
    C. WANTON BALIS, Jr. AND DEBORAH BALIS v. THE UNITED STATES
    [No. 50408.
    Decided April 3, 1956.
    Plaintiffs’ motion for rehearing overruled July 12, 1956]
    
      
      Mr. J. Louis Monarch for the plaintiffs. Messrs. Alfred J. McDowell, John Anthony Day, and Morgan, Lewis dk Bockius, were on the briefs.
    
      Mr. James X. Kilbridge, with whom was Mr. Assistant Attorney General H. Brian Holland, for the defendant. Mr. Andrew D. Sharpe was on the brief.
   Jones, Chief Judge,

delivered the opinion of the court:

Plaintiffs bring this action to recover an amount which they allege the Collector of Internal Bevenue collected erroneously as taxes for the year 1948.

. Plaintiff C. Wanton Balis, Jr. (hereinafter referred to as plaintiff), had been engaged in the reinsurance brokerage business for a long time. It is a specialized business, requiring intimate contacts between broker and client, connections with reinsurers, and the client’s confidence in the broker’s integrity and knowledge. Plaintiff, having the necessary qualifications, developed a prosperous business.

Since 1987 he had had a working arrangement with the insurance brokerage firm of Lukens, Savage, and Washburn, which had a large general insurance business. That firm, a partnership, had an informal partnership with plaintiff with respect to his reinsurance business. In the course of time, plaintiff’s share in the profits of the joint undertaking increased. Finally it was decided to formalize the agreement. The arrangement was put on a new basis. Plaintiff was to share in the general insurance business of the partnership and the partnership was to share in his reinsurance business. It was thought that both parties would profit thereby, the clients of each line of business helping the other to prosper.

To effectuate this arrangement two new partnerships were formed, in both of which plaintiff was a proprietary partner; Lukens, Savage, and Washburn were to carry on the business of insurance brokerage, and Lukens, Savage, Washburn, and Balis were to carry on the reinsurance business. The two partnership agreements, both of which were in writing, were substantially alike. Each provided, among other things, that the capital of the partnership was the excess of the partnership’s assets over its liabilities. The amount of each proprietary partner’s interest in capital was set forth in Schedule A attached to each partnership agreement. The amounts did not represent the actual monetary contributions made by the partners. It is not clear what they did represent. The amount listed opposite plaintiff’s name was, as of January 1, 1947, the date of the partnership agreements, about 68 percent and, as of January 1,1948, about 71 percent of the total capital listed in Schedule A of the reinsurance partnership; it was, as of January 1, 1948, about 2.7 percent of the total capital listed in Schedule A of the general insurance partnership. The capital account of the general insurance firm was much larger than that of the reinsurance firm. As a result, plaintiff’s 2.7 percent of the total capital in the general insurance partnership amounted to $12,813.47, while his 71 percent of the total capital in the reinsurance partnership amounted to only $134,202.21.

For the purpose of determining capital, good will was to be computed as set forth in section 8 of each agreement. It was to be determined at the end of each calendar year or upon the death or retirement of a proprietary partner. Section 8 defined good will as 150 percent of the average annual gross income of the partnership for the preceding three years. It was provided that, if certain parts of the business did not continue in the same volume as in the past, an adjustment to reduce the good will computation would be made.

If the good will as determined at the end of each year exceeded or was less than the capital stated in Schedule A an adjustment was to be made to make the capital equal to the then value of good will. The individual proprietary partners’ shares of the capital listed in Schedule A were then adjusted by distributing the change in capital in accordance with the partners’ shares in net earnings.

Schedule C of each partnershipi agreement listed the partners’ shares in net earnings. These percentages were subject to adjustment on or before January 31 of each year, by majority vote of the partners. As of January 1,1948, plaintiff had a 71 percent share in the earnings of the reinsurance partnership and a 2 percent share in earnings of the general insurance partnership. His share in the earnings of the reinsurance partnership had been 70 percent at the time the agreements were entered into.

With some exceptions here unimportant, each agreement provided that each partner should devote his entire talents and energy to the business of the two partnerships. Furthermore, it was specifically provided that all reinsurance business of the general insurance firm should be handled by the reinsurance partnership.

The agreements also provided formulae for settling the accounts of partners in case of death or retirement of one of the partners. Two general situations were contemplated: one, if the partnership did not continue in business, in which event an accounting was to be made in the capital, and net profits to each partner or his estate; the other, if the partnership did continue the business. In that event two further possibilities were provided for: one, if the partner leaving the partnership did not enter the same sort of business or if he died, he or his estate was to receive, in addition to his share of accumulated profits, a payment equal to the amount listed opposite his name in Schedule A, currently adjusted for good will, as described above. In the alternative, if the retiring partner did set up in the same business as the partnership, an effort should be made to allocate the accounts that belonged with the continuing partnership and the accounts that belonged with the retiring partner. In cases of doubt the customer was to be approached directly to determine his preference. Each account should then be valued at 150 percent of the average annual commissions produced by such account over the three years prior to the partner’s retirement. If the total amount of the retiring partner’s accounts, as valued by this method, exceeded his share of the capital in Schedule A, he was to pay the difference to the remaining partners. If, on the other hand, the total amount for these accounts was less than his share of the capital, the remaining partners were obligated to pay him the difference.

The undertaking did not work out as had been expected. Virtually all the new reinsurance business was due to plaintiff’s efforts and little if any new reinsurance business came directly from the general insurance firm’s activities. Accounts which were ultimately assigned to plaintiff were producing more than 96 percent of the reinsurance partnership’s income, yet his share in the earnings of the partnership and in the capital of Schedule A was only 71 percent.

After the formation of the new partnerships the reinsurance business grew in volume. The amount of plaintiff’s capital on Schedule A increased from $90,885.53 on January 1,1947, to $134,202.21 on January 1, 1948, while his share in the percentage of total capital increased only from 68 percent to 71 percent. Since he felt that he was receiving no sufficiently compensating benefit from his partnership in the general insurance business, which did not have a parallel increase in volume, plaintiff determined to leave both partnerships and set up his own reinsurance brokerage business.

Plaintiff retired from both partnerships on July 31, 1948, effective as of June 1,1948. He took with him 87 out of the 91 reinsurance accounts in the reinsurance brokerage firm. None of the accounts of the insurance brokerage firm were assigned to him. As a result of the split, it was determined that the plaintiff should pay the reinsurance partnership, which continued in business, $61,353.95 (the excess of the value of plaintiff’s accounts over his interest in capital) and that the insurance partnership should pay him $21,573.15 (the value of plaintiff’s interest in the capital schedule of that partnership). Plaintiff’s debt to the reinsurance partnership was reduced by $3,000, his share of the $4,000 paid-in-cash capital of that partnership. It was evidently assumed that he became entitled to this amount upon his retirement, though it does not appear what term of the partnership provided for this. The agreement provided that the payment the retiring partner should be called upon to make to the partnership, or vice versa, was to be a fixed obligation from the time of the partner’s retirement, payable in not more than 12 equal installments at or before the end of each 6-month period after the partner’s retirement, with interest at 5 percent per annum.

Incident to plaintiff’s retirement plaintiff and his former partners entered into an agreement whereunder each party agreed not to solicit the accounts assigned to the other for a period of 4% years. The facts indicate that the reinsurance brokerage business is a highly specialized field depending heavily upon the personal skill and character of the broker. Nor this reason it was improbable that any of plaintiff’s clients would have switched from plaintiff to the general insurance partnership, particularly since it did not have any real experience in this line of work.

The parties handled the payments to each other separately. In 1948 plaintiff paid $18,715.70 (of which $1,215.70 represented interest) on his debt to his former partners. He paid the balance in 1949 and 1950. That same year plaintiff received $3,403.21 (plus $449.45 interest) on the general insurance firm’s obligation to him.

Plaintiff deducted the amount paid as an expense in 1948, and counted the amount received as income in 1948. The reinsurance partnership treated the amount received as a long-term capital gain, whereas the general insurance partnership did not claim a deduction for what it paid plaintiff. The Commissioner of Internal Bevenue allowed a deduction for the interest paid by plaintiff but disallowed a deduction for the remainder of what he paid the reinsurance partnership ; he proposed to treat what plaintiff received as a long-term capital gain instead of as ordinary income. Plaintiff paid the additional amount assessed by the Commissioner and now sues for a refund.

Plaintiff claims that he is entitled to deduct the amounts he paid the reinsurance partnership under one of two theories: (1) he proposes to treat it as an ordinary and necessary expense under section 23 (a) (1) (A) of the Internal Revenue Code of 1939, as amended, or (2) as a loss sustained in his trade or business or on a transaction entered into for profit under sections 23 (e) (1) and (2) of the Internal Revenue Code of 1939. As an alternative, plaintiff proposes to exclude the amounts he paid to the reinsurance partnership from his income on the theory that they represent anticipated profits with the remaining partners in the event that the partnership had continued.

We do not think that plaintiff’s payment was an ordinary expense of his business. He bought his partners’ interest in the reinsurance firm so that he could again engage in the reinsurance business on his own account. This is not an ordinary expense of the business; see Philad Co. of Delaware v. Commissioner, 47 B. T. A. 565.

Nor do we think that the transaction can properly be treated as a loss under sections 23 (e) (1) and (2). Plaintiff contends that he had made a bad bargain in his partnership agreements and that he made the payments to be free of it. He cites cases which have held such payments to be deductible as ordinary losses or as business expenses. But in those cases the loss stemmed from a contract which was made in the course of carrying on a business. The loss here, if that term is applicable at all, stems from the partnership agreement itself. The payment was made when plaintiff changed from one form of doing business to another, at which time he sold his interest in the general insurance firm and bought his partners’ interest in the reinsurance accounts he was to take with him.

As a third alternative, plaintiff suggests that his payments to the reinsurance partnership should be excluded from his income on the theory that they represent the former partners’ shares in the earnings of plaintiff’s reinsurance business; similarly, that the amounts that plaintiff received from the general insurance firm should be included in his income on the theory that they represent plaintiff’s share in the earnings of the insurance brokerage partnership.

Plaintiff relies on the case of Hess v. Commissioner, 12 T. C. 778, in support of this contention. In that case the surviving member of a partnership was allowed to exclude from his income payments out of the business made to the widow of his deceased partner. These payments were made under the partnership agreement which provided that the widow of the deceased partner would be entitled to certain stipulated monthly amounts out of the income of the business, so long as the widow lived or as the same type of business was continued. The court held these payments to be an obligation of the surviving partner under the partnership agreement, and treated them as exclusions from the surviving partner’s income.

But the Hess case is distinguishable from the instant case. There the survivor was to make payments to the widow out of the income of the business; here the plaintiff became obligated to pay a fixed amount upon his retirement, and the insurance partnership had a similar obligation. The plaintiff argues that the result of the arrangement here was in practical terms the same as in the Hess case, that the parties simply provided for payment of an amount “roughly equivalent to a sharing of profits for a limited time following the retirement of a partner.”

It is this very difference which bring about a different result. In the instant case the terms of the contracts and the circumstances under which the agreements were made show clearly that the interests of the various parties constituted their capital. Upon entry into the partnership plaintiff was obligated to devote his skills and efforts completely to the partnership business; he could not enter the reinsur-anee business (or the insurance business) except by settling with his partners. The fact that plaintiff’s clients would deal only with him does not alter the undoubted right of plaintiff’s partners to prevent plaintiff from dealing with his clients except in strict accord with the partnership agreements.

The bargain was not one-sided. If plaintiff wished to retire for other purposes than going into the same business, or if he died, his partners were obligated to pay the capital credited to his name in Schedule A. If he took with him less in accounts than the amount set opposite Ms name, Ms partners had to pay him the difference. From the beginning, plaintiff’s share in the capital of Schedule A of the reinsurance partnership was evidently less than his contribution to the reinsurance business warranted. He nevertheless undertook this obligation in order to receive the benefits of the partnership. When the plaintiff did not realize the success he anticipated from the partnership, he still was saddled with the obligation he had incurred to enter it. Fie could not reenter the reinsurance business on Ms own except by satisfying this obligation. Under the circumstances, it was the condition plaintiff had to fulfill in order to receive his partners’ interest in the partnership and engage in business for himself. Such payment is most nearly described as a capital expenditure.

Plaintiff objects that the expenditure here was for the “good will” of a personal service business and cites authority to the effect that professional reputation is not a vendible asset. Plaintiff concludes that he could not have made a capital expenditure when he acquired no identifiable asset. It is quite clear that good will, as defined in section 8 of the partnership agreements, was something more than what is understood by that term as it is customarily used. Here the term was used in large part as a convenient yardstick for measuring the value of the interest which each partner had in the assets of the respective businesses.

We may assume, however, for the purposes of discussion, that the transaction did involve an element of good will as that term is commonly understood. Generally it is true that, per se, professional reputation is not an asset that can be bought and sold. But this is not so invariably, and the good will of a professional business may be the subject of sale. MacFadden v. Jenkins, 40 N. D. 422, 169 N. W. 151. It cannot be doubted that plaintiff’s right to exercise his professional skills had been circumscribed by the partnership agreements and that he had thus given his partners a share in accounts which would otherwise have been solely his own. He bought their share of the business in order to set up his own. He thereby made a capital expenditure. Newburger v. Commissioner, 13 T. C. 232.

Plaintiff’s petition will be dismissed. It is so ordered.

LaRamoee, Judge; Madden, Judge; Whitaker, Judge; and Littleton, Judge, concur.

FINDINGS OE FACT

The court, having considered the evidence, the report of Commissioner George H. Foster, and the briefs and argument of counsel, makes findings of fact as follows:

1. The plaintiffs are husband and wife, citizens of the United States and residents of Gladwyne, Lower Merion Township, Montgomery County, Pennsylvania.

2. On March 15,1949, the plaintiffs filed their joint United States individual income tax return for the year 1948 with the collector of internal revenue at Philadelphia, Pennsylvania. The aforesaid return set forth income tax liability for the year 1948 of $80,462.73, of which amount the plaintiffs paid to the aforesaid collector of internal revenue before March 15, 1949, $676.90 by withholding and $77,371.50 on declarations of estimated tax, leaving a balance due on the return of $2,414.33, which was paid on March 24,1949. No part of these payments is in controversy. This return reported an adjusted gross income of $159,920.20, including $118,433.47 reported on Schedule E of that return as follows:

Income from partnerships
Lukens, Savage, Washburn & Balis, Philadelphia_$111,392.62
Iiukens, Savage & Washburn, Philadelphia_ 7,040.85
Total- 118,433.47

3.On May 19, 1950, following an examination and audit of the plaintiffs’ aforesaid return by representatives of the Commissioner of Internal Revenue, tbe plaintiffs paid to the aforesaid collector of internal revenue a deficiency assessment of income tax for the year 1948 of $11,946.30 plus interest thereon of $800.07. These sums were assessed and collected within the time and in the manner provided by law.

4. The aforesaid deficiency in the plaintiff’s 1948 income tax was based, inter alia, upon the following adjustments of net income as reported by the plaintiffs on their return:

(a) The disallowance as a claimed deduction of the plaintiff, C. Wanton Balis, Jr., of a payment of $17,500 made by him in connection with his retirement from Lukens, Savage, Washburn, and Balis, a partnership of which he had theretofore been a member. This item was claimed on the return as a business deduction for expenses incurred by plaintiff, C. Wanton Balis, Jr., and explained in Schedule G on the return as follows:

The sum of $18,715.70 was paid by the taxpayer to the partnership of Lukens, Savage, Washburn & Balis pursuant to the partnership agreement and as a result of the taxpayer’s withdrawal from that firm. In substance, it represents an expense to the taxpayer of continuing to service his clients, which service produces the gross receipts reported on Schedule C of this tax return.

Of the amount so claimed, $1,215.70 was allowed in the audit as a proper deduction for interest paid to and reported by the partnership of Lukens, Savage, Washburn, and Balis on a partnership return of income for 1948 (Treasury Form 1065) filed with the collector of internal revenue on March 15,1949. The balance of $17,500 was disallowed.

(b) The treatment as a long-term capital gain, rather than as ordinary income as reported by plaintiffs, of a payment of $3,403.21 received in 1948 by the plaintiff, C. Wanton Balis, Jr., in connection with his retirement from Lukens, Savage and Washburn, another partnership of which he had theretofore been a member. This payment was made to the plaintiff by the partnership pursuant to provisions in another written agreement mentioned below.

5. The plaintiff, C. Wanton Balis, Jr. (hereinafter referred to as “plaintiff”) is a reinsurance broker. His company is Balis & Co., Inc., with business address at Packard Building, 15th and Chestnut Streets, Philadelphia 2, Pennsylvania. The company is entirely engaged in the reinsurance brokerage business except for occasional reinsurance advisory work.

6. Plaintiff has personally been engaged in the reinsurance brokerage business in Philadelphia since February 1980, except for a year and a half in Wilmington in 1933 and 1934. He has never been engaged in any other business except for four months with the Guaranty Trust Company of New York, following graduation from college.

7. Beinsurance brokerage is a highly specialized field. The relationship between reinsurance broker and client is confidential and personal. The broker must have an intimate knowledge of the client’s business, even though he also serves competitors. Plaintiff represents many small companies, with little experience in reinsurance matters, who look to him for guidance in many fields. A reinsurance broker’s service includes analysis of the client’s operations, and suggesting and devising programs of reinsurance designed to solve his client’s problems. The programs must be acceptable to reinsurance companies which participate, and a successful broker has access to reinsurers which is not available to his clients. Lloyds deals exclusively with brokers, and brokers make easily accessible to clients the total reinsurance capacity of Lloyds. Lloyds is a valuable connection because there are many risks that are more easily placed at Lloyds and more quickly placed at Lloyds than elsewhere.

8. A reinsurance broker must know the people, the markets, and the customary way in which their business is conducted. The mere mechanics of spreading a risk is technically reinsurance, but the initiative to see the need and the benefit, the ability to make the arrangements, and to apply the general reinsurance techniques, to the major branches of an insurance company’s business (such as fire, auto liability coverage, etc.) are the qualities required for recognition as a reinsurance broker. The recognized reinsurance broker is a specialist who serves the insurance companies rather than the insured.

9. Plaintiff was bom and brought up in Philadelphia and has lived in Philadelphia and immediate vicinity all his life except for thirteen years during which he lived in Wilmington. His first job in the reinsurance brokerage business was for Brown, Crosby and Company in Philadelphia at 4th and Walnut Streets. In 1937 he formed an association with the general insurance brokerage firm of Lukens, Savage and Washburn. Plaintiff knew them well, since his brother, Hark Balis, was and is a partner. Technically this association was a partnership, in which the above firm was one partner and plaintiff, as an individual, was the other partner. There was no written agreement originally. It was simply agreed to split the reinsurance profits equally between the two partners. The reason for this association was that it was hoped by plaintiff and by Lukens, Savage and Wash-bum that the latter could expand into the reinsurance field and obtain reinsurance accounts from the insurance companies with whom they dealt as general insurance brokers. Plaintiff has never done any general insurance brokerage. Lukens, Savage and Washburn had only one reinsurance account prior to association with plaintiff and had never had any other reinsurance experience except for this account, which was with the American Mutual Liability Insurance Company, and involved only the reinsurance of long-haul trucking risks of that company. This account, both before and after plaintiff’s association with Lukens, Savage and Washburn, was always handled solely and exclusively by Lewis Washburn of Lukens, Savage and Washburn. It was not normal reinsurance, such as the business in which plaintiff was engaged.

10. Sometime before 1947, plaintiff and Lukens, Savage and Washburn put their agreement to engage in the reinsurance brokerage and reinsurance company management business in writing under the partnership name of Lukens, Savage, Washburn and Balis. The agreement was changed periodically as to the division of the profits, with plaintiff’s share gradually being increased from 50 percent to 71 percent in 1948.

11. Lukens, Savage and Washburn had had a written agreement for years. As of January 1,1947, plaintiff also became a partner in the general insurance firm of Lukens, Savage, and Washburn. Plaintiff has never engaged in general insurance brokerage work, such as that in which that firm was engaged. The reason for his becoming a partner in Lukens, Savage and Washburn was a desire on the part of all concerned to cross-relate the partnerships by bringing all partners into both partnerships, so that there would be a closer coordination between the two businesses.

12. The two partnership agreements in force during the year 1948 which were entered into January 1, 1947, as amended to show changes effective January 1,1948, relating to the partners’ respective interests in capital and net earnings of the partnership were introduced in evidence. The two agreements were quite similar. We quote pertinent parts of the provisions of the Lukens, Savage, Washburn, and Balis partnership, noting significant differences in the Lukens, Savage and Washburn agreement in brackets:

The above parties to this agreement have formed and do hereby form a partnership under the title or firm name of “Lukens, Savage, Washburn, and Balis”, [Lukens, Savage & Washburn] for the continuance of the transaction of a reinsurance brokerage and reinsurance company management [general] insurance [brokerage] business in Philadelphia, Pennsylvania, and elsewhere, * * *
Section 2. Duration of Partnership. The term for which the partnership is to exist is the period beginning at the date hereof, and ending upon the death or retirement of any of the partners.
Section 3. Relationship with Lu7eens, Savage dk Wash-turn. All reinsurance business of the firm of Lukens, Savage & Washburn and of its partners shall be handled by the firm of Lukens, Savage, Washburn & Balis. In so far as Lukens, Savage, Washburn & Balis makes use of the offices, equipment, supplies, accounting and clerical service and similar items of overhead of Lukens, Savage & Washburn, an equitable portion of such overhead shall be borne by Lukens, Savage, Washburn & Balis.
Section 4. [Section 3] Capital.
(a) Capital is defined as the excess of the assets of the partnership over its liabilities. For the purpose of determining capital, good-will shall be valued as provided in Section 8.
(b) Only proprietary partners shall have any interest in capital. The amount of each proprietary partner’s capital as of the date of this partnership agreement it. the amount set after his name in Schedule A attached hereto. Good-will shall be valued hereafter as of each December 31. If the then value of good-will shall be greater than its value at the beginning of such calendar year, there shall be added to each partner’s capital that part of the increase represented by his earnings interest during such year. If the then valúe of good-will shall be less than its value at the beginning of such calendar year, there shall be deducted from each partner’s capital that part of the decrease represented by his earnings interest during such year. The capital of each partner as thus increased or decreased shall be his capital for the succeeding year.
* * # * *
Section 5. Distribution of Earnings. The earnings of the partnership for each calendar year, before any division of profits among the partners, shall be subject to the following charges:
* # * *
(c) After making the above charges, the net earnings of the business shall be distributed among all the partners in such proportions as the numbers set after their names respectively in Schedule C attached hereto bear to 100.
On or before January 31 of each year, the percentages applicable under this clause (c) to the calendar year then beginning shall be discussed and determined. If the percentages applicable to such year differ from those applicable to the preceding calendar year, a new Schedule C containing such new percentages shall be attached hereto; otherwise the Schedule C applicable to the preceding year shall remain and be applicable to the year then beginning.
$ * $ # $
Section 7. Activities of Partners. Each partner shall devote his entire talents and energy to the business of the partnership and shall not engage in any other business or occupation, except that the partners may serve as partners of the firm of Henry W. Brown & Company and of the firm of Lukens, Savage & Washburn [Lukens, Savage, Washburn & Balis] * * *. Each partner shall consult the others before accepting any public office or directorship or other similar position. * * *
Section 8. Good-will, etc.
(a) For all purposes hereof, the good-will of the partnership shall be construed to include the name of Lukens, Savage, Washburn & Balis and the good-will incident thereto, [the option to retain any lease or leases of the offices occupied by the partnership in Philadelphia, New York, or elsewhere,] and all papers, books, records, documents, correspondence and other files and customers’ lists at any time owned or posessed by the partnership or any of the predecessor partnerships.
(b) The good-will of the partnership shall be appraised as of December 31 of each calendar year and, m case of the death or retirement of any proprietary partner (provided the business of the partnership be continued) , as of the first day of the month during which such event occurs, in the following manner: The value of good-will shall be deemed to be one hundred and fifty percent (150%) of the average annual gross income of the partnership (consisting of commissions and fees (whether or not deferred), interest and dividends, after deducting commission expense), for the preceding three years, including within this period, to the extent necessary, the term of any predecessor partnership, and also, to such extent as the proprietary partners deem appropriate, such prior gross income of any partner who is admitted to the partnership at January 1 of the year which is then about to begin or was admitted at any time within the preceding three years; provided, however, that a percentage less than 150% may be applied in the valuation of specific items when, in the opinion of a majority of the proprietary partners, the probability of the continuance of the particular business in the same volume is substantially less than the normal expectancy of such continuance.
(c) Upon the retirement of any proprietary partner to enter the insurance brokerage "business, if the business of the partnership be continued, an effort shall be made to allocate accounts that clearly belong with the continuing partnership or with the retiring partner respectively to such continuing partnership or such retiring partner, and doubtful accounts shall be approached direct in order to determine their preference as between the two. The value of each such account shall be taken to be 150% of the average annual commissions or fees (less commission expense) produced by such account for the three years prior to the first day of the month during which the retirement of such partner occurs; provided, however, that a percentage less than 150.% may be applied in the valuation of specific items when, in the opinion of a majority of the proprietary partners, the probability of the continuance of the particular business in the same volume is substantially less than the normal expectancy of such continuance.
(d) If, upon the death or retirement of any partner, the business of the partnership shall not be continued, the business of tbe partnership may be wound up by the remaining partners, and in that event they shall account to the retiring partner, to the estate of any deceased partner, and to all the remaining partners for their respective interests, if any, in the Capital of the partnership and in the net profits of the partnership [and in deferred commission funds].
(e) Notwithstanding anything to the contrary contained herein, the partnership name shall not be assignable except to a partnership of which one or more of the proprietary partners hereunder are partners.
Section 9. management and Control. Those of the proprietary partners who are named in Schedule E attached hereto are herein called Managing Proprietary Partners. There shall at no time be less than three Managing Proprietary Partners. The Managing Proprietary Partners, by vote of a majority in number, may at any time and upon notice to that effect given to the other partners
(a) Change the proportion in which the profits of the partnership are divided as specified in Section 5, and for that purpose shall choose a committee of three of their number, which shall be charged with the duty of recommending any such changes;
(b) Change any one or more General Partners to Proprietary Partner’s; or any one or more Proprietary Partners to Managing Proprietary Partners; or
(c) Eequire any one or more or all of the partners to contribute or to increase or decrease their contributions to capital; or
(d) Compel one or more partners to retire from the partnership with or without cause; or
(e) In the event of the death or retirement of a partner, determine whether or not the business of the partnership shall be continued and, if the business is to be continued, by whom and upon what terms.
Additional partners may be admitted to the partnership only with the approval of all partners, and only upon such terms as to capital contribution, earnings interest and otherwise, as all the partners may approve.
Except as herein otherwise provided, all partnership matters shall be determined by vote of a majority, in number, of all the partners.
Section 10. Retirement. Any partner may retire from the partnership at any time.
Section 11. Continuance of Business. Except as specifically set forth in Sections 8,12, and 13 hereof, neither the estate of any deceased partner nor any retiring partner shall have any rights whatever in any partnership property, nor against the partnership nor against any member thereof (except as set forth in Section 6 hereof) in respect of any matter arising out of the partnership or the termination thereof.
Section 12. Bights of Retiring Partners Continuing in Insurance Broherage Business. Upon the retirement of any partner (whether voluntary or involuntary) if the business of the partnership shall be continued as permitted in Section 9 hereof, and if such retiring partner shall continue or expect to continue in the insurance brokerage business:
(a) The share of such partner in the profits of the partnership which, according to the past practice of the partnership, are divisible at the time of his retirement, calculated pro rata to the date of retirement, shall forthwith be paid to him [and he shall likewise be paid his interest in commissions deferred prior to his retirement, as and when such commissions are earned].
(b) In the case of a retiring proprietary partner, the division of business, as outlined in Section 8, shall be carried out; and the partnership shall pay to such retiring partner the value of his interest in capital of the partnership (good-will for such purpose being valued as provided in Section 8 hereof), less the value (as provided in Section 8 (c)) of accounts which the retiring proprietary partner takes with him; should such value of the accounts which the retiring partner takes with him exceed the amount which would otherwise be payable to him, he shall pay the amount of such excess to the partnership and the partnership shall not be required to make any payment to him. * * * Any payments required by this paragraph shall be fixed obligations of the partnership or the retiring proprietary partner, as the case may be, as of the date of his retirement, but shall be made in not more than twelve equal installments at or before the end of each six months’ period following the retirement of such partner, with interest thereon at the rate of five percent (5%) per annum. [Any cash required by the partnership for the purpose of paying said installments shall be supplied by the proprietary partners’ making contributions to their respective capital accounts in the proportion of their current earnings percentages at the time when each installment is payable, or in such other proportions as the Managing Proprietary Partners may determine.]

C. Wanton Balis, Jr., was a managing proprietary partner in both partnerships. The capital interest of C. Wanton Baiis, Jr., listed in Schedule A of the Lukens, Savage, Wash-bum, & Baiis partnership was $90,885.53 for January 1,1947, representing about 68 percent of total capital on Schedule A at that time; it was $134,202.21 for January 1, 1948, representing about 71 percent of total capital on Schedule A at that time. The capital interest of C. Wanton Baiis, Jr., listed in Schedule A of the Lukens, Savage, & Washburn partnership was $12,813.47 as of January 1,1948, representing about 2.7 percent of total capital on Schedule A at that time.

The net earnings percentages listed to C. Wanton Baiis, Jr., on Schedule C of the Lukens, Savage, Washburn &' Baiis partnership were 69.25 for 1947 and 70.82 for 1948. The net earnings percentage listed to C. Wanton Baiis, Jr., on Schedule C of the Lukens, Savage, & Washburn partnership was 2 percent for 1948.

13. Plaintiff continued as a proprietary partner of both partnerships until July 31, 1948, at which time he retired from both partnerships, effective as of June 1, 1948. The memorandum of agreement under which he retired was as follows:

C. Wanton Baiis, Jr., hereby retires from the firms of Lukens, Savage & Washburn and Lukens, Savage, Wash-burn & Baiis, effective as of the close of business July 31, 1948. The remaining partners propose to continue the business without using C. Wanton Baiis Jr.’s individual name, and C. Wanton Baiis, Jr., proposes to continue in the insurance brokerage business trading as Baiis & Co. In accordance with the terms of the Partnership Agreements, there has been allocated to Lukens, Savage & Washburn the accounts listed on Exhibit “A” hereto, and there has been allocated to C. Wanton Baiis, Jr., the accounts listed on Exhibit “B” hereto. The remaining partners, on the one hand, and C. Wanton Baiis, Jr., on the other, agree to cooperate so that the separation may occasion as little difficulty as is possible and agree specifically that neither party shall be free to solicit actively any account allocated to the other, until four and one-half years shall have elapsed from the date hereof.
The value of good will under Section 8 (b) and (c) of each Partnership Agreement shall be determined as if C. Wanton Baiis, Jr., had retired on June 1,1948.

. 14. Under the terms of the partnership agreements in force at the time of plaintiff’s retirement, his participations (effective on and after January 1, 1948) in the profits and losses and his interests in the capital (as defined in the partnership agreements) were approximately as follows:

Lukens, Savage, Washburn & Balis, participation in profits and losses, 71%; interest in capital, 71%;
Lukens, Savage & Washburn, participation in profits and losses, 2%; interest in capital, 2.7%.

15. A new partnership of the same name as the old firm of Lukens, Savage and Washburn was organized by those partners who remained after plaintiff’s retirement, and the former general insurance brokerage business was continued without interruption.

16. The underlying reason for plaintiff’s retirement from the two partnerships was that the two partnerships failed to function together as it was hoped originally that they would. The reinsurance firm became larger and more profitable than the general insurance brokerage firm. But none of this increase was due in any part to the fact that Lukens, Savage and Washburn was an established firm in the general insurance field.

Efforts were made by plaintiff and by the members of Lukens, Savage and Washburn to secure reinsurance business from insurance companies with which that firm did general insurance business, but none of these efforts resulted in any reinsurance business.

17. As an outgrowth of this situation, the senior partner of the general insurance brokerage firm decided that he wanted to come into the reinsurance business at the top of the ladder. Plaintiff opposed this plan as not feasible, and this situation culminated in the decision to separate the two businesses.

18. Upon his retirement from the two partnerships on July 81,1948, plaintiff continued in the reinsurance brokerage and reinsurance company management business as a sole proprietor under the name of Balis & Company (later incorporated) , pursuant to the above memorandum of agreement. He purchased all of the fixed assets of Lukens, Savage, Washburn and Balis at their book value of $12,822.47. He immediately set about trying to find office space of Ms own, but until he could do so, he continued to occupy the offices of the former partnership. On February 1, 1949, plaintiff signed a five-year lease for office space in the Packard Building, 15th and Chestnut Streets, Philadelphia. After having the space renovated, plaintiff moved to the new offices on August 1,1949.

19. At the time of the retirement of plaintiff from membership in Lukens, Savage, Washburn and Balis, as evidenced by the above memorandum of agreement, 87 of the partnership’s accounts were allocated to him (exhibit B of the agreement) and four accounts were allocated to the partnership (exhibit A of the agreement). Actually, the four accounts that were allocated to the partnership represented only two accounts. Since Allied American Mutual Fire Insurance, American Mutual Liability Insurance Company, and American Policyholders Insurance Company were all owned by the same company, they represented one account. The other account was Phoenix Insurance Company. Neither of these two accounts was technically reinsurance of the type plaintiff is engaged in. The Phoenix Insurance Company account represented a spreading of the risk assumed by Phoenix on some church properties among a number of insurance companies, since the church wanted a single policy. It was not a service to the Phoenix Insurance Company but to the church, whereas plaintiff is engaged in servicing the insurance companies. The account of the American Mutual Liability Insurance Company and its subsidiaries was also not reinsurance such as plaintiff handles. This account both before and after plaintiff’s association with Lukens, Savage and Washburn was always handled solely and exclusively by Lewis Washburn of Lukens, Savage and Washburn. It was not the whole account of American Mutual Liability Insurance Company but only a part of their reinsurance. It consisted of reinsurance of long-haul trucking risks of that company, under the so-called retrospective rating formula under which the premium was not determined until after the experience had evolved, and which would not be adaptable to any other form of reinsurance. Mr. Washburn’s connection with this particular account did not qualify him to assist plaintiff as a general reinsurance broker because plaintiff does not handle long-haul trucking accounts. Mr. Washburn would not be qualified to handle any of the 87 accounts allocated to plaintiff upon his retirement from the two partnerships.

20. The 87 accounts which plaintiff took with him were producing annually, prior to his retirement from Lukens, Savage, Washburn, and Balis, an average of more than 96 percent of the income of that partnership. The average total annual income for the three years prior to 1948 of the accounts which plaintiff took with him was $151,081.12 and of the accounts which remained with Lukens, Savage, and Washburn, $829.88.

21. The allocation of accounts made under the above memorandum of agreement was made pursuant to paragraph 8 of the articles of partnership of Lukens, Savage, Washburn, and Balis, set forth above. Only one of the 87 accounts allocated to plaintiff was considered doubtful by plaintiff’s partners. This account was approached direct to see whether it would stay with plaintiff or go with Lukens, Savage, and Wash-burn. The reaction of this account was immediate and emphatic that there was no question but that it would stay with plaintiff.

22. The value (as computed under the partnership agreement) of the 87 accounts which plaintiff took with him upon his retirement from membership in Lukens, Savage, Wash-burn, and Balis exceeded the value (as computed under the partnership agreement) of his interest in the capital of that partnership by $61,353.95.

23. Prior to the retirement of plaintiff from membership in Lukens, Savage, and Washburn, all of the general insurance brokerage business of that partnership was handled by partners other than plaintiff. All of the income of that partnership resulted from services rendered by partners other than plaintiff, who devoted none of his time to the business of this partnership. Upon his retirement from that partnership, as evidenced by the memorandum of agreement, he took none of the accounts of that firm with him.

24 The value (as computed under the partnership agreement) of the interest of the plaintiff in the capital of Lukens, Savage and Washburn at the time of his retirement therefrom was $21,573.15. Since none of the accounts of that partnership were allocated to him, he became entitled to receive payment for the full value, so computed, of his interest in that partnership capital.

25. The computation, under the formula contained in the two partnership agreements, of the amounts due to. and from the plaintiff upon his retirement from both partnerships, is shown in the following memorandum dated October 15,1948, signed by W. B. Whitney, then and now a partner in Lukens, Savage and Washburn:

To:.Mr. C. W. Balis, Jr.
Be: Lukens, Savage, Washburn & Balis and Lukens, Savage & Washburn
VALUATION OK GOODWILL AND SETTLEMENT UNDER PARTNERSHIP AGREEMENT
In our previous memorandum written by L. M. Wash-bum which showed a net balance payable by you to the remaining proprietary partners of $41,416.21, we made two errors as follows:
1. In arriving at the goodwill value of the American Mutual transfer at January 1948, we took the average annual value, but neglected to multiply this by 150%. The total amount of the transfer should be therefore, $8,177.79 instead of $5,451.86.
2. In arriving at the net amount in the previous memorandum we overlooked the fact that actually the $4,000.00 paid in cash capital of Lukens, Savage, Washburn & Balis remained in the hands of that Firm.
_ Therefore, in order to more clearly reflect the transactions having to do with your withdrawal and to correct the above two errors, we submit the following figures:
$524,582. 63 — Total LS&W Capital and Goodwill as of 5/31/48
21,573.15 — Due OWB Jr as of 7/31/48
503,009.48 — Remaining in LS&W
$231,866.50 — Total LSW&B Capital and Goodwill as of 5/31/48
168,267.73 — Due CWB Jr as of 7/31/48
63,698.77 — Remaining in LSW&B
$227, 866. 50 — LSW&B Goodwill (excluding Capital) as of 5/31/48
1,244. 82 — Goodwill value of accounts retained by LSW&B
226,621.68 — Goodwill value of accounts retained by CWBJr.
8226,621.68 — Due LSW&B
168,267.73 — Due CWBJr.
68,363.95 — Net amount due from CWBJr. to LSW&B
858,353.95 — Due from CWBJr. A/c LSW&B
21,573.15 — Due CWBJr. from LS&W
36,780.80 — net
We are advised by Mr. Bankin of Drinker, Biddle & Eeath that rather than you paying us on a net basis, LS&W should pay you $21,573.15 and LSW&B should receive from you $58,353.95. It is probably unnecessary to state that LS&W will pay you on the same basis as you elect to pay LSW&B; i. e., either in one lump sum or in installments.
/s/ W. B. WhitNev
WBW/m

Of the amount of $4,000 shown by the above memorandum as paid in cash capital of Lukens, Savage, Washburn, and Balis, all of which remained in the hands of that firm, the amount of $3,000 was contributed by plaintiff.

26. Plaintiff did not participate in arriving at the formula used in the two partnership agreements. When the partnership articles for Lukens, Savage, Washburn and Balis were drafted, they were directly copied, including the formula to be used upon retirement of a partner, from the Lukens, Savage and Washburn agreement. The formula was not altered. Plaintiff was agreeable to using the same form of agreement that had been developed by Lukens, Savage and Washburn many years before, prior to his connection with them, because he hoped and the others hoped that ultimately the two firms would be drawn into one.

27. In the cases of the accounts he took with him, plaintiff was responsible individually for their having been acquired by Lukens, Savage, Washburn and Balis in the first place. The clients in these accounts would not have agreed to having the accounts left with the firm rather than having them handled by plaintiff. When plaintiff came out of the partnership, he had the knowledge, the good will, and the contacts which he previously had. He no longer had to share his income from the 87 reinsurance accounts he took with him with the Lukens, Savage and Washburn people. Plaintiff’s reinsurance clients rarely came to the office to be serviced. The other partners of Lukens, Savage and Washburn never met the clients of plaintiff represented by the 87 accounts he took with him. In fact, in most cases plaintiff’s clients, being largely mutual companies, were competitors of the clients of Lukens, Savage and Washburn, who were stock companies.

28. During the year 1948, the plaintiff, C. Wanton Balis, Jr., paid $14,500 to Lukens, Savage, Washburn and Balis and also relinquished to that firm $3,000 to which he was entitled upon his withdrawal from that firm, on account of the principal of his obligation of $61,353.95 incurred as aforesaid upon his retirement from membership in that firm. He also paid $1,215.70 as interest, a total payment in 1948 of $18,-715.70, which is the sum that appears in paragraph 4 (a) above in an excerpt from Schedule G of the plaintiff’s return. Plaintiff paid the balance of his obligation of $61,353.95 in 1949 and 1950. During the year 1948 plaintiff received payment of $3,403.21 (plus $449.45 interest) from Lukens, Savage and Washburn on account of the principal obligation of $21,573.15 owing to him upon his retirement as aforesaid from membership in that firm. The amount so paid by him was claimed as an expense of the reinsurance business conducted by him as a sole proprietor, on Schedule C of the plaintiffs’ income tax return for the year 1948. The amount so received by him was included in taxable income on schedule E of that return as partnership income of Lukens, Savage and Washburn distributable to the said C. Wanton Balis, Jr.

29. The sum received by Lukens, Savage, Washburn and Balis from plaintiff in 1948 upon his retirement was treated on that partnerships’ return for 1948 as long-term capital gain. No deduction was claimed on the partnership return of Lukens, Savage and Washburn for 1948 for the sum that partnership paid to plaintiff upon his retirement.

30. On June 13, 1950, the plaintiffs filed with the collector of internal revenue at Philadelphia, Pennsylvania, a claim for refund of $11,749.47 of the sum of $12,746.37 additional tax and interest paid on May 19,1950, as aforesaid, attributable to the adjustments to the plaintiffs’ net income in respect of the payments made by and received by the plaintiff, C. Wanton Balis, Jr., in connection with his retirement from membership in Lukens, Savage, Washburn and Balis and Lukens, Savage and Washburn. The claim for refund stated as the grounds for the refund the following:

1. Regardless of the terminology of the partnership agreements, the taxpayer, upon his withdrawal from Lukens, Savage, Washburn and Balis, did not “purchase” or otherwise acquire a capital asset by virtue of the $17,500 payment in question. The so-called “capital”, consisting almost entirely of “goodwill”, necessarily at all times inhered in the taxpayer as an individual and was dependent upon his personal ability, skill, integrity, and his personal contacts with clients. The substance of the arrangement whereby the taxpayer made the payment in question was merely that the other “proprietary” partners were permitted by the agreement to share in the profits of the taxpayer’s business for a limited period of time, notwithstanding they were no longer co-proprietors. It is true that the obligation was fixed in amount. Essentially, however, this amounted merely to a commutation down to a present fixed value of a portion of the anticipated income over the next few years from the taxpayer’s business.
2. In the alternative, the payment made by the taxpayer to the other “proprietary” partners, pursuant to his obligation to them under the agreement, was in substance an expense incurred by the taxpayer incident to his continuing to service his clients, which service produced the income from the sole proprietorship reported on Schedule C of. his income tax return. Under this alternative view, the payment in question is properly deductible under Section 23 (a) (1) of the Internal Revenue Code.
3. As a second alternative, under the facts of this case, the cross arrangement whereby the taxpayer was admitted to membership in the firm of Lukens, Savage and Washburn as a “proprietary” partner, and the other members of that firm became “proprietary” partners in the firm of Lukens, Savage, Washburn and Balis, was a transaction entered into for profit. Upon the termination of the over-all venture and the taxpayer’s withdrawal from both partnerships he incurred a loss in the net amount of $36,600.80 ($58,353.95 minus $21,-573.15). This loss constituted a loss sustained in a transaction entered into for profit. In the taxable year the taxpayer made payment of $17,500 on account of his obligation and received payment of $3,403.21 on account of the obligation owing to him. The net amount of $14,096.79 is deductible by tbe taxpayer under section 23 (3) of the Internal Eevenue Code.

31. By letter dated April 9,1951, the Commissioner of Internal Eevenue gave notice to the plaintiffs by registered mail of disallowance in full of their said claim for refund.

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes that as a matter of law plaintiff is not entitled to recover, and the petition is therefore dismissed.  