*53 Decisions will be entered for the respondent.
Consideration received by petitioners-shareholders for individual covenants not to compete with vendee of their corporate stock, held, severable from price of stock and taxable to them as ordinary income.
*129 This consolidated proceeding involves deficiencies in income tax determined against petitioners as follows:
| Year and deficiency | ||||
| Petitioner | Docket | |||
| No. | ||||
| 1946 | 1947 | 1948 | ||
| Richard Ullman and Portia Ullman | 56676 | $ 7,388.76 | ||
| Herman Kaiser and Sylvia Kaiser | 56677 | 1,566.44 | ||
| David H. Ullman and Claire W. Ullman | 56678 | $ 14,795.55 | 44,309.54 | |
| David H. Ullman | 56679 | $ 58,488.69 | ||
| Richard Ullman | 56680 | 11,174.87 | ||
| Benjamin Ullman | 56681 | 6,083.48 | 13,857.64 | |
| Benjamin Ullman and Anna Ullman | 56682 | 8,955.74 |
*54 Certain minor adjustments referred to in several notices of deficiencies herein are not contested.
The sole issue for decision is whether the aggregate amount of $ 350,000 received by petitioners during the years 1946 through 1948, for individual covenants not to compete in a linen supply business, in which they had owned all of the capital stock, was taxable to them as ordinary income or as capital gain.
FINDINGS OF FACT.
Some of the facts are stipulated and are hereby found.
Petitioners Richard and Portia Ullman are husband and wife and filed a joint income tax return for the year 1948. Richard Ullman filed an individual return for each of the taxable years 1946 and 1947.
Petitioners David H. and Claire W. Ullman are husband and wife and filed a joint income tax return for each of the taxable years 1946 and 1948. For the year 1947 David H. Ullman filed an individual return.
*130 Petitioners Benjamin and Anna Ullman are husband and wife and filed a joint return for the year 1948. Benjamin Ullman filed an individual return for each of the taxable years 1946 and 1947.
All of the above-mentioned income tax returns were filed with the then collector of internal revenue for the*55 second district of New York.
Petitioners Herman and Sylvia Kaiser are husband and wife and filed a joint return for the year 1948 with the then collector of internal revenue for the district of Massachusetts.
Portia Ullman, Claire W. Ullman, Anna Ullman, and Sylvia Kaiser are involved herein only because of the joint returns filed by them with their respective husbands.
David H. Ullman, Richard Ullman, and Benjamin Ullman are brothers. David H. Ullman, D. H. Ullman, and David Ullman are one and the same person and will hereinafter be referred to as David.
In the early part of 1946 the three Ullman brothers were engaged in operating a number of laundries and linen supply companies, including Paramount Linen Supply Co., Inc. (and Bell Coat, Apron, Towel & Linen Supply Co., Inc., its subsidiary), Victory Barber Towel Supply Co., Inc., and Champion-Metro Towel Supply Co., Inc. They owned all the issued and outstanding capital stock of these three corporations (hereinafter called Paramount, Victory, and Champion, respectively) except for 6 per cent of the stock of Paramount which was held by Herman Kaiser, an employee who was the manager of the subsidiary company.
The three Ullman brothers*56 were also owners of all the issued and outstanding capital stock of Hygrade Steam Laundry, Inc., Victoria Coat, Apron Supply & Steam Laundry Co., Inc., Laundry Trucking Co., Inc., Learoy Realty Co., Inc., and Ellyou Realty Co., Inc.
In addition, the three brothers, or one or more of them, also owned interests in Blue Diamond Laundry No. 1, Inc., Westchester Coat & Apron Supply Co., Inc., Sunshine Quaker Laundry Service Co., Inc., and Consumers Textile Manufacturing Co., Inc. One or more of the Ullman brothers had an interest in Park House. David also had an interest in Suburban Coat, Apron & Linen Supply Co., Inc., of Lynn, Massachusetts. National Coat, Apron & Linen Supply Co., Inc., mentioned in the sales agreement, hereinafter more fully referred to, dated August 8, 1946, was owned by the nephew of David, and David had no interest in this corporation.
The Ullman brothers, who had many years of experience in the laundry and linen supply business, were the executive officers of the three linen supply corporations, Paramount, Victory, and Champion. David was president of these corporations and supervised the over-all operation of the enterprise. Benjamin had charge of the laundry*57 department located in the 96th Street plant which employed about 60 *131 persons. Richard was in charge of equipment and buying materials required in the operations of the corporations, and supervised the plant at Kent Avenue, Brooklyn, New York.
Customers for the linen supply business were obtained by special solicitors, managers, route supervisors, or route men. David seldom solicited customers personally. He visited customers in isolated cases and only when difficulties arose with a large account. Benjamin and Richard were "inside men" and did not have personal contact with customers of the business.
From 1936 until August 1946, Herman Kaiser managed and operated Bell Coat, Apron, Towel & Linen Supply Co., Inc. (the subsidiary of Paramount), located in Newark, New Jersey. In that capacity Herman did not solicit customers personally. Occasionally he would visit a key account for various reasons, such as collecting a bill or straightening out a complaint; but primarily his job was to supervise the internal affairs of the business.
About a year prior to August 8, 1946, David decided to sell the linen supply business and to disassociate himself from active participation *58 in that industry. His brothers, Benjamin and Richard, concurred with him in that decision. At that time David was about 45 years of age, was getting tired of the business, and his doctors had advised him to stop working. Benjamin, then 65 years of age, was agreeable to selling out because he also was not feeling well and his doctors had advised him to get out of the business. Richard, then about 60 years old, agreed to sell the linen supply business since he was not getting along with his two brothers and there was continual bickering among them.
David was friendly with Isadore Weinstein, chairman of the board, and Murray Cohen, president of Consolidated Laundries Corporation, hereinafter called Consolidated, and he discussed the possible sale of the linen supply business to them. The executive officers of Consolidated evinced interest in the proposal, and negotiations for the sale were thereafter carried out by David exclusively on behalf of all the petitioners with executive officers of Consolidated.
Conferences between David and Consolidated began about August 1945; the negotiations were then dropped temporarily and resumed again sometime in the early part of 1946. It took*59 about a year to negotiate the over-all transaction because the parties could not reach any agreement with respect to the method of payment of the sales price. After approximately a year, the parties to the negotiations arrived at a price of $ 40 per dollar of weekly collections from customers taking linen service, such collections being in excess of $ 25,000 per week. That method of determining a sales price was in accordance with the customary practice prevailing in the linen supply industry, the $ 40 figure varying as circumstances of the particular business involved might require.
*132 Assets of petitioners' linen supply business sold to Consolidated included the linens already in use, sewing machines, office and stock room equipment, office furniture, names and addresses of the customers, and employment contracts covering the drivers and supervisory personnel to operate the business.
Linens included in the total price of $ 40 per dollar of weekly sales represented a value of $ 20 to $ 22 for each dollar of weekly sales or approximately one-half of the total price. In addition to the $ 40 figure, all new linen in stock was to be paid for separately by Consolidated. The*60 contracts with customers for the supply of linens, included in the above assets, provided for a term of 2 years and were automatically renewable. These contracts were considered to be valuable by the parties to the transaction. Trucks were omitted from the assets that went with the proposed sale of the linen supply business because they were owned by Laundry Trucking Co., Inc., to whom a consideration of $ 25,000 was to be paid. Accounts receivable and moneys in the bank, less accounts payable, likewise were not included in the sales price but were subsequently to be adjusted by the accountants for the sellers and the buyer.
The contracts with employees, included in the sale of assets, provided that during their employment or after the end thereof, workers were prohibited from disclosing to any person, firm, or corporation, the name, address, or requirements of any customer of petitioners. These contracts further provided that for a period of 5 years after the termination of employment for any reason whatsoever, employees were prohibited from soliciting, serving, or catering to, or from being interested in any business in or connected with any other person, firm, or corporation*61 soliciting, servicing, or catering to any of the customers of the employer.
After David for the petitioners and Weinstein and Cohen for Consolidated had arrived at a price of $ 40 per dollar of weekly income as the consideration, Walter Rosenberg, petitioners' accountant, and Herman S. Glaser, then controller of Consolidated, were called upon to compute the weekly sales of the linen supply corporations; to ascertain the manner in which the total proceeds were to be allocated among the different companies sold; and to fix the details of the payments to petitioners.
The weekly sales of the linen supply corporations were computed by the accountants as follows: Paramount, $ 18,071; Bell (Paramount's subsidiary), $ 2,850; Champion, $ 3,427; Victory, $ 1,000; or a total of $ 25,348. The foregoing computation resulted in a round figure of 1 million dollars for the corporations, which amount was subject to adjustments to be made subsequently.
*133 In addition the sum of $ 25,000 computed for the value of the trucks of Laundry Trucking was deducted from the million dollars, leaving $ 975,000 as the price subject to adjustments.
During the discussions resulting in the price of $ 40 per*62 dollar of weekly income in computing the total price, there was no separate negotiation about including a covenant against competition by petitioners in that figure. On or before June 24, 1946, several weeks before the legal documents relating to the sales transaction were executed by the sellers and buyer, the question of assigning a certain amount of money for restrictive covenants came up for consideration. At a meeting held on June 24, 1946, between the accountants for the buyer and sellers, Glaser, representing Consolidated, wanted the sum of $ 400,000 set aside for the covenants not to compete out of the agreed price. Rosenberg, representing petitioners, was aware of the tax consequences of setting aside that amount for the restrictive covenant out of the total consideration agreed upon, and gave this factor "deliberate and careful consideration." Since Rosenberg did not have authority to accede to Glaser's request, the accountants submitted the figure to the sellers and buyer for their further consideration. Subsequently, the sum of $ 400,000 was reduced to $ 350,000 by the parties to the transaction.
David and the executive officers of Consolidated, Weinstein and Cohen, *63 were present at the negotiations relating to the purchase of the three corporations, the restrictive covenants, and the values assigned to them. Jacob Landau, general counsel of Consolidated, in whose office the negotiations were held and whose office drafted the documents involved, entered the discussion after the entire transaction was practically consummated. David had some knowledge of the tax consequences of a covenant not to compete. He submitted to the fixing of the aggregate amount of $ 350,000 for the restrictive covenants because the petitioners were anxious to sell the linen supply business, and did not wish to risk the possible refusal of Consolidated to go through with the transaction.
Petitioners were not related to any of the officers or stockholders of Consolidated. Paramount, one of the linen supply corporations included in the sale, owned nonvoting common stock in Consolidated, held under a voting trust certificate. The negotiations leading up to the execution of the legal documents relating to the sale of the three corporations and the restrictive covenants were carried on at arm's length.
On August 8, 1946, an "Agreement" was executed by petitioners and Consolidated*64 whereby petitioners agreed to sell to Consolidated for the sum of $ 520,000 all of the outstanding stock of Paramount (including that of Bell, its wholly owned subsidiary). The agreement, *134 hereinafter referred to as the Paramount contract, provided that the purchase price was to be paid at the time of closing to each of the petitioners in the same proportion as his respective stock ownership, as follows:
| Name | Amount |
| David Ullman | $ 307,944 |
| Richard Ullman | 97,760 |
| Benjamin Ullman | 83,096 |
| Herman Kaiser | 31,200 |
| Total | 520,000 |
The Paramount contract further provided that petitioners would execute and deliver to Consolidated covenants not to compete in the linen supply business, and in consideration thereof Consolidated agreed to pay them the following sums on the dates indicated:
| On signing of | Feb. 15, 1947 | Feb. 15, 1948 | |
| this contract | |||
| David Ullman | $ 34,466.04 | $ 68,932.08 | $ 68,932.08 |
| Richard Ullman | 10,941.60 | 21,883.20 | 21,883.20 |
| Benjamin Ullman | 9,300.36 | 18,600.72 | 18,600.72 |
| Herman Kaiser | 3,492.00 | 6,984.00 | 6,984.00 |
On August 8, 1946, the three Ullman brothers also entered into a similar "Agreement" with Consolidated for the sale of all the*65 stock of Champion for the sum of $ 105,000, which was to be paid at the time of closing to the sellers as follows:
| Name | Amount |
| David Ullman | $ 66,150 |
| Richard Ullman | 21,000 |
| Benjamin Ullman | 17,850 |
| Total | 105,000 |
The Champion agreement further provided that the sellers of the Champion stock would execute and deliver to Consolidated covenants not to compete in the linen supply business, and in consideration thereof Consolidated agreed to pay them the following sums on the dates indicated:
| On signing of | Feb. 15, 1947 | Feb. 15, 1948 | |
| this contract | |||
| David Ullman | $ 5,796 | $ 11,592 | $ 11,592 |
| Richard Ullman | 1,840 | 3,680 | 3,680 |
| Benjamin Ullman | 1,564 | 3,128 | 3,128 |
On August 8, 1946, another "Agreement" was also entered into with Consolidated by the three Ullman brothers, as sellers, for the *135 sale of all the stock of Victory for the sum of $ 22,000, which was to be paid at the time of closing to them as follows:
| Name | Amount |
| David Ullman | $ 13,860 |
| Richard Ullman | 4,400 |
| Benjamin Ullman | 3,740 |
| Total | 22,000 |
The Victory agreement further provided that the sellers would execute and deliver to Consolidated covenants not to compete in the linen supply*66 business, and in consideration thereof Consolidated agreed to pay them the following sums on the dates indicated:
| On signing of | Feb. 15, 1947 | Feb. 15, 1948 | |
| this contract | |||
| David Ullman | $ 1,638 | $ 3,276 | $ 3,276 |
| Richard Ullman | 520 | 1,040 | 1,040 |
| Benjamin Ullman | 442 | 884 | 884 |
The total amount of consideration stated to have been paid by Consolidated for the stock owned by petitioners in the three corporations (Paramount, Champion, and Victory), as specified in the aforesaid agreements, is $ 647,000. In the same agreements, the aggregate amount of consideration specified to have been paid to petitioners for the covenants not to compete in the three corporations is $ 350,000, and is allocated in the aforesaid agreements as follows:
| Name | Amount |
| David Ullman | $ 209,500.20 |
| Richard Ullman | 66,508.00 |
| Benjamin Ullman | 56,531.80 |
| Herman Kaiser | 17,460.00 |
| Total | 350,000.00 |
The respective amounts recited in the restrictive covenants represent the same proportion of the aggregate consideration for the individual covenants as petitioners' respective stock ownership in the three corporations.
Under date of August 8, 1946, the same date the three above-described sales *67 agreements were entered into, each of the Ullman brothers executed a separate agreement denominated "Restrictive Covenant" which stated in pertinent part as follows:
(a) That the undersigned will not, at any time hereafter, directly or indirectly, either as principal, agent, employer, employee, director, stockholder, officer, or in any other individual or representative capacity whatsoever, solicit, sell, serve, cater, prejudice or divert or assist, be interested in or connected with any other individual, firm or corporation that shall solicit, sell, serve, cater, prejudice or divert, or attempt to do any of the foregoing, to or with *136 any of the present or former customers of PARAMOUNT LINEN SUPPLY CO. INC., VICTORY BARBER TOWEL SUPPLY CO. INC., CHAMPION-METRO COAT AND APRON SUPPLY CO. INC., BELL COAT APRON TOWEL & LINEN SUPPLY CO. INC., CHAMPION COAT AND APRON SUPPLY CO. or VICTORY COAT, APRON AND LINEN SUPPLY CO. (hereinafter referred to as "the linen supply companies"), except as hereinafter provided.
(b) Nor will the undersigned do anything, directly or indirectly, to prejudice the existing good will of any of the linen supply companies aforementioned or to prejudice, *68 alter or influence the relationship between any of the said linen supply companies and any of their present or former customers or employees, or to divulge to anyone other than CONSOLIDATED LAUNDRIES CORPORATION, the names, addresses, requirements or any other information pertaining to any of the present or former customers of any of the said linen supply companies;
(c) Nor will the undersigned, for a period of seven years from the date hereof, directly or indirectly, in any capacity whatsoever, anywhere within the State of New Jersey, City of Philadelphia and environs thereof, the City of New York and the counties of Suffolk, Nassau, Westchester, Putnam, Ulster, Orange, Sullivan, Rockland and Dutchess, engage in, be interested in, connected with or assist financially or otherwise, any coat, apron, towel or linen supply business or laundry plant, or any other business so similar, in whole or in part, to the present business of any of said linen supply companies or CONSOLIDATED LAUNDRIES CORPORATION, so as to make the same, directly or indirectly, competitive with the business of any of said linen supply companies or CONSOLIDATED LAUNDRIES CORPORATION, or any part thereof.
Notwithstanding*69 the foregoing provisions, it is understood and agreed that the undersigned shall have the right to buy, manufacture and sell textiles such as are commonly used by linen supply companies, and to continue the present stockholdings or connections of the undersigned in the following corporations or firms:
BLUE DIAMOND LAUNDRY NO. 1, INC.
PARK HOUSE
YONKERS COAT, APRON & LINEN SUPPLY CO.
WESTCHESTER COAT & APRON SUPPLY CO. INC.
SUNSHINE QUAKER LAUNDRY SERVICE CO. INC.
NATIONAL COAT, APRON AND LINEN SUPPLY CO. INC.
upon condition, however, that the said corporation or firm shall not violate the provisions of paragraph (a) or (b) hereof, * * *
The corporations and firms enumerated in paragraph (c) above were linen supply companies engaged in the same kind of business as the three corporations sold to Consolidated.
Kaiser likewise executed a covenant not to compete with the same restrictions applicable to him as to the three Ullman brothers.
On August 8, 1946, David also executed a document designated "Trade Name Assignment" in which he transferred to Consolidated all of his right, title, and interest to the trade names, Champion Towel Supply Co., Champion Coat and Apron Supply Co., Victory*70 Coat, Apron and Linen Supply Co., and possibly Paramount Linen Supply *137 Co., "said transfer and assignment to include the good will in connection with any of said trade names." The trade names referred to were theretofore used by the corporations in which David held stock. After the sale of the business, these trade names were used by Consolidated on some of its trucks and in connection with one or more of its divisions.
On August 8, 1946, the Ullman brothers executed a document denominated "Guaranties" whereby they agreed, inter alia, to pay Consolidated the sum of $ 30 per dollar of the weekly average sales for any customer of Victory, Champion, Bell, or Consolidated, if such customer hereafter ceases to be a customer of said corporations and thereafter receives its laundering or linen services from, by, or through the following corporations: Westchester Coat & Apron Supply Co., Inc.; National Coat, Apron & Linen Supply Co., Inc.; Yonkers Coat, Apron & Linen Supply Co.; Sunshine Quaker Laundry Service Co., Inc. One or more members of the Ullman family had a business interest in these companies. The Ullmans acknowledged that the aforesaid sum of $ 30 per dollar represented*71 the reasonable amount of damages that would be sustained by reason of the loss of any linen supply customer.
On the same day, David likewise executed a "Guaranty," in which he agreed, among other things, to pay to Consolidated the sum of $ 30 per dollar of the weekly average sales for any customer of Victory, Champion, Paramount, Bell, or Consolidated, if such customer ceases to be a customer of said corporations and thereafter receives its laundering or linen services from, by, or through Blue Diamond Laundry No. 1, Inc., or Park House, in which firms one or more of the Ullman brothers had interests.
On August 8, 1946, pursuant to the prior negotiations one or more of the Ullman brothers executed a series of separate agreements whereby they sold to Consolidated all of the machinery, equipment, chattels, fixtures, trucks, and real property in the following corporations of which they owned all of the capital stock for the consideration specified, which was in addition to the $ 40 figure:
| Name of corporation | Consideration |
| Hygrade Steam Laundry, Inc | $ 60,000 |
| Victoria Coat, Apron Supply & Steam Laundry Co., Inc | 90,000 |
| Laundry Trucking Co., Inc | 25,000 |
| Learoy Realty Co., Inc | 115,000 |
| Ellyou Realty Co., Inc | 85,000 |
| Total | 375,000 |
*72 In 1946, there was a trade association in the linen supply industry of which Paramount and Victory were members. The linen supply association concerned itself with respect to legislation bearing on the industry, union activities, and the protection of each member against the "pirating" of customers by members. Also, in 1946, there was an *138 office towel supply association of which Champion was a member. Sanctions had in the past been imposed by the trade associations against "pirating" of customers. During 1946, Consolidated was not a member of either of these trade associations.
David's reputation in the linen supply industry was considered to be good. In the absence of a restrictive covenant, he could have financed and operated other linen supply companies. David had the necessary technical knowledge to set up a competitive business, or he could have worked for rival companies.
After Kaiser sold his minority stock interest in Paramount, he received a contract of employment with Consolidated as a solicitor of new accounts. If he had not accepted such employment or signed a covenant not to compete, he could have worked for another linen supply company.
At the time of*73 the instant trial Kaiser was operating a linen supply business in Lynn, Massachusetts, which he had purchased in July 1947, and both David and Benjamin Ullman were working in a supervisory capacity for two corporations wholly owned by them, namely, Sunshine Quaker Laundry Service Co., Inc., and Consumers Textile & Manufacturing Co., Inc. Richard Ullman is no longer active; his two sons are engaged in the laundry business and he assisted them financially when they started out. His health was good in 1946 and he could have worked for some other laundry or linen supply company if he had not signed the covenant not to compete.
Prior to the instant transaction, Consolidated had bought and sold numerous linen supply companies. It was the practice of Consolidated in negotiating for the acquisition of such a company, to bargain separately with respect to the amount to be paid for a restrictive covenant. Consolidated considered it very important to keep the sellers of a linen supply business to them out of competition for an extensive period, generally 5 to 7 years, so that they would lose the contacts they had established during the years they were in the business. In 1946, petitioners*74 were well known in the linen supply business and Consolidated considered them to be effective competitors. If petitioners had not agreed to execute the covenants not to compete, Consolidated would have paid them substantially less than the full amount of the consideration which they received.
After the sale, Consolidated recorded the amount of $ 350,000 on its books as a separate expense item attributable to the restrictive covenant and amortized its cost over a 7-year life.
Petitioners treated the total consideration received from the transaction as in payment for the capital stock, and reported the gain as long-term capital gain, allocating nothing separately to the restrictive covenant.
*139 The aggregate amount of $ 350,000 was paid to petitioners for the individual covenants not to compete, and the latter were evaluated and bargained for at arm's length as separate items in their negotiations.
OPINION.
The numerous cases dealing with covenants not to compete and their tax treatment by the purchasers and sellers of a business, respectively, arise against various factual backgrounds. At the outset, we note a distinction between the sale of a business by its direct owner *75 on the one hand, where goodwill is the property of the vendor and his covenant may well be a contributing factor in the sale of the entire business, e. g. (individuals), Aaron Michaels, 12 T. C. 17; Harold J. Burke, 18 T.C. 77">18 T. C. 77; (corporation) Toledo Blade Co. v. Commissioner, (C. A. 6) 180 F. 2d 357, affirming 11 T.C. 1079">11 T. C. 1079, certiorari denied 340 U.S. 811">340 U.S. 811, and, on the other, situations where the covenant is the personal agreement of individuals who, as such, have no direct proprietary rights in the goodwill, Estate of Mildred K. Hyde, 42 B. T. A. 738, including also transfers of corporate stock accompanied by personal covenants of the stockholders, Beals' Estate v. Commissioner, (C. A. 2) 82 F.2d 268">82 F. 2d 268; Helvering v. Salvage, 297 U.S. 106">297 U.S. 106; Cox v. Helvering, (C. A., D. C.) 71 F. 2d 987, affirming a Memorandum Opinion of this Court dated June 30, 1933; Gazette Telegraph Co., 19 T. C. 692,*76 affd. (C. A. 10) 209 F.2d 926">209 F. 2d 926; Clarence Clark Hamlin Trust, 19 T. C. 718, affirmed sub nom. Hamlin's Trust v. Commissioner, (C. A. 10) 209 F.2d 761">209 F. 2d 761.
Importance from the standpoint of the vendor, of course, lies in the treatment of his negative covenant as the equivalent of affirmative personal services and hence taxation of its proceeds as ordinary income under section 22 (a). See Beals' Estate v. Commissioner, supra;Cox v. Helvering, supra. An apt illustration of this principle is the case where the seller is to supply affirmative services as well as his negative commitment not to interfere with the business. Christensen Machine Co., 18 B. T. A. 256, 257; Black River Sand Corporation, 18 B. T. A. 490, 498.
In addition, even where a proprietorship is sold, the existence of a distinct and severable contract separately engendered and bargained for, with a consideration divisible from that relating to the sale of the business, may so nearly constitute a payment*77 for personal services as to be the purchase of a separate asset and correspondingly to give rise to ordinary income wholly divided from the capital gain growing out of the sale of the business. Rodney B. Horton, 143">13 T. C. 143; cf. Aaron Michaels, supra; and see Wilson Athletic G. Mfg. Co. v. Commissioner, (C. A. 7) 222 F. 2d 355, reversing T. C. Memo. 1954-163.
*140 This distinction is supported by the doctrine of the general law that the seller of a business enters automatically into an implied agreement not to interfere with the purchaser's beneficial use of the property received, "Tax Consequences of a Covenant Not to Compete," 27 Taxes 891">27 Taxes 891 (1949); specifically not to seek to attract away from the buyer the customers of the business being transferred. "After a voluntary sale, the seller, though he may compete, may not drum up or circularize the customers of the business." Judge (later Mr. Justice) Cardozo in In re Brown, 242 N. Y. 1, 10, 150 N. E. 581, 584. This, in fact, is what petitioners did in the present*78 case. And if the three laundry companies had been the makers of such a covenant as in Toledo Blade Co. v. Commissioner, supra, we might have agreed that no separate covenant was involved but only the articulation of a commitment which would in any event have been implied by the legal effect of the transaction itself. Here, however, the goodwill and customers were the property of the corporation and not of petitioners, Burnet v. Commonwealth Imp. Co., 287 U.S. 415">287 U.S. 415; Klein v. Board of Supervisors, 282 U.S. 19">282 U.S. 19, and we know of no principle which carries an implied agreement by a stockholder regarding the goodwill or customers of his corporation. See Ginsburg v. Warczak, 330 Ill. App. 89">330 Ill. App. 89, 69 N. E. 2d 733. Petitioners accordingly were paid for and the vendors secured a contract apart from and beyond the business itself.
The issue here, as it was in all of the cases mentioned, is whether the consideration ostensibly passing to the individual petitioners for their separate agreements not to compete with the buyer is to be taxed to them*79 as ordinary income as contrasted with the proceeds of the sale of their stock in the laundry companies which is concededly capital gain. The goodwill of the laundry companies, as we have said, did not belong to petitioners and it was not an asset that could be transferred by them as individuals.
In the transaction under consideration no title to the property or assets of a going concern passed from one ownership to another. These taxpayers and other owners of stock in the corporation did not sell the property, assets, or goodwill of a going concern. They merely sold stock. The contract for the sale of the stock contained a severable provision in which the sellers of stock covenanted not to engage in the * * * business in a specified area. And it contained separate and distinct provision evaluating the stock and the covenant not to compete * * *. Thus it is clear that the covenant not to compete was severable; that the parties dealt with it separately; and that the amount received for it was specified and therefore is ascertainable. * * * [Hamlin's Trust v. Commissioner, supra at 765.]
We think, under these circumstances, a heavy burden rests*80 upon the vendor to show that the consideration stated to have been received by him for a covenant without direct relation to the asset transferred is not what it appears to be on the surface of the contracts.
*141 * * * we have concluded that the written contract accurately reflected the agreement of the parties and that that agreement was reached at arm's length. In the circumstances, it is not incumbent on the Court to disturb the allocation of purchase price made by the parties themselves.
* * * the question * * * is not whether the covenant had a certain value, but, rather, whether the purchasers paid the amount claimed for the covenant as a separate item in the deal and so treated it in their negotiations * * * [Clarence Clark Hamlin Trust, supra at 724, 725.]
In this case, if anything, the balance of the evidence tips in respondent's favor. Not only was there apparently separate bargaining for the price paid for the covenant, since the original figure of $ 400,000 was ultimately reduced to $ 350,000, 2 but the careful language of the covenant permitting petitioners to continue their connection with certain other linen supply companies shows*81 that painstaking care and probably proposals and counterproposals must have contributed to the final text as accepted by both parties. We think it can scarcely be doubted that the covenant not to compete was separately made and separately bargained for, at least as to its terms and probably also as to its price. This is sufficient. As we said in Aaron Michaels, supra at 19:
If such an agreement can be segregated, not so much for purposes of valuation as in order to be assured that a separate item has actually been dealt with, the agreement is ordinary income and not the sale of a capital asset.
To this may be*82 added the fact that the buyers testified there could have been a sale without the covenants but for a much smaller price -- at a figure, in fact, which closely approximates the total payment minus the recited consideration for the covenant; that both the subsequent history and the terms of the covenant itself demonstrate that competition from petitioners was a real menace; and that petitioners concede that they or their representatives were aware of the possibility of taxation as ordinary income but proceeded with the transaction notwithstanding.
There is nothing in any of the cases to which we have been referred which casts serious doubt on this conclusion. Some are distinguishable as being direct sales by the proprietor of the business; others, as instances where a lump-sum price for an entire business was the only figure specified by the parties, thus interposing the difficulty of attributing a separate existence if not a separate consideration to the covenant; and a few, as covenants made in favor of the corporation whose *142 stock was being sold and not, as here, in favor of the buyers who would be the natural beneficiaries of such an agreement. 3
*83 Upon all the authorities and after careful consideration of the record, we find that the covenant was a separate agreement; that it was reached between the parties in arm's-length negotiations; and that it correctly incorporates the consideration paid for it, which should hence be treated as ordinary income to petitioners.
Decisions will be entered for the respondent.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Herman Kaiser and Sylvia Kaiser (Husband and Wife), Docket No. 56677; David H. Ullman and Claire W. Ullman (Husband and Wife), Docket No. 56678; David H. Ullman, Docket No. 56679; Richard Ullman, Docket No. 56680; Benjamin Ullman, Docket No. 56681; Benjamin Ullman and Anna Ullman, Docket No. 56682.↩
2. Although there is no evidence of the intervening steps, the burden was on petitioners. And one of them, David, is the only negotiator still able to testify. He could presumably have explained the reduction in price if it had been favorable. Wichita Terminal Elevator Co., 6 T. C. 1158, affd. (C. A. 10) 162 F. 2d 513↩.
3. A single authority may at first blush appear difficult to conform with the other cases in the field. George H. Payne, 22 T.C. 526">22 T. C. 526. There, however, we said (p. 530):
We have found as a fact that petitioner * * * first signed the contract which allocates no part of the purchase price to the covenant not to compete. This document is the only one before us which is signed and agreed upon by all three parties and, thus, is the only contract of sale under which the parties operated.↩