Annabelle Candy Co. v. Commissioner

314 F.2d 1 (9th Cir. 1962)

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Nature of the Case

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Facts

Altshuler and Sommers engaged as equal partners for manufacturing and selling candy. They incorporated, and each owned fifty percent of P's outstanding common stock. Altshuler became president and Sommers became vice president, and both were directors and actively conducted P's business. A ten-cent candy bar marketed under the name of 'Rocky Road' was the company jewel. P employed unique production methods in manufacturing its candy bar, which were valuable, and it marketed its candy bar in a distinctive red wrapper. Both Altshuler and Sommers had full knowledge of P's unique production methods. Altshuler and Sommers no longer got along, and each was interested in buying the other's fifty percent interest. An agreement provided for a total consideration of $115,000 to be paid in installments to Sommers by P. Sommers agreed, inter alia, to deliver his fifty percent stock interest, to retire from active participation as an officer and director, and not to compete nor engage in any activities which might be prejudicial to P's business for a period of five years. The agreement made no allocation of any portion of the total consideration of $115,000 to the restrictive covenants. P's dollar allocation to the covenant not to compete was made subsequent to May 15, 1956, without the knowledge or consent of Sommers. No separate or severable consideration was bargained for, or paid, for the covenant not to compete contained in the agreement of May 15, 1956. P's earned surplus amounted to $40,082.05 on May 15, 1956. By statute in California, a corporation may redeem its stock only out of earned surplus. (Calif.Corp.Code §§ 1705-1708.) Neither P's representatives nor Sommers and his counsel were aware of the possible applicability of these sections of the law of the State of California when they negotiated and signed their agreement of May 15, 1956. P allocated $80,554.67 of the $115,000 purchase price to the covenant not to compete and began amortization of the $80,554.67 over the covenant's five-year term at a rate of $16,110.93 per year, claiming $10,069.93 for the remainder of 1956, and the full $ 16,110.93 for 1957. D disallowed these claimed deductions; that no portion was allocable to the covenant not to compete. The Tax Court sustained on the basis of its finding that no separate or severable consideration was bargained for or paid for the covenant not to compete. P appealed. D contends that if a contract contains a covenant, but nothing has been paid for it, there is nothing to be deducted.'