*200 Decisions will be entered under Rule 50.
Held, under the facts, that the transaction in issue was a sale by petitioners of their interests in a partnership.
*159 Respondent determined the following deficiencies in income tax for 1946:
| Docket No. | Petitioner | Deficiency |
| 44834 | W. Ferd Dahlen | $ 12,278.09 |
| 44835 | James H. Forbes | 15,015.39 |
| 44836 | Myles P. Dyer | 6,129.09 |
| 44837 | Estate of Robert E. Hannegan, Deceased | 7,208.95 |
| 44857 | Walter H. S. Wolfner | 20,027.03 |
The issue is whether certain gain was realized from a sale of partnership assets, taxable as ordinary income, or from a sale of partnership interests, taxable as capital gain.
FINDINGS OF FACT.
The petitioners in Docket No. 44837 are the duly qualified executors of the estate of Robert E. Hannegan, who died October 6, 1949. The decedent, hereinafter referred to for convenience as Hannegan, filed his return for 1946 with the collector of internal revenue for the district of Maryland. The other petitioners were residents of Missouri in 1946 and filed their returns for that year with the collector*201 of internal revenue for the first district of Missouri.
On November 27, 1942, Dahlen, a coffee broker since 1917; Forbes, president of the James H. Forbes Tea & Coffee Company since 1928; Wolfner, a tea, coffee, and spice importer and broker for many years; and Hannegan, formed a partnership, with equal interests, to engage in the business of manufacturing soluble tea and coffee under the trade name of Forbes Soluble Tea & Coffee Company, hereinafter referred to as the partnership. Each partner made an initial contribution of $ 2,500, and thereafter made an additional contribution of $ 2,000. Hannegan, with the knowledge and without objection of other members of the partnership, entered into an agreement with petitioner Myles P. Dyer under the terms of which Dyer was to receive one-half *160 of Hannegan's one-fourth of the profits of the partnership. In accordance with this arrangement Dyer paid to Hannegan one-half of his contribution of $ 4,500 to the partnership. Dyer took no part in the management of the partnership. Thereafter Dyer reported as income to him amounts received from Hannegan under the agreement.
The partnership had an order from the War Department for soluble*202 coffee at the time it went into production. Later, the Federal Government froze sales of instant coffee for civilian use and thereafter the entire output of the partnership was sold to the United States Army. The freeze order was lifted about the summer of 1945 and a short time thereafter the Government canceled its purchase contracts with the partnership.
In September or October 1945 Wolfner entered into negotiations with the president of Hygrade Food Products Corporation for the sale of the partnership. At that time the sales price of coffee the partnership had on hand was subject to regulations of the Office of Price Administration. The parties reached an understanding that the selling price of the business would be fixed by including the coffee in the inventory at the prevailing O. P. A. prices, and that the machinery and equipment would be included at book value on August 31, 1945, adjusted to October 31, 1945, for depreciation.
On November 2, 1945, the partners entered into a written agreement with the Baker Importing Company, Inc., hereinafter referred to as Baker, a subsidiary of Hygrade Food Products Corporation, reading, in part, as follows:
FIRST: The Sellers agree *203 to, and do hereby, sell, transfer and convey to the Buyer, and the Buyer agrees to, and does hereby, purchase from the Sellers their coffee and tea manufacturing business, including their business of manufacturing and selling soluble coffee, located at and operated from 212-222 South Seventh Street, St. Louis, Missouri, under the name of FORBES SOLUBLE TEA & COFFEE COMPANY, consisting of the following assets, to wit:
(a) All of the Sellers' merchandise, inventories, raw material and supplies, of every kind and nature, on hand and located on the Sellers' aforesaid premises at the close of business on October 31, 1945, including all items listed in the annexed inventory, initialed by the representatives of the parties, * * *
(b) All of the Sellers' accounts receivable outstanding at the close of business on October 31, 1945, a list of which is furnished by the Sellers, initialed by them, * * *
(c) All machinery, tools, equipment, leasehold improvements, fixtures, furniture, vehicles and all other personal property of every kind and nature, located or used on or from said premises on October 31, 1945, including all items shown on Schedule C, initialed by the representatives of the parties, *204 * * *
(d) All right, title and interest of the Sellers to and in the items described as "Deferred", aggregating $ 6,252.87, as of August 31, 1945, and being listed amongst the Sellers' assets as "Deferred" * * *, which item is to be adjusted as of October 31, 1945.
*161 (e) All of the Sellers' goodwill, franchises, trade marks, trade brands, trade names, licenses, patents, processes and formulae owned by the Sellers or used in their said business, the Sellers hereby granting to the Buyer and any of its subsidiaries, affiliates or assignees, now or hereafter organized, the sole right to use the name FORBES SOLUBLE TEA & COFFEE COMPANY. The Sellers hereby furnish the Buyer with a list of all its said trade marks, trade brands and trade names * * *
(f) All of the Sellers' books and records pertaining to its business including all files, correspondence, books of account, ledgers and all other documents and records used by the Sellers in the operation of their said business.
* * * *
FOURTH: To induce the Buyer to make the foregoing purchase, the Sellers jointly and severally represent and warrant to the Buyer as follows:
* * * *
(e) That the Sellers have paid and discharged any and*205 all claims, demands and liabilities of every kind and nature against the Sellers pertaining to the assets hereby sold to the Buyer, except for minor purchases made in the regular course of business which are to be completed by the Buyer and which are not included in the sale of assets hereunder. The Sellers also represent that the affidavit of Walter H. S. Wolfner, to be furnished by the Sellers, certifying and guaranteeing that the Sellers have no creditors who are required to be notified of this sale, complies in all respects with the Bulk Sales Law of Missouri and all other statutory requirements. The Sellers agree to hold the Buyer harmless from and of any and all claims, demands or suits based upon failure to comply with said Bulk Sales Law or other statutory requirement.
The buyer agreed to pay for "all of the assets described in paragraph first hereof, including the items listed in Schedules A, B, C and D annexed," the sum of $ 472,437, of which $ 359,937 was to be paid on or before November 10, 1945, and the balance in four equal annual installments, without interest, commencing November 1, 1946, with a right to pay any installment in advance of the due date.
Title to all*206 of the assets purchased was to be deemed as having passed at the close of business on October 31, 1945, rentals, salaries, wages, and all other expenses to be adjusted as of that time.
The sellers agreed that they would not for a period of 10 years engage in any capacity in the manufacture of soluble coffee, and to reimburse the buyer for any account receivable not paid within 60 days.
The assets were not distributed in kind to the partners prior to the sale.
The buyer did not assume any of the liabilities of the partnership.
The buyer paid $ 359,937 on the purchase price about November 13, 1945, $ 28,125 on November 1, 1946, and the remainder in 1947, less a discount of 10 per cent.
The purchase was reflected on the books of the buyer as acquisition of assets as follows: *162
| Inventory of merchandise and supplies | 1 $ 420,931.67 |
| Accounts receivable | 1,524.28 |
| Prepaid rent | 300.00 |
| Prepaid insurance | 1,897.17 |
| Machinery and equipment | 47,783.88 |
| Total | $ 472,437.00 |
The buyer and seller took a physical inventory of the coffee and other assets on hand October 31, 1945, for the purposes of the sale, and computed an amount therefor*207 based upon O. P. A. prices.
Machinery, equipment, leasehold improvements, and office furniture and fixtures were sold at book value on August 31, 1945, adjusted to October 31, 1945, for depreciation.
After its acquisition of the assets Baker manufactured coffee in the plant which the partnership had occupied under a lease. The operations were conducted by Baker under the name and trade marks of Forbes Soluble Tea & Coffee Company for about 6 months.
The partnership received a license in its name from the Department of Agriculture for the importation of a specified quantity of green coffee. Such licenses were issued only to coffee manufacturers. Importations made under the licenses were checked periodically and if the authorized quantity had not been imported, there was probability that the license would be revoked or the quantity reduced. The licenses were not transferable to individuals. Approval of the licensor was necessary for transfer of a license to another manufacturer of coffee.
Concurrently with the sale to Baker the partnership discontinued its operation of the business, and, except in liquidation, conducted no business thereafter. Baker thereafter operated the business*208 and used the import license in the importation of coffee.
After the sale to Baker was consummated, Dahlen received permission from Baker to use the license for importation of coffee in excess of the manufacturing requirements of Baker. Dahlen then agreed with Wolfner that the commissions earned in the dealings of such imported coffee, less expenses paid by them, would be shared equally between Dahlen and Wolfner. Forbes and Hannegan were not parties to this subsequent agreement and had no interest therein, and all profits therefrom belonged to Dahlen and Wolfner.
The commissions earned and expenses paid from this Dahlen-Wolfner agreement were entered in the books of Dahlen. About August 1946, the auditor of Dahlen's books, who was also the accountant for the partnership, erroneously and without authority so to do, opened a "green coffee trading account" on the books of the partnership *163 and transferred the entries on Dahlen's books to that account. The entries so transferred were for transactions made during the period from March to August 1946, inclusive. Entries were made in the partnership books for transactions made in October and November 1946. The account reflected*209 a profit of $ 9,784.23 at the close of the partnership's fiscal year ended November 30, 1946, all of which belonged to Dahlen and Wolfner.
The return filed by the partnership for the fiscal year ended November 30, 1945, reported gross receipts from business of $ 1,967,238.50 and gross profits of $ 262,678.63 from such receipts.
The return filed by the partnership for the fiscal year ended November 30, 1946, reported gross profit of $ 1,750 from business, consisting of sales, less returns and allowances; other income in the amount of $ 14,499.14; gain of $ 160,738.17 realized on the sale to Baker; and deductions of $ 3,966.65. The "Other income" consisted of $ 4,563.03 representing the cancellation of a reserve for unemployment insurance and a refund received in an account kept for the purchase of jars; $ 88.31 received as a refund for an overpayment of interest; a refund of $ 63.57 for water; and $ 9,784.23 for "Profit on Green Coffee Trading Account." Deductions claimed in the total amount of $ 3,966.65 consisted of the following items:
| Office salaries | $ 1,461.56 |
| Repairs | 112.92 |
| Personal property tax | 35.16 |
| Depreciation on furniture | |
| and fixtures | 47.19 |
| Storage | 155.63 |
| Freight, express and | |
| hauling | 269.59 |
| Postage, printing and | |
| stationery | 15.38 |
| Legal and professional | $ 1,255.00 |
| Dues and subscriptions | 2.80 |
| Miscellaneous | 30.00 |
| Cancellation army contract | 127.56 |
| Insurance | 64.48 |
| Miscl. factory supplies | 89.45 |
| Advertising | 298.67 |
| Discount | 1.26 |
*210 One-fourth of one-half of the gain, or $ 20,092.27, was shown in the return as net long-term capital gain distributable to each partner. The ordinary income of $ 12,282.49 was reported to be distributable as follows:
| W. H. S. Wolfner | $ 4,516.68 |
| W. F. Dahlen | 4,516.68 |
| J. H. Forbes | 1,624.57 |
| R. E. Hannegan | 1,624.56 |
The shares of Forbes and Hannegan are equal to one-fourth of the ordinary income of $ 12,282.49 after deducting the trading account profits of $ 9,784.23, or $ 624.56, plus $ 1,000 of the $ 9,784.23. The amount of $ 1,000 was allocated to them by Wolfner and Dahlen without legal obligation to do so and was in the nature of a gift. The *164 shares of Wolfner and Dahlen were computed in the same manner except that each received one-half of the trading account profits not included in the shares of Forbes and Hannegan.
The return filed by the partnership for the fiscal year ended November 30, 1947, reported a loss of $ 9,162.28 resulting from profit of $ 1,493.24 in the "Green Coffee Trading Account" and expenses of $ 10,655.52, consisting of the following items:
| Legal and professional | $ 165.75 |
| Discount on note | 8,437.50 |
| Returns and allowances | 1,512.79 |
| Miscellaneous | 539.48 |
*211 All of the expenses related to the sale of the business. One-fourth of the expenses, amounting to $ 2,663.88, was allocated in the return to Forbes and Hannegan each as operating loss on their partnership interests, and a like amount, less one-half of the trading account profits, amounting to $ 1,917.26, to Wolfner and Dahlen.
In his determination of the deficiencies respondent held that the gain realized on the sale of the inventory was taxable as ordinary income and taxed the profit on the sale of machinery and equipment as long-term capital gain.
The sale made by the petitioners was of their partnership interests.
OPINION.
The difference between the parties under the issue is whether there were sales of partnership interests taxable as capital gain, as reported by the petitioners, or sales of assets of the business, taxable as ordinary income, as determined by the respondent. 2
*212 Respondent first asserts that the agreement of sale was in the form of a sale of assets. We do not so view it.
The contract of sale provided for a specified amount in payment of the "coffee and tea manufacturing business" of the partners, consisting, in general, of all of its tangible and intangible assets, including accounts receivable, deferred charges, and books and records, and excluding cash on hand. As part of the transaction the parties agreed to refrain from engaging or becoming interested in any capacity in the business of manufacturing soluble coffee for a period of 10 years. All operations of the business from the close of business on October 31, 1945, to the date of execution of the contract on November 2, 1945, were to be for the account of the buyer.
*165 The broad terms of the contract of sale disclose a purpose of the buyer to acquire and of the seller to sell a going business without interruption of activities. The buyer took possession of the plant as of the close of business on October 31, 1945, and at all times important thereafter operated it for its own account, for a short period in the trade name of the partnership, and used the import license for *213 obtaining quantities of raw coffee for future production requirements.
That the parties to the transaction intended to transfer the entire enterprise, instead of merely the physical assets, is clearly shown by testimony. The sale was negotiated by Wolfner, who testified that the negotiations were initiated by the buyer with the idea of acquiring the "business" and that it bought the partnership "lock, stock and barrel," and the secretary of Baker testified that a "going business" was acquired. Such testimony is consistent with the terms of the contract of sale, and the acts and conduct of the parties with reference thereto.
In support of his position respondent contends (a) that the import license was not transferred to Baker, and (b) that there was a continuation of the partnership business for 2 years after the sale to Baker.
We think there is no merit in either of these contentions.
The contract of sale, in (e) of paragraph First, wherein is transferred the goodwill, etc., of the business to Baker, also specifically transferred "all * * * franchises, * * * licenses, * * * owned by the Sellers or used in their said business."
Considering the importance and indispensability of the*214 import license in the future operations of the buyer, it would be unreasonable to construe the unqualified terms above quoted as not intended to include such license.
Furthermore, from the evidence we have found as a fact that after the sale Baker did use the import license for obtaining the importation of raw coffee for its production requirements.
So both by the terms of the contract and the acts of the parties with reference thereto, we must conclude that the import license was transferred to the buyer.
We think the record as a whole refutes the suggestion that the partnership continued in active business after the sale to Baker. Under the terms of the sale they were precluded from so doing, and we think the evidence conclusively shows that the partnership, concurrently with the transfer, did discontinue its going business activities, and all transactions thereafter were in liquidation.
We attach no importance to the fact that for the 2 years immediately succeeding the sale the partnership filed income tax returns, in the first of which they reported total gross income in the amount *166 of $ 1,750, and in the second of which no taxable income was reported. The business *215 in which the partnership had been engaged was of such magnitude it would naturally require some time in making financial transactions of settlement. According to the partnership income tax return for the year ended November 30, 1945, its total sales were approximately $ 1,967,000, and its gross profits $ 262,678.
Total income of less than one-tenth of 1 per cent of its sales for the previous year, and no income for the second year indicates a cessation rather than a continuation of the partnership business.
The fact that after the sale to Baker it agreed to let Dahlen import coffee under the import license in excess of its needs and Dahlen divided the profits from this business with Wolfner is of no significance. This was a separate business in which the original partners had no interest. The erroneous book entry is of no consequence and must give way to the actual facts.
Neither do we regard as significant the fact that cash was not involved as an asset in the sale or that liabilities were not assumed. Obviously, delivery of the cash on hand would have amounted to no more than an exchange of dollars and the absence of an agreement to assume liabilities in no sense negatives a *216 purchase or sale.
Estate of Herbert B. Hatch, 14 T.C. 251">14 T.C. 251, 3 is distinguishable. There the exclusions from the sale included the franchise the seller had been operating under and also the partnership name. Here the license to import coffee was transferred by the sale and Baker acquired the trade name and any goodwill the partnership might have had; here nothing was reserved.
In Kaiser v. Glenn, (C. A. 6, 1954) 216 F.2d 551">216 F.2d 551, 4 involving the same issue here presented, the court said:
In applying tax statutes, matters of substance are of first importance. In this case, the partners intended a sale of their partnership interests and their retention of the two contracts which could not be sold because the purchasing corporation would not accept them did not result in a continuation of the partnership business even though the partnership was not terminated until the partners' liability under*217 the contracts was liquidated. The sale was not of partnership assets but of the partnership business as a going concern.
We think the evidence here is opposed to the determination of respondent that the sale was merely of assets of a business, and find that the facts establish sales of partnership interests giving rise to capital gain, as contended by petitioners, and we accordingly so hold.
Decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: James H. Forbes, Docket No. 44835; Myles P. Dyer, Docket No. 44836; Estate of Robert E. Hannegan, Deceased, Irma P. Hannegan and Mercantile Trust Company, Executors, Docket No. 44837; and Walter H. S. Wolfner, Docket No. 44857.↩
1. $ 15,218.78 was for supplies.↩
2. Respondent taxed the gain realized on the sale of machinery and equipment as long-term capital gain. He concedes that the sale of a partnership interest constitutes a sale of a capital asset. G. C. M. 26379, 1950-1 C. B. 58↩.
3. Reversed on appeal, 198 F.2d 26">198 F.2d 26↩.
4. Reversing 114 F. Supp. 356">114 F. Supp. 356↩.