Depreciation of customer-based intangibles confirmed by Supreme Court in Newark Morning Ledger

Tax Executive, The, May-June, 1993 by Mark B. Persellin

Newark Morning Ledger Co.

In 1987, the Herald Company ("Herald") was merged into another newspaper publisher, Newark Morning Ledger ("Morning Ledger"), with Morning Ledger remaining as the successor company. Several years earlier, Herald had acquired and liquidated all of the stock of Booth Newspapers, Inc., thereby acquiring all of Booth's assets including its eight newspapers. Prevailing tax law required that Herald allocate its cost basis in the Booth stock (approximately $328 million) to the acquired assets in proportion to those assets fair market values.(21) Under this allocation method, $234 million was allocated to financial and tangible assets, $67.8 million to an asset described as "paid subscribers," and $26.2 million to "going concern value and goodwill." The intangible asset "paid subscribers" represented the 460,000 existing subscribers to the eight Booth newspapers as of the liquidation date. The $67.8 million value was the taxpayer's estimated present value of the future profits to be generated by the paid subscribers established using an "income approach.'' That method was based on an estimate of the average length of time the paid subscribers for each of the newspapers would remain as subscribers, and incorporated an estimate of collection costs associated with the future revenue flow. The estimated useful lives of the paid subscribers for the various newspapers ranged from 14.7 years to 23.4 years.

Herald computed and deducted straight-line depreciation on the paid subscribers asset based on the $67.8 million cost basis and the estimated remaining useful lives. The IRS disallowed the depreciation deductions, arguing that the intangible was indistinct from goodwill. The deficiency was paid and, after a timely refund claim was denied by the IRS, Morning Ledger (the successor corporation) filed a suit for the recovery of the taxes and associated interest in the United States District Court in New Jersey.

A. The District Court Rules in Favor of the Taxpayer. In addressing the requirements for depreciation as set forth in the Treas. Reg. (section) 1.167(a)-3, the district court first addressed the useful life of the paid subscribers asset.(22) The IRS asserted that the paid subscribers were "self-regenerating," thereby bringing into play the mass-asset argument. The district court rejected this argument, however, by concluding that "there is no automatic replacement for a subscriber who terminates his or her subscription."(23) The court then noted that substantial costs and efforts are associated with generating new subscribers as support for this conclusion.

The court next questioned whether the taxpayer had overcome its burden in establishing, with a reasonable degree of accuracy, the useful life of the paid subscribers asset. The taxpayer's statistical analysis of the subscribers' average remaining life was accepted by the court as reasonably accurate. The IRS attacked certain assumptions used in that analysis, but was bound by a pre-trial stipulation that required the adoption of the taxpayer's analysis upon the court's determination that the useful lives of paid subscribers could be estimated with a reasonable degree of accuracy. In other words, the taxpayer had only to establish that a reasonable degree of accuracy could be obtained in determining the estimated lives, not specific accuracy.