3820 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

Exchange Commission or the national

market system established pursuant to

section 11A of the Securities Exchange

Act of 1934 (15 U.S.C. 78f); or

(ii) A foreign securities exchange that

is regulated or supervised by a

governmental authority of the country

in which the market is located and

which has the following

characteristics—

(A) The exchange has trading volume,

listing, financial disclosure,

surveillance, and other requirements

designed to prevent fraudulent and

manipulative acts and practices, to

remove impediments to and perfect the

mechanism of a free and open, fair and

orderly, market, and to protect

investors; and the laws of the country in

which the exchange is located and the

rules of the exchange ensure that such

requirements are actually enforced; and

(B) The rules of the exchange

effectively promote active trading of

listed stocks.

(2) Exchange with multiple tiers. If an

exchange in a foreign country has more

than one tier or market level on which

stock may be separately listed or traded,

each such tier shall be treated as a

separate exchange.

(d) Stock in certain PFICs—(1)

General rule. Except as provided in

paragraph (d)(2) of this section, a foreign

corporation is a corporation described

in section 1296(e)(1)(B), and paragraph

(a)(2) of this section, if the foreign

corporation offers for sale or has

outstanding stock of which it is the

issuer and which is redeemable at its

net asset value and if the foreign

corporation satisfies the following

conditions with respect to the class of

shares held by the electing taxpayer—

(i) At all times during the calendar

year, the foreign corporation has more

than one hundred shareholders with

respect to the class, other than

shareholders who are related under

section 267(b);

(ii) At all times during the calendar

year, the class of shares of the foreign

corporation is readily available for

purchase by the general public at its net

asset value and the foreign corporation

does not require a minimum initial

investment of greater than $10,000

(U.S.);

(iii) At all times during the calendar

year, quotations for the class of shares

of the foreign corporation are

determined and published no less

frequently than on a weekly basis in a

widely-available permanent medium

not controlled by the issuer of the

shares, such as a newspaper of general

circulation or a trade publication;

(iv) No less frequently than annually,

independent auditors prepare financial

statements of the foreign corporation

that include balance sheets (statements

of assets, liabilities, and net assets) and

statements of income and expenses, and

those statements are made available to

the public;

(v) The foreign corporation is

supervised or regulated as an

investment company by a foreign

government or an agency or

instrumentality thereof that has broad

inspection and enforcement authority

and effective oversight over investment

companies;

(vi) At all times during the calendar

year, the foreign corporation has no

senior securities authorized or

outstanding, including any debt other

than in de minimis amounts;

(vii) Ninety percent or more of the

gross income of the foreign corporation

for its taxable year is passive income, as

defined in section 1297(a)(1) and the

regulations thereunder; and

(viii) The average percentage of assets

held by the foreign corporation during

its taxable year which produce passive

income or which are held for the

production of passive income, as

defined in section 1297(a)(2) and the

regulations thereunder, is at least 90

percent.

(2) Anti-abuse rule. If a foreign

corporation undertakes any actions that

have as one of their principal purposes

the manipulation of the net asset value

of a class of its shares, for the calendar

year in which the manipulation occurs,

the shares are not marketable stock for

purposes of paragraph (d)(1) of this

section.

(e) [Reserved]

(f) Special rules for regulated

investment companies (RICs)—(1)

General rule. In the case of any RIC that

is offering for sale, or has outstanding,

any stock of which it is the issuer and

which is redeemable at net asset value,

if the RIC owns directly or indirectly, as

defined in sections 958(a)(1) and (2),

stock in any passive foreign investment

company, that stock will be treated as

marketable stock owned by that RIC for

purposes of section 1296. Except as

provided in paragraph (f)(2) of this

section, in the case of any other RIC that

publishes net asset valuations at least

annually, if the RIC owns directly or

indirectly, as defined in sections

958(a)(1) and (2), stock in any passive

foreign investment company, that stock

will be treated as marketable stock

owned by that RIC for purposes of

section 1296.

(2) [Reserved]

(g) Effective date. This section applies

to shareholders whose taxable year ends

on or after January 25, 2000 for stock in

a foreign corporation whose taxable year

ends with or within the shareholder’s

taxable year. In addition, shareholders

may elect to apply these regulations to

any taxable year beginning after

December 31, 1997, for stock in a

foreign corporation whose taxable year

ends with or within the shareholder’s

taxable year.

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

Approved: January 12, 2000.

Jonathan Talisman,

Assistant Secretary of the Treasury.

[FR Doc. 00–1530 Filed 1–21–00; 8:45 am]

BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8865]

RIN 1545–AS77

Amortization of Intangible Property

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations relating to the amortization

of certain intangible property. The final

regulations reflect changes to the law

made by the Omnibus Budget

Reconciliation Act of 1993 (OBRA ’93)

and affect taxpayers who acquired

intangible property after August 10,

1993, or made a retroactive election to

apply OBRA ’93 to intangibles acquired

after July 25, 1991.

DATES: Effective Date: January 25, 2000.

Applicability Dates: These regulations

apply to property acquired after January

25, 2000. Regulations to implement

section 197(e)(4)(D) are applicable

August 11, 1993, for property acquired

after August 10, 1993 (or July 26, 1991,

for property acquired after July 25, 1991,

if a valid retroactive election has been

made under § 1.197–1T).

FOR FURTHER INFORMATION CONTACT: John

Huffman at (202) 622–3110 (not a tollfree number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information

contained in these final regulations has

been reviewed and, pending receipt and

evaluation of public comments,

approved by the Office of Management

and Budget (OMB) under 44 U.S.C. 3507

and assigned control number 1545–

1671.

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3821

The collection of information in this

regulation is in § 1.197–2(h)(9). This

information is required in order to

provide guidance on the time and

manner of making the election under

section 197(f)(9)(B). Under this election,

the seller of a section 197 intangible

may pay a tax on the sale in order to

avoid the application of the antichurning rules of section 197(f)(9) to the

purchaser. This information will be

used to confirm the parties to the

transaction, calculate any additional tax

due, and notify the purchaser of the

seller’s election. The likely respondents

are business or other for-profit

institutions.

Comments on the collection of

information should be sent to the Office

of Management and Budget, Attn: Desk

Officer for the Department of the

Treasury, Office of Information and

Regulatory Affairs, Washington, DC

20503, with copies to the Internal

Revenue Service, Attn: IRS Reports

Clearance Officer, OP:FS:FP,

Washington, DC 20224. Comments on

the collection of information should be

received by March 27, 2000. Comments

are specifically requested concerning:

Whether the collection of information

is necessary for the proper performance

of the functions of the Internal Revenue

Service, including whether the

information will have practical utility;

The accuracy of the estimated burden

associated with the collection of

information (see below);

How the quality, utility, and clarity of

the information to be collected may be

enhanced;

How the burden of complying with

the collection of information may be

minimized, including through the

application of automated collection

techniques or other forms of information

technology; and

Estimates of capital or start-up costs

and costs of operation, maintenance,

and purchase of services to provide

information.

Estimated total annual reporting

burden: 1500 hours.

Estimated average annual burden

hours per respondent varies from 2 to 4

hours, depending on individual

circumstances, with an estimated

average of 3 hours.

Estimated number of respondents: 500

per year.

Estimated annual frequency of

responses: 1.

An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information

unless it displays a valid control

number assigned by the Office of

Management and Budget.

Books or records relating to this

collection of information must be

retained as long as their contents may

become material in the administration

of any internal revenue law. Generally,

tax returns and tax return information

are confidential, as required by 26

U.S.C. 6103.

Background

On January 16, 1997, the IRS

published proposed regulations (REG–

209709–94) in the Federal Register (62

FR 2336) inviting comments under

sections 167(f) and 197. A public

hearing was held May 15, 1997.

Numerous comments have been

received. After consideration of all the

comments, the proposed regulations are

adopted as revised by this Treasury

decision.

Explanation of Provisions

Section 162(k) Application

Example 4 of the proposed regulation

§ 1.197–2(k) provided that amounts paid

for a covenant not to compete entered

into in connection with a redemption

was nondeductible under section 162(k)

and thus not subject to section 197.

Commentators suggested that guidance

on the application of section 162(k) to

transactions involving section 197

intangibles should be addressed in

regulations under section 162(k). No

reference to section 162(k) is made in

the final regulations.

Purchase of a Trade or Business

Certain intangibles are excepted from

the application of section 197 if they are

not acquired as part of a purchase of a

trade or business. The proposed

regulations provide that, for purposes of

section 197, a group of assets constitutes

a trade or business if their use would

constitute a trade or business under

section 1060 (that is, if goodwill or

going concern value could, under any

circumstances, attach to the assets).

In addition, the proposed regulations

treat a group of assets as a trade or

business if they include any customerbased intangibles or, with certain

exceptions, any franchise, trademark, or

trade name (the per se rules). The

preamble of the proposed regulations

state that the IRS intends to provide

additional guidance on the

circumstances in which a group of

assets is treated as a trade or business

in regulations under section 1060.

Although a number of comments

requested that the final regulations

under section 197 provide such

additional guidance, the final

regulations generally retain, without

amplification, the rules in the proposed

regulations. The IRS and Treasury

Department will, however, continue to

consider this issue during the

development of final regulations under

section 1060.

Commentators also requested

modifications to the per se rules. In

response to these comments, the final

regulations limit the applicability of

these rules to the cases specifically

described in the legislative history of

section 197 (that is, the acquisition of a

franchise, trademark, or trade name).

The final regulations retain the

proposed exceptions under which

certain franchises, trademarks, and trade

names are disregarded in applying the

per se rules. In addition, the regulations

clarify that a license of a trademark or

trade name is also disregarded in

applying the per se rules.

Computer Software

The final regulations contain rules

that supersede certain of the procedures

set forth in Revenue Procedure 69–21

(1969–2 C.B. 303), which provides

guidelines relating to costs incurred to

develop, purchase, or lease computer

software. Specifically, the final

regulations provide that purchased

computer software is amortizable over

15 years if section 197 applies and over

36 months if the software is not a

section 197 intangible. In addition, the

regulations clarify that section 197

(rather than § 1.162–11) applies to

certain costs incurred with respect to

leased software (that is, costs to acquire

a section 197 intangible that is a limited

interest in software). Computer software

costs included, without being separately

stated, in the cost of the computer

hardware (bundled software) continue

to be capitalized and depreciated as part

of the computer hardware. In addition,

the final regulations treat software costs

as currently deductible (and not subject

to section 197) if they are not chargeable

to capital account under the rules

applicable to licensing transactions

(discussed below) and are otherwise

currently deductible. The final

regulations clarify that, for this purpose,

an amount described in § 1.162–11 is

not currently deductible if, without

regard to § 1.162–11, such amount is

properly chargeable to capital account.

A proper and consistent practice of

taking software costs into account under

§ 1.162–11 may, however, be continued

if the costs are not subject to section

197.

A revenue procedure superseding

Rev. Proc. 69–21 and providing

procedures consistent with the rules in

the final regulations will be issued in

the near future. In the meantime,

taxpayers may not rely on the

3822 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

procedures in Rev. Proc. 69–21 to the

extent they are inconsistent with section

167(f), section 197, or the final

regulations.

Mortgage Servicing Rights

The proposed regulations treat

mortgage servicing rights relating to a

pool of mortgages as a single asset under

section 167(f) (relating to mortgage

servicing rights not acquired as part of

a purchase of a trade or business). Thus,

if some but not all mortgages in a pool

prepay, no loss is recognized.

Commentators assert that each right in

the pool is a discrete asset, and thus,

taxpayers should be able to recognize a

loss upon the prepayment of an

individual mortgage within the pool.

The Service and the Treasury

Department believe this is generally

inappropriate in cases where

depreciation is based on the average

useful life of the assets. See § 1.167(a)–

8. Thus, the regulations retain the rule

that no loss is recognized if some but

not all mortgages in a pool prepay or are

sold or exchanged. The final regulations

provide, however, that if a taxpayer

establishes multiple accounts within a

pool at the time of its acquisition, gain

or loss is recognized on the sale or

exchange of all mortgage servicing rights

within any such account.

When Section 197 Amortization Begins

The proposed regulations provide that

amortization begins the later of the first

day of the month in which the property

is acquired, or the first month in which

the active conduct of a trade or business

begins. Commentators suggest that the

literal language of section 197(a) allows

amortization beginning with the month

the intangible is acquired. Under section

197(c)(1), however, a section 197

intangible is amortizable only if it is

held in connection with the conduct of

a trade or business or an activity

described in section 212. Moreover,

there is no suggestion in the legislative

history that Congress intended to apply

a rule differing from those applicable

under section 167 and former section

1253(d).

Former section 1253(d)(2) provided,

in language similar to that in section

197(a), that the amortization of certain

amounts begins in the taxable year in

which the amounts are paid. Although

section 1253(d)(2) did not contain any

reference to section 162 or to use in a

trade or business, it was nevertheless

well established at the time of the

enactment of section 197 that the

provision embodied a trade or business

requirement and that amounts were not

deductible thereunder unless the

taxpayer was operating or conducting a

trade or business after the amounts were

paid.

Commentators suggest that it is

significant that section 167 refers to

‘‘property used in the trade or business’’

while property can qualify for

amortization under section 197 if it is

‘‘held in connection with the conduct of

a trade or business.’’ Further,

commentators assert that the language

used in section 197 is closer to the

‘‘held in connection with his trade or

business’’ language used in section 174,

which does not require the current

conduct of a trade or business, than to

the language of section 167. The

different language used in these

provisions can be explained, however,

without departing from previous

practice under sections 167 and 1253(d)

regarding the time at which

amortization commences. Broader

language under section 197 is necessary

because it applies to assets, such as

goodwill, that although held in

connection with the conduct of a trade

or business are not commonly viewed as

being used in the trade or business.

Further, modifying the language used in

section 174 by adding the words

‘‘conduct of’’ indicates that Congress

did not intend to change the

longstanding trade or business

requirement for purposes of determining

when amortization commences.

Consequently, the final regulations

retain the rule in the proposed

regulations that amortization begins no

earlier than the first day of the month

in which the active trade or business or

the activity described in section 212

begins.

Transactions Involving Partnerships

The final regulations relating to

partnership transactions have been

changed from the proposed regulations

in several respects to reflect the

recommendations of commentators.

Example 17 of the proposed regulation

§ 1.197–2(k) provided that a partner may

amortize a § 743 adjustment with

respect to a section 197 intangible only

if the formation of the partnership and

the sale of the partnership interest are

‘‘unrelated transactions.’’ Commentators

suggested that an unrelated transaction

standard would create significant

confusion for taxpayers. According to

the commentators, taxpayers would

have greater certainty with respect to

their transactions, and the government

still would be adequately protected, if

these transactions were analyzed under

general tax principles, including the

step transaction doctrine. The final

regulations remove the unrelated

transaction requirement. However, if the

transaction is structured so that, under

general principles of tax law, the

transaction is not properly characterized

as a sale of a partnership interest, then

section 197 will apply to the transaction

as recast to reflect its true economic

substance.

Certain commentators also requested

that Example 16 of proposed regulation

§ 1.197–2(k) be modified to allow a

partnership to amortize an intangible

contributed to the partnership under the

transferred basis rules under section

197(f)(2), even if a partner related to the

partnership under section 197(f)(9)(C)

had owned the intangible during the

transition period and, as part of an

integrated transaction, had sold the

intangible to an unrelated party before

forming the partnership. The

commentators suggested that because

section 197(f)(9)(E) generally permits

amortization for the stepped-up basis in

a partnership transaction under section

743 where a section 754 election was in

effect, amortization also should be

allowed in a sale of an intangible

followed by a contribution of the

intangible to a partnership, an

economically similar transaction. This

recommendation was not adopted. In

general, a partnership is treated as an

entity separate from its partners in

characterizing related party transfers.

See, e.g., Section 707(b)(1) (specifically

referenced in section 197(f)(9)(C)(i)(I)).

Section 197(f)(9)(E) does provide a

special anti-churning rule for certain

partnership transactions. However, this

special rule is not applicable in

situations where a partnership has a

transferred basis in the intangible under

section 723. With respect to the analogy

under section 743, where a transferee is

allowed to amortize a section 743 basis

step-up, it is only the increase in basis

that may be amortized, and the

amortization attributable to the basis

increase is segregated for use only by

the transferee partner. Neither of these

results necessarily follow from a sale of

property followed by a contribution of

the property to the partnership.

The proposed regulations did not

allow partners to deduct, for federal

income tax purposes, curative or

remedial amortization allocations from

the partnership in situations where the

asset was a section 197(f)(9) intangible

(and thus nonamortizable) in the hands

of the contributing partner.

Commentators have suggested allowing

curative and remedial allocations under

section 704(c). The final regulations

generally permit a partnership to make

curative or remedial allocations to its

noncontributing partners of

amortization relating to an asset that

was amortizable (or a zero-basis

intangible that otherwise would have

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3823

been amortizable) in the hands of the

contributor. For assets that were section

197(f)(9) intangibles (and thus

nonamortizable) in the hands of the

contributor, however, the partnership

may make deductible amortization

allocations to the noncontributing

partners under the remedial method

only. The final regulations permit

remedial allocations because, under

section 704(c), remedial allocations treat

the amortizable portion of contributed

property like newly purchased property,

with a new holding period and

determinable allocation of tax items.

This result, which is similar to the

result obtained for basis increases under

section 743, does not follow under the

curative method because curative

allocations are not determined as if the

applicable property were newly

purchased property. The decision to

allow amortization for remedial

allocations in these regulations also is

consistent with the decisions regarding

fungibility of partnership interests that

are inherent in the recently finalized

regulations under sections 743 and 755.

Finally, the rules governing section

704(c) allocations of amortization from

section 197 intangibles contributed to a

partnership in a nonrecognition

transaction are still subject to the antichurning provisions. Accordingly,

remedial allocations of deductible

amortization expenses may not be made

to a partner who is related to a partner

that contributes an intangible subject to

the anti-churning rules. Certain

problems may arise in maintaining

capital accounts where a partnership

elects to make remedial allocations, and

the anti-churning rules apply with

respect to one or more partners. These

problems also arise in the context of

section 734(b) adjustments and are

discussed in the preamble to the

proposed regulations relating to the

application of the anti-churning rules to

basis adjustments under sections 732(b)

and 734(b), which are being issued at

the same date as these final regulations.

Commentators requested that the final

regulations provide additional guidance

on how the special anti-churning rule of

section 197(f)(9)(E) applies to increases

in the basis of property under sections

732, 734, and 743. In accordance with

these comments, the final regulations

provide rules for determining the

amount of a basis adjustment under

sections 732(d) and 743 that will be

subject to the anti-churning rules. The

Treasury Department and the IRS also

are issuing, at the same time as these

final regulations, proposed regulations

addressing how to determine the

amount of a basis adjustment under

sections 732(b) and 734(b) that will be

subject to the anti-churning rules.

Finally, the final regulations provide

that where, for purposes of the antichurning rules, a partner is treated as

holding its proportionate share of

partnership property under section

197(f)(9)(E), the continued or

subsequent use (by license or otherwise)

of an intangible by a partner could cause

the anti-churning rules to apply with

respect to that partner’s share of the

intangible in situations where a basis

step-up under section 732(d) or 743(b)

otherwise would be amortizable. This

rule is necessary in order to prevent the

circumvention of section 197(f)(9)(A)

through the use of a partnership. The

proposed regulations being issued in

conjunction with these final regulations

expand the application of this rule to

basis adjustments under sections 732(b)

and 734(b).

Contracts for the Use of a Section 197

Intangible

The proposed regulations provide that

a right to use a section 197 intangible

pursuant to a license, contract, or other

arrangement is, itself, a section 197

intangible. The proposed regulations

further provide that amounts paid for

such a right are chargeable to capital

account, whether or not the payments

would have been deductible (for

example, as a royalty) if the right were

not a section 197 intangible. Under the

proposed regulations, the amount

chargeable to capital account is

generally determined without regard to

sections 483 and 1274 (that is, no part

of the amount paid is recharacterized as

unstated interest or original issue

discount). Finally, the proposed

regulations treat the acquisition of a

franchise, trademark, or trade name as

the acquisition of a trade or business,

thereby preventing other intangibles

acquired in the same transaction or

series of related transactions from

qualifying for any of the exceptions

applicable to separately acquired

property.

Commentators suggested that these

rules have negative consequences for

common cross-border and affiliate

licenses, which frequently include, in

addition to rights that would not be

subject to section 197 if not acquired as

part of a purchase of a trade or business,

rights to use a trademark or trade name.

Under prior law, amounts paid for these

licenses were generally currently

deductible. The proposed regulations,

however, require amortization over 15

years. In addition, cost recovery over the

15-year period is significantly

backloaded because the licenses

generally involve contingent payments

that are not includible in basis until the

year in which they are paid or incurred

and, in addition, the proposed

regulations provide that sections 483

and 1274 are generally inapplicable.

After further consideration of this

issue in light of the concerns raised by

the commentators, the IRS and Treasury

Department have concluded that,

particularly in the case of common

licensing transactions involving

technology and similar intangible

property, a different approach is

appropriate. The clearest indication of

Congressional intent on this issue is the

statement in the legislative history to

the effect that, with certain exceptions,

section 197 generally does not apply to

amounts that were otherwise currently

deductible before the enactment of

section 197. Nevertheless, the IRS and

Treasury Department are also mindful

that Congress directed the issuance of

such regulations as may be appropriate

to prevent avoidance of the purposes of

section 197.

The final regulations generally

provide that royalty payments under a

contract for the use of section 197

intangibles unconnected with the

purchase of a trade or business are not

required to be capitalized. Licensing

transactions will, however, be closely

scrutinized under the principles of

section 1235 for purposes of

determining whether the payments are,

in fact, deductible royalties or, instead,

represent purchase price that should be

charged to capital account.

The final regulations also modify the

rule that treats the acquisition of a

franchise, trademark, or trade name as

the acquisition of a trade or business.

Under the final regulations, the

acquisition of an interest in a trademark

or trade name is disregarded in

determining whether acquired property

is a trade or business if, under the

principles of section 1253, the grant of

the interest is not a transfer of all

substantial rights in the trademark or

trade name. Thus, the acquisition of

such an interest in a trademark or trade

name will not subject other intangibles

acquired in the same transaction or

series of related transactions to the

generally less favorable rules applicable

to intangibles acquired as part of a

purchase of a trade or business.

To prevent abuses, the final

regulations provide that if the right to

use a section 197 intangible is provided

under a license entered into as part of

a purchase of a trade or business,

amounts paid for the right are, as under

the proposed regulations, chargeable to

capital account. An exception, not

contained in the proposed regulations,

is provided for licenses of technology,

3824 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

know-how, and other similar items

(including most types of information

base). Royalties paid under these

licenses are not required to be

capitalized if the taxpayer establishes

that the payments are, in fact,

deductible royalties under general tax

principles and represent an arm’s-length

consideration for the transferred rights.

Finally, any amount otherwise

chargeable to capital account with

respect to a section 197 intangible and

payable after the acquisition of the

intangible to which it relates is treated,

in determining the tax treatment of the

purchaser, as an amount payable under

a debt instrument. Thus, the extent to

which such amounts are treated as

payments of principal and the time at

which the amount treated as principal is

included in basis is determined under

generally applicable rules relating to

imputed interest and original issue

discount. If, under these rules, a basis

increase occurs after the beginning of

the 15-year amortization period, the

increase is amortized over the

remainder of the 15-year period (or, in

the case of an increase occurring after

the end of the amortization period, is

immediately deductible).

Anti-churning Rules

The anti-churning rules of section 197

prevent taxpayers from converting

goodwill, going concern value, and

similar assets held or used at any time

during the transition period into

amortizable section 197 intangibles

through transactions such as transfers to

related parties. The proposed

regulations provide guidance on a

number of specific issues arising under

the anti-churning rules. The final

regulations retain this guidance with

certain modifications and, in addition,

set forth the purpose of the antichurning rules (generally, to prevent the

amortization of certain intangibles that

are not acquired after the applicable

effective date in a transaction giving rise

to a significant change in ownership or

use). The final regulations further

provide that the anti-churning rules are

to be applied in a manner that carries

out their purpose. The final regulations

include a rule providing that a

transaction will be presumed to have a

principal purpose of avoiding the antichurning rules if it does not effect a

significant change in ownership or use.

The final regulations also provide

additional guidance concerning the

circumstances in which persons are

treated as related for purposes of the

anti-churning rules. Section 197

provides that a relationship is tested for

purposes of the anti-churning rules both

immediately before and immediately

after the acquisition. The proposed

regulations further provide that, in the

case of intangibles acquired in a series

of related transactions, testing begins

immediately before the first acquisition

and continues until immediately after

the last acquisition. Comments

suggested that momentary relationships

created in the course of the acquisition

should be disregarded for purposes of

the anti-churning rules. Such

relationships can arise, for example, in

the course of a stock acquisition

followed by a liquidation or when assets

are contributed to a newly created

subsidiary and, pursuant to a binding

commitment, all stock of the subsidiary

is sold to an unrelated person or persons

immediately after the contribution.

To address these and similar

situations, the final regulations provide

that in the case of a series of related

transactions (or a series of transactions

that together comprise a qualified stock

purchase within the meaning of section

338(d)(3)) a person is treated as related

to another person if the relationship

exists immediately before the earliest

such transaction or immediately after

the last such transaction. In addition,

any relationship created as part of a

series of related transactions in which a

person acquires stock of a corporation

followed by a liquidation of the

acquired corporation under section 331

generally is disregarded. Further, as

with all other provisions of the

regulations relating to the anti-churning

rules, these provisions are to be applied

in a manner that carries out the purpose

of the anti-churning rules.

The final regulations also provide

guidance on the exemption from the

anti-churning rules if the person from

whom the taxpayer acquires an

intangible elects to recognize gain and

agrees to pay a specified amount of tax.

In general, these rules are the same as

those contained in the proposed

regulations, except that the proposed

regulations do not prescribe procedures

for making the election. The final

regulations provide guidance on the

manner of making the election,

including procedures that apply to

persons not otherwise subject to Federal

income tax.

Effective Dates

The regulations under sections 167(f)

and 197 were proposed to apply on the

date on which the final regulations are

published in the Federal Register.

Regulations to implement section

197(e)(4)(D) (separately acquired

contracts of fixed duration or amount)

were proposed to apply August 11,

1993, for property acquired after August

10, 1993 (or July 26, 1991, if a valid

retroactive election has been made

under § 1.197–1T). Comments suggested

that the applicability date should be

modified to clarify that the regulations

(other than the implementation of

section 197(e)(4)(D)) apply only to

property acquired on or after the date

final regulations are published. This

suggestion has been adopted.

Accordingly, the final regulations

generally apply only to intangible

property acquired after the date they are

published in the Federal Register.

The applicability date of the rules

implementing section 197(e)(4)(D) is

similarly clarified. Thus, the final

regulations provide that these rules

apply to property acquired after August

10, 1993 (or July 25, 1991, if a valid

retroactive election has been made

under § 1.197–1T). The regulations also

provide consent for changes in method

of accounting to comply with the rules

and automatic procedures for making

the change.

In addition, the final regulations

permit taxpayers to apply the rules in

the final regulations to property

acquired before the applicability date of

the final regulations (or to rely on the

proposed regulations for such property)

and provide similar consent and

automatic change procedures for

taxpayers that choose to apply the final

regulations to pre-effective date

acquisitions.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in

Executive Order 12866. Therefore, a

regulatory assessment is not required. It

is hereby certified that these regulations

do not have a significant impact on a

substantial number of small entities.

This certification is based on the fact

that the time required to prepare and

file the election statement and notify

acquirers is minimal and will not have

a significant impact on those few small

entities that choose to make the

election. Therefore, a Regulatory

Flexibility Analysis under the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) is not required. It also has

been determined that section 553(b) of

the Administrative Procedure Act (5

U.S.C. chapter 5) does not apply to these

regulations. Pursuant to section 7805(f)

of the Internal Revenue Code, the notice

of proposed rulemaking was submitted

to the Chief Counsel for Advocacy of the

Small Business Administration for

comment on its impact on small

business.

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3825

Drafting Information

The principal author of these

regulations is John Huffman, Office of

Assistant Chief Counsel (Passthroughs

and Special Industries), IRS. However,

other personnel from the IRS and

Treasury Department participated in

their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping

requirements.

Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602

are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an entry

in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.197–2 also issued under 26

U.S.C. 197(g). * * *

Par. 2. Section 1.162–11 is amended

by adding a sentence at the end of

paragraph (a) to read as follows:

§ 1.162–11 Rentals.

(a) * * * See § 1.197–2 for rules

governing the amortization of costs to

acquire limited interests in section 197

intangibles.

* * * * *

Par. 3. Section 1.167(a)–3 is amended

by adding a sentence at the end to read

as follows:

§ 1.167(a)–3 Intangibles.

* * * See sections 197 and 167(f)

and, to the extent applicable, §§ 1.197–

2 and 1.167(a)–14 for amortization of

goodwill and certain other intangibles

acquired after August 10, 1993, or after

July 25, 1991, if a valid retroactive

election under § 1.197–1T has been

made.

Par. 4. Section 1.167(a)–6 is amended

by adding two sentences at the end of

paragraph (a) to read as follows:

§ 1.167(a)–6 Depreciation in special cases.

(a) * * * See § 1.167(a)–14(c)(4) for

depreciation of a separately acquired

interest in a patent or copyright

described in section 167(f)(2) acquired

after January 25, 2000. See § 1.197–2 for

amortization of interests in patents and

copyrights that constitute amortizable

section 197 intangibles.

* * * * *

Par. 5. Section 1.167(a)–14 is added to

read as follows:

§ 1.167(a)–14 Treatment of certain

intangible property excluded from section

197.

(a) Overview. This section provides

rules for the amortization of certain

intangibles that are excluded from

section 197 (relating to the amortization

of goodwill and certain other

intangibles). These excluded intangibles

are specifically described in § 1.197–2(c)

(4), (6), (7), (11), and (13) and include

certain computer software and certain

other separately acquired rights, such as

rights to receive tangible property or

services, patents and copyrights, certain

mortgage servicing rights, and rights of

fixed duration or amount. Intangibles

for which an amortization amount is

determined under section 167(f) and

intangibles otherwise excluded from

section 197 are amortizable only if they

qualify as property subject to the

allowance for depreciation under

section 167(a).

(b) Computer software—(1) In general.

The amount of the deduction for

computer software described in section

167(f)(1) and § 1.197–2(c)(4) is

determined by amortizing the cost or

other basis of the computer software

using the straight line method described

in § 1.167(b)–1 (except that its salvage

value is treated as zero) and an

amortization period of 36 months

beginning on the first day of the month

that the computer software is placed in

service. If costs for developing computer

software that the taxpayer properly

elects to defer under section 174(b)

result in the development of property

subject to the allowance for depreciation

under section 167, the rules of this

paragraph (b) will apply to the

unrecovered costs. In addition, this

paragraph (b) applies to the cost of

separately acquired computer software

where these costs are separately stated

and the costs are required to be

capitalized under section 263(a).

(2) Exceptions. Paragraph (b)(1) of this

section does not apply to the cost of

computer software properly and

consistently taken into account under

§ 1.162–11. The cost of acquiring an

interest in computer software that is

included, without being separately

stated, in the cost of the hardware or

other tangible property is treated as part

of the cost of the hardware or other

tangible property that is capitalized and

depreciated under other applicable

sections of the Internal Revenue Code.

(3) Additional rules. Rules similar to

those in § 1.197–2 (f)(1)(iii), (f)(1)(iv),

and (f)(2) (relating to the computation of

amortization deductions and the

treatment of contingent amounts) apply

for purposes of this paragraph (b).

(c) Certain interests or rights not

acquired as part of a purchase of a trade

or business—(1) Certain rights to receive

tangible property or services. The

amount of the deduction for a right

(other than a right acquired as part of a

purchase of a trade or business) to

receive tangible property or services

under a contract or from a governmental

unit (as specified in section 167(f)(2)

and § 1.197–2(c)(6)) is determined as

follows:

(i) Amortization of fixed amounts.

The basis of a right to receive a fixed

amount of tangible property or services

is amortized for each taxable year by

multiplying the basis of the right by a

fraction, the numerator of which is the

amount of tangible property or services

received during the taxable year and the

denominator of which is the total

amount of tangible property or services

received or to be received under the

terms of the contract or governmental

grant. For example, if a taxpayer

acquires a favorable contract right to

receive a fixed amount of raw materials

during an unspecified period, the

taxpayer must amortize the cost of

acquiring the contract right by

multiplying the total cost by a fraction,

the numerator of which is the amount

of raw materials received under the

contract during the taxable year and the

denominator of which is the total

amount of raw materials received or to

be received under the contract.

(ii) Amortization of unspecified

amount over fixed period. The cost or

other basis of a right to receive an

unspecified amount of tangible property

or services over a fixed period is

amortized ratably over the period of the

right. (See paragraph (c)(3) of this

section regarding renewals).

(iii) Amortization in other cases.

[Reserved]

(2) Rights of fixed duration or

amount. The amount of the deduction

for a right (other than a right acquired

as part of a purchase of a trade or

business) of fixed duration or amount

received under a contract or granted by

a governmental unit (specified in

section 167(f)(2) and § 1.197–2(c)(13))

and not covered by paragraph (c)(1) of

this section is determined as follows:

(i) Rights to a fixed amount. The basis

of a right to a fixed amount is amortized

for each taxable year by multiplying the

basis by a fraction, the numerator of

which is the amount received during the

taxable year and the denominator of

which is the total amount received or to

be received under the terms of the

contract or governmental grant.

3826 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

(ii) Rights to an unspecified amount

over fixed duration of less than 15 years.

The basis of a right to an unspecified

amount over a fixed duration of less

than 15 years is amortized ratably over

the period of the right.

(3) Application of renewals. (i) For

purposes of paragraphs (c) (1) and (2) of

this section, the duration of a right

under a contract (or granted by a

governmental unit) includes any

renewal period if, based on all of the

facts and circumstances in existence at

any time during the taxable year in

which the right is acquired, the facts

clearly indicate a reasonable expectancy

of renewal.

(ii) The mere fact that a taxpayer will

have the opportunity to renew a

contract right or other right on the same

terms as are available to others, in a

competitive auction or similar process

that is designed to reflect fair market

value and in which the taxpayer is not

contractually advantaged, will generally

not be taken into account in

determining the duration of such right

provided that the bidding produces a

fair market value price comparable to

the price that would be obtained if the

rights were purchased immediately after

renewal from a person (other than the

person granting the renewal) in an

arm’s-length transaction.

(iii) The cost of a renewal not

included in the terms of the contract or

governmental grant is treated as the

acquisition of a separate intangible

asset.

(4) Patents and copyrights. If the

purchase price of a interest (other than

an interest acquired as part of a

purchase of a trade or business) in a

patent or copyright described in section

167(f)(2) and § 1.197–2(c)(7) is payable

on at least an annual basis as either a

fixed amount per use or a fixed

percentage of the revenue derived from

the use of the patent or copyright, the

depreciation deduction for a taxable

year is equal to the amount of the

purchase price paid or incurred during

the year. Otherwise, the basis of such

patent or copyright (or an interest

therein) is depreciated either ratably

over its remaining useful life or under

section 167(g) (income forecast method).

If a patent or copyright becomes

valueless in any year before its legal

expiration, the adjusted basis may be

deducted in that year.

(5) Additional rules. The period of

amortization under paragraphs (c) (1)

through (4) of this section begins when

the intangible is placed in service, and

rules similar to those in § 1.197–2(f)(2)

apply for purposes of this paragraph (c).

(d) Mortgage servicing rights—(1) In

general. The amount of the deduction

for mortgage servicing rights described

in section 167(f)(3) and § 1.197–2(c)(11)

is determined by using the straight line

method described in § 1.167(b)–1

(except that the salvage value is treated

as zero) and an amortization period of

108 months beginning on the first day

of the month that the rights are placed

in service. Mortgage servicing rights are

not depreciable to the extent the rights

are stripped coupons under section

1286.

(2) Treatment of rights acquired as a

pool—(i) In general. Except as provided

in paragraph (d)(2)(ii) of this section, all

mortgage servicing rights acquired in

the same transaction or in a series of

related transactions are treated as a

single asset (the pool) for purposes of

determining the depreciation deduction

under this paragraph (d) and any gain or

loss from the sale, exchange, or other

disposition of the rights. Thus, if some

(but not all) of the rights in a pool

become worthless as a result of

prepayments, no loss is recognized by

reason of the prepayment and the

adjusted basis of the pool is not affected

by the unrecognized loss. Similarly, any

amount realized from the sale or

exchange of some (but not all) of the

mortgage servicing rights is included in

income and the adjusted basis of the

pool is not affected by the realization.

(ii) Multiple accounts. If the taxpayer

establishes multiple accounts within a

pool at the time of its acquisition, gain

or loss is recognized on the sale or

exchange of all mortgage servicing rights

within any such account.

(3) Additional rules. Rules similar to

those in § 1.197–2(f)(1)(iii), (f)(1)(iv),

and (f)(2) (relating to the computation of

amortization deductions and the

treatment of contingent amounts) apply

for purposes of this paragraph (d).

(e) Effective date—(1) In general. This

section applies to property acquired

after January 25, 2000, except that

§ 1.167(a)–14(c)(2) (depreciation of the

cost of certain separately acquired

rights) and so much of § 1.167(a)–

14(c)(3) as relates to § 1.167(a)–14(c)(2)

apply to property acquired after August

10, 1993 (or July 25, 1991, if a valid

retroactive election has been made

under § 1.197–1T).

(2) Change in method of accounting.

See § 1.197–2(l)(4) for rules relating to

changes in method of accounting for

property to which § 1.167(a)–14 applies.

Par. 6. Section 1.197–0 is added to

read as follows:

§ 1.197–0 Table of contents.

This section lists the headings that

appear in § 1.197–2.

§ 1.197–2 Amortization of goodwill and

certain other intangibles.

(a) Overview.

(1) In general.

(2) Section 167(f) property.

(3) Amounts otherwise deductible.

(b) Section 197 intangibles; in general.

(1) Goodwill.

(2) Going concern value.

(3) Workforce in place.

(4) Information base.

(5) Know-how, etc.

(6) Customer-based intangibles.

(7) Supplier-based intangibles.

(8) Licenses, permits, and other rights

granted by governmental units.

(9) Covenants not to compete and other

similar arrangements.

(10) Franchises, trademarks, and trade

names.

(11) Contracts for the use of, and term

interests in, other section 197 intangibles.

(12) Other similar items.

(c) Section 197 intangibles; exceptions.

(1) Interests in a corporation, partnership,

trust, or estate.

(2) Interests under certain financial contracts.

(3) Interests in land.

(4) Certain computer software.

(i) Publicly available.

(ii) Not acquired as part of trade or business.

(iii) Other exceptions.

(iv) Computer software defined.

(5) Certain interests in films, sound

recordings, video tapes, books, or other

similar property.

(6) Certain rights to receive tangible property

or services.

(7) Certain interests in patents or copyrights.

(8) Interests under leases of tangible property.

(i) Interest as a lessor.

(ii) Interest as a lessee.

(9) Interests under indebtedness.

(i) In general.

(ii) Exceptions.

(10) Professional sports franchises.

(11) Mortgage servicing rights.

(12) Certain transaction costs.

(13) Rights of fixed duration or amount.

(d) Amortizable section 197 intangibles.

(1) Definition.

(2) Exception for self-created intangibles.

(i) In general.

(ii) Created by the taxpayer.

(A) Defined.

(B) Contracts for the use of intangibles.

(C) Improvements and modifications.

(iii) Exceptions.

(3) Exception for property subject to antichurning rules.

(e) Purchase of a trade or business.

(1) Goodwill or going concern value.

(2) Franchise, trademark, or trade name.

(i) In general.

(ii) Exceptions.

(3) Acquisitions to be included.

(4) Substantial portion.

(5) Deemed asset purchases under section

338.

(6) Mortgage servicing rights.

(7) Computer software acquired for internal

use.

(f) Computation of amortization deduction.

(1) In general.

(2) Treatment of contingent amounts.

(i) Amounts added to basis during 15-year

period.

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3827

(ii) Amounts becoming fixed after expiration

of 15-year period.

(iii) Rules for including amounts in basis.

(3) Basis determinations for certain assets.

(i) Covenants not to compete.

(ii) Contracts for the use of section 197

intangibles; acquired as part of a trade or

business.

(A) In general.

(B) Know-how and certain information base.

(iii) Contracts for the use of section 197

intangibles; not acquired as part of a trade

or business.

(iv) Applicable rules.

(A) Franchises, trademarks, and trade names.

(B) Certain amounts treated as payable under

a debt instrument.

(1) In general.

(2) Rights granted by governmental units.

(3) Treatment of other parties to transaction.

(4) Basis determinations in certain

transactions.

(i) Certain renewal transactions.

(ii) Transactions subject to section 338 or

1060.

(iii) Certain reinsurance transactions.

(g) Special rules.

(1) Treatment of certain dispositions.

(i) Loss disallowance rules.

(A) In general.

(B) Abandonment or worthlessness.

(C) Certain nonrecognition transfers.

(ii) Separately acquired property.

(iii) Disposition of a covenant not to compete.

(iv) Taxpayers under common control.

(A) In general.

(B) Treatment of disallowed loss.

(2) Treatment of certain nonrecognition and

exchange transactions.

(i) Relationship to anti-churning rules.

(ii) Treatment of nonrecognition and

exchange transactions generally.

(A) Transfer disregarded.

(B) Application of general rule.

(C) Transactions covered.

(iii) Certain exchanged-basis property.

(iv) Transfers under section 708(b)(1).

(A) In general.

(B) Termination by sale or exchange of

interest.

(C) Other terminations.

(3) Increase in the basis of partnership

property under section 732(b), 734(b),

743(b), or 732(d).

(4) Section 704(c) allocations.

(i) Allocations where the intangible is

amortizable by the contributor.

(ii) Allocations where the intangible is not

amortizable by the contributor.

(5) Treatment of certain reinsurance

transactions.

(i) In general.

(ii) Determination of adjusted basis.

(A) Acquisitions (other than under section

338) of specified insurance contracts.

(B) Insolvent ceding company

(C) Other acquisitions. [Reserved]

(6) Amounts paid or incurred for a franchise,

trademark, or trade name.

(7) Amounts properly taken into account in

determining the cost of property that is not

a section 197 intangible.

(8) Treatment of amortizable section 197

intangibles as depreciable property.

(h) Anti-churning rules.

(1) Scope and purpose.

(i) Scope.

(ii) Purpose.

(2) Treatment of section 197(f)(9) intangibles.

(3) Amounts deductible under section

1253(d) or § 1.162–11.

(4) Transition period.

(5) Exceptions.

(6) Related person.

(i) In general.

(ii) Time for testing relationships.

(iii) Certain relationships disregarded.

(iv) De minimis rule.

(A) In general.

(B) Determination of beneficial ownership

interest.

(7) Special rules for entities that owned or

used property at any time during the

transition period and that are no longer in

existence.

(8) Special rules for section 338 deemed

acquisitions.

(9) Gain-recognition exception.

(i) Applicability.

(ii) Effect of exception.

(iii) Time and manner of election.

(iv) Special rules for certain entities.

(v) Effect of nonconforming elections.

(vi) Notification requirements.

(vii) Revocation.

(viii) Election Statement.

(ix) Determination of highest marginal rate of

tax and amount of other Federal income

tax on gain.

(A) Marginal rate.

(1) Noncorporate taxpayers.

(2) Corporations and tax-exempt entities.

(B) Other Federal income tax on gain.

(x) Coordination with other provisions.

(A) In general.

(B) Section 1374.

(C) Procedural and administrative provisions.

(D) Installment method.

(xi) Special rules for persons not otherwise

subject to Federal income tax.

(10) Transactions subject to both antichurning and nonrecognition rules.

(11) Avoidance purpose.

(12) Additional partnership anti-churning

rules

(i) In general.

(ii) Section 732(b) adjustments. [Reserved]

(iii) Section 732(d) adjustments.

(iv) Section 734(b) adjustments. [Reserved]

(v) Section 743(b) adjustments.

(vi) Partner is or becomes a user of

partnership intangible.

(A) General rule.

(B) Anti-churning partner.

(C) Effect of retroactive elections.

(vii) Section 704(c) elections.

(A) Allocations where the intangible is

amortizable by the contributor.

(B) Allocations where the intangible is not

amortizable by the contributor.

(viii) Operating rule for transfers upon death.

(i) Reserved

(j) General anti-abuse rule.

(k) Examples.

(l) Effective dates.

(1) In general.

(2) Application to pre-effective date

acquisitions.

(3) Application of regulation project REG–

209709–94 to pre-effective date

acquisitions.

(4) Change in method of accounting.

(i) In general.

(ii) Application to pre-effective date

transactions.

(iii) Automatic change procedures.

Par. 7. Section 1.197–2 is added to

read as follows:

§ 1.197–2 Amortization of goodwill and

certain other intangibles.

(a) Overview—(1) In general. Section

197 allows an amortization deduction

for the capitalized costs of an

amortizable section 197 intangible and

prohibits any other depreciation or

amortization with respect to that

property. Paragraphs (b), (c), and (e) of

this section provide rules and

definitions for determining whether

property is a section 197 intangible, and

paragraphs (d) and (e) of this section

provide rules and definitions for

determining whether a section 197

intangible is an amortizable section 197

intangible. The amortization deduction

under section 197 is determined by

amortizing basis ratably over a 15-year

period under the rules of paragraph (f)

of this section. Section 197 also

includes various special rules pertaining

to the disposition of amortizable section

197 intangibles, nonrecognition

transactions, anti-churning rules, and

anti-abuse rules. Rules relating to these

provisions are contained in paragraphs

(g), (h), and (j) of this section. Examples

demonstrating the application of these

provisions are contained in paragraph

(k) of this section. The effective date of

the rules in this section is contained in

paragraph (l) of this section.

(2) Section 167(f) property. Section

167(f) prescribes rules for computing the

depreciation deduction for certain

property to which section 197 does not

apply. See § 1.167(a)–14 for rules under

section 167(f) and paragraphs (c)(4), (6),

(7), (11), and (13) of this section for a

description of the property subject to

section 167(f).

(3) Amounts otherwise deductible.

Section 197 does not apply to amounts

that are not chargeable to capital

account under paragraph (f)(3) (relating

to basis determinations for covenants

not to compete and certain contracts for

the use of section 197 intangibles) of

this section and are otherwise currently

deductible. For this purpose, an amount

described in § 1.162–11 is not currently

deductible if, without regard to § 1.162–

11, such amount is properly chargeable

to capital account.

(b) Section 197 intangibles; in general.

Except as otherwise provided in

paragraph (c) of this section, the term

section 197 intangible means any

property described in section 197(d)(1).

The following rules and definitions

provide guidance concerning property

3828 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

that is a section 197 intangible unless an

exception applies:

(1) Goodwill. Section 197 intangibles

include goodwill. Goodwill is the value

of a trade or business attributable to the

expectancy of continued customer

patronage. This expectancy may be due

to the name or reputation of a trade or

business or any other factor.

(2) Going concern value. Section 197

intangibles include going concern value.

Going concern value is the additional

value that attaches to property by reason

of its existence as an integral part of an

ongoing business activity. Going

concern value includes the value

attributable to the ability of a trade or

business (or a part of a trade or

business) to continue functioning or

generating income without interruption

notwithstanding a change in ownership,

but does not include any of the

intangibles described in any other

provision of this paragraph (b). It also

includes the value that is attributable to

the immediate use or availability of an

acquired trade or business, such as, for

example, the use of the revenues or net

earnings that otherwise would not be

received during any period if the

acquired trade or business were not

available or operational.

(3) Workforce in place. Section 197

intangibles include workforce in place.

Workforce in place (sometimes referred

to as agency force or assembled

workforce) includes the composition of

a workforce (for example, the

experience, education, or training of a

workforce), the terms and conditions of

employment whether contractual or

otherwise, and any other value placed

on employees or any of their attributes.

Thus, the amount paid or incurred for

workforce in place includes, for

example, any portion of the purchase

price of an acquired trade or business

attributable to the existence of a highlyskilled workforce, an existing

employment contract (or contracts), or a

relationship with employees or

consultants (including, but not limited

to, any key employee contract or

relationship). Workforce in place does

not include any covenant not to

compete or other similar arrangement

described in paragraph (b)(9) of this

section.

(4) Information base. Section 197

intangibles include any information

base, including a customer-related

information base. For this purpose, an

information base includes business

books and records, operating systems,

and any other information base

(regardless of the method of recording

the information) and a customer-related

information base is any information

base that includes lists or other

information with respect to current or

prospective customers. Thus, the

amount paid or incurred for information

base includes, for example, any portion

of the purchase price of an acquired

trade or business attributable to the

intangible value of technical manuals,

training manuals or programs, data files,

and accounting or inventory control

systems. Other examples include the

cost of acquiring customer lists,

subscription lists, insurance expirations,

patient or client files, or lists of

newspaper, magazine, radio, or

television advertisers.

(5) Know-how, etc. Section 197

intangibles include any patent,

copyright, formula, process, design,

pattern, know-how, format, package

design, computer software (as defined in

paragraph (c)(4)(iv) of this section), or

interest in a film, sound recording,

video tape, book, or other similar

property. (See, however, the exceptions

in paragraph (c) of this section.)

(6) Customer-based intangibles.

Section 197 intangibles include any

customer-based intangible. A customerbased intangible is any composition of

market, market share, or other value

resulting from the future provision of

goods or services pursuant to

contractual or other relationships in the

ordinary course of business with

customers. Thus, the amount paid or

incurred for customer-based intangibles

includes, for example, any portion of

the purchase price of an acquired trade

or business attributable to the existence

of a customer base, a circulation base,

an undeveloped market or market

growth, insurance in force, the existence

of a qualification to supply goods or

services to a particular customer, a

mortgage servicing contract (as defined

in paragraph (c)(11) of this section), an

investment management contract, or

other relationship with customers

involving the future provision of goods

or services. (See, however, the

exceptions in paragraph (c) of this

section.) In addition, customer-based

intangibles include the deposit base and

any similar asset of a financial

institution. Thus, the amount paid or

incurred for customer-based intangibles

also includes any portion of the

purchase price of an acquired financial

institution attributable to the value

represented by existing checking

accounts, savings accounts, escrow

accounts, and other similar items of the

financial institution. However, any

portion of the purchase price of an

acquired trade or business attributable

to accounts receivable or other similar

rights to income for goods or services

provided to customers prior to the

acquisition of a trade or business is not

an amount paid or incurred for a

customer-based intangible.

(7) Supplier-based intangibles.

Section 197 intangibles include any

supplier-based intangible. A supplierbased intangible is the value resulting

from the future acquisition, pursuant to

contractual or other relationships with

suppliers in the ordinary course of

business, of goods or services that will

be sold or used by the taxpayer. Thus,

the amount paid or incurred for

supplier-based intangibles includes, for

example, any portion of the purchase

price of an acquired trade or business

attributable to the existence of a

favorable relationship with persons

providing distribution services (such as

favorable shelf or display space at a

retail outlet), the existence of a favorable

credit rating, or the existence of

favorable supply contracts. The amount

paid or incurred for supplier-based

intangibles does not include any

amount required to be paid for the

goods or services themselves pursuant

to the terms of the agreement or other

relationship. In addition, see the

exceptions in paragraph (c) of this

section, including the exception in

paragraph (c)(6) of this section for

certain rights to receive tangible

property or services from another

person.

(8) Licenses, permits, and other rights

granted by governmental units. Section

197 intangibles include any license,

permit, or other right granted by a

governmental unit (including, for

purposes of section 197, an agency or

instrumentality thereof) even if the right

is granted for an indefinite period or is

reasonably expected to be renewed for

an indefinite period. These rights

include, for example, a liquor license, a

taxi-cab medallion (or license), an

airport landing or takeoff right

(sometimes referred to as a slot), a

regulated airline route, or a television or

radio broadcasting license. The issuance

or renewal of a license, permit, or other

right granted by a governmental unit is

considered an acquisition of the license,

permit, or other right. (See, however, the

exceptions in paragraph (c) of this

section, including the exceptions in

paragraph (c)(3) of this section for an

interest in land, paragraph (c)(6) of this

section for certain rights to receive

tangible property or services, paragraph

(c)(8) of this section for an interest

under a lease of tangible property, and

paragraph (c)(13) of this section for

certain rights granted by a governmental

unit. See paragraph (b)(10) of this

section for the treatment of franchises.)

(9) Covenants not to compete and

other similar arrangements. Section 197

intangibles include any covenant not to

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3829

compete, or agreement having

substantially the same effect, entered

into in connection with the direct or

indirect acquisition of an interest in a

trade or business or a substantial

portion thereof. For purposes of this

paragraph (b)(9), an acquisition may be

made in the form of an asset acquisition

(including a qualified stock purchase

that is treated as a purchase of assets

under section 338), a stock acquisition

or redemption, and the acquisition or

redemption of a partnership interest. An

agreement requiring the performance of

services for the acquiring taxpayer or

the provision of property or its use to

the acquiring taxpayer does not have

substantially the same effect as a

covenant not to compete to the extent

that the amount paid under the

agreement represents reasonable

compensation for the services actually

rendered or for the property or use of

the property actually provided.

(10) Franchises, trademarks, and

trade names. (i) Section 197 intangibles

include any franchise, trademark, or

trade name. The term franchise has the

meaning given in section 1253(b)(1) and

includes any agreement that provides

one of the parties to the agreement with

the right to distribute, sell, or provide

goods, services, or facilities, within a

specified area. The term trademark

includes any word, name, symbol, or

device, or any combination thereof,

adopted and used to identify goods or

services and distinguish them from

those provided by others. The term

trade name includes any name used to

identify or designate a particular trade

or business or the name or title used by

a person or organization engaged in a

trade or business. A license, permit, or

other right granted by a governmental

unit is a franchise if it otherwise meets

the definition of a franchise. A

trademark or trade name includes any

trademark or trade name arising under

statute or applicable common law, and

any similar right granted by contract.

The renewal of a franchise, trademark,

or trade name is treated as an

acquisition of the franchise, trademark,

or trade name.

(ii) Notwithstanding the definitions

provided in paragraph (b)(10)(i) of this

section, any amount that is paid or

incurred on account of a transfer, sale,

or other disposition of a franchise,

trademark, or trade name and that is

subject to section 1253(d)(1) is not

included in the basis of a section 197

intangible. (See paragraph (g)(6) of this

section.)

(11) Contracts for the use of, and term

interests in, section 197 intangibles.

Section 197 intangibles include any

right under a license, contract, or other

arrangement providing for the use of

property that would be a section 197

intangible under any provision of this

paragraph (b) (including this paragraph

(b)(11)) after giving effect to all of the

exceptions provided in paragraph (c) of

this section. Section 197 intangibles also

include any term interest (whether

outright or in trust) in such property.

(12) Other similar items. Section 197

intangibles include any other intangible

property that is similar in all material

respects to the property specifically

described in section 197(d)(1)(C)(i)

through (v) and paragraphs (b)(3)

through (7) of this section. (See

paragraph (g)(5) of this section for

special rules regarding certain

reinsurance transactions.)

(c) Section 197 intangibles;

exceptions. The term section 197

intangible does not include property

described in section 197(e). The

following rules and definitions provide

guidance concerning property to which

the exceptions apply:

(1)Interests in a corporation,

partnership, trust, or estate. Section 197

intangibles do not include an interest in

a corporation, partnership, trust, or

estate. Thus, for example, amortization

under section 197 is not available for

the cost of acquiring stock, partnership

interests, or interests in a trust or estate,

whether or not the interests are

regularly traded on an established

market. (See paragraph (g)(3) of this

section for special rules applicable to

property of a partnership when a section

754 election is in effect for the

partnership.)

(2) Interests under certain financial

contracts. Section 197 intangibles do

not include an interest under an existing

futures contract, foreign currency

contract, notional principal contract,

interest rate swap, or other similar

financial contract, whether or not the

interest is regularly traded on an

established market. However, this

exception does not apply to an interest

under a mortgage servicing contract,

credit card servicing contract, or other

contract to service another person’s

indebtedness, or an interest under an

assumption reinsurance contract. (See

paragraph (g)(5) of this section for the

treatment of assumption reinsurance

contracts. See paragraph (c)(11) of this

section and § 1.167(a)–14(d) for the

treatment of mortgage servicing rights.)

(3) Interests in land. Section 197

intangibles do not include any interest

in land. For this purpose, an interest in

land includes a fee interest, life estate,

remainder, easement, mineral right,

timber right, grazing right, riparian

right, air right, zoning variance, and any

other similar right, such as a farm

allotment, quota for farm commodities,

or crop acreage base. An interest in land

does not include an airport landing or

takeoff right, a regulated airline route, or

a franchise to provide cable television

service. The cost of acquiring a license,

permit, or other land improvement

right, such as a building construction or

use permit, is taken into account in the

same manner as the underlying

improvement.

(4) Certain computer software—(i)

Publicly available. Section 197

intangibles do not include any interest

in computer software that is (or has

been) readily available to the general

public on similar terms, is subject to a

nonexclusive license, and has not been

substantially modified. Computer

software will be treated as readily

available to the general public if the

software may be obtained on

substantially the same terms by a

significant number of persons that

would reasonably be expected to use the

software. This requirement can be met

even though the software is not

available through a system of retail

distribution. Computer software will not

be considered to have been substantially

modified if the cost of all modifications

to the version of the software that is

readily available to the general public

does not exceed the greater of 25

percent of the price at which the

unmodified version of the software is

readily available to the general public or

$2,000. For the purpose of determining

whether computer software has been

substantially modified—

(A) Integrated programs acquired in a

package from a single source are treated

as a single computer program; and

(B) Any cost incurred to install the

computer software on a system is not

treated as a cost of the software.

However, the costs for customization,

such as tailoring to a user’s

specifications (other than embedded

programming options) are costs of

modifying the software.

(ii) Not acquired as part of trade or

business. Section 197 intangibles do not

include an interest in computer software

that is not acquired as part of a purchase

of a trade or business.

(iii) Other exceptions. For other

exceptions applicable to computer

software, see paragraph (a)(3) of this

section (relating to otherwise deductible

amounts) and paragraph (g)(7) of this

section (relating to amounts properly

taken into account in determining the

cost of property that is not a section 197

intangible).

(iv) Computer software defined. For

purposes of this section, computer

software is any program or routine (that

is, any sequence of machine-readable

3830 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

code) that is designed to cause a

computer to perform a desired function

or set of functions, and the

documentation required to describe and

maintain that program or routine. It

includes all forms and media in which

the software is contained, whether

written, magnetic, or otherwise.

Computer programs of all classes, for

example, operating systems, executive

systems, monitors, compilers and

translators, assembly routines, and

utility programs as well as application

programs, are included. Computer

software also includes any incidental

and ancillary rights that are necessary to

effect the acquisition of the title to, the

ownership of, or the right to use the

computer software, and that are used

only in connection with that specific

computer software. Such incidental and

ancillary rights are not included in the

definition of trademark or trade name

under paragraph (b)(10)(i) of this

section. For example, a trademark or

trade name that is ancillary to the

ownership or use of a specific computer

software program in the taxpayer’s trade

or business and is not acquired for the

purpose of marketing the computer

software is included in the definition of

computer software and is not included

in the definition of trademark or trade

name. Computer software does not

include any data or information base

described in paragraph (b)(4) of this

section unless the data base or item is

in the public domain and is incidental

to a computer program. For this

purpose, a copyrighted or proprietary

data or information base is treated as in

the public domain if its availability

through the computer program does not

contribute significantly to the cost of the

program. For example, if a wordprocessing program includes a

dictionary feature used to spell-check a

document or any portion thereof, the

entire program (including the dictionary

feature) is computer software regardless

of the form in which the feature is

maintained or stored.

(5) Certain interests in films, sound

recordings, video tapes, books, or other

similar property. Section 197 intangibles

do not include any interest (including

an interest as a licensee) in a film,

sound recording, video tape, book, or

other similar property (such as the right

to broadcast or transmit a live event) if

the interest is not acquired as part of a

purchase of a trade or business. A film,

sound recording, video tape, book, or

other similar property includes any

incidental and ancillary rights (such as

a trademark or trade name) that are

necessary to effect the acquisition of

title to, the ownership of, or the right to

use the property and are used only in

connection with that property. Such

incidental and ancillary rights are not

included in the definition of trademark

or trade name under paragraph (b)(10)(i)

of this section. For purposes of this

paragraph (c)(5), computer software (as

defined in paragraph (c)(4)(iv) of this

section) is not treated as other property

similar to a film, sound recording, video

tape, or book. (See section 167 for

amortization of excluded intangible

property or interests.)

(6) Certain rights to receive tangible

property or services. Section 197

intangibles do not include any right to

receive tangible property or services

under a contract or from a governmental

unit if the right is not acquired as part

of a purchase of a trade or business. Any

right that is described in the preceding

sentence is not treated as a section 197

intangible even though the right is also

described in section 197(d)(1)(D) and

paragraph (b)(8) of this section (relating

to certain governmental licenses,

permits, and other rights) and even

though the right fails to meet one or

more of the requirements of paragraph

(c)(13) of this section (relating to certain

rights of fixed duration or amount). (See

§ 1.167(a)–14(c) (1) and (3) for

applicable rules.)

(7) Certain interests in patents or

copyrights. Section 197 intangibles do

not include any interest (including an

interest as a licensee) in a patent, patent

application, or copyright that is not

acquired as part of a purchase of a trade

or business. A patent or copyright

includes any incidental and ancillary

rights (such as a trademark or trade

name) that are necessary to effect the

acquisition of title to, the ownership of,

or the right to use the property and are

used only in connection with that

property. Such incidental and ancillary

rights are not included in the definition

of trademark or trade name under

paragraph (b)(10)(i) of this section. (See

§ 1.167(a)–14(c)(4) for applicable rules.)

(8) Interests under leases of tangible

property—(i) Interest as a lessor.

Section 197 intangibles do not include

any interest as a lessor under an existing

lease or sublease of tangible real or

personal property. In addition, the cost

of acquiring an interest as a lessor in

connection with the acquisition of

tangible property is taken into account

as part of the cost of the tangible

property. For example, if a taxpayer

acquires a shopping center that is leased

to tenants operating retail stores, any

portion of the purchase price

attributable to favorable lease terms is

taken into account as part of the basis

of the shopping center and in

determining the depreciation deduction

allowed with respect to the shopping

center. (See section 167(c)(2).)

(ii) Interest as a lessee. Section 197

intangibles do not include any interest

as a lessee under an existing lease of

tangible real or personal property. For

this purpose, an airline lease of an

airport passenger or cargo gate is a lease

of tangible property. The cost of

acquiring such an interest is taken into

account under section 178 and § 1.162–

11(a). If an interest as a lessee under a

lease of tangible property is acquired in

a transaction with any other intangible

property, a portion of the total purchase

price may be allocable to the interest as

a lessee based on all of the relevant facts

and circumstances.

(9) Interests under indebtedness—(i)

In general. Section 197 intangibles do

not include any interest (whether as a

creditor or debtor) under an

indebtedness in existence when the

interest was acquired. Thus, for

example, the value attributable to the

assumption of an indebtedness with a

below-market interest rate is not

amortizable under section 197. In

addition, the premium paid for

acquiring a debt instrument with an

above-market interest rate is not

amortizable under section 197. See

section 171 for rules concerning the

treatment of amortizable bond premium.

(ii) Exceptions. For purposes of this

paragraph (c)(9), an interest under an

existing indebtedness does not include

the deposit base (and other similar

items) of a financial institution. An

interest under an existing indebtedness

includes mortgage servicing rights,

however, to the extent the rights are

stripped coupons under section 1286.

(10) Professional sports franchises.

Section 197 intangibles do not include

any franchise to engage in professional

baseball, basketball, football, or any

other professional sport, and any item

(even though otherwise qualifying as a

section 197 intangible) acquired in

connection with such a franchise.

(11) Mortgage servicing rights. Section

197 intangibles do not include any right

described in section 197(e)(7)

(concerning rights to service

indebtedness secured by residential real

property that are not acquired as part of

a purchase of a trade or business). (See

§ 1.167(a)–14(d) for applicable rules.)

(12) Certain transaction costs. Section

197 intangibles do not include any fees

for professional services and any

transaction costs incurred by parties to

a transaction in which all or any portion

of the gain or loss is not recognized

under part III of subchapter C of the

Internal Revenue Code.

(13) Rights of fixed duration or

amount. (i) Section 197 intangibles do

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3831

not include any right under a contract

or any license, permit, or other right

granted by a governmental unit if the

right—

(A) Is acquired in the ordinary course

of a trade or business (or an activity

described in section 212) and not as part

of a purchase of a trade or business;

(B) Is not described in section

197(d)(1)(A), (B), (E), or (F);

(C) Is not a customer-based intangible,

a customer-related information base, or

any other similar item; and

(D) Either—

(1) Has a fixed duration of less than

15 years; or

(2) Is fixed as to amount and the

adjusted basis thereof is properly

recoverable (without regard to this

section) under a method similar to the

unit-of-production method.

(ii) See § 1.167(a)–14(c)(2) and (3) for

applicable rules.

(d) Amortizable section 197

intangibles—(1) Definition. Except as

otherwise provided in this paragraph

(d), the term amortizable section 197

intangible means any section 197

intangible acquired after August 10,

1993 (or after July 25, 1991, if a valid

retroactive election under § 1.197–1T

has been made), and held in connection

with the conduct of a trade or business

or an activity described in section 212.

(2) Exception for self-created

intangibles—(i) In general. Except as

provided in paragraph (d)(2)(iii) of this

section, amortizable section 197

intangibles do not include any section

197 intangible created by the taxpayer (a

self-created intangible).

(ii) Created by the taxpayer—(A)

Defined. A section 197 intangible is

created by the taxpayer to the extent the

taxpayer makes payments or otherwise

incurs costs for its creation, production,

development, or improvement, whether

the actual work is performed by the

taxpayer or by another person under a

contract with the taxpayer entered into

before the contracted creation,

production, development, or

improvement occurs. For example, a

technological process developed

specifically for a taxpayer under an

arrangement with another person

pursuant to which the taxpayer retains

all rights to the process is created by the

taxpayer.

(B) Contracts for the use of

intangibles. A section 197 intangible is

not a self-created intangible to the

extent that it results from the entry into

(or renewal of) a contract for the use of

an existing section 197 intangible. Thus,

for example, the exception for selfcreated intangibles does not apply to

capitalized costs, such as legal and other

professional fees, incurred by a licensee

in connection with the entry into (or

renewal of) a contract for the use of

know-how or similar property.

(C) Improvements and modifications.

If an existing section 197 intangible is

improved or otherwise modified by the

taxpayer or by another person under a

contract with the taxpayer, the existing

intangible and the capitalized costs (if

any) of the improvements or other

modifications are each treated as a

separate section 197 intangible for

purposes of this paragraph (d).

(iii) Exceptions. (A) The exception for

self-created intangibles does not apply

to any section 197 intangible described

in section 197(d)(1)(D) (relating to

licenses, permits or other rights granted

by a governmental unit), 197(d)(1)(E)

(relating to covenants not to compete),

or 197(d)(1)(F) (relating to franchises,

trademarks, and trade names). Thus, for

example, capitalized costs incurred in

the development, registration, or

defense of a trademark or trade name do

not qualify for the exception and are

amortized over 15 years under section

197.

(B) The exception for self-created

intangibles does not apply to any

section 197 intangible created in

connection with the purchase of a trade

or business (as defined in paragraph (e)

of this section).

(C) If a taxpayer disposes of a selfcreated intangible and subsequently

reacquires the intangible in an

acquisition described in paragraph

(h)(5)(ii) of this section, the exception

for self-created intangibles does not

apply to the reacquired intangible.

(3) Exception for property subject to

anti-churning rules. Amortizable section

197 intangibles do not include any

property to which the anti-churning

rules of section 197(f)(9) and paragraph

(h) of this section apply.

(e) Purchase of a trade or business.

Several of the exceptions in section 197

apply only to property that is not

acquired in (or created in connection

with) a transaction or series of related

transactions involving the acquisition of

assets constituting a trade or business or

a substantial portion thereof. Property

acquired in (or created in connection

with) such a transaction or series of

related transactions is referred to in this

section as property acquired as part of

(or created in connection with) a

purchase of a trade or business. For

purposes of section 197 and this section,

the applicability of the limitation is

determined under the following rules:

(1) Goodwill or going concern value.

An asset or group of assets constitutes

a trade or business or a substantial

portion thereof if their use would

constitute a trade or business under

section 1060 (that is, if goodwill or

going concern value could under any

circumstances attach to the assets). See

§ 1.1060–1T(b)(2). For this purpose, all

the facts and circumstances, including

any employee relationships that

continue (or covenants not to compete

that are entered into) as part of the

transfer of the assets, are taken into

account in determining whether

goodwill or going concern value could

attach to the assets.

(2) Franchise, trademark, or trade

name—(i) In general. The acquisition of

a franchise, trademark, or trade name

constitutes the acquisition of a trade or

business or a substantial portion thereof.

(ii) Exceptions. For purposes of this

paragraph (e)(2)—

(A) A trademark or trade name is

disregarded if it is included in computer

software under paragraph (c)(4) of this

section or in an interest in a film, sound

recording, video tape, book, or other

similar property under paragraph (c)(5)

of this section;

(B) A franchise, trademark, or trade

name is disregarded if its value is

nominal or the taxpayer irrevocably

disposes of it immediately after its

acquisition; and

(C) The acquisition of a right or

interest in a trademark or trade name is

disregarded if the grant of the right or

interest is not, under the principles of

section 1253, a transfer of all substantial

rights to such property or of an

undivided interest in all substantial

rights to such property.

(3) Acquisitions to be included. The

assets acquired in a transaction (or

series of related transactions) include

only assets (including a beneficial or

other indirect interest in assets where

the interest is of a type described in

paragraph (c)(1) of this section) acquired

by the taxpayer and persons related to

the taxpayer from another person and

persons related to that other person. For

purposes of this paragraph (e)(3),

persons are related only if their

relationship is described in section

267(b) or 707(b) or they are engaged in

trades or businesses under common

control within the meaning of section

41(f)(1).

(4) Substantial portion. The

determination of whether acquired

assets constitute a substantial portion of

a trade or business is to be based on all

of the facts and circumstances,

including the nature and the amount of

the assets acquired as well as the nature

and amount of the assets retained by the

transferor. The value of the assets

acquired relative to the value of the

assets retained by the transferor is not

determinative of whether the acquired

3832 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

assets constitute a substantial portion of

a trade or business.

(5) Deemed asset purchases under

section 338. A qualified stock purchase

that is treated as a purchase of assets

under section 338 is treated as a

transaction involving the acquisition of

assets constituting a trade or business

only if the direct acquisition of the

assets of the corporation would have

been treated as the acquisition of assets

constituting a trade or business or a

substantial portion thereof.

(6) Mortgage servicing rights.

Mortgage servicing rights acquired in a

transaction or series of related

transactions are disregarded in

determining for purposes of paragraph

(c)(11) of this section whether the assets

acquired in the transaction or

transactions constitute a trade or

business or substantial portion thereof.

(7) Computer software acquired for

internal use. Computer software

acquired in a transaction or series of

related transactions solely for internal

use in an existing trade or business is

disregarded in determining for purposes

of paragraph (c)(4) of this section

whether the assets acquired in the

transaction or series of related

transactions constitute a trade or

business or substantial portion thereof.

(f) Computation of amortization

deduction—(1) In general. Except as

provided in paragraph (f)(2) of this

section, the amortization deduction

allowable under section 197(a) is

computed as follows:

(i) The basis of an amortizable section

197 intangible is amortized ratably over

the 15-year period beginning on the

later of—

(A) The first day of the month in

which the property is acquired; or

(B) In the case of property held in

connection with the conduct of a trade

or business or in an activity described

in section 212, the first day of the month

in which the conduct of the trade or

business or the activity begins.

(ii) Except as otherwise provided in

this section, basis is determined under

section 1011 and salvage value is

disregarded.

(iii) Property is not eligible for

amortization in the month of

disposition.

(iv) The amortization deduction for a

short taxable year is based on the

number of months in the short taxable

year.

(2) Treatment of contingent

amounts—(i) Amounts added to basis

during 15-year period. Any amount that

is properly included in the basis of an

amortizable section 197 intangible after

the first month of the 15-year period

described in paragraph (f)(1)(i) of this

section and before the expiration of that

period is amortized ratably over the

remainder of the 15-year period. For this

purpose, the remainder of the 15-year

period begins on the first day of the

month in which the basis increase

occurs.

(ii) Amounts becoming fixed after

expiration of 15-year period. Any

amount that is not properly included in

the basis of an amortizable section 197

intangible until after the expiration of

the 15-year period described in

paragraph (f)(1)(i) of this section is

amortized in full immediately upon the

inclusion of the amount in the basis of

the intangible.

(iii) Rules for including amounts in

basis. See §§ 1.1275–4(c)(4) and 1.483–

4(a) for rules governing the extent to

which contingent amounts payable

under a debt instrument given in

consideration for the sale or exchange of

an amortizable section 197 intangible

are treated as payments of principal and

the time at which the amount treated as

principal is included in basis. See

§ 1.461–1(a)(1) and (2) for rules

governing the time at which other

contingent amounts are taken into

account in determining the basis of an

amortizable section 197 intangible.

(3) Basis determinations for certain

assets—(i) Covenants not to compete. In

the case of a covenant not to compete

or other similar arrangement described

in paragraph (b)(9) of this section (a

covenant), the amount chargeable to

capital account includes, except as

provided in this paragraph (f)(3), all

amounts that are required to be paid

pursuant to the covenant, whether or

not any such amount would be

deductible under section 162 if the

covenant were not a section 197

intangible.

(ii) Contracts for the use of section

197 intangibles; acquired as part of a

trade or business—(A) In general.

Except as provided in this paragraph

(f)(3), any amount paid or incurred by

the transferee on account of the transfer

of a right or term interest described in

paragraph (b)(11) of this section

(relating to contracts for the use of, and

term interests in, section 197

intangibles) by the owner of the

property to which such right or interest

relates and as part of a purchase of a

trade or business is chargeable to capital

account, whether or not such amount

would be deductible under section 162

if the property were not a section 197

intangible.

(B) Know-how and certain

information base. The amount

chargeable to capital account with

respect to a right or term interest

described in paragraph (b)(11) of this

section is determined without regard to

the rule in paragraph (f)(3)(ii)(A) of this

section if the right or interest relates to

property (other than a customer-related

information base) described in

paragraph (b)(4) or (5) of this section

and the acquiring taxpayer establishes

that—

(1) The transfer of the right or interest

is not, under the principles of section

1235, a transfer of all substantial rights

to such property or of an undivided

interest in all substantial rights to such

property; and

(2) The right or interest was

transferred for an arm’s-length

consideration.

(iii) Contracts for the use of section

197 intangibles; not acquired as part of

a trade or business. The transfer of a

right or term interest described in

paragraph (b)(11) of this section by the

owner of the property to which such

right or interest relates but not as part

of a purchase of a trade or business will

be closely scrutinized under the

principles of section 1235 for purposes

of determining whether the transfer is a

sale or exchange and, accordingly,

whether amounts paid on account of the

transfer are chargeable to capital

account. If under the principles of

section 1235 the transaction is not a sale

or exchange, amounts paid on account

of the transfer are not chargeable to

capital account under this paragraph

(f)(3).

(iv) Applicable rules—(A) Franchises,

trademarks, and trade names. For

purposes of this paragraph (f)(3), section

197 intangibles described in paragraph

(b)(11) of this section do not include any

property that is also described in

paragraph (b)(10) of this section

(relating to franchises, trademarks, and

trade names).

(B) Certain amounts treated as

payable under a debt instrument—(1) In

general. For purposes of applying any

provision of the Internal Revenue Code

to a person making payments of

amounts that are otherwise chargeable

to capital account under this paragraph

(f)(3) and are payable after the

acquisition of the section 197 intangible

to which they relate, such amounts are

treated as payable under a debt

instrument given in consideration for

the sale or exchange of the section 197

intangible.

(2) Rights granted by governmental

units. For purposes of applying any

provision of the Internal Revenue Code

to any amounts that are otherwise

chargeable to capital account with

respect to a license, permit, or other

right described in paragraph (b)(8) of

this section (relating to rights granted by

a governmental unit or agency or

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3833

instrumentality thereof) and are payable

after the acquisition of the section 197

intangible to which they relate, such

amounts are treated, except as provided

in paragraph (f)(4)(i) of this section

(relating to renewal transactions), as

payable under a debt instrument given

in consideration for the sale or exchange

of the section 197 intangible.

(3) Treatment of other parties to

transaction. No person shall be treated

as having sold, exchanged, or otherwise

disposed of property in a transaction for

purposes of any provision of the

Internal Revenue Code solely by reason

of the application of this paragraph (f)(3)

to any other party to the transaction.

(4) Basis determinations in certain

transactions —(i) Certain renewal

transactions. The costs paid or incurred

for the renewal of a franchise,

trademark, or trade name or any license,

permit, or other right granted by a

governmental unit or an agency or

instrumentality thereof are amortized

over the 15-year period that begins with

the month of renewal. Any costs paid or

incurred for the issuance, or earlier

renewal, continue to be taken into

account over the remaining portion of

the amortization period that began at the

time of the issuance, or earlier renewal.

Any amount paid or incurred for the

protection, expansion, or defense of a

trademark or trade name and chargeable

to capital account is treated as an

amount paid or incurred for a renewal.

(ii) Transactions subject to section

338 or 1060. In the case of a section 197

intangible deemed to have been

acquired as the result of a qualified

stock purchase within the meaning of

section 338(d)(3), the basis shall be

determined pursuant to section

338(b)(5) and the regulations

thereunder. In the case of a section 197

intangible acquired in an applicable

asset acquisition within the meaning of

section 1060(c), the basis shall be

determined pursuant to section 1060(a)

and the regulations thereunder.

(iii) Certain reinsurance transactions.

See paragraph (g)(5)(ii) of this section

for special rules regarding the adjusted

basis of an insurance contract acquired

through an assumption reinsurance

transaction.

(g) Special rules—(1) Treatment of

certain dispositions—(i) Loss

disallowance rules—(A) In general. No

loss is recognized on the disposition of

an amortizable section 197 intangible if

the taxpayer has any retained

intangibles. The retained intangibles

with respect to the disposition of any

amortizable section 197 intangible (the

transferred intangible) are all

amortizable section 197 intangibles, or

rights to use or interests (including

beneficial or other indirect interests) in

amortizable section 197 intangibles

(including the transferred intangible)

that were acquired in the same

transaction or series of related

transactions as the transferred intangible

and are retained after its disposition.

Except as otherwise provided in

paragraph (g)(1)(iv)(B) of this section,

the adjusted basis of each of the retained

intangibles is increased by the product

of—

(1) The loss that is not recognized

solely by reason of this rule; and

(2) A fraction, the numerator of which

is the adjusted basis of the retained

intangible on the date of the disposition

and the denominator of which is the

total adjusted bases of all the retained

intangibles on that date.

(B) Abandonment or worthlessness.

The abandonment of an amortizable

section 197 intangible, or any other

event rendering an amortizable section

197 intangible worthless, is treated as a

disposition of the intangible for

purposes of this paragraph (g)(1), and

the abandoned or worthless intangible is

disregarded (that is, it is not treated as

a retained intangible) for purposes of

applying this paragraph (g)(1) to the

subsequent disposition of any other

amortizable section 197 intangible.

(C) Certain nonrecognition transfers.

The loss disallowance rule in paragraph

(g)(1)(i)(A) of this section also applies

when a taxpayer transfers an

amortizable section 197 intangible from

an acquired trade or business in a

transaction in which the intangible is

transferred basis property and, after the

transfer, retains other amortizable

section 197 intangibles from the trade or

business. Thus, for example, the transfer

of an amortizable section 197 intangible

to a corporation in exchange for stock in

the corporation in a transaction

described in section 351, or to a

partnership in exchange for an interest

in the partnership in a transaction

described in section 721, when other

amortizable section 197 intangibles

acquired in the same transaction are

retained, followed by a sale of the stock

or partnership interest received, will not

avoid the application of the loss

disallowance provision to the extent the

adjusted basis of the transferred

intangible at the time of the sale exceeds

its fair market value at that time.

(ii) Separately acquired property.

Paragraph (g)(1)(i) of this section does

not apply to an amortizable section 197

intangible that is not acquired in a

transaction or series of related

transactions in which the taxpayer

acquires other amortizable section 197

intangibles (a separately acquired

intangible). Consequently, a loss may be

recognized upon the disposition of a

separately acquired amortizable section

197 intangible. However, the

termination or worthlessness of only a

portion of an amortizable section 197

intangible is not the disposition of a

separately acquired intangible. For

example, neither the loss of several

customers from an acquired customer

list nor the worthlessness of only some

information from an acquired data base

constitutes the disposition of a

separately acquired intangible.

(iii) Disposition of a covenant not to

compete. If a covenant not to compete

or any other arrangement having

substantially the same effect is entered

into in connection with the direct or

indirect acquisition of an interest in one

or more trades or businesses, the

disposition or worthlessness of the

covenant or other arrangement will not

be considered to occur until the

disposition or worthlessness of all

interests in those trades or businesses.

For example, a covenant not to compete

entered into in connection with the

purchase of stock continues to be

amortized ratably over the 15-year

recovery period (even after the covenant

expires or becomes worthless) unless all

the trades or businesses in which an

interest was acquired through the stock

purchase (or all the purchaser’s interests

in those trades or businesses) also are

disposed of or become worthless.

(iv) Taxpayers under common

control—(A) In general. Except as

provided in paragraph (g)(1)(iv)(B) of

this section, all persons that would be

treated as a single taxpayer under

section 41(f)(1) are treated as a single

taxpayer under this paragraph (g)(1).

Thus, for example, a loss is not

recognized on the disposition of an

amortizable section 197 intangible by a

member of a controlled group of

corporations (as defined in section

41(f)(5)) if, after the disposition, another

member retains other amortizable

section 197 intangibles acquired in the

same transaction as the amortizable

section 197 intangible that has been

disposed of.

(B) Treatment of disallowed loss. If

retained intangibles are held by a person

other than the person incurring the

disallowed loss, only the adjusted basis

of intangibles retained by the person

incurring the disallowed loss is

increased, and only the adjusted basis of

those intangibles is included in the

denominator of the fraction described in

paragraph (g)(1)(i)(A) of this section. If

none of the retained intangibles are held

by the person incurring the disallowed

loss, the loss is allowed ratably, as a

deduction under section 197, over the

remainder of the period during which

3834 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

the intangible giving rise to the loss

would have been amortizable, except

that any remaining disallowed loss is

allowed in full on the first date on

which all other retained intangibles

have been disposed of or become

worthless.

(2) Treatment of certain

nonrecognition and exchange

transactions—(i) Relationship to antichurning rules. This paragraph (g)(2)

provides rules relating to the treatment

of section 197 intangibles acquired in

certain transactions. If these rules apply

to a section 197(f)(9) intangible (within

the meaning of paragraph (h)(1)(i) of this

section), the intangible is,

notwithstanding its treatment under this

paragraph (g)(2), treated as an

amortizable section 197 intangible only

to the extent permitted under paragraph

(h) of this section.

(ii) Treatment of nonrecognition and

exchange transactions generally—(A)

Transfer disregarded. If a section 197

intangible is transferred in a transaction

described in paragraph (g)(2)(ii)(C) of

this section, the transfer is disregarded

in determining—

(1) Whether, with respect to so much

of the intangible’s basis in the hands of

the transferee as does not exceed its

basis in the hands of the transferor, the

intangible is an amortizable section 197

intangible; and

(2) The amount of the deduction

under section 197 with respect to such

basis.

(B) Application of general rule. If the

intangible described in paragraph

(g)(2)(ii)(A) of this section was an

amortizable section 197 intangible in

the hands of the transferor, the

transferee will continue to amortize its

adjusted basis, to the extent it does not

exceed the transferor’s adjusted basis,

ratably over the remainder of the

transferor’s 15-year amortization period.

If the intangible was not an amortizable

section 197 intangible in the hands of

the transferor, the transferee’s adjusted

basis, to the extent it does not exceed

the transferor’s adjusted basis, cannot be

amortized under section 197. In either

event, the intangible is treated, with

respect to so much of its adjusted basis

in the hands of the transferee as exceeds

its adjusted basis in the hands of the

transferor, in the same manner for

purposes of section 197 as an intangible

acquired from the transferor in a

transaction that is not described in

paragraph (g)(2)(ii)(C) of this section.

The rules of this paragraph (g)(2)(ii) also

apply to any subsequent transfers of the

intangible in a transaction described in

paragraph (g)(2)(ii)(C) of this section.

(C) Transactions covered. The

transactions described in this paragraph

(g)(2)(ii)(C) are—

( 1) Any transaction described in

section 332, 351, 361, 721, or 731; and

(2) Any transaction between

corporations that are members of the

same consolidated group immediately

after the transaction.

(iii) Certain exchanged-basis property.

This paragraph (g)(2)(iii) applies to

property that is acquired in a

transaction subject to section 1031 or

1033 and is permitted to be acquired

without recognition of gain

(replacement property). Replacement

property is treated as if it were the

property by reference to which its basis

is determined (the predecessor property)

in determining whether, with respect to

so much of its basis as does not exceed

the basis of the predecessor property,

the replacement property is an

amortizable section 197 intangible and

the amortization period under section

197 with respect to such basis. Thus, if

the predecessor property was an

amortizable section 197 intangible, the

taxpayer will amortize the adjusted

basis of the replacement property, to the

extent it does not exceed the adjusted

basis of the predecessor property,

ratably over the remainder of the 15-

year amortization period for the

predecessor property. If the predecessor

property was not an amortizable section

197 intangible, the adjusted basis of the

replacement property, to the extent it

does not exceed the adjusted basis of the

predecessor property, may not be

amortized under section 197. In either

event, the replacement property is

treated, with respect to so much of its

adjusted basis as exceeds the adjusted

basis of the predecessor property, in the

same manner for purposes of section

197 as property acquired from the

transferor in a transaction that is not

subject to section 1031 or 1033.

(iv) Transfers under section

708(b)(1)—(A) In general. Paragraph

(g)(2)(ii) of this section applies to

transfers of section 197 intangibles that

occur or are deemed to occur by reason

of the termination of a partnership

under section 708(b)(1).

(B) Termination by sale or exchange

of interest. In applying paragraph

(g)(2)(ii) of this section to a partnership

that is terminated pursuant to section

708(b)(1)(B) (relating to deemed

terminations from the sale or exchange

of an interest), the terminated

partnership is treated as the transferor

and the new partnership is treated as

the transferee with respect to any

section 197 intangible held by the

terminated partnership immediately

preceding the termination. (See

paragraph (g)(3) of this section for the

treatment of increases in the bases of

property of the terminated partnership

under section 743(b).)

(C) Other terminations. In applying

paragraph (g)(2)(ii) of this section to a

partnership that is terminated pursuant

to section 708(b)(1)(A) (relating to

cessation of activities by a partnership),

the terminated partnership is treated as

the transferor and the distributee

partner is treated as the transferee with

respect to any section 197 intangible

held by the terminated partnership

immediately preceding the termination.

(3) Increase in the basis of partnership

property under section 732(b), 734(b),

743(b), or 732(d). Any increase in the

adjusted basis of a section 197

intangible under sections 732(b) or

732(d) (relating to a partner’s basis in

property distributed by a partnership),

section 734(b) (relating to the optional

adjustment to the basis of undistributed

partnership property after a distribution

of property to a partner), or section

743(b) (relating to the optional

adjustment to the basis of partnership

property after transfer of a partnership

interest) is treated as a separate section

197 intangible. For purposes of

determining the amortization period

under section 197 with respect to the

basis increase, the intangible is treated

as having been acquired at the time of

the transaction that causes the basis

increase. The provisions of paragraph

(f)(2) of this section apply to the extent

that the amount of the basis increase is

determined by reference to contingent

payments. For purposes of the effective

date and anti-churning provisions

(paragraphs (l)(1) and (h) of this section)

for a basis increase under section

732(d), the intangible is treated as

having been acquired by the transferee

partner at the time of the transfer of the

partnership interest described in section

732(d).

(4) Section 704(c) allocations —(i)

Allocations where the intangible is

amortizable by the contributor. To the

extent that the intangible was an

amortizable section 197 intangible in

the hands of the contributing partner, a

partnership may make allocations of

amortization deductions with respect to

the intangible to all of its partners under

either the curative or remedial

allocation methods described in the

regulations under section 704(c). See

§ 1.704–3(c) and (d).

(ii) Allocations where the intangible is

not amortizable by the contributor. To

the extent that the intangible was not an

amortizable section 197 intangible in

the hands of the contributing partner,

the intangible is not amortizable by the

partnership. However, if a partner

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3835

contributes a section 197 intangible to a

partnership and the partnership adopts

the remedial allocation method for

making section 704(c) allocations of

amortization deductions, the

partnership generally may make

remedial allocations of amortization

deductions with respect to the

contributed section 197 intangible in

accordance with § 1.704–3(d). See

paragraph (h)(12) of this section to

determine the application of the antichurning rules in the context of

remedial allocations.

(5) Treatment of certain reinsurance

transactions—(i) In general. Section 197

applies to any insurance contract

acquired from another person through

an assumption reinsurance transaction.

For purposes of section 197, an

assumption reinsurance transaction is—

(A) Any arrangement in which one

insurance company (the reinsurer)

becomes solely liable to policyholders

on contracts transferred by another

insurance company (the ceding

company); and

(B) Any acquisition of an insurance

contract that is treated as occurring by

reason of an election under section 338.

(ii) Determination of adjusted basis—

(A) Acquisitions (other than under

section 338) of specified insurance

contracts. The amount taken into

account for purposes of section 197 as

the adjusted basis of specified insurance

contracts (as defined in section

848(e)(1)) acquired in an assumption

reinsurance transaction that is not

described in paragraph (g)(5)(i)(B) of

this section is equal to the excess of—

(1) The amount paid or incurred (or

treated as having been paid or incurred)

by the reinsurer for the purchase of the

contracts (as determined under § 1.817–

4(d)(2)); over

(2) The amount of the specified policy

acquisition expenses that are

attributable to the reinsurer’s net

positive consideration for the

reinsurance agreement (as determined

under § 1.848–2(f)(3)).

(B) Insolvent ceding company. The

reduction of the amount of specified

policy acquisition expenses by the

reinsurer with respect to an assumption

reinsurance transaction with an

insolvent ceding company where the

ceding company and reinsurer have

made a valid joint election under

section 1.848–2(i)(4) is disregarded in

determining the amount of specified

policy acquisition expenses for

purposes of this paragraph (g)(5)(ii).

(C) Other acquisitions. [Reserved]

(6) Amounts paid or incurred for a

franchise, trademark, or trade name. If

an amount to which section 1253(d)

(relating to the transfer, sale, or other

disposition of a franchise, trademark, or

trade name) applies is described in

section 1253(d)(1)(B) (relating to

contingent serial payments deductible

under section 162), the amount is not

included in the adjusted basis of the

intangible for purposes of section 197.

Any other amount, whether fixed or

contingent, to which section 1253(d)

applies is chargeable to capital account

under section 1253(d)(2) and is

amortizable only under section 197.

(7) Amounts properly taken into

account in determining the cost of

property that is not a section 197

intangible. Section 197 does not apply

to an amount that is properly taken into

account in determining the cost of

property that is not a section 197

intangible. The entire cost of acquiring

the other property is included in its

basis and recovered under other

applicable Internal Revenue Code

provisions. Thus, for example, section

197 does not apply to the cost of an

interest in computer software to the

extent such cost is included, without

being separately stated, in the cost of the

hardware or other tangible property and

is consistently treated as part of the cost

of the hardware or other tangible

property.

(8) Treatment of amortizable section

197 intangibles as depreciable property.

An amortizable section 197 intangible is

treated as property of a character subject

to the allowance for depreciation under

section 167. Thus, for example, an

amortizable section 197 intangible is not

a capital asset for purposes of section

1221, but if used in a trade or business

and held for more than one year, gain

or loss on its disposition generally

qualifies as section 1231 gain or loss.

Also, an amortizable section 197

intangible is section 1245 property and

section 1239 applies to any gain

recognized upon its sale or exchange

between related persons (as defined in

section 1239(b)).

(h) Anti-churning rules—(1) Scope

and purpose—(i) Scope. This paragraph

(h) applies to section 197(f)(9)

intangibles. For this purpose, section

197(f)(9) intangibles are goodwill and

going concern value that was held or

used at any time during the transition

period and any other section 197

intangible that was held or used at any

time during the transition period and

was not depreciable or amortizable

under prior law.

(ii) Purpose. To qualify as an

amortizable section 197 intangible, a

section 197 intangible must be acquired

after the applicable date (July 25, 1991,

if the acquiring taxpayer has made a

valid retroactive election pursuant to

§ 1.197–1T; August 10, 1993, in all other

cases). The purpose of the anti-churning

rules of section 197(f)(9) and this

paragraph (h) is to prevent the

amortization of section 197(f)(9)

intangibles unless they are transferred

after the applicable effective date in a

transaction giving rise to a significant

change in ownership or use. (Special

rules apply for purposes of determining

whether transactions involving

partnerships give rise to a significant

change in ownership or use. See

paragraph (h)(12) of this section.) The

anti-churning rules are to be applied in

a manner that carries out their purpose.

(2) Treatment of section 197(f)(9)

intangibles. Except as otherwise

provided in this paragraph (h), a section

197(f)(9) intangible acquired by a

taxpayer after the applicable effective

date does not qualify for amortization

under section 197 if—

(i) The taxpayer or a related person

held or used the intangible or an interest

therein at any time during the transition

period;

(ii) The taxpayer acquired the

intangible from a person that held the

intangible at any time during the

transition period and, as part of the

transaction, the user of the intangible

does not change; or

(iii) The taxpayer grants the right to

use the intangible to a person that held

or used the intangible at any time

during the transition period (or to a

person related to that person), but only

if the transaction in which the taxpayer

grants the right and the transaction in

which the taxpayer acquired the

intangible are part of a series of related

transactions.

(3) Amounts deductible under section

1253(d) or § 1.162–11. For purposes of

this paragraph (h), deductions allowable

under section 1253(d)(2) or pursuant to

an election under section 1253(d)(3) (in

either case as in effect prior to the

enactment of section 197) and

deductions allowable under § 1.162–11

are treated as deductions allowable for

amortization under prior law.

(4) Transition period. For purposes of

this paragraph (h), the transition period

is July 25, 1991, if the acquiring

taxpayer has made a valid retroactive

election pursuant to § 1.197–1T and the

period beginning on July 25, 1991, and

ending on August 10, 1993, in all other

cases.

(5) Exceptions. The anti-churning

rules of this paragraph (h) do not apply

to—

(i) The acquisition of a section

197(f)(9) intangible if the acquiring

taxpayer’s basis in the intangible is

determined under section 1014(a); or

(ii) The acquisition of a section

197(f)(9) intangible that was an

3836 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

amortizable section 197 intangible in

the hands of the seller (or transferor),

but only if the acquisition transaction

and the transaction in which the seller

(or transferor) acquired the intangible or

interest therein are not part of a series

of related transactions.

(6) Related person—(i) In general.

Except as otherwise provided in

paragraph (h)(6)(ii) of this section, a

person is related to another person for

purposes of this paragraph (h) if—

(A) The person bears a relationship to

that person that would be specified in

section 267(b) (determined without

regard to section 267(e)) and, by

substitution, section 267(f)(1), if those

sections were amended by substituting

20 percent for 50 percent; or

(B) The person bears a relationship to

that person that would be specified in

section 707(b)(1) if that section were

amended by substituting 20 percent for

50 percent; or

(C) The persons are engaged in trades

or businesses under common control

(within the meaning of section 41(f)(1)

(A) and (B)).

(ii) Time for testing relationships.

Except as provided in paragraph

(h)(6)(iii) of this section, a person is

treated as related to another person for

purposes of this paragraph (h) if the

relationship exists—

(A) In the case of a single transaction,

immediately before or immediately after

the transaction in which the intangible

is acquired; and

(B) In the case of a series of related

transactions (or a series of transactions

that together comprise a qualified stock

purchase within the meaning of section

338(d)(3)), immediately before the

earliest such transaction or immediately

after the last such transaction.

(iii) Certain relationships disregarded.

In applying the rules in paragraph (h)(7)

of this section, if a person acquires an

intangible in a series of related

transactions in which the person

acquires stock (meeting the

requirements of section 1504(a)(2)) of a

corporation in a fully taxable

transaction followed by a liquidation of

the acquired corporation under section

331, any relationship created as part of

such series of transactions is

disregarded in determining whether any

person is related to such acquired

corporation immediately after the last

transaction.

(iv) De minimis rule—(A) In general.

Two corporations are not treated as

related persons for purposes of this

paragraph (h) if—

(1) The corporations would (but for

the application of this paragraph

(h)(6)(iv)) be treated as related persons

solely by reason of substituting ‘‘more

than 20 percent’’ for ‘‘more than 50

percent’’ in section 267(f)(1)(A); and

(2) The beneficial ownership interest

of each corporation in the stock of the

other corporation represents less than

10 percent of the total combined voting

power of all classes of stock entitled to

vote and less than 10 percent of the total

value of the shares of all classes of stock

outstanding.

(B) Determination of beneficial

ownership interest. For purposes of this

paragraph (h)(6)(iv), the beneficial

ownership interest of one corporation in

the stock of another corporation is

determined under the principles of

section 318(a), except that—

(1) In applying section 318(a)(2)(C),

the 50-percent limitation contained

therein is not applied; and

(2) Section 318(a)(3)(C) is applied by

substituting ‘‘20 percent’’ for ‘‘50

percent’’.

(7) Special rules for entities that

owned or used property at any time

during the transition period and that are

no longer in existence. A corporation,

partnership, or trust that owned or used

a section 197 intangible at any time

during the transition period and that is

no longer in existence is deemed, for

purposes of determining whether a

taxpayer acquiring the intangible is

related to such entity, to be in existence

at the time of the acquisition.

(8) Special rules for section 338

deemed acquisitions. In the case of a

qualified stock purchase that is treated

as a deemed sale and purchase of assets

pursuant to section 338, the corporation

treated as purchasing assets as a result

of an election thereunder (new target) is

not considered the person that held or

used the assets during any period in

which the assets were held or used by

the corporation treated as selling the

assets (old target). Thus, for example, if

a corporation (the purchasing

corporation) makes a qualified stock

purchase of the stock of another

corporation after the transition period,

new target will not be treated as the

owner during the transition period of

assets owned by old target during that

period even if old target and new target

are treated as the same corporation for

certain other purposes of the Internal

Revenue Code or old target and new

target are the same corporation under

the laws of the State or other

jurisdiction of its organization.

However, the anti-churning rules of this

paragraph (h) may nevertheless apply to

a deemed asset purchase resulting from

a section 338 election if new target is

related (within the meaning of

paragraph (h)(6) of this section) to old

target.

(9) Gain-recognition exception—(i)

Applicability. A section 197(f)(9)

intangible qualifies for the gainrecognition exception if—

(A) The taxpayer acquires the

intangible from a person that would not

be related to the taxpayer but for the

substitution of 20 percent for 50 percent

under paragraph (h)(6)(i)(A) of this

section; and

(B) That person (whether or not

otherwise subject to Federal income tax)

elects to recognize gain on the

disposition of the intangible and agrees,

notwithstanding any other provision of

law or treaty, to pay for the taxable year

in which the disposition occurs an

amount of tax on the gain that, when

added to any other Federal income tax

on such gain, equals the gain on the

disposition multiplied by the highest

marginal rate of tax for that taxable year.

(ii) Effect of exception. The antichurning rules of this paragraph (h)

apply to a section 197(f)(9) intangible

that qualifies for the gain-recognition

exception only to the extent the

acquiring taxpayer’s basis in the

intangible exceeds the gain recognized

by the transferor.

(iii) Time and manner of election. The

election described in this paragraph

(h)(9) must be made by the due date

(including extensions of time) of the

electing taxpayer’s Federal income tax

return for the taxable year in which the

disposition occurs. The election is made

by attaching an election statement

satisfying the requirements of paragraph

(h)(9)(viii) of this section to the electing

taxpayer’s original or amended income

tax return for that taxable year (or by

filing the statement as a return for the

taxable year under paragraph (h)(9)(xi)

of this section). In addition, the taxpayer

must satisfy the notification

requirements of paragraph (h)(9)(vi) of

this section. The election is binding on

the taxpayer and all parties whose

Federal tax liability is affected by the

election.

(iv) Special rules for certain entities.

In the case of a partnership, S

corporation, estate or trust, the election

under this paragraph (h)(9) is made by

the entity rather than by its owners or

beneficiaries. If a partnership or S

corporation makes an election under

this paragraph (h)(9) with respect to the

disposition of a section 197(f)(9)

intangible, each of its partners or

shareholders is required to pay a tax

determined in the manner described in

paragraph (h)(9)(i)(B) of this section on

the amount of gain that is properly

allocable to such partner or shareholder

with respect to the disposition.

(v) Effect of nonconforming elections.

An attempted election that does not

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3837

substantially comply with each of the

requirements of this paragraph (h)(9) is

disregarded in determining whether a

section 197(f)(9) intangible qualifies for

the gain-recognition exception.

(vi) Notification requirements. A

taxpayer making an election under this

paragraph (h)(9) with respect to the

disposition of a section 197(f)(9)

intangible must provide written

notification of the election on or before

the due date of the return on which the

election is made to the person acquiring

the section 197 intangible. In addition,

a partnership or S corporation making

an election under this paragraph (h)(9)

must attach to the Schedule K–1

furnished to each partner or shareholder

a written statement containing all

information necessary to determine the

recipient’s additional tax liability under

this paragraph (h)(9).

(vii) Revocation. An election under

this paragraph (h)(9) may be revoked

only with the consent of the

Commissioner.

(viii) Election Statement. An election

statement satisfies the requirements of

this paragraph (h)(9)(viii) if it is in

writing and contains the information

listed below. The required information

should be arranged and identified in

accordance with the following order and

numbering system:

(A) The name and address of the

electing taxpayer.

(B) Except in the case of a taxpayer

that is not otherwise subject to Federal

income tax, the taxpayer identification

number (TIN) of the electing taxpayer.

(C) A statement that the taxpayer is

making the election under section

197(f)(9)(B).

(D) Identification of the transaction

and each person that is a party to the

transaction or whose tax return is

affected by the election (including,

except in the case of persons not

otherwise subject to Federal income tax,

the TIN of each such person).

(E) The calculation of the gain

realized, the applicable rate of tax, and

the amount of the taxpayer’s additional

tax liability under this paragraph (h)(9).

(F) The signature of the taxpayer or an

individual authorized to sign the

taxpayer’s Federal income tax return.

(ix) Determination of highest marginal

rate of tax and amount of other Federal

income tax on gain—(A) Marginal rate.

The following rules apply for purposes

of determining the highest marginal rate

of tax applicable to an electing taxpayer:

(1) Noncorporate taxpayers. In the

case of an individual, estate, or trust, the

highest marginal rate of tax is the

highest marginal rate of tax in effect

under section 1, determined without

regard to section 1(h).

(2) Corporations and tax-exempt

entities. In the case of a corporation or

an entity that is exempt from tax under

section 501(a), the highest marginal rate

of tax is the highest marginal rate of tax

in effect under section 11, determined

without regard to any rate that is added

to the otherwise applicable rate in order

to offset the effect of the graduated rate

schedule.

(B) Other Federal income tax on gain.

The amount of Federal income tax

(other than the tax determined under

this paragraph (h)(9)) imposed on any

gain is the lesser of—

(1) The amount by which the

taxpayer’s Federal income tax liability

(determined without regard to this

paragraph (h)(9)) would be reduced if

the amount of such gain were not taken

into account; or

(2) The amount of the gain multiplied

by the highest marginal rate of tax for

the taxable year.

(x) Coordination with other

provisions—(A) In general. The amount

of gain subject to the tax determined

under this paragraph (h)(9) is not

reduced by any net operating loss

deduction under section 172(a), any

capital loss under section 1212, or any

other similar loss or deduction. In

addition, the amount of tax determined

under this paragraph (h)(9) is not

reduced by any credit of the taxpayer.

In computing the amount of any net

operating loss, capital loss, or other

similar loss or deduction, or any credit

that may be carried to any taxable year,

any gain subject to the tax determined

under this paragraph (h)(9) and any tax

paid under this paragraph (h)(9) is not

taken into account.

(B) Section 1374. No provision of

paragraph (h)(9)(iv) of this section

precludes the application of section

1374 (relating to a tax on certain builtin gains of S corporations) to any gain

with respect to which an election under

this paragraph (h)(9) is made. In

addition, neither paragraph (h)(9)(iv)

nor paragraph (h)(9)(x)(A) of this section

precludes a taxpayer from applying the

provisions of section 1366(f)(2) (relating

to treatment of the tax imposed by

section 1374 as a loss sustained by the

S corporation) in determining the

amount of tax payable under paragraph

(h)(9) of this section.

(C) Procedural and administrative

provisions. For purposes of subtitle F,

the amount determined under this

paragraph (h)(9) is treated as a tax

imposed by section 1 or 11, as

appropriate.

(D) Installment method. The gain

subject to the tax determined under

paragraph (h)(9)(i) of this section may

not be reported under the method

described in section 453(a). Any such

gain that would, but for the application

of this paragraph (h)(9)(x)(D), be taken

into account under section 453(a) shall

be taken into account in the same

manner as if an election under section

453(d) (relating to the election not to

apply section 453(a)) had been made.

(xi) Special rules for persons not

otherwise subject to Federal income tax.

If the person making the election under

this paragraph (h)(9) with respect to a

disposition is not otherwise subject to

Federal income tax, the election

statement satisfying the requirements of

paragraph (h)(9)(viii) of this section

must be filed with the Philadelphia

Service Center. For purposes of this

paragraph (h)(9) and subtitle F, the

statement is treated as an income tax

return for the calendar year in which the

disposition occurs and as a return due

on or before March 15 of the following

year.

(10) Transactions subject to both antichurning and nonrecognition rules. If a

person acquires a section 197(f)(9)

intangible in a transaction described in

paragraph (g)(2) of this section from a

person in whose hands the intangible

was an amortizable section 197

intangible, and immediately after the

transaction (or series of transactions

described in paragraph (h)(6)(ii)(B) of

this section) in which such intangible is

acquired, the person acquiring the

section 197(f)(9) intangible is related to

any person described in paragraph (h)(2)

of this section, the intangible is,

notwithstanding its treatment under

paragraph (g)(2) of this section, treated

as an amortizable section 197 intangible

only to the extent permitted under this

paragraph (h). (See, for example,

paragraph (h)(5)(ii) of this section.)

(11) Avoidance purpose. A section

197(f)(9) intangible acquired by a

taxpayer after the applicable effective

date does not qualify for amortization

under section 197 if one of the principal

purposes of the transaction in which it

is acquired is to avoid the operation of

the anti-churning rules of section

197(f)(9) and this paragraph (h). A

transaction will be presumed to have a

principal purpose of avoidance if it does

not effect a significant change in the

ownership or use of the intangible.

Thus, for example, if section 197(f)(9)

intangibles are acquired in a transaction

(or series of related transactions) in

which an option to acquire stock is

issued to a party to the transaction, but

the option is not treated as having been

exercised for purposes of paragraph

(h)(6) of this section, this paragraph

(h)(11) may apply to the transaction.

(12) Additional partnership antichurning rules—(i) In general. In

3838 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

determining whether the anti-churning

rules of this paragraph (h) apply to any

increase in the basis of a section

197(f)(9) intangible under section

732(b), 732(d), 734(b), or 743(b), the

determinations are made at the partner

level and each partner is treated as

having owned and used the partner’s

proportionate share of partnership

property. In determining whether the

anti-churning rules of this paragraph (h)

apply to any transaction under another

section of the Internal Revenue Code,

the determinations are made at the

partnership level, unless under § 1.701–

2(e) the Commissioner determines that

the partner level is more appropriate.

(ii) Section 732(b) adjustments—

Reserved.

(iii) Section 732(d) adjustments. The

anti-churning rules of this paragraph (h)

do not apply to an increase in the basis

of partnership property under section

732(d) if the distributee partner was not

related (at the time of the transfer of the

partnership interest) to the person who

transferred the partnership interest with

respect to which the distribution is

being made.

(iv) Section 734(b) adjustments—

Reserved.

(v) Section 743(b) adjustments. The

anti-churning rules of this paragraph (h)

do not apply to an increase in the basis

of partnership property under section

743(b) if the person acquiring the

partnership interest is not related to the

person transferring the partnership

interest.

(vi) Partner is or becomes a user of

partnership intangible—(A) General

rule. If, as part of a series of related

transactions that includes a transaction

described in paragraph (h)(12) (iii) or (v)

of this section, an anti-churning partner

or a person related to an anti-churning

partner becomes (or remains) a user of

an intangible that is treated as

transferred in the transaction (as a result

of the partners being treated as having

owned their proportionate share of

partnership assets), the anti-churning

rules of this paragraph (h) apply to the

proportionate share of such intangible

that is treated as transferred by the antichurning partner, notwithstanding the

application of paragraph (h)(12) (iii) or

(v) of this section.

(B) Anti-churning partner. For

purposes of this paragraph (h)(12)(vi),

anti-churning partner means—

(1) With respect to all intangibles held

by a partnership on or before August 10,

1993, any partner, but only to the extent

that

(i) The partner’s interest in the

partnership was acquired on or before

August 10, 1993, or

(ii) The interest was acquired from a

person related to the partner on or after

August 10, 1993, and such interest was

not held by any person other than

persons related to such partner at any

time after August 10, 1993

(disregarding, for this purpose, a

person’s holding of an interest if the

acquisition of such interest was part of

a transaction or series of related

transactions in which the partner or

persons related to the partner

subsequently acquired such interest),

(2) With respect to any section

197(f)(9) intangible acquired by a

partnership after August 10, 1993, that

is not amortizable with respect to the

partnership, any partner, but only to the

extent that

(i) The partner’s interest in the

partnership was acquired on or before

the date the partnership acquired the

section 197(f)(9) intangible, or

(ii) The interest was acquired from a

person related to the partner on or after

the date the partnership acquired the

section 197(f)(9) intangible, and such

interest was not held by any person

other than persons related to such

partner at any time after the date the

partnership acquired the section

197(f)(9) intangible (disregarding, for

this purpose, a person’s holding of an

interest if the acquisition of such

interest was part of a transaction or

series of related transactions in which

the partner or persons related to the

partner subsequently acquired such

interest), and

( 3) With respect to any intangible, a

partner who received an interest in the

partnership in exchange for such

intangible (or a portion thereof) or a

related person who received such

interest in the partnership from such a

partner, but only to the extent that the

intangible (or portion thereof)

transferred by such partner is not an

amortizable section 197 intangible with

respect to the partnership.

(C) Effect of retroactive elections. For

purposes of paragraph (h)(12)(vi)(B) of

this section, references to August 10,

1993, are treated as references to July

25, 1991, if the relevant party made a

valid retroactive election under § 1.197–

1T.

(vii) Section 704(c) allocations—(A)

Allocations where the intangible is

amortizable by the contributor. The antichurning rules of this paragraph (h) do

not apply to the curative or remedial

allocations of amortization with respect

to a section 197(f)(9) intangible if the

intangible was an amortizable section

197 intangible in the hands of the

contributing partner (unless paragraph

(h)(10) of this section applies so as to

cause the intangible to cease to be an

amortizable section 197 intangible in

the hands of the partnership).

(B) Allocations where the intangible is

not amortizable by the contributor.

Notwithstanding paragraph (g)(3)(ii) of

this section, where the section 197(f)(9)

intangible was not an amortizable

section 197 intangible in the hands of

the contributing partner, a partner may

not receive remedial allocations of

amortization under section 704(c) that

are deductible for Federal income tax

purposes if that partner is related to the

partner that contributed the intangible.

Taxpayers may use any reasonable

method to determine amortization of the

asset for book purposes, provided that

the method used does not contravene

the purposes of the anti-churning rules

under section 197 and this paragraph

(h). A method will be considered to

contravene the purposes of the antichurning rules if the effect of the book

adjustments resulting from the method

is such that any portion of the tax

deduction for amortization attributable

to section 704(c) is allocated, directly or

indirectly, to a partner who is subject to

the anti-churning rules with respect to

such adjustment.

(viii) Operating rule for transfers upon

death. For purposes of this paragraph

(h)(12), if the basis of a partner’s interest

in a partnership is determined under

section 1014(a), such partner is treated

as acquiring such interest from a person

who is not related to such partner, and

such interest is treated as having

previously been held by a person who

is not related to such partner.

(i) [Reserved]

(j) General anti-abuse rule. The

Commissioner will interpret and apply

the rules in this section as necessary

and appropriate to prevent avoidance of

the purposes of section 197. If one of the

principal purposes of a transaction is to

achieve a tax result that is inconsistent

with the purposes of section 197, the

Commissioner will recast the

transaction for Federal tax purposes as

appropriate to achieve tax results that

are consistent with the purposes of

section 197, in light of the applicable

statutory and regulatory provisions and

the pertinent facts and circumstances.

(k) Examples.The following examples

illustrate the application of this section:

Example 1. Advertising costs. (i) Q

manufactures and sells consumer products

through a series of wholesalers and

distributors. In order to increase sales of its

products by encouraging consumer loyalty to

its products and to enhance the value of the

goodwill, trademarks, and trade names of the

business, Q advertises its products to the

consuming public. It regularly incurs costs to

develop radio, television, and print

advertisements. These costs generally consist

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3839

of employee costs and amounts paid to

independent advertising agencies. Q also

incurs costs to run these advertisements in

the various media for which they were

developed.

(ii) The advertising costs are not chargeable

to capital account under paragraph (f)(3) of

this section (relating to costs incurred for

covenants not to compete, rights granted by

governmental units, and contracts for the use

of section 197 intangibles) and are currently

deductible as ordinary and necessary

expenses under section 162. Accordingly,

under paragraph (a)(3) of this section, section

197 does not apply to these costs.

Example 2. Computer software. (i) X

purchases all of the assets of an existing trade

or business from Y. One of the assets

acquired is all of Y’s rights in certain

computer software previously used by Y

under the terms of a nonexclusive license

from the software developer. The software

was developed for use by manufacturers to

maintain a comprehensive accounting

system, including general and subsidiary

ledgers, payroll, accounts receivable and

payable, cash receipts and disbursements,

fixed asset accounting, and inventory cost

accounting and controls. The developer

modified the software for use by Y at a cost

of $1,000 and Y made additional

modifications at a cost of $500. The

developer does not maintain wholesale or

retail outlets but markets the software

directly to ultimate users. Y’s license of the

software is limited to an entity that is

actively engaged in business as a

manufacturer.

(ii) Notwithstanding these limitations, the

software is considered to be readily available

to the general public for purposes of

paragraph (c)(4)(i) of this section. In addition,

the software is not substantially modified

because the cost of the modifications by the

developer and Y to the version of the

software that is readily available to the

general public does not exceed $2,000.

Accordingly, the software is not a section 197

intangible.

Example 3. Acquisition of software for

internal use. (i) B, the owner and operator of

a worldwide package-delivery service,

purchases from S all rights to software

developed by S. The software will be used by

B for the sole purpose of improving its

package-tracking operations. B does not

purchase any other assets in the transaction

or any related transaction.

(ii) Because B acquired the software solely

for internal use, it is disregarded in

determining for purposes of paragraph

(c)(4)(ii) of this section whether the assets

acquired in the transaction or series of

related transactions constitute a trade or

business or substantial portion thereof. Since

no other assets were acquired, the software

is not acquired as part of a purchase of a

trade or business and under paragraph

(c)(4)(ii) of this section is not a section 197

intangible.

Example 4. Governmental rights of fixed

duration. (i) City M operates a municipal

water system. In order to induce X to locate

a new manufacturing business in the city, M

grants X the right to purchase water for 16

years at a specified price.

(ii) The right granted by M is a right to

receive tangible property or services

described in section 197(e)(4)(B) and

paragraph (c)(6) of this section and, thus, is

not a section 197 intangible. This exclusion

applies even though the right does not

qualify for exclusion as a right of fixed

duration or amount under section

197(e)(4)(D) and paragraph (c)(13) of this

section because the duration exceeds 15

years and the right is not fixed as to amount.

It is also immaterial that the right would not

qualify for exclusion as a self-created

intangible under section 197(c)(2) and

paragraph (d)(2) of this section because it is

granted by a governmental unit.

Example 5. Separate acquisition of

franchise. (i) S is a franchiser of retail outlets

for specialty coffees. G enters into a franchise

agreement (within the meaning of section

1253(b)(1)) with S pursuant to which G is

permitted to acquire and operate a store

using the S trademark and trade name at the

location specified in the agreement. G agrees

to pay S $100,000 upon execution of the

agreement and also agrees to pay, throughout

the term of the franchise, additional amounts

that are deductible under section 1253(d)(1).

The agreement contains detailed

specifications for the construction and

operation of the business, but G is not

required to purchase from S any of the

materials necessary to construct the

improvements at the location specified in the

franchise agreement.

(ii) The franchise is a section 197

intangible within the meaning of paragraph

(b)(10) of this section. The franchise does not

qualify for the exclusion relating to selfcreated intangibles described in section

197(c)(2) and paragraph (d)(2) of this section

because the franchise is described in section

197(d)(1)(F). In addition, because the

acquisition of the franchise constitutes the

acquisition of an interest in a trade or

business or a substantial portion thereof, the

franchise may not be excluded under section

197(e)(4). Thus, the franchise is an

amortizable section 197 intangible, the basis

of which must be recovered over a 15-year

period. However, the amounts that are

deductible under section 1253(d)(1) are not

subject to the provisions of section 197 by

reason of section 197(f)(4)(C) and paragraph

(b)(10)(ii) of this section.

Example 6. Acquisition and amortization

of covenant not to compete. (i) As part of the

acquisition of a trade or business from C, B

and C enter into an agreement containing a

covenant not to compete. Under this

agreement, C agrees that it will not compete

with the business acquired by B within a

prescribed geographical territory for a period

of three years after the date on which the

business is sold to B. In exchange for this

agreement, B agrees to pay C $90,000 per year

for each year in the term of the agreement.

The agreement further provides that, in the

event of a breach by C of his obligations

under the agreement, B may terminate the

agreement, cease making any of the payments

due thereafter, and pursue any other legal or

equitable remedies available under

applicable law. The amounts payable to C

under the agreement are not contingent

payments for purposes of § 1.1275–4. The

present fair market value of B’s rights under

the agreement is $225,000. The aggregate

consideration paid for all assets acquired in

the transaction (including the covenant not to

compete) exceeds the sum of the amount of

Class I assets and the aggregate fair market

value of all Class II, Class III, Class IV, Class

V, and Class VI assets by $50,000. See

§ 1.338–6T(b) for rules for determining the

assets in each class.

(ii) Because the covenant is acquired in an

applicable asset acquisition (within the

meaning of section 1060(c)), paragraph

(f)(4)(ii) of this section applies and the basis

of B in the covenant is determined pursuant

to section 1060(a) and the regulations

thereunder. Under §§ 1.1060–1T(c)(2) and

1.338–6T(c)(1), B’s basis in the covenant

cannot exceed its fair market value. Thus, B’s

basis in the covenant immediately after the

acquisition is $225,000. This basis is

amortized ratably over the 15-year period

beginning on the first day of the month in

which the agreement is entered into.

Although the payments under the agreement

($270,000) exceed the amount allocated to

the covenant by $45,000, all of the remaining

consideration ($50,000) is allocated to Class

VII assets (goodwill and going concern

value). See §§ 1.1060–1T(c)(2) and 1.338–

6T(b).

Example 7. Stand-alone license of

technology. (i) X is a manufacturer of

consumer goods that does business

throughout the world through subsidiary

corporations organized under the laws of

each country in which business is conducted.

X licenses to Y, its subsidiary organized and

conducting business in Country K, all of the

patents, formulas, designs, and know-how

necessary for Y to manufacture the same

products that X manufactures in the United

States. Assume that the license is not

considered a sale or exchange under the

principles of section 1235. The license is for

a term of 18 years, and there are no facts to

indicate that the license does not have a fixed

duration. Y agrees to pay X a royalty equal

to a specified, fixed percentage of the

revenues obtained from selling products

manufactured using the licensed technology.

Assume that the royalty is reasonable and is

not subject to adjustment under section 482.

The license is not entered into in connection

with any other transaction. Y incurs

capitalized costs in connection with entering

into the license.

(ii) The license is a contract for the use of

a section 197 intangible within the meaning

of paragraph (b)(11) of this section. It does

not qualify for the exception in section

197(e)(4)(D) and paragraph (c)(13) of this

section (relating to rights of fixed duration or

amecause it does not have a term of less than

15 years, and the other exceptions in section

197(e) and paragraph (c) of this section are

also inapplicable. Accordingly, the license is

a section 197 intangible.

(iii) The license is not acquired as part of

a purchase of a trade or business. Thus,

under paragraph (f)(3)(iii) of this section, the

license will be closely scrutinized under the

principles of section 1235 for purposes of

determining whether the transfer is a sale or

exchange and, accordingly, whether the

payments under the license are chargeable to

3840 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

capital account. Because the license is not a

sale or exchange under the principles of

section 1235, the royalty payments are not

chargeable to capital account for purposes

section 197. The capitalized costs of entering

into the license are not within the exception

under paragraph (d)(2) of this section for selfcreated intangibles, and thus are amortized

under section 197.

Example 8. License of technology and

trademarks. (i) The facts are the same as in

Example 7, except that the license also

includes the use of the trademarks and trade

names that X uses to manufacture and

distribute its products in the United States.

Assume that under the principles of section

1253 the transfer is not a sale or exchange of

the trademarks and trade names or an

undivided interest therein and that the

royalty payments are described in section

1253(d)(1)(B).

(ii) As in Example 7, the license is a

section 197 intangible. Although the license

conveys an interest in X’s trademarks and

trade names to Y, the transfer of the interest

is disregarded for purposes of paragraph

(e)(2) of this section unless the transfer is

considered a sale or exchange of the

trademarks and trade names or an undivided

interest therein. Accordingly, the licensing of

the technology and the trademarks and trade

names is not treated as part of a purchase of

a trade or business under paragraph (e)(2) of

this section.

(iii) Because the technology license is not

part of the purchase of a trade or business,

it is treated in the manner described in

Example 7. The royalty payments for the use

of the trademarks and trade names are

deductible under section 1253(d)(1) and,

under section 197(f)(4)(C) and paragraph

(b)(10)(ii) of this section, are not chargeable

to capital account for purposes of section

197. The capitalized costs of entering into the

license are treated in the same manner as in

example 7.

Example 9. Disguised sale. (i) The facts are

the same as in Example 7, except that Y

agrees to pay X, in addition to the contingent

royalty, a fixed minimum royalty

immediately upon entering into the

agreement and there are sufficient facts

present to characterize the transaction, for

federal tax purposes, as a transfer of

ownership of the intellectual property from

X to Y.

(ii) The purported license of technology is,

in fact, an acquisition of an intangible

described in section 197(d)(1)(C)(iii) and

paragraph (b)(5) of this section (relating to

know-how, etc.). As in Example 7, the

exceptions in section 197(e) and paragraph

(c) of this section do not apply to the transfer.

Accordingly, the transferred property is a

section 197 intangible. Y’s basis in the

transferred intangible includes the

capitalized costs of entering into the

agreement and the fixed minimum royalty

payment payable at the time of the transfer.

In addition, except to the extent that a

portion of any payment will be treated as

interest or original issue discount under

applicable provisions of the Internal Revenue

Code, all of the contingent payments under

the purported license are properly chargeable

to capital account for purposes of section 197

and this section. The extent to which such

payments are treated as payments of

principal and the time at which any amount

treated as a payment of principal is taken

into account in determining basis are

determined under the rules of § 1.1275–

4(c)(4) or 1.483–4(a), whichever is applicable.

Any contingent amount that is included in

basis after the month in which the

acquisition occurs is amortized under the

rules of paragraph (f)(2)(i) or (ii) of this

section.

Example 10. License of technology and

customer list as part of sale of a trade or

business. (i) X is a computer manufacturer

that produces, in separate operating

divisions, personal computers, servers, and

peripheral equipment. In a transaction that is

the purchase of a trade or business for

purposes of section 197, Y (who is unrelated

to X) purchases from X all assets of the

operating division producing personal

computers, except for certain patents that are

also used in the division manufacturing

servers and customer lists that are also used

in the division manufacturing peripheral

equipment. As part of the transaction, X

transfers to Y the right to use the retained

patents and customer lists solely in

connection with the manufacture and sale of

personal computers. The transfer agreement

requires annual royalty payments contingent

on the use of the patents and also requires

a payment for each use of the customer list.

In addition, Y incurs capitalized costs in

connection with entering into the licenses.

(ii) The rights to use the retained patents

and customer lists are contracts for the use

of section 197 intangibles within the meaning

of paragraph (b)(11) of this section. The rights

do not qualify for the exception in

197(e)(4)(D) and paragraph (c)(13) of this

section (relating to rights of fixed duration or

amount) because they are transferred as part

of a purchase of a trade or business and the

other exceptions in section 197(e) and

paragraph (c) of this section are also

inapplicable. Accordingly, the licenses are

section 197 intangibles.

(iii) Because the right to use the retained

patents is described in paragraph (b)(11) of

this section and the right is transferred as

part of a purchase of a trade or business, the

treatment of the royalty payments is

determined under paragraph (f)(3)(ii) of this

section. In addition, however, the retained

patents are described in paragraph (b)(5) of

this section. Thus, the annual royalty

payments are chargeable to capital account

under the general rule of paragraph

(f)(3)(ii)(A) of this section unless Y

establishes that the license is not a sale or

exchange under the principles of section

1235 and the royalty payments are an arm’s

length consideration for the rights

transferred. If these facts are established, the

exception in paragraph (f)(3)(ii)(B) of this

section applies and the royalty payments are

not chargeable to capital account for

purposes of section 197. The capitalized

costs of entering into the license are treated

in the same manner as in Example 7.

(iv) The right to use the retained customer

list is also described in paragraph (b)(11) of

this section and is transferred as part of a

purchase of a trade or business. Thus, the

treatment of the payments for use of the

customer list is also determined under

paragraph (f)(3)(ii) of this section. The

customer list, although described in

paragraph (b)(6) of this section, is a customerrelated information base. Thus, the exception

in paragraph (f)(3)(ii)(B) of this section does

not apply. Accordingly, payments for use of

the list are chargeable to capital account

under the general rule of paragraph

(f)(3)(ii)(A) of this section and are amortized

under section 197. In addition, the

capitalized costs of entering into the contract

for use of the customer list are treated in the

same manner as in Example 7.

Example 11. Loss disallowance rules

involving related persons. (i) Assume that X

and Y are treated as a single taxpayer for

purposes of paragraph (g)(1) of this section.

In a single transaction, X and Y acquired

from Z all of the assets used by Z in a trade

or business. Z had operated this business at

two locations, and X and Y each acquired the

assets used by Z at one of the locations.

Three years after the acquisition, X sold all

of the assets it acquired, including

amortizable section 197 intangibles, to an

unrelated purchaser. The amortizable section

intangibles are sold at a loss of $120,000.

(ii) Because X and Y are treated as a single

taxpayer for purposes of the loss

disallowance rules of section 197(f)(1) and

paragraph (g)(1) of this section, X’s loss on

the sale of the amortizable section 197

intangibles is not recognized. Under

paragraph (g)(1)(iv)(B) of this section, X’s

disallowed loss is allowed ratably, as a

deduction under section 197, over the

remainder of the 15-year period during

which the intangibles would have been

amortized, and Y may not increase the basis

of the amortizable section 197 intangibles

that it acquired from Z by the amount of X’s

disallowed loss.

Example 12. Disposition of retained

intangibles by related person. (i) The facts are

the same as in Example 11, except that 10

years after the acquisition of the assets by X

and Y and 7 years after the sale of the assets

by X, Y sells all of the assets acquired from

Z, including amortizable section 197

intangibles, to an unrelated purchaser.

(ii) Under paragraph (g)(1)(iv)(B) of this

section, X may recognize, on the date of the

sale by Y, any loss that has not been allowed

as a deduction under section 197.

Accordingly, X recognizes a loss of $50,000,

the amount obtained by reducing the loss on

the sale of the assets at the end of the third

year ($120,000) by the amount allowed as a

deduction under paragraph (g)(1)(iv)(B) of

this section during the 7 years following the

sale by X ($70,000).

Example 13. Acquisition of an interest in

partnership with no section 754 election. (i)

A, B, and C each contribute $1,500 for equal

shares in general partnership P. On January

1, 1998, P acquires as its sole asset an

amortizable section 197 intangible for $4,500.

P still holds the intangible on January 1,

2003, at which time the intangible has an

adjusted basis to P of $3,000, and A, B, and

C each have an adjusted basis of $1,000 in

their partnership interests. D (who is not

related to A) acquires A’s interest in P for

$1,600. No section 754 election is in effect for

2003.

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3841

(ii) Because there is no change in the basis

of the intangible under section 743(b), D

merely steps into the shoes of A with respect

to the intangible. D’s proportionate share of

P’s adjusted basis in the intangible is $1,000,

which continues to be amortized over the 10

years remaining in the original 15-year

amortization period for the intangible.

Example 14. Acquisition of an interest in

partnership with a section 754 election. (i)

The facts are the same as in Example 13,

except that a section 754 election is in effect

for 2003.

(ii) Pursuant to paragraph (g)(3) of this

section, for purposes of section 197, D is

treated as if P owns two assets. D’s

proportionate share of P’s adjusted basis in

one asset is $1,000, which continues to be

amortized over the 10 years remaining in the

original 15-year amortization period. For the

other asset, D’s proportionate share of P’s

adjusted basis is $600 (the amount of the

basis increase under section 743 as a result

of the section 754 election), which is

amortized over a new 15-year period

beginning January 2003. With respect to B

and C, P’s remaining $2,000 adjusted basis in

the intangible continues to be amortized over

the 10 years remaining in the original 15-year

amortization period.

Example 15. Payment to a retiring partner

by partnership with a section 754 election. (i)

The facts are the same as in Example 13,

except that a section 754 election is in effect

for 2003 and, instead of D acquiring A’s

interest in P, A retires from P. A, B, and C

are not related to each other within the

meaning of paragraph (h)(6) of this section.

P borrows $1,600, and A receives a payment

under section 736 from P of such amount, all

of which is in exchange for A’s interest in the

intangible asset owned by P. (Assume, for

purposes of this example, that the borrowing

by P and payment of such funds to A does

not give rise to a disguised sale of A’s

partnership interest under section

707(a)(2)(B).) P makes a positive basis

adjustment of $600 with respect to the

section 197 intangible under section 734(b).

(ii) Pursuant to paragraph (g)(3) of this

section, because of the section 734

adjustment, P is treated as having two

amortizable section 197 intangibles, one with

a basis of $3,000 and a remaining

amortization period of 10 years and the other

with a basis of $600 and a new amortization

period of 15 years.

Example 16. Termination of partnership

under section 708(b)(1)(B). (i) A and B are

partners with equal shares in the capital and

profits of general partnership P. P’s only asset

is an amortizable section 197 intangible,

which P had acquired on January 1, 1995. On

January 1, 2000, the asset had a fair market

value of $100 and a basis to P of $50. On that

date, A sells his entire partnership interest in

P to C, who is unrelated to A, for $50. At the

time of the sale, the basis of each of A and

B in their respective partnership interests is

$25.

(ii) The sale causes a termination of P

under section 708(b)(1)(B). Under section

708, the transaction is treated as if P transfers

its sole asset to a new partnership in

exchange for the assumption of its liabilities

and the receipt of all of the interests in the

new partnership. Immediately thereafter, P is

treated as if it is liquidated, with B and C

each receiving their proportionate share of

the interests in the new partnership. The

contribution by P of its asset to the new

partnership is governed by section 721, and

the liquidating distributions by P of the

interests in the new partnership are governed

by section 731. C does not realize a basis

adjustment under section 743 with respect to

the amortizable section 197 intangible unless

P had a section 754 election in effect for its

taxable year in which the transfer of the

partnership interest to C occurred or the

taxable year in which the deemed liquidation

of P occurred.

(iii) Under section 197, if P had a section

754 election in effect, C is treated as if the

new partnership had acquired two assets

from P immediately preceding its

termination. Even though the adjusted basis

of the new partnership in the two assets is

determined solely under section 723, because

the transfer of assets is a transaction

described in section 721, the application of

sections 743(b) and 754 to P immediately

before its termination causes P to be treated

as if it held two assets for purposes of section

197. See paragraph (g)(3) of this section. B’s

and C’s proportionate share of the new

partnership’s adjusted basis is $25 each in

one asset, which continues to be amortized

over the 10 years remaining in the original

15-year amortization period. For the other

asset, C’s proportionate share of the new

partnership’s adjusted basis is $25 (the

amount of the basis increase resulting from

the application of section 743 to the sale or

exchange by A of the interest in P), which is

amortized over a new 15-year period

beginning in January 2000.

(iv) If P did not have a section 754 election

in effect for its taxable year in which the sale

of the partnership interest by A to C occurred

or the taxable year in which the deemed

liquidation of P occurred, the adjusted basis

of the new partnership in the amortizable

section 197 intangible is determined solely

under section 723, because the transfer is a

transaction described in section 721, and P

does not have a basis increase in the

intangible. Under section 197(f)(2) and

paragraph (g)(2)(ii) of this section, the new

partnership continues to amortize the

intangible over the 10 years remaining in the

original 15-year amortization period. No

additional amortization is allowable with

respect to this asset.

Example 17. Disguised sale to partnership.

(i) E and F are individuals who are unrelated

to each other within the meaning of

paragraph (h)(6) of this section. E has been

engaged in the active conduct of a trade or

business as a sole proprietor since 1990. E

and F form EF Partnership. E transfers all of

the assets of the business, having a fair

market value of $100, to EF, and F transfers

$40 of cash to EF. E receives a 60 percent

interest in EF and the $40 of cash contributed

by F, and F receives a 40 percent interest in

EF, under circumstances in which the

transfer by E is partially treated as a sale of

property to EF under § 1.707–3(b).

(ii) Under § 1.707–3(a)(1), the transaction is

treated as if E had sold to EF a 40 percent

interest in each asset for $40 and contributed

the remaining 60 percent interest in each

asset to EF in exchange solely for an interest

in EF. Because E and EF are related persons

within the meaning of paragraph (h)(6) of this

section, no portion of any transferred section

197(f)(9) intangible that E held during the

transition period (as defined in paragraph

(h)(4) of this section) is an amortizable

section 197 intangible pursuant to paragraph

(h)(2) of this section. Section 197(f)(9)(F) and

paragraph (g)(3) of this section do not apply

to any portion of the section 197 intangible

in the hands of EF because the basis of EF

in these assets was not increased under any

of sections 732, 734, or 743.

Example 18. Acquisition by related person

in nonrecognition transaction. (i) A owns a

nonamortizable intangible that A acquired in

1990. In 2000, A sells a one-half interest in

the intangible to B for cash. Immediately after

the sale, A and B, who are unrelated to each

other, form partnership P as equal partners.

A and B each contribute their one-half

interest in the intangible to P.

(ii) P has a transferred basis in the

intangible from A and B under section 723.

The nonrecognition transfer rule under

paragraph (g)(2)(ii) of this section applies to

A’s transfer of its one-half interest in the

intangible to P, and consequently P steps into

A’s shoes with respect to A’s nonamortizable

transferred basis. The anti-churning rules of

paragraph (h) of this section apply to B’s

transfer of its one-half interest in the

intangible to P, because A, who is related to

P under paragraph (h)(6) of this section

immediately after the series of transactions in

which the intangible was acquired by P, held

B’s one-half interest in the intangible during

the transition period. Pursuant to paragraph

(h)(10) of this section, these rules apply to B’s

transfer of its one-half interest to P even

though the nonrecognition transfer rule

under paragraph (g)(2)(ii) of this section

would have permitted P to step into B’s shoes

with respect to B’s otherwise amortizable

basis. Therefore, P’s entire basis in the

intangible is nonamortizable. However, if A

(not B) elects to recognize gain under

paragraph (h)(9) of this section on the

transfer of each of the one-half interests in

the intangible to B and P, then the intangible

would be amortizable by P to the extent

provided in section 197(f)(9)(B) and

paragraph (h)(9) of this section.

Example 19. Acquisition of partnership

interest following formation of partnership.

(i) The facts are the same as in Example 18

except that, in 2000, A formed P with an

affiliate, S, and contributed the intangible to

the partnership and except that in a

subsequent year, in a transaction that is

properly characterized as a sale of a

partnership interest for Federal tax purposes,

B purchases a 50 percent interest in P from

A. P has a section 754 election in effect and

holds no assets other than the intangible and

cash.

(ii) For the reasons set forth in Example 16

(iii), B is treated as if P owns two assets. B’s

proportionate share of P’s adjusted basis in

one asset is the same as A’s proportionate

share of P’s adjusted basis in that asset,

which is not amortizable under section 197.

For the other asset, B’s proportionate share of

the remaining adjusted basis of P is

amortized over a new 15-year period.

3842 Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations

Example 20. Acquisition by related

corporation in nonrecognition transaction. (i)

The facts are the same as Example 18, except

that A and B form corporation P as equal

owners.

(ii) P has a transferred basis in the

intangible from A and B under section 362.

Pursuant to paragraph (h)(10) of this section,

the application of the nonrecognition transfer

rule under paragraph (g)(2)(ii) of this section

and the anti-churning rules of paragraph (h)

of this section to the facts of this Example 18

is the same as in Example 16. Thus, P’s entire

basis in the intangible is nonamortizable.

Example 21. Acquisition from corporation

related to purchaser through remote indirect

interest. (i) X, Y, and Z are each corporations

that have only one class of issued and

outstanding stock. X owns 25 percent of the

stock of Y and Y owns 25 percent of the

outstanding stock of Z. No other shareholder

of any of these corporations is related to any

other shareholder or to any of the

corporations. On June 30, 2000, X purchases

from Z section 197(f)(9) intangibles that Z

owned during the transition period (as

defined in paragraph (h)(4) of this section).

(ii) Pursuant to paragraph (h)(6)(iv)(B) of

this section, the beneficial ownership interest

of X in Z is 6.25 percent, determined by

treating X as if it owned a proportionate (25

percent) interest in the stock of Z that is

actually owned by Y. Thus, even though X

is related to Y and Y is related to Z, X and

Z are not considered to be related for

purposes of the anti-churning rules of section

197.

Example 22. Gain recognition election. (i)

B owns 25 percent of the stock of S, a

corporation that uses the calendar year as its

taxable year. No other shareholder of B or S

is related to each other. S is not a member

of a controlled group of corporations within

the meaning of section 1563(a). S has section

197(f)(9) intangibles that it owned during the

transition period. S has a basis of $25,000 in

the intangibles. In 2001, S sells these

intangibles to B for $75,000. S recognizes a

gain of $50,000 on the sale and has no other

items of income, deduction, gain, or loss for

the year, except that S also has a net

operating loss of $20,000 from prior years

that it would otherwise be entitled to use in

2001 pursuant to section 172(b). S makes a

valid gain recognition election pursuant to

section 197(f)(9)(B) and paragraph (h)(9) of

this section. In 2001, the highest marginal tax

rate applicable to S is 35 percent. But for the

election, all of S’s taxable income would be

taxed at a rate of 15 percent.

(ii) If the gain recognition election had not

been made, S would have taxable income of

$30,000 for 2001 and a tax liability of $4,500.

If the gain were not taken into account, S

would have no tax liability for the taxable

year. Thus, the amount of tax (other than the

tax imposed under paragraph (h)(9) of this

section) imposed on the gain is also $4,500.

The gain on the disposition multiplied by the

highest marginal tax rate is $17,500 ($50,000

× .35). Accordingly, S’s tax liability for the

year is $4,500 plus an additional tax under

paragraph (h)(9) of this section of $13,000

($17,500—$4,500).

(iii) Pursuant to paragraph (h)(9)(x)(A) of

this section, S determines the amount of its

net operating loss deduction in subsequent

years without regard to the gain recognized

on the sale of the section 197 intangible to

B. Accordingly, the entire $20,000 net

operating loss deduction that would have

been available in 2001 but for the gain

recognition election may be used in 2002,

subject to the limitations of section 172.

(iv) B has a basis of $75,000 in the section

197(f)(9) intangibles acquired from S. As the

result of the gain recognition election by S,

B may amortize $50,000 of its basis under

section 197. Under paragraph (h)(9)(ii) of this

section, the remaining basis does not qualify

for the gain-recognition exception and may

not be amortized by B.

Example 23. Section 338 election. (i)

Corporation P makes a qualified stock

purchase of the stock of T corporation from

two shareholders in July 2000, and a section

338 election is made by P. No shareholder of

either T or P owns stock in both of these

corporations, and no other shareholder is

related to any other shareholder of either

corporation.

(ii) Pursuant to paragraph (h)(8) of this

section, in the case of a qualified stock

purchase that is treated as a deemed sale and

purchase of assets pursuant to section 338,

the corporation treated as purchasing assets

as a result of an election thereunder (new

target) is not considered the person that held

or used the assets during any period in which

the assets were held or used by the

corporation treated as selling the assets (old

target). Because there are no relationships

described in paragraph (h)(6) of this section

among the parties to the transaction, any

nonamortizable section 197(f)(9) intangible

held by old target is an amortizable section

197 intangible in the hands of new target.

(iii) Assume the same facts as set forth in

paragraph (i) of this Example 23, except that

one of the selling shareholders is an

individual who owns 25 percent of the total

value of the stock of each of the T and P

corporation.

(iv) Old target and new target (as these

terms are defined in § 1.338–1(c)(13)) are

members of a controlled group of

corporations under section 267(b)(3), as

modified by section 197(f)(9)(C)(i), and any

nonamortizable section 197(f)(9) intangible

held by old target is not an amortizable

section 197 intangible in the hands of new

target. However, a gain recognition election

under paragraph (h)(9) of this section may be

made with respect to this transaction.

Example 24. Relationship created as part

of public offering. (i) On January 1, 2001,

Corporation X engages in a series of related

transactions to discontinue its involvement

in one line of business. X forms a new

corporation, Y, with a nominal amount of

cash. Shortly thereafter, X transfers all the

stock of its subsidiary conducting the

unwanted business (Target) to Y in exchange

for 100 shares of Y common stock and a Y

promissory note. Target owns a

nonamortizable section 197(f)(9) intangible.

Prior to January 1, 2001, X and an

underwriter (U) had entered into a binding

agreement pursuant to which U would

purchase 85 shares of Y common stock from

X and then sell those shares in a public

offering. On January 6, 2001, the public

offering closes. X and Y make a section

338(h)(10) election for Target.

(ii) Pursuant to paragraph (h)(8) of this

section, in the case of a qualified stock

purchase that is treated as a deemed sale and

purchase of assets pursuant to section 338,

the corporation treated as purchasing assets

as a result of an election thereunder (new

target) is not considered the person that held

or used the assets during any period in which

the assets were held or used by the

corporation treated as selling the assets (old

target). Further, for purposes of determining

whether the nonamortizable section 197(f)(9)

intangible is acquired by new target from a

related person, because the transactions are

a series of related transactions, the

relationship between old target and new

target must be tested immediately before the

first transaction in the series (the formation

of Y) and immediately after the last

transaction in the series (the sale to U and

the public offering). See paragraph

(h)(6)(ii)(B) of this section. Because there was

no relationship between old target and new

target immediately before the formation of Y

(because the section 338 election had not

been made) and only a 15% relationship

between old target and new target

immediately after, old target is not related to

new target for purposes of applying the antichurning rules of paragraph (h) of this

section. Accordingly, Target may amortize

the section 197 intangible.

Example 25. Other transfers to controlled

corporations. (i) In 2001, Corporation A

transfers a section 197(f)(9) intangible that it

held during the transition period to X, a

newly formed corporation, in exchange for

15% of X’s stock. As part of the same

transaction, B transfers property to X in

exchange for the remaining 85% of X stock.

(ii) Because the acquisition of the

intangible by X is part of a qualifying section

351 exchange, under section 197(f)(2) and

paragraph (g)(2)(ii) of this section, X is

treated in the same manner as the transferor

of the asset. Accordingly, X may not amortize

the intangible. If, however, at the time of the

exchange, B has a binding commitment to

sell 25 percent of the X stock to C, an

unrelated third party, the exchange,

including A’s transfer of the section 197(f)(9)

intangible, would fail to qualify as a section

351 exchange. Because the formation of X,

the transfers of property to X, and the sale

of X stock by B are part of a series of related

transactions, the relationship between A and

X must be tested immediately before the first

transaction in the series (the transfer of

property to X) and immediately after the last

transaction in the series (the sale of X stock

to C). See paragraph (h)(6)(ii)(B) of this

section. Because there was no relationship

between A and X immediately before and

only a 15% relationship immediately after, A

is not related to X for purposes of applying

the anti-churning rules of paragraph (h) of

this section. Accordingly, X may amortize the

section 197 intangible.

Example 26. Relationship created as part

of stock acquisition followed by liquidation.

(i) In 2001, Partnership P purchases 100

percent of the stock of Corporation X. P and

X were not related prior to the acquisition.

Immediately after acquiring the X stock, and

Federal Register / Vol. 65, No. 16 / Tuesday, January 25, 2000 / Rules and Regulations 3843

as part of a series of related transactions, P

liquidates X under section 331. In the

liquidating distribution, P receives a section

197(f)(9) intangible that was held by X during

the transition period.

(ii) Because the relationship between P and

X was created pursuant to a series of related

transactions where P acquires stock (meeting

the requirements of section 1504(a)(2)) in a

fully taxable transaction followed by a

liquidation under section 331, the

relationship immediately after the last

transaction in the series (the liquidation) is

disregarded. See paragraph (h)(6)(iii) of this

section. Accordingly, P is entitled to amortize

the section 197(f)(9) intangible.

Example 27. Section 743(b) adjustment

with no change in user. (i) On January 1,

2001, A forms a partnership (PRS) with B in

which A owns a 60-percent, and B owns a

40-percent, interest in profits and capital. A

contributes a nonamortizable section

197(f)(9) intangible with a value of $80 and

an adjusted basis of $0 to PRS in exchange

for its PRS interest and B contributes $120

cash. At the time of the contribution, PRS

licenses the section 197(f)(9) intangible to A.

On February 1, 2001, A sells its entire

interest in PRS to C, an unrelated person, for

$80. PRS has a section 754 election in effect.

(ii) The section 197(f)(9) intangible

contributed to PRS by A is not amortizable

in the hands of PRS. Pursuant to section

(g)(2)(ii) of this section, PRS steps into the

shoes of A with respect to A’s

nonamortizable transferred basis in the

intangible.

(iii) When A sells the PRS interest to C, C

will have a basis adjustment in the PRS

assets under section 743(b) equal to $80. The

entire basis adjustment will be allocated to

the intangible because the only other asset

held by PRS is cash. Ordinarily, under

paragraph (h)(12)(v) of this section, the antichurning rules will not apply to an increase

in the basis of partnership property under

section 743(b) if the person acquiring the

partnership interest is not related to the

person transferring the partnership interest.

However, A is an anti-churning partner

under paragraph (h)(12)(vi)(B)(3) of this

section. Because A remains a user of the

section 197(f)(9) intangible after the transfer

to C, paragraph (h)(12)(vi)(A) of this section

will cause the anti-churning rules to apply to

the entire basis adjustment under section

743(b).

(l) Effective dates—(1) In general. This

section applies to property acquired

after January 25, 2000, except that

paragraph (c)(13) of this section

(exception from section 197 for

separately acquired rights of fixed

duration or amount) applies to property

acquired after August 10, 1993 (or July

25, 1991, if a valid retroactive election

has been made under § 1.197–1T).

(2) Application to pre-effective date

acquisitions. A taxpayer may choose, on

a transaction-by-transaction basis, to

apply the provisions of this section and

§ 1.167(a)–14 to property acquired after

August 10, 1993 (or July 25, 1991, if a

valid retroactive election has been made

under § 1.197–1T) and on or before

January 25, 2000.

(3) Application of regulation project

REG–209709–94 to pre-effective date

acquisitions. A taxpayer may rely on the

provisions of regulation project REG–

209709–94 (1997–1 C.B. 731) for

property acquired after August 10, 1993

(or July 25, 1991, if a valid retroactive

election has been made under § 1.197–

1T) and on or before January 25, 2000.

(4) Change in method of accounting—

(i) In general. For the first taxable year

ending after January 25, 2000, a

taxpayer that has acquired property to

which the exception in § 1.197–2(c)(13)

applies is granted consent of the

Commissioner to change its method of

accounting for such property to comply

with the provisions of this section and

§ 1.167(a)–14 unless the proper

treatment of such property is an issue

under consideration (within the

meaning of Rev. Proc. 97–27 (1997–21

IRB 10)(see § 601.601(d)(2) of this

chapter)) in an examination, before an

Appeals office, or before a Federal court.

(ii) Application to pre-effective date

acquisitions. For the first taxable year

ending after January 25, 2000, a

taxpayer is granted consent of the

Commissioner to change its method of

accounting for all property acquired in

transactions described in paragraph

(l)(2) of this section to comply with the

provisions of this section and

§ 1.167(a)–14 unless the proper

treatment of any such property is an

issue under consideration (within the

meaning of Rev. Proc. 97–27 (1997–21

IRB 10)(see § 601.601(d)(2) of this

chapter)) in an examination, before an

Appeals office, or before a Federal court.

(iii) Automatic change procedures. A

taxpayer changing its method of

accounting in accordance with this

paragraph (l)(4) must follow the

automatic change in accounting method

provisions of Rev. Proc. 99–49 (1999–52

IRB 725)(see § 601.601(d)(2) of this

chapter) except, for purposes of this

paragraph (l)(4), the scope limitations in

section 4.02 of Rev. Proc. 99–49 (1999–

52 IRB 725) are not applicable.

However, if the taxpayer is under

examination, before an appeals office, or

before a federal court, the taxpayer must

provide a copy of the application to the

examining agent(s), appeals officer, or

counsel for the government, as

appropriate, at the same time that it files

the copy of the application with the

National Office. The application must

contain the name(s) and telephone

number(s) of the examining agent(s),

appeals officer, or counsel for the

government, as appropriate.

PART 602—OMB CONTROL NUMBERS

UNDER THE PAPERWORK

REDUCTION ACT

Par. 8. The authority citation for part

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 9. In § 602.101, paragraph (b) is

amended by adding an entry to the table

in numerical order to read as follows.

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section identified

and described

Current

OMB Control

No.

*****

1.197–2 ................................. 1545–1671

*****

David Mader,

Acting Deputy Commissioner of Internal

Revenue.

Approved: January 14, 2000.

Jonathan Talisman,

Acting Assistant Secretary of the Treasury.

[FR Doc. 00–1380 Filed 1–20–00; 1:19 pm]

BILLING CODE 4830–01–U

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 8869]

RIN 1545–AU77

Subchapter S Subsidiaries

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations that relate to the treatment

of corporate subsidiaries of S

corporations and interpret the rules

added to the Internal Revenue Code by

section 1308 of the Small Business Job

Protection Act of 1996. These

regulations provide the public with

guidance needed to comply with

applicable law and will affect S

corporations and their shareholders.

DATES: Effective Date: These regulations

are effective January 20, 2000.

Applicability Date: For dates of

applicability, see §§ 1.1361–4(a)(3)(iii),

1.1361–4(a)(5)(i), 1.1361–5(c)(2),

1.1361–6, 1.1362–8(e), and 301.6109–

1(i)(4).

FOR FURTHER INFORMATION CONTACT:

Jeanne M. Sullivan (202) 622–3050 (not