*11 Decisions will be entered for the respondent.
Petitioners, equal partners in White Way Pure Milk Company, sold the assets of the partnership to Pet Dairy Products Company and entered into individual covenants not to compete for a period of 10 years. Held, (1) that partnership assets were sold and not partnership interests; (2) that payments under the covenants not to compete were ordinary income and not capital gain from the sale of goodwill; (3) that the sales price of the partnership's inventory of milk and dairy products was $ 17,770.49 and not $ 10,000 as reported; and (4) that the sales price of the partnership's expendable supplies was $ 9,171.95, which represented short-term capital gain, since such supplies have not been shown to have been held for more than 6 months.
*515 The respondent determined deficiencies in income tax against the petitioners for the taxable year 1957 as follows:
| Docket No. | Petitioner | Deficiency |
| 86667 | Emmette L. Barran and Martha Barran | $ 2,626.08 |
| 86706 | C. E. Winton and Drucilla Winton | 2,735.25 |
*516 The questions presented are: (1) Whether petitioners sold their partnership interests or whether they sold partnership assets; (2) whether monthly payments made to each of the petitioners by the purchaser for their separate agreements not to compete constituted ordinary income*13 or capital gain; (3) what was the value of the partnership's inventory at October 31, 1957, and the selling price thereof; and (4) whether the sale of certain supplies was a sale of capital assets held for less than 6 months.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found as stipulated.
Petitioners Emmette L. Barran, sometimes referred to herein as petitioner or Barran, and Martha Barran are husband and wife and reside in Decatur, Alabama. They filed a joint income tax return for 1957 with the district director of internal revenue at Birmingham.
Petitioners C. E. Winton, sometimes referred to herein as petitioner or Winton, and Drucilla Winton were husband and wife in 1957 and resided in Decatur, Alabama. For the taxable year 1957, an income tax return captioned "C. E. and Drucilla Winton" was filed with the district director at Birmingham. This return, executed by C. E. Winton under date of April 15, 1958, was not executed by Drucilla Winton.
Prior to 1941, Barran and Winton were engaged in the milk business as route salesmen for the Decatur Ice Cream and Creamery Company, hereafter referred to as Creamery Company. In 1941, they left the Creamery Company*14 and started their own milk business, as equal partners, operating under the name of White Way Pure Milk Company, sometimes referred to herein as the partnership or White Way. Their principal place of business was in Decatur, with distribution points in Florence and Boaz, Alabama. The partnership operated in competition with the Creamery Company and its business was built at least in part upon former customers of the Creamery Company.
White Way's plant was located on land fronting 600 feet on U.S. Highway 31, Decatur. In addition, it owned another 200 feet fronting on such highway. Its business operations extended into 13 or more counties in northern Alabama, and it owned approximately 18 milk delivery trucks. Barran handled the distribution of milk, but was more familiar with wholesale customers in the Decatur area than retail customers on the milk routes. Winton handled administrative matters at the plant and for the partnership. The partners devoted their time to the business of the partnership.
Prior to the taxable year, the petitioners purchased a milk business from an individual named Jerry Roden. At the time of purchase, Roden agreed that he would not compete with White*15 Way for a period of 5 years.
*517 During 1956 and 1957 the petitioners negotiated with various concerns for the sale of their business. White Way was heavily indebted and the business was not profitable. In August 1957, negotiations were initiated with Pet Dairy Products Company, a Delaware corporation with its principal place of business in Johnson City, Tennessee, sometimes hereafter referred to as Pet.
Late in August 1957, an engineer of Pet visited petitioners' plant at Decatur and inspected it and the equipment used in the business. The engineer submitted a report to Pet which listed the size, capacity, the date purchased, and other information regarding the equipment and assets of the partnership. Pet used this report to determine a value for the assets used in the partnership's milk business. Thereafter, other members of the Pet organization, including its secretary, inspected White Way's plant.
On October 30, 1957, the petitioners met with representatives of Pet in Pet's general offices at Johnson City, Tennessee. The representatives of Pet initially present included R. O. Jenkins, executive vice president, Tom Happle, a vice president, L. H. Cassmeyer, secretary, *16 and others. Later S. J. Milligan, an attorney for Pet, located in Greenville, Tennessee, came over and joined the conference, following a phone call from Jenkins.
At the October 30, 1957, conference, Pet offered to purchase the plant, equipment, and accounts receivable connected with White Way's milk business for $ 530,000. After some discussion, Jenkins sought and obtained permission from Pet's main office in St. Louis to increase the offer by $ 20,000. Thereupon, Pet agreed to purchase and White Way agreed to sell the land, plant, equipment, and accounts receivable for the sum of $ 550,000, such amount to be adjusted depending upon whether an actual appraisal showed the accounts receivable to be more or less than the $ 75,000 figure included therefor.
At the conference on October 30, 1957, Jenkins informed petitioners that, in addition to the $ 550,000, Pet would pay each of them $ 100,000 if they agreed not to compete with Pet over a period of 120 months, a portion of which would be earned each month as they stayed out of business. Barran and Winton retired to another office and upon their return to the conference agreed to accept Jenkins' proposition.
Milligan did not participate*17 in the initial negotiations, but arrived at the conference late in the afternoon. He was then informed that an understanding had been reached by the parties in connection with the purchase and sale of a fluid milk plant, and that they wanted their agreement reduced to writing. Milligan discussed with Barran, Winton, and Jenkins the matters on which the parties had agreed and made some notes on a scratch pad with respect thereto. He then dictated a memorandum, which, after being typed by a secretary, was brought back into the conference. Milligan, Barran, Winton, and *518 Jenkins went over the document prepared by Milligan word for word from the beginning to the end. All parties present accepted the instrument as being drafted in accordance with their agreement. Winton executed this preliminary agreement for the partnership; Barran and Winton executed the agreement individually; and Jenkins executed it for Pet.
The aforesaid agreement, dated October 30, 1957, after stating that it was entered into at Johnson City between Winton and Barran, "Partners doing business as Whiteway Pure Milk Company," and Pet, sometimes referred to in the agreement as the Company, provided in *18 pertinent part as follows:
Witnesseth: An Agreement of purchase and sale has this day been entered into by and between the parties hereto in reference to the assets of Whiteway Pure Milk Company in the State of Alabama. It is understood that this instrument is a preliminary agreement the details of which above transaction and the details in reference to the sale and purchase aforesaid will be fully set forth in instruments to be hereafter executed by the respective parties, however, as a memorandum of sale, it is this day agreed by the parties as follows:
The Partnership will sell and the Company will purchase the following assets:
(1) Real estate on which the plant in Decatur is located which is the lot fronting approximately 400 ft. on Route 31 and extending back between approximately parallel lines a distance of approximately 300 ft.
(2) In addition to the real estate described above in item (1), 200 ft. additional land will be included, same being located on the northerly side of the present lot making a total frontage of 600 ft. on the highway side, additional 200 ft. frontage to extend back from the highway, a distance of 300 ft. making the lot 600 ft. on the highway, extending*19 back 300 ft.
(3) All buildings on said lot.
(4) All machinery, equipment, tools, supplies presently used in connection with the operation of the plant located at Decatur, Alabama and also plants located at Florence and Boaz, Alabama.
(5) All trucks used in operation of said business at the three (3) above named locations.
(6) All milk, raw and processed and all other dairy products on hand as of the date of the delivery of the assets.
(7) All accounts receivable as of the aforesaid date.
The delivery of the assets and the acceptance of same by the Company shall be as of mid-night on October 31, 1957.
In consideration of the transfer and delivery of the above enumerated assets free and clear of all encumbrances, title thereto to be acceptable to council [sic] for the Company, the Company agrees to pay and the Partnership agrees to accept the sum of Five Hundred and Fifty Thousand Dollars ($ 550,000.00), of which sum One Hundred Thousand Dollars, ($ 100,000.00) is this day paid by the Company to the members of the Partnership, the receipt of which is hereby acknowledged. It is presently estimated that the value of the accounts receivable will be Seventy-Five Thousand Dollars ($ *20 75,000.00) and that estimate is used in arriving at the price of Five Hundred and Fifty Thousand Dollars ($ 550,000.00) contracted to be paid, however, it is mutually agreed that the value of said accounts receivable will be forthwith appraised by the Company's Credit Manager *519 and the Partners and the valuation of same at Seventy-Five Thousand Dollars ($ 75,000.00) will be increased or reduced to meet the appraised valuation of same and the total of Five Hundred and Fifty Thousand Dollars ($ 550,000.00) will be adjusted accordingly. After the accounts receivable have been appraised and title papers showing the title to the above enumerated assets to be free and clear of encumbrances, have been delivered to the Company, the balance of the purchase price will be forthwith paid in cash.
A non-competitive agreement will be entered into between the individual parties and the Company whereby the Company agrees to pay and the Partnership agrees to accept the sum of Two Hundred Thousand Dollars ($ 200,000.00) for a non-competitive agreement to extend over a period of ten (10) years from and after November 1, 1957 and same to have territorial limitations limited to Jefferson County*21 Alabama and all counties in Alabama, north, northeast, and northwest therefrom and adjacent counties in Tennessee, the names of the counties to be set forth in said agreement.
The sum of Two Hundred Thousand Dollars ($ 200,000.00) shall be payable in one hundred and twenty (120) equal monthly installments and the agreement shall contain a provision that in the event the terms of said agreement are not complied with by the Partners, the payment of all monthly installments thereafter accruing shall cease and the Company shall not thereafter be liable for any payments thereunder.
As a part of the consideration for this agreement, the Partnership agrees to forthwith transfer and assign to the Company, all permits issued to it by Alabama Milk Control Board, and by the State and County authorities, and also to transfer and assign all licenses which have been issued to the Partnership in the event same are transferrable.
It is understood and agreed that the Company shall not be responsible for the payment of any sales tax on the purchase of the assets.
At the October 30, 1957, conference, petitioners conducted their negotiations without the benefit of their attorney or their accountant. *22 Their attorney, William B. Eyster, was first informed of the sale on the morning of November 1, 1957, when Milligan, Winton, and Barran came to his office and Winton and Barran informed him that they had sold to Pet. On November 1, 1957, and thereafter, the legal documents deemed necessary to consummate the agreement of October 30, 1957, were prepared in the office of Eyster. Cassmeyer and Milligan represented Pet at these conferences; Eyster represented the partnership and the petitioners individually.
On November 1, 1957, the parties executed a bill of sale, which reads in pertinent part as follows:
That for and in consideration of the sum of TWO HUNDRED AND FORTY-FIVE THOUSAND DOLLARS ($ 245,000.00) good and lawful money in hand paid by the PARTY OF THE SECOND PART to the PARTIES OF THE FIRST PART, the receipt whereof is hereby acknowledged, the parties of the FIRST PART have this day bargained and sold, and by these presents do hereby sell, transfer and deliver unto the PARTY OF THE SECOND PART all trucks, machinery, equipment, milk dispensers, fixtures and miscellaneous tools now installed and located at the places of business of the PARTIES OF THE FIRST PART in Decatur, Florence*23 and Boaz, Alabama and used in connection with and *520 in the operation of said Dairy, and all other personal properties exclusive of notes and Accounts Receivable pertaining to said White Way Pure Milk Company, wheresoever located, there being included in the sale of said personal property all operating supplies on hand as of the close of business October 31, 1957, the value of said operating supplies having been determined by the PARTIES OF THE FIRST PART to be TEN THOUSAND DOLLARS ($ 10,000.00). However, said amount is included in the consideration hereinbefore recited.
In addition to the above personal property, THE PARTIES OF THE FIRST PART have this day bargained and sold, and by these presents do hereby sell, transfer and deliver unto the PARTY OF THE SECOND PART all Accounts Receivable as shown by the books and records of the PARTNERSHIP as of the close of business of October 31, 1957. The exact amount of same not having as yet been determined, however, the value of said Accounts Receivable shall be forthwith determined by an appraisal of the same to be had by the Credit Manager of the PARTY OF THE SECOND PART, and the members of the PARTNERSHIP of the PARTIES OF THE*24 FIRST PART, and upon same being determined, PARTY OF THE SECOND PART will thereupon pay to the PARTIES OF THE FIRST PART the appraised value of said Accounts Receivable, in cash.
* * * *
The sale and transfer of the aforesaid assets shall be effective as of the close of business October 31, 1957.
The term "operating supplies" as used in the bill of sale means inventory.
On November 1, 1957, petitioners, as individuals and as members of the partnership, together with their wives, executed a deed whereby they transferred certain real estate as agreed to Pet for a consideration of $ 230,000.
During the conferences on November 1, 1957, Eyster objected to the covenants not to compete because there was no security or guarantee that the monthly payments would be made to the widow of Barran or Winton in the event of death and no provision was made for interest. Pet refused to incorporate security or interest provisions in the agreements not to compete because, among other things, the monthly payments had to be earned each month by petitioners' compliance with their covenants not to compete.
On November 1, 1957, Barran and Winton executed individual agreements with Pet, wherein each convenanted*25 and agreed with Pet in pertinent part as follows (the provisions of each document are the same except for the name of the petitioner, and Pet Dairy Products Company is sometimes referred to as the Company):
Whereas, Pet Dairy Products Company has acquired the assets of White Way Pure Milk Company, a partnership composed of C. E. Winston and Emmette L. Barran, with principal place of business in Decatur, Alabama, and
Whereas, said Company desires and intends to take over the operation of the business of said White Way Pure Milk Company and serve the customers thereof.
Now, Therefore, in consideration of the payments to be made as hereinafter set forth, the said Emmette L. Barran, the individual, covenants and agrees with the Company, its successors and assigns, that he will not engage, either directly or indirectly, either for himself or as agent or servant of any party *521 engaged in a similar business, or as the owner of stock in any corporation now existing or which may hereafter be formed, excepting only the ownership of listed stocks, or any financing or promoting of any similar business in the business of buying, receiving, shipping, processing, dealing, or in vending dairy*26 products for a period of one hundred twenty (120) months from and after the date hereof within the counties of Jefferson, Lauderdale, Limestone, Madison, Jackson, Dekalb, Marshall, Morgan, Lawrence, Colbert, Franklin, Marion, Winston, Cullman, Blount, Etowah, Cherokee, Calhoun, St. Clair, Walker, Fayette, Lamar, Cleburne, Alabama, and adjacent Counties in Tennessee.
The said Company, in consideration of the agreement of said individual, covenants and agrees to pay to him the sum of $ 833.33 per month for one hundred twenty (120) consecutive months, the first payment to be made on December 1, 1957, and a like amount on the 1st day of each succeeding month thereafter until 119 such payments have been made; and the further payment of $ 833.33 on the 1st day of the 120th month; provided that at the time each of said payments becomes due and payable the said Emmette L. Barran, the individual herein, has fully complied with the terms of this agreement as hereinbefore set forth.
In the event that said individual shall fail to comply in all respects with the terms of this agreement, as hereinbefore set forth, then upon such default upon his part all future payments shall cease and determine, *27 and the Company shall have no further liability in respect thereof and shall not be required to make any further payments to said individual.
As an exception to the restrictions on the individual as hereinbefore set forth, he may so long as it is mutually agreeable to the parties hereto, be employed by the Company in such capacity or capacities and at such salary as may be mutually agreed upon, and the acceptance of employment by Pet Dairy Products Company in such capacity as he may be employed shall not constitute a breach of this agreement.
The petitioners' agreements not to compete with Pet were witnessed by their attorney, Eyster.
On November 1, 1957, petitioners executed a further agreement which recites that they, as members of the partnership, entered into a contract of sale with Pet "whereby they sold and delivered the assets of said partnership and warranted the title thereto." Therein, as additional security to the warranty, petitioners agreed that Pet could apply to its reimbursement of loss upon breach of warranty any sums then or thereafter owing by Pet to the petitioners.
On November 1, 1957, petitioners and Pet executed an escrow agreement whereby $ 161,163.72 was*28 paid by Pet to the escrow agent, which amount was "the balance of the purchase price of the assets described in the Bill of Sale" executed by the parties on the same day. Eyster was appointed escrow agent, accepted the appointment, and agreed to disburse such sum in the manner provided in the escrow agreement.
On November 8, 1957, petitioners and Pet executed an agreement fixing the reasonable value of the accounts receivable of White Way at Boaz, Decatur, and Florence as $ 87,167.85.
On or about November 1, 1957, Barran was 42 years of age, and Winton was 44 years of age. They were young, healthy, and experienced in the milk business. Pet would not have purchased the assets *522 of White Way without individual convenants from the petitioners that they would not compete. Pet usually obtained covenants not to compete in connection with its purchases of assets of milk businesses.
The documents executed on October 30 and November 1, 1957, contained no provisions with respect to goodwill, or Pet's right to use the trade name "White Way Pure Milk Company." Pet continued using White Way imprinted cartons on hand at October 31, 1957, and exhausted the inventory of milk cartons in*29 about 60 days. Pet changed the name on the plant as soon as it could.
Pet acquired a partial list of White Way's customers from the accounts receivable, but it acquired no other list of White Way's customers. The route men or drivers knew their cash customers, but no list thereof was furnished Pet. Most of White Way's employees stayed on with Pet.
From 1951, until he retired on January 15, 1958, because of poor health, C. N. Garrett was head bookkeeper of White Way. Prior to his employment by White Way, Garrett was employed for 25 years with the Creamery Company and Meadow Gold, a division of Beatrice Foods Corporation.
It was Garrett's practice to prepare monthly statements of income for White Way which included the ending inventory. Garrett typed the inventory sheet as to the items to be included in the inventory and turned the sheet over to Manley, the plant manager (now deceased), who made the count. The inventory was then referred back to Garrett for pricing. The last inventory which Garrett priced was August of 1957.
For the month of October 1957, Garrett typed the inventory, consisting of two sheets, and Manley entered the count, 1 but Garrett did not price or extend*30 the items in the inventory as he usually did, as he had been orally informed by one of the partners that the inventory was to be sold for $ 10,000. Garrett merely noted at the bottom of the October 1957 inventory sheets the following: "Estimated Trade Inventory to Pet Dairy Products Co. $ 10,000.00." During 1959 the prices and extensions as to individual items on the October 1957 inventory sheets were entered. The extended amount for the item "Boaz Stock" was taken from the inventory prepared by Pet. The ending inventory of White Way as of October 31, 1957, as priced and extended in 1959, was $ 13,567.43.
On November 1, 1957, Pet took a detailed inventory of all raw and processed milk and dairy products on hand at the Boaz, Decatur, and Florence locations of White Way. Included*31 in this inventory were: *523 Paper cartons of various sizes for milk, butter and cheese, wax, glue, and wire, as well as the milk and dairy products themselves, such as stock for milk, ice cream, and mixes, bulk milk, materials for orange drink, chocolate milk, and mixes, cottage cheese, and butter. Pet valued this inventory at $ 19,559.62.
On November 1, 1957, Pet took a detailed inventory of all expendable supplies on hand at White Way's locations. The specific classes of items included in this inventory were: Cleaning, miscellaneous, office, and laboratory supplies, miscellaneous selling supplies, glass bottles, bottle caps, truck gasoline and oil, truck parts, and plant equipment parts. Pet valued this inventory of expendable supplies at $ 9,870.49.
On November 1, 1957, Pet also took a detailed inventory of all tools and small equipment, which it valued at $ 10,668.25. Some of these items were depreciable and are reflected on a depreciation schedule.
At November 1, 1957, and thereafter, White Way was negotiating with the Atlantic and Pacific Tea Company for the construction of a store building on its remaining piece of real estate, which A&P would then lease. The land*32 involved was exclusive of the land sold to Pet. Its book value was $ 6,172.92.
At December 31, 1957, the partnership's balance sheet showed cash in the amount of $ 10,083.85, land with a book value of $ 6,172.92, and total assets of $ 16,256.77. Its liabilities consisted of accounts payable in the amount of $ 5,818.44, partners' capital accounts aggregating $ 10,438.33, and total liabilities of $ 16,256.77. Winton's and Barran's capital accounts at December 31, 1957, were $ 5,931.70 and $ 4,506.63, respectively.
Subsequent to December 31, 1957, Barran purchased Winton's half interest in the remaining land owned by the partnership, paying him $ 17,500 therefor. In 1958, Barran developed this land into a commercial property.
Since 1951, the income tax returns of the petitioners and of White Way have been prepared by a representative of Ernst & Ernst, certified public accountants. B. R. Smith, manager of Ernst & Ernst in northern Alabama, prepared petitioners' income tax returns for 1957 and 1958, and White Way's tax returns for 1956 and 1957. Smith also prepared amended income tax returns for petitioners for 1958, and he prepared White Way's final income tax return for 1958.
In*33 preparing the individual and the partnership returns for 1957, Smith used the agreements of October 30 and November 1, 1957, and the partnership's books of account. Smith was not a participant in nor was he consulted by petitioners about their transaction with Pet. Smith first heard of the sale by reading about it in the newspaper; he learned the details of the transaction in January or February 1958, *524 while preparing the 1957 income tax returns for the petitioners and the partnership.
For the calendar year 1957, the partnership return reported an ordinary loss of $ 7,248.39, and long-term capital gains of $ 261,349.19. In computing its "Cost of goods sold" for the calendar year 1957, the partnership totaled its inventory at the beginning of the year, its purchases during the year, and its supplies, aggregating $ 590,719.24, but deducted no amount for inventory at the end of the year, which it explained: "Less inventory at end (included in sales)."
In a schedule attached to its 1957 return, the partnership reported the total amount received from Pet Dairy Products Company as follows:
| Sale of inventory -- included in sales | $ 10,000.00 |
| Accounts receivable | 87,167.85 |
| Other items bought for resale | 23,738.30 |
| Plant, machinery and equipment, and land | 441,261.70 |
| Total | 562,167.85 |
*34 In a schedule attached to its 1957 return, the partnership reported long-term capital gains of $ 261,721.93 from the sale of the plant, the sale of a farm, and installment income. This was offset by a long-term loss of $ 372.74 on a truck destroyed by fire, in arriving at net long-term capital gains of $ 261,349.19.
In their individual income tax returns for 1957, each petitioner reported one-half of the partnership's ordinary loss of $ 7,248.39 for 1957, that is, $ 3,624.20 for Barran and $ 3,624.19 for Winton; each reported half of the net long-term capital gains of the partnership, that is, $ 65,337.30 for Barran and $ 65,337.29 for Winton; each reported income of $ 833.33 received from Pet Dairy Products Company under his agreement not to compete, that is, the first of the 120 monthly payments due thereunder; and each reported a salary of $ 937.50 from Pet.
Upon examining the partnership's 1957 return, respondent determined that $ 17,770.49 of the total sales price received from Pet represented the amount received for inventory, rather than the $ 10,000 reported. Accordingly, respondent increased the partnership's ordinary income by the difference of $ 7,770.49, and reduced *35 its net long-term capital gains by this amount. Respondent's adjustment wiped out the ordinary loss of $ 7,248.39 reported by the partnership and resulted in ordinary income in the amount of $ 522.10 for the calendar year 1957.
Respondent also adjusted the partnership's 1957 income by determining that $ 9,171.95 of the total sales prices received from Pet represented the amount received for the partnership's inventory of expendable supplies on October 30, 1957. Respondent also determined *525 that the $ 9,171.95 constituted a short-term capital gain, rather than a long-term capital gain, as reported on the partnership return. Accordingly, short-term capital gain was increased by $ 9,171.95 and net long-term capital gain was decreased by $ 9,171.95.
In his determination of deficiencies, respondent adjusted the share of each petitioner's income from the partnership in accordance with the adjustments made to the partnership's income. Instead of an ordinary loss, respondent determined that during the taxable year each petitioner realized from the partnership (a) ordinary income in the amount of $ 261.05, (b) short-term capital gains in the amount of $ 4,585.98 ($ 4,585.97 as to*36 Winton), and (c) net long-term capital gains of $ 122,203.37, half of which was includable in each petitioner's income.
Under the agreements of October 30 and November 1, 1957, Pet purchased specific partnership assets. Pet did not agree to purchase nor did it purchase the partnership interest of either petitioner.
The monthly payment of $ 833.33 received by each petitioner in 1957 from Pet for complying with their agreement not to compete constituted ordinary income to the petitioners, and was not capital gain derived from the sale of goodwill.
The sales price of White Way's inventory of milk and dairy products to Pet was $ 17,770.49.
OPINION.
The initial contention of the petitioners raises a question of fact, namely, whether they sold partnership interests to Pet or partnership assets. On brief, they concede that if they sold individual assets, they did not sell partnership interests. It is their position that they sold a going milk business, that such milk business was the only business owned by the partnership, and they therefore sold their partnership interests. They cite and rely on Hatch's Estate v. Commissioner, 198 F. 2d 26, reversing*37 14 T.C. 251">14 T.C. 251.
The facts do not support petitioners' contention. The various documents executed by the parties make no reference to a transfer of petitioners' partnership interests to Pet. On the contrary, these documents refer exclusively to the specific assets sold. The preliminary agreement of October 30, 1957, states that it is an agreement "of purchase and sale * * * in reference to the assets of" White Way; that the "Partnership will sell and the Company [Pet] will purchase the following assets: * * *"; that the "delivery of the assets and the acceptance of same by the Company shall be as of mid-night on October 31, 1957"; and that in "consideration of the transfer and delivery of the above enumerated assets free and clear of all encumbrances," Pet agrees to pay and the partnership agrees to accept *526 $ 550,000. The instrument is completely devoid of any reference whatsoever to the partnership interests of the petitioners or of any expression of intent to purchase or sell partnership interests.
The documents executed on November 1, 1957, in consummating the purchase and sale, deal with assets and not with partnership interests. According *38 to the bill of sale, petitioners sold, transferred, and delivered to Pet specific assets installed and located at Decatur, Florence, and Boaz, and all other personal properties used in the dairy business, except notes and accounts receivable, but including operating supplies at October 31, 1957, estimated at $ 10,000. The bill of sale provided for an appraisal of accounts receivable to ascertain whether their value exceeded or was less than the $ 75,000 at which they were included in the $ 245,000 purchase price of such assets, after which the purchase price would be adjusted accordingly. The bill of sale further stated that "The sale and transfer of the aforesaid assets shall be effective as of the close of business October 31, 1957." The deed executed November 1, 1957, by petitioners and their wives, transferred the real property therein described to Pet for a stipulated consideration of $ 230,000. Neither document mentions or refers to petitioners' partnership interests.
The convenants not to compete which were executed by Barran and Winton on November 1, 1957, recite that Pet "has acquired the assets of" White Way, "a partnership composed of" the petitioners, and that Pet "desires*39 and intends to take over the operation of the business of" White Way "and serve the customers thereof." No reference or mention is made in these instruments regarding petitioners' partnership interests.
The fifth document executed on November 1, 1957, in consummating the purchase and sale agreement of October 30, 1957, was a security agreement indemnifying Pet against loss under the warranty contained in the bill of sale. The security agreement specifically states that petitioners, "as members of" a partnership, "entered into a contract of sale with" Pet "whereby they sold and delivered the assets of said partnership and warranted the title thereto to be free and clear of all liens and encumbrances."
And finally on November 1, 1957, petitioners and Pet entered into an escrow agreement, which states that petitioners, as members of the partnership, had "sold and delivered" the assets of the partnership to Pet. Under this escrow agreement Pet paid the sum of $ 161,163.72 to petitioners' attorney, as escrow agent, who agreed to disburse this sum in the manner therein provided. The sum placed in escrow is described in the agreement as "representing the balance of the purchase price *40 of the assets described in the Bill of Sale."
If we are to give effect to the language used by the parties in the documents consummating the transaction, we must recognize the *527 parties' only concern was with assets of the partnership. There was a meeting of the minds that the subject matter of the transaction was the purchase and sale of partnership assets. It is only by inference that the transaction can be converted into a transfer of petitioners' partnership interests, and no such inference is justified by this record.
In support of their contention that partnership interests were sold, petitioners point to their testimony that they had no intention of continuing their partnership relation after October 31, 1957. The self-serving nature of this testimony materially weakens its weight as evidence, and it is further weakened by petitioners' testimony that after October 31, 1957, the partnership was actively negotiating with the Atlantic and Pacific Tea Company to construct a store building on partnership land which would then be leased to A&P. Had these negotiations been successful, the partnership may have continued operating indefinitely. Furthermore, there is nothing*41 conclusive in petitioners' argument that partnership interests were transferred, because it had no employees and no income after October 31, 1957. The important fact is that partnership assets were the subject matter of the purchase and sale, not partnership interests.
Our determination here is not in conflict with Hatch's Estate v. Commissioner, relied on by petitioners. There, the agreement provided for the sale of "all of the business of Hatch Chevrolet Company" to the purchaser. The written agreements herein contain no corresponding provisions. The closest approach thereto appears in the petitioners' covenants not to compete, which state that Pet "desires and intends to take over the operation" of White Way "and serve the customers thereof." But this language must be read in connection with the language that precedes it, namely, that Pet "has acquired the assets of" White Way. When due regard is had for the language used in the agreements between Pet and the petitioners, as the Hatch opinion relied on admonishes us to do, we must hold, as we do, that partnership assets were sold, not partnership interests.
Petitioners refer to section 708 of the Internal Revenue*42 Code of 1954 as being consistent with the fact that partnership interests were sold. This section deals with the continuation of a partnership in subsection (a), and the termination of a partnership in subsection (b). The general rule under (a) is that "an existing partnership shall be considered as continuing if it is not terminated." The general rule under (b)(1) is that "For purposes of subsection (a), a partnership shall be considered as terminated only if --
(A) no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or
(B) within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.
*528 The above provisions of the 1954 Code and the regulations promulgated thereunder, sec. 1.708-1 (iii), Income Tax Regs., afford no support to petitioners. There was a continuation of their partnership activities after the sale of the bulk of the partnership assets, and at no time was there a sale to Pet or another of any interest in partnership profits. The transaction between the partners in 1958 was a purchase by Barran of Winton's*43 interest in the remaining piece of land owned by the partnership. The date of the dissolution of the partnership and the winding up of its affairs and distribution of its property does not appear of record. Furthermore, the provisions of the 1954 Code referred to by petitioners relate primarily to sales or exchanges of partnership interests, a situation which does not exist here.
In their income tax returns for 1957, each petitioner treated Pet's first $ 833.33 payment under the covenants not to compete as ordinary income. They now contend that such treatment was erroneous. They claim that they sold a going business including its goodwill. Under their theory the covenants not to compete were incidental to and accompanied the transfer of goodwill primarily for the purpose of assuring the purchaser the beneficial enjoyment of the goodwill acquired. Since the authorities hold that goodwill is a capital asset, Aaron Michaels, 12 T.C. 17">12 T.C. 17, and cases cited, petitioners claim that the payments in question are proceeds of sale and hence are capital gains, not ordinary income.
The facts of record do not support petitioners' theory that they in fact sold *44 goodwill. Their dairy business was heavily in debt and they wanted to sell. They negotiated with others as well as Pet. There can be no doubt, therefore, that the negotiations between petitioners and Pet were at arm's length, with each party bargaining for its or his advantage. Petitioners were able to persuade Pet to raise its initial offer from $ 530,000 to $ 550,000. The preliminary agreement, the bill of sale, and the deed are specific as to the tangible personal property and the real estate delivered and conveyed for $ 550,000, plus an adjustment for accounts receivable. Goodwill was not listed among the assets enumerated and transferred to Pet, nor were there specific provisions in such instruments relating to the conveyance of intangible property, which provisions might have encompassed goodwill as one of the assets purchased and sold.
On the contrary, the testimony and the documentary evidence establish that the parties were concerned with, discussed at length, and finally agreed upon the terms and the provisions of the accompanying covenants not to compete. The officials of Pet testified that they would not have purchased the assets without such covenants from the petitioners. *45 Pet was aware of the manner in which petitioners had started White Way and it had no intention of facing a recurrence of *529 Creamery Company's experience. Furthermore, it was consistent with Pet's practices in acquiring the assets of other dairies to insist upon a covenant not to compete.
Petitioners contend that they sold the dairy business and its goodwill for $ 750,000, and payment was deferred as to $ 200,000 thereof. This contention does not square with the facts. Petitioners do not deny that the covenants and the character of the monthly payments thereunder were discussed by the contracting parties, but they do deny any understanding that the covenants provided for anything other than deferred payments of part of the total purchase price. It is apparent, we think, that petitioners' attorney recognized the agreement as a covenant not to compete and sought some modification of its conditions for payment, but Pet rejected the proposal, insisting that petitioners had to comply with their covenants in order to earn the monthly payments. Petitioners alleged lack of understanding as to the purpose and the reasons for the covenants not to compete is at variance with their*46 own action in exacting a 5-year covenant not to compete from Jerry Roden when they purchased his milk business. Furthermore, while the preliminary agreement of sale provided for payment of $ 200,000 for the covenants, the documents as executed by the parties provide only for payment of $ 833.33 a month for 120 consecutive months, provided that, at the time each payment became due and payable, petitioners had fully complied with their covenants. It is thus apparent that the purchase price for the assets was $ 550,000 and the monthly payments were for compliance with the covenants not to compete.
Petitioners claim that on October 31, 1957, they owned a going milk business with existing goodwill, but that after midnight Pet owned such business and its goodwill. They do not claim that goodwill existed because of the earnings of the business, or because of their personal contacts with their customers; rather their claim is based on the fact that they had established customer routes, which they assert are valuable in the same manner as circulation lists of newspapers and customer lists of laundries. They cite The Pevely Dairy Co., 1 B.T.A. 385">1 B.T.A. 385, as a case*47 involving almost the exact facts as the instant case, except for the fact that it was not the dairy plant that was acquired by Pevely, but the operating routes of two other dairies.
In the Pevely case, a purchaser of milk routes deducted their cost as ordinary and necessary expenses. The Commissioner determined that what Pevely actually purchased was goodwill and that the cost thereof should be capitalized. We sustained the Commissioner, pointing out that goodwill was the specific asset sold under one contract and, although not specifically mentioned in the second contract, goodwill was the principal thing of value transferred in the sale of *530 milk routes by the other dairy. In each contract the consideration for the goodwill transferred was fixed at a certain price per customer. In this case, none of the discussions, negotiations, or written instruments mentioned or referred to goodwill, as an asset involved in the transaction, nor for that matter is there any mention or reference therein to milk routes, customers, customer lists, or trade name. To the contrary, it was the matter of the covenant not to compete that was discussed and bargained for.
Since the facts*48 establish that the covenants not to compete were executed after arm's-length negotiations between the contracting parties, whereby the terms of the convenants and the payments thereunder were fixed and agreed to, we are entitled to assume that the covenants are meaningful. Under such circumstances strong proof must be adduced by the party seeking to overcome his covenant, Ullman v. Commissioner, 264 F. 2d 305, affirming 29 T.C. 129">29 T.C. 129; Schulz v. Commissioner, 294 F. 2d 52, affirming 34 T.C. 235">34 T.C. 235, and such proof is lacking in this case. It may be that the petitioners now find themselves at a disadvantage taxwise, but in the absence of fraud it is not ordinarily open to the parties to question their own contractual agreements. Rogers v. United States, 290 F.2d 501">290 F. 2d 501.
Our next question involves the value and the selling price of White Way's inventory of milk and dairy products at October 31, 1957. The value determined by White Way and the amount included in the lump-sum consideration recited in the bill of sale was $ 10,000. The*49 parties are agreed that $ 10,000 is an estimated value for White Way's inventory. After taking a detailed inventory on November 1, 1957, Pet valued the inventory at $ 19,559.62. 2 In his determination of deficiency, respondent fixed the value of White Way's inventory at $ 17,770.49, and increased the partnership's ordinary income by the difference between the $ 10,000 reported by White Way as income and the $ 17,770.49 value or selling price as determined by him.
Petitioners now contend that their accountant's failure to take a deduction for a closing inventory does not seem to be in accordance with the provisions of section 1013 of the 1954 Code. Section 1013 deals with the basis of property included in inventory, and provides as follows: "If the property should have been included in the last inventory, the basis shall be the *50 last inventory value thereof." Petitioners claim that even if they sold individual assets instead of partnership interests there would still have to be a closing inventory to ascertain the profit or loss from the partnership's operations from January 1 to October 31, 1957.
*531 We can see no merit to this argument. In the first place, we are of the opinion that White Way's accountant was correct in preparing the partnership's return on a calendar year basis. The partnership did not terminate on October 31, 1957, and it had no closing inventory on December 31, 1957. Furthermore, even if partnership sales are reduced by $ 10,000, as representing sales of inventory, and the cost of goods sold is similarly reduced by the $ 10,000, as the valuation of the nonexistent closing inventory, the gross profit will be unchanged.
The principal dispute is over the items inventoried and the amounts thereof and over the pricing procedures and the prices of the various items listed. Our findings show that White Way followed a policy of preparing monthly statements of income using end of the month inventories. Garrett and Manley collaborated in preparing these monthly inventories for White *51 Way. The October 1957 inventory departed from the practice previously followed, in that the pricing of the inventoried items and the extensions were not entered on the inventory sheets until sometime in 1959. 3 Pet, however, took a detailed inventory on November 1, 1957, and valued such milk and dairy products inventory at that time. Both White Way's and Pet's valuations exceeded the $ 10,000 valuation of inventory in the bill of sale.
A comparison of the inventories of White Way and Pet shows rather startling differences in amounts, principally in raw and bottled sweet milk. White Way's inventory as of October 31, 1957, shows raw milk on hand in the amount of 7,870 pounds; Pet's inventory as of November 1, 1957, the next*52 day, shows raw milk on hand in the amount of 47,867 pounds, or a difference of 39,997 pounds. Similarly, White Way's inventory shows bottled sweet milk in the amount of 2,526 pounds; Pet's inventory shows bottled sweet milk in the amount of 30,053 pounds, a difference of 27,525 pounds. In pricing these two inventory items, White Way and Pet used substantially different values. White Way priced its raw milk at $ 6.05 per hundredweight, whereas Pet priced raw milk at $ 3 per cwt. For bottled sweet milk, White Way used a value of $ 6.28 per cwt., while Pet used a value of $ 8.99 per cwt.
In their briefs, petitioners list 8 items which they claim were omitted from Pet's inventory and 10 items from Pet's inventory that were omitted from White Way's. Clearly the admission that these 10 items were omitted from White Way's inventory would require an adjustment to the extent of their value. Since the only evidence as to value of those 10 items is the values fixed by Pet, petitioners' inventory valuation would have to be increased in any event by their aggregate value. With respect to the 8 items claimed to have been omitted, it appears *532 that Pet inventoried them as expendable*53 supplies, and not as milk or dairy products. The first 2 of the 8 items are quart and half pint glass bottles numbering 86.24 gross and 43 gross, respectively. In its expendable supplies inventory, glass bottles, Pet inventoried 1,292 dozen quart bottles and 822 dozen half pint bottles, which amount to over 107 gross and 68 gross, respectively. Similarly, under cleaning expense, Pet inventoried cleansers and cleaning compounds using names and with amounts which check out with the other 6 items claimed to have been omitted from Pet's inventory. The treatment to be accorded these 8 items is discussed infra.
Petitioners also contend that White Way consistently followed a method of taking inventory as of the end of each month and that because thereof its inventory as of October 31, 1957, should control over Pet's inventory taken after the end of the month. They contend further that they have followed a consistent method in pricing their inventory and that greater weight should be given to such consistency than to any particular method of inventorying or basis of valuation, citing section 1.471-2, Income Tax Regs., which deals with the valuation of inventories. They contend further*54 that any change in method at this time would constitute a change in White Way's method of accounting.
We are not impressed by these arguments. It is clear from the items of inventory discussed above that White Way's inventory failed to list some items, understated the unit count of its raw and bottled sweet milk, and its pricing was done long after October 31, 1957. Other comparisons, which also detract from the reliability of White Way's inventory, are available but need not be recited. Our question is not to decide between the inventories of White Way and Pet, but whether the value determined by the respondent for White Way's inventory represented its selling price to Pet. It was the burden of the petitioners to show that White Way's valuation was correct and that respondent's determination was wrong. This petitioners have failed to do. And, in addition, respondent's affirmative evidence, documentary and oral, definitely supports his determination. We therefore hold that respondent's determination that $ 17,770.49 of the total purchase price was paid for White Way's inventory of milk and dairy products was proper. It follows that White Way's ordinary income for 1957 was *55 $ 7,770.49 more than the $ 10,000 it reported from the sale of its inventory.
Respondent adjusted the long-term capital gain reported by White Way by eliminating $ 9,171.95 therefrom, after determining that this amount of the total sales price received from Pet represented short-term capital gain realized from the sale of supplies. Pet's detailed inventory *533 classified certain inventory items as expendable supplies, and these classes are set forth in our findings. Included therein are the glass bottles, cleansers, and compounds that White Way included in its inventory of October 31, 1957, which petitioners claimed Pet omitted from its inventory. The expendable supplies as inventoried by Pet not only included the aforementioned classes of items, but it also inventoried various other supplies, including bottle caps, truck parts, and equipment parts, the aggregate value of which was fixed by Pet at $ 9,870.49.
The parties agree that White Way realized a capital gain from the sale of supplies to Pet; they differ on whether it was a long-term or short-term capital gain. A short-term capital gain is defined as "gain from the sale or exchange of a capital asset held for not more*56 than 6 months." Sec. 1222(1), 1954 Code. In view of respondent's determination, the burden is on the petitioners to establish that White Way's supplies were held for 6 months or more, if they are to overcome the presumption in favor of respondent's action.
In discussing their burden of proof, petitioners state that the expendable supplies category included 749,109 4 individual items, and urge that it "would be impossible to set out, with any degree of certainty, the holding period of every individual item." They confess their inability to meet any such burden of proof, and urge that it would be more reasonable to deal with the holding period of the expendable supplies as a group.
*57 Petitioners are in no better position if expendable supplies are considered as a group. They rely mainly on the testimony of Winton to carry their burden. There is nothing definitive in Winton's testimony about the holding period of expendable supplies as a group, or of the specific classes of supplies included therein. We understand from his testimony that some used automobile parts lay around the garage for a considerable length of time, that additional supplies were bought before stocks on hand were exhausted, that new and old stocks were commingled so that it was impossible to tell whether new or old stock was being used, and that it was unnecessary to stock new automobile parts, as local supply houses could quickly supply the partnership needs. Such testimony is too general to establish a holding period for White Way's supplies, and the determination of the respondent is accordingly sustained.
Decisions will be entered for the respondent.
Footnotes
1. The items listed in the October 1957 inventory were primarily milk and dairy products, which included milk, cream, cheese, butter, mixes, glass bottles, paper cartons, wax and glue, and supplies, such as cleaning compounds and cleansers.↩
2. Respondent states that Pet valued this inventory at $ 18,719.09. Exhibit U, however, indicates that respondent's figure fails to include the inventory at Florence, valued at $ 840.53.↩
3. The record does not disclose who priced the October 1957 inventory or when in 1959 such pricing was done. However, the record discloses that deficiencies had been proposed against petitioners by a revenue agent's report dated January 2, 1959, and petitioners' protest was filed March 27, 1959.↩
4. Pet's inventory of expendable supplies lists 13 different-sized gaskets aggregating over 34,000 units and seven different kinds of bottle caps aggregating 659,000 units as being on hand at November 1, 1957. Such inventory also shows thousands of individual units in the truck and plant repair classifications, as well as 7,184 gallons of gasoline and over 300 quarts of motor oil.↩