holder at that time, I am not inclined to accept the latter. We must assume, therefore, that the additional amounts which Mr. Teeples was to receive, whether he worked or not, were in part consideration to be paid for his stock. GOFFE, J., agrees with this opinion. HALL, J. I respectfully dissent. If a cash method taxpayer transfers $1,000 of trade receivables to an outside party in exchange for the assumption and payment of $1,000 of the taxpayer's trade payables, he has no taxable income. He realizes $1,000 of gross income on the receivables, for they have been sold for payment of the payables, but he realizes an offsetting deduction of $1,000 on the payables, for they have been paid for by the recipient of the receivables. See James M. Pierce Corp. v. Commissioner, 326 F. 2d 67 (C.A. 8, 1964), reversing 38 T.C. 643 (1962); Royal Oak Apartments, Inc., 43 T.C. 243 (1964); Andrew Jergens, 17 T.C. 806 (1951). Under the majority's reasoning, the same taxpayer making the same exchange with his wholly owned corporation will have $1,000 of taxable income. Section 351, intended as a shield against recognition of gain on incorporation, thereby perversely becomes a sword to impose a tax where none would be due in an ordinary recognizing transaction. The difficulty with the majority's reasoning does not lie in the application of section 357 (c), for the statutory mandate there is clear. In our illustration, the incorporating taxpayer has caused his corporation to assume $1,000 of liabilities, and the receivables transferred had a zero basis. Accordingly, $1,000 "shall be considered as a gain from the sale or exchange of *** property [the receivables] which is not a capital asset." Sec. 357 (c) (1). In other words, the taxpayer has made a taxable sale of his receivables. But what for? Clearly, assumption and payment of the payables. It is the assumption, under the statute, which generates the gain. But, as we have noted, when a cash method taxpayer sells his receivables for assumption and payment of his payables, he is just as much entitled to a deduction for payment of the payables as he is accountable for income on the sale of the receivables. Section 357 (c) takes so much of the transaction out of section 351 and treats it as an ordinary recognizing exchange. It should be so treated as to both payables and receivables. Nothing in section 351 or 357 requires treatment of only one side of the receivable-payable "sale" as a recognizing transaction. The statutory purpose is far better served if payables paid by the transferee in the taxable year of transfer are treated as deductible to the transferor to the extent the offsetting receivables are treated as received by him. Since payment of a deductible liability by a cash method taxpayer gives rise to a deduction, the same deduction should be allowed on payment when section 357 (c) treats the liability as assumed in exchange for receivables. Admittedly no such deduction is available where assets are transferred in a section 351 transaction to the extent not treated as a sale under section 357. Arthur L. Kniffen, 39 T.C. 553, 566-567 (1962); Doggett v. Commissioner, 275 F. 2d 823 (C.A. 4, 1960), affirming a Memorandum Opinion of this Court, certiorari denied 364 U.S. 824 (1960); Citizens Nat. Trust & Savings Bank v. Welch, 119 F. 2d 717 (C.A. 9, 1941). Likewise, a bankrupt gets no deduction on the mere transfer of assets to a trustee, where a new entity is created and there is no direct correspondence between transfer of assets and subsequent payment of the bankrupt's liabilities. Henry C. Mueller, 60 T.C. 36, 43-44 (1973); B & L Farms Co. v. United States, 238 F. Supp. 407, 409-410 (S.D. Fla. 1964), affirmed per curiam 368 F. 2d 571 (C.A. 5, 1966), certiorari denied 389 U.S. 835 (1967). Neither of these situations is comparable to the present facts, where (in order to avoid a negative basis) section 357 treats a portion of what would otherwise be a section 351 transaction as a taxable sale. Our analysis is fully in accord with the purpose of section 357 (c). Under it, there is no need to strain, as does Bongiovanni v. Commissioner, 470 F. 2d 921 (C.A. 2, 1972), to read the word "liabilities" in a difficult-to-define, artificial "tax" sense. Section 357 (c) is given full, literal effect. As a matter of appropriate allocation, in the case of incorporation of a cash basis business, the trade accounts payable should, for this purpose, be netted against the trade accounts receivable, up to the lesser of the trade accounts payable or the amount of liabilities treated as paid under section 357 (c). Such an allocation is simple, straightforward and best follows the statutory intent. Applying these principles to the present case, the liabilities assumed exceeded the adjusted basis of assets transferred by $102,367.73. Accordingly, there is $102,367.73 of section 357 (c) gain. There were $164,065.54 of unrealized accounts payable, and $317,146.96 of unrealized receivables. The corporation paid all the payables in peti 1 In Arthur L. Kniffen, 39 T.C. 553 (1962), the cash method taxpayer conceded and the Court found $8,246.58 of income under sec. 357 (c) (1) on the transfer to a corporation of a sole proprietorship, the liabilities of which exceeded the adjusted basis of its assets by that amount. Among the liabilities so transferred and paid by the transferee were $22,466.31 in unpaid business expenses. The taxpayer claimed the full amount thereof as a deduction and it was denied on the authority of Doggett v. Commissioner, 275 F.2d 823 (C.A. 4, 1960), affirming a Memorandum Opinion of this Court, certiorari denied 364 U.S. 824 (1960), and Citizens Nat. Trust & Savings Bank v. Welch, 119 F. 2d 717 (C.A. 9, 1941). The findings of fact do not indicate whether the assumed payables were in fact paid during the same taxable year. The taxpayer did not, in any event, contend that he was entitled to a deduction limited to the extent of his sec. 357 (c) (1) gain, and the Court did not consider the point. The authorities cited in Kniffen by the Court, while clearly barring the deduction of the full $22,466.31, do not involve the present question of whether amounts taken out of sec. 351 by application of sec. 357 (c) should give rise to deductions on payment of the liabilities giving rise to the application of that section. tioner's same taxable year. Accordingly, all $102,367.73 of the section 357 (c) gain would properly be allocated to sale of the receivables in exchange for assumption and payment of the payables, and the partnership should be treated as having paid $102,367.73 of the payables. Since the payables appear to have represented ordinary and necessary business expenses (they were all deducted by the corporation), the partnership was entitled to deduct that amount, which exactly offsets the section 357 (c) ordinary gain on the receivables. There should be no net addition to taxable income on the transaction. It is not necessary for present purposes to consider the effect, if any, of application of the above analysis to the subsequent corporate payment of the payables assumed and receipt of the receivables purchased thereby. FORRESTER and FEATHERSTON, JJ., agree with this dissent. LIBERO P. BALDARELLI AND RITA I. BALDARELLI, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT JACK H. AND ERLENE SHAFFER, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket Nos. 3338-70, 3482–70. Filed October 9, 1973. In 1966, S sold his partnership interest in an H & R Block franchise to B for $45,000 payable in four annual installments. The purchase and sale agreement included a covenant not to compete to which the parties allocated no value. Held: The noncompete covenant will not be assigned a value by this Court absent "strong proof" as to what its value might be. Therefore, S correctly reported the income he received as a long-term capital gain and B is not entitled to amortization deductions. Charles W. Froehlich, Jr., and Edward E. Weissman, for the petitioners in docket No. 3338-70. Gino P. Cecchi, for the petitioners in docket No. 3482-70. DAWSON, Judge: * In these consolidated cases the respondent determined the following Federal income tax deficiencies: Pursuant to a notice of reassignment sent to counsel for all parties, and to which no objections were filed, these cases were reassigned on Aug. 9, 1973, from Judge Austin Hoyt to Judge Howard A. Dawson, Jr., for disposition. We must decide the proper treatment under sections 167 and 1221, I.R.C. 1954,1 to be given certain payments made pursuant to a sale of a partnership interest. Respondent initially took inconsistent positions in order to protect the revenue by denying to the buyer amortization of an alleged covenant not to compete while simultaneously denying capital gain treatment to the seller. In his brief the respondent has chosen to side with the seller. FINDINGS OF FACT Some of the facts have been stipulated. This stipulation and the exhibits attached thereto are incorporated herein by this reference. Libero P. and Rita I. Baldarelli, husband and wife, were legal residents of Sacramento, Calif., when they filed their petition herein. Their joint Federal income tax returns for the years 1966 and 1967 were prepared on the cash receipts and disbursements method and were filed with the district director of internal revenue at San Francisco, Calif. Jack H. and Erlene Shaffer, husband and wife, were legal residents of Concord, Calif., when they filed their petition herein. Their joint Federal income tax returns for the years 1966 and 1967 were prepared on the cash receipts and disbursements method and were filed with the Internal Revenue Service Center at Ogden, Utah. On July 1, 1961, Baldarelli agreed with H & R Block, Inc., that in consideration for his operating an H & R Block tax return preparation service, H & R Block would grant him a franchise to operate in San Francisco and Oakland, Calif. The franchise was to be operated only under the name of H & R Block, Inc. The franchise agreement specifically detailed the services to be provided by Baldarelli. The hours of operation were set; the source and price of any forms used were determined; and the required accuracy and quality control of the final work product were specified. Baldarelli agreed to charge for his service according to a schedule of fees established by H & R Block, Inc. For the use and recognition of the corporate name H & R Block, Inc., Baldarelli promised to pay a certain percentage of his gross receipts with a discount for prompt payment. Baldarelli retained the right to "sell, assign, transfer or convey in any lawful manner," his rights under the agreement subject to the approval of H & R Block, Inc. Such approval was not to be "unreasonably" withheld. 1 All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. 46 61 UNITED STATES TAX COURT REPORTS (44) Baldarelli agreed that if the franchise agreement was terminated by virtue of a breach on his part he would not, directly or indirectly, compete with H & R Block, Inc., for 5 years. No geographic limitation to this covenant was provided. No specific value was assigned to this portion of the franchise agreement. On December 14, 1962, Baldarelli, without objection from H & R Block, Inc., amended the franchise agreement by making two additional individuals parties to the franchise agreement. The additional parties were George Brenner and Jack Shaffer. Prior to this, on December 12, 1962, Baldarelli, Brenner, and Shaffer entered into a joint venture agreement. They agreed to form a corporation to be called Libero Corp. with ownership to be 60 percent to Baldarelli and 20 percent to Brenner and 20 percent to Shaffer. The joint venture agreed to abide by the terms and conditions of the franchise agreement with H & R Block, Inc. Brenner and Shaffer were to divide equally the first $16,000 in yearly profits. Profits greater than that amount were to be distributed according to percentage of ownership. If yearly profits reached $100,000, Brenner and Shaffer each agreed to relinquish one-half of their interest in the venture. At that point they were each to receive a yearly salary of $20,000. There were provisions dealing with the withdrawal of either Brenner or Shaffer from the joint venture. Neither would have any interest whatsoever in the H & R Block, Inc., franchise; however, their capital contribution of $1,000 would be returned. The agreement of December 12, 1962, was amended to provide alternative procedures following the withdrawal of Brenner or Shaffer from the joint venture and to provide a buy-out price for a portion of any deceased joint venturer's interest. On December 16, 1962, the three joint venturers agreed to assign all their rights under the H & R Block, Inc., franchise to the Libro 2 Corp. It was agreed that any ownership interest in the franchise would exist only to the extent of stock ownership in the corporation. No such corporation was formed prior to July 1966. Partnership returns (Form 1065) were filed for 1963, 1964, 1965, and 1966 (to June 30, 1966). Each of these returns listed Baldarelli, Brenner, and Shaffer as partners. The profits for these years were apportioned in accordance with the ratio established in the joint venture agreement. On June 21, 1966, Baldarelli and Shaffer signed an agreement whereby Shaffer sold and Baldarelli bought Shaffer's partnership interest in the H & R Block, Inc., franchise operation. At that time This agreement used this spelling. All other references in the record are to the Libero Corp. Libero is the first name of Baldarelli, petitioner in docket No. 3338-70. liarelli, Shaffer rements with H Lifornia. This s percent of the rent interest,3 For Shaffer's in 5000 in annual er unsecured p . Had the fr lost due to c as agreement, t ven. This wa Coration of any s Saffer's share Er adjustments Paragraph 5 o Agreement signed & COVENANT NO bereafter engage the tax service b Ser be conducted, (3) years fro whether Selle or or sharehol ar, business ent er in the status ed, however, he i onal services re TD, either dire as related to prof hers in said join Line of said partn Sly or indirect ar to said name Rough drafts o s and conditi renant not to co e first covenant aration busin Tada. The seco nities. He cou |