61 T.C. 461">*461 The Commissioner determined deficiencies in petitioner's income tax as follows:

The sole issue for decision is whether the amounts paid by petitioner O'Dell & Co. pursuant to a dual covenant to perform services and not to compete which was executed in connection with the acquisition of an insurance agency and brokerage business, were properly attributable to such covenant thereby entitling petitioner to deductions therefor in the years in issue.

FINDINGS OF FACT

The parties have filed a stipulation of facts which, together with its accompanying exhibits, is incorporated herein by this reference.

Petitioner O'Dell & Co., a California corporation, maintained its principal office in San Marino, Calif., at the time of filing its petition herein. It timely filed Federal corporate income tax returns for the taxable years 1966, 1967, 1968, and1974 U.S. Tax Ct. LEXIS 169">*171 1969 with the district director of internal revenue at Los Angeles, Calif.

Petitioner was at all times relevant herein engaged in a general insurance agency and brokerage business. Richard W. O'Dell (O'Dell) was its president, chief executive officer, and major stockholder. O'Dell first entered the insurance agency and brokerage business in the early 1930's; since 1946 he has conducted his own business, initially as an individual and subsequently as president of petitioner.

Until his death in May 1966, Clarence O. Hunt had, for a number of years, owned and operated the Butler-Hunt Agency (Butler-Hunt), also a general insurance and brokerage business. Butler-Hunt, like 61 T.C. 461">*462 petitioner, dealt primarily in commercial and industrial insurance, and relied upon a comparatively small number of large clients for the bulk of its business. For the 3 years ending prior to Hunt's death, Butler-Hunt's average gross annual commission was $ 55,751.80. At the time of Hunt's death the company employed no salesmen and had an office staff of two.

The Estate of Clarence O. Hunt was probated in the Superior Court of the State of California, for the County of Los Angeles. Mildred B. Hunt, the1974 U.S. Tax Ct. LEXIS 169">*172 decedent's widow and sole beneficiary under his will, was appointed executrix. Because Mrs. Hunt was not licensed to conduct an insurance agency and brokerage business, she applied for and was issued an estate certificate of convenience by the insurance commissioner of the State of California enabling her as executrix to operate Butler-Hunt during the period prior to probate sale. Subsequent to her husband's death, Mrs. Hunt received several offers from men willing to manage the business in her behalf, but she decided instead to sell the business. Nonetheless she was confident that, had its sale proved unfeasible, she could have continued the business herself. Despite having no working experience in the insurance business, Mrs. Hunt was personally acquainted with the executives of many of her husband's clients, and she believed that after 25 years of marriage to an insurance broker she had learned enough to enable her to pass the State insurance licensing examination without a great deal of additional preparation. Moreover, she knew most of the executives at both of the insurance companies which Butler-Hunt represented, Centennial Insurance Co. and Firemen's Fund Insurance Co., 1974 U.S. Tax Ct. LEXIS 169">*173 having maintained friendships at Fireman's extending back in some cases to the days when her husband had worked there before their marriage.

In accordance with her decision to sell Butler-Hunt, Mrs. Hunt gave public notice of the intended probate sale and requested bids therefor. The official "Inventory and Appraisement" of Clarence Hunt's estate, which was filed with the probate court, placed the value of Butler-Hunt at $ 25,000 plus $ 3,107.50 for its furniture and an additional $ 100 for its sundry assets. No appreciable goodwill was associated with the location of Butler-Hunt's office inasmuch as it handled very little walk-in business. Upon learning of the proposed sale, O'Dell met with Mrs. Hunt in order to express his company's interest in acquiring Butler-Hunt and to obtain a compilation of Butler-Hunt's basic customers and annual income. There was no discussion at that time respecting the form petitioner's bid would take. O'Dell was fully aware that prior to Clarence Hunt's death Mrs. Hunt had never been licensed in California to act as an insurance agent, broker, or solicitor.

Mrs. Hunt received 11 bids, including petitioner's, for the purchase of Butler-Hunt. The 1974 U.S. Tax Ct. LEXIS 169">*174 bids offered terms of purchase substantially as follows: 61 T.C. 461">*463

1974 U.S. Tax Ct. LEXIS 169">*175 61 T.C. 461">*464 It was the fear that Mrs. Hunt might become affiliated with another insurance agency which prompted O'Dell to include a covenant not to compete in petitioner's bid. In particular, he foresaw at least the possibility of Mrs. Hunt calling upon the executives of Butler-Hunt's existing clients and prevailing upon them, whether through sympathy or friendship, to review and discuss their insurance problems with her new employer. In so doing, Mrs. Hunt would not have been engaged in the insurance business such that a license would have been required. While O'Dell had no way of knowing whether or not Mrs. Hunt would in fact enter such employment, it was essential, he felt, that he secure a guarantee that she would not. At that time Mrs. Hunt was 49 years old, in good health, with plans to remain in the same area and confident of her ability to obtain the appropriate insurance licenses if necessary. Consequently, it was O'Dell's position that Butler-Hunt's business and the covenant with Mrs. Hunt comprised a package, neither part of which he was willing to purchase absent the other.

Of lesser importance but nonetheless of value to O'Dell was securing Mrs. Hunt's active services1974 U.S. Tax Ct. LEXIS 169">*176 in the event they were required. The insurance brokerage business is highly personalized, with success dependent to a considerable extent upon personal contact and friendship. In addition to this, it is essential that a broker have good relations with the insurance companies with which he must place his business. The bulk of Butler-Hunt's business consisted of insurance policies with expiration terms of 1 or 3 years. Although O'Dell did not know for certain whether he would need Mrs. Hunt's assistance, in light of the schedule of potential renewals over the course of the 3 succeeding years, he wanted to make certain of Mrs. Hunt's availability both for the purpose of recommending petitioner to existing clients of Butler-Hunt and as a source of customer background information. Moreover, her acquaintances among the insurance companies' executives might have proved to be an asset. O'Dell did not expect Mrs. Hunt to render any technical services under their agreement.

Subsequent to submitting petitioner's bid, O'Dell met with Donald Hubbs, an attorney representing both the estate and Mrs. Hunt individually, at which time Hubbs proposed that O'Dell increase the offered price for 1974 U.S. Tax Ct. LEXIS 169">*177 the business by $ 10,000 and concurrently reduce the consideration for the covenant not to compete and the consultation agreement by $ 10,000 in addition to extending the payments over 4 years instead of 3. O'Dell acquiesced in Hubbs' counterproposal inasmuch as he wished to consummate the sale and it did not substantially alter petitioner's total dollar outlay while nevertheless permitting it an extended period of payment. O'Dell understood, though, that the increase in the amount paid for Butler-Hunt and the corresponding reduction of payments to Mrs. Hunt were detrimental to petitioner's 61 T.C. 461">*465 tax position. Other than this tax aspect, however, it was of little consequence to O'Dell how the price was allocated.

Hubbs thereafter prepared a Return of Sale of Personal Property and Petition for Confirmation by the Probate Court, which incorporated the revised terms of sale. No other bids were submitted, and the Probate Court confirmed petitioner's bid on September 6, 1966. Immediately thereafter, in an adjoining room of the courthouse, Hubbs, O'Dell, and Mrs. Hunt met, whereupon Mrs. Hunt, as executrix signed a bill of sale for Butler-Hunt, and both O'Dell and Mrs. Hunt signed1974 U.S. Tax Ct. LEXIS 169">*178 a document prepared by Hubbs entitled "Consultation Agreement" which contained an employment agreement and a covenant not to compete, as previously discussed by O'Dell and Hubbs. ¹ Specifically, Mrs. Hunt agreed to make herself available to petitioner 3 days a month for consultation while refraining from undertaking any competitive activity in Los Angeles, Imperial, San Bernardino, Riverside, Orange, San Diego, Ventura, and Kern Counties for a period of 4 years. Petitioner agreed to pay Mrs. Hunt $ 1,030 per month throughout the life of the agreement. In addition to the terms noted above, the agreement provided that in the event of Mrs. Hunt's death during the course of the agreement, the remaining monthly payments would be made to Pamela Hunt, Mrs. Hunt's daughter, who was then 21 years old and a candidate for a Ph.D. degree at the University of California at Los Angeles. At that time Mrs. Hunt also filled out a form to be used by petitioner for withholding tax and social security purposes.

1974 U.S. Tax Ct. LEXIS 169">*179 Petitioner thereafter began making monthly payments of $ 1,030 to Mrs. Hunt which continued through August 1970, as per their agreement. For her part, Mrs. Hunt spoke to all of Butler-Hunt's existing clients in an effort to assure them of O'Dell's and petitioner's ability and reputation. She also contacted executives of Centennial and Fireman's Fund with whom she was acquainted in order to vouch for O'Dell's business reputation. Aside from such initial contacts, Mrs. Hunt thereafter spoke to client representatives on an irregular and infrequent basis, and never at the request of O'Dell. To the extent that Mrs. Hunt did render assistance to petitioner by supplying information concerning clients' backgrounds, such services were nominal.

Throughout this period petitioner suffered an abnormally high rate of attrition among the accounts acquired through Butler-Hunt. Due to the particulars of each lost account, however, O'Dell had concluded with respect to each that Mrs. Hunt's personal intervention would have been unfruitful, and consequently he had not requested it. Nonetheless, petitioner did secure some renewals of the annual term policies and at least one renewal of a 3-year 1974 U.S. Tax Ct. LEXIS 169">*180 policy. At all times during the period 61 T.C. 461">*466 of the agreement, Mrs. Hunt was ready and willing to render to petitioner the agreed-upon services.

During the years here in issue, petitioner listed amounts paid to Mrs. Hunt on its books as wages and salary and deducted such amounts, as well as associated payroll taxes, from gross income on its Federal income tax returns. Also, from each monthly payment to Mrs. Hunt, petitioner withheld FICA taxes and California disability insurance taxes, as well as Federal income taxes. Correspondingly, Mrs. Hunt reported the amounts she received on her Federal income tax returns as ordinary income in the appropriate years. However, following an Internal Revenue Service audit of Mrs. Hunt's returns as well as the estate and income tax returns of the estate, respondent determined that these amounts did not represent salary and wages to Mrs. Hunt and the Government therefore made a refund to Mrs. Hunt. Concomitantly the overall tax liability of the estate was increased, but in an amount that was less than Mrs. Hunt's refund.

In his notice of deficiency, the Commissioner refused to allow petitioner's deductions "because it was not established that1974 U.S. Tax Ct. LEXIS 169">*181 the amounts deducted as salary represented compensation for personal services actually rendered. If it was intended that such payments represent payments toward a covenant not to compete, they are not allowable because it has not been established that the covenant not to compete had economic value."

OPINION

The issue before us concerns the deductibility of payments made by petitioner pursuant to a consultation agreement and covenant not to compete executed in connection with petitioner's purchase of Butler-Hunt. It is petitioner's position that the agreed-upon purpose of such payments accurately reflected their economic substance and that petitioner is therefore entitled to deduct those amounts either as a salary expense under section 162(a)(1)² or as the amortized cost of the covenant not to compete under section 167(a)(1), ³ or as both. Respondent, however, argues that the Consultation Agreement is a sham, devoid of any independent economic significance and devised solely as a vehicle for petitioner's tax avoidance. Consequently, respondent 61 T.C. 461">*467 contends that the agreement will not support the claimed deductions; rather, the payments to Mrs. Hunt were entirely in consideration1974 U.S. Tax Ct. LEXIS 169">*182 for the goodwill of Butler-Hunt and therefore constitute capital expenditures. We hold for petitioner.

It is well settled that when knowledgeable parties execute a covenant not to compete for a limited period in connection with the sale of a business and they expressly assign payments thereto, and when that covenant has economic significance independent of the purchase of the business itself, such a covenant not 1974 U.S. Tax Ct. LEXIS 169">*183 to compete is a wasting intangible asset in the hands of the covenantee and is depreciable over the course of its useful life. Balthrope v. Commissioner, 356 F.2d 28, 31 (C.A. 5), affirming a Memorandum Opinion of this Court; Ullman v. Commissioner, 264 F.2d 305, 307-308 (C.A. 2), affirming 29 T.C. 129">29 T.C. 129; Henry P. Wager, 52 T.C. 416">52 T.C. 416, 52 T.C. 416">419; Eleanor M. Lutz, 45 T.C. 615">45 T.C. 615, 45 T.C. 615">634, reversed on other grounds 396 F.2d 412 (C.A. 9); Benjamin Levinson, 45 T.C. 380">45 T.C. 380, 45 T.C. 380">389; sec. 1.167(a)-3, Income Tax Regs. Petitioner here seeks to have us recognize the validity of the covenant exactly as it is written. ⁴It is an elementary rule of tax law, however, that in proper cases the Commissioner may look beyond the formal dealings of the parties and assert taxability upon the substance of the transaction, Higgins v. Smith, 308 U.S. 473">308 U.S. 473; Griffiths v. Commissioner, 308 U.S. 355">308 U.S. 355; Gregory v. Helvering, 293 U.S. 465">293 U.S. 465,1974 U.S. Tax Ct. LEXIS 169">*184 and this principle is particularly applicable in cases involving covenants not to compete, Schulz v. Commissioner, 294 F.2d 52 (C.A. 9), affirming 34 T.C. 235">34 T.C. 235; Rich Hill Insurance Agency, Inc., 58 T.C. 610">58 T.C. 610; J. Leonard Schmitz, 51 T.C. 306">51 T.C. 306, affirmed on other grounds sub nom. Throndson v. Commissioner, 457 F.2d 1022 (C.A. 9).

1974 U.S. Tax Ct. LEXIS 169">*185 In determining the economic significance of the covenant before us, the ultimate inquiry is whether the parties intended that petitioner's payments to Mrs. Hunt constitute consideration for her noncompetition or whether they were in fact disguised components of the purchase price of the business. ⁵ The Ninth Circuit has provided a useful formulation of the proper focus in such cases ( Schulz v. Commissioner, 294 F.2d 52, 55 (C.A. 9), affirming 34 T.C. 235">34 T.C. 235):

61 T.C. 461">*468 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.

There is no question that the agreement before us is the product of knowledgeable negotiations on behalf of petitioner and Mrs. Hunt and as such represents a true meeting of the minds. See Glenn W. Lucas, Jr., 58 T.C. 1022">58 T.C. 1022, and National Service Industries, Inc. v.United States ( N.D. Ga., 32 A.F.T.R.2d (RIA) 73-5863, 73-2U.S.T.C. par. 9703). Consequently, 1974 U.S. Tax Ct. LEXIS 169">*186 it remains only to examine those factors which tend to reveal the true economic import of the covenant before us.

Generally speaking, the countervailing tax interests of the parties to a noncompetition covenant act to deter schemes without economic substance. Shulz v. Commissioner, 294 F. 2d at 55; Ullman v. Commissioner, 264 F.2d 305, 307 (C.A. 2); Benjamin Levinson, 45 T.C. 380">45 T.C. 380, 45 T.C. 380">389; 67 Yale L. J. 1261, 1261-1262 (1958). And although1974 U.S. Tax Ct. LEXIS 169">*187 the parties' tax awareness is not a necessary condition for attributing tax validity to their agreement ( Hamlin's Trust v. Commissioner, 209 F.2d 761, 765 (C.A. 10), affirming 19 T.C. 718">19 T.C. 718), where, as here, the parties did consider their respective and adverse tax positions, it is evidence that the product of their bargaining mirrors the reality of their economic interests.

With regard to the noncompetition clause of the agreement before us, the record persuades us that in entering into such an arrangement petitioner acted in the manner of a party genuinely concerned with its economic future. There was unequivocal expert testimony at trial that one in the circumstances of Mrs. Hunt could have effectively competed with respect to Butler-Hunt's prior customers, rendering a covenant not to compete crucial to the prospective purchaser of such an agency. In light of Mrs. Hunt's then recent widowhood and her social contacts among Butler-Hunt's clients, O'Dell had ample cause to fear that a competing agency might pay for her assistance in attracting petitioner's newly acquired clients. Moreover, the evidence shows that Mrs. 1974 U.S. Tax Ct. LEXIS 169">*188 Hunt was knowledgeable, albeit not experienced, in insurance matters; she had the prospect of assistance from her late husband's associates in establishing a business; she enjoyed the friendship of potential clients as well as of executives of two insurance companies with which she might place her business; she was healthy; and she intended to maintain her residence in the same area. In prior decisions courts have deemed the covenantor's competitive possible intent and prospects to be probative of the economic substance of a covenant not to compete, and we are not inclined to rule that petitioner acted unreasonably in providing against such a contingency under these circumstances. See General Insurance Agency, Inc. v. Commissioner, 401 F.2d 324, 329 (C.A. 4), affirming a Memorandum Opinion of this 61 T.C. 461">*469 Court (inability to compete); Schulz v. Commissioner, 294 F.2d 52, 54 (C.A. 9) (no desire or ability to compete); Benjamin Levinson, 45 T.C. 380">45 T.C. 380, 45 T.C. 380">390 (desire to compete, adequate health); Rich Hill Insurance Agency, Inc., 58 T.C. 610">58 T.C. 610, 58 T.C. 610">618 (moved1974 U.S. Tax Ct. LEXIS 169">*189 from area, no intention to compete); J. Leonard Schmitz, 51 T.C. 306">51 T.C. 306, 51 T.C. 306">320, affirmed on other grounds sub nom. Throndson v. Commissioner, 457 F.2d 1022 (C.A. 9) (lived outside business area); Balthrope v. Commissioner, 356 F.2d 28, 33 (C.A. 5) (poor health, useful knowledge of business); Harry A. Kinney, 58 T.C. 1038">58 T.C. 1038, 58 T.C. 1038">1043-1044 (ability to compete without desire to do so, poor health). Furthermore, the terms of the covenant were genuinely but realistically restrictive, extending over an 8-county area for a period of 4 years, the time during which Mrs. Hunt's competition would have been most damaging. Compare Schulz v. Commissioner, 294 F.2d 52, 54 (C.A. 9).

Respondent has argued that the covenant not to compete was superfluous and consequently without economic substance inasmuch as under applicable California law a contract for the sale of a business includes an implied covenant that the vendor will not thereafter directly solicit the customers of the business thereby depriving the purchaser of the fruits of his1974 U.S. Tax Ct. LEXIS 169">*190 bargain. Brown v. Superior Court, 34 Cal. Rptr. 559">34 Cal. Rptr. 559, 212 P.2d 878, 881; Harrison v. Cook, 213 Cal. App. 2d 527">213 Cal. App. 2d 527, 29 Cal. Rptr. 269">29 Cal. Rptr. 269, 29 Cal. Rptr. 269">271 (2d Dist. Ct. App.); Bergum v. Weber, 136 Cal. App. 2d 389">136 Cal. App. 2d 389, 288 P.2d 623, 625 (2d Dist. Ct. App.). He argues in this regard that Mrs. Hunt's ability to compete existed only with respect to past customers the solicitation of whom was barred by California law in any circumstances. However, the covenant itself was not thus limited, and since the vendor of the Butler-Hunt agency was the estate of Mrs. Hunt's deceased husband, not Mrs. Hunt in her individual capacity, there appears to be serious question under California law whether any covenant not to compete would be implied as against her. Cf. California Linoleum & Shades Supplies v. Schultz, 105 Cal. App. 471">105 Cal. App. 471, 287 P. 980 (2d Dist. Ct. App.) (president of vendor corporation who signed agreement not personally bound). Accordingly, the covenant arising by operation of California law did not deprive1974 U.S. Tax Ct. LEXIS 169">*191 the express covenant of Mrs. Hunt of economic reality since it was arguably "desirable to define precisely" the rights of the parties "rather than to guess what a court may decide" in the particular circumstances (see Harvey Radio Laboratories, Inc. v. Commissioner, 470 F.2d 118, 119 (C.A. 1)), and "reasonable men, genuinely concerned with their economic future" ( Schulz v. Commissioner, 294 F. 2d at 55) might well prefer to have their rights protected under the compulsion of an explicit convenant rather than to take a chance upon the uncertain coercive power of a possibly inapplicable implied contract.

61 T.C. 461">*470 Nor are we persuaded by respondent's empirical argument that the combined cost of the Consultation Agreement and the agency, $ 90,190, approximated the true value of the agency alone, indicating that the consideration assigned to the agreement was baseless. Respondent starts with the premise that as a general rule the business of any insurance agency is worth 1 1/2 times its gross annual commissions, and he deduces therefrom that Butler-Hunt was worth $ 89,377.70, ⁶ or only $ 812.30 less than what petitioner1974 U.S. Tax Ct. LEXIS 169">*192 paid. We do not accept respondent's initial assumption. While a factor of 1.5 may be appropriate in a particular factual context, it is not necessarily so here. Indeed, a comparison of the 11 bids submitted for the purchase of Butler-Hunt, each made at arm's length by a person or organization engaged in the insurance business, indicates estimates of Butler-Hunt's cash value ranging from $ 27,000 to $ 72,000. We are unwilling to ignore the obviously informed judgments reflected in these offers in favor of an abstract formula of valuation which does not have any solid support in the record. In this light we cannot conclude that the $ 40,750 paid by petitioner that was allocated to Butler-Hunt constituted inadequate compensation. Cf. Henry P. Wager, 52 T.C. 416">52 T.C. 416, 52 T.C. 416">419. The fact that O'Dell regarded the agency and the agreement as a single package for which he was willing to pay a particular price, however allocated, does not negate the economic reality of the actual allocation to the purchase contract arrived at through arm's-length bargaining between parties with adverse interests. Harvey Radio Laboratories, Inc. v. Commissioner, 470 F.2d 1181974 U.S. Tax Ct. LEXIS 169">*193 (C.A. 1), affirming a Memorandum Opinion of this Court. Likewise, in these circumstances, we do not attach pivotal significance to the fact that the payments pursuant to the agreement comprised 54 percent of the price of the package. See Bennett v. Commissioner, 450 F.2d 959 (C.A. 6), affirming per curiam a Memorandum Opinion of this Court (80 percent); Eleanor M. Lutz, 45 T.C. 615">45 T.C. 615, 45 T.C. 615">630, 45 T.C. 615">633-634 (89 percent); Benjamin Levinson, 45 T.C. 380">45 T.C. 380, 45 T.C. 380">391 (97 percent).

Although in some circumstances a provision in a noncompetition covenant for the termination of payments upon the death of the covenantor has been regarded as evidence of the ordinary nature of such income to the covenantor, ⁷ the inverse does not necessarily hold true. The price of the covenant was $ 49,440, 1974 U.S. Tax Ct. LEXIS 169">*194 and the method and timing of payments to which Mrs. Hunt and petitioner agreed is not of controlling significance. Henry P. Wager, 52 T.C. 416">52 T.C. 416, 52 T.C. 416">419; Benjamin Levinson, 45 T.C. 380">45 T.C. 380, 45 T.C. 380">391.

61 T.C. 461">*471 Finally, the fact that Mrs. Hunt agreed to perform and in fact did provide only nominal services pursuant to the consultation provision of the agreement does not undermine a finding of economic substance in the agreement. See Henry P. Wager, 52 T.C. 416">52 T.C. 416, 52 T.C. 416">419. The consideration allocated to the Consultation Agreement reflected the value of the covenant not to compete as well as the consultation provision. There is no indication therein that anything in excess of a nominal portion of the consideration was properly attributable to Mrs. Hunt's employment.

This is perhaps a borderline case, but we are satisfied on the evidence before us that the scales tip1974 U.S. Tax Ct. LEXIS 169">*195 in petitioner's favor.

Decision will be entered for the petitioner.