*187 Decision will be entered under Rule 50.
Petitioners, and another shareholder, sold all the capital stock of a newspaper for $ 383,572.26. Two contracts of sale were introduced into evidence, alike in all respects except that one allocated $ 100,000 of the total consideration to a paragraph containing a covenant by the sellers not to compete for a 10-year period.
Held, on the facts, the total consideration was paid for the capital stock of the newspaper. The value of the covenant was not bargained for, and it was incidental to the transfer of the newspaper's goodwill.
*527 These consolidated proceedings involve deficiencies in income tax determined against George H. Payne and Madeline Payne for the year 1946 in like amounts of $ 7,009.44. The sole issue is whether the purchaser of a newspaper from petitioners and one Thomas L. Kerney paid $ 100,000 of the total proceeds for an agreement not to compete.
FINDINGS OF FACT.
George H. Payne (hereinafter referred to as petitioner) and Madeline Payne*188 were husband and wife residing in Santa Clara County, California, during 1946. They filed separate income tax returns on the community property basis for that year with the collector of internal revenue for the first district of California.
Petitioner has been in the newspaper business for 30 or more years, as a reporter, national advertising representative, editor, and publisher. In 1943 he found that a newspaper at Marysville, California, called the Appeal-Democrat was for sale. Petitioner and one Thomas L. Kerney (hereinafter referred to as Kerney) purchased the Appeal-Democrat, believing that it had a great potential for growth. They each acquired 50 per cent of the stock of its corporate publisher, Marysville-Yuba City Publishers, Incorporated.
The agreement between petitioner and Kerney provided for the complete operation of the paper by the petitioner, but required that he spend no more than 3 days per week in Marysville. During most of the period in which he managed the paper, petitioner devoted a substantial portion of his time to his duties as Chairman of the California Horse Racing Board. Petitioner continued to reside in his home which is approximately 200 miles *189 from Marysville, a trip of 4 1/2 hours. He did not contemplate moving to Marysville since that area was not agreeable either to him or to his wife.
Kerney resided in Trenton, New Jersey, where he was general manager and part owner of the Trenton Times. Kerney took an inactive part in the management of the Appeal-Democrat. He came out to California no more than four times, for periods of but one to three days, before the paper was subsequently sold in 1946.
The paper prospered, and its earnings for the year 1945, including the salaries of the two owners, were in excess of $ 75,000. The population *528 of Marysville is approximately 7,500, and in 1946 the paper's circulation was over 8,000.
Petitioner and Kerney were approached by one Smith Davis, a newspaper broker, regarding the sale of their paper to one R. C. Hoiles (hereinafter referred to as Hoiles). Hoiles was an experienced newspaper publisher. At the time of trial, he and his family owned 10 newspapers in various parts of the United States.
After preliminary negotiations, petitioner, Hoiles, and Smith Davis met at the offices of the paper on March 15, 1946, to execute the contract of sale. A contract was signed by*190 petitioner and Hoiles providing for the sale of the capital stock of the newspaper for a total consideration of $ 383,572.26. It had been signed by Kerney prior to this time. Among the various provisions, the contract contained a covenant of the sellers not to compete in the Marysville area for a period of 10 years. No specific value was assigned to this covenant. The paragraph containing the covenant states as follows:
III.* * * *
(9) SELLER does hereby sell to BUYER all of the good will of the said business actually vested in them, and SELLER agrees that for a term of ten years from the date hereof they nor either of them nor any of them will engage in the newspaper or newspaper publishing business in the COUNTIES of YUBA and SUTTER, either as stockholders, owners, managers, publishers or editors so long as BUYER or any person deriving the said actual good will from BUYER on a like business in either of said counties either as individuals or through a corporation the controlling stock, ownership of which is vested in BUYER or person deriving title to said good will from said BUYER.
Later on that same day, petitioner was requested by Hoiles to change certain of the terms of *191 the contract. Hoiles desired that a value of $ 100,000 or $ 125,000 be assigned to the covenant not to compete in order to ameliorate the tax consequences for him. Hoiles was assisted by Smith Davis in his efforts to convince petitioner. Petitioner at first refused to alter the arrangement. However, he then consented to the allocation of a $ 100,000 value to the covenant; but, on the condition that Hoiles first sign the following "side agreement," to which Hoiles agreed:
MEMORANDUM OF AGREEMENT
In connection with the contract made between George H. Payne and Thomas L. Kerney, as SELLER, and R. C. Hoiles and Associates, as BUYER, the following is agreed:
1. That, if in the opinion of the lawyers of the SELLER, the item in the Contract calling for $ 100,000.00 for SELLER'S not engaging in competition in the Counties of Yuba and Sutter for ten years would cause them to pay taxes on their incomes as regular income, in place of taxes as Capital Gains, then that paragraph of the *529 contract is to be rewritten limiting the restraining agreement to the total sale price, making a total price of $ 383,572.26.
/S/ R. C. Hoiles
Buyer
/S/ George H. Payne
Seller
The contract*192 of sale was then retyped in its entirety, while petitioner and Hoiles waited. The only changes made in the contract were the reduction of the stated consideration for the stock by $ 100,000, and the assignment of a $ 100,000 value to the paragraph providing for the covenant not to compete and the transfer of goodwill. The pertinent paragraphs are as follows:
II.BUYER agrees to buy said stock and agrees that upon delivery to him on or before March 30, 1946 of the stock certificates evidencing the ownership of 1,745 shares of stock of Marysville-Yuba City Publishers, Incorporated, a California corporation, he will pay and deliver to said SELLER the additional sum of $ 273,572.26 lawful money of the United States. 1
* * * *
III.* * * *
(9) In consideration of the additional sum of $ 100,000.00 paid to SELLER by BUYER, SELLER does hereby sell to BUYER all of the good will of the said business actually vested in them, and SELLER agrees that for a term of ten years from the date hereof they nor either of them nor any of them will engage in the newspaper or newspaper publishing business in the COUNTIES of YUBA and SUTTER, either as stockholders, owners, managers, publishers or editors*193 so long as BUYER or any person deriving the said actual good will from BUYER on a like business in either of said counties either as individuals or through a corporation the controlling stock, ownership of which is vested in BUYER or persons deriving title to said good will from said BUYER.
* * * *
The retyped contract was then signed by petitioner and Hoiles. The signature of Kerney does not appear on the retyped contract or the side agreement.
During December 1946 and January 1947, petitioner and Hoiles corresponded regarding revision of the second contract in accordance with the "side agreement." Petitioner was under the impression that it had superseded the original contract, despite the absence of Kerney's signature. Hoiles agreed to rewrite the contract, and petitioner answered as follows:
* * * *
I note you say you will re-write the contract having the restraining agreement as a part of the total*194 sale, making the total sale price as per contract, and you *530 will send it to me in a few days for approval. Upon receipt of the agreement I will contact Mr. Kerney -- and if agreeable to both of us -- make whatever change is advisable.
* * * *
The second contract was never rewritten and signed by the petitioner, Kerney, and Hoiles.
Respondent determined that $ 100,000 of the total consideration was attributable to the covenant not to compete, and that petitioners should have reported their respective shares of this $ 100,000 as ordinary income rather than as capital gains.
The second document executed on March 15, which assigned a $ 100,000 value to the paragraph containing the covenant not to compete, did not accurately reflect the transaction as understood by the parties. The $ 100,000 is properly part of the purchase price of the capital stock of the newspaper.
OPINION.
The sole issue for our consideration is purely a factual one; namely, whether the petitioners and the coowner of their newspaper sold a covenant not to compete for $ 100,000 at the time they sold their newspaper. The respondent contends that they did and that, consequently, petitioners should have treated*195 the allocable shares of the $ 100,000 as ordinary income rather than as capital gains. Petitioners claim that the $ 100,000 in issue was merely part of the purchase price of the newspaper stock and that the covenant alone was worthless. They argue that any contract or papers assigning a $ 100,000 value to it were executed only to enable the purchaser to treat this part of the purchase price of the newspaper as a depreciable capital asset, thus realizing substantial savings in his taxes.
The petitioner submitted into evidence 2 contracts for the sale of the newspaper. The text of the 2 contracts is exactly alike except that one of them reduces the total consideration payable for the capital stock of the newspaper by $ 100,000 and allocates that amount to the paragraph containing the covenant not to compete. The parties have engaged in considerable controversy as to which document was executed first.
We have found as a fact that petitioner, Kerney, and Hoiles first signed the contract which allocates no part of the purchase price to the covenant not to compete. This document is the only one before us which is signed and agreed upon by all three parties and, thus, is the only contract*196 of sale under which the parties operated.
*531 Respondent also contends that even if we accept this first contract as the only effective one, the subsequent conduct of the parties evidences their intent that $ 100,000 of the total consideration was being paid for the covenant not to compete. Petitioner's testimony was forthright and direct; his statement that the total consideration was paid for the capital stock seems to us to represent the business arrangement of the parties. The only other witness was the purchaser, Hoiles. He was deliberately evasive and threw little light on the negotiations leading to the newspaper's sale. We do not believe that the purchaser and sellers considered the covenant to be worth over 25 per cent of the total purchase price, or even discussed its actual value, if any. Hoiles was aware that there was little likelihood that either of the sellers would ever compete with him in the Marysville area. The willingness of Hoiles to revise the second document, which assigned a separate consideration to the paragraph containing the covenant, as evidenced by the side agreement and his subsequent letters, indicates that it did not express the true understanding*197 of the parties. The only contract which did accurately reflect their understanding is the first one. It must consequently determine the tax consequences.
We are convinced that the total consideration paid was the agreed-upon price of the stock of the newspaper, and that the covenant not to compete was but an incidental factor meant to assure the effective transfer of the newspaper's goodwill. See . The record clearly demonstrates that the covenant is inextricably linked with the transfer of the corporate goodwill. The pertinent paragraph of the contract states, in part:
SELLER does hereby sell to BUYER all of the good will of the said business actually vested in them, and SELLER agrees that for a term of ten years from the date hereof they nor either of them nor any of them will engage in the newspaper or newspaper publishing business in the COUNTIES of YUBA and SUTTER, * * *
The personal goodwill of the sellers being nontransferable, the goodwill here referred to is obviously that of the corporation. Any value attributable to the covenant is nonseverable from this goodwill. .*198
The covenant not to compete was never actually dealt with as a separate item in the business transaction, never bargained for, never evaluated. , affd. (C. A. 10, 1954). Any discussions which the parties had about it revolved about whether the buyer should be given a tax advantage which might cause an unfavorable tax result for the sellers, rather than about the actual value of the covenant. Petitioners are *532 entitled to capital gains treatment on the entire proceeds of the sale of their newspaper stock, its goodwill, and the accompanying covenant. See , affd. (C. A. 6, 1950), certiorari denied ; .
Petitioner's subsequent correspondence with Hoiles indicates that he had the erroneous impression that his concessions for the latter's tax benefit were binding upon him, even though the second document had not been signed by Kerney. *199 However, Kerney owned 50 per cent of the capital stock of the newspaper; and it is obvious that the only binding contract of sale is the first one, which was executed by the two sellers and the purchaser. In addition, the allocation by the second document of a $ 100,000 value to the paragraph containing the covenant was mere "window dressing," inserted only to benefit the purchaser tax-wise. It bears no relation to the actuality of the transaction, and even had this contract been executed by all three parties to the sale, it could not affect the taxable result. Taxpayers may so arrange their affairs as to minimize taxation. But once a transaction has crystallized, the tax consequences must depend on substance and actuality rather than form or recited consideration in the contract. ; .
Our ultimate finding of fact that the second document executed on March 15, which assigned a $ 100,000 value to the covenant not to compete, did not accurately reflect the understanding of the parties distinguishes the instant case *200 from , affd. (C. A. 10, 1954). A contrary finding of fact was the decisive element in our refusal to disturb the allocation to the covenant made by the parties in that case, for we stated, at page 724, as follows:
Undoubtedly, this Court, in a proper case, is not bound by the parol evidence rule in seeking to determine the tax consequences of a transaction to which the Government is not a party. . This does not help petitioners, for after taking into account all of the relevant facts of the transaction and considering the whole record, we have concluded that the written contract accurately reflected the agreement of the parties and that that agreement was reached at arm's length. In the circumstances, it is not incumbent on the Court to disturb the allocation of purchase price made by the parties themselves.
It, therefore, follows that the total consideration was paid for the capital stock of the newspaper.
Decision will be entered*201 under Rule 50.
Footnotes
1. An additional consideration of $ 10,000 for the capital stock is provided for by paragraph I of both documents.↩