Opinion
Docket No. 13453.
1948-02-27
H. R. SMITH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Robert Ash, Esq., Carl F. Bauersfeld, Esq., and John Y. Merrell, Esq., for the petitioner. John W. Alexander, Esq., for the respondent.
Petitioner, a member of a partnership engaged in business in Texas, sold his partnership interest, which he had owned for more than one year, to one of his copartners and two other individuals. Held, the gain realized upon the sale was a long term capital gain. Robert Ash, Esq., Carl F. Bauersfeld, Esq., and John Y. Merrell, Esq., for the petitioner. John W. Alexander, Esq., for the respondent.
The Commissioner determined a deficiency in income tax for the year 1943 in the amount of $14,638.24. The question involved is whether the gain realized by the taxpayer when he sold his interest in a Texas partnership was taxable as ordinary income or was a capital gain.
FINDINGS OF FACT.
Petitioner is a resident of San Antonio, Texas, and he filed his income tax return for 1942 with the collector of internal revenue for the first district of Texas.
On or about June 11, 1941, the Hyman Supply Co., a partnership, was organized by Vance Hyman, Hugo Allen, and the petitioner, and it engaged in the business of selling oil field supplies in Alice, Texas. In this partnership petitioner furnished all the capital in the amount of $60,000. The other partners contributed their services. Petitioner owned a 65 per cent interest in the business, Hyman a 25 per cent interest, and Allen a 10 per cent interest. On December 31, 1942, the petitioner sold his interest in the partnership to Vance Hyman, George T. Shumate, and H. E. Harper:
+------------------------+ ¦Vance Hyman ¦25/65¦ +------------------+-----¦ ¦George T. Shumate ¦30/65¦ +------------------+-----¦ ¦H.E. Harper ¦10/65¦ +------------------------+
George T. Shumate was employed by the Hyman Supply Co. as bookkeeper prior to the sale of Smith's interest.
The partnership assets as of December 31, 1942, were as follows:
+-----------------------------------------------------------+ ¦ASSETS ¦ +-----------------------------------------------------------¦ ¦Current assets: ¦ ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Cash in bank ¦ ¦ ¦$3,739.29¦ +-----------------------------+---------+---------+---------¦ ¦Accounts receivable—trade ¦ ¦ ¦30,458.52¦ +-----------------------------+---------+---------+---------¦ ¦Accounts receivable—other ¦ ¦ ¦1,239.21 ¦ +-----------------------------+---------+---------+---------¦ ¦Notes receivable ¦ ¦ ¦5,804.15 ¦ +-----------------------------+---------+---------+---------¦ ¦Petty cash ¦ ¦ ¦70.00 ¦ +-----------------------------+---------+---------+---------¦ ¦Merchandise inventory ¦ ¦ ¦46,296.57¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦ ¦87,607.74¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Fixed assets: ¦ ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Automobiles and trucks ¦$3,548.61¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Less reserve for depreciation¦1,012.57 ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦$2,536.04¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Buildings ¦3,520.16 ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Less reserve for depreciation¦545.31 ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦2,974.85 ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Furniture and fixtures ¦702.00 ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Less reserve for depreciation¦88.83 ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦613.17 ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Machinery and equipment ¦540.35 ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Less reserve for depreciation¦108.07 ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦432.28 ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Land ¦ ¦1,301.25 ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦ ¦7,857.59 ¦ +-----------------------------+---------+---------+---------¦ ¦Deferred charges: ¦ ¦ ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Cash deposits ¦ ¦135.00 ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Miscellaneous inventories ¦ ¦1,200.00 ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦Prepaid insurance ¦ ¦201.68 ¦ ¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦ ¦1,536.68 ¦ +-----------------------------+---------+---------+---------¦ ¦ ¦ ¦ ¦97,002.01¦ +-----------------------------------------------------------+
LIABILITIES AND NET WORTH. Current liabilities: Accounts payable $23,593.50 Accrued taxes payable 18.76 Reserve for Federal taxes withheld 12.46 23,624.72 Other liabilities: Accrued interest payable 4,980.13 Net worth: H.R. Smith 62,078.24 Vance Hyman 4,460.72 Hugo Allen 1,858.20 68,397.16 97,002.01
The date of the acquisition of the fixed assets set out above and their cost are as follows:
+-----------------------------------------+ ¦Schedule of Fixed Assets Dec. 31,1942. ¦ +-----------------------------------------¦ ¦ ¦ ¦ ¦ +-----------------------------------------+
Autos and trucks: Date acquired Cost 1-1940 Chevrolet truck 7-26-41 $1,155.31 1-1941 Chevrolet truck 12- 1-41 1,150.00 1-1942 Chevrolet sedan 11-12-42 1,243.30 Total 3,548.61 Buildings: Store building 5-22-42 2,500.00 Loading platforms and racks Various, 1941 788.67 ----do 1-30-42 39.50 ----do 12-31-42 191.99 Total 3,520.16
At the time of the sale of petitioner's interest the unpaid balance of the purchase price therefor was secured to him by a mortgage on the partnership assets. The gain which he realized from the sale was $24,397.22.
OPINION.
HARLAN, Judge:
The petitioner contends that he sold an interest in a partnership, a capital asset, and that the gain realized is therefore a capital gain.
The respondent contends that under the law of Texas, the sale by a partner of his interest in a partnership dissolves the partnership; that the Hyman Supply Co. was dissolved at the moment petitioner sold his interest; that accordingly the petitioner sold and the purchasers received an undivided interest in the specific assets of the firm; and that the gain from this transaction should be taxed as ordinary income.
On brief the respondent recognizes that this and other courts have decided, under facts which do not differ materially from those here involved, that what was sold was a capital asset— an intangible consisting of a right to share in the value of the partnership after settlement of its affairs, and not an interest in the assets of the partnership as such. Dudley T. Humphrey, 32 B.T.A. 280; Commissioner v. Shapiro, 125 Fed.(2d) 532; Allan S. Lehman, 7 T.C. 1088; affd., 165 Fed.(2d) 383; and Thornley v. Commissioner, 147 Fed.(2d) 416.
The respondent attempts to distinguish the above cited cases from the instant proceeding on the ground that they were decided under the laws of states which have adopted the Uniform Partnership Act, whereas the facts of the instant proceeding disclose that the partners resided and the partnership engaged in business in the State of Texas, which has not adopted the act. However, it is to be noted that the Uniform Partnership Act contains the following language:
The dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up, of the business.
The New York courts have interpreted this section in Patrikes v. J.C.H. Service Stations (1943), 41 N.Y.S. 158, wherein the court said at page 168:
When a partner ceases to be associated in the carrying on of a business so that the relation of the partners is changed, a dissolution is effected for all purposes except liquidation.
We are unable to accept the respondent's argument that there is a material difference on the question as to the theoretical dissolution of a partnership by the withdrawal of a living partner in states where the Uniform Partnership Act is accepted and states where it is not in force.
Furthermore, the law governing partnerships in the State of Texas is not so materially different from the Uniform Partnership Act as to require a different conclusion in this proceeding from that reached in the above cited cases. The Texas courts have held that the interest of each partner in the partnership property is his share in the surplus after the partnership debts are paid, and after the partnership accounts are settled, and the rights of the partners inter se are adjusted; that a partner has no specific interest in any particular chattel or part of the property of the firm; and that a sale by one partner of his interest has the effect of dissolving the partnership. Sherk v. First National Bank (Tex. Com. App.), 206 S.W. 507; Egan v. American State Bank (Tex. Civ. App.), 67 S.W.(2d) 1071; Oliphant v. Markham, 79 Tex. 543; 15 S.W. 569. Substantially the same law prevails in states which have adopted the Uniform Partnership Act. See State v. Elsbury (Supreme Court of Nevada), 175 Pac.(wd) 430; Windom National Bank v. Klein, 191 Minn. 447; 254 N.W. 602, 604; Commissioner v. Lehman, 165 Fed.(2d) 383; Commissioner v. Shapiro, supra.
The only cases cited by the respondent in support of his contention are City Bank Farmers Trust Co. v. United States, 47 Fed.Supp. 98, and Williams v. McGowan, 152 Fed.(2d) 570. This Court and the Second Circuit in the Lehman case and the Third Circuit in Thornley v. Commissioner, supra, rejected the decision of the Court of Claims in the City Bank Farmes Trust Co. case, and we decline to follow it in this proceeding. In Williams v. McGowan, supra, the issue was whether an ordinary loss or a capital loss was sustained by a surviving partner who purchased the interest of his deceased partner and later sold the entire business. That case is clearly distinguishable from the instant proceeding on its facts, for here wer are dealing with the sale of a partnership interest and not the sale of a business as an entirety.
On the authority of Dudley T. Humphrey, supra; Commissioner v. Shapiro, supra; Allan S. Lehman, supra; and Thornley v. Commissioner, supra, we hold that the gain realized by petitioner upon the sale of his interest in the partnership constituted a capital gain.
Reviewed by the Court.
Decision will be entered under Rule 50.