52 T.C. 18">*18 The respondent determined deficiencies in income tax for the taxable years 1963 and 1964 in the respective amounts of $ 2,406.69 and $ 8,293.63.

The sole issue for decision is whether payments totaling $ 50,000 received by the petitioner Edmond C. Maseeh in 1963 and 1964 constituted payment for an agreement not to compete and hence ordinary income as determined by the respondent, or proceeds from the sale of goodwill of a business, and hence capital gain as contended by the petitioner.

FINDINGS OF FACT

Some of the facts have been stipulated and the stipulations are incorporated herein by this reference.

Petitioners are husband and wife and resided in Scottsdale, Ariz., on the date their petition was1969 U.S. Tax Ct. LEXIS 159">*160 filed in the Tax Court. They filed joint returns for the taxable years 1963 and 1964 with the district director of internal revenue, Phoenix, Ariz. The wife is a party only because of having filed joint returns, and hereinafter the husband will be referred to as the petitioner.

The petitioner operated, from 1952 to 1963, as sole proprietor, a wholesale food-distributing business located in Tucson, Ariz., known as Maseeh Distributing Co. ¹ He sold snack-type items to chain stores and other grocery stores in two northern and three southern counties of Arizona. With the exception of a line known as Dandy Candy (a trade name created by petitioner), the lines of products sold by petitioner were sold under distributorship agreements with manufacturers of lines of products which were nationally or regionally advertised through various media, i.e., newspapers, magazines, radio, and TV, the cost of which was generally borne by the manufacturers. Such nationally or regionally known lines consisted of Laura Scudder, Weston Biscuits, Brach Candy, Culbison Dressings, and Old London, 52 T.C. 18">*19 Inc. ² The Laura Scudder line accounted for about 50 percent of petitioner's gross sales and the1969 U.S. Tax Ct. LEXIS 159">*161 Dandy Candy line accounted for about 20 percent of the total sales.

The distributorships under which petitioner operated gave him exclusive rights to distribute products within his areas of operation so long as he performed well for the companies granting the distributorships. ³

1969 U.S. Tax Ct. LEXIS 159">*162 The snack food industry is highly competitive. Petitioner conducted his business from a centrally located and accessible warehouse in Tucson. The major activity consisted of contacting and servicing buyers and keeping the distributed products rotated and fresh. The petitioner employed approximately 15 people, consisting of 8 salesmen, 2 supervisors, clerical help, warehousemen, and delivery men. The selling was conducted generally by the salesmen and sales supervisors. Petitioner's staff had considerable experience. Some had been with the company for many years. Petitioner himself acted as general manager of the business, his duties consisting principally of dealing with manufacturers of products purchased, promoting products, and directing company personnel and policies. Petitioner knew the purchasing agents and store owners within his areas of operation, and although he contacted them less frequently than his sales personnel, he had called on them frequently in the past. He was highly regarded by his competitors in the snack food industry, and his personal efforts had contributed to the success of his business. The business experienced an annual increase in gross sales1969 U.S. Tax Ct. LEXIS 159">*163 which rose from about $ 60,000 in its first year to about $ 750,000 in 1963.

During 1963, petitioner was contacted by representatives of the Pet Milk Co., a Delaware corporation doing business as Laura Scuder's, in regard to the sale of his business. As a consequence he, doing business as Maseeh Distributing Co., and Pet Milk, doing business as Laura Scudder's, entered into a contract dated July 1, 1963, but executed at a later time wherein it was recited that the petitioner desired to sell and the purchaser desired to acquire the petitioner's distributing business and certain personal property used in such business. Therein the petitioner agreed to sell and the purchaser agreed to buy (1) all inventories of raw material, packaging supplies, work in progress, and finished goods at actual cost to the petitioner or market value, whichever might be lower as of the closing date 52 T.C. 18">*20 (July 20, 1963); (2) all automobiles, tools, equipment, office furniture, office equipment and supplies, and fixtures used in the business for $ 85,716.35; and (3) all accounts receivable at book value as of the closing date.

On July 20, 1963, the petitioner executed a bill of sale reciting that in consideration1969 U.S. Tax Ct. LEXIS 159">*164 of $ 138,677.37 there was sold to Pet Milk Co. all the personal property and accounts receivable set forth in exhibits attached thereto "together with all other personal property of whatsoever kind and wherever located, used by the said seller in the conduct of his business as the Maseeh Distributing Company." The exhibits attached thereto listed physical equipment, such as motor vehicles, office equipment, etc., without indicating value or selling price; inventories at cost totaling $ 22,659.81, and accounts receivable totaling $ 30,301.21.

On July 20, 1963, the petitioner doing business as Maseeh Distributing Co. and Pet Milk doing business as Laura Scudder's entered into a separate agreement in which it was recited that whereas the purchaser was purchasing the capital assets and accounts receivable of the petitioner and planned to conduct a potato chip and snack business in the territory previously served by the petitioner and that whereas it was desirable that the purchaser have a noncompetitive agreement with the petitioner, the petitioner agreed with the purchaser that he would not engage either directly or indirectly, either for himself or for another person, in the States 1969 U.S. Tax Ct. LEXIS 159">*165 of Arizona, California, and Nevada, in a similar business for a period of 5 years from the date of the agreement, or for the period of his employment by the purchaser plus 2 years, whichever period might be longer. It was recited that in consideration of such agreement of the petitioner, the purchaser agreed to pay him the sum of $ 14,500 on the date of the agreement, and a balance of $ 35,500, without interest, on January 10, 1964. The agreement set forth a schedule of liquidated damages to be paid by the petitioner to the purchaser should the petitioner fail to comply with the terms of the agreement.

The negotiations which culminated in the above documents were initiated sometime in 1963. The petitioner met with representatives of Laura Scudder's on or about July 1, 1963, and advised them that he would sell his business for $ 75,000, in addition to his equipment, inventory, and accounts receivable. ⁴ At a time not precisely shown petitioner furnished to Laura Scudder's a list of his equipment which he therein valued at $ 60,716.35 for purposes of the sale. ⁵ There was no 52 T.C. 18">*21 discussion at that time of an agreement not to compete and no final agreement was reached. Two1969 U.S. Tax Ct. LEXIS 159">*166 or three days later petitioner received a telephone call from a representative of Laura Scudder's who advised him that Laura Scudder's would be willing to pay the figure which he asked, and petitioner was requested to obtain permission from the manufacturers to sell his distributorships. At that time there was no discussion of an agreement not to compete. Later, at the request of Laura Scudder's, petitioner agreed to the allocation of $ 25,000 of the $ 75,000 figure to the equipment in addition to the $ 60,716.35, and to the allocation of the remaining $ 50,000 to the agreement not to compete.

All the above documents were signed at the 1969 U.S. Tax Ct. LEXIS 159">*167 same time, on or about July 20, 1963, at which time there was a discussion of the agreement not to compete. All the documents involved were prepared by Laura Scudder's. At no time during the negotiations did the petitioner have any legal advice as to the tax consequences of the signing of the agreement not to compete. At his request the agreement not to compete provided for the payment of $ 14,500 (29 percent) in 1963 and $ 35,500 in 1964, because he had heard that less tax would be incurred upon a sale if only 29 percent of the price is received in the year of sale. At no time did any representative of Laura Scudder's make any representations to the petitioner as to the tax effect of the agreement not to compete.

Upon the sale of his business to Laura Scudder's the petitioner was employed by that company as general manager for the State of Arizona. His employment began in July 1963 and continued until July 1966, at which time he accepted a more lucrative position as president of Weston Biscuits, a manufacturer of snack food items, operating in Texas, which was outside the jurisdictional confines of the agreement not to compete. Petitioner felt that he was bound by such agreement1969 U.S. Tax Ct. LEXIS 159">*168 not to compete.

Laura Scudder's paid petitioner $ 30,301.21 by check dated July 31, 1963. It paid him $ 108,376.16 and $ 14,500 by two checks dated August 14, 1963. It paid him $ 35,500 by check dated January 10, 1964.

In his return for the taxable year 1963, petitioner included the payment of $ 14,500 on Schedule D, Form 1040, and treated the amount as long-term gain from the sale of a capital asset with the notation that such amount was "29% of Covenant Received in 1963 for agreement not to compete in business." On his return for the taxable year 1964, petitioner included the payment of $ 35,500 on Schedule D, Form 1040, and again treated the amount as long-term capital gain with the notation that such amount was for "Goodwill."

Respondent disallowed long-term capital gain treatment to both the $ 14,500 payment in 1963 and the $ 35,500 payment in 1964 and determined that petitioner "realized ordinary income in the taxable 52 T.C. 18">*22 years ended December 31, 1963, and December 31, 1964, in the respective amounts of $ 14,500 and $ 35,000 on the receipt of those amounts from Pet Milk Company under the separate noncompetitive agreement dated July 20, 1963."

OPINION

The petitioner contends1969 U.S. Tax Ct. LEXIS 159">*169 that the amount of $ 50,000 stated in the separate agreement not to compete as being the consideration for such agreement was not in reality such and taxable as ordinary income as determined by the respondent, but, rather, constituted payment for goodwill which is taxable as long-term capital gain.

It has been held in a long line of cases that when the parties to a transaction such as the one here involved have specifically entered into an agreement not to compete and have therein stated the consideration therefor, strong proof must be adduced by them to overcome that declaration. , affirming ; , affirming ; ; , affirming ; , affirming on this issue ;1969 U.S. Tax Ct. LEXIS 159">*170 , affirming ; , affirming a Memorandum Opinion of this Court; and . In the Schulz case, the court after concurring in the strong-proof requirement stated in part:

However, we think that the covenant must have some independent basis in fact or some arguable relationship with business reality such that reasonable men, genuinely concerned with their economic future, might bargain for such an agreement.

The petitioner testified that in his first discussions with Laura Scudder's he offered to sell his distributing business for $ 75,000 over and above an amount to be paid for inventories, equipment, and accounts receivable, and that therefore $ 75,000 of the amount which he received represented payment for goodwill, consisting of an organization of experienced personnel, customer lists, and distributorships, all of which he stated were valuable. Sometime prior to the execution of the bill of sale the purchaser requested that1969 U.S. Tax Ct. LEXIS 159">*171 $ 25,000 of the $ 75,000 figure be allocated as selling price of the equipment over and above the amount of $ 60,716.35 which the petitioner had asked for the equipment, and that $ 50,000 of the $ 75,000 figure be allocated as consideration for the separate agreement not to compete. The petitioner acceded to these requests and signed the separate agreement not to compete which recited the consideration of $ 50,000. However, he claims that the agreement not to compete had no independent significance or economic 52 T.C. 18">*23 reality and that therefore the $ 50,000 should not be treated as consideration therefor, but should be treated as proceeds from the sale of goodwill. He stated that he agreed to this allocation in ignorance of the tax consequences which would flow therefrom, although he concedes that no representative of Laura Scudder's at any time made any representations to him concerning the tax consequences of the agreement not to compete.

Upon a careful consideration of the entire record, it is our conclusion that the petitioner has not met his burden of showing that the agreement not to compete did not have some independent basis in fact or business reality, and that such agreement, 1969 U.S. Tax Ct. LEXIS 159">*172 including the recited consideration, did not represent the actual intention and agreement of the parties.

In support of his contention that the agreement not to compete had no economic reality, the petitioner stated that he felt that after the sale of his business he could not in any event have entered into competition with such accepted brand names as Laura Scudder, Brach Candy, and Weston Biscuit and have "done quite significant damage." Nevertheless, considering his many years of experience, the fact that he was known to the various store owners and purchasing agents, the fact that he was highly regarded by his competitors, and the fact that his personal efforts had contributed to the substantial growth of his business, we cannot conclude that it would have been unreasonable for Laura Scudder's, out of concern for its economic future, to have required an agreement not to compete. Indeed, the above factors tend to show a genuine business reason for the agreement not to compete. See ⁶

1969 U.S. Tax Ct. LEXIS 159">*173 The petitioner also testified that he had agreed to work for Laura Scudder's and had no intention of going back into business. However, these facts do not establish that there was no economic reality to the agreement not to compete. There always remained the possibility that the petitioner might change his mind, leave Laura Scudder's, and engage in competition, and this is recognized by the terms of the agreement. We note that after 3 years the petitioner did leave Laura Scudder's to become president of another company which manufactured snack food items.

The fact that it was Laura Scudder's which requested that $ 50,000 be assigned to the agreement not to compete and the fact that the petitioner may have been ignorant of the tax consequences of the 52 T.C. 18">*24 agreement are not determinative. As stated in :

But the effectiveness taxwise of an agreement is not measured by the amount of preliminary discussion had respecting it. It is enough if parties understand the contract and understandingly enter into it. * * * It is reasonably clear that the sellers failed to give consideration to the tax consequences1969 U.S. Tax Ct. LEXIS 159">*174 of the provision, but where parties enter into an agreement with a clear understanding of its substance and content, they cannot be heard to say later that they overlooked possible tax consequences. * * *

To similar effect, see

We think there can be no doubt that the petitioner understood the agreement when he entered into it. He testified that he read the agreement, that there was some discussion with regard thereto, that he felt bound by it, and that when he left the employ of Laura Scudder's he took a position outside the geographical confines of the agreement.

None of the instruments which were executed allocated any of the selling price to goodwill; indeed, goodwill was not mentioned therein. And, although the petitioner claims that $ 75,000 of the purchase price constituted payment for goodwill, he did not testify that there was at any time any agreement to that effect between him and Laura Scudder's. Furthermore, although there is evidence directed toward the value of goodwill, it is not sufficient to fix the amount thereof. Upon this record we cannot determine what amount, if any, was paid for goodwill. 1969 U.S. Tax Ct. LEXIS 159">*175 If there was any payment for goodwill such payment may be included in the amount of $ 85,716.35 recited as the price of equipment and treated by the petitioner as such with consequent long-term capital gain treatment. As stated above, the petitioner at the request of the purchaser, agreed to the allocation to such equipment of $ 25,000 over and above the petitioner's asking price for such equipment, which asking price itself appears to have been substantially in excess of both original and depreciated cost. However, we go no further here than to hold that it has not been established that any portion of the $ 50,000 in question constituted payment for goodwill.

On brief the respondent relies, among other cases, upon , reversing , in which it was held that a party may challenge the tax consequences of his agreement as construed by the Commissioner only by adducing proof which in an action between the parties to the agreement would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc. In1969 U.S. Tax Ct. LEXIS 159">*176 view of our conclusion above that the petitioner has not shown by strong proof that the $ 50,000 in question did not represent consideration for the agreement not to compete, we find it unnecessary to consider the applicability of the more stringent rule set forth in the Danielson case.

Decision will be entered for the respondent.