Rev. Rul. 74-29

Advice has been requested regarding the application of section 337 of the Internal Revenue Code of 1954 to a sale of property by a liquidating corporation where a portion of the sales price is specifically allocated to a covenant not to compete.

Y corporation was engaged in the vending machine business. Y, following the adoption of a plan of complete liquidation by its shareholders, entered into an arm's length agreement with A, an individual, whereby Y, in consideration of $100x, agreed (1) to sell property, as defined in section 337(b) of the Code, to A, and (2) not to compete with A in the vending machine business for a stated period of time within a limited geographic area. The covenant not to compete had independent significance other than merely assuring the effective transfer of the goodwill of the Y business. The agreement between Y and A specifically allocated the amount of $10x (of the total consideration of $100x) to the covenant not to compete and this amount represented the value of the covenant.

Section 337 of the Code provides, in pertinent part, that, as a general rule, no gain or loss will be recognized to a corporation from the sale or exchange by it of property, as defined in section 337(b), within the 12-month period following the adoption by the corporation of a plan of complete liquidation provided all of the assets of the corporation, less assets retained to meet claims, are distributed to the shareholders within such 12-month period.

An amount received by the seller of a going business in consideration for a covenant not to compete, which is separately bargained for and clearly severable from the goodwill of the business in that it has independent significance, is ordinary income to the seller. See Ullman v. Commissioner, 264 F.2d 305 (2d Cir. 1958). Such payment is not gain realized from the sale of property, as defined in section 337(b) of the Code, and is thus not subject to the nonrecognition provisions of section 337. See Harvey Radio Laboratories, Inc. v. Commissioner, 31 ccH Tax Ct. Mem. 333 (1972), aff'd, 470 F.2d 118 (1st Cir. 1972).

Accordingly, the $10x received by Y, in payment for the covenant not to compete, is not subject to the nonrecognition provisions of section 337 of the Code and is ordinary income to Y.