The opinion of the court was delivered by: LEVET
Opinion, Findings of Fact and Conclusions of Law.
In this tax refund action the plaintiff, The Reuben H. Donnelley Corporation (hereinafter "Donnelley") seeks to recover $105,292.80 plus interest which it paid pursuant to corporate income tax deficiencies for the taxable years 1953 through 1957. The complaint is in two counts. The first count seeks to recover $33,274.39 plus interest on the ground that a deduction representing the amortization on a covenant not to compete held by Donnelley was erroneously disallowed in 1955, 1956 and 1957. The second count seeks to recover $72,018.41 plus interest on the ground that certain sums relating to a contract between Donnelley and the Illinois Bell Telephone Company were erroneously included in income for the taxable years 1953, 1954, 1955, 1956 and 1957. The government's answer sets up a setoff, alleging that in 1955, 1956 and 1957 the taxpayer erroneously deducted as salary expense certain amounts which were in fact paid to purchase a capital asset.
After hearing testimony of the parties, examining the exhibits, the pleadings, the briefs and proposed findings of fact and conclusions of law submitted by counsel, this court makes the following Findings of Fact and Conclusions of Law:
Covenant Not To Compete
1. On April 18, 1955, at a special meeting of the Executive Committee of Donnelley, the President reported on the developments in connection with the proposed purchase of the Case-Shepperd-Mann Publishing Corporation. The minutes then state:
"Further discussion was had and it was stated that the sellers should also agree that for a period of ten years from the date of sale they would not, except with the prior written consent of the buyer, engage in any competition in the fields serviced by these four trade magazines."
A motion was passed authorizing negotiation at the original tentative figure discussed of $500,000 and then this resolution appears:
"BE IT ALSO RESOLVED That negotiations be continued as to buying the corporation outright if contractual guarantees are given releasing Donnelley from all liabilities, either against Case-Shepperd-Mann Corporation or individually against the present owners, and that agreement is reached on the covenant not to compete."
2. On April 25, 1955, a so-called "Agreement of Understanding Between The Reuben H. Donnelley Corporation and Case-Shepperd-Mann Publishing Corporation" was executed. The agreement provided for the sale of all of the stock of the Case-Shepperd-Mann Publishing Corporation owned by Messrs. I. Herbert Case, Frederick Shepperd, and Karl M. Mann, to Donnelley for the sum of $715,000 and for the furnishing by the sellers of a warranted balance sheet showing "assets of a fair market value of approximately $215,000.00 not including good will, book plates, stencils, etc." A further provision read: "Messrs. Case, Shepperd and Mann agree not to enter into the fields serviced by these publications [that is, the four magazines concerned] in any competing manner."
3. On May 18, 1955, at a meeting of the Board of Directors of Donnelley, Curtiss E. Frank, Executive Vice President, was authorized to enter into a contract with Messrs. Case, Shepperd, and Mann for the purchase of the entire outstanding stock of Case-Shepperd-Mann Publishing Corporation and "an agreement with said individuals not to compete with this Corporation, directly or indirectly, by engaging in the publication, sale or distribution of [certain magazines] for a period of ten (10) years for an aggregate consideration of Seven Hundred Fifteen Thousand Dollars ($715,000) * * *."
4. On June 8, 1955, Donnelley closed the agreement of sale with Messrs. Case, Shepperd, and Mann whereby Donnelley bought 710 shares of the capital stock of Case-Shepperd-Mann Publishing Corporation, being all of the issued and outstanding stock, at a total purchase price of $715,000.00. The said agreement contained an agreement on the part of the sellers not to compete, which provided as follows:
"12. The Sellers agree that for a period of ten (10) years from the date of closing herein they will not directly or indirectly engage in the publication, sale or distribution of a magazine in the fields serviced by FIRE ENGINEERING, WATER WORKS ENGINEERING, WASTES ENGINEERING AND ELECTRICITY ON THE FARM except with the prior written consent of the Buyer."
Paragraph 14 of the said agreement provided:
"14. This agreement is not severable."
5. The covenant not to compete was never discussed at length by the sellers among themselves during the period of negotiations prior to the sale. The sellers believed, however, that the giving of such covenants was customary in transactions as the one involved in this case. There is testimony that Case discussed with his advisor, Morris Goldman, why the covenant had been changed from five to ten years in a final draft, but that is the only discussion which appears with regard to the covenant. Goldman said ten years was customary. Case reported the change to Mann and Shepperd, who had no objection.
6. The sellers never stated to each other or to any representative of Donnelley that the covenant had value or was of substantial value. Mann and Shepperd, however, testified that they believed the covenant had substantial value, although they had not discussed it. Case felt it had value, but he never considered whether its value was substantial or not.
7. Morris Goldman, an advisor to the sellers, testified that he recommended that they grant a covenant not to compete before the final price was set. All that was mentioned was that the sellers would have to grant a covenant, and one was granted when Donnelley requested it. Goldman said that neither a cost nor a specific allocation for the covenant was discussed.
8. None of the sellers at any time intended to allocate a dollar value to the covenant. None ever discussed an allocation of dollar value or a specific value for the covenant with anyone else. There is testimony that the tax advisor of the sellers, one Bell, declined for tax reasons to place a dollar value on the covenant in the agreement when he was asked to do so by Frank, Donnelley's representative.
9. No dollar value was fixed for the covenant in the agreement of June 8, 1955.
10. The balance sheets of Case-Shepperd-Mann Publishing Corporation attached to the sales contract of June 8, 1955 show the following valuation of assets as of April 30, 1955 (Ex. 4).
Current assets $298,846.69
Furniture, Fixtures and Equipment 8,337.16
Goodwill, Copyright and Subscrip-
tion Lists 107,891.90
LIABILITIES and CAPITAL
Current Liabilities $ 98,063.38
Capital Stock 71,000.00
11. After the June 8, 1955 closing, Donnelley determined that $210,000 was the value paid for the covenant and set up that amount on its books as the price paid for the covenant. There was testimony that Donnelley informed the sellers at the closing that it was placing a dollar value on the covenant; however, the evidence is insufficient to warrant such a finding. I do not find the testimony of Frank and Fager on this factual issue persuasive. Furthermore, all of the sellers testified that they did not recall such a statement.
In his report of the closing, Frank stated:
"The three tax questions were resolved prior to the closing as follows:
"(c) Immediately upon acquisition of the stock a value will be placed on the Donnelley books upon the covenant not to compete. Mr. Warner will determine what value is to be attributed to the covenant based on the facts of the case. This was explained to the Sellers at the closing." (Ex. 21)
12. In a report dated June 29, 1955, H. W. Warner, Treasurer of Donnelley, indicated that he had determined "that the amount of $210,000 is the value paid for the covenant 'not to compete'" and directed that an entry be made on the books to this effect. The report does not state how he arrived at the sum of $210,000. (Ex. 6) Other testimony reveals that Warner computed the $210,000 by allowing $7,000 per year for ten years to each individual for not competing. This figure corresponded in many respects to the annuity under Donnelley's retirement plan that a Donnelley employee would receive who had worked for Donnelley for thirty years at an average salary of $20,000.
13. In a report dated June 28, 1955, D. W. Kendrick of Arthur Andersen & Co. stated that the $210,000 figure "would result in assigning about one-half of the cost of the intangible to goodwill and one-half to the covenant not to compete." (Ex. 8)
14. Everett C. Johnson, a partner in Arthur Andersen & Co., testified that the $210,000 figure was a fair one to be assigned to the covenant. He did not, however, have any information as to any negotiations between the sellers and Donnelley as to a separate amount to be paid for the covenant. Johnson also did not have any specialized knowledge as to the value of a covenant not to compete in the publishing business.
15. At a meeting of the Board of Directors of Donnelley on July 27, 1955, it was determined that the amount paid and to be paid for the Case-Shepperd-Mann Publishing Corporation should be divided as follows:
$430,000 Proportion of Capital Stock payment.
75,000 Escrow payment to Irving Trust Company, Escrow Agent.
$505,000 Representing the purchase of the capital stock of the Case-
Shepperd-Mann Publishing Corporation.
210,000 Covering the value of the covenant between I. Herbert
Case, Karl M. Mann and Frederick Shepperd not to com-
$715,000 Total amount paid. (Ex. 9)
16. On August 24, 1955, Warner authorized that appropriate entries for the purchase price be made as follows:
"Original purchase price $715,000.00
Covenant not to compete 210,000.00
Net values capitalized established through Journal #1 251,312.85
17. Donnelley has failed to prove by a fair preponderance of the evidence that there was an intent between the sellers and Donnelley to allocate any ...