Opinion
Docket No. 13651.
1949-02-17
VIOLET NEWTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Wilford H. Payne, Esq., for the respondent.
The petitioner and her husband, a marital community in the State of Washington, sold the business owned by them for a lump sum consideration. Included in the assets sold were an inventory of merchandise, accounts receivable, credit deposits, good will, and the right to use the firm name. There was no breakdown or allocation in the selling price on account of the tangible and intangible properties sold. The petitioner treated the gain from the sale of the business as all capital gain, while the respondent determined that the gain constituted 95.51224 per cent ordinary gain and 4.48776 per cent capital gain. Held, that insufficient evidence was introduced to establish a selling price for good will and other intangibles, and the respondent's determination is sustained. Wilford H. Payne, Esq., for the respondent.
This proceeding involves a deficiency in income tax for the taxable year ended December 31, 1943, in the amount of $707.66. The deficiency is due to two adjustments to petitioner's net income as disclosed by her return for the year 1943, as follows:
+--+ ¦¦¦¦ +--+
Income tax Victory tax net income net income Net income as disclosed by return $7,430.75 $6,069.66 Additional income: (a) Additional profit on sale of inventories 3,487.06 3,487.06 Total 10,917.81 9,556.72 Additional deduction: (b) Adjustment of capital gain 1,493.53 0 Net income adjusted 9,424.28 9,556.72
Respondent explained these adjustments in a statement attached to the deficiency notice as follows:
(a) It is held that a sale of the business known as the Puget Sound Novelty Company in which you have an interest on a community property basis, resulted in a capital gain derived from the sale of the fixed assets and an ordinary business gain from the sale of the inventories, the percentage of gain being apportioned to each classification pro rata, in accordance with the following:
+------------------------------------------------------------------------+ ¦Profit reported per your husband's return ¦$6,301.81¦ +--------------------------------------------------------------+---------¦ ¦Receipts from sale understated by ¦1,000.00 ¦ +--------------------------------------------------------------+---------¦ ¦ ¦ ¦ ¦ +--------------------------------------------------------------+---------¦ ¦Total profit realized ¦$7,301.81¦ +--------------------------------------------------------------+---------¦ ¦Depreciated fixed assets, per books ¦$659.36 ¦4.48776% ¦ +------------------------------------------------+-------------+---------¦ ¦Cost of inventories sold ¦14,032.05 ¦95.51224%¦ +------------------------------------------------+-------------+---------¦ ¦ ¦$14,691.41 ¦100% ¦ +------------------------------------------------+-------------+---------¦ ¦ ¦ ¦ ¦ +--------------------------------------------------------------+---------¦ ¦Gain allocated to sale of inventories (95.51224% of $7,301.81)¦$6,974.12¦ +--------------------------------------------------------------+---------¦ ¦One-half reportable as your share of community income ¦$3,487.06¦ +--------------------------------------------------------------+---------¦ ¦Reported per return ¦0 ¦ +--------------------------------------------------------------+---------¦ ¦ ¦ ¦ ¦ +--------------------------------------------------------------+---------¦ ¦Income increased by this adjustment ¦$3,487.06¦ +--------------------------------------------------------------+---------¦ ¦(b) In accordance with the explanation under (a) above: ¦ ¦ +--------------------------------------------------------------+---------¦ ¦Capital gain realized (4.48776% of $7,301.81) ¦$327.69 ¦ +--------------------------------------------------------------+---------¦ ¦50% taxable as long term gain ¦$163.85 ¦ +--------------------------------------------------------------+---------¦ ¦One-half reportable by you as your share of community income ¦$81.93 ¦ +--------------------------------------------------------------+---------¦ ¦Reported per return ¦1,575.46 ¦ +--------------------------------------------------------------+---------¦ ¦ ¦ ¦ ¦ +--------------------------------------------------------------+---------¦ ¦Decrease of income by this adjustment ¦$1,493.53¦ +------------------------------------------------------------------------+
The petitioner concedes that in computing the gain in 1943 from the sale of the business owned by the marital community the receipts from the sale thereof were understated by $1,000. Petitioner, by appropriate assignments of error, contests the remainder of the adjustments.
The sole issue for our consideration is whether the amount of gain realized upon the sale in 1943 of the business known as the Puget Sound Novelty Co. constituted a capital gain in its entirety, as claimed by petitioner, or constituted 95.51224 per cent ordinary income and 4.48776 per cent capital gain, as determined by respondent.
FINDINGS OF FACT.
Petitioner is an individual, residing in Seattle, Washington. Her income tax return for the year 1943 was filed with the collector of internal revenue for the district of Washington, at Tacoma, Washington.
During the year 1943 the petitioner, Violet Newton, was the wife of Cly C. Newton, and she and her husband constituted a marital community under the laws of the State of Washington.
In 1943 Cly C. Newton and Violet Newton owned the Puget Sound Novelty Co. which was engaged in business as a wholesale distributor of pinball machines and amusement devices. The business was located at 114 Elliott Avenue West, Seattle, Washington. The business was sold on December 24, 1943, for a total consideration of $22,150. The amount of the gain realized on the transaction was $7,301.81.
The sale of the Puget Sound Novelty Co. covered all its assets and property, including furniture, fixtures and equipment, the stock of merchandise on hand, a deposit on equipment ordered but not yet delivered, amounting to $2,950, a reserve with the American Discount Co. of approximately $2,670, accounts receivable, good will, and the right to use the name ‘Puget Sound Novelty Company.‘ The purchasers, A. J. Sandtner, George Schnabel, Vern H. Preston, and Thelma Oliver, agreed to assume the debts and obligations of the business, with certain limitations. Among the assets sold were an inventory of pinball machines, various amusement devices, and related equipment, listed at $14,033.05, some of which were in good and some in poor condition. This inventory was dated November 30, 1943. The amounts listed in the inventory for the various machines were based on the cost of the machines, either cash paid therefor or by way of allowance on trade-ins on other machines. In many instances, in order for these machines to be salable it was necessary that they be repaired and reconditioned.
Paragraph 1 of the agreement of sale provided as follows:
The SELLER agrees to sell all the assets of the Puget Sound Novelty Company, including the furniture, fixtures and equipment, the stock of merchandise on hand, the deposit on equipment ordered but not yet delivered in the sum of $2,950.00, the reserve with the American Discount Company which will hereafter accrue in the sum of approximately $2,670.00, Accounts Receivable, Good Will, and the sole exclusive right to use the name ‘Puget Sound Novelty Company.‘
Petitioner and her husband claimed in their returns for 1943 that the entire amount of the gain realized from the sale of the business constituted capital gain.
The respondent, on the other hand, determined in his deficiency notice that the sale resulted in ordinary gain, derived from the sale of inventories and equipment, and capital gain from the sale of fixed assets in the proportions of 95.51224 per cent and 4.48776 per cent respectively.
The business known as the Puget Sound Novelty Co. was acquired by W. F. Duggan on or about July 24, 1940, on behalf of Cly C. Newton. At the time of its acquisition the business was known as the Evergreen Novelty Corporation, and its name was later changed to ‘Puget Sound Novelty Company.‘ It was not incorporated. The price paid for this business in 1940 was $1,540. The assets consisted of all the fixtures, tools, mechanical parts, and novelty games used for the carrying on of the business located on the premises at 114 Elliott Avenue West. There were also included in the purchase price of $1,540 the good will and trade name of the Evergreen Novelty Corporation, together with the lease of the property at 114 Elliott Avenue West. The location at 114 Elliott Avenue West was an important consideration, as Elliott Avenue West is commonly referred to as ‘pinball row‘ or ‘coin machine row.‘ After the acquisition of the business no part of the cost thereof was allocated to good will on its books of account.
In the year 1940 the building located at 114 Elliott Avenue West was occupied by the Evergreen Novelty Corporation under a lease from the owner for a period of one year from January 1 to December 31, 1940. That lease was assigned to W. F. Duggan on July 24, 1940, for the benefit of Cly C. Newton. This 1940 lease and assignment were subject to an option to renew for a further period of one year, which was exercised by the lessee. Before the expiration of this lease and option in December 1941, W. F. Duggan and Cly C. Newton, doing business as the Puget Sound Novelty Co., entered into a new lease on December 8, 1941, for a period of one year from January 1 to December 31, 1942, with no option for renewal. On December 8, 1942, the parties entered into another lease covering a period of one year from January 1 to December 31, 1943, with no option for renewal.
In December 1943 Edward W. Andrews, the owner of the building at 114 Elliott Avenue West, was approached by Schnabel, one of the purchasers of the business known as the Puget Sound Novelty Co., with reference to the leasing of the premises for the further use of the business. Thereafter a new lease covering the property was entered into by E. W. Andrews and his wife, Margaret C. Andrews, as lessors and A. J. Sandtner, George Schnabel, Vern H. Preston, and Thelma Oliver, doing business as the Puget Sound Novelty Co., as lessees, under date of January 29, 1944, for a period of three years commencing February 1, 1944, and ending January 31, 1947. The new lease provided for payment of an increased rental of $10 per month.
Merchandise of the character sold by the Puget Sound Novelty Co. and covered by its inventory dated November 30, 1043, was extremely scarce and difficult to get at that time. This resulted in an increase in the prices which were obtainable for such merchandise. No new machines were being manufactured during 1943 and the company made its profit by purchasing used machines and repairing and reconditioning them for sale. Some of the machines in the inventory had values in excess of those listed for them in the inventory.
The sale of the business known as the Puget Sound Novelty Co. was a sale of the entire business for the lump sum of $22,150, without any breakdown or allocation as between the various properties which were sold. If some of the purchase price of $22,150 was paid for good will, we do not know how much it was, and there is no evidence in the record upon which we could base an allocation of part of the purchase price to good will. After the purchase of the business the purchasers set up an item of good will on their books of account as of December 23, 1943, in the amount of $2,000. However, in January 1944 this item of $2,000 for good will was eliminated and transferred to the parts inventory, increasing the parts inventory to $3,000.
The Puget Sound Novelty Co. had an oral arrangement with various manufacturers for distribution of their products. It had an oral arrangement with Mills Novelty Co. for the right to sell electrical phonographs, which also covered spare parts. The Mills Novelty Co. was not manufacturing such machines in 1943, as it was engaged in war work. This relationship was terminable at will by the Mills Novelty Co. In 1944, after the sale of the Puget Sound Novelty Co., the purchasers negotiated with the Mills Novelty Co. and obtained an oral arrangement that when the company again began manufacturing machines the Puget Sound Novelty Co. would be the distributor thereof in that area.
OPINION.
BLACK, Judge:
Respondent determined and here contends that the admitted gain of $7,301.81 realized by the petitioner and her husband, Cly C. Newton, upon the sale of their business known as the Puget Sound Novelty Co. constituted 95.51224 per cent ordinary gain and 4.48776 per cent capital gain. The petitioner contends that the gain realized upon the sale of the business was a capital gain and therefore taxable at the capital gain rates under section 117 of the Internal Revenue Code.
The position of the petitioner is that the entire gain on the transaction resulted from the sale of intangibles such as good will, the right to do business under the name ‘Puget Sound Novelty Company,‘ the location value of the premises on ‘pinball row‘ or ‘coin machine row,‘ and the ‘franchise‘ or right to represent various manufactures in the distribution of their products. Intangibles such as these are capital assets under section 117 of the Internal Revenue Code, since they were not stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of their trade or business, or property used in their trade or business of a character which would be subject to any allowance for depreciation. See Aaron Michaels, 12 T.C. 17; Rainier Brewing Co., 7 T.C. 162; affd., 165 Fed(2d) 217; rehearing denied (C.C.A., 9th Cir.), 166 Fed.(2d) 324; Ensley Bank & Trust Co. v. United States, 61 Fed. Supp. 317; affd., 154 Fed.(2d) 968; certiorari denied, 329 U.S. 732.
The respondent's determination herein is presumed to be correct and the burden is upon the petitioner to prove that it is wrong. Welch v. Helvering, 290 U.S. 111. Has the petitioner herein overcome the presumption of correctness which adheres to the respondent's determination? The facts show that the assets for which the unit consideration was paid included the furniture, the fixtures and equipment, the stock of merchandise on hand, the deposit on equipment ordered but not yet delivered in the amount of $2,950, the reserve with the American Discount Co. in the sum of approximately $2,670, accounts receivable, good will, and the right to use the name ‘Puget Sound Novelty Company.‘ There was some evidence that the location on Elliott Avenue West, which was known as ‘pinball row‘ or ‘con machine row,‘ had some value. The principal operators or dealers of pinball machines were located in that area. However, the facts show that petitioner and her husband did not own or control the location or have any valuable claim thereto which could be transferred to the purchasers. At the time of the sale the premises were leased under a year to year lease with the owner, with no option of renewal. Moreover, the sale took place on December 24, 1943, and the lease expired on December 31, 1943, and it was necessary for the prospective purchasers to open negotiations with the building owner for the renewal of the lease. As far as the ‘franchise‘ or the right to represent various manufacturers in the distribution of their products had value, no such franchise was proved. There was some evidence of oral arrangements with various manufacturers for the distribution of their machines and equipment, and thus whatever relationship the Puget Sound Novelty Co. had with such manufacturers was permissive and terminable at will by the manufacturer. No proof was offered that the name ‘Puget Sound Novelty Company‘ had a value and no item of good will was ever set up on the books of account of the Puget Sound Novelty Co. or its predecessor, the Evergreen Novelty Corporation.
Moreover, the evidence convinces us that the assets which are clearly identifiable and of the most value were the tangible assets, particularly the inventory of merchandise, which was valued at $14,033.05. In addition there was included in the sale price of the business the cash deposit on equipment ordered but not yet delivered in the amount of $2,950, a reserve with the American Discount Co. in the sum of approximately $2,670, and an undepreciated value of fixed assets in the amount of $659.36, aggregating the amount of $20,312.14, which is very near the total selling price of $22,150 for the business. The evidence also indicates that the price of the various machines listed in the inventory represented the cost of the machines to the firm. The evidence also establishes that no such amusement machines were being manufactured in 1943, due to the war, and the scarcity of such equipment had caused prices to increase, and that at least some of the machines listed in the inventory were actually worth more than the amounts at which they were listed therein. The evidence thus supports respondent's contention that the tangibles included in the inventory were the things of real value which were sold at a profit, rather than good will and other intangibles.
We conclude, therefore, that insufficient evidence has been introduced to establish that any definite part of the gain resulted from the sale of good will and other intangibles, and the respondent's determination is sustained. Cf. Green v. Allen, 67 Fed. Supp. 1004; Williams v. McGowan, 152 Fed.(2d) 570.
Decision will be entered for the respondent.