Amortization of intangibles under sections 167 and 197 - comments submitted Sept 29, 1997 by Tax Executives Institute to the IRS regarding Internal Revenue Code sections 167 and 197

Tax Executive, The, Nov-Dec, 1997

In respect of the anti-churning rule, Prop. Reg. [sections] 1.197-2(h)(6(ii) provides --

A person is treated as related

to another person if the

relationship exists --

(A) In the case of a

single transaction,

immediately before

or immediately after

the acquisition of

the intangible involved; or

(B) In the case of a

series of related

transactions, at any

time during the period

beginning immediately before the

earliest acquisition

and ending immediately

after the last

acquisition of any

intangible acquired

in a series of transactions.

TEI is concerned that the proposed regulations may have ramifications for purposes of a "busted section 351" transaction.(6) This transaction may typically be described, as follows:

Parent transfers stock of Target

to Newco in exchange for

Newco common stock. Under

a binding agreement made

prior to the transfer, Parent

immediately transfers more

than 80 percent of Newco

stock to underwriters who

sell the stock to the public in

a firm-commitment underwriting.

A joint election is

made under section

338(h)(10) by Parent and

Newco to treat the transaction

as a deemed asset acquisition.

In the foregoing example, Newco's acquisition of Target's intangible assets would be subject to amortization under section 197's 15-year rule. Under the proposed regulations, however, the momentary stock ownership of Newco by Parent may create a related-party status between Parent and Newco; the intangible assets would thus fail to qualify for amortization under section 197. TEI submits that this result is contrary to the legislative history of section 197 and established case law and rulings and, moreover, ignores the economic substance of the transaction.

The House report on section 197 provides, as follows:

It is anticipated that in the

case of a transaction to which

section 338 of the Code applies,

the corporation that is

treated as selling its assets

will not be considered related

to the corporation that is

treated as purchasing the

assets if at least 80 percent

of the stock of the corporation

that is treated as selling

its assets is acquired by purchase

after July 25, 1991.

H.R. Rep. No. 103-111 at 780 n.157. See also S. Print No. 36, 103d Cong., 1st Sess. 423 n.34 (1993) (Senate Report). Although this passage technically addresses only the relationship between the new and old targets, we submit the same rationale should obtain for the relationship between Parent and Newco.

Under section 338(a), the target corporation is treated as having sold all of its assets at the close of the acquisition date at fair market value in a single transaction, and is treated as a new corporation that purchased all its assets on the date after the acquisition date. For purposes of these rules, the wholly transitory ownership of Newco stock by Parent is ignored. See Private Letter Ruling 9142013 (July 17, 1991) ("Parent is not a person from whom the ownership of stock would, under section 318 of the Code, be attributed to Buyer within the meaning of section 338(h)(3)(A)(iii)."); Private Letter Ruling 9541039 (July 20, 1995) (the acquisition by a new corporation of all the stock of another subsidiary of the new corporation's parent, and the deemed acquisition of the acquired corporation's affiliates, will each qualify under section 338). See also Treas. Reg. [sections] 1.338-2(d) ("[N]ew target is treated as a new corporation that is unrelated to old target for purposes of subtitle A of the Internal Revenue Code. Thus, in the section 338(a)(1) deemed sale, new target is treated as purchasing assets from an unrelated person and ... is not considered related to old target for purposes of section 168."). Thus, the proposed regulations conflict with the consistent treatment of the transaction under section 338.