Mclaughlin, Hastie and Smith, Circuit Judges.
WILLIAM F. SMITH, Circuit Judge.
This matter is before the Court on petitions to review decisions of the Tax Court, 41 T.C. 535, in three related cases consolidated for the purpose of hearing. The petitions of Foxman and Grenell*fn1 challenge the decision as erroneous only as it relates to them. The petition of the Commissioner seeks a review of the decision as it relates to Jacobowitz only if it is determined by us that the Tax Court erred in the other two cases.
The cases came before the Tax Court on stipulations of fact, numerous written exhibits and the conflicting testimony of several witnesses, including the taxpayers. The relevant and material facts found by the Tax Court are fully detailed in its opinion. We repeat only those which may contribute to an understanding of the narrow issue before us.
As the result of agreements reached in February of 1955, and January of 1956, Foxman, Grenell and Jacobowitz became equal partners in a commercial enterprise which was then trading under the name of Abbey Record Manufacturing Company, hereinafter identified as the Company. They also became equal shareholders in a corporation known as Sound Plastics, Inc. When differences of opinion arose in the spring of 1956, efforts were made to persuade Jacobowitz to withdraw from the partnership. These efforts failed at that time but were resumed in March of 1957. Thereafter the parties entered into negotiations which, on May 21, 1957, culminated in a contract for the acquisition of Jacobowitz's interest in the partnership of Foxman and Grenell. The terms and conditions, except one not here material, were substantially in accord with an option to purchase offered earlier to Foxman and Grenell. The relevant portions of the final contract are set forth in the Tax Court's opinion.
The contract, prepared by an attorney representing Foxman and Grenell, referred to them as the "Second Party," and to Jacobowitz as the "First Party." We regard as particularly pertinent to the issue before us the following clauses:
" WHEREAS, the parties hereto are equal owners and the sole partners of ABBEY RECORD MFG. Co., a partnership, * * *, and are also the sole stockholders, officers and directors of SOUND PLASTICS, INC., a corporation organized under the laws of the State of New York; and
" WHEREAS, the first party is desirous of selling, conveying, transferring and assigning all of his right, title and interest in and to his one-third share and interest in the said ABBEY to the second parties; and
" WHEREAS, the second parties are desirous of conveying, transferring and assigning all of their right, title and interest in and to their combined two-thirds shares and interest in SOUND PLASTICS, INC., to the first party;
" NOW, THEREFORE, IT IS MUTUALLY AGREED AS FOLLOWS:
" First : The second parties hereby purchase all the right, title, share and interest of the first party in ABBEY and the first party does hereby sell, transfer, convey and assign all of his right, title, interest and share in ABBEY and in the moneys in banks, trade names, accounts due, or to become due, and in all other assets of any kind whatsoever, belonging to said ABBEY, for and in consideration of the following. * * *"
The stated consideration was cash in the sum of $242,500; the assignment by Foxman and Grenell of their stock in Sound Plastics; and the transfer of an automobile, title to which was held by the Company. The agreement provided for the payment of $67,500 upon consummation of the contract and payment of the balance as follows: $67,500 on January 2, 1958, and $90,000 in equal monthly installments, payable on the first of each month after January 30, 1958. This balance was evidenced by a series of promissory notes, payment of which was secured by a chattel mortgage on the assets of the Company. This mortgage, like the contract, referred to a sale by Jacobowitz of his partnership interest to Foxman and Grenell. The notes were executed in the name of the Company as the purported maker and were signed by Foxman and Grenell, who also endorsed them under a guarantee of payment.
The down payment of $67,500 was by a cashier's check which was issued in exchange for a check drawn on the account of the Company. The first note, in the amount of $67,500, which became due on January 2, 1958, was timely paid by a check drawn on the Company's account. Pursuant to the terms of an option reserved to Foxman and Grenell, they elected to prepay the balance of $90,000 on January 28, 1958, thereby relieving themselves of an obligation to pay Jacobowitz a further $17,550, designated in the contract as a consultant's fee. They delivered to Jacobowitz a cashier's check which was charged against the account of the Company.
In its partnership return for the fiscal year ending February 28, 1958, the Company treated the sum of $159,656.09, the consideration received by Jacobowitz less the value of his interest in partnership property, as a guaranteed payment made in liquidation of a retiring partner's interest under § 736,(a)(2) of the Internal Revenue Code of 1954, Title 26 U.S.C.A. This treatment resulted in a substantial reduction of the distributive shares of Foxman and Grenell and consequently a proportionate decrease in their possible tax liability. In his income tax return Jacobowitz treated the sum of $164,356.09, the consideration less the value of his partnership interest, as a long term capital gain realized upon the sale of his interest. This, of course, resulted in a tax ...