Petition — Fedders Corp. v. Commissioner

é ftice- Supreme Court, US. |

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4

i JUL 1 5 1981

ALEXANDIRTE SteVAS

In THE CLERK a

Supreme Court of the United States

OctroBer TERM, 1981

FEpDpDERS CORPORATION AND SUBSIDIARIES,

Petitioners,

0.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

ON PETITION FOR WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

PETITION FOR WRIT OF CERTIORARI

Joun B. SHERMAN

425 Park Avenue

New York, New York 10022

(212) 371-5400

Attorney for Petitioners

WEISMAN, CELLER, SPETT,

Mop.in & WERTHEIMER

Of Counsel

i

QUESTION PRESENTED FOR REVIEW

1, Does a company which acquires a business which has no

excess earnings capacity also acquire goodwill for purposes of

the federal income tax laws? There is a conflict among the

circuits with respect to this issue.

LIST OF PARTIES AND LISTING

PURSUANT TO RULE 28.1

All parties to the proceeding in the court whose judgment is

sought to be reviewed were:

Fedders Corporation*

Fedders Financial Corporation

Fedders Center, New Orleans, Inc.

Warren-Connolly Co., Inc.

Fedders Center, Inc.

Fedders Center, Chicago, Inc.

Fedders-Norge Distributors of New Orleans, Inc.

Fedders-Norge Distributors of Chicago, Inc.

Fedders Puerto Rico, Inc.

- Fednor Corporation

~ RMR Corporation

Fedders Oklahoma, Inc.

Petitioners-Appellants

and

Commissioner of Internal Revenue

Respondent-Appellee

* Fedders Corporation is the parent corporation of the other petitioners. The

petitioners have no other parent corporations, subsidiaries or affiliates except

Fedders Corporation, and its wholly-owned subsidiaries hold minority interests

in the securities of other corporations.

ii

TABLE OF CONTENTS

Question Presented for Review ...............c:ccccccceeeeees

List of Parties and Listing Pursuant to Rule 28.1 .......

Reference to Opinion Below ................::ccccsecceeeeeeeeees

Statement of Grounds of Jurisdiction ....................00.

NNR Ar IN IND oe ee cil) si a cuscchakauhobioneeeses

A. Basis for federal jurisdiction alleged in the

GONE OF Mee COUN iss ssisitessocsssensssecdecessccoeee

Argument

The Conflict Among The Circuits With The

Resulting Confusion In The Law Requires A

Decision Of This Court As To The Definition

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(| RIRE Sep SOLE SPORE RD aS S

Appendix:

Judgment Order of United States Court of

Appeals for the Third Circuit ......................:06

Tax Court’s Memorandum: Findings of Fact and

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iii

TABLE OF AUTHORITIES

Boe v. Commissioner, 307 F.2d 339 (9th Cir. 1962) ...

Buddy Schoellkopf Products, Inc., 65 T.C. 640 (1975)

Burke v. Canfield, 121 F.2d 877 (D.C. Cir. 1941)......

C.F. Honey Co., 5 B.T.A. 175 (1926) .........cccccseseeees

Commissioner v. Killian, 214 F.2d 852 (5th Cir. 1963)

Computing & Software, Inc., 64 T.C. 223 (1975)......

Concord Control, Inc. v. Commissioner, 615 F.2d

RA TB Ce Ce SOD ss scassksspackesecsnctesuvccekeassece

Houston Chronicle Publishing Co. v. United States,

481 F.2d 1240 (Sth Cir 1978) oo... eceesseeeeeeeees

Karan v. Commissioner, 319 F.2d 303 (7th Cir. 1963)

VGS Corp., 68 T.C. 563, 590 (1977) ..sccecsccssssesssesssees

Wilmot Fleming Engineering Co., 65 T.C. 847 (1976)

Go oOo Dm

In THE

Supreme Court of the United States

OcToBER Term, 1981

FEeppERS CORPORATION AND SUBSIDIARIES,

Petitioners,

v.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

ON PETITION FOR WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

REFERENCE TO OPINION BELOW

The Memorandum Findings of Fact and Opinion of the

United States Tax Court which was adopted by the United

States Court of Appeals for the Third Circuit and upon which

the judgment sought to be reviewed was rendered is reported at

389 TCM (CCH) 1.

STATEMENT OF GROUNDS OF JURISDICTION

(i) The judgment sought to be reviewed was entered on April

16, 1981.

(ii) N/A

(iii) N/A

(iv) This Court has jurisdiction to review the judgment in

question by writ of certiorari pursuant to 28 U.S.C. §1254(1)

(1976).

2

STATEMENT OF THE CASE

A. Basis for federal jurisdiction alleged in the court

of first instance.

The Tax Court had jurisdiction, pursuant to 26 U.S.C. §6213,

over Fedders’ petition to redetermine the deficiency assessed ‘by

the Commissioner of Internal Revenue.

B. Introduction

This Petition involves a widespread problem which necessarily

occurs in every business acquisition, i.e., whether the acquisition

resulted in the transfer of any goodwill for federal income tax

purposes to the acquiring company. As we will show, the state of

the law in this area, which includes a conflict among the circuits,

is such that there is no definition of goodwill which is consist-

ently applied by the courts. The present case clearly demon-

strates this confusion. The courts below specifically held that the

Petitioners Fedders Corporation and Subsidiaries (“‘Fedders’’)

had not acquired any goodwill according to one common legal

standard. Nevertheless, the Tax Court and the Court of Appeals

then went on to apply a totally different and inconsistent

standard so as to conclude that Fedders acquired intangibles

worth $4.5 million. This resulted in a serious injustice to Fedders

which was thereby saddled with an additional tax liability in

excess of $6 million including interest. Fedders, however, is only

one example of the numerous cases in which this type of injustice

has arisen or is likely to arise. A decision of this Court is,

therefore, necessary to create uniformity in the law so as to

eliminate the anomalous situation which exists at the present.

C. Statement of Facts

This case involves the determination of the federal income tax

consequences of the purchase by Fedders on July 1, 1968 of

certain assets of the Norge Division (“Norge’’) of Borg-Warner

Corporation (‘Borg-Warner’). Norge was a manufacturer of

“white goods’, i.e., major kitchen and laundry appliances.

Fedders calculated its income taxes without reducing the

values of any of the Norge assets on account of claimed goodwill,

3

going concern value, or any other intangible allegedly relating

to those assets. Fedders’ position that the Norge assets had no

such value is consistent with the acquisition agreement between

Fedders and Borg-Warner (the ‘‘Agreement’’) (e.g., A 671,

689).* Fedders treated the Norge assets as having the same

tangible values for tax and financial reporting purposes (A 180,

700). These values are also consistent with the values the parties

reflected in the Agreement (A 689). Borg-Warner, on the other

hand, claimed for tax purposes that the assets sold to Fedders

included intangibles allegedly worth $45 million. Borg-Warner's

tax returns allocated the purchase price paid by Fedders

($45,213,255) to each category of assets and intangibles, con-

cluding that $22,171,068 of the purchase price was for Norge

intangibles. In so doing, Borg-Warner deliberately and con-

sciously took advantage of the confusion in the law regarding

goodwill. Thus, the record in this case makes clear that Borg-

Warner, as its own chairman testified at trial, thought that Norge

had no goodwill (and, indeed, had negative goodwill due to poor

product quality). Nevertheless, Borg-Warner claimed on its tax

returns that Norge had substantial goodwill, in the expectation

that the Commissioner would pursue Fedders, which would

have the large “deficiency” as a result of not declaring the

acquisition of goodwill on its tax returns (A 598-600, 708-10).

The Respondent, Commissioner of Internal Revenue (“‘Com-

missioner’), took inconsistent positions with respect to the

parties’ tax treatment of the transaction. Thus, the Commis-

sioner essentially applied Borg-Warner’s treatment to Fedders’

tax returns and Fedders’ treatment to Borg-Warner’s tax returns

(A 25-64). In so doing, as to Fedders, the Commissioner reduced

the cost basis of the assets acquired by Fedders below the values

agreed upon by the parties, thus artificially increasing the

amount of taxable income realized on the current assets and

reducing the depreciation deductions for the fixed assets (A 25-

64). As a result, the Commissioner assessed a deficiency of

$14,903,769 against Fedders attributable to the claimed Norge

* The abbreviation ‘A’ refers to pages of the Appendix in the Court of

Appeals, which has been requested to be certified and transmitted pursuant to

Rules 19.1 and 19.2 of the Rules of this Court.

4

intangibles, consisting of $7,606,217 for Fedders’ tax year 1968,

$6,970,209 for tax year 1969, and $327,343 for tax year 1970

(Derived from Notice of Deficiency [ibid. }).

Both Fedders and Borg-Warner petitioned the Tax Court for

redetermination of their respective alleged deficiencies, and the

two proceedings were consolidated. At the trial, the Commis-

sioner asserted that he is merely a stakeholder, and that his only

interest is to make certain that the transaction is treated consist-

ently for tax purposes by both parties. He specifically refrained

from taking any position on the merits of the dispute (e.g., A

123-24).

D. The Decision of the Courts Below

After a full trial on the merits, the Tax Court issued a detailed

Memorandum Findings of Fact and Opinion (App. 3a-42a).* In

this Memorandum, the Court made numerous specific findings

of fact relating to the poor and unprofitable nature of Norge’s

business and operations prior to the acquisition, as well as the

extensive efforts which Fedders was required to conduct after

the acquisition in an attempt to make the Norge business

profitable. These fact findings are fully supported by the record;

they are not in dispute in this Petition, nor were they in dispute

in the Court of Appeals.

The Tax Court recognized in its Opinion that applicable case

law with respect to the existence of goodwill requires ‘the

expectation of continuing excess earning capacity and some

competitive advantage or continued patronage’ (App. 29a). As

a result of its fact findings the Court came to the inevitable

conclusion that ““Norge had no goodwill in the sense of excess

earnings capacity” (App. 30a) and, indeed, that “the picture of

Norge that emerges from the record is a company that, since

World War II, was unable consistently to earn a profit except

under the exceptional managerial leadership of Judson Sayre”

(App. 29a-30a).

iia abbreviation “App.” refers to pages of the Appendix to this Petition,

infra.

5

Having found that by utilizing one of the applicable legal

standards Norge had no goodwill, the Court then chose another,

inconsistent, legal standard in order to find that the Norge name

had a value of $4.5 million. Thus, the Court stated that “lack of

profitability does not in and of itself prove the absence of

intangible value” (App. 30a, footnote omitted).

Based on its Memorandum, the Tax Court assessed deficien-

cies against Fedders totalling $3,268,677.28 plus interest (A 958).

On appeal, the Third Circuit affirmed, based on the Tax Court's

Memorandum Findings and Opinion. Thus, the Court of Ap-

peals itself adopted the legal inconsistencies which resulted in

the Tax Court's holding.

ARGUMENT

The Conflict Among The Circuits With The Resulting

Confusion In The Law Requires A Decision Of This Court As

To The Definition Of Goodwill

The complete disarray with respect to the legal definition of

goodwill for federal income tax purposes is exemplified by the

conflict between the circuits regarding this issue. Thus, the

“continued excess earnings capacity/competitive advantage’’

definition was adopted by the Sixth Circuit in Concord Control,

Inc. v. Commissioner, 615 F.2d 1153, 1155 (6th Cir. 1980), as

follows:

“The Commissioner argues that the Tax Court

erred in finding that no goodwill was purchased in

1964. The Commissioner contends that the Tax Court

committed an error of law by requiring an expectancy

of continued customer patronage or competitive ad-

vantage in addition to excess earnings over the normal

industry average to establish the existence of goodwill.

No Court has adopted the Commissioner's position

and there is ample authority to the contrary.”

On the other hand, the Third Circuit in the present case, by

adopting the Opinion of the Tax Court, has held that goodwill

can exist even in the absence of profitability, let alone excess

earnings capacity.

6

Furthermore, the Fifth, Seventh, Ninth and District of Col-

umbia Circuits have held that goodwill consists only of the

expectancy of continued patronage, e.g., Houston Chronicle

Publishing Co. v. United States, 481 F.2d 1240 (5th Cir. 1973);

Karan v. Commissioner, 319 F.2d 303 (7th.Cir. 1963); Commis-

sioner v. Killian, 314 F.2d 852 (5th Cir. 1963); Boe v. Commis-

sioner, 307 F.2d 339 (9th Cir. 1962); Burke v. Canfield, 121 F.2d

877 (D.C. Cir. 1941).

This conflict between the circuits is reflected in various

opinions of the Tax Court. Thus the “continued excess earnings

- capacity/competitive advantage” definition has been adopted in

recent cases in that Court. In VGS Corp., 68 T.C. 563, 590

(1977) “goodwill” was defined in the following terms:

“To support a finding that goodwill was transferred,

it is necessary that the business was such that the

purchaser could expect aot only continued excess

earning capacity but also some competitive advantage

or continued patronage; i.e., the expectancy that old

customers satisfied with the quality of services or

product would return” (68 T.C. at 590).

Similar'y, in Wilmot Fleming. Engineering Co., 65 T.C. 847

(1976), the Court held that:

“Focusing on the character of the partnership busi-

ness, we do not accord much significance to the face

of the partnership's profitability; high earnings per se

do not constitute*goodwill. Estate of Leopold Kaffie,

44 B.T.A. 843 (1941); Donal A. Carty, 38 T.C. 46

(1962); Estate of Henry A. Maddock, supra; A. T.

Miller, 39 T.C. 940 (1963), affd. 333 F.2d 400 (8th

Cir. 1963). More important is the question whether

the business was such as to provide its purchaser with

the expectancy of both continuing excess earning

capacity and also of competitive advantage or contin-

ued patronage” (65'T.C. at 860-61).

And, in Concord Control Inc., 35 TCM 1345 (1976), §76,301

P-H Memo TC (1976), aff d, 615 F.2d 1153 (6th Cir. 1980), the

Court held that:

‘

*

7

‘A precondition to the possession of transferable

goodwill is a finding that the seller's business is of

such a nature as to provide the purchaser with the

expectancy of both continuing excess earning capacity

and competitive advantage or continued patronage.

Wilmot Fleming Engineering Co., 65 T.C. 847, 861

(1976). Excess earning capacity in and of itself is

insufficient to demonstrate the transfer of goodwill.”

(385 TCM at 1356, §76,301 P-H Memo TC at 76-1333. )

Indeed, as we have seen, the Tax Court in the present case

recognized the validity of this definition.

On the other hand, the Tax Court in Computing & Software,

Inc., 64 T.C. 223 (1975), agreed with the definition adopted by

the Fifth, Seventh, Ninth and District of Columbia Circuits, to

the effect that goodwill consists only of the expectation of

continued customer patronage. Accord, C.F. Hovey Co., 4

B.T.A. 175 (1926). And, in Buddy Schoellkopf Products, Inc., 65

T.C. 640 (1975), the Tax Court held that a company which had

not been operated at a profit and which had lost much of its

reputation, nevertheless had goodwill due to the existence of its

trade name.

From the foregoing, the only thing that is clear is that there is

no definition of goodwill which has been uniformly or consist-

ently applied by the federal courts. This is a serious problem,

which only this Court can resolve. That a uniform and consistent

definition of goodwill for federal income tax purposes is a major

issue which should be resolved by this Court is self-evident. The

question of what constitutes goodwill inevitably arises in every

business acquisition. It is necessary for the parties to such

acquisitions, as well as the Commissioner, to know what the law

is in this regard, particularly since substantial sums of money are

usually involved.* The present state of the law creates uncer-

* In the present case, the deficiency asserted by the Commissioner against

Fedders, including interest, came to in excess of $20 million. The deficiency

assessed by the Tax Court, including interest, is in excess of $6 million. The net

vo of Fedders as reported as of October 31, 1980 is only approximately $25

million,

8

tainty in business dealings, and promotes litigation. Parties

should not be required to act at their peril with their substantial

rights determined by the fortuitous circumstance of which circuit

ultimately hears their case. A clear legal standard is needed, and

only this Court can provide it.

CONCLUSION

For the foregoing reasons, Petitioners pray that this Court

issue a writ of certiorari to review the judgment of the Court of

Appeals for the Third Circuit.

Respectfully submitted,

Joun B. SHERMAN

Attorney for Petitioners

Weisman, Celler, Spett,

Modlin & Wertheimer

Of Counsel

APPENDIX

la

UNITED STATES COURT OF APPEALS

FOR THE THIRD DISTRICT

Nos. 80-2257 and 80-2258

Feppers Corporation and Subsidiaries,

Appellant in No. 80-2257

CoMMISSIONER OF INTERNAL REVENUE,

Appellant in No. 80-2258

On Appeal From the United States Tax Court

T.C. No. 060533-75

Argued March 23, 1981

Before HunTER, SLoviter, and Wispom,”* Circuit Judges,

JUDGMENT ORDER

After consideration of all contentions raised by appellants, it is

ADJUDGED and ORDERED that for the reasons set forth in

its opinion, T.C. Memo 1979-350 (Sept. 4, 1979), the judgment

of the Tax Court be and is hereby affirmed.

Costs taxed against appellants.

By the Court

James Hunter, III, Circuit Judge

Attest:

Sally Mrvos, Clerk

Date: April 16, 1981

* Honorable John M. Wisdom, United States Circuit Judge for the Fifth

Circuit, sitting by designation

3a

TAX COURT’S MEMORANDUM FINDINGS OF FACT

AND OPINION

T.C. Memo, 1979-350

UNITED STATES TAX COURT

Feppers Corporation and Subsidiaries,

v. Petitioners,

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

Borc-WaARNER CORPORATION,

Petitioner,

v.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

Docket Nos. 6053-75, Filed September 4, 1979

6476-75.

Lawrence N. Weiss, for the petitioners in docket No. 6053-75.

Joseph E. McAndrews, Nora A. Bailey, and Neal F. Farrell,

for the petitioner in docket No. 6476-75.

Marwin A. Batt, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

TANNENWALD, Judge: Respondent determined the following

deficiencies in petitioners’ Federal income tax:

Docket No. Year Ended Deficience

6053-75 August 31, 1968 $7,606,216.89

August 31, 1969 7,141,349. 10

August 31, 1970 557,506.00

6476-75 . December 31, 1968 6,316, 749.57

4a

The primary issue for our decision is the allocation of the

purchase price paid by Fedders Corporation for Borg-Warner

Corporation’s Norge Division. The resolution of this issue de-

pends, in part, upon whether petitioners made a bona fide

allocation of the purchase price in their sales contract and upon

whether any intangible assets of value were sold to Fedders. If

we determine that Fedders acquired valuable intangible assets,

we must then decide whether such assets were abandoned, thus

giving rise to an abandonment loss. Also at issue is whether

Borg-Warner is entitled to a worthless stock loss under section

165(g)(3)! for stock in its subsidiary, Warren-Connolly Com-

pany.”

FINDINGS OF FACT

Some of the facts have been stipulated and are fcund accord-

ingly. The stipulations of facts and attached exhibits are incor-

porated herein by this reference.

The petitioner Fedders. Corporation (Fedders) is a New York

corporation and had its principal office at Edison, New Jersey, at

the time of filing the petition herein. It filed its Federal income

tax returns as consolidated returns on the accrual basis on behalf

' All section references are to the Internal Revenue Code of 1954, as

amended and in effect during the years at issue, unless otherwise indicated.

* In their petition, Fedders and its subsidiary, Fedders Financial Corpora-

tion, claim entitlement to deductions for accrued state taxes in excess of the

amount allowed by respondent and Fedders claims entitlement to a deduction

for repair expenses that respondent determined must be capitalized. Fedders

introduced no evidence at trial and made no arguments on brief with respect

to these issues, Further, Fedders stated on brief that it would not “add to the

Court's burden by making a point as to * * * other issues."’ Accordingly, we

conclude that Fedders has conceded these issues. In any event, we would hold

for respondent on these issues on the ground that Fedders has failed to carry

its burden of proof. Welch v. Helvering, 290 U.S. 111 (1933); Rule 142(a), Tax

Court Rules of Practice and Procedure.

Fedders also states on brief that there are other issues that are affected by

our determination of the allocation of the purchase price and suggests

that these can be eaieed in connection with the Rule 155 computation. We

admonish Fedders that proceedings under Rule 155 are strictly limited to

consideration of the correct computation of the deficiency and no further

argument will be heard on issues decided herein or on new issues. Bankers’

Pocahontas Coal Co. v. Burnet, 287 U.S. 308 (1932); Estate of Stein v.

Commissioner, 40 T.C. 275, 280 (1963); Rule 155(c), Tax Court Rules of

Practice and Procedure.

5a

of itself and its subsidiaries for the years at issue with the office

of the Internal Revenue Service at Philadelphia, Pennsylvania.

The petitioner Borg-Warner Corporation (Borg-Warner) is a

Delaware corporation and had its principal office at Chicago,

Illinois, at the time of filing the petition herein. It filed its

original Federal income tax return for 1968 and an amended

return on the accrual basis with the office of the Internal

Revenue Service at Chicago, Illinois.

Fedders and Borg-Warner are unrelated publicly-owned cor-

porations whose stocks are traded on the New York Stock

Exchange. On July 1, 1968, Borg-Warner sold its Norge Division

(Norge) to Fedders for $45,213,255, its net book value. Payment

was made with $20 million in cash, a negotiable subordinated

promissory note in the face amount of $13,213,255, with interest

at 7 percent, maturing in 1980, a non-negotiable promissory

note in the face amount of $3,600,000, with interest at 7 percent,

maturing in 1969, and 210,000 shares of Fedders common stock,

$1.00 par value, with a total market value of $8,400,000.

Additionally, Fedders assumed certain liabilities of the Norge

Division.

Borg-Warner is a diversified manufacturer, which is engaged

primarily in the production of chemicals and plastics, builder

and consumer products, industrial equipment, specialty steels,

and automotive equipment. Until it sold its Norge Division to

Fedders, Borg-Warner, through that Division, manufactured

and marketed a iine of ‘white goods’’ appliances, consisting of

home laundry equipment and gas and electric ranges, and

commercial laundry and dry cleaning equipment. The Norge

Division also marketed refrigerators, freezers, dishwashers, food

waste disposals, water heaters, and ranges manufactured by

others. In addition, the Norge Division manufactured and

marketed room air conditioners.

With the exception of private label sales (sales to retailers who

market products under their own names), Borg-Warner sold its

white goods appliances under the Norge brand name. It sold its

room air conditioners under the names ‘Norge’ and “York.”

Although these products, and advertising with respect to them,

6a

sometimes bore the trademarks ‘Borg-Warner’ or “BW,” the

Norge Division did not advertise or promote the Norge name

with either of these trademarks other than in a manner which

showed that Norge was a division of Borg-Warner and that Borg-

Warner had financial responsibility for the Division. Norge

products were marketed outside the United States, under the

Norge name, through Borg-Warner International Corporation, a

subsidiary of Borg-Warner.

The Norge Division had been operated by Borg-Warner since

1929, when Borg-Warner acquired Detroit Gear, which at the

time manufactured refrigerators under the Norge name. From

the time of its acquisition by Borg-Warner until World War II,

the Norge Division operated successfully. It manufactured one

of the first plug-in types of refrigerators. Around 1936, it was

second only to the Frigidaire Division of General Motors in the

sale of refrigerators. After World War II (during which it

engaged entirely in the production of war products), Norge

returned to the appliance business. In order to meet competition,

it quickly put into production a freon compressor for refrigera-

tors to replace the sulphur dioxide system it had manufactured

before the War. Norge had not concentrated on developing the

new compressor prior to the War and it was not sufficiently

tested before being marketed. It was defective and resulted in

many refrigerator failures. The Norge Division spent aproxi-

mately $16 million to fulfill its commitments under warranties

by replacing defective refrigerators and parts. Norge also rede-

signed the defective compressor. Largely because of these

expenditures, Norge was not profitable during the period 1949-

1952.

In the early 1950's, the Norge Division developed new

products, primarily automatic washers and dryers, and thereby

expanded its product line beyond refrigerators. However, in the

opinion of Borg-Warner’s board of directors and top manage-

ment, the Norge Division lacked the type of management

required to effectively merchandise its white goods appliances.

In order to solve this problem, in 1954 Borg-Warner hired

Judson S. Sayre to serve as president of the Norge Division. Mr.

Sayre had a long, successful history in the white goods appliance’

business and had acquired the reputation in the industry of

7a

being the ‘father of the automatic washer” because of his very

successful efforts to manufacture and market this product as

president of the Bendix Corporation.

Mr. Sayre served as president of the Norge Division from 1954

to 1960, and during this period, Norge was very successful in

increasing sales and profits. These increased sales and profits

resulted from increased advertising, increased research and

development for new products, improvements in product design,

improvements in manufacturing and marketing procedures, and

changes in personnel at the manufacturing and distribution

levels. During Mr. Sayre’s tenure as president of the Norge

Division, the Division invented a dry cleaning machine, which it

merchandised through a franchise operation known as Norge

Villages (the sale of coin operated laundry and dry cleaning

equipment), and also constructed a modern refrigerator plant in

leased premises at Fort Smith, Arkansas, in order to expand

refrigerator production.

Mr. Sayre resigned as president of the Norge Division in 1960,

although he continued as chairman and chief executive officer of

the Division until 1962. During the early 1960's, the Norge

Division experienced substantial losses, because of overexpan-

sion of the Norge Village franchising operation, over-capacity in

the refrigerator plant at Fort Smith, and poor management. The

Norge Village business became oversaturated and there were

substantial failures of these franchise operations, which were

undercapitalized. Norge, which had financed the franchises,

incurred substantial losses in the years 1962 through 1966

because of these failures. In addition, although it had originally

anticipated that it would be able to generate sufficient additional

sales to use to full capacity the new Fort Smith refrigerator

plant, Norge was unable to do so and, therefore, had unabsorbed

overhead costs at this plant. The Fort Smith lease and manufac-

turing facilities were sold to Whirlpool Corporation in 1966 and

Norge began at that time to purchase refrigerators from the

Kelvinator Division of American Motors and to market them

under the Norge name.

Some members of Borg-Warner’s board of directors had

always had reservations about the Norge Division. While most

8a

of Borg-Warner’s business was of an industrial type, Norge’s

business was in consumer products, required comparatively

higher advertising and selling budgets, and was more dependent

upon volume sales to make a profit. Norge had proved unable to

earn a rate of return on its investment that compared favorably

with other Borg-Warner divisions. Although dissatisfaction

among the board of directors was quelled during the years that

Mr. Sayre consistently produced profits fo Norge, it came to the

fore again when Norge incurred losses in the early 1960's.

In the early 1960's, management actively considered disposing

of the Norge business. One alternative considered was a liqui-

dation, but it was rejected because it was estimated that large

losses would be sustained on inventories and receivables of the

Norge Division in a liquidation. Borg-Warner also considered a

merger of the Kelvinator Division of American Motors and

Norge into a separate corporation, but the Antitrust Division of

the United States Department of Justice did not approve the

merger. Borg-Warner had discussions with several other compa-

nies during the period 1963-1965 regarding the sale of the

Norge Division, none of which progressed to the point of serious

negotiations. When none of the alternatives proved attractive,

management decided to sell the Fort Smith plant, thereby

reducing unused capacity, to employ new management in an

effort to make the Norge Division profitable, and to defer a

decision as to its future.

Alonzo B. Kight, who had been president of the Borg-Warner

International Corporation and had had experience in merchan-

dising Norge products through that position, was installed as

president of the Norge Division in 1965. Mr. Kight’s efforts were

directed to improving the financial position of Norge. A major

innovation during this period was an increase in Norge’s private

label business, which was principally with Montgomery Ward.

Norge’s private label business constituted approximately 18

percent of its gross sales in 1966 and 23 percent in 1967.

The sales, pre-tax profit, Federal income and excess profits tax,

and net income after tax of the Norge Division for each of the

years 1950 to July 1968 were as follows:

Net Profit or Loss Federal Income & Net Income!

Year Sales Before Tax Excess Profits Tax After Taxes

1950 $ 62,904,862 $(2,319,785) — $(2,319,785)

1951 47,448,638 (9,255,045) = (9,255,045)

1952 46,438,349 998,998 $ 599,399 399,599

1953 43,142,370 (1,432,929) 13,229 (1,446, 156)

1954 73,769,608 4,101,144 2,132,595 1,968,549

1955 128,966,393 11,746,293 6,274,472 5,471,821

1956 110,966,791 7,796,926 4,054,401 3,742,525

1957 93,418,446 5,152,024 2,679,053 2,472,971

1958 91,394,444 4,906,779 2,551,525 2,355,254

1959 119,695,452 9,257,658 4,687,986 4,569,672

1960 85,333,538 (1,272,181) 798,696 (2,070,877)

1961 114,525,678 6,961,318 3,619,885 3,341,433

1962 117,456,385 5,401,772 2,808,922 2,592,850

1963 98,897,106 (13,749,991) (6,639,140) (7,110,851)

1964 113,102,477 (6,687,469) (3,343,735) (3,343,734)

1965 107,267,876 (8,598,012) aa (8,598,012)

1966 124,951,484 58,658 28,189 30,468

1967 112,204,718 1,008,950 = 1,008,950

1968 (6 mos) 68,206, 185 2,066,497 1,091,110 975,387?

' Corporate overhead and debt, which was absorbed by Borg-Warner, has not been taken into account in computing the above figures.

The above figures also reflect intercompany profits on sales to Borg-Warner International.

2 Estimated at 52.8%.

10a

In the ten years preceding the sale of the Norge Division to

Fedders, Norge’s share of the appliance market declined. With

respect to washers, dryers, and refigerators, the decline was more

marked in sales under the Norge name while Norge’s share of

the private label market remained more stable.

Prior to its acquisition of Norge, Fedders was engaged primar-

ily in the manufacture and sale of air conditioning equipment

and had an excellent reputation in the air conditioning industry.

The majority of its air conditioners were sold by appliance

dealers. Fedders felt that appliance dealers were most familiar

with the manufacturers of a full line of home appliances and

tended to promote these brands more than others. Fedders

decided that a full white goods line would give it a marketing

advantage and in 1964 decided to expand its business. In 1964,

Fedders entered into a supply contract with the Franklin Divi-

sion of Studebaker Industries for refrigerators, freezers, washers,

and dryers. However, this arrangement proved unsatisfactory

because Fedders had little control over the production schedules

and product quality and found it was unable to sell these

products at a competitive price. Fedders decided that it should

manufacture its own products and began in 1965 by expanding

its plant in Edison, New Jersey, to enable it to produce refriger-

ators. Fedders invested $7,000,000 in its expanded facilities at

Edison. At the time of its acquisition of Norge, production of

refrigerators was proceeding in accordance with Fedders’ plans,

but had not reached a large enough volume to absorb expenses.

In order to accelerate its entrance into the white goods

appliance industry, Fedders desired to acquire a company in

that field. Fedders negotiated with Studebaker Industries to

acquire the Franklin Division, but the negotiations terminated

without an acquisition.

Fedders considered Norge an attractive company for its

purposes because: (1) Norge sold 150,000 refrigerators annually,

but had no manufacturing facility for refrigerators so there

would be no duplication of manufacturing facilities for this

lla

appliance; (2) Norge had an established brand name in the

home laundry business while Fedders had not begun production;

(3) Norge manufactured and sold about 125,000 room air

conditioners annually and this operation could be consolidated

with Fedders’ production; (4) Fedders would acquire existing

distribution outlets and manufacturing facilities at less than

present day prices; and (5) the combined companies would have

prospective sales of 250 to 300 million dollars and savings would

result from a merger of sales, advertising, and administrative

operations.

When Fedders contacted Borg-Warner, Borg-Warner indi-

cated it would consider selling Norge at net book value and

negotiations ensued, At first, Borg-Warner insisted upon receiv,

ing the purchase price in cash, but in March or April, 1968,

agreed to payment of part of the price with securities and notes.

On July 1, 1968, Borg-Warner and Fedders entered into an

agreement, pursuant to which Borg-Warner sold its Norge

Division as a going concern to Fedders for a purchase price

equal to the net book value of Norge as of June 30, 1968. Borg-

Warner agreed to sell and Fedders agreed to purchase the assets

and rights relating to the operation of Norge that were listed in

the contract, regardless of whether said assets and rights were

shown on Norge’s audited balance sheet, as agreed upon, for

purposes of determining the purchase price.

The following assets and rights were specifically included:

(1) Installments and accounts receivable, inventories, prepay-

ments, deferred items, and fixed assets;

(2) Specified patents (except that Borg-Warner retained a

royalty-free nonexclusive license), patent applications, invento-

ries, copyrights, license rights (subject to a royalty-free subli-

cense in Borg-Warner), and specified trademarks and trade-

names together with the goodwill appurtenant thereto;

(3) Drawings, blueprints, specifications, designs, and data

prepared by Norge;

12a

(4) Catalogues, brochures, sales literature, promotional mate-

rial, and other selling material relating to the operations of

Norge.

(5) Books of account, records, files, invoices, customers’ lists,

suppliers’ lists, and other data relating to the operations of

Norge, except its general ledger;

(6) Rights of Borg-Warner under all contracts, licenses, leases,

commitments, sales orders, and purchase orders that Fedders

agreed to assume;

(7) All other assets and rights of every kind and nature, real

or personal, tangible or intangible, which were owned by and

used by Borg-Warner solely in connection with the business of

its Norge Division whether or not such assets were reflected in

the audited balance sheet, upon which the purchase price was

determined, except the assets and properties specifically ex-

cluded from the sale; and

(8) Outstanding stock of Warren-Connolly Company, Inc.,

Norge Appliance & Sales Co. of California, Inc., Norge Appli-

ance & Sales Co. of Florida, Inc., Norge Appliance & Sales Co.

of New Jersey, Inc., Norge Appliance & Sales Co. of Pennsylva-

nia, Inc., Norge Appliance & Sales Co. of Texas, Inc., and Norge

Appliance Sales & Service, Inc.

The principal trademark specified was “Norge’’ which was

registered in 52 countries. However, ‘Norge’ is the Norwegian

name for Norway and, because of its geographical significance,

Borg-Warner had had a difficult time registering it in some

foreign countries. Exhibits to the agreement included a list of 77

Norge domestic distributors, private label contracts with Mont-

gomery Ward and others, leases, employment agreements,

Norge Village franchise agreements, and a list of commercial

laundry distributors.

The following assets and rights were specifically excluded:

13a

(1) Cash and securities;

(2) The trademarks and trade names “Borg-Warner” and

chi B-W"’;

(3) Accounts receivable due from Borg-Warner, its divisions,

and its subsidiaries;

(4) Tax refund claims;

(5) Insurance contracts with certain exceptions relating to

products liability insurance;

(6) Inventions, patents, and patent applications (a) in the

field of thermoelectrics, (b) in the field of hydrostatic transmis-

sion, and (c) covering or relating to any product or process in the

developmental stage; and

(7) A claim against Whirlpool Corporation for accrued rents,

The agreement provided that the net book value of Norge

would be determined by an audited balance sheet prepared by

Peat, Marwick, Mitchell & Co., certified public accountants

employed by Borg-Warner, and approved by Arthur Young &

Company, certified public accountants for Fedders. A Pro Forma

Balance Sheet was attached to the contract and set forth all

assets and liabilities that were to be shown on the audited

balance sheet.

Peat, Marwick, Mitchell & Co, submitted to Arthur Young &

Company the following audited balance sheet:

l4da

NORGE DIVISION OF BORG-WARNER CORPORATION

AND WARREN-CONNOLLY COMPANY, INC.

Combined Balance Sheet

June 30, 1968

Assets

Current assets:

Receivables:

Notes:

Trade and customer $ 3,101,401

Installment contracts

(including amounts due

after one year) 2,076,183

Accounts:

Trade and customer 19,484,321

Other 571,876

25,233,781

Less allowance for doubtful

receivables 1,450,297

Receivables, net 23,783,484

Inventories of finished goods,

work in process, materials,

and supplies, at the lower of

cost (first-in, first-out) or

market 28,240,205

Prepaid expenses 923,496

Total current assets 52,947,185

Property, plant, and equipment, at cost

Land $ 14,850

Buildings and land

improvements 6,634,266

Machinery and equipment 7,138,177

Construction in progress 30,976

13,818,269

Less accumulated depreciation 5,366,721

15a

Property, plant, and

equipment, net 8,451,548

Deferred charges and other

assets, less amortization 515,055

61,913,788

Liabilities and Divisional Equity

Current liabilities:

Accounts payable 10,590,357

Accrued expenses 4,104,924

Total current

liabilities 14,695,281

Provision for extended

warranties 1,135,252

Divisional equity contingent

liabilities 46,083,255

$61,913,788

The accounting firms, however, were unable to reach an

agreement on all items. The final purchase price was determined

by executives of Borg-Warner and Fedders to be $45,213,255,

without audit and without resolution of the disputes over specific

items. Fedders also agreed to assume liabilities of Norge shown

on its audited balance sheet.

The copyrighted materials included in the sale of the Norge

Division had no significant value. Because appliance models are

modified annually, service and sales training manuals become

outdated very quickly.

In the white goods appliance industry, the only patents that

are valuable are those that cannot be easily circumvented and

that can be licensed to other manufacturers for a royalty. None

16a

of the patents included in the sale of the Norge Division fall

within this definition.

The white goods appliance industry consists of the manufac-

ture of washers, dryers, ranges, refrigerators, freezers, and

dishwashers, It is a cyclical industry, which is subject to condi-

tions in the housing market, inflation, and money availability. It

requires a large capital investment and substantial expenditures

for advertising. Because of high overhead, it is difficult to make

a profit without a large volume of sales. In the 1960's profits in

the industry declined because prices of appliances decreased

while costs increased.

A good system of distribution is extremely important in the

appliance business. Appliances may be distributed through

independent distributors, factory branches, or dealers’ buying

groups.

Norge marketed approximately 40 percent of its domestic

products through independent distributors, a procedure whereby

an independent businessman has an exclusive right to sell Norge

products to dealers. Independent distributors buy goods from

the manufacturer on a nonrecourse basis for sale to dealers, who

operate retail stores and sell white goods appliances to the

ultimate consumer. The bulk of dealers sell more than one

manufacturer's line of white goods appliances, whereas a distrib-

utor carries only one white goods line.

In the white goods appliance industry, the independent

distributor serves both a warehousing and sales and service

function for a manufacturer's products. The distributor supplies

inventory, service parts, and service facilities to dealers and

finances dealer purchases. The distributor provides a marketing

program for the manufacturer's products and employs salesmen

to market the manufacturer's line to dealers. The independent

distributor is required to have a substantial capital investment at

risk in his business to carry inventory, parts and dealer receiv-

ables. Expenditures are also required to support a marketing

17a

program, including advertising, sales promotion activities and

displays.

Norge marketed approximately 20 percent of its domestic

products through eight Norge factory branches. Major appliance

manufacturers generally prefer the independent distributor ar-

rangement, which provides an independent relationship with an

entrepreneur who has a large investment in inventory and a real

profit motive to sell the manufacturer's products. If a manufac-

turer operates through a factory branch, it has substantial capital

requirements to carry inventory until it is sold to dealers, carry

dealer receivables, employ managers, salesmen and servicemen,

and support the marketing program that must be maintained for

dealers. It also has to rely on managers who have no entrepre-

neurial stake in the enterprise.

Dealers’ buying groups are groups of dealers who buy directly

from the manufacturer and eliminate the role of the distributor.

A brand name that is widely recognized and that represents a

reputation for good performance and durability is an important

asset in attracting distributors and dealers. A distributor can

generally sell a larger volume and make a greater profit with a

good brand name and also usually has fewer service require-

ments. It is difficult for'a manufacturer with a new name to

attract distributors and dealers but once a good name is estab-

lished the distributors and dealers help to maintain it because

they usually give the best known brand name the most promi-

nent display space.

It is common in the major appliance industry for white goods

appliance distributors to also carry a ‘brown goods’’ line (tele-

visions, radios, and stereos). Many of the Norge distributors had

strong brown goods lines, Zenith or Motorola, which associations

strengthened the distributorships.

A brand name is established aad maintained primarily through

advertising and good performance. Brand names are not trans-

ferable from one industry to another or from one major appliance

to another.

18a

In order to establish consumer awareness of a new brand

name in the white goods appliance industry, a company would

have to spend about $18 million for advertising over five years,

and might spend as much as $8-10 million a year for several

years. Once having established consumer awareness, the com-

pany would have to continue to spend large amounts in advertis-

ing to maintain consumer awareness. However, the fact that

consumer awareness has been established does not guarantee

that a product will be successful. Performance, reputation, and

service are necessary to a successful product.

In the period from 1965 through 1967, average annual trace-

able advertising (television, magazines, and newspaper supple-

ments) of the top ten major appliance manufacturers was

$2,067,000. Borg-Warner spent $859,000, $1,096,000 and

$1,043,000 in each of those years, respectively, and ranked

eighth, eighth, and seventh, respectively. The average total

annual expenditures, including nontraceable advertising, were

approximately $3,000,000 in the period 1965-1967.

Approximately 20-25 percent of consumers consult Consumers

Union reports before purchasing a major household appliance.

Over the years 1960-1968, Norge washers and dryers showed a

downward trend in Consumers Union reports. Norge refrigera-

tors maintained a more stable position.

Following the acquisition of Norge, Fedders made major

administrative changes. In accordance with plans formulated

prior to the purchase, Fedders eliminated duplicative adminis-

trative sales and personnel functions by disbanding the Norge

headquarters in Chicago and absorbing its functions at Fedders’

headquarters in Edison, New Jersey. Within two months, essen-

tially all Norge personnel had been discharged or had left Norge

voluntarily.

Prior to the acquisition of Norge, Fedders had not made a

detailed investigation of Norge’s distribution system and Fed-

ders was disappointed when it took over the operation of Norge.

19a

Borg-Warner had dealt with its independent distributors on an

individual basis, granting price concessions, advertising funds,

and lenient credit policies to those distributors who demanded

or needed such help as a prerequisite to doing business. Fedders

felt that these policies placed too great a financial burden on

Norge and instituted uniform treatment of all distributors. At

least partially because of these changes, Fedders lost 38 out of

77 distributors in the first two years after the acquisition and lost

eight more in the third year. These distributorship contracts

were cancelled in some instances by Fedders and in others by

the distributor.

Fedders also closed seven out of eight Norge factory branches

and combined Norge’s Chicago branch with Fedders’ Chicago

branch. Fedders was interested in distributing its products

through dealers’ buying groups (see p. 25, supra) and ap-

proached two large buying groups. The groups, however,

showed little interest in Norge.

Fedders felt that Norge’s dealer structure was very poor and

that this made it difficult to obtain distributors. They also

believed the lack of dealers diminished the value of consumer

advertising because many consumers would not be able to find a

dealer from whom they could buy Norge appliances. Therefore,

Fedders decided to emphasize advertising in trade publications

with the intent of building up demand among dealers. Trade

advertising is less expensive than consumer advertising and

Fedders spent considerably less on advertising than Borg-War-

ner had spent.

Fedders encountered problems with the quality of the Norge

dryer that had been introduced in May 1968 and in 1969

Fedders retooled. In 1970, Fedders retooled for the Norge

washer.

Within a few days of the acquisition, Kelvinator, from whom

Norge purchased washers, was sold to White Consolidated

20a

Industries, which increased prices by ten percent. Because of

Kelvinator’s increased price, Fedders tried to rapidly increase its

own production of refrigerators. These efforts resulted in lower

quality.

Fedders marketed its appliances under both the Norge and

Fedders names. It sold identical air conditioners under both

names, charging a higher price for the Fedders air conditioner.

For a period in the early 1970's, Fedders used the name “ Norge

by Fedders,”” emphasizing the name Norge.

The total dollar volume of appliances sold under the Norge

and Fedders names for the years 1969 through 1976 was as

follows:

Refrigerators Freezers

Year Norge Fedders Norge Fedders

1969 $14,547,743 $2,476,841 $3,955,828 $246,558

1970 12,887,424 336,512 4,591,275 61,438

1971 21,885,776 _ 4,477,275 _—

1972 17,933,294 _ 8,123,392 _

1973 15,275,700 _- 7,579,600 _

1974 1,963,723 _ 358,065 _—

1975 _ _ _ _

1976 i _ =

2la

Dishwashers Electric Ranges Gas Ranges

Norge Norge Norge

1969 $ 690,480 $1,926,586 $2,484,736

1970 1,027,876 2,468,500 2,607,396

1971 1,627,114 2,605,630 1,963,488

1972 1,887,666 2,898,501 1,188,506

1973 1,884,114 2,844, 100 1,283,975

1974 686,268 218,523 297,966

1975 897,339 — —_

1976 626,085 _ _

Commercial Commercial Commercial

Washers Dryers Dry Cleaners

Norge Norge Norge

1975 $1,299,710 $158,038 $407,931

1976 1,706,035 362,810 471,005

Norge

Automatic Wring Electric Gas

Washers Washers Dryers Dryers

1969 $12,741,246 $1,641,804 $3,987,605 $4,550,700

1970 15,263,690 1,292,736 4,641,480 4,687,850

1971 17,074,224 1,526,694 5,287,590 4,018,014

1972 20,674,452 523,068 3,883,125 3,752,567

1973 15,565,940 89,312 4,963,872 2,865,968

1974 3,603,076 79,716 1,548,039 569,432

1975 28,291,957 — 9,464,096 3,586,981

1976 38,225,346 a 14,077,064 5,903,175

During the four years following the sale, Fedders expended

the following amounts on capital improvements relating to

Norge:

8/31/69 8/31/70 8/31/71 8/31/72

Land Improvements $ 33,515 $ 28,510 $ 150,349 $ 12,369

Land 100,000 129,415 11,443 29,684

Leasehold

Improvements — 15,247 — —

Buildings 102,358 121,647 3,272,307 62,466

Machinery and

Equipment 347,540 1,474,661 957,696 294,261

Vehicles 3,200 — — 5,000

Furniture and

Fixtures 5,833 18,522 12,545 6,133

Jigs and Dies 237,937 1,044,839 2,097,893 582,390

Total $830,383 $2,832,841 $6,502,233 $992,303

23a

During the ten years preceding the sale of Norge, Borg-

Warner spent the following amounts on capital improvements to

fixed assets® in the Norge Division:

Year Fixed Assets Additions

1958 7 $ 134,690

1959 1,418,230

1960 1,020,077

1961 6,716,033!

1962 1,591,163

1963 2,903,467

1964 3,884,681

1965 1,782,683

1966 1,043,888

1967 678,047

1968 (6 months) 425,920

' This figure includes construction of the Fort

Smith refrigerator plant.

OPINION

Fedders and Borg-Warner made different allocations of the

purchase price paid for Norge on their tax returns. Fedders

allocated the purchase price to the individual assets according to

their book values, with certain adjustments which it thought

more accurately reflected market values. Fedders allocated no

part of the purchase price to intangible assets. Borg-Warner

independently determined the fair market value of each asset

and allocated the sales proceeds to the individual assets accord-

ing to their relative fair market values. According to its determi-

nation, the total fair market value of the Norge assets was

$113,229,231 and the fair market value of the intangible assets

5 The record does not indicate how much Borg-Warner spent for retooling in

these years. Such amounts are included in the amounts shown for Fedders

under “Jigs and Dies.” This fact must be considered when comparing figures.

24a

was $45,000,000. Allocating the sales proceeds on this basis, it

attributed $22,171,068 to intangible assets.‘

Respondent determined deficiencies against both parties to

the transaction, using Fedders’ allocation to determine the

deficiency against Borg-Warner and using Borg-Warner’s allo-

cation to determine the deficiency against Fedders.5 He takes

the position of a stakeholder, leaving it to the Court to resolve

the differences between the parties in accordance with the well

established rule that, upon the sale of a going business, the

purchase price must be allocated among the individual assets to

determine the seller's gain or loss on each asset and to establish

the buyer's basis in each asset. Watson v. Commissioner, 345

U.S. 544, 552 (1953); Williams v. McGowan, 152 F.2d 570, 572

(2d Cir. 1945); F & D Rentals, Inc. v. Commissioner, 44 T.C.

335, 346 (1965), affd. 365 F.2d 34 (7th Cir. 1966). See section

1.334-1(c)(4)(viii), Income Tax Regs.

Initially, we must dispose of a procedural issue raised by

Fedders. In the notice of deficiency sent to Fedders, respondent

allocated a portion of the purchase price to ‘‘goodwill.’’ Fedders

contends that some intangible assets, such as going-concern

value, are distinct from goodwill and that respondent has the

‘In making this allocation, Borg-Warner valued the sales proceeds at .

$55,790,307. Subsequently, Borg-Warner and respondent agreed that the total

sales proceeds equals $56,550,507.

5 In determining the deficiency against Fedders, respondent determined that

the total consideration paid was $58,169,043, consisting of the net book value

of $45,213,255 plus liabilities of $12,955,788. See R.M. Smith, Inc. v. Commis-

sioner, 69 T.C. 317, 321-322 (1977), affd. 591 F.2d 248 (3d Cir. 1979). We are

unable to independently determine from the record the amount of liabilities

assumed. However, since Borg-Warner requested as a finding of fact that the

liabilities assumed were in the amount of $12,955,788 (the amount used by

respondent in the deficiency nofice to Fedders) and neither respondent nor

Fedders objected to this proposed finding, we assume that it is correct.

Fedders’ argument that respondent used Borg-Warner's tax basis in making

the allocation in its deficiency notice to Fedders is not supported by the facts.

Borg-Warner’s tax basis in the Norge assets was $62,325,364.

25a

burden of proof with respect to the existence of any intangibles

that are not encompassed by the term “ goodwill.”’

When respondent raises a new matter that was not included

in his notice of deficiency to the taxpayer he has the burden of

proof with respect to that matter. See Rule 142(a), Tax Court

Rules of Practice and Procedure. A new theory or reason that is

presented to sustain a deficiency is treated as “new matter’

when it increases the amount of the deficiency, requires presen-

tation of different evidence, or is inconsistent with resondent's

original determination. Estate of Emerson v. Commissioner, 67

T.C. 612, 620 (1977); Florists’ Transworld Delivery Assn. v.

Commissioner, 67 T.C. 333, 348 (1976); Sanderling, Inc. v.

Commissioner, 66 T.C. 748, 757-758 (1976), affd. 571 F.2d 174

(8d Cir, 1978). However, when respondent has merely clarified

or developed his original determination without raising new

factual issues or altering the amount of the deficiency, the

burden of proof does not shift to him, Estate of Jayne v.

Commissioner, 61 T.C. 744, 748-749 (1974); McSpadden v.

Commissioner, 50 T.C. 478, 493 (1968).

We recognize that some cases distinguish going-concern value

from goodwill. See, e.g., VGS Corp. v. Commissioner, 68 T.C.

563, 591 (1977). But, there are also cases that find it unnecessary

to make such a distinction. See Winn-Dixie Montgomery, Inc. v.

United States, 444 F.2d 677, 685 (Sth Cir. 1971); Computing &

Software, Inc. v. Commissioner, 64 T.C, 228, 234-235 (1975).

Goodwill has been recognized as a broad and elusive concept.

The Supreme Court, in Menendez v. Holt, 128 U.S. 514, 522

(1888), defined goodwill as—

every positive advantage that has been acquired by

the old firm in the progress of its business, whether

connected with the premises in which the business

was previously carried on, or with the name of the late

firm, or with any other matter carrying with it the

benefit of the business. ***

See also, In re Brown, 242 N.Y. 1, 150 N.E. 581 (1926) (“any

privilege that gives a reasonable expectancy of preference in the

race of competition’’), This Court has also on occasion taken a .

26a

broad view of goodwill, stating that it “may arise from: (1) the

mere assembly of the various elements of a business, workers,

customers, ete., (2) good reputation, customers’ buying habits,

(3) list of customers and their needs, (4) brand name, (5) secret

processes, and (6) other intangibles affecting earnings.’ Staab v.

Commissioner, 20 T.C, 834, 840 (1953),

Whatever may be the substantive ramification of the differ-

ence between ‘goodwill’ and “going-concern value,’ we think

it clear that, in a procedural context, no new factual issues can

be said to have been raised by arguments made under the rubric

of respondent's use of the term “goodwill with respect to

going-concern value, brand name, distributorships, or other

intangible values. Moreover, Fedders has been represented by

competent counsel throughout this proceeding and there is no

evidence that they were misled by respondent's notice of

deficiency. Accordingly, we hold that no new matters have been

raised by respondent and the burden of proof does not shift to

him. Nevertheless, we are constrained to note that our decision

herein would be the same, regardless of which party has the

burden of proof. See pp. 65-66, infra.

We turn now to the substantive dispute between the parties.

Fedders claims that it acquired certain assets of the Norge

Division, that these assets were valued by the parties at their

book values through arms’s length negotiations, and that the

intangible assets were valued at zero. According to Fedders,

Borg-Warner is now attempting to vary the terms of their

agreement in contravention of the rule in Commissioner v.

Danielson, 878 F.2d 771 (3d Cir. 1967), vacating and remanding

44 T.C. 549 (1965), that a party to a contract may challenge the

tax consequences of his agreement only if he proves it is

unenforceable against the other party to the contract because of

mistake, undue influence, fraud, duress, etc. 378 F.2d at 775. In

the alternative, Fedders argues that the purchase price should

be allocated according to the negotiated book values because

* For a similar argument, see Concord Control, Inc. v. Commissioner, T.C.

Memo., 1976-301.

27a

that allocation is in accord with economic reality, Borg-Warner

contends that the purchase price was a lump-sum payment for

Norge as a going business, that no allocation of the price among

specific assets was made, and that it is the task of this Court to

make such an allocation, We think that Borg-Warner has framed

the issue correctly.

It is clear that Fedders did not acquire certain assets of the

Norge Division, but rather acquired the entire business as a

going concern, with certain minor exclusions, The preamble of

the contract stated that the seller desires to sell and the buyer

desires to purchase the “business and its assets, including the

good will of said business as a going concern.” In accordance

with the contract, Borg-Warner retained certain assets (see pp.

19-20, supra) and assigned to Fedders specifically enumerated

assets and

All other assets and rights of every kind and nature,

real or personal, tangible or intangible, which are

owned by and used by Seller [Borg-Warner] solely in

connection with the business of Division [Norge],

whether or not such assets are reflected in the Pro

Forma Balance Sheet or are to be reflected in the

Audited Balance Sheet***

Moreover, the Pro Forma Balance Sheet, which set forth all

assets that were to be included in the Audited Balance Sheet,

included patents and goodwill. The fact that a few assets were

excluded from the transaction does not impair the going-concern

nature of the business. See Winn-Dixie Montgomery, Inc. v.

United States, 444 F.2d at 679-680.

It is also clear that the parties did not allocate the price among

the individual assets in. their agreement. The sales contract is

written in terms of a purchase price equal to net book value and

makes no reference whatsoever to allocation of that price. See

Winn-Dixie Montgomery, Inc. v. United States, 444 F.2d at 679.

That no allocation was intended is evidenced from the fact that

the parties agreed upon the final purchase price without resolv-

ing their dispute over the book value of certain assets. We do

28a

not question the testimony of the current president of Fedders

that Fedders refused to pay anything for intangibles. But, we

think this is merely evidence that Fedders would not pay a

premium over net book value and not that the parties agreed to

an allocation of the purchase price. See Winn-Dixie Mont-

gomery, Inc, v. United States, 444 F.2d at 680-682.

Because the parties did not allocate the price among the

separate assets in their contract, the rule of Commissioner v.

Danielson, supra, is inapplicable.’ See Shepard v, Commissioner,

57 T.C. 600, 610-611 (1972), revd. by unpublished order 481

F.2d 1899 (Sd Cir, 1973).

Turning to the task of allocating the purchase price among

the individual assets, we begin by determining the value of the

intangible assets. This is a question of fact (see Wilmot Fleming

Engineering Co. v. Commissioner, 65 T.C. 847, 861 (1976)) that

cannot by determined on the basis of any simplistic rule or

formula. In reaching our conclusion, we have studied the

witnesses’ testimony and the exhibits with great care. We have

considered the factors that might bear on a purchaser's decision

to acquire a company and on his determination of the price he is

willing to pay, including the history of Norge, its earnings, its

sales, its place in the white goods industry, the nature of that

industry, and its likely future. While no useful purpose would be

served by a detailed explication of our reasoning, the major

factors bearing on our decision are discussed below.

Norge’s poor history of earnings is an important fact that

tends to show that the Norge intangibles were worth consider-

ably less than Borg-Warner claims. The concepts of goodwill

and going-concern value are associated with the expectation of

7 Even if the parties had made an allocation, we think that the Danielson

rule would in any event be inapplicable because both parties are before the

Court. Freeport Transport, Inc. vo. Commissioner, 63 T.C, 107, 115-116 (1974).

We do not think that the a bility of Danielson depends on whether the

respondent takes the role of an active or passive stakeholder, as Fedders con-

tends. Rather, we think the critical point is whether respondent chooses to rely

on the parties’ agreement. See Freeport Transport, Inc. vo. Commissioner,

supra at 118 (Tannenwald, J., concurring).

29a

continued profits notwithstanding a change in ownership. Thus,

goodwill is frequently defined as the expectation of continuing

excess earning capacity and some competitive advantage or

continued patronage. E.g., VGS Corp. v. Commissioner, 68 T.C.

at 590; Wilmot Fleming Engineering Co. v. Commissioner,

supra at 861. Similarly, going-concern value is defined in terms

of the ability to generate income. In VGS Corp., we said (p. 592)

that the theory of going-concern value is—

that even in the absence of goodwill, excess earning

capacity, and the like, the ability of a business to

continue to function and generate income without

interruption as a consequence of the change in own-

ership, is a vital part of the value of a going concern.

Winn-Dixie Montgomery, Inc. v. United States, 444

F.2d 677, 685 (Sth Cir. 1971); Computing & Software,

Inc. v. Commissioner, 64 T.C. 223, 235 (1975).

Moreover, we are mindful that the purpose of a business is, by

definition, to make a profit. Cf. Godfrey v. Commissioner, 335

F.2d 82, 84 (6th Cir. 1964), affg. T.C. Memo. 1963-1; Hirsch v.

Commissioner, 315 F.2d 731, 736 (9th Cir. 1963), affg. T.C.

Memo. 1961-256.

Accordingly, in reaching our conclusion herein, we have

placed considerable weight on Norge’s poor earnings history.

We have not overlooked Norge’s profitability from 1952 to 1962,

but we think its success during this period was largely attribut-

able to the outstanding talent of Judson Sayre. The managerial

ability, experience, and personal attributes of an individual are

not transferable goodwill.* Wilmot Fleming Engineering Co. v.

Commissioner, supra at 861; Estate of Gannon v. Commissioner,

21 T.C. 1073, 1081 (1954); MacDonald v. Commissioner, 3 T.C.

720, 727 (1944). We have also considered the fact that, after a

period of losses following Sayre’s retirement, Norge began to

earn a profit again before its sale to Fedders. Further, we

recognize that Norge’s losses were due in part to two specific

problems, namely, the Norge Villages and the Fort Smith plant.

Nevertheless, the picture of Norge that emerges from the record

* However, the contractual right to an individual's services, if sold as part of

‘going-concern, may be an intangible asset. See United States v. Cornish, 348

F 2d 175, 182 (9th Cir. 1965).

30a

is a company that, since World War II, was unable consistently

to earn a profit except under the exceptional managerial leader-

ship of Judson Sayre.

On the other hand, the fact that Norge was not consistently

profitable is not dispositive of the issue. Just as high earnings

alone do not prove the existence of goodwill, Wilmot Fleming

Engineering Co. v. Commissioner, supra at 860-861; Carty v.

Commissioner, 38 T.C. 46, 58 (1962), lack of profitability does

not in and of itself prove the absence of any intangible value.®

Buddy Schoellkopf Products, Inc. v. Commissioner, 65 T.C. 640,

645, 647-648 (1975); Computing & Software, Inc. v. Commis-

sioner, 64 T.C. at 235; C.F. Hovey Co. v. Commissioner, 4

B.T.A. 175, 177 (1926).

Concededly, Norge had no goodwill in the sense of excess

earnings capacity and Borg-Warner does not contend otherwise.

Nor do we think that Norge had much going-concern value in

the sense of an inherent capacity to continue generating a profit.

To the contrary, its ability to earn a profit at all was tenuous.

The changes that Fedders made after its acquisition of Norge in

personnel, plant, product lines, and distribution support our

conclusion. No doubt, as Borg-Warner contends, some of these

changes merely reflect differences between Borg-Warner's and

Fedders’ management in business policy and philosophy. The

magnitude and number of changes, however, undermine this

argument. If Norge had been a more profitable operation, we

doubt that Fedders would have been so quick to make changes.

In addition, we have been influenced by Borg-Warner’s own

recognition of the need to make substantial changes by either

investing more capital in Norge or merging with another white

goods company.

‘The fact that the business was sold at net book value and no

dollar value was ever assigned to intangibles in the parties’

negotiations also tends to show the Norge intangibles had little

value. See Wilmot Fleming Engineering Co. v. Commissioner,

65 T.C. at 860.

*See Pensacola Greyhound Racing, Inc. v. Commissioner, T.C. Memo.

1973-225, affd. in unpublished opinion (5th Cir. 1974).

Sla

Notwithstanding the factors discussed above, we are con-

vinced that the Norge name was valuable. Fedders itself took

this position in materials prepared for its lenders, in public

statements after the acquisition, and in statements to securities

analysts. More importantly, Fedders used the Norge name

extensively.'"° See Winn-Dixie Montgomery Inc. v. United

States, 444 F.2d at 681; Computing & Software, Inc. v. Commis-

sioner, 64 T.C. at 235. These statements and actions, together

with the extensive evidence of the importance of a brand name

in the white goods industry, are compelling evidence that the

Norge name had value, one aspect of which at least was to

accelerate Fedders’ ability to enter the field more effectively

than if it had had to establish a new name from scratch. We

conclude that, to the extent that the Norge Division had any

goodwill or going-concern value (such as its distributorship

system), it emanated from and was inextricably intertwined with

the name Norge.!!

There are, as in most cases, other factors that favor the

opposite conclusion. Norge’s market share was small and declin-

ing and its ratings in consumer publications showed a downward

trend, a factor which would tend to reduce the value of the

Norge name. Further, a large portion of its sales were to

companies that sold Norge products under their own labels. We

think that quality and price, not brand name, would be the

important considerations in such sales. We have given careful

consideration to these factors and have taken them into account

in determining the value of the Norge name.

© See R. M. Smith, Inc. v. Commissioner, T.C. Memo. 1977-23.

'! We find it unnecessary to draw fine distinctions between goodwill, going-

concern value, tradename, and other intangibles because Fedders makes no

claim that it acquired any valuable intangible assets that are amortizable

Compare Houston Chronicle Publishing Co. v. United States, 481 F.2d 1240,

1247 (5th Cir. 1973); Union Bankers Insurance Co. v. Commissioner, 64 T.C.

807, 831-832 (1975). But method of allocation varies by Bbbbb over conversion.

32a

We turn now to the task of placing a value on the Norge

name. Fedders, adhering to its position that the Norge name

had no value, introduced no evidence on this aspect of the issue.

Borg-Warner sought to prove the value of the Norge name

through expert testimony. Glenn S. Olinger, a businessman with

over 20 years of experience in the appliance industry, testified

that a purchaser of a household appliance business would require

a discount of % to % of the book value if he were not acquiring

the brand name of the business. Because of the general nature of

Mr. Olinger’s testimony, it is of little assistance in valuing the

Norge name. His conclusion is based on his knowledge of

negotiations regarding a contemplated sale of Ford's refrigerator

business without the name Philco, but the evidence provides no

basis for comparison of the Philco and Norge names. Moreover, .

Mr. Olinger had almost no knowledge of Norge’s operations at

the time of Fedders’ acquisition.

Borg-Warner also presented evidence of the cost of creating

consumer awareness of a new brand name. Mr. Olinger testified

that in 1968 it would cost $8-$10 million a year for several years

to acquire consumer recognition of a new name. The record does

not reveal the foundation of his opinion (other than his general

experience) and, therefore, his opinion is difficult to evaluate.

On balance, we are unable to accord it much weight.

On the other hand, the testimony of Richard Larko, an

advertising executive, was based on a written study which was

admitted into evidence. According to his study, an expenditure

of approximately $18 million over five years would be required

to establish consumer awareness of a brand name by 1968, the

year in which Fedders acquired the Norge name by purchase.

He projects high expenditures in the first two years ($5,400,000

in year one, $3,750,000 in year two) followed by an expenditure

of $3,000,000 in each of the last three years, a figure somewhat

higher than the average of $2,067,000 expended each year by

the top ten (see p. 27, supra). We find that Mr. Larko’s study is

carefully reasoned and reliable. However, in basing an argument

on this study, Borg-Warner failed to take into account the fact

that there is a cost involved in maintaining the favorable impact

33a

of any trade name. Thus, we think that the relevant figure is not

the cost of establishing a new name, as argued by Borg-Warner,

but rather is the amount by which the cost of establishing a new

name exceeds the cost of maintaining an existing name. The

difference between Mr. Larko’s estimate of the cost of establish-

ing a new name ($18 million over five years) and the average

expenditures for traceable advertising by the top ten companies

over five years ($2,067,000 X 5 = $10,335,000) is $7,665,000.

Moreover, since the Norge name had some negative attributes,

Mr. Larko’s figure should be further reduced to account for the

expense that a purchaser would have to incur to try to improve

the Norge image. Taking all these factors into account, as well

as the factors we considered in determining whether any value

at all attached to the Norge name (see p. 50-51, supra), we

conclude that the fair market value of the Norge name and any

goodwill or going-concern value that emanated from the name

was $4.5 million. Cf. Buddy Schoellkopf Products, Inc. v.

Commissioner, 65 T.C. 640 (1975). We think it is important to

note, however, that, although we have placed substantial em-

phasis on the estimated cost of establishing a trade name in

arriving at a value for the Norge name (cf. Richard S. Miller &

Sons v. United States, 210 Ct. Cl. 431, 447, 537 F.2d 446, 456

(1976)), we are not adopting any firm principle regarding the

use of such analysis in other cases. Each situation will have its

own variants and we have simply adopted this approach as

providing the most probative evidence based upon the particular

facts and circumstances revealed by the record herein.

. Having determined that the fair market value of the Norge

intangibles was $4.5 million, we turn now to the question of how

to allocate the purchase price among the Norge assets. The rule

is simply stated: where a lump sum is paid for a going business,

after valuing cash and cash equivalents at their face values, the

balance of the purchase price is allocated among the remaining

individual assets according to their relative fair market values.

Victor Meat Co. v. Commissioner, 52 T.C. 929, 931 (1969); F.

& D. Rentals, Inc. v. Commissioner, 44 T.C. at 346.

34a

Fedders argues that if the intangibles have any value, the

proper adjustment to account for such value is to the cost basis

of the fixed assets and not to the current assets. It offered no

independent evidence of the fair market value of either the fixed

assets or the current assets. As support for its position, Fedders

relies on the testimony of its expert, Donald Kehoe, a certified

public accountant, and on case law, particularly VGS Corp. v.

Commissioner, 68 T.C. 563 (1977), and Northern Natural Gas

Co. v. United States, 470 F.2d 1107 (8th Cir. 1973).

We think neither the expert testimony nor the case law

requires the result that Fedders seeks.

Mr. Kehoe cited Accounting Principles Board Opinion No. 16

(August, 1970) as the authority for his opinion. We have read

this opinion and find it is silent on the precise issue before us.

Yet, even if this were the rule for purposes of financial account-

ing, we would not be bound by it. Thor Power Tool Co. v.

Commissioner, 439 U.S. — (Jan. 1979).

With respect to the cases cited by Fedders, it is true that in

those cases, the court stated that the amount of the lump-sum

purchase price attributable to going-concern value must be

excluded from the values the taxpayer assigned to depreciable

assets. VGS Corp. v. Commissioner, supra at 592; Northern

Natural Gas Co. v. United States, supra at 1110. However,

Fedders overlooks the fact that the courts’ statements were made

in the context of the Commissioner's assertion that the fixed

assets were overvalued, thus reflecting enhancement by going-

concern value, and that the Court agreed with this assertion.

The value of the current assets was not at issue. Fedders has not

argued that the book value of the fixed assets is inflated. To the

contrary, Fedders argues that the book value is a price negoti-

ated at arm's length and, thus, equal to fair market value.

Moreover, because book values represent cost less depreciation,

we are inclined to doubt that they reflect enhancement by the

value of intangibles.

Although Fedders does not state its position in terms of cash

equivalency, its argument is essentially that current assets should

be treated as cash equivalents. Where the facts warranted such

35a

treatment, prepaid insurance and other prepaid expenses have

been treated as cash equivalents, see Victor Meat Co. v. Com-

missioner, supra at 933, and accounts receivable guaranteed by

the seller have been treated as cash equivalents, Bixby v.

Commissioner, 58 T.C. 757, 786 (1972). But, as a general rule,

current assets are not cash equivalents. See Victor Meat Co. v.

Commissioner, supra; Boise Cascade Corp. v. United States, 288

F. Supp. 770 (S.D. Idaho 1968).

Borg-Warner discerns three separate intangible assets in

Norge: (1) going-concern value; (2) brand name; and (3) distri-

bution system. It then reduces the book value of the tangible

assets that are enhanced by the separate intangible assets by the

amount attributable to the intangibles, although as our subse-

quent discussion will reveal, Borg-Warner appears to recognize

that these elements are not totally unrelated but tend to coalesce

under the umbrella of the Norge name—a point of view which

is consistent with our own previously articulated position. For

the reasons stated below, we think Borg-Warner’s approach is

without merit.

Borg-Warner approaches the allocation of going-concern

value in a manner’similar to that of Fedders. Citing cases which

state that going-concern must be valued separately from depre-

ciable assets and relying on Mr. Olinger’s testimony that an

appliance company without a brand name would sell at a

discount of % to %, Borg-Warner bootstraps itself to the conclu-

sion that % to % of the book value of Norge’s land, plant, and

equipment represents going-concern value. Like Fedders, how-

ever, Borg-Warner has presented no evidence as to the fair

market value of the fixed assets but, rather, assumes, without

proving, that the book value of the fixed assets reflects enhance-

ment by going-concern value. Another defect in Borg-Warner's

approach is that it relies on Mr. Olinger’s testimony, which dealt

with the value of a brand name, for its argument as to going-

concern value, which it distinguishes from brand name.

Borg-Warner contends the inventory and accounts receivable

are the assets that are most affected by the value of the brand

name and distributorship system. It then argues that the fair

market value of the accounts receivable and inventory is the

36a

amount for which they could be sold without the Norge name

and distributorship system. Its experts testified that the inventory

could only be sold under these conditions at a discount of % to

% off book value and that the accounts receivable could only be

sold at a discount of 15 percent off book value. Borg-Warner

attributes the difference between this amount and book value to

the intangible assets. We think that Borg-Warner has applied

the wrong standard of valuation.

The basic legal definition of fair market value is the price at

which property would change hands in a transaction between a

willing buyer and a willing seller, neither being under compul-

sion to buy or sell, and both being reasonably informed as to all

relevant facts. See 10 Mertens, Law of Federal Income Taxation,

sec. 59.01 (1976 rev.). When a business is sold as a package, its

assets must be valued in that posture. Kraft Foods Co. v.

Commissioner, 21 T.C. 513, 585 (1954), revd. on another issue

232 F.2d 118 (2d Cir. 1956). In the case of inventory, this means

it must be valued on the theory that it may be sold to a

hypothetical willing buyer having facilities equal to that of the

seller for distributing it at retail. Knapp King-Size Corp. v.

United States, 208 Ct. Cl. 533, 551-552, 527 F.2d 1392, 1401-

1402 (1975).

Borg-Warner relies heavily on the testimony of witnesses as to

the discount that would be necessary to sell the inventory

without a brand name, i.e. they assumed a forced sale of the

inventory on a liquidation basis, separate from the business of

which it was a part and to a buyer who did not have an

established market in which to sell it. We think such testimony

is of minimal relevance herein because it ignores, as does Borg-

Warner's argument based thereon, the economic reality of the

sale to Fedders. Borg-Warner rejected the option of liquidating

Norge because it would have incurred substantial losses on the

sale of its inventory and accounts receivable. Instead, it chose to

sell the Norge Division as a package and we think it can be

inferred that, by choosing this option, it avoided the large losses

that it would have suffered on liquidation. Because the valuation

it seeks herein would result in large losses, it appears that such

valuation is closer to the liquidation values than to the amount a

87a

buyer would pay for inventory and receivables purchased as part

of an entire business. That Borg-Warner’'s valuation does not

reflect economic reality is further evidenced by the fact that it

would result in large profits for Fedders and large losses for

Borg-Warner. We cannot believe that Borg-Warner would sell

its inventory and receivables to Fedders at such a discount if

Fedders could obtain the same price for them that Borg-Warner

could have obtained through normal market distribution. We

conclude that Borg-Warner takes much too narrow a view of the

proper method of valuing the inventory and receivables sold to

Fedders. Knapp King-Size Corp. v. United States, supra.

United States v. Cornish, 348 F.2d 175 (9th Cir. 1965), upon

which Borg-Warner relies for the proposition that the inventory

must be valued at the price it would bring if sold without regard

to the Norge name, is inapposite. In Cornish, the court refused

to accept the taxpayer's valuation of timber on the basis of a

“work back’’ or conversion formula. The formula began with

estimated sales realization and subtracted expenses and antici-

pated profit. The court believed that this formula improperly

took into account the prospect that the business would get more

and better timber out of a given tree than most other sawmills,

a prospect that was attributable to the sellers’ unique skills and

abilities. In reaching its decision, the court considered separately

the past exercise and the future exercise of the sellers’ skills and

abilities. With respect to the past exercise of the sellers’ skills

and abilities, the court concluded that they were an inseparable

part of the sawmills and were properly reflected in the valuation

of the sawmills. For this reason, the court stated that the formula

had the effect of valuing this element twice. With respect to the

prospect that the sellers would exercise their skills and abilities

in the future, the court held that this was an intangible asset,

but that it had not been purchased by the buyers because the

sellers were not contractually committed to devote their skills to

the business. Therefore the court concluded that it was improper

to include these skills and abilities in the valuation of the timber.

We fail to see the relevance of Cornish to the instant case.

In Jack Daniel Distillery v. United States, 180 Ct. Cl. 308, 379

F.2d 569 (1967), the court held that it was proper, for purposes

38a

of section 334(b)(2), to value unbottled Jack Daniel whiskey on

the assumption that the purchaser was acquiring the right to use

the Jack Daniel label. The court rejected the Commissioner's

contention that the Jack Daniel name was an intangible asset

that had to be separately valued because the court found that

Jack Daniel acquired uniqueness during the distillation and

leaching process prior to being placed in barrels to age and

because, as a matter of commercial practice, the whiskey would

not be sold at all without the right to use the Jack Daniel name.

See Heaven Hill Distilleries, Inc. v. United States, 201 Ct. Cl.

423, 432-434, 476 F.2d 1327, 1333 (1973).

Borg-Warner argues at length that Norge appliances are not

unique like Jack Daniel whiskey and that Jack Daniel Distillery

v. United States, supra, is therefore not controlling. While we

tend to agree with Borg-Warner’s distinction, we do not think

that it support the opposite inference which Borg-Warner seeks

to draw from it to support its valuation of the Norge inventory at

% of book value. As we have already pointed out, such a

valuation applies the wrong standard because it is based on the

assumption that the inventory is not sold as part of a package

but rather to a buyer who has no established market in which to

‘sell it. See pp. 59-60, supra. Moreover we note two further

factors which support our conclusion that Jack Daniel Distillery

is inapplicable: (1) the issue before the court, in that case, was a

narrow one, i.e. limited to the valuation of existing unbottled

whiskey and did not involve, as does the case before us, the

valuation of a business sold as a package and the auxi!.ary right

to use a trade name on goods to be manufactured and sold in the

future and (2) there was no issue as to any inventory which

might be available for sale under a private label as in the case

herein, it being clear that the unbottled whiskey could, because

of its uniqueness, only be marketed under the Jack Daniel name.

Cf. Bourjois, Inc. v. McGowan, 85 F.2d 510 (2d Cir. 1936).

Having rejected Fedders’ argument that the book values of

the assets represent prices negotiated at arm’s length for individ-

ual assets and having rejected Borg-Warner’s evidence as irrele-

vant under the applicable standard for measuring fair market

value, we are left with the task of allocating the purchase price

39a

among the assets on the basis of a rather barren record.

Respondent's position as a stakeholder does not shift the burden

of proof. See Wilmot Fleming Engineering Co. v. Commis-

sioner, 65 T.C. at 860; Freeport Transport, Inc. v. Commis-

sioner, 63 T.C. 107, 116-117 (1974) (Dawson, J., concurring),

and cases cited thereat. Had we not found a value for intangi-

bles, we think we technically would have been justified in

sustaining each of respondent's determinations on the ground

that both petitioners have failed to carry their burden of proof.

However, we have found a value of $4.5 million for the

intangibles of the Norge Divisivn, i.e., the Norge name, and in

any event we think such a disposition inappropriate for cases

such as this where both parties are before us. See Freeport

Transport, Inc. v. Commissioner, supra at 115. Accordingly, we_

proceed to allocate the purchase price as best we can on the

basis of the record herein.

After careful consideration of the record, we conclude that the

book values of the Norge assets are the best evidence of their

fair market value.'* We are well aware that book value does not

'* We note that there is evidence of the replacement value of the Norg

plants in the record. However, neither party has relied on it as evidence of fair

market value.

Because Borg-Warner and Fedders never agreed on the book value of

each individual asset but rather compromised and agreed to a figure of

$45,215,255 for the final purchase price, the record does not contain a balance

sheet that reflects the final purchase price or its breakdown. Therefore, the

ape are directed to use the book values shown on the balance sheet prepared

y Peat, Marwick, Mitchell & Co, (the PMM balance sheet) (see p. 21, supra)

as a starting point and to make the following adjustments to reflect the final

terms of the sale. Since the liabilities assumed by Fedders amounted to

$12,955,788 (see footnote 5, supra) and the parties agreed that $45,213,255 was

the net book value of the Norge Division for purposes of determining the

selling price, the aggregate book value of the assets is determined to be

$58,169,043 ($45,215,255 plus $12,955,788). The aggregate book value of the

assets shown on the PMM balance sheet is $61,913,788. The value of each

asset shown on the PMM balance sheet is to be reduced by an amount

determined by the following formula:

A

X= Bp *e

In the formula, X equals the amount to be subtracted from a given asset (the

“unknown"), A equals the value of a given asset as shown on the PMM

balance sheet, B equals $61,913,788, the aggregate value of the assets as shown

on the PMM balance sheet and C equals $3,744,745, the difference between

40a

necessarily bear any relationship to fair market value, but book

value is some evidence of fair market value and has been

resorted to in the absence of other evidence. See Bos Lines, Inc.

v. Commissioner, 354 F.2d 830, 839 (8th Cir. 1965), affg. T.C.

Memo. 1965-71; Blum v. Commissioner, 5 T.C. 702, 709 (1945).

There is strong evidence that the parties thought that, in this

case, book values did bear considerable relationship to fair

market values: the fact that Norge was sold for its net book

value, the fact that Fedders has steadfastly maintained that the

book values represent negotiated fair market values, and the fact

that Borg-Warner used book values as a starting point for its

discounts (which we have rejected) and did not introduce any

evidence of fair market value independent of book value.

Moreover, under the terms of the sales contract, the book value

of the inventory was to be determined at the lower of cost or

market value. It is, by definition, equal to or less than Borg-

Warner's investment and we think it is not unreasonable to infer

that a buyer would be willing to pay this amount for the

inventory as part of a going-concern. Similarly, we think that it

is not unreasonable to infer that a buyer would be willing to pay

book value, that is, face value less a reserve for bad debts, for

accounts receivable acquired as part of a going business.

the aggregate value of $61,913,788 shown in the PMM balance sheet and the

aggregate value of $58,169,043 which reflects the final purchase price.

After determining the book value of each asset in accordance with the above

directions, the purchase price is then to be allocated among the individual

assets using the following formula:

D

Y FE x F

In the formula, Y is the portion of the purchase price to be allocated to a given

asset (the “unknown’), D is the fair market value of a given asset (for

B sacra ill it is $4.5 million and for the other assets it is the book value

adjusted in accordance with the directions above), E is the total fair market

value of all assets ($58,169,043 plus $4,500,000 equals $62,669,043), and F is

the total purchase price. (Borg-Warner and the respondent agreed that the

total sales equals $56,550,507. Fedders was not a party to this

agreement but as far as the record and briefs indicate, Fedders does not

disagree with respondent's determination that, as to it, the purchase price paid

by Fedders is $58,169,043, the sum of $45,213,255 $12,955,788, the

liabilities assumed by Fedders. See footnotes, 4, 5, supra).

4la

At this point we are constrained to note that the issue involved

herein has many of the qualities found in the usual valuation

case. It therefore lacks the talismanic precision with which

counsel for each of the parties has sought to imbue it and was

clearly more susceptible of disposition by way of negotiation and

settlement rather than being subjected to the judicial process

with its concomitant inordinate expenditure of time, effort, and

money by all concerned. See Messing v. Commissioner, 48 T.C.

502, 512 (1967). Indeed, the Court repeatedly sought to per-

suade the parties to pursue the settlement route, all to no avail.

Accordingly, we have discharged the responsibility thrust upon

us, carefully avoiding the blandishment of the parties to dissect

each element with a surgical knife. Rather, we have carefully

considered each of the elements discussed by the parties in the

context of the entire record before us and weighed all of the

facts and circumstances revealed herein.

Fedders argues that, if it did acquire any intangible assets of

value, it abandoned those assets within the first year after the

acquisition and is entitled to an abandonment loss under section

165(a). In making our determination as to the value of the Norge

Division's intangible assets, we considered the substantial

changes that Fedders made following the acquisition as evidence

that Norge had little going-concern value as such and concluded

that any intangible value that was transferred emanated from

and was inextricably intertwined with the Norge name. See p.

49, supra. It is clear that Fedders did not abandon the Norge

name. Accordingly, Fedders is not entitled to an abandonment

loss.

Borg-Warner claims entitlement to an ordinary loss under

section 165(g)(3) for its stock in Warren-Connolly Company, a

wholly owned subsidiary whose sole activity was distribution of

the Norge Division's products. Borg-Warner had a tax basis of

$2,258,301 in the stock and valued it at $1,503,776 in its original

allocation of the sales proceeds from Norge. In his deficiency

notice to Borg-Warner, respondent used Fedders’ allocation,

which had allocated no part of the purchase price to Warren-

Connolly stock. Borg-Warner accepted respondent's valuation of

42a

the Warren-Connolly stock and attempts to capitalize on it by

claiming a worthless stock deduction.

We think that the record does not support Borg-Warner's

contention that its Warren-Connolly stock was worthless on the

date of sale. The balance sheet that Peat, Marwick, Mitchell &

Co. prepared, which was the subject of price negotiations and

was, with certain adjustments, the basis upon which Fedders

allocated the purchase price, was a combined balance sheet

which reflected the assets of both Norge and Warren-Connolly.

Thus, the fact that Fedders allocated no part of the purchase

price to Warren-Connolly stock does not mean that it allocated

no part of Warren-Connolly’s assets. On the record herein, we

have held that the book values of the separate assets are the best

evidence of their fair market values and, as far as we can

determine from the record, some of those assets belonged to

Warren-Connolly, Thus, we conclude that Borg-Warner has

failed to sustain its burden of proof that its stock in Warren-

Connolly was worthless in 1968 and it is therefore not entitled to

a worthless stock deduction.

To reflect the foregoing,

Decisions will be entered

under Rule 155.