*3485 The amount paid by two partners to a third partner, in excess of such partner's interest in the capital and undivided proflt in the partnership, to secure his withdrawal from the partnership, such partner taking with him that portion of the business of the partnership which he had secured and the payment resulting in the acquisition of no capital asset by those making the payment, held to be deductible in computing net taxable income.
*692 These proceedings are for the redetermination of deficiencies in income taxes. In the case of Aitkin, the Commissioner has determined a deficiency for the year 1920 amounting to $620.83. In the case of Kynett, he has determined a deficiency for the years 1920 and 1921 amounting to $557.47.
FINDINGS OF FACT.
The petitioners are residents of the State of Pennsylvania, with offices at 1516 Chestnut Street, Philadelphia.
During the year 1916, the petitioner, Aitkin, and one H. H. Dippy formed a partnership for the purpose of conducting an advertising agency. On January 1, 1920, a new partnership was formed*3486 for the same purpose, by Aitkin, Dippy, and the petitioner, Kynett. Each partner had a one-third interest in the firm. The partnership agreement was in writing and contained the following provisions:
7. At the end of each year during the continuance of this copartnership, a balance shall be struck, and after the general debts of the firm and the salaries of said parties are provided for and equalized, the remaining net profits shall then be equally divided between the said parties.
8. Upon dissolution of said co-partnership, after payment of all debts, the assets shall be divided between the parties as follows:
(a) There shall be repaid to each of said parties his original capital contribution.
(b) There shall then be repaid to each party the amount of additional capital which he may have contributed to said firm either by way of uncollected profit or contributions.
(c) The remaining assets shall then be divided equally between the said parties.
* * *
10. If a partner becomes disabled mentally or physically and the surviving partners cause the partnership to be dissolved and enter into a new partnership *693 among themselves or with others within a period*3487 of six months after the dissolution of this partnership, then the survivors each agree to pay the disabled party the sum of $2,500, representing his share of the good will unless the disability has been removed within the aforesaid period of six months after dissolution.
The agreement provided that the partnership might be terminated on January 1 of any year upon notice by any partner, otherwise to continue in force from year to year.
In the summer of 1920 dissension arose in the partnership. Dippy extended credit to one of his clients which petitioners considered as unwarranted and as jeopardizing the firm. Without the consent of his partners he canceled an obligation due the partnership. He made promises to clients which were impossible of performance. He failed to devote his best efforts to the affairs of the partnership.
On September 3, 1920, Dippy, Aitkin, and Kynett mutually agreed to dissolve the partnership as of August 31, 1920. The agreement of dissolution contained the following provisions:
2. Except as hereinafter set forth, Dippy hereby agrees to sell to Aitkin and Kynett, who agree to purchase equally, all the right, property and interest whatsoever which*3488 Dippy hath or should have in and to all and singular the assets of the said partnership including cash, merchandise, bills, notes and accounts receivable, leases, contracts, furniture, fixtures and supplies, for a price or sum which shall be the amount of the personal account of Dippy plus $200.00, plus one-third of the undivided profit as of August 31, 1920, less any sums drawn by Dippy above his salary, plus $5000.00.
The amount thus payable to Dippy shall become due upon the closing of the books and the presentation of an accountant's statement, which shall be obtained by Aitkin and Kynett as soon hereafter as possible.
In computing the amount payable to Dippy, there shall be deducted from the resources the sum of $2,062.22, representing the indebtedness to the partnership of Anderson Motor Company, and the sum of $3,674.01, representing the amount due to the partnership by Arrow Grip Manufacturing Company, which two accounts shall be collected by Aitkin and Kynett, and the net collections divided equally among the parties hereto.
The sum ascertained to be due to Dippy as aforesaid shall be paid as follows: $10,000.00 in cash upon the execution hereof, receipt whereof by*3489 Dippy hereby is acknowledged, and the balance in cash when ascertained, provided that Aitkin and Kynett shall and hereby do sell and deliver to Dippy all unbilled merchandise carried in stock for accounts which are recognized as accounts of Dippy, to wit, Atwater Kent Manufacturing Company, Ajax Metal Company, Philadelphia Electric Company, H. G. McFadden Company, Witherbee Storage Battery Company, Trexler Company, L. Adler Sons Company, Jacob Reed and Sons, and Snellenburg Clothing Company.
Dippy agrees to purchase said merchandise at cost, which cost shall be credited against the balance which will become payable to Dippy hereunder.
* * *
Aitkin and Kynett agree for the term of one year from the date hereof not to golicit directly or indirectly the business of any of the accounts specified in P. 2, and Dippy agrees for the same term not to solicit the business of any other accounts of the partnership.
* * *
*694 Aitkin and Kynett hereby agree to indemnify Dippy and save him harmless from and against any and all claims, demands, loss and expense by reason of any and all debts, liabilities and obligations of the partnership, Aitkin and Kynett hereby assuming and*3490 agreeing fully to pay and discharge any and all such debts, liabilities and obligations.
Dippy's capital investment at the time of organization of Dippy and Aitkin was $200. Dippy had $1,515.97 to his credit on the books of the partnership on September 1, 1920. One-third of the undivided profits of the partnership from January 1, 1920, to September 1, 1920, amounted to $14,154.56. These three amounts were paid to Dippy. In addition to them, he was paid $5,000 by Aitkin and Kynett. This additional payment was not made for any assets, tangible or intangible, but was the amount demanded by Dippy before he would consent to an immediate dissolution of the partnership and was paid by the petitioners to protect themselves against the injury which they anticipated would result from a continuance of the partnership.
On or about September 1, 1920, petitioners organized the firm of Aitkin, Kynett Co., a partnership.
In computing their net income for 1920, petitioners claimed a deduction of $2,500 each, on account of the said $5,000 paid to Dippy. The Commissioner has determined that the said payment of $5,000 was a capital item and not deductible as an ordinary and necessary business*3491 expense.
OPINION.
PHILLIPS: The Commissioner has conceded that the petitioners acquired no physical assets from Dippy upon his retirement from the firm of Dippy and Aitkin. He contends, however, that they acquired something intangible in return for the payment of $5,000, and that, therefore, such payment did not represent a business expense.
Petitioners have shown that the nature of their advertising business was such that each member of the firm had his own clients who gave their business to the firm in reliance upon the integrity, ability and genius of the particular member with whom they dealt. The good will of the firm was, in substance, the sum of the good will attaching to the individual partners. When Dippy retired, he took with him his clients, their accounts and their business. The firm, as such, had no accounts or clients. The petitioners continued to handle the accounts of those clients whom they had procured. The undisputed testimony is that Dippy had extended unwarranted credits to customers, that he had canceled collectible indebtedness to the firm, that he had made promises to customers which were impossible to perform, and that he failed to devote his*3492 best efforts to the success *695 of the firm. So long as he was a partner he was in a position to bind these petitioners to an extent which they considered to be not only entirely unwarranted but also as wasting and endangering their resources. His continuance in the business was a threat to their financial stability and their business reputation. We are satisfied that the payment to Dippy of $5,000 in excess of his share of the capital and profits of the business was not in payment for any asset which he conveyed to the petitioners, either tangible or intangible, but was rather for the purpose of assuring the petitioners that he would no longer be able to bind them by his acts.
The respondent relies upon paragraph 10 of the partnership agreement, quoted above in the findings of fact as demonstrating that the partnership had a good will value, which the partners recognized. It is to be noted, however, that the payment there mentioned was to be made only if one of the partners was disabled mentally or physically. In such an event, that partner would no longer be able to handle the accounts of his clients, and it would be reasonable to suppose that the remaining partners*3493 would have an advantage in seeking to induce these clients to continue with such remaining partners. Here Dippy was not disabled. Not only did he take with him his own clients but the petitioners agreed not to solicit these clients for one year. Each individual had his own clients and each continued to serve these clients. The two situations are not comparable.
It is to be noted that in the present case the benefits which were derived from this payment did not extend beyond the taxable year. By the terms of the partnership agreement it could have been terminated at the close of 1920. Had the petitioners waited until then, Dippy would have been entitled only to his share of the capital and profits. The payment of $5,000 was the condition imposed by Dippy for his withdrawal four months before the partnership could be terminated under the agreement. We are therefore not concerned with the situation which would be presented had the benefits of this payment extended beyond the taxable year.
The payment which these petitioners made to protect themselves against the future actions of Dippy was directly connected with and proximately resulted from their business. No capital*3494 asset was acquired. The situation is not unlike that presented to the Supreme Court in ; ; 6 Am. Fed. Tax Rep. 7358, where expenses of defending and action for an accounting, instituted by a former partner, were allowed as a deduction from income as ordinary and necessary business expenses. We are of the opinion that the Commissioner erred in refusing to allow the deductions claimed.
Decision will be entered under Rule 50.