1952 U.S. Tax Ct. LEXIS 22">*22 Decision will be entered under Rule 50.
Petitioner is a partner in an old and well established accounting firm. The partnership agreement provided that upon the death, retirement or withdrawal of a partner his interest in the firm assets and business should be transferred to the continuing partners, that the partnership should not thereby be dissolved, and there should be paid to him or to his estate in settlement of all claims against the continuing partners and the assets, the amount of his capital contribution, the balance of his current account and his proportionate share of profits for the current year. He was also to receive an additional amount to be determined by the administrative partners, which, in case of death or retirement at age 65, was to be equal to not less than his share of three years' earnings, past or future, and was to be paid over a 6-year period out of distributable profits. In 1947 these additional payments were made to retired partners and the estate of a deceased partner. Held: These payments were distributions of income to the retired partners and estate and are deductible by the continuing partners in determining the distributable income taxable1952 U.S. Tax Ct. LEXIS 22">*23 to them.
19 T.C. 445">*445 Respondent determined a deficiency in income tax for the calendar year 1947 in the amount of $ 2,906.29. Petitioners, 1952 U.S. Tax Ct. LEXIS 22">*24 husband and wife, filed a joint return for 1947 with the collector of internal revenue, Customhouse, New York, New York. Petitioner Carol F. Hall is a member of the partnership of Touche, Niven & Co., public accountants and auditors. The partnership's return of income, filed for its fiscal year ended September 30, 1947, reported an amount as ordinary income 19 T.C. 445">*446 distributed to two retired partners and to the estate of a deceased partner. Respondent determined that such payments were made for the purchase of capital assets, the interests of the retiring or deceased partners, and were not expenditures deductible in determining the distributable income of the partnership. Respondent allocated to petitioner Carol F. Hall his pro rata share (7/116) of the amount so paid. The sole issue is whether these payments represent part of the purchase price of partners' interests, or on the other hand distributions of income to the retired partners and the estate of the deceased partner, and therefore deductible in determining the partnership's distributable profits. The deficiency involves other adjustments not in controversy. Certain corrections in the determination are stipulated 1952 U.S. Tax Ct. LEXIS 22">*25 and will be given effect in a computation under Rule 50.
This proceeding was consolidated for hearing, but not for opinion, with those of Charles R. Whitworth, et al, Docket No. 28723, and Francis J. Clowes, Docket No. 29262. Whitworth and Clowes were members of the partnership of Touche, Niven & Co., who retired prior to 1947. Respondent determined deficiencies in those cases holding that the payments here in controversy represented distributions of partnership income taxable as ordinary income to the retired partners. Whitworth and Clowes have filed briefs supporting their contentions that the payments were part of the consideration for the purchase of their partnership interests and are taxable to them as capital gains. A joint stipulation of facts with exhibits was filed and testimony introduced which is for consideration in all three proceedings.
FINDINGS OF FACT.
The stipulated facts are found accordingly and the exhibits attached are incorporated herein by reference.
Petitioner Carol F. Hall was in 1947 and has been since 1936 a member of the partnership of Touche, Niven & Co., public accountants and auditors, hereinafter referred to as the firm. The firm kept its1952 U.S. Tax Ct. LEXIS 22">*26 books and filed its partnership returns of income on the basis of fiscal years ended September 30. The firm was originally founded in 1900 by George A. Touch, of London, England, who later changed his name to Touche, and John B. Niven of New York, New York. The firm later established offices in other cities of the United States and Canada with resident partners or resident managers. A partnership agreement signed in 1922 named six members as senior partners, George A. Touche and Andrew W. Tait, of London; John B. Niven, Charles R. Whitworth, Henry E. Mendes, and Francis J. Clowes, in the United States. Other members were admitted to the partnership in later years. Whitworth entered the employ of the firm in 1913 and became a partner in 1919, at which time he made a capital contribution 19 T.C. 445">*447 of $ 12,500. He remained a member of the firm until May 1, 1942. Clowes entered the employ of the firm in 1915 and became a partner in 1919. He made a capital contribution of $ 26,000. He ceased to be a partner as of September 30, 1946, having theretofore attained the age of 65 years. Victor H. Stempf became a member of the firm about 1922. He made a capital contribution of $ 22,000. 1952 U.S. Tax Ct. LEXIS 22">*27 He died on April 18, 1946, while still a partner.
A new partnership agreement was signed in 1936, naming seventeen partners, including Carol F. Hall. Five of these were designated administrative partners -- Niven, Whitworth, Mendes, Clowes, and Victor H. Stempf.
The partnership agreement of 1936 provided, inter alia:
ARTICLE IV
Firm Name
Section 1. The firm name of Touche, Niven & Co. shall belong to and may be used by the partnership and shall not be sold or disposed of so long as the partnership shall continue in existence.
Upon the dissolution of the partnership or the termination thereof as provided in Article I hereof, the firm name shall become the property of the then surviving Administrative partners and may be disposed of in such manner and upon such terms as a majority in interest of the Administrative partners shall determine.
Section 2. In the event of the death, retirement, or withdrawal of any of the partners during the term of the partnership, the deceased, retiring or withdrawing partner shall have no interest in the firm name and shall have no right to receive any payment therefor.
ARTICLE V
Management and Control
Section 1. The business and affairs of the 1952 U.S. Tax Ct. LEXIS 22">*28 partnership shall be managed and controlled by the Administrative partners and all matters involving the general policy of the firm and its administration shall be decided by the Administrative partners. Except as in this Agreement otherwise specifically provided, in the event of any difference of opinion among the Administrative partners any matter or question shall be decided by a majority in interest of the Administrative partners.
* * * *
ARTICLE VII
Stated Capital
Section 1. The stated capital of the partnership on the taking effect of this Agreement shall consist of the number of units of a stated value of $ 2500 each set forth in the attached Participation Schedule No. 1. The participations of the individual partners in the stated capital shall be in the same ratios as their participations in the distributable profits, and the stated capital at the time of 19 T.C. 445">*448 taking effect of this Agreement shall be contributed by the partners in such ratios and to the amount of their respective participations therein, as set forth in the attached Participation Schedule No. 1 showing the ratio, number of units and amount of the participation of each partner.
* * * *
Section 3. In the1952 U.S. Tax Ct. LEXIS 22">*29 event of the death, retirement or withdrawal of any of the partners as hereinafter provided, there shall be repaid to such retiring or withdrawing partner or the legal representative of such deceased partner, in the manner provided in Section 1 (c) of Article XI hereof, an amount equal to his paid-up participation in the stated capital at the date of his death, retirement or withdrawal. By decision of a majority in interest of the Administrative partners, the stated capital and the number of units therein may be decreased by the amount of such repayment, or the stated capital and the number of units therein may be readjusted to the former aggregate amount and number or to such other amount, number or stated value, as the Administrative partners may determine, by proportionate contributions from the remaining partners. If the stated capital is decreased by the repayment as aforesaid, the participations of the remaining partners in the remaining stated capital shall remain at the same number of units and the same amounts as before.
* * * *
ARTICLE X
Death, Retirement or Withdrawal
Section 1. The death, retirement or withdrawal of any partner shall not dissolve the partnership between1952 U.S. Tax Ct. LEXIS 22">*30 the other partners.
Section 2. Any partner may retire from the partnership at any time after the first day of October, 1936 upon giving six (6) calendar months prior notice in writing of his intention so to do and his retirement shall be effective as at the date specified in such notice, notwithstanding that such date does not coincide with the end of a fiscal year. Such notice shall be deemed to be sufficient if sent by registered mail addressed to the firm at its principal office in New York City not less than six (6) calendar months prior to the date when such retirement is to become effective.
* * * *
Section 6. Upon the death, retirement or withdrawal of any of the partners during the term of partnership the interest of the deceased, retiring or withdrawing partner in the firm assets and business shall be and become vested in and transferred to the surviving or continuing partners in the proportion of their participations in the stated capital and distributable profits and the retiring or withdrawing partner or the legal representative of the deceased partner shall have no interest in or claim against the firm assets and business or the firm name except the right to receive 1952 U.S. Tax Ct. LEXIS 22">*31 the payments hereinafter provided for in Article XI hereof.
* * * *
ARTICLE XVII
Liquidation
Section 1. In the event that the partnership shall be dissolved or terminated by the Administrative partners as in Article I provided, the surviving Administrative 19 T.C. 445">*449 partners shall become the sole and exclusive owners of the firm name, books, records and files of the partnership and shall be entitled to continue the business without liquidation or to liquidate the business or to dispose of the business as a majority in interest of the Administrative partners may determine without accountability to any of the other partners except for the payment to such partners of the amounts due them under the provisions of Section 1 of Article XI hereof. The partnership shall not be deemed to be dissolved or terminated by the death, retirement, or withdrawal of one or more of the partners.
Article XI of the agreement was amended by certain Amendatory Agreements in 1940 and 1943. As so amended it provided:
ARTICLE XI
Payments to Deceased, Retiring or Withdrawing Partner
Section 1. If any partner shall die, retire or withdraw for any reason whatsoever during the term of the partnership there shall1952 U.S. Tax Ct. LEXIS 22">*32 be payable to such retiring or withdrawing partner or to the personal representative of such deceased partner the following payments, which shall be computed and paid in the following manner and at the following times:
(a) An amount equal to the sum of (a) any loan by the partner to the firm, (b) any balance standing to his credit in his current account after crediting or debiting such account with all items not theretofore taken into the account but applicable thereto from the close of the preceding fiscal year to the date of his death, retirement or withdrawal, and (c) any other indebtedness due from the firm to him other than the sums due under paragraphs (b) and (c) hereof. Such balance shall be payable immediately.
(b) Such proportion of the distributable profits, as defined in Article II hereof, to which he would have been entitled for the then current fiscal year as the period from the beginning of such year to the date of death, retirement or withdrawal shall be to the whole of the then current fiscal year. Such sum shall be credited directly to the partner or his estate and shall be payable thereafter at such time or times and in such amounts during the ensuing fiscal1952 U.S. Tax Ct. LEXIS 22">*33 year as a majority in interest of the Administrative partners may determine.
(c) An amount equal to his paid-up participation in the stated capital, as set forth in the Participation Schedule in effect at the date of his death, retirement or withdrawal. Said sum shall be paid in six (6) equal semi-annual instalments, the first of which shall be payable at the expiration of six (6) months from the date of death, retirement or withdrawal, and the unpaid balance thereof shall bear interest at the rate of 5% from the date of death, retirement or withdrawal. The continuing or surviving partners shall have the privilege at any time and from time to time of accelerating the payment of the whole or any part or parts thereof prior to the due date at any time without notice or bonus.
The surviving or continuing partners shall have the right to offset against the payments to be made under paragraphs (a), (b) and (c) hereof any claims which the partnership may have against such deceased, retiring or withdrawing partner arising out of the partnership or this Agreement.Section 2. If any partner shall retire pursuant to Section 2 of Article X hereof after attaining the age of sixty-five years1952 U.S. Tax Ct. LEXIS 22">*34 or shall die at any age, there shall 19 T.C. 445">*450 be payable, in addition to the amounts hereinbefore provided in paragraphs (a), (b) and (c) of Section 1 of this Article XI, to such retiring partner, or to the personal representatives of such deceased partner, out of distributable profits, such amount as may be determined by the decision of a majority in interest of the Administrative partners but in no event less than the smaller of the following:
(a) an amount equal to three (3) times the annual average of the sum of the salary plus the distributable profits of the partnership which such deceased or retiring partner received or was entitled to receive in respect of the business of the partnership carried on during the ten (10) fiscal years of the partnership next preceding the fiscal year in which such partner died or retired; or
(b) an amount equal to the sum of the salary plus the distributable profits of the partnership to which such deceased or retiring partner would have been entitled, if he had not died or retired and if his ratio in the profits of the partnership had not been altered, in respect of the business of the partnership carried on during the three (3) succeeding1952 U.S. Tax Ct. LEXIS 22">*35 fiscal years of the partnership, including the fiscal year in which such partner died or retired, but for the purposes of this subdivision (b) the distributable profits shall be determined after deducting current salaries and current interest on capital of any additional partners as well as those of the surviving or continuing partners.
The amount so determined to be payable shall be payable, without interest, in six (6) equal annual instalments, the first of which shall become payable at the expiration of one (1) year from the date of death or retirement or at such earlier date as a majority in interest of the Administrative partners may determine, but, unless the distributable profits then available shall not be sufficient, no annual instalment payment during each of the first three (3) years after such death or retirement shall be less than fifty per cent (50%) of the annual salary of such deceased or retired partner at the date of his death or retirement, or less than five thousand dollars ($ 5,000) per annum.
The payment under this Section 2 is intended as a distribution of income to the retiring partner or the estate of a deceased partner for a limited period subsequent to1952 U.S. Tax Ct. LEXIS 22">*36 his retirement or death.
* * * *
The provisions for the payment to be made under this Section 2 of this Article XI are limited to the cases specifically provided for hereunder and do not apply to any partner who retires or withdraws at any other age or for any other cause.
Section 3. Notwithstanding any of the provisions of this Article XI, by decision of a majority in interest of the Administrative partners, there may be paid such sum of money in such instalments as they shall deem advisable to any partner retiring before he attains the age of sixty-five (65) years or to any other partner who may withdraw for any other reason.
Section 4. The amounts payable under this Article XI to a retiring or withdrawing partner and to the personal representative of a deceased partner shall be paid by the continuing or surviving partners and accepted by the retiring or withdrawing partner and by the personal representative of a deceased partner in full, final and complete settlement and satisfaction of all the claims of such retiring, withdrawing or deceased partner, as a partner, against the partnership, the surviving or continuing partners, and the assets of the partnership.
19 T.C. 445">*451 Under1952 U.S. Tax Ct. LEXIS 22">*37 date of October 27, 1939, Whitworth wrote the firm as follows:
I have hitherto expressed the view that I should like to retire from the firm when I reach the age of sixty, which will occur on October 12, 1943. I have been giving further consideration to the matter and am convinced not only that I should retire from the firm on September 30, 1943 but that, in the meantime, I should be relieved of all administrative duties. I feel that the orderly administration of the business and affairs of the firm makes it desirable that I give notice at this time, in a formal manner, of my intention to retire and of my desire for a less active status in the meantime, so that my partners may plan for the future of the firm and act accordingly. Furthermore, in view of the fact that the partnership agreement makes specific provisions for voluntary retirement of a partner only "after attaining the age of sixty-five years" it would also be helpful to me to make definite arrangements with the firm at this time for my retirement and interim status so that I can plan my affairs accordingly.
I understand that it is agreeable to the firm that upon my retirement on September 30, 1943, the provisions of1952 U.S. Tax Ct. LEXIS 22">*38 Section 2 of Article XI of the partnership agreement shall be applicable notwithstanding the fact that I shall not have then attained the age of sixty-five years; that in the meantime, except that my aggregate participation in the profits of the firm, including salary, shall not exceed an average for the four years of $ 20,000.00 per annum, my present salary and interest in the distributable profits shall continue unchanged, but that my status shall be no longer that of an administrative partner.
Accordingly I hereby give notice of my intention to retire from the firm on September 30, 1943 and agree that my retirement shall be effective as of that date, with the understanding that this letter shall be deemed to be sufficient notice under the provisions of Section 2 of Article X, and that the provisions of Section 2 of Article XI shall be applicable to my retirement and that I shall at that time surrender all of my interest in the firm and the firm name and assets, subject only to my right to receive the payments provided for in said Section 2 of Article XI, as well as the payments provided for in Section 1 of Article XI. It is also understood that upon my request you will accelerate1952 U.S. Tax Ct. LEXIS 22">*39 the payments provided under Section 2 of Article XI so that the said payments shall be made in five instead of six years. It is, of course, understood that in case of my death prior to September 30, 1943, my estate shall not be a partner in the firm and the provisions of Sections 1 and 2 of Article XI with respect to payments upon the death of a partner shall immediately be applicable.
From October 1, 1939 until my retirement I shall have a less active status as set forth above but nevertheless I shall retain my interest in the firm and shall be entitled to vote as a member of the firm in accordance with my interest in the distributable profits in connection with firm matters and until my actual retirement my present salary and participation in the distributable profits shall continue subject to the limitation set forth above.
If this is agreeable to you will you kindly note your acceptance on the duplicate hereof, and this letter and your acceptance shall constitute an agreement between the firm and myself effective as of the date of your acceptance.
The firm noted acceptance of the terms of this letter. Whitworth was relieved of his duties as an administrative partner.
19 T.C. 445">*452 1952 U.S. Tax Ct. LEXIS 22">*40 On April 30, 1942, Whitworth retired from the partnership to accept a commission as Assistant Supervisor of Cost Estimate for the Signal Corps, United States Army, in the Chicago District. He was then 59 years of age.
After some interim correspondence the firm wrote Whitworth under date of November 27, 1942:
Although all arrangements as to your retirement from the firm as of May 1, 1942 have been heretofore informally agreed upon, it seems to us advisable to incorporate our agreement in a letter signed by the firm and approved by you.
This will confirm your retirement as a partner in the firm of Touche, Niven & Co. as of May 1, 1942. Notwithstanding your retirement, the financial arrangements agreed upon in our agreement of October 27, 1939 shall remain unchanged and accordingly you shall be entitled to receive the following payments:
1. For the fiscal years ending September 30, 1942 and September 30, 1943 you shall receive an amount equal to your salary and interest in the distributable profits of the firm under the partnership agreement the same as though you had remained a member of the firm, except that (a) as provided in our agreement of October 27, 1939, your aggregate 1952 U.S. Tax Ct. LEXIS 22">*41 participation in the profits of the firm, including salary, shall not exceed an average for the four years ending September 30, 1943 of $ 20,000 per annum but (b) any deficiency below $ 20,000 per annum in any of said four years shall be made good to the extent of any excess over $ 20,000 available from any prior or subsequent year of said four year period, the intention being that the average for the four year period shall be determined on a cumulative basis.
2. Notwithstanding the fact that you have not and will not have attained the age of sixty-five years on September 30, 1943, you shall be entitled to receive the retirement payments provided for in Section 2 of Article XI of the Partnership Agreement which shall be computed and be payable as if you had retired on September 30, 1943 except that, upon your request, we will accelerate the payments provided under Section 2 of Article XI so that the said payments shall be made in five instead of six years.
3. You shall be entitled to receive the payments provided for in Section 1 of Article XI of the Partnership Agreement but, notwithstanding your retirement as of May 1, 1942, said payments shall be determined and be payable as if 1952 U.S. Tax Ct. LEXIS 22">*42 you had retired on September 30, 1943.
4. It is understood that in case of your death prior to September 30, 1943 the provisions of Sections 1 and 2 of Article XI with respect to payments upon the death of a partner shall be applicable immediately.
It is also understood that as of May 1, 1942 you have surrendered all of your interest in the firm and the firm name and assets subject only to your right to receive the payments above provided for.
We should appreciate it if you would note your approval on the enclosed duplicate hereof and this letter and your approval shall constitute an agreement between the firm and yourself.
Whitworth noted his approval of this arrangement.
After April 30, 1942, Whitworth performed no services for the firm.
The firm paid Whitworth $ 20,405.17 during its fiscal year ended in 1942 and $ 20,000 during its fiscal year ended in 1943. Such amounts were reported as partners' distributable income in the firm's income tax information returns. In the firm's participation schedule effective 19 T.C. 445">*453 October 1, 1941, Whitworth's annual salary was shown as $ 15,000 and his share of profits as 5/105. In the participation schedules effective October 1, 1942, 1952 U.S. Tax Ct. LEXIS 22">*43 and thereafter, Whitworth was not included as a participant in the salaries and profits. In each of the firm's fiscal years ended in 1944, 1945, 1946, 1947, and 1948, the firm paid Whitworth $ 12,000.
In addition to such payments the firm paid Whitworth the credit balance of $ 12,500 in his capital account, and $ 3,978.36 as his share of the cash surrender value of a policy on the life of John B. Niven. The premiums paid had been charged to Whitworth and other partners proportionately. These two payments were not deducted by the firm in computing distributable income nor were they reported as distributions of income to Whitworth.
Under date of November 21, 1945, Clowes gave notice to the firm of his intention to withdraw and retire as of September 30, 1946. Under date of July 10, 1946, Clowes wrote the firm:
Under our partnership agreement, there becomes payable to me following my retirement as of September 30, 1946, in addition to my share of distributable profits for the year ending September 30, 1946, and my partnership capital and interest thereon (both of which are or will be matters of record), the additional retirement payments provided for under Section 2 of Article XI, 1952 U.S. Tax Ct. LEXIS 22">*44 of the partnership agreement.
It is stipulated, first, in Section 2 that the measure of the additional retirement payments shall be (see page 14 of the agreement):
"Such amount as may be determined by the decision of a majority in interest of the Administrative partners".
It is further provided, however, that the minimum thus determinable under the discretion vested in the administrative partners shall not be less than the smaller of:
(a) three times the retiring partner's annual average partnership income for the past ten years (paragraph numbered (a) of Section 2 of Article XI., as amended as of October 1, 1943; see page 43 of the partnership agreement); or
(b) the partnership income the retiring partner would have received if he had continued as a partner during the three years succeeding retirement (paragraph numbered (b) of Section 2 of Article XI.; see pages 14-15 of the partnership agreement.)
I now claim the right to have my additional retirement payments under Section 2 of Article XI, determined under (a) above, at three times my annual average partnership income for the ten fiscal years ending September 30, 1946, without reference to alternative (b) based on the1952 U.S. Tax Ct. LEXIS 22">*45 three years subsequent to September 30, 1946; and I call on the administrative partners to discharge the duty imposed on them under the above quoted provision of Section 2 of Article XI., by determining the amount of my retirement payments immediately following my retirement on that basis and not to cause me to wait for three years for final determination.
Will you please acknowledge this letter indicating whether this proposal is agreed to.
19 T.C. 445">*454 Under date of November 8, 1946, Niven wrote Clowes as follows:
With reference to our recent correspondence relating to the waiving of the so-called "catch clause" in the partnership agreement, in so far as it relates to any limitation upon the amount of your retiring allowances, the matter was given careful consideration by the administrative partners last Monday, having before them your final letter of September 27th, as well as Mr. Pell's letter to you of August 28th.
We were all along, of course, fully alive to the fact that the administrative partners had a discretion in the matter and that they could waive the clause (subdivision (b) of Section 2 of Article XI) if they should see fit. At the same time Mr. Pell seems to have the1952 U.S. Tax Ct. LEXIS 22">*46 same opinion as we had, namely, that it was purely a matter for their discretion and that there was no legal obligation upon the administrative partners to act as suggested.
The administrative partners, however, not as a legal obligation but entirely as an act of grace, decided, after considering all the circumstances, that they would waive the terms of subdivision (b) and the amount of your retirement allowance will accordingly be regarded as a fixed amount, namely, $ 21,224.85 per annum to be paid for a period of six years, an aggregate of $ 127,349.10, subject of course to the further terms recited in your letter of September 27th.
During the fiscal year ended in 1947 the firm paid Clowes a total of $ 25,887.20, which consisted of $ 162.50 interest, $ 4,500 as compensation for services rendered after September 30, 1946, and $ 21,224.70 pursuant to the agreement with the administrative partners. In November 1946 the firm paid Clowes the balance of $ 26,000 in his capital account and the amount of his share in the profits for the fiscal year ended September 30, 1946. The payment of $ 26,000 was not deducted by the firm in determining distributable income nor was it reported as 1952 U.S. Tax Ct. LEXIS 22">*47 a distribution of income to Clowes.
Clowes was relieved of his duties as an administrative partner in November 1944 at his own request. Neither Clowes nor Whitworth made any agreement or promise not to compete with the firm after retirement.
The firm paid to the estate of Victor H. Stempf the balance of $ 22,000 in Stempf's capital account, the credit balance of $ 125 in his current account and $ 7,581.31 for the period April 18, 1946, to September 30, 1946. The payment of $ 22,000 was not deducted by the firm in computing distributable income, nor was it reported as a distribution of income. During the fiscal year ended in 1947 the firm paid the estate $ 950.77 in interest on capital and $ 15,443.41 pursuant to the contract. This was computed as follows: The annual average of the salary and profits to which Stempf was entitled during the ten years ended September 30, 1946, was $ 33,694.72. One-half of this, or $ 16,847.36, was the amount payable to the estate annually for 6 years. Eleven-twelfths of this, or $ 15,443.41 was paid by the firm. The balance was paid by the successor partnership described below.
19 T.C. 445">*455 As of September 1, 1947, the firm was dissolved and the partners, 1952 U.S. Tax Ct. LEXIS 22">*48 with others, formed a new partnership under the name of Touche, Niven, Bailey & Smart. The partnership agreement thereof provided that the Stempf estate was to be entitled to 5 1/2 per cent of the profits from September 1, 1947, to April 19, 1952, but not to exceed $ 16,847.36 for each fiscal year. It further provided for payment to Clowes of $ 21,224.85 per year for 5 years from October 1, 1947. This partnership distributed $ 1,403.95 to the Stempf estate for one month of the fiscal year ended in 1947.
In 1947 the firm had 19 active partners, employed a staff of about 200 accountants and maintained offices in New York, Chicago, St. Louis, Minneapolis, Los Angeles, Detroit, and Cleveland.
In the partnership return of income for the fiscal years ended in 1944, 1945, and 1946 the payments to Whitworth were treated as distributions of income and not as payments for acquisition of his interest in the firm. In the return for 1947 the amounts paid Whitworth, Clowes, and the Stempf estate were reported as ordinary income distributed to partners with the notation that Whitworth and Clowes were retired and that the amounts shown indicated their credits for the year.
The firm possessed 1952 U.S. Tax Ct. LEXIS 22">*49 working papers concerning its clients' organizational history and background which were of value to the firm in that this information would not have to be obtained again if further accounting work was done for those clients.
The capital contributed by the partners was a factor in producing income as it enabled the firm to carry payrolls of work in progress until the fees could be collected.
The firm accounted for its income on a cash basis and did not take into account bills rendered but unpaid nor work in progress. Records were kept of work in progress at salary cost and of unpaid bills with a reserve for uncollectible accounts. The amounts thereof at the close of the fiscal years ended in 1940 to 1946 were:
| Uncollected | Salary cost | |
| Year | fee, bills | of work in |
| rendered | progress | |
| 1940 | $ 34,355 | $ 85,449 |
| 1941 | 52,527 | 85,270 |
| 1942 | 61,986 | 68,916 |
| 1943 | 68,089 | 95,360 |
| 1944 | 67,757 | 68,654 |
| 1945 | 88,769 | 94,266 |
| 1946 | 81,486 | 119,911 |
As of April 30, 1942, when Whitworth withdrew to accept employment with the United States Army, these amounts were, respectively, $ 72,195.74 and $ 263,600.19. By September 30, 1942, such fees had 19 T.C. 445">*456 been collected or written off1952 U.S. Tax Ct. LEXIS 22">*50 and such work in progress had been liquidated.
During the fiscal years ended in 1940 to 1946 the firm had from 16 to 20 partners. The following shows the partnership income before partners' salaries, interest and retirement payments, the amount of partners' salaries for each of those fiscal years, and the partners' equity, according to the firm's statement of financial condition at the end of the fiscal year:
| Partnership | Partners' | Partners' | |
| Fiscal year ended in -- | income | salaries | equity |
| 1940 | $ 288,944 | $ 217,000 | $ 245,581 |
| 1941 | 357,717 | 207,000 | 317,324 |
| 1942 | 503,583 | 209,038 | 431,625 |
| 1943 | 553,712 | 204,500 | 579,823 |
| 1944 | 610,439 | 213,500 | 598,248 |
| 1945 | 597,298 | 206,000 | 616,916 |
| 1946 | 720,608 | 244,083 | 597,142 |
OPINION.
The partnership of Touche, Niven & Company paid certain amounts during its fiscal year ended September 30, 1947, to Whitworth, Clowes, and the estate of Victor E. Stempf. The sole issue is whether $ 48,668.26 of these amounts was paid as part of the purchase price of the interests of these former partners, or as a distribution of profits, as income, to the retired partners and the estate.
If the payments in controversy were paid as part of the1952 U.S. Tax Ct. LEXIS 22">*51 purchase price of the interests of the former partners, they would not be deductible in computing the distributable income of the partnership taxable to the continuing partners, of whom Carol F. Hall is one, and, accordingly, in the hands of the retired partners, Whitworth and Clowes, the payments would be properly treated as capital gains. This is the position taken by the respondent in this proceeding, and by the retired partners in their related proceedings. On the other hand, if the payments represented distributions of firm income to the retired partners and the estate of the deceased partner, they would not be includible in the profits taxable to the continuing partners and would be taxable as ordinary income to the retired partners. This is the position of these petitioners and is also the position taken by respondent in the related cases of Whitworth and Clowes.
The payments in controversy were part of a total of $ 228,433.26 which the administrative partners had agreed to pay Whitworth, Clowes, and the estate of Stempf under the partnership agreement of 1936, which was in effect at the times Whitworth and Clowes retired and Stempf died. This agreement provided that the1952 U.S. Tax Ct. LEXIS 22">*52 death or retirement of a partner should not dissolve the partnership between the 19 T.C. 445">*457 remaining partners and required the continuing partners to make certain payments to the retired partners or estates of deceased partners. The continuing partners were required by Article XI, section 1, to repay any loan made the firm by the former partner, as well as his current account balance and his share of the past distributable profits. His paid-up participation in the stated capital was to be repaid in installments with interest. Article XI, section 2, provided that in case of the death of a partner, or his retirement at age 65 there was to be paid, in addition, an amount to be fixed by the administrative partners, which amount was to be measured by the former partner's share in earnings in past years or the share he would have had in the next 3 years' profits had he continued as a partner; it was to be paid out of distributable profits in installments over a period of 6 years; and the agreement stated the payment "is intended as a distribution of income to the retiring partner or the estate of a deceased partner for a limited period subsequent to his retirement or death." In section1952 U.S. Tax Ct. LEXIS 22">*53 3 of Article XI, authority was given the administrative partners to pay such sum as they might deem advisable in the case of any partner retiring before reaching age 65, or withdrawing for any other reason.
The solution of the question depends upon the intent of the parties and that is to be derived from the 1936 partnership agreement. Despite contrary arguments, we think the payments here involved were made pursuant to section 2 of Article XI of that agreement and, accordingly, are controlled by that section. Whitworth argues that section 2 applies only in cases of death or retirement at age 65 and therefore cannot be applicable in his case, since he retired at age 59, but his correspondence with the firm effecting the agreement under which the payments were made to him contradicts this assertion. He wrote the firm giving notice of his intention to retire on September 30, 1943, stating that he agreed that his retirement
shall be effective as of that date, with the understanding that * * * the provisions of Section 2 of Article XI shall be applicable to my retirement, [Emphasis added.]
The firm's letter of November 27, 1942, to Whitworth stated
you shall be entitled to1952 U.S. Tax Ct. LEXIS 22">*54 receive the retirement payments provided for in Section 2 of Article XI of the Partnership Agreement [Emphasis added.]
Clowes also argues that the payments made to him were not pursuant to section 2 of Article XI. His point is that since the administrative partners agreed to compute his payments upon the basis of the past earnings without applying the alternative limitation of the earnings of the subsequent 3 years, the arrangement was not made under section 2, but was made under section 3, giving the administrative partners general authority to make discretionary payments in the case of other retirements. The letters effecting the agreement with 19 T.C. 445">*458 Clowes do no bear out his contention. He claimed the right "to have my additional retirement payments under Section 2 of Article XI determined" without reference to alternative (b), the limitation based on subsequent earnings. The administrative partners decided "that they would waive the terms of subdivision (b)," of section 2. The context of the correspondence clearly shows the intention of the administrative partners and of these retiring partners, that their retirement payments should be fixed pursuant to section 2, 1952 U.S. Tax Ct. LEXIS 22">*55 as modified in certain particulars at their own requests. The payments to the Stempf estate were also measured by the prior earnings alone without limitation by reference to subsequent earnings. These payments were likewise made pursuant to section 2, rather than section 3.
The payments, being made pursuant to section 2, are subject to certain other provisions of that section. They were to be made "out of distributable profits" and they were "intended as a distribution of income to the retiring partner or the estate of a deceased partner for a limited period subsequent to his retirement or death." Also, it was provided that no annual installment in the first 3 years should be less than 50 per cent of the partner's annual salary at death or retirement or less than $ 5,000, "unless the distributable profits shall not be sufficient." Thus the payments were keyed to the existence of profits, and the intent appears that a partner who retired, or the estate of a partner who died, was to continue for a time to participate in the profits on the same basis and in approximately 50 per cent of the amount as before the event. We find no language in the written agreement which would justify1952 U.S. Tax Ct. LEXIS 22">*56 a conclusion that the retiring partners intended to "sell" their interest in the partnership to the continuing partners, or vice versa, that the continuing partners intended to "buy" the retiring partners' interests.
The case of Charles F. Coates, 7 T.C. 125, is here apposite. There are factual differences, but we do not think them significant. Respondent has acquiesced in that case, 1946-2 C. B. 2. Coates was a continuing partner in an accounting firm which provided in the partnership contract that the death of a partner should not operate to dissolve the co-partnership, that the estate should continue as a member for 5 years with no direct voice in management, that the estate should participate in the net earnings in stated proportions and not be liable for losses, that the deceased partner's "capital interest" should be settled as soon as possible, and that at the end of 5 years and the completion of the payments the interest of the deceased parties should terminate. No partner had contributed any capital and capital was not important in that personal service organization. The "capital interest" consisted of (1) the1952 U.S. Tax Ct. LEXIS 22">*57 pool of undrawn earnings (the amount withdrawn having been limited to 85 per cent of each partner's share 19 T.C. 445">*459 for the previous year) and (2) the value of the work then in process. We noted that since the agreement provided for the return of any remaining interest in the firm's assets it was difficult to find evidence of an intent to sell the interest of the deceased partner, that the parties placed no value upon the good will and partnership name and that ordinarily no substantial value attaches to good will of such a personal service partnership. We said further:
In addition to the provisions for the return of the "capital interests" to the estates are the provisions with which we are here concerned for participation by the estate of a deceased partner in the earnings of the partnership for five years after the partner's death. These payments have no relation to the other type of payments provided for the liquidation of the capital account. They provide simply that the estate of any deceased partner shall participate to the extent there provided in the net earnings of the partnership for a period of five years. The evidence establishes that this provision was intended 1952 U.S. Tax Ct. LEXIS 22">*58 by the parties not to be the consideration paid by the surviving partners for the capital interest of a deceased partner upon the dissolution and liquidation of the partnership, but was intended to be a present consideration given by each partner upon the formation of the partnership. It was intended to be in the nature of a mutual insurance plan, the disadvantage of which each partner was willing to accept in consideration of a similar commitment for his benefit on the part of all other partners, and, in part, as further compensation for the past services of the deceased partner payable after his death.
These payments were not made in liquidation of any capital interest of the deceased partner in the firm's assets. The only payments of this nature required upon the death of a partner were the payments on account of past earnings and work in process, here designated as the "capital account." In addition to these payments, the estate of a deceased partner was entitled to the payment of a share of post death earnings, not in consideration of a sale of partnership assets on liquidation, but in consideration of mutual promises contained in the original partnership agreement having no1952 U.S. Tax Ct. LEXIS 22">*59 relationship to such a sale. These payments arose out of and depended upon the contract and their character must be determined by its terms. The estate acquired, upon the death of the partner, a vested contractual right to a share of the earnings, as earnings, and this right was fortified by a power lodged in the trustee to require a liquidation of the business if its rights were not fully respected by the surviving partners. When and as the income was earned, it became immediately subject to the preexisting rights of the estates to their share of it. The amounts so distributable to the estates were not distributable to any surviving partner, with the result that here, as in Richard P. Hallowell, 2nd, supra, the disputed amount attributed by the respondent to each surviving partner may not be regarded as "his distributive share, whether distributed or not, of the net income of the partnership."
The case of Richard P. Hallowell, 2nd, 39 B. T. A. 50, referred to in the above quotation, is also in point. There, the agreement provided that the interest of the estate of a deceased partner should be deemed a loan and that1952 U.S. Tax Ct. LEXIS 22">*60 the estate should have the same interest in profits the deceased partner would have had if living, until the termination of a period agreed upon. Since settlement of the capital interest 19 T.C. 445">*460 was to be accomplished under other provisions of the agreement, we concluded that the estate shared in profits as a matter of right under the contract. See also Sidney Hess, 12 T.C. 773, and cf. Estate of Boyd C. Taylor, 17 T.C. 627.
Clowes and Whitworth, and respondent in this proceeding, rely upon certain cases to the effect that where the partners agree that a deceased partner's interest shall be acquired by the surviving partners by payments of firm profits to his estate, there is a sale of the interest and the profits so paid are taxable to the survivors and represent the purchase price of a capital asset. See Hill v. Commissioner (C. A. 1, 1930), 38 F.2d 165, affirming 14 B. T. A. 572; Pope v. Commissioner (C. A. 1, 1930), 39 F.2d 420, affirming 14 B. T. A. 584; W. Frank Carter, 36 B. T. A. 60 (1937),1952 U.S. Tax Ct. LEXIS 22">*61 and Estate of Bavier C. Miller, 38 B. T. A. 487 (1938). In these cited cases the deceased partners had made a capital investment in the partnership which was not repaid to their estates, but was transferred to the surviving partners in consideration of the payments involved. In the present case the capital investments of the deceased or retiring partners were returned to them in full pursuant to section 1 (c) of Article XI. Payment of the distributable profits for the current year of retirement or death was also provided for in section 1 (b) of Article XI. The payments provided for in section 2 or 3 of that Article were additional and distinct. Since they could not be a return of capital they could be only distributions of income. We think these cases are distinguishable on their facts. No sale or purchase of partnership interests was here intended. See Bull v. United States, 295 U.S. 247">295 U.S. 247 (1935).
Clowes and Whitworth contend that the partnership had good will of a considerable value and working papers which were an asset in their business, that the interest of the retiring partners in these items was the subject1952 U.S. Tax Ct. LEXIS 22">*62 of a sale in the transfer of their interests to the continuing partners and that the payments in controversy were intended as the purchase price of these assets. This argument is not borne out by the agreement. Article IV provides that a deceased, retiring, or withdrawing partner shall have no interest in the firm name and no right to receive any payment therefor. As to the good will, in the first place it is inextricably associated with the firm name and not transferable otherwise, and in the second place the good will of a personal service organization such as this, is rarely a vendible article. Charles F. Coates, supra.As for any good will attaching to Whitworth or Clowes individually and separate from firm good will, these retiring partners made no agreement not to compete with the firm and hence must be deemed not to have relinquished or transferred it, if indeed it could be transferable. The firm in its financial calculations at no time placed any value upon the firm name, good will, or working 19 T.C. 445">*461 papers. Nor do we find anything in the agreement disclosing any intention to value good will as such or to make any payments in consideration1952 U.S. Tax Ct. LEXIS 22">*63 of the sale thereof to the surviving partners.
We think that the partners in entering into the 1936 agreement, intended that a retired partner, or the estate of a deceased partner, should share in the profits of the firm, as profits, for a limited period after the event, that the provision was in the nature of a mutual insurance plan in which each partner assumed its possible burdens in consideration of the assumption of a like obligation by his partners to him, and that the payments here in controversy were properly deducted by the continuing partners in determining the distributable partnership income taxable to them.
Because of conceded adjustments,
Decision will be entered under Rule 50.