*256 Decision will be entered for the respondent.
Ordinary Income -- Amounts Received for Covenant not to Compete. -- The owners of the entire capital stock in a newspaper publishing business sold their stock pursuant to a written contract which also contained a covenant by each shareholder not to engage in the newspaper business for a period of ten years. The agreement allocated the purchase price, $ 150 for each share of stock and $ 50 per share for the covenant not to engage in business. Held, the covenant was a separate item of the transaction and the selling stockholders received ordinary income therefor.
*718 In these consolidated proceedings petitioners contest the following deficiencies in income tax determined for the year 1946:
| Docket No. | Deficiency |
| 28135 | $ 16,467.02 |
| 28605 | 15,827.61 |
The only question for decision is whether the vendors of stock in a newspaper publishing company who also covenanted in the contract*257 of sale not to engage in the newspaper publication or distribution business, realized ordinary income or capital gain insofar as that part of the transaction relating to this covenant is concerned.
FINDINGS OF FACT.
Some of the facts have been stipulated and are so found.
Clarence Clark Hamlin Trust (The Exchange National Bank of Colorado Springs and Tor Hylbom, Trustees), hereinafter called the Hamlin Trust, is a trust which filed its income tax return for 1946 with the collector for the district of Colorado.
T. E. Nowels (hereinafter called Nowels), was an individual whose joint return with his wife, Bertie M. Nowels, for 1946, also was filed with the collector for the district of Colorado.
The Gazette and Telegraph Company (hereinafter called Gazette-Telegraph), a Colorado corporation, for a number of years prior to January 10, 1946, was engaged in publishing the only morning and *719 evening daily newspapers in Colorado Springs, Colorado, a city of about 40,000 population.
On January 10, 1946, the entire stock of Gazette-Telegraph consisting of 5,000 shares of $ 100 par value each, was sold to R. C. Hoiles and his two sons, Clarence and Harry. On that date, the names of *258 the stockholders and the number of shares sold by each were as follows:
| Clarence Clark Hamlin Trust | 1146 shares |
| T. E. Nowels | 950 shares |
| J. A. Carruthers | 254 shares |
| Mae Carruthers | 77 shares |
| El Pomar Investment Co | 1248 shares |
| Mrs. Foster | 104 shares |
| Mrs. Hamlin | 100 shares |
| Elizabeth Hylbom | 2 shares |
| J. R. Miller | 60 shares |
| Dick Nowels | 100 shares |
| Mrs. Ross | 156 shares |
| C. L. Tutt | 703 shares |
| F. R. Wadell | 100 shares |
| Total | 5000 shares |
The stock was sold after negotiations initiated by R. C. Hoiles with T. E. Nowels, president of Gazette-Telegraph and editor of the paper, in the fall of 1945. The first Hoiles' offer for all of the stock was $ 750,000. On October 15, 1945, Nowels wrote Hoiles that the stockholders he had consulted felt they had a million dollar property and could sell at that figure. He wrote that the papers had paid a good rate of interest on that figure.
On October 18, 1945, Hoiles wrote Nowels as follows:
It is difficult to get action when there are a lot of stockholders. We would be willing to buy any part of the stock so long as we had control. We would want, however, to offer all the stockholders the same price per share we paid for what we *259 bought.
On December 4, 1945, Hoiles wrote Nowels: "We are very much interested in the property."
On December 4, 1945, Nowels wrote Hoiles that Tutt and Carruthers agreed with him that the entire set-up was worth no less than a million dollars.
On December 11, Hoiles wrote Nowels that "I take it the answer is negative to $ 750,000. Before considering paying one million dollars we would like some further information." He asked for the various pertinent figures such as salaries paid and other items of information. Nowels thereupon furnished the figures requested.
On December 24, 1945, Hoiles wrote Nowels:
We make you the following proposition to buy the stock of your corporation:
We will pay $ 1,000,000 for all the stock of the corporation and a restraining order from entering the business in the territory for ten years, plus any amount *720 the corporation has in cash above indebtedness and accrued taxes, or minus whatever amount is equivalent to the difference between the cash and the indebtedness including accrued taxes.
We would also want a guarantee that the present stockholders would reimburse the new stockholders if any libel suits started against the newspapers as a result*260 of publication of articles prior to the date of transfer of stock.
In case all the stock cannot be secured, we would be willing to buy 70 per cent of it at this rate if the balance could not be purchased.
On December 27, 1945, Nowels wrote Hoiles as follows:
This is to acknowledge receipt of your letter dated December 24, in which your proposal is outlined.
I assure you it will be given immediate and serious consideration. We will give you an answer as soon as all stockholders can be familiarized with the proposition and given a chance to express their views and record their wishes. It is a decision that cannot be reached hastily, as you well know.
The plain fact is that a final determination will be harder for me to make than for the other stockholders for the simple reason that, if we decide to accept, I will be selling not only my stock but also my job. This, obviously, will be tough, from any standpoint.
My health was never better and I will be like the proverbial fish out of water if I turn over my keys and sit around home twirling my thumbs. My nature is such that I could not be happy without something to occupy my mind and time. The last 45 years of my life have been*261 devoted to building the papers to their present standard, and I am just as active now as I was when I took over the management 30 years ago next April. In short, I would be selling, in addition to my stock interest, a nice annual income that would be cut off instanter. Nor would I be able to invest my money in anything from which I could obtain a comparable interest rate.
But, of course, a decision must be reached in due course. You will hear from me as soon as it is made.
On December 29, 1945, Hoiles wrote Nowels:
This acknowledges receipt of yours of December 27.
Should we buy the property we would expect to have our younger son there as publisher. He has not had a great deal of experience. For this reason we would be glad to have you stay with the newspaper properties for two or three years as counselor and adviser to him and to do such things as would help transfer the good will to the new owners. For this service we would be willing to pay you 5 per cent of the profits before taxes. The position might be quite permanent as we are at present negotiating for still another property, and if we should get another property of considerable size we would be scarce of management*262 and might badly need you at Colorado Springs. If you are concerned about how you would invest the money, we would be willing to agree to pay for your stock over a period of ten or fifteen years and pay you interest at the rate of 5 per cent.
We would want part of the price of the stock to be a restraining contract so we could set it up in the new corporation and amortize it and thus reduce our taxes. Of course, if 70 per cent of the stock can be bought without your stock, you could keep your stock. The reason we want at least 2/3 instead of a bare majority is that we would want to set up a new corporation in order to make it better from a tax standpoint, and we might not be able to do this if we did not have 2/3, as the Colorado law requires 2/3 of the stock to consent to the liquidation *721 of a corporation. You could at least keep enough of the stock of the new corporation to be president of it to go with your job as counsellor. We certainly would be glad to have you as president.
As each such letter from Hoiles was received by Nowels he took it to Charles A. Tutt (hereinafter called Tutt) and John A. Carruthers (hereinafter called Carruthers), two of the stockholders, *263 to discuss it with them. He also showed them copies of his answers to Hoiles, as each was sent.
About January 7, 1946, Hoiles and his two sons came to Colorado Springs to consummate the sale.
On January 9, 1946, Nowels accepted, for 1 year, Hoiles' offer to stay with the newspapers in consideration of 5 per cent of the net profits before taxes. This 1 year agreement was carried out by the parties. Nowels died February 20, 1949.
On January 9, 1946, Carruthers, who was a lawyer, made a draft of contract in accordance with his understanding of the agreement of the parties. Said draft, which was dated January 10, 1946, read as follows:
AGREEMENT Made and entered into this 10th day of January, A. D., 1946, by and between R. C. HOILES, CLARENCE HOILES, and HARRY HOILES, all of Santa Ana, California, as First Parties, and the undersigned stockholders of The Gazette and Telegraph Company, as Second Parties,
WITNESSETH:
WHEREAS, First Parties desire to purchase all of the shares of stock of The Gazette and Telegraph Company or at least seventy per cent (70%) thereof, and,
WHEREAS, Second Parties desire to sell and dispose of their stock in the said The Gazette and Telegraph Company at *264 the price and on the terms hereinafter set forth.
NOW THEREFORE, in consideration of the mutual covenants and agreements of the parties hereto, it is understood and agreed:
1. First Parties agree to pay to each of the undersigned Second Parties the sum of Two Hundred Dollars ($ 200.00) per share for each share set opposite the name of each of the Second Parties upon proper assignment and delivery to First Parties of the certificate or certificates representing the ownership of Second Parties in the stock of The Gazette and Telegraph Company.
2. Second Parties and each of them agree as part of the consideration hereof that they and each of them will not engage in the newspaper publication or distribution business in competition with First Parties, their successors and assigns, in the County of El Paso, State of Colorado, for a period of ten (10) years from and after the date hereof.
3. Second Parties and each of them agree to indemnify and hold First Parties, their successors and assigns, free and harmless from any liability for suits for libel because of or as a result of publication of any article or articles in the papers owned by The Gazette and Telegraph Company prior to January*265 10, 1946.
IN WITNESS WHEREOF the parties hereto have set their hands and seals the day and year first above written and Second Parties have set opposite their respective names the number of shares of stock in The Gazette and Telegraph Company which they will sell at the price and on the terms herein set forth.
*722 The original of this draft was signed by Nowels and Carruthers and the signatures of certain other sellers were obtained in order to facilitate closing on the following day.
On January 10, Nowels, his son Richard, Tutt, and Carruthers met with Hoiles and his two sons. At the conference on that date Hoiles stated that the contract was satisfactory, but asked whether the sellers would have any objection to putting in the contract a clause that the restraining order, as he termed it, would be evaluated at $ 50 a share and the stock would be evaluated at $ 150 a share. Hoiles stated that the purpose of such a clause was to make the contract enforceable and to help the buyers tax-wise.
The stockholders present agreed to the clause because they thought it would make no difference to the stockholders. There was only a brief discussion of the proposed allocation of the *266 purchase price between stock and the covenant not to engage in the newspaper publication or distribution business. Hoiles then dictated the following paragraph:
First Parties and Second Parties have agreed that the two items of said sale are evaluated as follows, to-wit: (a) the stock per share of the corporation, $ 150.00, and (b) the prohibition and refraining from carrying on business as set forth in Paragraph 2 hereof, $ 50.00.
The contract was then retyped with no change except the addition of this paragraph and the renumbering of succeeding paragraphs. The contract, as thus retyped, was thereafter executed by all of the stockholders.
Newspaper publishing and distribution is a highly competitive field.
Hoiles had had extensive experience in the newspaper business and the purchase of newspaper properties. In the sale of such properties it is customary to insert in the contract a restriction against competition by the sellers and Hoiles insisted on such a covenant in this transaction. The purchase of the stock would not have been consummated without it.
Some of the selling stockholders were passive investors in Gazette-Telegraph stock. Others, such as Nowels, his son Richard, *267 and F. R. Waddell, were active in the newspaper business. Another stockholder, Elizabeth Hylbom, wrote some columns and articles for the papers in question.
Hoiles was concerned about competition from the individual stockholders, as well as from the Hamlin Trust and El Pomar Investment Company. His primary concern was that the stockholders might lend funds to or invest in a competing newspaper. He made no investigation of the legal power or authority of the Hamlin Trust or the El Pomar Investment Company so to do. He also was concerned that the individual stockholders might engage in the newspaper business *723 in the vicinity where they were known, should a competing newspaper be started.
To the Hoileses the agreement of the stockholders not to engage in competition in the newspaper publication or distribution business had value and the consideration stated in the contract of January 10, 1946, as allocable to the restraining agreement was in fact paid by them for such agreement.
The contract of purchase and sale executed on January 10, 1946, accurately reflected the transaction as understood by the parties and the agreement was reached as a result of arm's length bargaining.
*268 The agreement on the part of the stockholders not to engage in the newspaper publication or distribution business has been observed.
The petitioners reported the sale on their income tax returns as a capital transaction and showed their entire gain as long term capital gain.
Some months later the Hoileses assigned their rights acquired under the contract to a new corporation created under the laws of Colorado called Gazette Telegraph Company, which new corporation claimed annual amortization on the amount paid for the agreement of the stockholders of Gazette-Telegraph not to engage in the newspaper business for 10 years, on its income tax returns.
The Commissioner disallowed this amortization and petitions were filed in this Court protesting the disallowance in dockets Nos. 24861 and 24862.
In the instant cases the Commissioner took a position contrary to his position in the aforementioned cases and held that $ 57,300 of the proceeds received by the Hamlin Trust and $ 47,500 of the proceeds received by Nowels constituted consideration for their agreements not to engage in the newspaper publication or distribution business and hence was taxable as ordinary income.
OPINION.
This case*269 confronts us with the not unusual situation in which respondent, to protect the revenue, takes inconsistent positions with respect to the tax consequences of the same transaction. See ; . Here, respondent would tax the selling stockholders on the portion of the purchase price allocated to the covenant not to compete as ordinary income to them. In , on the other hand, respondent contended that the purchasing stockholders paid the entire purchase price for the stock and nothing for the covenant not to compete and so are not entitled to amortize the amount claimed to have been paid for the covenant.
*724 Inevitably this adds to the difficulty of reaching a decision, for almost irreconcilable interpretations of the evidence are strongly urged by the parties to the transaction, in the understandable efforts of each party to gain a tax advantage, while respondent presents contrary arguments in each case, though in the nature of things he should lose one and win the other.
*270 Petitioners here primarily contend that the money they received from the Hoileses was all received for their stock in Gazette-Telegraph and that none was received for their covenant not to engage in the newspaper publishing or distribution business. This, of course, would make meaningless the clause of the contract specifically allocating the agreed upon $ 200 as follows: $ 150 for each share of stock and $ 50 on a per share basis to each stockholder for the covenant.
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.
This Court has said in :*271
It is well settled that if, in an agreement of the kind which we have here, the covenant not to compete can be segregated in order to be assured that a separate item has actually been dealt with, then so much as is paid for the covenant not to compete is ordinary income and not income from the sale of a capital asset. . On the other hand, where the covenant not to compete accompanies the transfer of good will in the sale of a going concern and it is apparent that the covenant not to compete has the function primarily of assuring to the purchaser the beneficial enjoyment of the good will which has been acquired, the covenant is regarded as nonseverable and as being in effect a contributing element of the assets transferred. Toledo Newspaper Co., 2. T. C. 794; ; Aaron Michaels, supra. [
As stated in , we think this case is distinguishable from Toledo Newspaper Co. and Toledo Blade Co. [referred to in the excerpt above from the Horton*272 case]. Here, petitioners were selling their stock in Gazette-Telegraph. They were not selling a going business together with the good will, in which event the covenant not to compete might have been regarded as non-severable. The parties to the instant transaction, in our opinion, treated the covenant as a separate item of their negotiations and while it is evident *725 that petitioners might not have fully appreciated the significance tax-wise of what they were doing, the purchasers were fully aware of what the consequences to them might be, and had put the petitioners on notice that tax problems were involved.
Much of petitioners' evidence bore on the value of the covenant, which value, as they saw it, was zero, because none of them, according to their contention, intended to engage further in the newspaper business anyway and there was doubt about the legal capacity of the Hamlin Trust and El Pomar Investment Company so to do. This, it seems to us, begs the question, which is not whether the covenant had a certain value, but, rather, whether the purchasers paid the amount claimed for the covenant as a separate item in the deal and so treated it in their negotiations. *273 This, we have found, they did.
We see nothing in the record before us which would require a result inconsistent with our decision in Accordingly,
Decision will be entered for the respondent.
Johnson, J., dissenting: As the trier of the facts who heard the testimony in this case I cannot agree with the conclusion reached in the majority opinion that in the transaction here the sellers were paid $ 50 per share for their covenant not to compete and that same constituted a separate item of the transaction. True, the recital in the contract so states, but the evidence and record as a whole proves the falsity of this statement. On the contrary it clearly appears from the evidence that the owners sold the stock coupled with an agreement not to compete for a lump sum of $ 200 per share.
The buyers and sellers had so agreed and a written contract to that effect was prepared and signed by all of the sellers and tendered to the buyers for their signatures, whereupon Hoiles, acting for the buyers, said "the contract was satisfactory", but asked whether the sellers "to help the buyers tax-wise" would have any objection*274 to an additional clause evaluating the agreement not to compete at $ 50 a share and the stock at $ 150 a share. The sellers, unaware of its tax consequences or monetary detriment to them, with practically no discussion or consideration, agreed to its inclusion and Hoiles, well versed in income tax liability based upon his experience in the purchase of many newspapers, wrote the additional paragraph to the contract which constitutes the basis of respondent's contention and upon which the majority opinion is based.
*726 That the recitals in this added paragraph do not accurately or correctly reflect the facts or the consideration of the transaction but are window-dressing inserted for income tax purposes only is apparent from the record. In support of this conclusion we cite:
(1) The circumstances under which it was inserted, the reasons therefor and lack of consideration given thereto all tend to discredit its probative value and stamp its provisions as being other than bona fide and realistic.
(2) It is the only evidence in the record that a separate value was placed upon the stock and the agreement not to compete. In the negotiations covering several months, discussion as*275 to the price to be paid was always on overall figure.
(3) It is in conflict with all other evidence in the record that the value of the stock was $ 150 per share, and the record as a whole impeaches this valuation as being a sum far below either its real, market, or profit-earning value.
(4) Except for Hoiles' unsupported testimony at the hearing to that effect, it is the only evidence that the agreement not to compete was of the value of $ 50 a share. Measured by the evidence as a whole, this value magnifies out of all proportion the value, if any, possessed by the noncompetitive agreement of the sellers. Nowels was the only one of the sellers whose training and experience might cause him to compete, and before consummation of the sale, Hoiles had employed him by written contract to work for the buyers.
Recitals of a written instrument as to the consideration are not conclusive and it is always competent to show by parol or other extrinsic evidence what the real consideration was. . Tax consequences from the sale of property depend upon the substance and actuality of the transaction rather than the form*276 or recited consideration in the contract. . As was said by the Supreme Court in this case:
* * * To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.
Believing that petitioners have sustained their contention that no part of the consideration was separately paid for the covenant not to compete and accordingly none of same was ordinary income, I therefore respectfully dissent.