*1343 Petitioners acquired a one-third interest in a partnership for $90,000. Held, that such payment is not deductible from income, either as an ordinary and necessary business expense or as a loss.
*219 In the proceedings at Duckets 30893 and 39731, the respondent asserts deficiencies against Burt L. Davis for the years 1922, 1923, 1924 and 1925 in the respective amounts of $1,275.55, $1,493.57, $1,994.50 and $1,161.87. At Docket 30894 he asserts deficiencies against Winfield S. Davis for the years 1922 and 1923 in the respective amounts of $461.54 and $2,496.51. The three proceedings were consolidated for hearing. The sole issue involved is whether a certain amount paid to a retiring partner by the petitioners, in installments, shall be regarded as a capital expenditure, a loss, or a necessary business expense.
FINDINGS OF FACT.
Prior to September 30, 1923, Burt L. Davis, Winfield S. Davis and William F. Hougard were, and for some years had been partners, each with a one-third interest in the business of J. B. F. Davis*1344 & Son, which, for many years, had been operated as a general insurance brokerage agency, in San Francisco, California, and was then the oldest concern of its kind on the Pacific Coast. In addition to its main office at San Francisco, where 80 people were employed, it had a branch at Seattle, Washington, which was conducted by 10 or 12 employees. This concern was founded by J. B. F. Davis long prior to 1886, at which date Winfield S. Davis was taken into the business as a partner. In 1895 the father died and some time thereafter Burt L. Davis became a partner. Hougard was first employed about 1890 and, without making any capital contribution, became a partner with a small interest in 1907. About 1920 he became an equal partner with the petitioner. He was an aggressive and effective insurance man, and, after his acquisition of a one-third interest, assumed an important position in the concern and endeavored to dominate, control and direct its affairs without much consideration for the wishes or the feelings of his partners. He brought in many new customers and was largely responsible for a substantial expansion of business during the years just preceding September 30, 1923.
*1345 Early in 1923 considerable friction developed between the petitioners and Hougard, who demanded complete control of the business and threatened court action and a receivership, whereupon the petitioners decided to get him out and themselves continue the business as a new partnership under the old name. Hougard at first demanded $175,000 as consideration for his retirement. After long continued and acrimonious negotiations, he finally agreed to take $90,000. Thereupon the petitioners and Hougard executed an agreement on September 17, 1923, providing for the retirement of Hougard from the firm, which, so far as relevant here, is as follows:
*220 1. That the partnership of J. B. F. Davis & Son owned by the parties hereto be and the same shall be terminated and dissolved by mutual consent as of September 30, 1923.
2. That a complete auditing and accounting of the business of J. B. F. Davis & Son be had showing the condition of said business on the 30th day of September, 1923, in the same manner as had prevailed in the past, and the results to be certified by George T. Klink, Public Accountant. That when said audit and accounting of the business of J. B. F. Davis & Son*1346 be had that all debts owing and liabilities incurred by the firm of J. B. F. Davis & Son be deducted in figuring all profits that have accrued prior to the 30th day of September, 1923, and that the profits accrued and undivided be distributed as follows: One-third (1/3) to Winfield S. Davis, one of the parties of the first part, one-third (1/3) to Burt L. Davis, one of the parties of the first part, and one-third (1/3) to William F. Hougard, the party of the second part.
3. That the parties of the first part hereby purchase from the party of the second part, his undivided one-third (1/3) interest in and to the business of J. B. F. Davis & Son as the same exists on September 30, 1923, for the sum of NINETY THOUSAND ($90,000) Dollars, said Ninety Thousand ($90,000) Dollars to be paid as follows: Forty-five Thousand ($45,000) Dollars in cash, lawful money of the United States of America, to be paid by the parties of the first part to the party of the second part upon the signing of this agreement, receipt whereof is hereby acknowledged by said party of the second part; Forty-five Thousand ($45,000) Dollars of said purchase-price in two (2) promissory notes, each in the sum of Twenty-two*1347 Thousand Five Hundred ($22,500) Dollars, payable one (1) year from date, without interest, one (1) of said promissory notes to be signed by Winfield S. Davis, one of the parties of the first part, to the order of the party of the second part, and endorsed or secured by collateral satisfactory to the party of the second part, and the other of said promissory notes, in the sum of Twenty-two Thousand Five Hundred ($22,500) Dollars to be signed by Burt L. Davis, one of the parties of the first part, to the order of the party of the second part, and endorsed or secured by collateral satisfactory to the party of the second part.
4. That in the sale by the party of the second part to the parties of the first part of his undivided one-third (1/3) interest in and to the business of J. B. F. Davis & Son, as of September 30th, 1923, said party of the second part sells all right, title and interest in and to the copartnership business of J. B. F. Davis & Son, and same includes all right, title, and interest in and to the the right to go into the general insurance business and solicit or receive orders partnership name, and in and to all furniture, fixtures, contracts, all books of record of*1348 every kind and nature, and all other property and assets of every kind and description belonging to said partnership of J. B. F. Davis & Son, as the same exists on the said 30th day of September, 1923, and whether herein expressly enumerated or not. And said parties of the first part shall have the right to continue the said business of J. B. F. Davis & Son as the successors of all the parties hereto.
5. IT IS EXPRESSLY UNDERSTOOD that the party of the second part reserves the right to go into the general business and solicit or receive orders of business from customers or clients formerly doing business with J. B. F. Davis & Son, but in no way to advertise himself as the successor, or as a former partner of, or formerly connected with said J. B. F. Davis & Son.
* * *
*221 Winfield S. Davis paid one-half of the $90,000 consideration for the retirement of Hougard in 1923, subject to a discount, which left a net payment by him in that year in the amount of $43,425, and Burt L. Davis paid $16,250 in 1923 and $28,750 in 1925. The firm of J. B. F. Davis & Son, with the two petitioners as sole partners, continued in business throughout the taxable years and thereafter. *1349 In the year 1923 its net distributable income was $83,235.85. In 1925 it distributed to Burt L. Davis the amount of $27,174.22.
Immediately after September 30, 1923, Hougard established an insurance brokerage business of his own in San Francisco. He solicited and retained a substantial number of accounts which he and others had previously secured for J. B. F. Davis & Sons. In 1924 and 1925 the business of the partnership decreased somewhat more than one-third in volume as compared with the two preceding years, and the income of each of the two remaining partners, therefore, was substantially less than in 1923 and the years just prior thereto.
OPINION.
LANSDON: At the hearing in these proceedings the petitioners abandoned their allegations of error as to the years 1922 and 1924, conceding that the deficiencies determined for those years were correct. Pursuant thereto the respondent's determination as to such years will be approved.
Subsequent to the filing of the petition at Docket 30894, Winfield S. Davis died. His regularly appointed executors, Clara May Davis, Kenneth M. Davis and Anita MacDonald, have been substituted as parties petitioners.
In their income-tax*1350 returns for the taxable years and several others, the petitioners each deducted a pro rata part of the payment to Hougard, apparently as amortization of such amount. These deductions were disallowed by the Commissioner. Petitioners now seek to deduct the entire amount in the years in which the several installments were paid as losses sustained in such years, or, in the alternative, as ordinary and necessary business expenses. The respondent contends that the entire payment to Hougard was consideration for his interest in the business and was a capital expenditure.
The petitioners' contention must be that nothing of value was acquired in consideration of the $90,000 payment to Hougard. They do not contend that a payment for which tangible or intangible assets were acquired would be deductible as a loss in the taxable year. We think it is clear from the evidence that both tangible and intangible assets were acquired in consideration of the payment to Hougard, namely, all right, title, and interest in and to the partnership name *222 of J. B. F. Davis & Son and to the use of such name; all right, title, and interest in and to all furniture, fixtures, contracts, books of*1351 account, and all other property and assets of every kind and description belonging to the partnership; and the agreement by Hougard that he would not advertise himself as the successor, former partner, or as having been formerly connected with the J. B. F. Davis & Son partnership. Perhaps the assets were not worth the amount paid for them, but we think the Board is not concerned with that question. Even if the Davis brothers paid more than Hougard's interest was worth, no loss was sustained at the time of payment.
In , we had a similar question presented. There the petitioners contended, as they do here, that the amounts were paid to avoid threatened legal action and its injurious effects to the business, as well as to assure retirement of the partner who threatened such legal action. We held that such payments were made to acquire the retiring partner's interest in the partnership good will and that such payments were capital expenditures. At the hearing in that case the petitioners testified, as they did in the instant proceeding, that in making the payments they did not consider that they were made to acquire any*1352 interest in the good will of the business which the retiring partner might have had, but that the payments were made to prevent legal action.
We think the partnership of J. B. F. Davis & Son had good will of substantial value. It had operated as a general insurance brokerage agency in San Francisco for more than 50 years and doubtless had many clients who purchased insurance through the firm because of its long standing good reputation and good service. The good will of a partnership is ordinarily considered part of the partnership assets and is to be accounted for upon termination of the partnership. Hougard had an interest in any good will of J. B. F. Davis & Son and was entitled to an accounting therefor upon termination of the partnership. We think such interest in the good will was acquired along with other partnership assets in consideration of the payment of $90,000.
The facts of , are distinguished from the facts of the instant case. We there held that a payment of $5,000 to secure the withdrawal of a partner from the partnership was deductible in computing net income, since it resulted in the acquisition of no capital*1353 asset. The benefit of the $5,000 payment did not extend beyond the taxable year, since by the terms of the partnership agreement it could have been terminated at the close of 1920. The payment was made to secure the partner's withdrawal from the firm four months before that time.
The petitioners argue in their brief that the Board erroneously excluded certain testimony offered by them to show that the written *223 agreement from which we have quoted in our findings of fact was entered into under duress and that $90,000 payment was a "hold-up," paid only to prevent Hougard from carrying out his threat of legal proceedings to force a receivership which would wreck the business. Even if we concede their contention that the payment was a "hold-up" and that they were forced to sign the agreement to save their business, we are still of the opinion that the amount is not deductible. Regardless of their motive in making the payment, the fact remains that in exchange therefor they did acquire capital assets of considerable value. At the time they concluded to purchase Hougard's interest in the partnership for $90,000 the petitioners could only estimate the additional profits*1354 which each might expect from the additional one-sixth interest in subsequent partnership profits. We do not know the basis for their estimate or the value which they placed upon the tangible and intangible assets of the partnership. We do know, however, that they paid $90,000 for a one-third interest therein and in our opinion such payment was not an expense incurred to protect the business or a loss at the time it was made.
Reviewed by the Board.
Decisions will be entered for the respondent.