70 U.S.P.Q. (BNA) 12">*13 7 T.C. 162">*162 The respondent determined deficiencies in income tax, declared value excess profits tax, and excess profits tax for the years 1940 and 1941 as follows:

Petitioner contests the determination made by the respondent. Petitioner contends that $ 1,000,000 of promissory notes which it received in the taxable year 1940 did not constitute ordinary income, as respondent 7 T.C. 162">*163 has determined. Petitioner contends that it received the notes as the consideration for the sale of1946 U.S. Tax Ct. LEXIS 150">*152 its trade names, brands, and trade-marks in the State of Washington and the Territory of Alaska.

There are four questions to be decided in this proceeding. The first question is whether there was a sale of a capital asset. If there was a sale of a capital asset, a second question must be determined, namely, the amount of the gain or loss, which, in turn, requires our determination of the basis of the capital asset as of March 1, 1913. Petitioner contends that no gain was realized because it attributes a March 1, 1913, value to the property involved of more than $ 1,000,000, the amount of the consideration received in 1940. The third question relates to the adjusted basis of the property which was sold. The fourth question is whether any part of the $ 1,000,000 which petitioner received in 1940 is allocable to an agreement not to compete which was contained in the contract of April 23, 1935.

The issue with respect to the excess profits tax for the year 1941 in the amount of $ 26,119.92 has been abandoned by the petitioner, so that the deficiency for 1941 is $ 26,119.92.

The case is submitted on the pleadings, certain stipulations, and oral and documentary evidence submitted at1946 U.S. Tax Ct. LEXIS 150">*153 the hearing.

FINDINGS OF FACT.

The petitioner is a corporation, organized under the laws of the State of California, with its principal office and place of business in the city and county of San Francisco, California. The income tax returns for the periods here involved were filed with the collector of internal revenue for the first district of California at San Francisco, California.

Petitioner's predecessor in interest, Seattle Brewing & Malting Co., (sometimes hereinafter referred to as Seattle) was incorporated under the laws of the State of Washington in 1893. Its principal place of business was in Seattle, where it built a brewery and manufactured beer, ale, and other alcoholic malt beverages for sale under the trade name and brand of "Rainier."

In 1903 a new corporation by the name of "Seattle Brewing and Malting Co." (also referred to hereinafter as Seattle) was organized under the laws of West Virginia. This corporation acquired all the assets of the Washington corporation, including the trade name "Rainier," and operated the business until the end of 1915 when, because of statewide prohibition, it stopped the manufacture of beer and ale in the State of Washington and 1946 U.S. Tax Ct. LEXIS 150">*154 began manufacturing these products at San Francisco, California, through its wholly owned subsidiary, Rainier Brewing Co., a Washington corporation, until national prohibition went into effect in 1920.

70 U.S.P.Q. (BNA) 12">*14 7 T.C. 162">*164 In 1925 Seattle and its wholly owned subsidiary, Rainier Brewing Co., were merged through a nontaxable reorganization into a California corporation known as Pacific Products, Inc., which was organized in 1925 for that purpose. This company acquired all the assets of the two former companies, which included the plants in Seattle and San Francisco, together with their assets, business, good will, trademarks, trade names, and labels. In 1927 Pacific Products, Inc., acquired by purchase the right to use the trade name "Tacoma." Pacific Products, Inc., operated the business until 1932 when, through a nontaxable reorganization, "Rainier Brewing Co., Inc.," a California corporation organized in 1932, acquired all the assets of Pacific Products, Inc. (except certain designated assets not used in the conduct of its manufacturing business) including the trade names "Rainier" and "Tacoma." In 1937 Rainier Brewing Co., Inc., was merged into the Pacific Products, Inc., in a nontaxable1946 U.S. Tax Ct. LEXIS 150">*155 reorganization, and Pacific Products, Inc., as the surviving company, changed its name to Rainier Brewing Co., the petitioner herein.

Rainier Brewing Co., Inc., carried on the business that had been conducted by its predecessor, and with the repeal of prohibition in 1933 resumed the manufacture and sale of real beer, ale, and other alcoholic malt beverages under the trade name "Rainier." Such products were manufactured at the plant in San Francisco. The plant in Seattle was only used as a warehouse and sales office for distribution of the products in the State of Washington.

In view of the rapid expansion of business following the repeal of prohibition the officers of Rainier Brewing Co., hereinafter referred to as petitioner, in about the year 1935 considered reopening the Seattle plant as a brewery. About that time, however, they were approached by a competing company in the State of Washington, known as the Century Brewing Association (hereinafter referred to as Century), with a view to acquiring the right to use the trade names "Rainier" and "Tacoma" in the manufacture and sale of beer in the State of Washington and the Territory of Alaska and to have the name Seattle Brewing1946 U.S. Tax Ct. LEXIS 150">*156 & Malting Co.

The trade name "Rainier" had a well established and recognized value by reason of its use and development and Century was desirous of acquiring the right to use it in connection with the manufacture and sale of its own beer. The trade name "Tacoma" was less used and was not so valuable.

As a result of negotiations a contract was entered into between petitioner and Century on April 23, 1935, under which Century purchased certain property and equipment located in Seattle and certain personal property, and secured the right to use the trade names "Rainier" and "Tacoma" in the State of Washington and the Territory of Alaska (hereinafter sometimes referred to as Washington) in 7 T.C. 162">*165 consideration of the payment of certain sums to be determined on a production basis or a minimum royalty specified therein.

The contract of April 23, 1935, after reciting the mutual desire of petitioner to sell and Century to purchase petitioner's Seattle plant and certain personal property located in Seattle and the State of Washington, and of Century to secure by royalty contract and of petitioner to grant the right to use the trade names "Rainier" and "Tacoma," within the State of Washington1946 U.S. Tax Ct. LEXIS 150">*157 and the Territory of Alaska, and after providing in detail for the sale of the physical properties, continues with the following provisions:

Licensing Agreement

Seventh: Rainier hereby grants to Century the sole and exclusive perpetual right and license to manufacture and market beer, ale and other alcoholic malt beverages within the State of Washington and the Territory of Alaska under the trade-names and brands of "Rainier" and "Tacoma" together with the right to use within said State and Territory any and all copyrights, trademarks, labels, or other advertising media adopted or used by Rainier in connection with its beer, ale, or other alcoholic malt beverages.

Eighth: In consideration of said perpetual right and license, Century agrees to pay to Rainier in cash, lawful money of the United States, a royalty amounting to seventy-five cents (75 cents) per barrel (consisting of 31 gallons) for every barrel of beer, ale, or other alcoholic malt beverages sold or distributed in the State of Washington and the Territory of Alaska under the said trade names or brands of "Rainier" and "Tacoma" up to a total of one hundred twenty-five thousand (125,000) barrels annually, and eighty cents1946 U.S. Tax Ct. LEXIS 150">*158 (80 cents) per barrel for all such products distributed within said territory annually in excess of said amount of one hundred twenty-five 70 U.S.P.Q. (BNA) 12">*15 thousand (125,000) barrels; provided, however, that the minimum annual amount to be so paid by Century to Rainier shall be the sum of Seventy-five Thousand Dollars ($ 75,000.00), which said amount is herein termed "minimum annual royalty". Said payments shall be made in lawful money of the United States as follows:

* * * *

Century further agrees that annually on the 1st day of August of each year, commencing with the 1st day of August, 1936, it will deliver to Rainier a statement prepared by Price, Waterhouse & Co., or other Certified Public Accountants acceptable to Rainier, showing the sales of beer, ale and other alcoholic malt beverages under the trade names or brands of "Rainier" and "Tacoma" for the contract year commencing July 1st and ending June 30th immediately preceding the date of such statement.

Rainier shall have the right, at its own cost and expense, to examine the books, records and accounts of Century for the purpose of verifying any such statement so submitted to determine the accuracy thereof.

Ninth: Rainier agrees that during1946 U.S. Tax Ct. LEXIS 150">*159 the period of time this agreement remains in force, it will not manufacture, sell or distribute, within the territory herein described, directly or through or by any subsidiary company or instrumentality wholly owned or substantially controlled by it, beer, ale, or other alcoholic malt beverages, or directly or indirectly enter into competition with Century in said territory. It is understood and agreed, however, that Rainier shall have the sole and exclusive right to manufacture, sell, and distribute non-alcoholic beverages 7 T.C. 162">*166 within said territory under said trade names or brands of "Rainier" and "Tacoma" and any and all other trade names or brands that it owns and desires to use.

Rainier agrees that during the period of time this agreement remains in force it will maintain in full force and effect Federal registrations of said trade names or brands, "Rainier" and "Tacoma" and will likewise maintain in full force and effect the present registration of said trade names or brands within the State of Washington and Territory of Alaska. Should Rainier fail to so maintain its rights under said trade names or brands, then and in that event Century shall have the right to pay 1946 U.S. Tax Ct. LEXIS 150">*160 any and all amounts necessary to so maintain said trade names or brands for and in the name of Rainier, and shall be entitled to deduct any and all amounts so paid from the royalties then due or thereafter becoming due under this agreement.

Tenth: Century agrees that any and all beer, ale, or other alcoholic malt beverages manufactured by it pursuant to this agreement and marketed under said trade names and brands of "Rainier" and "Tacoma" shall at all times be of a quality at least equal to the quality of similar products then manufactured and marketed under said trade names and brands by Rainier; and shall be manufactured under the same formulae used in the manufacture of similar products by Rainier, which formulae Rainier shall make available to Century.

Eleventh: It is understood and agreed by and between the parties hereto that should Century at any time be prevented from manufacturing, selling, and distributing beer, ale, or other alcoholic malt beverages due to strikes, boycotts, fires, earthquakes or acts of God, for periods of time in excess of three (3) months, and as a result thereof Century shall fail to earn a sufficient amount from the operation of its entire business1946 U.S. Tax Ct. LEXIS 150">*161 to enable it to pay the royalty next due and payable under this agreement, then and in that event, the time of payment of such royalty shall be deferred for a period of time equal and equivalent to the period during which such cause shall continue, but in no event beyond a date upon which Century has available sufficient funds to pay royalty payments that have accrued; provided, however, that during any such period when royalty payments shall be so deferred, Century shall apply all of its monthly net income derived from the operation of its entire business toward the payment of any royalties so due.

Should the citizens residing in any portion of the territory covered by this agreement elect to adopt local prohibition laws prohibiting the manufacture, sale, and distribution of beer, ale, or other alcoholic malt beverages in such community, and should Century, due to such laws, be unable to sell and distribute within the territory described in this agreement, beer, ale, and other alcoholic malt beverages manufactured under the trade-names and brands of "Rainier" and "Tacoma" in a quantity at least equal to fifty-two thousand 70 U.S.P.Q. (BNA) 12">*16 (52,000) barrels annually, then and in that event, the minimum1946 U.S. Tax Ct. LEXIS 150">*162 royalty payable hereunder shall be reduced during the continuance of the operation of such laws by the percentage that the sales of such products under such trade names and brands of "Rainier" and "Tacoma" sold within that particular community bear to the total sales of such products by Century under such brands within the entire territory covered hereby, which percentage shall be based upon the average sales of such products theretofore made hereunder.

It is further understood and agreed by and between the parties hereto that should Century at any time be prevented from manufacturing, selling and distributing beer, ale, or other alcoholic malt beverages under the brands and trade names of "Rainier" and "Tacoma", in a quantity at least equal to fifty-two thousand (52,000) barrels annually, due to governmental action, war regulation, 7 T.C. 162">*167 or general prohibitory laws adopted by the United States of America or the State of Washington, then and in that event Century shall have the option of terminating this agreement or submitting to arbitration, in the manner hereinafter provided, the question of adjusting the minimum royalties payable hereunder during the continuance of such restriction1946 U.S. Tax Ct. LEXIS 150">*163 upon the operation of its business. In the event that Century elects to submit the matter to arbitration, it agrees to abide by any decision rendered by the arbiters, and to pay the minimum royalties so fixed, in the manner and at the times herein provided. Rainier agrees, in the event of such arbitration, to accept the royalties so fixed in satisfaction of the obligation of Century for such period.

Twelfth: Century agrees that upon acquiring title to the real property herein agreed to be sold to it by Rainier, it will, in addition to executing the mortgage provided in paragraph Third hereof, execute and deliver to Rainier such document or documents as Rainier shall deem necessary to cause said real property to stand as security for the prompt and faithful compliance by Century of all of its obligations under this agreement, to the end that should Century default in the performance of its obligations under this agreement and should Rainier elect to terminate this agreement, then and in that event, title to said real property shall pass to Rainier, free and clear of all liens and encumbrances, as and for liquidated damages due to such default.

Century further agrees that should it1946 U.S. Tax Ct. LEXIS 150">*164 sell said property, it will, under written agreements satisfactory to Rainier, impound the proceeds received from such sale to the extent of Two Hundred Fifty Thousand Dollars ($ 250,000.00), or such sums as shall be realized on said sale, which said impounded funds shall thereafter stand as security for the prompt and faithful compliance by Century of all of its obligations under this agreement, and in the event of default, be transferred and delivered to Rainier as and for liquidated damages.

It is understood and agreed by and between the parties hereto that in the event of the default of Century hereunder, the termination of this agreement by Rainier, and the transfer or delivery to Rainier of said real property, or such impounded proceeds as liquidated damages, Rainier shall, in addition thereto, be entitled to recover any and all royalties due and payable under this agreement at the time of the termination thereof, which said amounts Century agrees to pay upon demand.

Thirteenth: It is understood and agreed by and between the parties hereto that at any time after this agreement has been in force for five (5) years, Century shall have the right and option of electing to terminate1946 U.S. Tax Ct. LEXIS 150">*165 all royalties thereafter payable hereunder by notifying Rainier of its election so to do, and by executing and delivering to Rainier the promissory notes of Century aggregating in principal amount the sum of One Million Dollars ($ 1,000,000.00) dated as of the date of the exercise of such option, bearing interest from date at the rate of five per cent (5%) per annum, which said promissory notes shall be divided into five (5) equal maturities and shall be payable respectively on or before one (1), two (2), three (3), four (4), and five (5) years after the dates thereof.

Paragraphs fourteenth to twenty-fifth were headed "Miscellaneous Provisions." In paragraph fourteenth Century agreed to purchase from petitioner at prevailing market prices all malt required in the manufacture of beer, ale, and other alcoholic malt beverages under the trade names and brands of "Rainier" and "Tacoma." In paragraph fifteenth Century agreed to use its best efforts to increase the sales of alcoholic malt beverages within its territory and to 70 U.S.P.Q. (BNA) 12">*17 expend in 7 T.C. 162">*168 advertising amounts equal to those expended in advertising all other beverages manufactured and sold by it under other brands in Washington. In1946 U.S. Tax Ct. LEXIS 150">*166 paragraph seventeenth petitioner agreed to cause the old "Seattle Brewing and Malting Company," the West Virginia corporation, to change its name to the end that Century might adopt the name "Seattle Brewing & Malting Company." Paragraph twenty-second provided that if Century should fail to fully and promptly carry out the terms and provisions of the agreement or to make payments according thereto after proper notice by petitioner, such failure should be considered an event of default and petitioner should cancel the agreement by written notice to Century, in which event all the rights of Century should terminate and liquidated damages as specified in paragraph twelfth would accrue to petitioner. It was further provided in paragraph twenty-fourth that the agreement should be binding upon and inure to the benefit of the parties and their respective successors and assigns, provided, however, that no rights of Century should be assigned by it without the written consent of petitioner first had and obtained.

The contract was carried into execution. In pursuance of paragraph seventeenth of the agreement Century changed its name from Century Brewing Association to "Seattle Brewing & Malting1946 U.S. Tax Ct. LEXIS 150">*167 Company" (sometimes hereinafter referred to as either Century or the purchaser). Petitioner withdrew from the sale and distribution of its alcoholic malt products in Washington. The Seattle plant was deeded by petitioner to Century and Century conveyed the Seattle plant to a bank as trustee and executed its trust indenture with petitioner as beneficiary, all in accordance with the terms of the agreement. From time to time thereafter various amendments were made to the contract of April 23, 1935, none of which substantially affected the provisions respecting the use of the trade names.

Thereafter Century operated under the licensing agreement until July 1, 1940, and royalties paid pursuant thereto were claimed and allowed as deductions for income tax purposes. During the period from June 30, 1935, to July 1, 1940, Century sold alcoholic malt beverages in Washington and the Territory of Alaska under the name of "Rainier" in the quantities set out below and paid "royalties" thereon as follows:

1946 U.S. Tax Ct. LEXIS 150">*168 7 T.C. 162">*169 On July 1, 1940, Century exercised the option granted to it in paragraph thirteenth of the agreement and executed and delivered to petitioner promissory notes in the aggregate amount of $ 1,000,000, bearing interest at 5 per cent and payable on five equal maturity dates of one, two, three, four, and five years, respectively, thereafter. These notes were made payable to petitioner. Note No. 1, in the amount of $ 200,000, was paid on its due date July 1, 1941. Notes Nos. 2 and 3, for $ 200,000 each, payable on July 1, 1942, and July 1, 1943, respectively, were paid in 1942. In consideration for the advance payment petitioner granted to Century, subject to all the terms and conditions of the contract of April 23, 1935, the "sole and perpetual right and license" to manufacture and market alcoholic malt beverages within the State of Idaho under the trade names and brands "Rainier" and "Tacoma" without any payment therefor other than the payment of the remaining promissory notes given by Century in settlement of all royalty payments under the agreement of April 23, 1935.

In the fall of 1942 Century arranged to pay in advance the notes of July 1, 1944, and July 1, 1945, in 1946 U.S. Tax Ct. LEXIS 150">*169 the principal amount of $ 200,000 each, together with interest thereon, less $ 10,000 of such interest, in consideration of petitioner (1) releasing the properties held by the First National Bank of Seattle, as trustee, from the lien thereon and directing the conveyance of such property to Century; (2) releasing the provisions in the contract of April 23, 1935, for the purchase of malt from petitioner; and (3) amending the contract of April 23, 1935, so as to permit the manufacture and sale of beer under the trade names of "Rainier" and "Tacoma" to any plant or plants owned or controlled by Century within the States of Idaho and Washington and the Territory of Alaska without the necessity of securing the written consent of petitioner in connection therewith.

Aside from the changes indicated above as consideration for advance payment 70 U.S.P.Q. (BNA) 12">*18 of the notes and accrued interest thereon, no changes were made in the contract of April 23, 1935, after the election by petitioner to exercise the right to "terminate the payment of all royalties" by the payment of $ 1,000,000.

Upon the exercise of the option and the execution and delivery to petitioner of its promissory notes aggregating $ 1,000,000, 1946 U.S. Tax Ct. LEXIS 150">*170 Century acquired the perpetual and exclusive right to manufacture and market beer, ale, and other alcoholic malt beverages within the State of Washington and the Territory of Alaska without any further payments and without regard for the amount of alcoholic malt beverages so manufactured and sold.

By the exercise of the option, as provided in paragraph thirteenth of the contract, and the payment of the consideration of $ 1,000,000, 7 T.C. 162">*170 Century acquired the exclusive and perpetual right to manufacture and sell alcoholic malt beverages in the designated territory under the trade names "Rainier" and "Tacoma." This transaction constituted the sale and acquisition of a capital asset.

From the time of its organization in 1893 to 1915 the predecessor of petitioner had brewery and manufacturing facilities located at Seattle in the State of Washington. In the fall elections of November 1914 the State of Washington adopted prohibition, effective January 1, 1916, and in 1915 Seattle, a predecessor of petitioner, moved its manufacturing business from the State of Washington to the State of California, where it built a brewery at San Francisco and removed thereto all of the brewing machinery1946 U.S. Tax Ct. LEXIS 150">*171 from its Washington plant, except the cold storage facilities. After 1915 the plant in Seattle was not operated as a brewery, but was used for storage of "Rainier" products which were shipped from San Francisco for sale in the State of Washington. These products during the era of national prohibition consisted of near beer containing one-half of one per cent alcohol.

Upon the repeal of prohibition in 1933 petitioner began the sale of "Rainier" beer and other alcoholic malt beverages in the State of Washington under the trade name "Rainier," which it continued until 1935, when it entered into the agreement under which Century acquired the exclusive and perpetual right to manufacture and sell alcoholic malt beverages under the trade names "Rainier" and "Tacoma" in the State of Washington and the Territory of Alaska and petitioner agreed not to compete with Century in the sale of alcoholic malt beverages under these trade names in the limited territory designated in the agreement.

From 1908 (and prior thereto) until 1913 a predecessor of petitioner sold alcoholic malt beverages under the trade name "Rainier" in the States of Washington, Montana, Nevada, Arizona, California, and Oregon, 1946 U.S. Tax Ct. LEXIS 150">*172 and also exported beer to the Orient, Central America, Honolulu, and South America.

In the State of Washington during the period 1908 to 1913 beer was distributed through a licensing system under which the brewery would set up a saloon or acquire the license to a saloon. These saloons, termed "captive saloons," would then dispense only the beer of the brewery holding the license. In 1913 Seattle, a predecessor of petitioner, owned 21 saloons and licensed considerably more. During the five-year period ended June 30, 1913, Seattle's investment in the 21 captive saloons averaged $ 79,347.28. Such investments were included in plant properties, in financial statements, or balance sheets.

In 1909 the State of Washington passed a local option law which provided for a vote on the liquor question in towns, cities, and the unincorporated portions of counties as separate units. In 1910 70 municipal 7 T.C. 162">*171 local option elections were held in the state, of which 35 voted dry, abolishing thereby 129 saloons. Of the 38 counties of the state, 10 voted under the rural county law during 1910, of which number 9 voted dry, abolishing thereby from the rural districts of these counties 40 saloons, 1946 U.S. Tax Ct. LEXIS 150">*173 the total number of saloons abolished during 1910 being 169. In 1912 129 elections were held, 84 of which resulted in dry victories, while 45 resulted in wet victories. As a result of these elections 360 saloons were abolished and 71 per cent of the area of the state was made dry. The unincorporated portions of 19 counties were without saloons, 4 counties were entirely dry, and 71 municipalities, including 15 county seats, had no license. In 1913 220 elections were held under the local option law, 140 of which resulted in dry victories, while only 80 resulted in wet victories. As a result of these elections, 572 saloons were abolished and 87 per cent of the area of the state was made dry. In that year the unincorporated portions of 34 counties were without saloons and 6 counties were entirely dry. In 1913 most of the railroads had discontinued the sale of 70 U.S.P.Q. (BNA) 12">*19 intoxicating liquors and the steamboat companies were rapidly following the example of the railroads. At that time the question of state prohibition was a live issue in the State of Washington. In 1912 and 1913 over 300 news articles and 33 editorials were published on the subject in 4 of the leading newspapers of the state. 1946 U.S. Tax Ct. LEXIS 150">*174 Articles on the subject appeared in leading magazines and in the yearbooks of the Anti-Saloon League and United States Breweries Association, which were available to persons desiring such information.

At March 1, 1913, local option was increasing in the State of Washington and there was a definite trend toward state-wide prohibition. The state went dry in the election of November 3, 1914. The vote was for prohibition 189,840, against 171,208.

During the fiscal year ended June 30, 1913, the management of Seattle, a predecessor of petitioner, authorized the expenditure of $ 128,000 on plant improvements. Substantial expenditures were made by other breweries about this time.

The following table shows sales of petitioner's predecessor in barrels and the net income from sales within and without the State of Washington for the fiscal years ended June 30, 1908, through June 30, 1912:

1946 U.S. Tax Ct. LEXIS 150">*175 7 T.C. 162">*172 Of the total average net income for the five years ended June 30, 1912, 82.25 per cent is allocable to sales within the State of Washington and 17.75 per cent is allocable to sales in the territory outside of Washington.

The following table shows the petitioner's predecessor's tangible assets invested in the brewery business for the fiscal years from June 30, 1907, through June 30, 1912, including accounts receivable, but excluding bills receivable shown on the balance sheets as "investments":

70 U.S.P.Q. (BNA) 12">*20 1946 U.S. Tax Ct. LEXIS 150">*176 The average value of tangible assets during the five years ended June 30, 1912, was $ 2,519,379.74.

The bills receivable shown on the balance sheets for the same period were as follows:

In its income tax return for 1940 petitioner computed the value of its good will as of March 1, 1913, to be in excess of $ 1,000,000, which it used as a basis for computing profit or loss on the transaction in 1940, in which it granted to Century the perpetual and exclusive right to use the trade names "Rainier" and "Tacoma" in connection with the manufacture and sale of alcoholic malt beverages in the State of Washington and the Territory of Alaska in consideration of promissory notes aggregating $ 1,000,000. In computing the value of good will as of March 1, 1913, it used the average value of tangible assets during the five years ended June 30, 1912, which it determined to be $ 2,519,379.74 and the average net earnings for the same period, $ 383,018.91. In computing the1946 U.S. Tax Ct. LEXIS 150">*177 value of the "trade-names and other intangibles" as of March 1, 1913, it allowed 8 per cent return on the average value of tangible assets, or $ 201,550.38, and excess earnings of $ 181,468.53, applicable to intangible assets. The amount applicable to intangibles was capitalized at 15 per cent, or $ 1,209,790.20, which it treated as the "estimated March 1, 1913, value of trade-names and other intangible assets which were sold by virtue of the grant of a 7 T.C. 162">*173 perpetual right to the use thereof to the Seattle Malting and Brewing Co. during 1940."

The fair market value, as of March 1, 1913, of the trade names "Rainier" and "Tacoma" apportionable to the State of Washington and the Territory of Alaska was $ 514,142.

Petitioner's predecessors filed income tax returns for the years 1918, 1919, and 1920, but claimed no deduction therein for obsolescence of good will or trade names. In July 1920 Seattle filed a claim for abatement of taxes for the year 1919, based on a claim for obsolescence of good will. In this claim it computed the value of the good will of Seattle as of March 1, 1913 (based on the average invested capital for the years 1903 to 1913, inclusive, which was capitalized1946 U.S. Tax Ct. LEXIS 150">*178 at 10 per cent and an average earning for the same period of $ 81,336.04 which was capitalized at 15 per cent), to be $ 542,240.27. The Commissioner computed the good will value as of March 1, 1913, to be $ 406,680.20, which was arrived at by using the same figures as those used by Seattle, but changing the capitalization rate of good will from 15 per cent to 20 per cent. He then allocated the amount of $ 406,680.20 to the 70 U.S.P.Q. (BNA) 12">*21 following years in the following amounts:

Petitioner's predecessors, Seattle and Rainier, derived tax benefits from such allocation as follows:

In determining the deficiency here in question the respondent treated the $ 1,000,000 received by petitioner in 1940 as ordinary income and included the entire amount in petitioner's gross income.

OPINION.

Issue 1. -- The first issue raised by the pleadings is whether $ 1,000,000 in notes received by petitioner in 1940, in consideration of the exclusive and perpetual right to use the trade names "Rainier" and "Tacoma" in the manufacture and sale of alcoholic malt beverages1946 U.S. Tax Ct. LEXIS 150">*179 in the State of Washington and the Territory of Alaska, was ordinary income and taxable as such. The question turns on whether the sum of $ 1,000,000 is to be regarded as prepaid royalties, or whether it is to be regarded as an expenditure in the acquisition of a capital asset.

7 T.C. 162">*174 The decision of this issue is governed by the decision in Seattle Brewing & Malting Co., 6 T.C. 856. In that case the issue was whether the taxpayer (the purchaser) was entitled to deduct from its income any portion of the $ 1,000,000 which on July 1, 1940, it agreed to pay to Rainier upon the exercise of the option of electing to terminate all royalties payable under the contract of April 23, 1935, under a theory that the $ 1,000,000 constituted a payment of royalties. The contract there under consideration was the same contract which we have before us here, and the decision of the question depended upon whether the $ 1,000,000 was paid in the acquisition of a capital asset or whether it was royalties paid under a licensing agreement. The evidence in the instant case is not materially different from the evidence presented in the Seattle case. In that case we1946 U.S. Tax Ct. LEXIS 150">*180 said:

* * * We find no ambiguity in the contract and the language in paragraph thirteenth is clear. It provides that at any time after five years petitioner "shall have the right and option of electing to terminate all royalties thereafter payable hereunder" by executing and delivering to Rainier its promissory notes in the principal sum of $ 1,000,000. Obviously, it was intended that after the execution of the notes all royalty payments as such should cease. The agreement admits of no other construction. Thereafter Rainier must look for payment to the promissory notes and not to the contract. The execution and delivery of the notes put an end to the payment of royalties on a barrelage basis and was the consideration for the exclusive and perpetual use of such rights thereafter. It is our opinion that upon the exercise of the option petitioner acquired a capital asset for which it paid $ 1,000,000. * * *

Upon the authority of Seattle Brewing & Malting Co., supra, we hold that the transaction here in question was a capital transaction and the sum received by petitioner for the exclusive and perpetual right to use the trade names in the manufacture1946 U.S. Tax Ct. LEXIS 150">*181 and sale of alcoholic malt beverages within the limited territory was not ordinary income within the purview of section 22 of the Internal Revenue Code.

Issue 2. -- Since the sum which petitioner received from Century on July 1, 1940, did not constitute ordinary income, but represented a payment for a capital asset, a question arises whether or not petitioner realized any gain from the transaction as it was carried out by Century. It is the contention of the petitioner that the entire face amount of the notes received in 1940 upon the exercise of the option constitutes proceeds from a sale, and that it is entitled to use as its basis, for the computation of gain or loss on the transaction, the March 1, 1913, value of the trade names, and that such value was in excess of the $ 1,000,000 received. Petitioner concedes, however, that in computing the adjusted basis for such property there should be deducted the sum of $ 138,137.40, which is that portion of the total amount of $ 406,680.20 "allowed" by respondent as a deduction for obsolescence 70 U.S.P.Q. (BNA) 12">*22 of 7 T.C. 162">*175 good will to petitioner's predecessor in the years 1918 to 1920, inclusive, which represented a tax benefit to petitioner's1946 U.S. Tax Ct. LEXIS 150">*182 predecessor.

The respondent, on the other hand, contends that petitioner is not entitled to use the March 1, 1913, value, if any, as the basis for the trade names and good will, since such property was wholly destroyed by the advent of national prohibition in 1920, and, since petitioner has not shown any cost allocable to trade names incurred since that date, the new basis for the revived trade names must be considered to be zero. He further challenges the value of the trade names contended for by the petitioner and, in the alternative, contends that the agreement not to compete can not be regarded as part of the trade names or good will transferred; that at least one-half of the $ 1,000,000 in option notes constituted compensation to petitioner for its agreement not to compete in the beer business in the Washington area, and was, therefore, ordinary income to petitioner; and that, accordingly, the amount received as proceeds from the sale can not be in excess of $ 500,000. He further contends, in the alternative, that there must be deducted from the March 1, 1913, value, in order to find an adjusted basis, the entire sum of $ 406,680.20 which was "allowed" as obsolescence of petitioner's1946 U.S. Tax Ct. LEXIS 150">*183 predecessor for the years 1918 to 1920, inclusive.

The respondent's contention that petitioner is not entitled to use the March 1, 1913, value, if any, as the basis for the trade names and good will disposed of in 1940, because such property was wholly destroyed by the advent of national prohibition, does not find support in the record. There is no evidence whatever in the record that the trade name "Rainier" became worthless as a result of prohibition. Indeed the record conclusively establishes the contrary. The trade name was never abandoned during prohibition, but was used in the sale of near beer and soft drinks under such labels as "Rainier," "Rainier Lager," "Rainier Old German Lager," and "Rainier Malt Tonic" throughout the period of state prohibition in Washington and national prohibition thereafter. Moreover, the registration of its trade names in the United States Patent Office and in the State of Washington was kept alive from 1898 down to the present time, having been renewed from time to time during this period. Upon the repeal of prohibition after 1932 "Rainier" beer was again put on the market by petitioner. Although it is obvious that the value attaching to the1946 U.S. Tax Ct. LEXIS 150">*184 trade name "Rainier" and the good will of petitioner's predecessor corporations fluctuated very materially during the period from 1915 to 1933, it nevertheless does not follow that Rainier lost the use of its 1913 basis. The good will survived and it is immaterial that its value revived after prohibition. It has never been supposed that the fluctuation of value of property would destroy the taxpayer's basis. In fact, if a deduction has been taken for worthlessness, such deduction will 7 T.C. 162">*176 deprive a taxpayer of its basis only to the extent that it results in a tax benefit. Cf. Estate of James N. Collins, 46 B. T. A. 765; affd., 320 U.S. 489">320 U.S. 489, and John V. Dobson, 46 B. T. A. 770; affd., 320 U.S. 489">320 U.S. 489. We are of the opinion that the petitioner's basis for determining gain or loss upon the sale of its trade names and good will in 1940 is the fair market value of such property as of March 1, 1913, adjusted under section 113 (b) (1) (B) of the Internal Revenue Code.

In the instant case it is apparent that the good will value to be applied against the amount received1946 U.S. Tax Ct. LEXIS 150">*185 for the trade names in 1940 is the value of the trade names as of March 1, 1913, so the value to be placed thereon is what a willing buyer, with a full knowledge of the facts, would pay and a willing seller, not acting under any compulsion to sell, would accept for such property. In the computations by the petitioner's expert witnesses there has been no allowance for the value of good will, as such, separate and apart from the trade names used in the business. The petitioner insists that the good will, as mathematically computed under an approved formula, represents the value of the trade names. Good will is an intangible, and just what goes into the caldron to make up the sum of its ingredients is sometimes difficult to determine, but it would seem clear that the value of the trade names was not the full content of good will value attached to the business of petitioner's predecessors as of March 1, 1913. In determining the value of the trade names, we have taken into consideration all of the evidence in the record, including the stipulations of the parties, the opinions of the expert witnesses, and the methods used by them in arriving at their estimated values of the good will1946 U.S. Tax Ct. LEXIS 150">*186 as of March 1, 1913. We have also considered the fact that the total value of good will included other elements besides the value of the trade names, and that there was a pronounced trend toward prohibition in the State of Washington, where 82 per cent of the 70 U.S.P.Q. (BNA) 12">*23 income from sales of petitioner's products was realized. Moreover, we have assumed a buyer conversant with all these facts. In our judgment the value of the trade names here in question as of March 1, 1913, was $ 514,142, and we have so found as a fact.

In C. C. Wyman & Co., 8 B. T. A. 408, we said that good will is not necessarily confined to a name. It may as well attach to a particular location where the business is transacted, or to a list of customers, or to other elements of value in the business as a going concern. In Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151, Justice Holmes said that the value of the thing to be taxed must be estimated as of the time when the act is done, "but the value of property at a given time depends upon the relative intensity of the social desire for it at that time, expressed in the money that it would bring in the market." 1946 U.S. Tax Ct. LEXIS 150">*187 Obviously "relative intensity of the social desire" for the trade names "Rainier" 7 T.C. 162">*177 and "Tacoma" at March 1, 1913, would have been tempered by all of the hazards incident to the business and the future prospects of gain then apparent from the use of such trade names.

Issue 3. -- The above holding brings us to the third question, relating to the adjusted basis to be used for determining gain or loss from the transaction in 1940 wherein the petitioner granted and the purchaser, Century, acquired an exclusive and perpetual right to use the trade names "Rainier" and "Tacoma" in the manufacture and sale of alcoholic malt beverages in the State of Washington and the Territory of Alaska for $ 1,000,000. The applicable provision of the statute is set out in the margin. ¹

1946 U.S. Tax Ct. LEXIS 150">*188 It appears from the record that petitioner's predecessors filed income tax returns for the years 1918, 1919, and 1920, but claimed no deduction therein for obsolescence of good will or trade names. In July 1920 Seattle, a predecessor, filed a claim for abatement of taxes for the year 1919 based on a claim for obsolescence of good will due to prohibition legislation. The Commissioner computed the good will value as of March 1, 1913, to be $ 406,680.20. Of this amount $ 345,061.95 was allocated to the year 1918, $ 59,153.48 to the year 1919, and $ 2,464.77 to the year 1920. It is stipulated that petitioner's predecessors derived tax benefits from such allocation in the amounts of $ 78,983.92 for the year 1918 and $ 59,153.48 for the year 1919, making a total of $ 138,137.40. The respondent now argues that $ 406,680.20 was "allowed" for obsolescence of good will and that this amount must be deducted from the March 1, 1913, value as determined here in computing the adjusted basis under section 113 (b) (1) (B) of the Internal Revenue Code. The respondent relies on Virginian Hotel Corporation of Lynchburg v. Helvering, 319 U.S. 523">319 U.S. 523; rehearing denied, 1946 U.S. Tax Ct. LEXIS 150">*189 320 U.S. 810">320 U.S. 810, and Commissioner v. Kennedy Laundry Co., 133 Fed. (2d) 660; certiorari denied, 319 U.S. 770">319 U.S. 770; rehearing denied, 320 U.S. 810">320 U.S. 810. It is the petitioner's position that because no claim was made by its 7 T.C. 162">*178 predecessors for obsolescence for the years 1918 and 1920 the amount allocated to those years by the Commissioner, as to which no tax benefit was realized, has not been "allowed" within the meaning of section 113 (b) (1) (B) or within the decision of the Supreme Court in the Virginian Hotel case. It argues that no amount was "allowable" for obsolescence of good will due to prohibition within the decision of the Supreme Court in Clarke v. Haberle Crystal Springs Brewing Co., 280 U.S. 384">280 U.S. 384, and, therefore, the amount of obsolescence "allowed" must be limited to the amount as to which a tax benefit was realized.

The Virginian Hotel case, supra, dealt solely with tangible assets. It is apparent from a perusal of the decision and the dissents thereto that the purpose 70 U.S.P.Q. (BNA) 12">*24 of the statute was to limit depreciation to1946 U.S. Tax Ct. LEXIS 150">*190 the taxable year in which it occurred and not permit the taxpayer to accumulate and apply it in a subsequent year when it would better suit his purpose. The Court pointed out that the provision in the statute makes it plain that the depreciation basis is reduced by the amount allowable each year, whether or not claimed, and that the basis must be reduced by that amount even though no tax benefit results from the use of depreciation as a deduction. "Wear and tear do not wait on net income." This situation can only arise in cases dealing with depreciable property. In the opinion the Court said:

* * * "Allowed" connotes a grant. Under our federal tax system there is no machinery for formal allowances of deductions from gross income. Deductions stand if the Commissioner takes no steps to challenge them. Income tax returns entail numerous deductions. If the deductions are not challenged, they certainly are "allowed" since tax liability is then determined on the basis of the returns. Apart from contested cases, that is indeed the only way in which deductions are "allowed".

Annual depreciation in the case of good will is not permissible, because from the very nature of the asset 1946 U.S. Tax Ct. LEXIS 150">*191 it is not depreciable. Annual depreciation can only arise in cases dealing with depreciable property. Where, as in the case here, we have nondepreciable property the same situation does not obtain. A trade name is built up over the years and in the normal course of events is appreciated rather than depreciated, so that there is no amount allowable for exhaustion during a taxable year unless during that year there is a destruction of such intangible property. The Virginian Hotel case, supra, is, therefore, not controlling here. It is distinguishable on its facts and the rationale of that decision is not applicable here. The same may be said of Commissioner v. Kennedy Laundry Co., supra, also relied upon by the respondent.

A more serious objection to the respondent's claim, however, is the fact that the Supreme Court in 280 U.S. 384">Clarke v. Haberle Crystal Springs Brewing Co., supra, held that exhaustion or obsolescence of good will due to the prohibition amendment was not within the intendment of 7 T.C. 162">*179 the statute. In the opinion Mr. Justice Holmes, speaking for the Court, said:

* * * It seems to us plain 1946 U.S. Tax Ct. LEXIS 150">*192 without help from Mugler v. Kansas, 123 U.S. 623">123 U.S. 623, that when a business is extinguished as noxious under the Constitution the owners cannot demand compensation from the Government, or a partial compensation in the form of an abatement of taxes otherwise due. It seems to us no less plain that Congress cannot be taken to have intended such a partial compensation to be provided for by the words "exhaustion" or "obsolescence." Neither word is apt to describe termination by law as an evil of a business otherwise flourishing, and neither becomes more applicable because the death is lingering rather than instantaneous.

It is well settled that, when the Supreme Court declares an act of the legislature to be unconstitutional, such an act never was law and was never binding as law. By the same token, where the Supreme Court has declared that the words "exhaustion" and "obsolescence" as used in the revenue laws do not include a loss of good will due to the prohibition amendment, the interpretation of the revenue laws must be to the effect that such a deduction was never granted by Congress. Since such deduction was never allowable under the revenue laws, it1946 U.S. Tax Ct. LEXIS 150">*193 is difficult to see how the Commissioner by "allowing" a deduction which was never claimed can bind the taxpayer by such deduction as "allowed" within the meaning of the revenue act. In other words, a deduction "allowed," but not claimed or actually taken, can hardly be said to be "allowed" where there was no basis in the statute for such an allowance. Certainly, exhaustion and obsolescence can not be said to be allowed in the sense that those terms are used and understood by the Supreme Court in the Virginian Hotel case, supra, when applied to nondepreciable intangible assets. See also Renziehausen v. Lucas, 280 U.S. 387">280 U.S. 387. We hold, therefore, that, for the purpose of computing the adjusted basis, the fair market value of the trade names as of March 1, 1913, can only be reduced by such amount as petitioner's predecessors received tax benefits therefrom, the amount of $ 138,137.40.

Issue 4. -- The fourth and last question is whether any part of the $ 1,000,000 received by petitioner in 1940 should be allocated to petitioner's agreement not to compete which is set out in paragraph ninth of the contract of April 23, 1935. The petitioner1946 U.S. Tax Ct. LEXIS 150">*194 contends that such agreement was incidental to the grant by it of an exclusive and perpetual right to use the trade names, and 70 U.S.P.Q. (BNA) 12">*25 that the agreement had no value separate and apart from the trade names or good will. The respondent contends that at least $ 500,000 of the $ 1,000,000 paid on the exercise of the option agreement must be considered as an amount paid for the agreement not to compete.

In determining the deficiency, the respondent treated the $ 1,000,000 which petitioner received in 1940 as ordinary income under the royalty 7 T.C. 162">*180 contract, and neither in the deficiency notice ²1946 U.S. Tax Ct. LEXIS 150">*196 nor in the pleadings ³ is any value assigned by the respondent to the agreement not to compete, and no mention is made of it. Without any question, it is well settled that any amount received for an agreement not to compete would be taxable as ordinary income. Estate of Mildred K. Hyde, 42 B. T. A. 738; John D. Beals, 31 B. T. A. 966; affd., 82 Fed. (2d) 268; Christensen Machine Co., 18 B. T. A. 256; Christensen Machine Co. v. United States (Ct. Cls.), 50 Fed. (2d) 282.1946 U.S. Tax Ct. LEXIS 150">*195 There is, however, no direct evidence in the record as to the value of the agreement not to compete, nor does it appear that Century would not have purchased the exclusive right to the trade names without the agreement not to compete. Certainly there is nothing in the record to indicate that such agreement not to compete was worth $ 500,000.

It is obvious that in 1935, when the contract between petitioner and Century was entered into, an agreement not to compete had a substantial value, and it can not be said that paragraph ninth of the contract was mere words. It was perfectly possible for petitioner to sell the exclusive and perpetual right to use its trade names in the limited territory without any agreement not to compete, and it is conceivable that in that situation it might have continued selling beer in the territory under another trade name. Undoubtedly such competition, backed by petitioner's1946 U.S. Tax Ct. LEXIS 150">*197 advertising and sales organization and by the good will attached to its corporate name, would have had some effect upon the sale of beer by Century under the trade name "Rainier." Moreover, there was obviously a nuisance value attaching to the right to compete which the purchaser of the trade name would want to eliminate, but any competition would be seriously narrowed by the equity rule, which was followed in the State of Washington, that the sale of the good will of a business carries with it an implied covenant by the seller that he 7 T.C. 162">*181 will not solicit the custom for which the purchaser paid, and with which he parted, for the consideration received. So, while the petitioner, in the absence of an agreement not to compete, might have been at liberty to engage in a similar business in the same locality in his own name, it is very doubtful whether he could have sold the same beer under another name and advertised the fact without being enjoined by the purchaser of his trade names. In Cooper & Co. v. Anchor Securities Co. (Supreme Court of Washington, 1941), 113 Pac. (2d) 845, suit was brought to restrain Anchor Securities Co. and its officers1946 U.S. Tax Ct. LEXIS 150">*198 from directly soliciting insurance business from defendant's former customers after a sale of the business and good will to the plaintiff. In its opinion, holding that an injunction should issue, the court said:

In the absence of express or implied conditions in the contract of sale of a business together with the good will thereof to the contrary the vendor is 70 U.S.P.Q. (BNA) 12">*26 at liberty to set up a similar business in the same locality and carry it on in his own name. Annotations 11 Ann. Cas. 573 et seq; 19 L. R. A., N. S., 762 et seq; 82 A. L. R. 1030 et seq. However, the sale of good will of a business carries with it, even in the absence of a restrictive covenant, the implied obligation that the seller will not solicit his old customers or do any act that would interfere with the vendee's use and enjoyment of that which he had purchased.

Upon the advent of prohibition in Washington petitioner built a brewery in California and thereafter manufactured beer in that state. Having resumed the sale of beer in the State of Washington after the repeal of prohibition in 1933, it had undoubtedly built up an advertising and sales organization for1946 U.S. Tax Ct. LEXIS 150">*199 that state. When the contract of April 23, 1935, was entered into it owned the old brewery property at Seattle, which it used for offices and as a cold storage plant and warehouse. But under the contract the old brewery property was sold to Century and petitioner discontinued its beer business in the State of Washington. This situation continued during the five-year period from 1935 to 1940, during which time its transactions with Century were on a royalty basis, so that in 1940, when petitioner sold the exclusive and perpetual right to use its trade names and brands in connection with the manufacture and sale of alcoholic malt beverages, it was not engaged in any business of selling alcoholic malt beverages in the State of Washington. During this five-year period, from 1935 to 1940, Century had built up its sales of "Rainier" beer through advertising and its own sales organization from 60,000 barrels sold in 1936 to 131,000 barrels sold in 1940, so that the agreement by petitioner not to compete had little, if any, value in 1940. In the opinion of the Board of Tax Appeals in Christensen Machine Co., supra, it was said, in discussing an agreement1946 U.S. Tax Ct. LEXIS 150">*200 not to compete for a period of five years:

* * * It [the purchaser] thus obtained the right to conduct its business free from Christensen's competition during a period when it was not in a strong position. This was a valuable asset in the hands of the petitioner, the benefits of 7 T.C. 162">*182 which would continue over a period which would not necessarily be coextensive with the five-year period provided in the agreement. To illustrate, the petitioner in two years' time might have so strengthened its position that Christensen's competition could not affect it, or in the five years it might have so strengthened its position that as a consequence for one or more years thereafter Christensen's competition would be less severe than it otherwise would have been. The fact remains, however, that as each year passed, the time was that much nearer when the benefits derived from the contract would be completely exhausted. [Italics supplied.]

It must be borne in mind that the sale here in question was made in 1940 and not in 1935. In our judgment, considering all of the facts and the legal restrictions under which petitioner would have had to compete had it chosen to do so, we are of the1946 U.S. Tax Ct. LEXIS 150">*201 opinion that any value which the agreement not to compete had in 1935 had been exhausted when, in 1940, Century elected to exercise the option and purchase the exclusive and perpetual right to use the trade names in its business.

We hold, therefore, that no part of the $ 1,000,000 received by petitioner for the exclusive and perpetual right to use its trade names in the State of Washington and the Territory of Alaska was received in payment for its agreement not to compete with the purchaser in that territory.

Decision will be entered under Rule 50.