capital assets which had a limited life and that deductions for exhaustion thereof are allowable under section 23(k), *696 Revenue Act of 1928, which provides for the deduction of a "reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence." The respondent's position is that the substance of the contracts was to convey to Babbitt the good will of its competitors and that the element of restraint of competition can not be segregated and separately valued.
*918 The decided cases are to the effect that the cost of eliminating competition is a capital asset. Where the restraint or elimination is for a definite and limited term the cost may be exhausted over such term, ; ; ; ; ; . On the other hand, where the benefits of restraint or elimination of competition are permanent or of indefinite duration, no deduction for exhaustion is allowable. ; affirmed as ; .
It appears on the face of the contracts here that Babbitt acquired several kinds of property, among others, the business, good will, trade-marks, trade brands, processes, licenses, formulae, and covenants to refrain from competition. If we had nothing but these contracts*919 to go on we would agree with the respondent that a segregation can not be made. We have, however, uncontradicted evidence on this phase of the case dealing with it from two angles, namely, the substantial value of the covenants to refrain from competition and the comparatively minor value of the other properties. Three witnesses testified on this subject. One, a certified public accountant whose experience with Babbitt and other lye concerns dates back to 1916. Another, a manufacturer of cleaning products including lye, who is a competitior of Babbitt, chairman of the Code Authority of the Lye Industry, and has been engaged in the lye business since 1915. The third, a lawyer who has been general counsel and a member of the board of directors of Babbitt since 1923 and negotiated the contracts here involved.
The testimony of these witnesses is that trade brands, trade-marks, or labels are of very little value in the lye industry; formulae are of no value because the formula of each brand is required to be printed on the container. Sales are dependent on price and the personal contact of the producer with wholesalers and jobbers. The testimony is that labels and trade-marks*920 can be changed with but little effect on sales if the contact with wholesalers in maintained by the producer. The primary object of Babbitt in entering into the contracts *697 was to eliminate competition and thus enable it to maintain its sales volume. The testimony is directly to the point that Babbitt would not have purchased the businesses of its competitors without the agreements to refrain from competition.
There is but little range in the testimony of the relative values of the noncompetition agreements and the other properties acquired under the contracts. The highest value placed on any of the covenants to refrain from competition is 90 percent of the entire contract price, and the lowest is 85 percent, assigned by one witness to the Hall covenant. Recognizing that this is not a matter susceptible of exact valuation and that there is room for some variation of opinion as to relative values, we are inclined to accept the lower figure given, 85 percent, as representing the relative value of the covenant to refrain from competition. This percentage in our opinion represents a fair allocation of the price paid under each contract for the restraining covenant, and*921 is to be treated as the cost of such convenant. , and As the covenant in each case was for a definite period of years, under the cases above cited, the cost is exhaustible over such periods, namely, 25 years under the Hall contract, 15 years under the Schield contract, and 20 years under the Ford contract.
Decision will be entered under Rule 50.
Footnotes
1. Includes "Star" and "Schield" brands hereinafter mentioned. ↩