ELY, Circuit Judge:
This appeal is from a District Court decision in favor of the Government in an action for tax refund instituted by taxpayer under 28 U.S.C. § 1346(a)(1) (1964). Taxpayer properly invokes our jurisdiction under 28 U.S.C. § 1291 (1964).
The taxpayer, a company engaged in the manufacture and sale of both multiwall and textile bags, sold its multiwall bag business to West Virginia Pulp and Paper Company. Negotiations, initiated by the purchaser in early May of 1958, led to the execution, on June 18, 1958, of an "Asset Purchase Agreement". Under the instrument's terms, the taxpayer agreed not to reenter the multiwall bag business or compete with the purchaser in such business for a five-year period. At the same time, in a lease agreement with Friedman Bag Company, the parent of taxpayer, the purchaser agreed not to manufacture textile bags on the leased premises during the same period. Taxpayer had desired that mutual covenants not to compete be included within the terms of the "Asset Purchase Agreement", but the purchaser insisted that the final sale agreement not define such a broad obligation as to it.
The sale agreement called for the payment to taxpayer of $918,704.50. Of this total amount, $503,396.30 was allocated "for the personal property and agreements not to compete". In the agreement itself, no specific sum was allocated to taxpayer's covenant not to compete. In its books of account and in its tax return, the taxpayer allocated $505,499.41 to its sale of fixed assets and reported a long-term capital gain of $363,498.52. It allocated nothing to the covenant. The Commissioner of Internal Revenue, through the District Director, determined that $250,000.00 of the reported gain was attributable to taxpayer's covenant not to compete and, therefore, constituted ordinary income. For a more detailed summary of the circumstances relevant to the transaction, the District Court's Findings of Fact and Conclusions of Law, not reported elsewhere, are reproduced below.fn1
Appellant makes two contentions. First, it says that the trial court erred in its finding that it and the purchaser, at the time of the execution of the "Asset Purchase Agreement", intended to allocate a portion of the purchase price to the covenant not to compete. Inasmuch as the agreement itself does contain a covenant by taxpayer not to compete, we cannot hold that a finding that the parties intended to allocate some portion of the purchase price to the covenant was clearly erroneous. United States v. United States Gypsum Co., 333 U.S. 364, 394-395, 68 S.Ct. 525, 92 L.Ed. 746 (1948); Yandell v. United States, 315 F.2d 141 (9th Cir. 1963); Fed.R.Civ.P. 52(a).
Our principal attention must be focused on taxpayer's second contention, that, assuming the existence of intent to allocate some portion of the purchase price to taxpayer's covenant, the District Court erred in upholding the District Director's determination that $250,000.00 was a proper sum for such allocation.
Neither party distinguished itself in presenting adequate evidence to enable the trial court to decide, and us to review, the issue which is before us. The Commissioner saw $250,000.00 as the difference between $503,396.30, that part of the purchase price assigned "for the personal property and agreements not to compete" and $253,396.30, the value of the personal property as shown by taxpayer's books, and determined that such amount must necessarily be the value of the covenant not to compete. There is no other evidence tending to support a $250,000.00 evaluation of the covenant. However, the Commissioner's determination carries with it a presumption of its correctness, and it is the taxpayer's burden to demonstrate the determination's incorrectness. Lewis v. Reynolds, 284 U.S. 281, 283, 52 S.Ct. 145, 76 L.Ed. 293 (1932); Roybark v. United States, 218 F.2d 164 (9th Cir. 1954); see 10 Mertens, Federal Income Taxation § 58A.01 (Supp. 1965); see also United States v. Rindskopf, 105 U.S. 418, 422, 26 L.Ed. 1131 (1881). To us, it seems apparent that the District Court, confronted with unsatisfactory evidence, believed, quite understandably, that its only choice was to apply the presumption and uphold the Commissioner. The difficulty of a taxpayer's position, when faced with the presumption in certain situations, has recently been emphasized by Judge Brown of the Fifth Circuit. He wrote,
"This case shows that what is euphemistically called a `presumption' becomes an absolute to sustain the Commissioner's implied finding in the deficiency determination. In practical effect it puts the imprimatur of law on the unassailable character of a figure plucked out of the air by the Commissioner. I do not think that the presumption is intended to infuse that infallibility into the undisclosed conclusions of this ephemeral agent.
"The Taxpayer loses because he did not prove
how much was attributable to the covenant not to compete. How could he when the parties did not? I assume it had some value. I would think it proper to find out what a
fair value would be. Hence, my dissent is not an either or situation of total victory for Government or Taxpayer. There is still a place for a determination of that value. And the omnipresent, brooding presumption does not supply a substitute. Nor can it be sugar coated by the references to the equitable nature of a tax refund suit. Here in the name of equity the law puts its blessing on a fiat."
David v. Phinney, 350 F.2d 371, 377 (5th Cir. 1965) (dissenting opinion). (Emphasis in original.)
Judge Brown's language closely fits our reaction to the result of the challenged determination in the case at bar.
The key to the determination of the value of a covenant not to compete is the intent of the parties at the time of the execution of their agreement. Annabelle Candy Co. v. Commissioner, 314 F.2d 1 (9th Cir. 1962). Here, while the taxpayer may have failed to prove that which the parties intended as the value of the covenant or its exact, actual worth, it did offer sufficient evidence to prove that it was not intended that it was valued at $250,000.00. Furthermore, there is uncontradicted evidence that it was not in fact worth $250,000.00.
The first indication of intent at the time of the agreement is found in the agreement itself, where the parties assigned no specific value to the covenant. In Annabelle Candy Co., supra, Judge Barnes, for our court, wrote that the failure to assign a value to the covenant in the contract is "pretty good evidence that no such allocation was intended [although] it is not conclusive on the parties as would be the case if there had been an express affirmance or disavowal in the agreement." 314 F.2d at 7; see also Rinehart Oil News Co., P-H Tax Ct.Mem. ¶ 65,178, 6-29-65. It is true that the covenant was discussed at length by the parties during their negotiations, but it is also quite apparent from the entire record that allocation of a particular value to the covenant was not discussed, nor were the tax consequences.
Since the agreement did not fix a particular value which the parties intended be assigned to the covenant, we look at other evidence for indication of intent. The entries in the books of account of the parties are of some relevance. The taxpayer allocated no part of the purchase price to the covenant. It has consistently maintained that the assets transferred by the agreement were acquired by it at substantially below their true value and that the price paid by the purchaser was in recognition of this higher value and should be accorded capital gain treatment. This contention is partially supported by the fact that the purchaser, in its books, allocated $158,784.41 as the value of taxpayer's covenant, an amount $91,215.59 less than the value fixed by the Commissioner. This allocation by the purchaser, to be amortized over a five-year period, is relevant, although it is, of course, not controlling. If the purchaser of a business is already a profitable going concern, it would ordinarily prefer to allocate as high a value as possible to the covenant because the amortization expense allowed as a deduction would offset its ordinary income. See Note, Tax Treatment of Covenants Not to Compete: A Problem of Purchase Price Allocation, 67 Yale L.J. 1261 (1958); see also Jensen, Purchases of Intangible Business Assets, Tulane 14th Tax Inst. 195 (1965); Freling, Sales of Intangible Business Assets, 14th Tulane Tax Inst. 209 (1965). The District Court expressly found that the goodwill of the taxpayer's multiwall bag business was of "minimal value". Finding of Fact No. XIX. "Minimal value" means some value; therefore, the maximum value of the covenant, whatever the intent of the parties, must necessarily be something less than the full $250,000.00 allocated by the Commissioner. Since the $250,000.00 represents the only source of consideration for both the goodwill and the covenant, a finding that the goodwill had some value is manifestly inconsistent with determination that the entire sum represents the value of the covenant alone.
In addition to payment for inventories, accounts receivable, and certain miscellaneous items, the purchaser agreed to pay to the taxpayer the latter's cost of both its multiwall and textile bag machinery plus $250,000.00 although it was agreed that taxpayer should retain the textile bag machinery. The Commissioner did not disallow as capital gain that portion of the total proceeds which was attributable to the cost to taxpayer of the retained textile bag machinery.
It is questionable, although perhaps not impossible, that a proprietorship's agreement not to compete with the purchaser of its business for five years can be said to be worth as much as $250,000.00, while, at the same time, it is said that the goodwill of the business has only a "minimal value". Any attempted explanation for such an extreme disparity in values which are ordinarily more closely related is, under the circumstances of this case, difficult of total acceptance.
The District Court determined in its Finding of Fact No. XXI, that "Fulton employed no secret processes in its manufacture of multiwall bags and in May or June, 1958, there were other companies manufacturing and selling multiwall bags on the Pacific Coast." This indicates that a $250,000.00 evaluation of the covenant, even if made by the parties, bore no "arguable relationship with business reality such that reasonable men, genuinely concerned with their economic future, might bargain for such an agreement." Schulz v. Commissioner of Internal Revenue, 294 F.2d 52, 55 (9th Cir. 1961). It would seem that whatever value is placed on the covenant by the taxpayer or by the Commissioner, the relationship between the terms of the agreement and "business reality" is a factor which should command the court's careful consideration.
From the District Court's findings and conclusions, we are unable to see that the test formulated in Annabelle Candy Co., supra, regarding the intent of the parties, was applied. The course of the trial court's reasoning seems to have been that since the covenant was in fact a part of the agreement, the taxpayer, contrary to its protests, intended that the covenant have some value and that the value must necessarily be $250,000.00, the amount chosen by the Commissioner and fixed by calculating the excess of the money received for "personal property and agreements not to compete" over the book value of the "personal property". This simply is not enough. In the light of the whole body of evidence, unsatisfactory as it is, the Commissioner's determination was arbitrary and insupportably oppressive to the taxpayer. "The parties are entitled to a clear cut decision as to what their intent was, as evidenced by the agreement and all the surrounding circumstances." Annabelle Candy Co. v. Commissioner, supra, 314 F.2d at 8.
We remand the cause to the District Court for a redetermination in the light of the views which we have expressed and such additional evidence as the parties may choose to offer.
Reversed.