                       T.C. Memo. 1998-430



                     UNITED STATES TAX COURT



       C.H. ROBINSON, INC. AND SUBSIDIARIES, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

               C.H. ROBINSON, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 9730-96, 26811-96.      Filed December 8, 1998.



     William J. Hippee, Jr. and David B. Strong, for petitioners

in docket Nos. 9730-96 and 26811-96.

     Edward J. Plumier, for petitioner in docket No. 9730-96.

     Jack Forsberg, for respondent.
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             MEMORANDUM FINDINGS OF FACT AND OPINION

     SWIFT, Judge:   For the years in issue, respondent determined

deficiencies in petitioners' consolidated Federal income taxes as

follows:


                          Year           Deficiency
                          1990            $275,348
                          1991             494,345
                          1992              21,320


For 1992, petitioners claim an overpayment of $310,359.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

     The issues for decision are whether payments totaling

$2,166,000 qualify as amortizable business expenses relating to a

covenant not to compete and whether payments totaling $749,905

qualify as deductible salary expenses for services rendered.


                         FINDINGS OF FACT

     Some of the facts are stipulated and are so found.

     When the petitions were filed, petitioners' principal place

of business was located in Eden Prairie, Minnesota.

     During the years in issue, C.H. Robinson, Inc. (petitioner),

was a Minnesota corporation and the parent corporation of a group

of affiliated corporations that filed consolidated Federal income
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tax returns.   Petitioner and its affiliated corporations were

engaged in various businesses relating to the distribution and

sale of produce and the provision of transportation and customs

brokerage services.

     In 1990, Meyer Customs Brokers, Inc. (MCB), was a Minnesota

corporation engaged in the customs brokerage business.     Services

provided by customs brokers involve the processing and

documentation of import goods through U.S. Customs, the payment

of duties and freight charges, and freight forwarding.

     Prior to the transaction discussed below, Joel Meyer (Meyer)

was president and sole shareholder of MCB, and the stock

ownership of MCB was not in any way related to the stock

ownership of petitioner.   Other than the absence of any

relationship in the stock ownership of petitioner and of MCB, the

identity of the owners of the stock in petitioner is not

disclosed in the record.

     In 1984, Meyer founded MCB.   As of 1990, Meyer was 40 years

of age and had been involved in the customs brokerage business

for over 15 years.    Meyer had developed extensive relationships

with the clients of MCB, and Meyer was the key individual who, on

behalf of MCB, maintained contact with the clients.    The earnings

of MCB depended primarily on the efforts of Meyer.    In each of

1988 and 1989, Meyer was paid a salary by MCB of $600,000 and
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$800,000, respectively.     Meyer was a particularly effective

businessman and was well regarded as a customs broker.

     In late 1989, representatives of petitioner and C.H.

Robinson International, Inc. (International), a wholly owned

subsidiary of petitioner, initiated negotiations with Meyer for

acquisition by International of certain assets of MCB (the assets

of MCB), including the goodwill, customer lists, and trade names,

but excluding certain assets, principally cash and accounts

receivable.

     As summarized in the schedule below, an offer and several

counteroffers were made by Meyer individually and as

representative of MCB, and by representatives of petitioner and

International relating to the amount of cash and stock

consideration to be paid to MCB for the assets of MCB and

relating to amounts to be paid to Meyer under a 3-year covenant

not to compete and a contingent salary bonus agreement:

                                    Under               Under
   Consideration to              MCB's Offer       International's
    be Paid to MCB                 to Sell         Counteroffer to
      and Meyer as                of 8/16/89    Purchase of 11/28/89
Cash                              $2,000,000         $1,500,000
Stock in petitioner                1,000,000                  0
Promissory note                      500,000                  0
Salary bonus over 3 years                  0            750,000
Covenant not to compete                    0            750,000
  Total amount to be paid
    to MCB and to Meyer          $3,500,000         $3,000,000



     After receiving tax advice, in early January of 1990,

representatives of petitioner and of International revised
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International's counteroffer to which revised counteroffer Meyer

and MCB agreed.    The final form of the agreement that was reached

on January 11, 1990, between Meyer individually, and as

representative of MCB, and International is summarized below:

           Consideration to
             be Paid to MCB                            Form
              and Meyer as                     As Finally Agreed to
     Cash                                          $ 300,000
     Stock in petitioner                                    0
     Promissory note                                        0
     Salary bonus over 3 years                        750,000
     Covenant not to compete
           Amount at closing           $1,290,000
           Amount in 1991                 292,000
           Amount in 1992                 292,000
           Amount in 1993                 292,000
     Total to be paid under Covenant                2,166,000
     Total amount to be paid to MCB
       and to Meyer                                 $3,216,000


     On March 7, 1990, the acquisition of the assets of MCB was

consummated.   At closing, International paid to MCB the $300,000

cash due and to Meyer the $1,290,000 due under the purported

covenant not to compete, and Meyer entered into the 3-year

covenant not to compete with International and a 3-year

employment agreement reflecting the contingent salary bonus.

     After the acquisition, MCB's customs brokerage business was

conducted as a division of International and continued to

prosper.

     Under the employment agreement, Meyer agreed to expand the

customs brokerage business throughout the United States.          The

employment agreement also contained a 2-year nonsolicitation
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clause to commence upon termination of Meyer's employment with

International under which, after his employment with

International, Meyer was prohibited from soliciting for 2 years

any of MCB's former clients.

     The $750,000 contingent salary bonus was to be paid to Meyer

ratably in March of 1991, 1992, and 1993 -- $250,000 in each

year -- if the customs brokerage business of International

reached a net profits goal in each year of $700,000, prior to

deductions for taxes and prior to Meyer's salary, bonus, and

profit-sharing contributions (net profits).   If the $700,000 net

profits goal was not reached, a pro rata share of the $250,000

salary bonus was to be paid to Meyer corresponding to the

percentage of the $700,000 net profits goal that was reached.

The $700,000 net profits goal was based on the fact that MCB's

annual net profits in years immediately preceding 1990 were

approximately $700,000.   After termination of employment with

International or after Meyer's death, no salary bonus would be

paid to Meyer or to his heirs.

     For each of the years 1990, 1991, and 1992, in addition to

the $1,290,000 paid at closing, Meyer was paid the $292,000 under

the purported covenant not to compete.   Also with respect to

1990, 1991, and 1992, all or a majority of the $700,000 net

profits goal for the customs brokerage business was reached, and

Meyer was paid by International as a salary bonus $245,905 in
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1990, $250,000 in February of 1992 for 1991, and $250,000 in late

1992 for 1992.

     On Meyer's individual Federal income tax returns for 1990,

1991, and 1992, Meyer reported and treated as ordinary income the

$1,290,000 he received at closing under the purported covenant

not to compete, the three annual payments of $292,000 he received

under the covenant not to compete, and the three annual payments

of approximately $250,000 he received as salary bonuses.

     On petitioners' consolidated corporate Federal income tax

returns for 1990, 1991, and 1992, ordinary business expense

deductions were claimed with respect to the covenant not to

compete in the respective amounts of $601,677, $722,000, and

$722,000 -- a total of $2,166,000.1   Also, ordinary business

expense deductions were claimed for 1990, 1991, and 1992 with

respect to the amounts accrued and/or paid to Meyer each year as

a salary bonus.

     On audit, respondent disallowed petitioners' claimed

deductions relating to the covenant not to compete and to the

salary bonus on the grounds that the amounts paid as such

actually represent nondeductible capital expenditures.

1
     The business expense deductions claimed for the covenant not
to compete represent a 3-year amortization of a total of
$2,045,677, which is $120,323 less than the total stated amount
of $2,166,000 purportedly paid for the covenant not to compete.
The $120,323 difference is not explained in the record, and the
$120,323 apparently has not been claimed as a business expense
deduction for the years in issue.
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                               OPINION

Amounts Paid to Meyer as Covenant Not To Compete

     Amounts paid for covenants not to compete generally are

deductible over the life of the covenants as current business

expenses.   Warsaw Photographic Associates, Inc. v. Commissioner,

84 T.C. 21, 48 (1985).   Amounts paid, however, for goodwill or

for the going concern value of a business generally are treated

as nondeductible capital expenditures.     Fong v. Commissioner,

T.C. Memo. 1984-402, affd. without published opinion 816 F.2d 684

(9th Cir. 1987).

     To be respected for Federal income tax purposes, covenants

not to compete should reflect economic reality.     Patterson v.

Commissioner, 810 F.2d 562, 571 (6th Cir. 1987), affg. T.C. Memo.

1985-53; Lemery v. Commissioner, 52 T.C. 367, 375 (1969), affd.

per curiam 451 F.2d 173 (9th Cir. 1971).    Taxpayers generally

bear the burden of proving entitlement to claimed deductions.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     In 1990, at the time of the purchase of the assets of MCB,

Meyer was an experienced, relatively young, and successful

customs broker.    As a result of his investments and the sale of

the assets of MCB, Meyer had sufficient capital available and the

ability to start a new customs brokerage business and to compete

effectively with International.   We believe that the covenant not
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to compete that Meyer entered into with petitioner and with

International had substantial economic reality, although, as

explained below, a portion of the amount allocated thereto by

Meyer, MCB, petitioner, and International, we regard as

excessive, and we treat as a nondeductible capital expenditure.

     Petitioners' and respondent's expert witnesses valued the

covenant not to compete at $2,300,000 and at $26,800,

respectively.

     The offer and counteroffers that were made during

negotiations for purchase of the assets of MCB suggest that the

$1,290,000 cash payment made at closing purportedly relating to

and for the covenant not to compete did not, in substance,

constitute payment for the covenant not to compete.    Rather, this

$1,290,000 cash payment was made at closing along with the stated

$300,000 cash portion of the purchase price.    Together, these two

cash payments are closely associated with the terms of

International's original counteroffer under which it was proposed

that International would make at closing a $1.5 million cash

payment for the assets of MCB.    Also, under that original

counteroffer, only $750,000 was to be allocated to the covenant

not to compete.   Only after tax advice was obtained by

International were the terms of the counteroffer modified to

reflect a much higher stated amount to be allocated to the

covenant not to compete.
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     Ignoring the $1,290,000 cash paid at closing purportedly for

the covenant not to compete, the total of $876,000 that was paid

for 1990, 1991, and 1992 for the covenant not to compete

($292,000 for each of 1990, 1991, and 1992), strongly resembles

International's original counteroffer under which a total of

$750,000 was to be paid for the covenant not to compete.

     We conclude that the $1,290,000 cash paid at closing

purportedly relating to the covenant not to compete does not

reflect economic reality, should be treated as consideration paid

for the assets of MCB, and constitutes a nondeductible capital

expenditure.   We also conclude that the cumulative $876,000 paid

for 1990, 1991, and 1992 for the covenant not to compete does

reflect economic reality, and the deductions relating thereto (to

be amortized over 3 years) are deductible as current business

expenses for each year.


Amounts Paid to Meyer as a Salary Bonus

     Under section 162(a)(1), ordinary and necessary business

expense deductions are allowed, including reasonable allowances

for salaries or other compensation paid for personal services.

Sec. 1.162-7(a), Income Tax Regs.   More specifically with regard

to salary bonuses, amounts paid for salary bonuses to employees

are deductible "when * * * made in good faith and as additional

compensation for the services actually rendered by the employees,
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provided such payments, when added to the stipulated salaries, do

not exceed a reasonable compensation for the services rendered."

Sec. 1.162-9, Income Tax Regs.

     Whether amounts paid as salary bonuses are to be treated as

reasonable and as paid for services rendered constitutes a

factual question.   American Intl Coal Co., Inc. v. Commissioner,

T.C. Memo. 1982-204, affd. without published opinion 709 F.2d

1490 (3d Cir. 1983).

     Many factors are to be considered in determining whether

compensation should be treated as reasonable in amount.    Mayson

Manufacturing Co. v. Commissioner, 178 F.2d 115, 119 (6th Cir.

1949), remanding a Memorandum Opinion of this Court.   Where

earnings of a corporation are not dependent upon efforts of a

large number of employees but are primarily dependent upon

efforts of a few key individuals and where the retention of these

individuals in the employ of the corporation is necessary to its

continued successful operation, the use of a percentage of

profits may be a valid manner to compute a reasonable level of

compensation for services rendered.    In Foos v. Commissioner,

T.C. Memo. 1981-61, we treated compensation measured by

90 percent of net corporate profits as not reasonable, but we

treated compensation measured by 65 percent of net corporate

profits as reasonable.
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     Respondent argues that the annual salary bonus paid to Meyer

of $245,905 for 1990 and of $250,000 for 1991 and 1992

constitutes disguised consideration for acquisition of the assets

of MCB.   Respondent also argues that because Meyer intended to

remain with International and because International was already

achieving annual net profits of $700,000, the annual net profits

contingency was not significant.

     Petitioners argue that the payments made each year as a

salary bonus constitute reasonable compensation for services

rendered by Meyer to International and are fully deductible as

ordinary and necessary business expenses.

     We agree with petitioners with regard to the salary bonus.

     Meyer’s receipt each year of the salary bonus was contingent

on Meyer's rendering significant services to International.

During each year, Meyer managed the operations and expansion of

International, and Meyer maintained virtually all of the former

clients of MCB.   The earnings of International depended primarily

on the efforts of Meyer.

     In the 2 years prior to the acquisition of the assets of

MCB, Meyer received annual salaries from MCB of $600,000 and

$800,000.   During each of the years in issue and treating the

salary bonus as part of his annual compensation for services

rendered and not taking into account amounts paid under the

covenant not to compete, Meyer's total annual compensation from
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International equaled $400,000, consisting of the stated salary

of $150,000 and the salary bonus of $250,000 -- approximately 60

percent of the annual salary Meyer received in 1988 and 1989.

     We conclude that the $245,905 paid to Meyer for 1990 and the

$250,000 paid to Meyer for each of the years 1991 and 1992 as a

salary bonus should be treated as reasonable compensation paid to

Meyer for services he rendered to International and as currently

deductible ordinary and necessary business expenses.

     To reflect the foregoing,


                                      Decisions will be entered

                                 under Rule 155.
