Opinion
Docket Nos. 8657-73, 8757-73, 8758-73.
Filed January 29, 1976.
Partnership was dissolved and two partners sold assets of the partnership business to corporation which continued the business. Held, no part of the sale price was attributable to goodwill or "deferred sales"; excess of sale price over book value was allocable to machinery and equipment: partners' gain from sale was ordinary income under secs. 735(a)(1) and 751(c) (effectively, recapture of accelerated depreciation under sec. 1245); and one partner is liable for additional tax under sec. 47, I.R.C. 1954.
Lloyd J. Schumacker and Paul W. Lunkenheimer, for the petitioner in docket No. 8657-73.
Alphonsus R. Romeika, for the petitioners in docket Nos. 8757-73 and 8758-73.
Richard N. Weinstein, for the respondent.
Respondent determined deficiencies in petitioners' Federal income tax as follows: Docket No. Petitioner(s) TYE Deficiency
8657-73 Wilmot Fleming Engineering Co. .... 9/30/68 $18,141.69 9/30/69 12,722.53 8757-73 Wilmot E. Fleming and Pauline B. Fleming ............... 12/31/68 29,183.88 8758-73 Estate of Wilmot Fleming, deceased, Provident National Bank, Wilmot E. Fleming and William M.B. Fleming, Coexecutors and Ruth G. Fleming .............. 12/31/68 1,641.75 Petitioner Wilmot Fleming Engineering Co. has conceded that a claimed bad debt deduction shall be disallowed for fiscal 1970 in order to compute the correct net operating loss deduction for fiscal 1968; accordingly, the following specific issues remain for decision:(1) Whether petitioner Wilmot Fleming Engineering Co. used the proper basis for certain purchased assets in computing the depreciation thereon claimed for fiscal years 1968, 1969, and 1970;
(2) Whether petitioners, Wilmot E. and Pauline B. Fleming and the Estate of Wilmot Fleming, deceased, Provident National Bank, Wilmot E. Fleming and William M. B. Fleming, Coexecutors, and Ruth G. Fleming, properly characterized the respective gain recognized from the sale of certain partnership assets as capital gain; and
Although these petitioners sometimes refer to the transaction as a sale of their respective partnership interests rather than of partnership assets, they do not argue for the former characterization, and on the basis of our findings, infra, we view the instant transaction as a sale of assets following the dissolution of the partnership. We recognize, however, that in other circumstances the difference in characterization may be of significance.
(3) Whether, upon the sale of partnership assets, petitioners Wilmot E. and Pauline B. Fleming realized an investment credit recapture pursuant to section 47, I.R.C. 1954, in excess of the amount reported on their return. In essence, resolution of these issues depends on our determination as to whether goodwill and/or "deferred sales" were included among the partnership assets purchased by Wilmot Fleming Engineering Co. from Wilmot and Wilmot E. Fleming and if so, the proper allocation of the sale price to those assets purchased. If all of the gain realized by Wilmot and Wilmot E. Fleming on the sale of their interests in the partnership assets to the corporation was attributable to machinery and equipment, the gain will be ordinary income under sections 735(a)(1) and 751(c) (in essence, to effect depreciation recapture under section 1245), and Wilmot E. Fleming will be liable for additional tax under section 47 (recapture of investment credit).
All section references are to the Internal Revenue Code of 1954, as amended and in effect in the years in issue, unless otherwise specified.
FINDINGS OF FACT
Certain facts have been stipulated by the parties and are accordingly so found.
The petitioner in docket No. 8657-73 is Wilmot Fleming Engineering Co., a Pennsylvania corporation with its principal office located in Philadelphia, Pa. It filed its income tax returns based on the accrual method of accounting for its fiscal years ended September 30, 1968, and September 30, 1969, with the Internal Revenue Service Center, Mid-Atlantic Region, Philadelphia, Pa. Wilmot Fleming Engineering Co. will hereinafter be referred to as the corporation.
The petitioners in docket No. 8757-73 are Wilmot E. Fleming and Pauline B. Fleming, husband and wife, residing in Jenkintown, Pa. Their joint Federal individual income tax return for the year ended December 31, 1968, was filed with the Internal Revenue Service Center, Mid-Atlantic Region, Philadelphia, Pa. Pauline B. Fleming is a party solely by reason of having filed a joint return with her husband; therefore, these petitioners will hereinafter be referred to as Wilmot.
The petitioners in docket No. 8758-73 are the Estate of Wilmot Fleming, deceased, and Ruth G. Fleming. Wilmot Fleming died February 4, 1970, and Provident National Bank, Wilmot E. Fleming, and William M.B. Fleming were appointed executors of his estate by the Register of Wills of Montgomery County, Pa. The petition was filed and verified on behalf of the estate solely by Wilmot E. Fleming, coexecutor. The joint Federal individual income tax return of Wilmot and Ruth G. Fleming for the calendar year 1968 was filed with the Internal Revenue Service Center, Mid-Atlantic Region, Philadelphia, Pa. Ruth G. Fleming is a party solely by reason of having filed a joint return with her husband and will not hereinafter be referred to. Wilmot Fleming will hereinafter be referred to as "the father" or "decedent."
From October 29, 1948, to March 31, 1968, decedent and his sons, Wilmot E. and William M. B. Fleming, operated a manufacturing machine shop business as partners trading as Wilmot Fleming Iron Steel Co., then, during the later years, as Wilmot Fleming Engineering Co. (hereinafter referred to as the partnership), pursuant to a written agreement by which each partner was entitled to share in one-third of the profit and bear one-third of the loss.
On which date the partnership was dissolved, as described infra.
The partnership business was started by decedent in 1922 and from its inception involved primarily the machining of parts and equipment, which material was usually supplied by the particular customer. Except for the period 1948-56 when it built special chemical equipment to order, the partnership did not have a product line nor did it own any trademarks or patents. The partnership did, however, engage in some design work.
The original site remained the major location of the business throughout the life of the partnership. Although the premises were sold in March 1968 by the partnership to William M. B. Fleming Industries, Inc., a corporation wholly owned by William, the site continued, as of the date of trial, to be the primary location of the business conducted by the corporation (Wilmot Fleming Engineering Co.).
William joined the business in June 1938, Wilmot thereafter in 1944; both had worked in the business periodically during their high school and college years, thereby acquiring a basic familiarity with the business operations. There was no formal division of responsibilities between William and Wilmot because their activities overlapped considerably and varied according to the exigencies of the business although, as a general matter, William was responsible for the running of the plant, the production, and the quality and service of the operations, while Wilmot devoted himself primarily to the administration and sales aspects. In this capacity, Wilmot worked to broaden the client base of the business in order to make the partnership less dependent on economic conditions in general and on certain customers in particular. Wilmot procured almost all accounts of the partnership from the time he became a partner to the partnership dissolution (March 31, 1968), except for a few in existence prior to his becoming a partner and with the possible exception of a few others. While a partner, Wilmot serviced all accounts, which included: E.I. DuPont, Hercules Powder, Philadelphia Electric, Rohm Haas, Owens Illinois, Owens Corning, FMC-American Viscose, General Electric, and Atlantic Refining. Such customers did not, however, deal exclusively with the partnership but also did business with its local competitors.
Although the business became increasingly competitive, particularly in the later years prior to March 31, 1968, the partnership developed and maintained an excellent reputation for quality workmanship, prompt deliveries, and superior service. The name Fleming was used throughout the existence of the partnership and was well known. The corporation, since its incorporation March 27, 1968, used and continues to use the same name as the partnership; i.e., Wilmot Fleming Engineering Co.
Although the use of the name was not a subject of negotiation, William requested, as manifest in the agreements of Mar. 28, 1968, infra, the right to retain the name in honor of his father.
Sometime prior to August 1967, William had become dissatisfied with the partnership arrangement; his father, who by March 31, 1968, had reached 89 years of age, had not actively participated in the business affairs of the partnership for more than 5 years, and Wilmot, serving since January 1963 as a representative, and subsequently as a senator, in the General Assembly of the Commonwealth of Pennsylvania, could no longer devote full-time efforts to the partnership. Accordingly, from August 1967 to mid-March 1968, William and Wilmot, each with the benefit of counsel, engaged in negotiations to effectuate the transfer of the business to William. Initially, Wilmot proposed a figure of approximately $325,000 for his interest; William originally offered $220,000. In the course of the subsequent bargaining, alternative plans were submitted by or for Wilmot which reflect the fact that William and Wilmot considered several factors in arriving at a sale price, including the book value of the partnership property, the value of the machinery and equipment in excess of the book value, the earning capacity of the partnership, and the capitalized value of excess earnings, as well as the overall ability of the business to finance the proposed arrangements. Discussion was of a lump-sum purchase of the partnership assets; there was no specific mention of goodwill or deferred sales nor any attempt to attribute values thereto.
Decedent took no part in the discussions; instead, William and Wilmot undertook to represent his interests.
Under date of March 20, 1968, the three partners (decedent, William, and Wilmot) entered into an agreement, entitled "Partnership Dissolution Agreement," effective March 31, 1968, which in pertinent part provides as follows:
PARTNERSHIP DISSOLUTION AGREEMENT
AGREEMENT entered into this 20th day of March, A.D. 1968 by and among WILMOT FLEMING, party of the first part, WILLIAM M. B. FLEMING, party of the second part, and WILMOT E. FLEMING, party of the third part,
WITNESSETH:
* * *
WHEREAS it is the desire of the parties hereto to dissolve said partnership and to provide for the disposition of the right, title and interest of each of the partners in and to the property of said partnership upon said dissolution, under and subject, nevertheless, to his pro rata share of the liabilities of said partnership appearing on the books of said partnership upon said dissolution,
NOW, THEREFORE, it is hereby agreed as follows:
1. The partnership of the parties hereto trading as Wilmot Fleming Engineering Co. is hereby dissolved and the partnership is hereby terminated effective March 31, 1968.
2. The business heretofore conducted by the partnership shall be continued as heretofore until the close of business on March 30, 1968.
3. The real estate owned by the partnership shall be sold to Fleming Industries, Inc., a Pennsylvania corporation, for the sum of One Hundred Fifty-nine Thousand One Hundred Dollars, settlement to be held on or before April 1, 1968.
4. Each of the parties hereto is hereby separately authorized to convey to Wilmot Fleming Engineering Co., a Pennsylvania corporation, all his right, title and interest in and to specific partnership property upon the dissolution of said partnership, under and subject, nevertheless, to his pro rata share of the liabilities of said partnership appearing on the books of said partnership upon said dissolution.
5. The parties hereto agree to execute such deeds, assignments and other documents advisable or necessary to effect the dissolution of said partnership and the transfer of the partnership property as aforesaid.
Thereafter, on March 27, 1968, William caused the corporation, Wilmot Fleming Engineering Co., to be formed under the laws of the Commonwealth of Pennsylvania. On March 28, 1968, Wilmot entered into an agreement with the corporation which set forth the following:
WITNESSETH:
WHEREAS Wilmot has heretofore been a member of the partnership known as Wilmot Fleming Engineering Co.; and
WHEREAS said partnership is about to be dissolved by agreement as of March 31, 1968; and
WHEREAS it is the desire of Wilmot to sell and Corporation to buy all the right, title and interest of Wilmot in specific partnership property upon the dissolution of said partnership, subject, however, to Wilmot's pro rata share of the liabilities of said partnership appearing on the books of said partnership,
NOW, THEREFORE, it is hereby agreed as follows:
1. Wilmot hereby agrees to sell to Corporation, which hereby agrees to buy, all of the right, title and interest in and to specific property of said partnership, Wilmot Fleming Engineering Co., to which Wilmot shall become entitled upon the dissolution of said partnership effective March 31, 1968 under and subject, nevertheless, to the payment of Wilmot's pro rata share of the liabilities of said partnership appearing on the books of said partnership.
2. Corporation shall pay to Wilmot for the right, title and interest in and to partnership property being purchased hereunder the total sum of $250,000.00 payable in cash in full at time of settlement.
3. As part of the assets being conveyed hereunder, Wilmot does hereby also grant and convey to Corporation the sole and exclusive right to the use of the name "Wilmot Fleming" as part of the name or style of any trade or corporate name for use in business similar to that of said partnership in combination with any other words including, but not by way of exclusion, "Wilmot Fleming Engineering Co.," "Wilmot Fleming Industries, Inc." "Wilmot Fleming Manufacturing Co.," "Wilmot Fleming Machine Co.," "Wilmot Fleming Iron and Steel Co."
* * *
5. * * * Wilmot agrees at any time thereafter to execute such other and additional assignments or documents necessary or desirable to effect the complete transfer of the property rights being sold hereunder.
On March 28, 1968, the corporation entered into an agreement with decedent which was substantially the same as that between it and Wilmot and differed only in respect of the purchase price and method of payment, as to which the agreement provided:
2. Corporation shall pay to Fleming [decedent] for the right, title and interest in and to partnership property being purchased hereunder the total sum of $160,000 as follows: $18,000.00 at settlement and the balance in 120 equal monthly installments including both principal and interest at the rate of 6 percent per annum, * * *, commencing the first day of May, A.D. 1968 and ending on the first day of April, A.D. 1978.
Also on March 28, 1968, the corporation and William executed an agreement similar to those of the same date, supra, except that instead of cash, William was to receive 500 shares of the corporation's capital stock.
Pursuant to these respective agreements of March 28, 1968, on March 29, 1968, Wilmot, decedent, and William, respectively executed and delivered a general assignment in favor of the corporation.
As of March 31, 1968, the balance sheet of the partnership was as shown on page 854.
The partnership had certain additional assets such as cutting tools, patterns, jigs, and drawings which were not included on its books but which were worth approximately $40,000.
Cost less Accumulated accumulated Cost depreciation depreciation
WILMOT FLEMING ENGINEERING CO. Balance Sheet (unaudited) Mar. 31, 1968 ASSETS Current assets: Cash ..................................................... $121,395.81 Accounts receivable: Trade .................................... $149,714.54 Affiliated company ....................... 5,437.69 155,152.23 ----------- Inventories, at cost: Raw materials and finished parts ......... 6,756.99 Work in progress ......................... 125,680.80 132,437.79 ----------- Prepaid insurance ........................................ 2,192.46 ---------- Total current assets ............................... 411,178.29 Equipment — n. A: Machinery ........ $559,047.34 $380,464.63 $178,582.71 Automobile and truck .......... 6,909.78 2,874.94 4,034.84 Office equipment ...... 25,209.23 17,507.15 7,702.08 Other equipment ...... 1,682.50 1,401.94 280.56 ----------- ----------- ---------- 592,848.85 402,248.66 190,600.19 190,600.19 ----------- Total ................................................ 601,778.48 =========== LIABILITIES Current liabilities: Notes payable, bank, due within 1 year ................... $36,000.00 Accounts payable, trade .................................. 69,899.84 Accrued payroll .......................................... 5,018.88 Taxes withheld and accrued: Philadelphia mercantile license and general business ....................... $551.36 Payroll taxes ............................ 615.84 Philadelphia taxes withheld .............. 422.75 Philadelphia net profits tax ............. 3,280.83 Pennsylvania sales tax ................... 28.32 4,899.10 ----------- Deferred sales (see n. 1 — analysis of partners' capital) ................................... 108,191.26 ----------- Total current liabilities ................................. 224,009.08 Long-term notes payable, bank, less $36,000 due in 1 year ................................... 45,000.00 Partnership capital: Wilmot Fleming ............................ 124,836.00 William M. B. Fleming ..................... 21,556.25 Wilmot E. Fleming ......................... 186,377.15 332,769.40 ----------- Total ................................................. 601,778.48 =========== Note A: As a result of equipment acquired during the year ended Mar. 31, 1968, $3,071.77 of investment tax credits are available as a reduction of personal income taxes of the partners payable on partnership income for the year ending Mar. 31, 1968. No provision, however, has been made herein for Federal income taxes of the partners.Note 1: Since the company records income on the computed contract basis of accounting, no effect has been given to the following gross profit on jobs in progress at Mar. 31, 1968 * * *
In 1971, the corporation engaged James J. Walsh, who was engaged in the business of buying and selling new and used metalworking machinery, to appraise the value of the machinery and equipment acquired by the corporation as of March 31, 1968. The total value of that machinery and equipment was determined to be $414,320, which figure was composed of the replacement cost for property of similar type and condition, plus installation and transportation costs per item; alternatively, the appraisal indicated an orderly liquidation value of $332,480. Neither figure purported to appraise the machinery and equipment as part of a going business.
The appraisal figures of $415,870 and $333,640 were subsequently adjusted by the amounts of $1,550 and $1,160, respectively, to correct for machinery erroneously included therein.
The following chart reflects the book net worth, earnings, personal withdrawals, and net earnings of the partnership for the 5-year period prior to dissolution (figures are rounded): Book net worth Personal Net FYE Mar. 31 (net tangible assets) Earnings withdrawals earnings
1964 ........... $341,000 $71,000 $39,000 $32,000 1965 ........... 396,000 120,000 50,000 70,000 1966 ........... 388,000 124,000 47,000 77,000 1967 ........... 457,000 191,000 69,000 122,000 1968 ........... 333,000 158,000 79,000 79,000 --------- ------- ------- ------- Total ........ 1,915,000 664,000 284,000 380,000 Average ...... 383,000 132,800 56,800 76,000 On Schedule D of his joint income tax return for 1968, Wilmot reported capital gain from a partnership interest in the amount of $63,622.85. Wilmot also reported tax from recomputing prior year investment credit from the partnership in the amount of $56.91.Decedent's joint income tax return for 1968 indicated profit on a sale of a partnership interest in the amount of $35,164 of which, pursuant to the installment method of reporting under section 453, $5,909.61 was reported on Schedule D as capital gain. On an attached statement, decedent reported recapture of investment tax credit from the partnership for the years 1963 through 1967, inclusive, in the total amount of $5,006.96.
Respondent determined that the capital gain reported by Wilmot and decedent, respectively, was ordinary income under sections 751 and 1245.
By agreement of the parties, no part of the gain reported resulted from the sale of the real property referred to in n. 5 supra.
In setting up its books to reflect the purchase, the corporation applied the sale price as follows: Capital Excess of accounts sale price per books Sale over capital 3/31/68 price accounts 3/31/68 Accumulated Cost depreciation Excess of sale price Cost less over capital Equipment accumulated accounts valuation depreciation 3/31/68 4/1/68
Value includes $550 additional value attributable to legal fee re: purchase of assets by successor.
Accordingly, on its income tax returns for its fiscal years ended September 30, 1968, 1969, and 1970, the corporation claimed depreciation of furniture, fixtures, and leasehold improvements in the amount of $43,335.41 for 1968, $74,503.29 for 1969, and $54,651.42 for 1970. Respondent has disallowed depreciation of $11,759.06, $24,095.69, and $13,235.62, respectively.
The fiscal year ended Sept. 30, 1970, is involved in this case to determine the net operating loss carryback to fiscal 1968. Respondent issued to the corporation a notice of adjustment for fiscal 1970 in conjunction with the statutory notice of the deficiencies for fiscal years 1968 and 1969.
The corporation now contends that $64,840 of the sale price should be allocated to the inventory on deferred sales, and acknowledges that if this is done, this will reduce the depreciation basis of its furniture, fixtures, and equipment in the same amount and, as a result, reduce its depreciation allowance to $36,253.94 for the fiscal year 1968, $62,378.54 for the fiscal year 1969, and $46,211.88 for the fiscal year 1970. This recomputation reflects audit discussions with respondent's agents; the corporation did not, however, file amended returns based on the reallocation from machinery and equipment to deferred sales. By virtue of this recomputation, the corporation now claims a refund for its fiscal year ended September 30, 1968, in the amount of $21,095.78 and admits to a deficiency for its fiscal year ended September 30, 1969, in the amount of $6,401.87.
The partnership used the direct costing method in valuing its inventory on deferred sales and did not report profit or loss until a contract was completed. Progress payments were accounted for by a debit to accounts receivable and a credit to deferred sales. In arriving at the adjustment figure of $64,840, the corporation applied the percentage-of-completion method to each contract.
OPINION
In these consolidated cases, we are presented with the following issues:
(1) Whether Wilmot Fleming Engineering Co. properly computed its basis in machinery and equipment purchased from decedent and Wilmot in respect of which property the corporation claimed depreciation deductions for its fiscal years 1968, 1969, and 1970 in excess of the respective amounts allowed therefore by respondent;
(2) Whether decedent and Wilmot properly characterized their respective gain from the sale of their interests in partnership assets as capital gain; and
(3) Whether, as a result of the aforementioned sale, Wilmot realized an investment credit recapture in excess of that reported on his return for 1968.
All of these questions entail, as a threshold matter, our determination as to whether goodwill was among the assets of the going business distributed to decedent, William, and Wilmot upon the dissolution of their partnership and immediately thereafter transferred to Wilmot Fleming Engineering Co. We must then consider the proper allocation of the sale price paid to decedent and Wilmot for their respective interests in such assets.
We do not believe that the rule expressed in Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), vacating and remanding 44 T.C. 549 (1965), cert. denied 389 U.S. 858 (1967), applies to preclude our inquiry. Here, not only are all parties to the transaction represented before the Court but, more importantly, petitioners do not seek to obviate specific allocation provisions in their written agreements as was the case in Danielson, but rather, in the absence of any such specificity, attempt to establish that their respective positions comport with their agreements. Cf. Copperhead Coal Co. v. Commissioner, 272 F.2d 45 (6th Cir. 1959), affg. a Memorandum Opinion of this Court.
It is not disputed that the sum of $410,000 paid to decedent and Wilmot for their shares of the assets of the business exceeded their combined basis in these assets by the amount of $98,786.85. In setting up its books as of March 31, 1968, the corporation first allocated the sale price among all the assets to the extent of their book values. It then attributed the excess sale price to machinery and equipment with a resulting cost basis therein of $289,937.04 which, when added to the basis of the assets received from William, constituted the basis upon which the corporation computed the total depreciation claimed. Subsequently, in response to the position taken by respondent in respect of the other petitioners, the corporation allocated a portion of the sale price to deferred sales, which reallocation, by increasing cost of goods sold, gave rise to the claim for refund of income tax for fiscal 1968. In neither its original allocation nor its subsequent adjustment did the corporation treat any part of the sale price as attributable to goodwill.
As stated, the respective capital accounts of decedent and Wilmot were $124,836 and $186,377.15, which figures, by operation of sec. 732(b) and (c), equal the basis of the property distributed to them upon liquidation of the partnership.
After addition of $550 to reflect a legal fee, the total excess amounted to $99,336.85.
Under sec. 362(a), the corporation's basis in the assets transferred by William was $12,346.73.
On the other hand, Wilmot and the Estate of Wilmot Fleming both contend that the total $98,786.85 gain realized represented goodwill and therefore was properly reported as capital in character. If attributable, however, to machinery and equipment, such gain will, pursuant to sections 735(a)(1) and 751(c), be treated as ordinary (thus effecting recapture of accelerated depreciation under section 1245) and further, warrant application of section 47 under which Wilmot would realize the investment credit recapture in issue.
Since we have characterized the transaction as a sale of partnership assets, respondent's alternative reliance on sec. 751(a) is inappropriate, and sec. 735 instead applies to characterize the gain in issue. In pertinent part, sec. 735 provides:
SEC. 735. CHARACTER OF GAIN OR LOSS ON DISPOSITION OF DISTRIBUTED PROPERTY.
(a) SALE OR EXCHANGE OF CERTAIN DISTRIBUTED PROPERTY. —
(1) UNREALIZED RECEIVABLES. — Gain or loss on the disposition by a distributee partner of unrealized receivables (as defined in section 751(c)) distributed by a partnership, shall be considered gain or loss from the sale or exchange of property other than a capital asset.
Sec. 751(c) defines "unrealized receivables" to include sec. 1245 recapture gain.
That is, the sale would constitute an early disposition within the meaning of sec. 47(a)(1).
Respondent, having taken inconsistent positions as between the two sides of the sale transaction, is in essence a stakeholder herein. See Leon R. Meyer, 46 T.C. 65 (1966), affd. on this issue 383 F.2d 883 (8th Cir. 1967); Estate of Goodall v. Commissioner, 391 F.2d 775, 782-783 (8th Cir. 1968), cert. denied 393 U.S. 829 (1968); M. Lucile Harrison, 59 T.C. 578, 592 n. 13 (1973); Freeport Transport Inc., 63 T.C. 107, 116-117 (1974) (concurring opinion by Dawson, C.J.); J. Leonard Schmitz, 51 T.C. 306 (1968), affd. sub nom. Throndson v. Commissioner, 457 F.2d 1022 (9th Cir. 1972). On brief, respondent suggests that the parties did not intend to allocate any part of the sale price to either goodwill or deferred sales. If, however, we find that the excess sale price is not allocable in its entirety to machinery and equipment and in fact is attributable also to deferred sales, respondent proposes an allocation between the two classes of assets in proportion to their respective fair market values.
Respondent's position as stakeholder does not, however, have any effect on the burden of proof which remains on the respective petitioners. Rule 142, Tax Court Rules of Practice and Procedure. See Freeport Transport, Inc., 63 T.C. 107, 116-117 (1974) (concurring opinion by Dawson, C.J.), and the cases cited therein at pp. 116-117.
Respondent has indicated that if dealing only with the corporation, respondent would have accepted the corporation's income tax returns as filed as to the allocation of sale price to machinery and equipment.
Turning, then, to the question of whether goodwill was among the assets purchased by the corporation from decedent and Wilmot, we note at the outset that the burden is on Wilmot and the Estate of Wilmot Fleming to show what portion of the sale price is attributable to goodwill. Charles W. Miller, 56 T.C. 636 (1971); Redman L. Turner, 47 T.C. 355 (1967). Such determination is essentially a factual inquiry. Meister v. Commissioner, 302 F.2d 54 (2d Cir. 1962); Republic Steel Corp. v. United States, 40 F. Supp. 1017 (Ct.Cl. 1941); George H. Payne, 22 T.C. 526 (1954). Accordingly, upon our analysis of the instant transaction in the context of the factors recognized as indices of goodwill, see, for example, Theo. Planz, Inc., 10 B.T.A. 1158 (1928); D. K. MacDonald, 3 T.C. 720 (1944); Erwin D. Friedlaender, 26 T.C. 1005 (1956); Estate of Henry A. Maddock, 16 T.C. 324 (1951); In Re Brown, 242 N.Y. 1, 150 N.E. 581 (1926), we find that no goodwill was sold by decedent and Wilmot.
While we recognize that the absence of any specific reference to goodwill in the written agreements supra is not conclusive, Copperhead Coal Co. v. Commissioner, 272 F.2d 45 (6th Cir. 1959), affg. a Memorandum Opinion of this Court; John Q. Shunk, 10 T.C. 293 (1948), revd. and remanded on another issue 173 F.2d 747 (6th Cir. 1949), such fact, together with the fact that goodwill was not specifically mentioned in the negotiations between William and Wilmot, strongly militates against the existence of goodwill. Moreover, even if we were to view the language of the March 28, 1968, agreements providing for the use of the name "Wilmot Fleming" as indicative of goodwill, the failure to allocate any portion of the purchase price thereto evidences that no such allocation was intended. Cf. Charles W. Miller, supra; Annabelle Candy Co. v. Commissioner, 314 F.2d 1 (9th Cir. 1962); Winchell Co., 51 T.C. 657 (1969). Further, we note that neither the partnership nor the corporation listed goodwill as an asset on their respective balance sheets and books, which omission, while not disproving the existence of goodwill, John Q. Shunk, supra, R. E. Baker, 37 B.T.A. 1135, 1149 (1938), does support our finding as to the absence of goodwill. John Winthrop Wolcott, 39 T.C. 538 (1962).
Although goodwill may attach to a particular name, Charles W. Miller, 56 T.C. 636 (1971), we believe that the provision for the right to use the Fleming name reflects personal rather than business motivation on the part of William.
Focusing on the character of the partnership business, we do not accord much significance to the fact of the partnership's profitability; high earnings per se do not constitute goodwill. Estate of Leopold Kaffie, 44 B.T.A. 843 (1941); Donal A. Carty, 38 T.C. 46 (1962); Estate of Henry A. Maddock, supra; A. T. Miller, 39 T.C. 940 (1963), affd. 333 F.2d 400 (8th Cir. 1963). More important is the question whether the business was such as to provide its purchaser with the expectancy of both continuing excess earning capacity and also of competitive advantage or continued patronage. Donal A. Carty, supra; Estate of Henry A. Maddock, supra; Charles W. Miller, supra; In re Brown, supra. Here, however, the partnership had no product line, trademarks, or patents to which goodwill might attach. Although the partnership enjoyed a favorable business reputation, the increasing competition in the contract-bidding procedure by which customers were acquired belies any competitive preference inhering in the business. Similarly, transferable goodwill would not exist as a function of the ability, experience, acquaintanceship, or other personal attributes of either Wilmot or William. D. K. MacDonald, supra; John Q. Shunk, 10 T.C. at 303-304; Howard B. Lawton, 6 T.C. 1093, 1100 (1946). Wilmot, the seller, was not continuing in the business and William was, in effect, the buyer. Their dominating influence and overall importance to the success of the business further disproves the existence of transferable goodwill attributable to the business itself.
Finally, a comparison of the sale price with the capitalized earning capacity of the business and with the value of the other assets purchased reveals no excess value representative of goodwill. See George J. Staab, 20 T.C. 834 (1953), and Violet Newton, 12 T.C. 204 (1949), respectively. Not only, as demonstrated by expert testimony, does the capitalized value of the partnership's business so closely approximate the sale price as to render goodwill, if any, negligible but also the fact that the appraised value of the machinery and equipment substantially exceeded book value indicates that the excess sale price reflects these assets, rather than goodwill or, as now urged by the corporation, deferred sales.
On the basis of the foregoing, we, therefore, hold that no goodwill was sold by the decedent and Wilmot to the corporation and that none of the gain on the sale was attributable to deferred sales; instead, the gain resulting from the sale was attributable to the value of the depreciated machinery and equipment. Accordingly, it follows that the corporation used the proper basis in computing the depreciation claimed for fiscal 1968, 1969, and 1970 and that, pursuant to section 735(a)(1), the respective gain reported by decedent and Wilmot in respect of the sale is ordinary in character. Additionally, Wilmot realized an investment credit recapture as determined by respondent, and the corporation is not entitled to increase its cost of goods sold for fiscal 1968 to reflect an increase in value of deferred sales.
Because of concessions,
Decision will be entered under Rule 155 in docket No. 8657-73.
Decisions will be entered for respondent in docket Nos. 8757-73 and 8758-73.