## Facts

- Sam Altshuler and Fred Sommers operated a candy business as equal partners and incorporated Annabelle Candy Company (Annabelle) in California in November 1954, beginning corporate operations on January 1, 1955.
- Altshuler and Sommers each owned 50% of Annabelle’s common stock; Altshuler served as president and Sommers as vice president, and both actively ran the company.
- Annabelle’s success depended largely on a ten-cent candy bar sold as “Rocky Road.”
- The “Rocky Road” name and the recipe/formula were not protected by patent, trademark, or trade name registration.
- Sommers decided to sell his shares. Altshuler and Sommers entered into a written agreement for Altshuler’s purchase of Sommers’s 50% stock interest for a lump-sum price of $115,000.
- The agreement included a covenant barring Sommers from competing for five years, which Altshuler considered highly valuable.
- The parties preliminarily settled on the $115,000 price before they began discussing the covenant, and the executed agreement did not allocate any portion of the $115,000 to the covenant.
- Altshuler’s bookkeeper advised Altshuler to specify severable consideration for the covenant for tax reasons, but the agreement was not revised to include an allocation.
- After the buyout (with Altshuler now the sole owner), Annabelle’s federal tax return unilaterally allocated $80,554.67 of the $115,000 purchase price to the covenant and claimed amortization deductions over the covenant’s five-year term.
- The Commissioner disallowed the amortization deductions and determined deficiencies for 1956 and 1957 (noticed July 14, 1959).
- The Tax Court upheld the deficiencies (decision entered June 12, 1961), and Annabelle petitioned for review in the United States Court of Appeals for the Ninth Circuit.

## Issues

1. Whether Annabelle could claim amortization deductions for a portion of a lump-sum stock-purchase price as the cost of a five-year covenant not to compete when the written agreement contained no allocation of consideration to the covenant and the allocation was made only on the taxpayer’s return.
2. Whether the Tax Court’s finding—that no definite portion of the $115,000 was actually paid as separate consideration for the covenant—was clearly erroneous.

## Decision

- The Ninth Circuit affirmed the Tax Court’s decision sustaining the Commissioner’s disallowance of the amortization deductions.
- The court treated the question of allocation between stock value/goodwill (if any) and a covenant not to compete as a factual matter reviewed under a clear-error standard.
- The absence of any contractual allocation, the timing of the negotiations (price set before covenant discussions), and the failure to follow advice to specify consideration supported the Tax Court’s finding that the covenant was not separately priced in the deal.
- Because Annabelle failed to prove that a definite part of the $115,000 was paid for the covenant as a separate item, Annabelle had no amortizable basis in the covenant.

## Legal Principles

- A covenant not to compete may be amortized over its term only if the taxpayer proves that a definite portion of the consideration was actually paid for the covenant as a separately bargained-for item.
- When a purchase agreement states a lump-sum price and does not allocate consideration to a covenant, a later, unilateral allocation on a tax return generally does not establish basis for amortization.
- Courts look to what the parties actually agreed to and documented at the time of the transaction; tax reporting after the fact does not control where it conflicts with the transaction’s terms and proof of intent.
- The Tax Court’s allocation findings are factual determinations and are upheld on appeal unless clearly erroneous.

## Conclusion

The Ninth Circuit held that Annabelle could not amortize any portion of the $115,000 stock-purchase price as the cost of Sommers’s five-year covenant not to compete because the agreement set a lump-sum price without any allocation to the covenant and the evidence supported the Tax Court’s finding that no separate consideration was paid for it.


Annabelle Candy Co. v. Commissioner, 314 F.2d 1 (1962)