                        T.C. Memo. 1996-28



                      UNITED STATES TAX COURT



   THE BRINSON COMPANY-MIDWEST, INC., ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 26949-93, 26950-93,     Filed January 25, 1996.
                 26951-93.



     William A. Neilson, for petitioners.

     Kathleen O. Lier, for respondent.



                        MEMORANDUM OPINION


     WRIGHT, Judge:   This matter is before the Court on

petitioners' motion for award of reasonable litigation and



     1
      Cases of the following petitioners are consolidated
herewith: The Brinson Company, Inc., docket No. 26950-93; and
The Brinson Company-Texas, Inc., docket No. 26951-93.
                                 - 2 -

administrative costs under section 74302 and Rule 231.    Prior to

trial, the parties reached a basis for settlement.     When the

cases were called from the calendar on March 13, 1995, in New

Orleans, Louisiana, the parties appeared and filed decision

documents reflecting their settlement.     Accordingly, this Court

entered decisions on March 16, 1995.     These decisions were

subsequently vacated and set aside on May 30, 1995, and

petitioners were permitted to file their motion for award of

reasonable litigation and administrative costs.     On August 14,

1995, respondent filed a notice and supporting memorandum of law

objecting to petitioners' motion for award of reasonable

litigation and administrative costs.

     The primary issue for decision is whether petitioners have

established that respondent's position in the underlying actions

was not substantially justified.     If we find that respondent's

position was not substantially justified, we then must determine

whether the litigation and administrative costs claimed by

petitioners are reasonable.     As is discussed herein, we hold that

respondent's position in the underlying actions was substantially

justified.

Background

         Upon review of the pleadings, petitioners' motion for

reasonable litigation and administrative costs, and respondent's

     2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                               - 3 -

memorandum in support of her notice of objection to petitioners'

motion, the facts underlying this action may be best surmised as

follows.   Each petitioner is a corporation organized under the

laws of the State of Louisiana.   Petitioner Brinson Company-

Texas, Inc., and petitioner Brinson Company-Midwest, Inc., are

both wholly owned subsidiaries of petitioner Brinson Co., Inc.

(hereinafter Brinson).   Petitioners are involved in the

importation and distribution of German automobile parts.     Prior

to December 23, 1985, Brinson was a family-owned closely held

corporation.   Gunther G. Wittich and Brigitte G. Wittich, husband

and wife, were the principal owners.   Their two sons, Rainier R.

Wittich and Michael W. Wittich, each maintained a less

significant ownership position.

     During the first half of the 1980's, a somewhat less than

harmonious relationship existed between Gunther and Brigitte,

both personally and with regard to the operation of Brinson.

The couple received a divorce decree in March 1985.   Following

the divorce, the family divided and formed two factions, Gunther

and Rainier on one side and Brigitte and Michael on the other

side.   Difficulties quickly ensued because both alliances

controlled exactly one-half of Brinson, and neither side could

agree with the other regarding its operation.   These problems

were resolved in 1985 when Brinson's board of directors,

consisting of Gunther, Brigitte, and Rainer, voted to terminate

Brigitte and Michael from Brinson's employ.   On October 9, 1985,
                               - 4 -

5 days following her employment termination, Brigitte filed a

motion seeking permanent alimony in Louisiana State court.

     Two months after their employment relationship ended,

Brigitte and Michael entered into stock redemption and

noncompetition agreements with Brinson.   Brigitte was 62 years

old at the time these agreements were executed.   The terms of the

stock redemption agreement called for Brinson to purchase the

entire stock interests of both Brigitte and Michael.    The terms

of the noncompetition agreement required Brinson to pay a

specific amount annually to both Brigitte and Michael for a

period of 10 years in exchange for their agreement not to compete

with Brinson for a period of 15 years.    By amendment, on April 3,

1986, this 15-year term was reduced to a 5-year term.

     In February 1986, after Brigitte and Brinson executed the

noncompetition and redemption agreements, Brigitte sought to have

her claim for permanent alimony dismissed.   On February 14, 1986,

an order was issued by a Louisiana State court granting her

motion to dismiss.

     On January 27, 1987, 13 months after the execution of the

original noncompetition agreement, Brigitte died from cirrhosis

of the liver.   Brigitte was 63 years old at the time of her

death.

     Brinson amortized the noncompetition agreements and

allocated a portion of the deductions to its subsidiaries,

Brinson Company-Texas and Brinson Company-Midwest.   On their
                                - 5 -

Federal income tax returns for taxable years 1989 and 1990,

petitioners claimed their allocable portions of the amortized

noncompetition agreements with respect to both Brigitte and

Michael.    Although respondent was originally satisfied with the

valuation of the noncompetition agreement with respect to

Michael, respondent was not so satisfied with respect to

Brigitte.    Maintaining that the noncompetition agreement with

respect to Brigitte was inaccurately valued, respondent mailed a

notice of deficiency with respect to taxable years 1989 and 1990

to each petitioner on September 24, 1993.    In each deficiency

notice, respondent disallowed the portion of the amortization of

the noncompetition agreement allocated amongst petitioners with

respect to Brigitte.

     In January 1995, less than 2 months prior to trial, Michael

informed respondent that his testimony at trial would differ from

information he had earlier provided to respondent's agent.    In

light of this information previously unknown to respondent,

respondent reassessed her position and ultimately conceded each

case.    This full concession was reflected in decisions filed with

this Court when the cases were called for trial, but their

decisions were subsequently vacated in order to permit

petitioners to file their motion for reasonable costs.

Discussion

        Under section 7430(a), a "prevailing party", in specified

civil tax proceedings, may be awarded a judgment for reasonable
                               - 6 -

administrative and litigation costs.   To be a prevailing party

under section 7430(c)(4), the party seeking such award must: (1)

Establish that the position of the United States in the

proceeding was not substantially justified, sec. 7430(c)

(4)(A)(i); (2) substantially prevail with respect to the amount

in controversy, or have substantially prevailed with respect to

the most significant issue or set of issues presented, sec.

7430(c)(4)(A)(ii); and (3) establish that the party had the

requisite net worth at the time the proceeding was commenced,

sec. 7430(c)(4)(A)(iii).

     Additionally, a judgment for administrative and litigation

costs will not be awarded under section 7430(a) unless the Court

determines: (1) That the prevailing party has exhausted the

administrative remedies available within the Internal Revenue

Service (Service), sec. 7430(b)(1); and (2) that the prevailing

party has not unreasonably protracted the Court proceeding, sec.

7430(b)(4).   See Bragg v. Commissioner, 102 T.C. 715, 717 (1994);

Polyco, Inc. v. Commissioner, 91 T.C. 963, 966-967 (1988).

     Respondent agrees that petitioners substantially prevailed

in the underlying actions, met the net worth requirement, have

not unreasonably protracted the Court proceeding, and have

exhausted their administrative remedies.   Thus, we focus our

analysis on considering whether respondent's position was

substantially justified.
                              - 7 -

     Petitioners bear the burden of proving that respondent's

position was not substantially justified.    Rule 232(e); Estate of

Johnson v. Commissioner, 985 F.2d 1315, 1318 (5th Cir. 1993);

Bragg v. Commissioner, supra; Coastal Petroleum Refiners, Inc. v.

Commissioner, 94 T.C. 685, 688 (1990).   Petitioners, however,

need not show bad faith to establish that respondent's position

was not substantially justified for purposes of a motion for

administrative and litigation costs under section 7430.     Estate

of Perry v. Commissioner, 931 F.2d 1044, 1046 (5th Cir. 1991);

Powers v. Commissioner, 100 T.C. 457 (1993), affd. in part and

revd. in part 43 F.3d 172 (5th Cir. 1995).

     Whether the position of the United States in this proceeding

was substantially justified depends on whether respondent's

position and actions were reasonable in light of the facts of the

case and the applicable legal precedents.    Pierce v. Underwood,

487 U.S. 552 (1988); Bragg v. Commissioner, supra at 716; Coastal

Petroleum Refiners, Inc. v. Commissioner, supra at 688.     The

reasonableness of respondent's position necessarily requires

considering what respondent knew at the time she took her

position and the events that occurred afterwards.    Rutana v.

Commissioner, 88 T.C. 1329, 1334 (1987); Don Casey Co. v.

Commissioner, 87 T.C. 847, 862 (1986).   Generally, respondent's

concession of all or part of a case is not by itself sufficient

to establish that respondent's position was unreasonable.     Sokol

v. Commissioner, 92 T.C. 760, 767 (1989); Wasie v. Commissioner,
                               - 8 -

86 T.C. 962, 969 (1986).   A position is substantially justified

if the position is "justified to a degree that could satisfy a

reasonable person".   Pierce v. Underwood, supra at 565; see also

Lennox v. Commissioner, 998 F.2d 244, 248 (5th Cir. 1993), revg.

in part T.C. Memo. 1992-382; Norgaard v. Commissioner, 939 F.2d

874, 881 (9th Cir. 1991), affg. in part and revg. in part T.C.

Memo. 1989-390.   That standard is the same as the reasonable

basis both in fact and law standard used by this and other

courts.   Pierce v. Underwood, supra at 564; Powers v.

Commissioner, supra at 471.

      Other factors that may be taken into account in making this

determination include (1) whether the Government used the costs

and expenses of litigation against its position to extract

concessions from the taxpayer that were not justified under the

circumstances of the case, (2) whether the Government pursued the

litigation against the taxpayer for purposes of harassment or

embarrassment, or out of political motivation, and (3) such other

factors as the Court finds relevant.   H. Rept. 97-404, at 12

(1981); see also Sher v. Commissioner, 89 T.C. 79, 85 (1987),

affd. 861 F.2d 131 (5th Cir. 1988).

     With respect to a claim for reasonable administrative costs,

the phrase "position of the United States", as used in section

7430, means the position taken by the United States in any

administrative proceeding to which section 7430 applies as of the

earlier of (1) the date of the receipt by the taxpayer of the
                               - 9 -

notice of decision of the Appeals Office of the Service or (2)

the date of the notice of deficiency.   Sec. 7430(c)(7)(B).   It

appears from each record that prior to the issuance of the

deficiency notices, a notice of decision was not sent to

petitioners.   Accordingly, for purposes of petitioners' claim for

reasonable administrative costs, the position of the United

States means the position taken by the Service in an

administrative proceeding to which section 7430 applies as of

September 24, 1993, the date of the notice of deficiency in the

instant cases.

     With respect to a claim for reasonable litigation costs, the

phrase "position of the United States", as used in section 7430,

means the position taken by the United States in a judicial

proceeding to which section 7430 applies.   Sec. 7430(c)(7)(A).

Thus, the position of the United States means the position taken

by respondent in the instant cases.    Generally, the Commissioner

initially takes a position on the date an answer is filed in

response to the petition.   Huffman v. Commissioner, 978 F.2d

1139, 1148 (9th Cir. 1992), affg. in part and revg. in part T.C.

Memo. 1991-144.   Respondent filed an answer to each action on

February 25, 1994.   Therefore, the position of the United States

for purposes of petitioners' claims for reasonable litigation

costs is the position first taken by respondent in the instant

cases on or after February 25, 1994.
                               - 10 -

     Generally, when the Commissioner presents evidence which, if

credited by the Court, is sufficient to support a decision in the

Commissioner's favor, there will be a reasonable basis for the

Commissioner's position.    See Wilfong v. United States, 991 F. 2d

359, 369 (7th Cir. 1993).

     From the onset of the underlying actions, respondent

questioned the valuation of the covenant not to compete.

Respondent was primarily concerned with how the total amount paid

to Brigitte was allocated between the stock redemption price and

the covenant not to compete.   Such concern is clearly legitimate.

There has been a great deal of litigation involving the

allocation of a purchase price to a covenant not to compete.

See, e.g., Throndson v. Commissioner, 457 F.2d 1022, 1024 (9th

Cir. 1972), affg. Schmitz v. Commissioner, 51 T.C. 306 (1968);

Commissioner v. Danielson, 378 F.2d 771, 775 (3d Cir. 1967),

vacating and remanding 44 T.C. 549 (1965); Ullman v.

Commissioner, 264 F.2d 305, 307-308 (2d Cir. 1959), affg. 29 T.C.

129 (1957); Major v. Commissioner, 76 T.C. 239 (1981).     The

principal inquiry has been whether the amount allocated to the

covenant not to compete reflected business reality or whether

that amount was artificially allocated to such covenant solely

for tax purposes.

     Covenants not to compete are intangible capital assets and

their cost may be amortized over their useful lives.   See

Peterson Machine Tool, Inc. v. Commissioner, 79 T.C. 72, 80
                                - 11 -

(1982), affd. 54 AFTR 2d 84-5139, 84-2 USTC par. 9885 (10th Cir.

1984); sec. 1.167(a)-3, Income Tax Regs.      However, the fact that

a taxpayer has allocated a specific amount to a covenant not to

compete is not controlling for tax purposes.       Lemery v.

Commissioner, 52 T.C. 367, 375 (1969), affd. per curiam 451 F.2d

173 (9th Cir. 1971).    We may look beyond the formal dealings of

the parties to see if the form reflects the substance of those

dealings.   Annabelle Candy Co. v. Commissioner, 314 F.2d 1, 5

(9th Cir. 1962), affg. T.C. Memo. 1961-170; Buckley v.

Commissioner, T.C. Memo. 1994-470.       In order for the form in

which the parties have cast their transaction to be respected for

tax purposes, the covenant not to compete must have some

independent basis in fact or some arguable relationship with

business reality such that a reasonable person, genuinely

concerned with his or her economic future, might bargain for such

an agreement.   Schulz v. Commissioner, 294 F.2d 52, 55 (9th Cir.

1961), affg. 34 T.C. 235 (1960).    This test is commonly referred

to as the "economic reality" test.       See Patterson v.

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

1985-53.

     The Court of Appeals for the Fifth Circuit has held that

determining whether a covenant has economic reality is a

threshold inquiry.     Balthrope v. Commissioner, 356 F.2d 28, 31

(5th Cir. 1966), affg. T.C. Memo. 1964-31.      The essential
                                - 12 -

question is whether the payments allocated to the covenant not to

compete are, in fact, payments for something else.    Id.

     Using the reasoning set down in the above-cited cases and

similar cases, and based on the facts as surmised from the

records of the instant cases, we conclude that the position

maintained by respondent had a reasonable basis in both fact and

law throughout both proceedings.    The facts as understood by

respondent, especially when viewed collectively, form the

foundation of her position.    The stock redemption and the

covenants not to compete were executed simultaneously.      Michael

informed respondent's agent that significant negotiation did not

precede the allocation and that both he and Brigitte simply

accepted the offer as presented by Brinson.    Michael further

informed respondent's agent that the underlying factor motivating

Brigitte's and his decision to accept the offer as presented,

without consideration on their behalf, was the desire to quickly

sever all ties with Brinson.

     Additionally, respondent construed the available facts

pertaining to Brigitte's age and death as suggesting that the

covenant not to compete was erroneously valued.    The original

covenant not to compete had a 15-year life and was executed when

Brigitte was 62 years of age.    Respondent's concern was whether

and to what extent Brigitte could pose a competitive threat to

Brinson for a 15-year period ending when Brigitte would be 77

years old.   Moreover, in light of Brigitte’s having died from
                              - 13 -

cirrhosis of the liver 13 months after executing the covenant not

to compete, respondent concluded that Brigitte was in a state of

poor and declining health at the time the covenant not to compete

was executed.   Furthermore, given the nature of Brigitte's

illness, respondent also assumed that Brigitte's ailing health

was known by both parties at the time the covenant was executed.

See Commissioner v. Killian, 314 F.2d 852 (5th Cir. 1963), affg.

T.C. Memo. 1961-83; Krug v. Commissioner, T.C. Memo. 1981-522.

     Three other events further caused respondent concern with

regard to the valuation of the covenant not to compete.    First,

respondent explains that, because the execution of the covenant

not to compete followed rather than preceded Brigitte's

termination from Brinson, Brinson may not have perceived Brigitte

as a legitimate competitive threat.    Such a perception by

Brinson, respondent contends, lends support to her position that

the covenant not to compete was overvalued.    Second, respondent

explains that Brigitte sought and received a dismissal of her

alimony claim against Gunther immediately following the execution

of the covenant not to compete.   Respondent's concern here was

that the covenant not to compete may have contained an alimony

component.   See Balthrope v. Commissioner, supra.   Third,

respondent explains that the covenant not to compete was not

designed to terminate upon the death of Brigitte; rather, its

terms required continued payments payable to her estate.

Respondent maintains that this fact lends further support to her
                               - 14 -

concern that the payments to Brigitte were for a purpose other

than to prevent competition.    See id.; Ackerman v. Commissioner,

T.C. Memo. 1968-254.

     Petitioners contend that respondent's reallocation between

the stock redemption and the covenant not to compete is

erroneous.    Petitioners focus their argument on respondent's

assumption and conclusion regarding the health and abilities of

Brigitte.    Petitioners do not dispute that Brigitte died from

cirrhosis of the liver; however, petitioners explain that

Brigitte's health complications occurred and became known to the

parties after the agreements were executed.

     Petitioners had ample opportunity to dispel respondent's

erroneous assumption, yet they failed to do so.    On at least two

occasions, respondent's agent sought access to Brigitte's medical

records only to be denied the opportunity by petitioners.

     Petitioners also argue that they computed the value

allocated to the covenant several times and that their valuation,

and not respondent's valuation, is correct.    This may very well

be true, but petitioners failed to produce their computations or

deliver them to respondent when requested.    In fact, the record

indicates that petitioners were uncooperative with respondent up

until early 1995, shortly before these cases were scheduled for

trial.

     Having reviewed these cases based upon the available

information, we find respondent's position credible.    Petitioners
                                - 15 -

have not carried their burden of demonstrating that the position

of the United States was not substantially justified.   Given the

facts available to respondent as of the time period applicable

under section 7430(c)(7) in respect of each proceeding, legal

precedent did substantially support that position.   Consequently,

it is not necessary for us to consider the reasonableness of the

costs claimed by petitioners.    Accordingly, petitioners' motion

is denied.

     To reflect the foregoing,

                                          Appropriate orders and

                                     decisions will be entered.
