                           T.C. Memo. 2001-260



                         UNITED STATES TAX COURT



            BEMIDJI DISTRIBUTING CO., INC., Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent

     CORTLAND F. LANGDON AND JEAN M. LANGDON, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 7186-99, 7264-99.               Filed October 1, 2001.


     Garry A. Pearson and Jon J. Jensen, for petitioners.

     Blaine C. Holiday, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION


         PARR, Judge:   In separate notices of deficiency,1

respondent determined deficiencies in petitioners' income taxes

as follows:


     1
      These cases have been consolidated for purposes of trial,
briefing, and opinion.
                                 - 2 -

         Petitioner               Docket No.     Year     Deficiency

 Bemidji Distributing Co.(BDC)     7186-99      2/28/93   $408,000
 Cortland F. and Jean M.           7264-99     12/31/92      9,905
   Langdon (the Langdons)

     The deficiencies stem from the 1992 sale of the assets of

BDC, an ongoing wholesale beer distributor, to Bravo Beverage,

Ltd. (Bravo) for $2,017,461.     Bravo required that the purchase

agreement between it, BDC, and petitioner Cortland F. Langdon

(Mr. Langdon) (BDC's president and sole shareholder), allocate

$1.2 million of the purchase price to two agreements with Mr.

Langdon:     $200,000 to a 2-year consulting agreement and $1

million to a 5-year covenant not to compete.     Nothing was

allocated to certain intangible assets, including goodwill, going

concern value, or exclusive distribution rights with two major

brewing companies.

     After concessions,2 the issues for decision are:      (1)

Whether all or part of Bravo's payment to Mr. Langdon for the

covenant not to compete was a disguised payment for intangibles,

taxable to BDC, and a nondeductible dividend to Mr. Langdon; and

(2) whether a portion of BDC's payment of sales expenses was a

nondeductible constructive dividend to Mr. Langdon, paid to

obtain the covenant not to compete and the consulting agreement.




     2
      Respondent concedes that the parties to the sale and
exchange properly allocated $200,000 to the 2-year consulting
agreement between Bravo and Mr. Langdon.
                                 - 3 -

     All section references are to the Internal Revenue Code in

effect for the taxable years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure.

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulated facts and the accompanying exhibits are

incorporated herein by this reference.

     BDC is a Minnesota corporation, whose primary place of

business was in Bemidji, Minnesota, when it filed its petition in

these cases.   When they filed their petition, the Langdons

resided in Bemidji, Minnesota.

A.   BDC and the Wholesale Beer and Beverage Distribution Business

     In 1933, Mr. Langdon's father founded BDC.     BDC grew to be

the largest wholesale beer distributor in northern Minnesota,

enjoying an estimated 53 percent of the wholesale beer sales in

its geographic market by 1990.

     Mr. Langdon became part owner of BDC in 1943 and began full-

time employment with the company in 1945.     He operated the

business for 46 years until he sold it to Bravo.

     Since its founding, BDC maintained its business offices and

warehouse in Bemidji, the county seat of Beltrami County.       It had

customers in seven counties in northern Minnesota, including all

of Beltrami, Clearwater, and Hubbard Counties and parts of Cass,

Itasca, Koochiching, and Polk Counties.     Of its 242 customers
                                - 4 -

that year, 130 were "on-premises" retail outlets (i.e., bars and

restaurants), and 112 were "off-premises" retail outlets.     Mr.

Langdon had lived in Bemidji all his life and had made it a point

to know all the tavern and restaurant operators in town.     Some

customers had been personal friends for as long as 20 years, but

there was a large turnover of others because many were tavern

owners or operators who tended to turn over their businesses.

     In 1990, BDC served a geographic market with approximately

74,000 permanent residents.    Of those, about 25,000 lived within

5 miles of Bemidji, the only city of significant size within a

100-mile radius.    In addition, a large number of part-time summer

residents, tourists, and others visit the area each year.     There

are around 100 resorts in the region around Bemidji, with     large

tracts of Federal, State, and privately owned forests, as well as

lakes and rivers.   Itasca State Park is 32 miles southwest of

Bemidji.

     During 1990, wholesale beer distributors in that market sold

about 700,000 cases of beer.   Of that, BDC sold 369,864 cases of

beer on the basis of "24/12 ounce equivalents".   BDC held

exclusive distribution rights from Miller Brewing Co., Stroh's

Brewing Co., Minnesota Brewing Co., Leinenkugel Brewing Co., and

Martlet Importing Co. in all of Beltrami, Clearwater, and Hubbard

Counties and in parts of Cass, Itasca, Koochiching, and Polk

Counties.   The only large breweries with which it did not have
                                   - 5 -

distribution agreements were Anheuser Busch (Budweiser), Pabst,

and Coors.

       During its tax years ended February 28, 1991, and February

29, 1992, BDC generated $197,923 and $215,236 net after-tax

income, respectively.       Net income before taxes was $337,554 in

1991 and $361,362 in 1992.       Simple cashflow (before depreciation,

amortization, interest, and principal payments on debt and

taxes), with certain adjustments for optional or one-time

expenses, was $366,500 for 1990 and $420,500 for 1991.3

       The company had 10 employees and owned all its operating

assets, including its delivery trucks and office and warehouse

space.       In each of the years 1991 and 1992, the company paid Mr.

Langdon $90,000 in wages.

B.   Sale of BDC's Assets

       By early 1990, Mr. Langdon began to consider the possibility

of selling BDC's business.       At that time, Mr. Langdon and his

wife, respectively, were approximately 69 years old and 68 years

old.       Nevertheless, he was ambivalent about selling.   He and his

wife were in good health, and Mr. Langdon worked every day,

actively managing every aspect of the business.       He had expanded

the business throughout the 1980's and continued to do so up

until the time of sale.       For instance, in 1988 Mr. Langdon added



       3
      These figures are included in the accountants' statement
furnished with the offering.
                               - 6 -

Matilda Bay wine coolers to his list of products.     In 1989, he

obtained permission to purchase the distribution rights to Coors

Beer.   After negotiations with Coors, however, Mr. Langdon

withdrew because he viewed Coors' sales quotas as impossible to

achieve in his region.   The minutes of the April 24, 1989, annual

directors' meeting state that "Bemidji Distributing Company will

persue [sic] other brand acquisitions."

     The minutes also reflect other plans for expansion:

          The President also advised that an addition to the
     warehouse will be necessary in the immediate future
     because of the increasing number of brands and packages
     introduced by brewery suppliers, and the fact that the
     storage area for company owned vehicles has been beyond
     capacity for a number of years. The demand by Miller
     for a 45-day inventory from spring through summer also
     presents a storage space problem.

     At the time of the sale, the Anheuser Busch (the largest

brewery in the nation) distributorship and Skaar Distributing

(Skaar), who sold Pabst, were BDC's competitors.     The owner of

Skaar had died, and his son sent out feelers to see whether Mr.

Langdon wanted to buy it.

     However, Mr. Langdon had no sons and did not want to pass on

the business to his two daughters.     More importantly, he also

dreaded having to renegotiate a Teamsters' contract that was set

to expire in May 1994, because past negotiations had been bitter.

No other distributor north of the Twin Cities had a union

contract.
                               - 7 -

     Around April 1990, Mr. Langdon contacted Pohle Partners,

Inc. (Pohle Partners), a company that specialized in appraising

and brokering the sale of wholesale beer distribution businesses

throughout the United States, to discuss a possible sale of BDC.4

     In mid 1990, Mr. Langdon agreed to have Pohle Partners

appraise BDC's business and to preliminarily market it to

potential purchasers.   He made it clear that he had made no firm

decision to sell, and Pohle Partners so stated in the offering

package.   It was understood that BDC and Mr. Langdon would have

to approve the terms of any offer.     No fee would be owed to Pohle

Partners, unless a sale was consummated and BDC and Mr. Langdon

were paid.   However, if the company were sold, Pohle Partners

would receive a specified percentage of the total purchase price.

For purposes of determining this fee, the total purchase price




     4
      Pohle Partners was well known throughout the wholesale beer
industry and enjoyed an excellent reputation as a broker. Since
about 1978, it had brokered hundreds of sales of wholesale beer
businesses. Mr. Langdon was acquainted with Paul L. Pohle and
Robert W. Pohle, the two principals of Pohle Partners. Paul
Pohle had previously owned and operated a wholesale beer
distribution business in the Minneapolis-St. Paul area.
                                    - 8 -

would include any amount the purchaser paid for Mr. Langdon's

covenant not to compete and/or consulting agreement.5

     Pohle Partners subsequently appraised BDC at almost $2

million.

     Minutes of the annual meeting of BDC's board of directors on

April 18, 1991, reflect the following:

          The president [Mr. Langdon] reported that Pohle
     Partners have approximately ten firms interested in
     acquiring Bemidji Distributing Company. An appraisal
     of the sale value of Bemidji Distributing Company has
     been made by Pohle Partners and it is in the
     neighborhood of two million dollars. The president
     feels that an offer to prospective buyers of the amount
     of the appraisal is satisfactory and has accepted the
     figure.

     An information package was prepared by Pohle Partners for

potential purchasers.       With respect to the nature of business and

franchise and territorial protections, the package states:

          This is an opportunity to acquire a prosperous
     beer distribution business in a broadly based,
     progressive market with the brands of the second
     largest national brewer, Miller Brewing Company, which
     together with products of other suppliers, provides
     excellent brand diversification.

                *       *       *      *    *     *     *


     5
      In its letter dated July 19, 1990, to Mr. Langdon, Pohle
Partners enclosed the following fee schedule:

          Purchase Price
        Over           But Not Over    Fee
             *    *      *     *     *      *     *
     1,000,000      2,000,000      $50,000, plus 4 percent of
                                       excess over $1,000,000
     2,000,000      3,000,000      $90,000, plus 3 percent of
                                       excess over $2,000,000
                                - 9 -

     Franchise and Territory Protection: BDC has agreements
          with its suppliers providing certain rights to the
          wholesaler in its relationship with the supplier
          and granting exclusive territories which is
          supported by a strong state beer franchise law.


Regarding the nature of sale, price, and terms, the package

states:

                                VIII.
                   Nature of Sale, Price and Terms
          Assets Purchased from BDC and Owner, Individually

                           Nature of Sale

     Sale of certain corporate assets which are within the
     general categories set forth below and a covenant not
     to compete and a consulting agreement from the owner
     individually.

                                Price
                Asset                      Price
          Accounts Receivable              $60,000   (1)
          Inventories                      300,000   (1)
          Equipment                        105,000   (2)
          Warehouse and Land               300,000
          Intangibles                    1,200,000   (3)
            Total                        1,965,000

           Notes: (1) These are estimates; actual amounts will
                  be determined at closing with inventory
                  priced at current laid-in-costs, i.e.,
                  current supplier prices and freight charges
                  and taxes.

                  (2) As these assets will likely change in
                  the normal course of business, the purchase
                  price will change accordingly.

                  (3) Intangibles amount to be allocated among
                  company intangible assets (customer lists,
                  franchise rights, goodwill, etc.) and
                  agreements with owner.

                           Terms--Cash
                              - 10 -

     On June 3 and 5, 1992, BDC, Mr. Langdon, and Bravo executed

a purchase agreement to sell all BDC's assets for $2,017,461.

The purchase agreement included the separate consulting agreement

and covenant not to compete, signed by Mr. Langdon and Bravo.

The principals of Bravo were from Hobbs, New Mexico.   They had

never lived in Minnesota and had no experience either in Bemidji

or as beer distributors.   In negotiations with Pohle Partners

they insisted on both a consulting contract and a strong,

enforceable covenant not to compete as conditions of the sale.

     The purchase agreement allocated $817,461 to BDC's tangible

operating assets and accounts receivable, $200,000 to a 2-year

consulting agreement, and $1 million to a 5-year covenant not to

compete between Mr. Langdon and Bravo.   Nothing was allocated to

any of BDC's intangible assets such as goodwill, going concern

value, and exclusive distribution rights.   The purchase agreement

stated:

          D. Seller's Intangible Property: No additional
     consideration shall be due from Buyer to Seller for
     Seller's Intangible Property, such assets to be
     transferred from Seller to Buyer in consideration of
     the benefits to be derived by Seller under the
     remaining provisions of this Agreement.

     Mr. Langdon did not negotiate with Bravo over the

allocations.   He knew that Bravo's offer to purchase was

contingent upon the execution of a covenant not to compete, and

accepted Bravo's proposal that full value for the intangibles be

allocated to the consulting agreement and the covenant.
                              - 11 -

     The sale of the business under the June 3 and 5, 1992,

purchase agreement closed on or about October 30, 1992.

     BDC incurred and deducted $107,815 for expenses of the sale

transaction.

C.   Notices of Deficiency

     In the notice of deficiency issued to BDC, respondent

determined, among other things, that BDC failed to report $1.2

million of income received from Bravo.6   Alternatively, if the

allocations should be upheld, respondent determined that the

selling expenses incurred by BDC were improperly allocated, and

these expenses attributable to the consulting agreement and

covenant (59.48 percent) are a constructive dividend to Mr.

Langdon and not deductible by BDC.

      The notice of deficiency issued to the Langdons was

consistent, determining that 59.48 percent of selling expenses is

a constructive dividend to Mr. Langdon.

      Shortly before the trial in the instant cases, respondent

conceded that Mr. Langdon's consulting agreement with Bravo had a

value of $200,000.   At trial and on brief, respondent conceded

that the covenant had a value of $121,000.




     6
      The Langdons reported and paid personal income tax on the
$1.2 million, in keeping with the purchase agreement allocation.
                                - 12 -

                                OPINION

Issue 1. Fair Market Value of the Covenant Not To Compete
Entered Into by Mr. Langdon and Bravo

     The amounts of any tax deficiencies of the parties herein

turn on the value of the covenant not to compete.     That is so

because, as to BDC, the amount properly allocated to intangibles

(in excess of basis) is taxable as capital gain.     When it is

distributed to the shareholder (Mr. Langdon), it is treated as a

nondeductible dividend and taxed again to him.     See secs.

61(a)(7), 11, 301(c)(1).

     On the other hand, the amount allocated to the covenant will

be taxed to the shareholder as ordinary income, but such amount

will escape tax at the corporate level.     Thus, it is only taxed

once, not twice.   The same applies to the consulting agreement.

In other words, the consulting agreement and covenant, even

though part of a total package, are treated as separate

agreements between the buyer and shareholder, and the selling

company is not taxed thereon.

     The buyer's interests are not adverse.     It can ratably

deduct the cost of the covenant not to compete over the life of

the covenant-–in this case 5 years.      See sec. 1.167(a)-3, Income

Tax Regs.   So once again, the more that is allocated to the

covenant, the greater the tax benefit to all parties.7



     7
      Bravo, the buyer, was not before the Court.
                                - 13 -

     Allocation rules are governed by section 1060, which

generally mandates the use of the residual method of purchase

price allocation as set forth in section 338(b)(5) and the

accompanying regulations.   Sec. 1.1060-1T(a)(1), Temporary Income

Tax Regs., 53 Fed. Reg. 27039 (July 18, 1988).

     However, as amended by the Omnibus Budget Reconciliation Act

of 1990 (OBRA 1990), Pub. L. 101-508, sec. 11323(a), 104 Stat.

1388, 1388-464, section 1060(a) further provides:

     If in connection with an applicable asset acquisition,
     the transferee and transferor agree in writing as to
     the allocation of any consideration, or as to the fair
     market value of any of the assets, such agreement shall
     be binding on both the transferee and transferor unless
     the Secretary determines that such allocation (or fair
     market value) is not appropriate.

This amendment is generally effective for acquisitions made after

October 9, 1990, and applies to these cases.   OBRA 1990 sec.

11323(d), 104 Stat. 1388-465.

     The legislative history concerning the above amendment to

section 1060(a), among other things, provides, in pertinent part:

          The committee does not intend to restrict in any
     way the ability of the IRS to challenge the taxpayers'
     allocation to any asset or to challenge the taxpayers'
     determination of the fair market value of any asset by
     any appropriate method, particularly where there is a
     lack of adverse tax interests between the parties. [H.
     Rept. 101-881, at 351 (1990).]
                                - 14 -

As we have observed, there are no adverse tax interests between

the parties here.8   We strictly scrutinize an allocation if it

does not have adverse tax consequences for the parties; adverse

tax interests deter allocations which lack economic reality.

Wilkof v. Commissioner, 636 F.2d 1139 (6th Cir. 1981), affg. per

curiam T.C. Memo. 1978-496; see also Lorvic Holdings, Inc. v.

Commissioner, T.C. Memo. 1998-281 (and cases cited therein).

     In Buffalo Tool & Die Manufacturing Co. v. Commissioner, 74

T.C. 441, 446-448 (1980), we noted that where the Commissioner

challenges a contractual allocation (as in the cases at hand),

two tests are applied by the courts.     In Buffalo Tool & Die

Manufacturing Co., we stated:

     [Those tests are] whether (a) the contractual
     allocation has "some independent basis in fact or some
     arguable relationship with business reality such that
     reasonable [persons], genuinely concerned with their
     economic future, might bargain for such agreement," in
     which event, the allocation will generally be upheld
     (Schulz v. Commissioner, 294 F.2d at 55), or (b) the
     allocation by the buyer and the seller of a lump-sum
     purchase price is unrealistic, which neither the
     respondent nor this Court is bound to accept (Rodman v.
     Commissioner, 542 F.2d 845 (2d Cir. 1976), affg. on




     8
      Prior to repeal of the preferential tax rate for capital
gain in the Tax Reform Act of 1986 (TRA 1986), Pub. L. 99-514,
100 Stat. 2085, the grantor of a covenant not to compete had an
incentive to minimize the amount paid for such a covenant because
payments received in exchange therefor constituted ordinary
income to the grantor, while the amount realized from the sale of
other business assets might qualify for the preferential tax rate
applied to net capital gain. See Schulz v. Commissioner, 294
F.2d 52, 55 (9th Cir. 1961), affg. 34 T.C. 235 (1960).
                             - 15 -

     this issue a Memorandum Opinion of this Court; F. & D.
     Rentals, Inc. v. Commissioner, 44 T.C. 335, 345 (1965),
     affd. 365 F.2d 34 (7th Cir. 1966)).

          In determining which test to apply herein, we
     first look to the circumstances under which the
     allocation * * * [was agreed to]. * * * [Id. at 447.]

     Although respondent originally argued that neither the

consulting agreement nor the covenant had economic reality,

respondent now concedes that the consulting agreement was worth

the $200,000 alotted to it, and that the covenant has economic

reality to the extent of $121,000.    Our task, then, is to

establish the value of the covenant.

Relevant Factors

     Courts have spelled out the relevant circumstances that must

be considered in evaluating a covenant not to compete.    These

include: (a) The seller's (i.e., covenantor's) ability to

compete; (b) the seller's intent to compete; (c) the seller's

economic resources; (d) the potential damage to the buyer posed

by the seller's competition; (e) the seller's business expertise

in the industry; (f) the seller's contacts and relationships with

customers, suppliers, and others in the business; (g) the buyer's

interest in eliminating competition; (h) the duration and

geographic scope of the covenant, and (i) the seller's intention

to remain in the same geographic area.    Lorvic Holdings, Inc. v.

Commissioner, supra (and cases cited therein); see also Thompson

v. Commissioner, T.C. Memo. 1997-287.
                                - 16 -

     Petitioners rely on these factors to sustain the allocation.

They did not offer an expert witness.      Respondent did not discuss

these factors, at trial or on brief, relying instead on the

testimony of an expert witness, Nhoth Chouravong, to establish

the value.    Neither party offered any evidence as to the value of

the other intangibles.    We first apply the enumerated factors to

the facts of these cases and then turn to Mr. Chouravong's

report.

     All the factors, with the possible exception of one, favor a

substantial allocation to the covenant.

     (a)    The seller's ability to compete.    Mr. Langdon certainly

had the ability to compete.     Neither his health nor his age was

an impediment, and he was working at full throttle, continuing to

expand the business when it was sold.      Respondent argues that,

because of existing exclusive distributorships, the only avenues

open for petitioner were to start from scratch with specialty

beers.     But that is not correct:   Mr. Langdon could have

purchased Skaar, which was a business in place representing

Pabst, or he could have gone to work for the Budweiser

wholesaler.

     (b)     The seller's intent to compete.   At the time of the

sale, Mr. Langdon did not intend to compete.      He believed it

would be unethical to do so, especially during the 2 years of his

consulting contract.     However, he could have changed his mind.
                                - 17 -

Moreover, the existence of a consulting contract does not negate

the need for a covenant:    The purchaser could abrogate the

contract for instance, or be terminated for cause.     See Peterson

Mach. Tool, Inc. v. Commissioner, 79 T.C. 72, 85 (1982) (holding

that an employment contract of a covenantor for the duration of

the covenant not to compete is entitled to some weight, but is

not determinative).

       Mr. Langdon's primary reason for selling was not to retire

but to avoid negotiating with the union once again.     Since no

other distributor in his region was unionized, that factor would

not have prevented him from reentering the business.       Therefore,

the factor of the seller's intention to compete may slightly

favor respondent, but only slightly.

       (c)   The seller's economic resources.   After the sale, Mr.

Langdon had ample economic resources to either start from scratch

or buy an existing business.

       (d)   Potential damage to the buyer.   If Mr. Langdon had

competed with Bravo, he could have greatly harmed the company.

Because of his long personal friendships with customers, they

certainly would have redirected a portion of their business to

him.    However, because of the limited brand names available from

Skaar or Budweiser, it is probable that BDC's customers would

have continued to purchase from Bravo as well.     Mr. Langdon might

also have been able to attract some of his former employees,
                               - 18 -

thereby weakening Bravo.    Using the record and our best judgment,

we find that Bravo would have lost about one-third of its

business (from loss of sales and efficiency due to lost

personnel) if Mr. Langdon had reentered the market.

     (e)    The seller's business expertise in the industry.     Mr.

Langdon had 46 years of experience with every phase of the beer

distribution business and had built BDC to be the leading

distributor in the region.    His expertise cannot be doubted.

     (f)    The seller's relationships with customers, suppliers,

and others in the business.    Mr. Langdon had cultivated business

and personal relationships with his customers and suppliers over

many years.    It is reasonable to assume they would have been

loyal to him.

     (g)    The buyer's interest in eliminating competition.

Bravo's need and desire to eliminate competition from Mr. Langdon

were clear from the beginning of negotiations.    Indeed, the sale

was contingent on a strong covenant not to compete.    As noted

above, there were good reasons for this.    Bravo might not have

survived if Mr. Langdon had gone into competition with it.

     (h)    The duration and geographic scope of the covenant.

Five years was a reasonable length of time to extend the

covenant.    Mr. Langdon would have been 76 years old by the time

it expired and not likely to reenter the market after a 5-year

hiatus.    The geographic scope of the covenant was also
                               - 19 -

reasonable, being apparently limited to the places where BDC

already had customers.

     (i)    The seller's intention to remain in the same geographic

area.   Mr. Langdon had lived in Bemidji all his life and intended

to remain there.    He was still living there at time of trial.

Respondent's Expert

     Respondent submitted the expert witness report and testimony

of Nhoth Chouravong to establish the value of Mr. Langdon's

covenant not to compete.

     Expert testimony may help the Court understand an area

requiring specialized training, knowledge, or judgment.    Snyder

v. Commissioner, 93 T.C. 529, 534 (1989).    We may be selective in

deciding what part of an expert's testimony we accept.     Helvering

v. Natl. Grocery Co., 304 U.S. 282, 295 (1938); Silverman v.

Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo.

1974-285; Parker v. Commissioner, 86 T.C. 547, 561 (1986).

     Mr. Chouravong is employed as a general and industrial

engineer with the IRS and has valued closely held businesses and

various types of tangible (real and personal) and intangible

property.   He has a B.S. degree in industrial engineering and an

M.B.A. with a major in finance.

     However, only 20 percent of Mr. Chouravong's actual job

duties involves doing valuations.    He is not certified by any

professional organization.    He has never valued a beer
                                - 20 -

distributorship, although he has valued three covenants not to

compete in other businesses over the past 5 years.   He did not

interview Mr. Langdon nor anyone associated with the business.

     Mr. Chouravong opined that the fair market value of the

covenant was $121,000, based upon a number of assumptions of

dubious validity.   He assumed, for instance, a growth in the

business of 2.7 percent per year, "based on the average growth

rate from 1988 through 1991".    We cannot verify this figure since

he does not identify the source of this information and no

documents demonstrating this were attached to the report or are

otherwise in the record.   We do know, however, that for the 2

most recent (and relevant) fiscal years, those ending February

28, 1991, and February 29, 1992, the rate of growth was 9.19

percent (from $197,923 to $215,236).

     Mr. Chouvarong then piled discounts upon discounts.

Beginning with a potential net income of $217,700, he seems to

have assumed a potential 50 percent loss of business if Mr.

Langdon were to compete.   He then halved this on the ground that

Mr. Langdon would need 6 months of startup time, an assumption

that would not apply under either of the most likely scenarios,

buying an existing distributorship or going to work for one.

     Further, Mr. Chouravong assumed only a 45 percent likelihood

that Mr. Langdon would actually compete in the first year (with

decreasing percentages in subsequent years).   On the other hand,
                               - 21 -

if Mr. Langdon had begun to compete in year one, it seems to us

equally reasonable to increase the amount of loss that Bravo

would have experienced in the out years.     See Buckley v.

Commissioner, T.C. Memo. 1994-470.      Mr. Chouravong's assumption

that Mr. Langdon would not compete was based upon four additional

assumptions.   Two are not supported at all by the record, and the

others are on shaky ground:   (1) That Mr. Langdon would not

compete because he wanted to be free of the union; however, none

of the other distributorships were unionized, so this was clearly

not a deterrent.   (2) That Mr. Langdon would have to work with

only microbreweries, which was not true.     (3) That the consulting

agreement would be a deterrent.   We agree that it would have some

effect but, for reasons stated above, it is not determinative.

(4) That Mr. Langdon’s age, time in business, and personal

reasons would deter him.   Although one might suppose that a 71-

year-old person would want to retire, Mr. Langdon did not cite

that as a consideration in his testimony, which we found to be

credible.   It is equally reasonable to believe that Mr. Langdon's

lengthy time in business might cause him to want to continue,

since he was obviously continuing to build and enjoy the business

at time of sale.

     The "other personal reasons" presumably refers to the lack

of a male heir.    Mr. Langdon did not name that as a reason, and,

in any event, it would not deter him from going to work for
                              - 22 -

another distributor or from taking over a business that his

daughters could sell at his death.     In short, we are persuaded

that the likelihood (and certainly the ability) of Mr. Langdon's

reentering the business should not be discounted.

     Mr. Chouravong also applied an additional 24.2-percent

discount on the basis of various cumulative "risk" factors.     We

cannot discern a risk factor in a covenant not to compete, other

than that the covenant will be violated.     However, the covenant

provided for remedies in the case of breach, including injunctive

relief and money damages.   The entire value of the covenant was

paid "up front".   A covenant is not like an investment on which a

return is earned over time.   The only return bargained for is the

grantor's forbearance.   If Mr. Langdon died before the 5 years

expired, he would still be unable to compete.     A discount for

risk thus also seems inappropriate.

     It may be that Mr. Chouravong was attempting to derive the

present value of BDC's operating profits for the life of the

covenant as an outer limit to the value of the covenant.     See

Buckley v. Commissioner, supra.   If so, however, he has failed to

persuade us of an appropriate discount rate, and we decline to

invent one out of whole cloth.

     On the other hand, we agree with respondent that (1) the

allocation of $1 million by the purchase agreement to the

covenant was not the result of arm's-length bargaining, and (2)
                                - 23 -

BDC, Mr. Langdon, and Bravo, in agreeing to this allocation, did

not have competing tax interests.     Mr. Langdon, through Pohle

Partners, was well aware of the potential tax advantages to both

buyer and seller of allocating the entire $1 million to the

covenant.9

     We also agree that it was unreasonable to have allocated

nothing to goodwill and going-concern value, including the value

of the distributorships.     In its appraisal of BDC's business,

Pohle Partners concluded that the intangible assets (its customer

lists, franchise rights, goodwill, etc.), together with the

consulting agreement and covenant, were worth a combined $1.2

million.     The record reflects that the intangible assets had

substantial value.

     Neither party presented evidence as to the value of the

intangibles.     The fact that the goodwill, or the value of the

company, as a going concern, was not mentioned in the contract of



     9
      Pohle Partners provided to Mr. Langdon a 1988 article
entitled "Acquisition in Today's Beer World". In that article,
after mentioning the TRA 1986 changes discussed supra note 8, the
Pohles discuss the use of allocations to covenants not to compete
to alleviate potentially, in part, the effect of those tax law
changes, where the wholesale beer business of a closely held,
regular C corporation is being sold. The article notes that
these covenants will typically be with the individual
shareholders who own the corporation selling the business, and
further states: "In an asset sale, there is not a tax affect
within the [selling] corporation because the contracts are with
the individuals * * * Again, the purchaser is satisfied because
of the deductability [over the life of the covenant of the
payments made]".
                               - 24 -

purchase is not controlling.   Copperhead Coal Co. v.

Commissioner, 272 F.2d 45, 48 (6th Cir. 1959), affg. T.C. Memo.

1958-9; Concord Control, Inc. v. Commissioner, 78 T.C. 742, 745

(1982).

     Goodwill exists where there is an "expectancy of both
     continuing excess earning capacity and also of
     competitive advantage or continued patronage." Wilmot
     Fleming Engineering Co. v. Commissioner, 65 T.C. 847,
     861 (1967). More succinctly, it has been described as
     the probability that 'old customers will resort to the
     old place.' Metallics Recycling Co. v. Commissioner,
     79 T.C. 730 (1982); Brooks v. Commissioner, 36 T.C.
     1128, 1133 (1961); see also Miller v. Commissioner, 56
     T.C. 636, 649 (1971). The indicia of goodwill are
     numerous and include practically every imaginable trait
     that has a positive bearing on earnings.

Solitron Devices, Inc. v. Commissioner, 80 T.C. 1, 18 (1983),

affd. without published opinion 744 F.2d 95 (11th Cir. 1984).

There frequently is an overlap between the goodwill and going-

concern value of a business.   Id. at 20.    Going-concern value has

been defined as "the additional element of value which attaches

to property by reason of its existence as an integral part of a

going concern", and that such value is manifested by the ability

of the acquired business to continue generating sales without

interruption during and after acquisition.     Id. at 19-20; Concord

Control, Inc. v. Commissioner, supra at 746; VGS Corp. v.

Commissioner, 68 T.C. 563, 592 (1977).

     In the instant cases, Bravo acquired an established and

profitable wholesale beer and beverage distribution business with

a workforce in place.   The buyer had no startup expenses.   In
                              - 25 -

addition to acquiring all the real estate and tangible personal

property that BDC used in that business, Bravo acquired BDC's

customer lists and exclusive brand and distribution rights in the

market area the business served.    We find that substantial

goodwill and going-concern value was transferred by BDC.

     Petitioners cite cases upholding large allocations to

covenants.   These cases all predate the TRA 1986, and thus,

unlike here, involved parties with competing tax interests.    See

Intl. Multifoods Corp. v. Commissioner, 108 T.C. 25, 46 (1997)

(cases upholding the contracting parties' allocation of a

specific amount to a covenant not to compete are premised upon

the assumption that the competing tax interests of the parties

will ensure that the allocation is the result of arm's-length

bargaining; where that assumption is unwarranted, there is no

reason to be bound to the allocation in the contract); Buffalo

Tool & Die Manufacturing Co. v. Commissioner, 74 T.C. at 446-448;

see also H. Rept. 101-881, at 351 (1990).    The cases on which

petitioners rely are innapposite.

     We reject respondent's proposed valuation of $121,000 as

unrealistically low and built upon faulty assumptions.

Petitioners, who did not offer an expert, have calculated, based

upon different discount rates and assumptions, that the covenant

is worth $2,247,992.   This is totally unrealistic, inasmuch as it

exceeds the entire purchase price of the business.    We therefore
                              - 26 -

will use our best judgment, based upon the record, sketchy as it

may be.

     An allocation to a covenant not to compete lacks
     economic reality where there is no showing that the
     seller would experience a loss comparable to the amount
     supposedly paid for the covenant such that it would
     bargain for substitute compensation in that amount or
     that the buyer would lose such an amount were the
     seller to compete against it. [Buckley v.
     Commissioner, T.C. Memo. 1994-470 (citing Forward
     Communications Corp. v. United States, 221 Ct. Cl. 582,
     608 F.2d 485, 493-494 (1979).]

     Income projected to be earned over the next 5 years, without

discounts or increases (or taking into account optional or one-

time items), is $1,075,000 ($215,000 x 5).   This is perhaps the

maximum amount Bravo could lose, if Mr. Langdon competed and

drove it completely out of business.   Mr. Langdon's potential

loss of income, of course, is considerably more: $1,075,000 plus

his $90,000 salary per annum for 5 years, minus the $200,000

consulting contract, or $1,325,000, if he took all the corporate

earnings as dividends.

     Both scenarios are highly unlikely.   We believe that, if he

competed, Mr. Langdon would not take away more than one-third of

BDC's business, because he would be unable to sell his former

products, and BDC would retain some customers through their brand

loyalty.   We are also mindful that, while Bravo might not survive

without the covenant not to compete, neither would it survive

without employees, distributors, or customers.   Therefore, we

find that the covenant not to compete has a fair market value of
                                - 27 -

$334,000, and that the remaining $666,000 of the $1 million in

issue represents the other intangibles.

Constructive Dividend

     A constructive dividend occurs where a corporation has

conferred an economic benefit on the shareholder in order to

distribute available earnings and profits without expectation of

repayment.    See Truesdell v. Commissioner, 89 T.C. 1280, 1295

(1987).     We hold that the additional $666,000 properly allocable

to intangibles was nondeductible capital gain income to BDC that

was then distributed to Mr. Langdon as ordinary dividend

income.10

Issue 2. Constructive Dividend Received by Mr. Langdon From BDC
for Expenses Paid To Obtain the Consulting Agreement and the
Covenant Not To Compete

     BDC incurred and deducted $107,815 for expenses of the sale

of its assets.    In the notices of deficiency, respondent

determined that $60,581.39 of the selling expenses was allocable

to Mr. Langdon's consulting agreement and covenant and, thus,

taxable to him as a constructive dividend, not deductible by BDC.

On brief, respondent acknowledges that BDC is entitled to deduct

those selling expenses that are not allocable to Mr. Langdon's

consulting agreement and covenant, and agrees that only the pro

rata portion of the expenses allocable to the consulting



     10
      Neither party argued that BDC did not have sufficient
earnings and profits for dividend treatment.
                               - 28 -

agreement and covenant should be treated as a constructive

dividend to Mr. Langdon.

     In determining whether an expenditure by a corporation

represents a constructive dividend to the shareholder, it is also

necessary to decide whether the expenditure primarily benefited

the shareholder personally rather than furthered the interest of

the corporation.   Hagaman v. Commissioner, 958 F.2d 684, 690-691

(6th Cir. 1992), affg. on this issue T.C. Memo. 1987-549; Ireland

v. United States, 621 F.2d 731, 735 (5th Cir. 1980); see also

Loftin & Woodard, Inc. v. United States, 577 F.2d 1206, 1214 (5th

Cir. 1978); Hood v. Commissioner, 115 T.C. 172, 179-180 (2000)

     Where the expenses are those of the shareholder, the showing

a corporation must make to deduct those expenses is a strong one.

To avoid constructive dividend treatment, the taxpayer must show

that the corporation primarily benefited from the payment of the

shareholder's expenses.    Hood v. Commissioner, supra at 181.

     In the instant cases, BDC did not require Mr. Langdon to pay

his pro rata share of the transaction's selling expenses.     Mr.

Langdon received $200,000 for his consulting agreement and

$334,000 for the covenant, or a total of $534,000 of the

$2,017,461 total purchase price.   Petitioners have not addressed

this issue, either at trial or on brief; we thus deem the issue

waived.   We hold that BDC's payment of the selling expenses

allocable to Mr. Langdon's consulting agreement and covenant
                             - 29 -

primarily benefited him and not BDC.   Accordingly, the pro rata

share of the selling expenses attributable to Mr. Langdon and

paid by BDC is a constructive dividend taxable to him and

nondeductible by BDC.

     To reflect respondent's concessions and the foregoing,

                                         Decisions will be entered

                                   under Rule 155.
