2336 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

Room, room 3313, Internal Revenue

Building, 1111 Constitution Avenue

NW., Washington, DC. Because of access

restrictions, visitors will not be

admitted beyond the Internal Revenue

Service Building lobby more than 15

minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons that wish to present oral

comments at the hearing must submit

comments by April 16, 1997 and submit

an outline of the topics to be discussed

and the time to be devoted to each topic

by May 1, 1997.

A period of 10 minutes will be

allotted to each person for making

comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal author of these

regulations is Brendan P. O’Hara, Office

of the Assistant Chief Counsel

(Corporate), IRS. However, other

personnel from the IRS and Treasury

Department participated in their

development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 continues to read in part as

follows:

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

Par. 2. Section 1.338(b)–2 is added to

read as follows:

§ 1.338(b)–2 Allocation of adjusted

grossed-up basis among target assets.

[The text of this section is the same

as the text of the amendments to

§ 1.338(b)–2T published elsewhere in

this issue of the Federal Register].

Par. 3. Section 1.338(b)–3 is added to

read as follows:

§ 1.338(b)–3 Subsequent adjustments to

adjusted grossed-up basis.

[The text of this section is the same

as the text of the amendments to

§ 1.338(b)–3T published elsewhere in

this issue of the Federal Register].

Par. 4. Section 1.1060–1 is added to

read as follows:

§ 1.1060–1 Special allocation rules for

certain asset acquisitions.

[The text of this section is the same

as the text of the amendments to

§1.1060–1T published elsewhere in this

issue of the Federal Register].

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 97–655 Filed 1–9–97; 2:53 pm]

BILLING CODE 4830–01–U

26 CFR Part 1

[REG–209709–94]

RIN 1545–AS77

Amortization of Intangible Property

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Notice of proposed rulemaking

and notice of public hearing.

SUMMARY: This document contains

proposed regulations relating to the

amortization of certain intangible

property. The proposed 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.

This document also provides notice of

a public hearing on the proposed

regulations.

DATES: Comments must be received by

April 16, 1997. Requests to appear and

outlines of oral comments to be

presented at the public hearing

scheduled for May 15, 1997, must be

received by April 24, 1997.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–209709–94),

room 5228, Internal Revenue Service,

POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions

may be hand delivered between the

hours of 8 a.m. and 5 p.m. to:

CC:DOM:CORP:R (REG–209709–94),

Courier’s Desk, Internal Revenue

Service, 1111 Constitution Avenue NW.,

Washington, DC. Alternatively,

taxpayers may submit comments

electronically via the Internet by

selecting the Tax Regs option of the IRS

Home Page, or by submitting comments

directly to the IRS Internet site at

http:\\www.irs.ustreas.gov\prod\tax

lregs\comments.html. The public

hearing will be held in the

Commissioner’s Conference Room

(Room 3313), Internal Revenue

Building, 1111 Constitution Avenue

NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations, John

Huffman at (202) 622–3110; concerning

submissions and the hearing, Michael

Slaughter at (202) 622–8452 (not tollfree numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed

regulations under sections 167(f) and

197. These provisions were added to the

Internal Revenue Code of 1986 (the

Code) by section 13261 of OBRA ’93,

and apply to intangible property

acquired after August 10, 1993 (or after

July 25, 1991, if a valid retroactive

election to apply OBRA ’93 to

intangibles has been made pursuant to

§ 1.197–1T).

The proposed regulations provide

definitions and rules for amortization of

intangible property subject to sections

197 and 167(f). On June 24, 1994, the

IRS published Announcement 94–92

(1994–28 I.R.B. 139) in the Federal

Register (59 FR 32670) inviting

comments under section 197 relating to

the amortization of goodwill and certain

other intangibles that should be

addressed in proposed regulations. The

IRS has reviewed these comments and

has addressed certain issues raised in

the comments in the proposed

regulations. However, because these

comments were received in anticipation

of the issuance of these proposed

regulations, and because these

regulations are subject to further

comment and a public hearing, no

attempt has been made to describe all of

the principal comments that are not

reflected in these regulations or the

reasons therefor.

Explanation of Provisions

1. General Overview

Sections 167(f) and 197 provide

comprehensive rules for the

depreciation and amortization of many

intangible assets. Intangible assets

subject to section 197 are broadly

defined to include most intangible

assets acquired in connection with the

acquisition of a trade or business and

certain other separately acquired

intangible assets. The adjusted basis of

an amortizable section 197 intangible

must be amortized over a 15-year

period. Certain other intangible assets

are excluded from section 197 for

various reasons. In some cases, such as

stock and partnership interests, the asset

is property of a character that is not

subject to an allowance for depreciation

because it represents a permanent

investment that can only be recovered

through disposition of the asset

(including worthlessness). In other

cases, such as computer software,
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules 2337

purchased mortgage servicing rights,

service and supply contracts, and

certain other contracts or rights with a

fixed duration, other cost recovery

methods were prescribed by the OBRA

’93 amendments. In still other cases,

such as motion picture films, television

series, books, and sound recordings,

other cost recovery methods that were

in effect prior to OBRA ’93 are more

appropriate under the circumstances.

Section 167(f) provides alternative

methods of depreciation for certain of

the intangibles excluded from the

application of section 197.

The proposed regulations provide

guidance for certain intangible property

subject to sections 167(f) and 197. The

section 167(f) proposed regulations

provide rules for intangible property

subject to the allowance for depreciation

under section 167 and specifically

excluded from section 197. These

intangible assets include certain

computer software, rights to receive

tangible property or services, rights of

fixed duration, patents, copyrights, and

mortgage servicing rights. These

proposed regulations reserve guidance

on the method of depreciating the cost

of separately acquired rights to receive

tangible property or services where the

amount of the property or services to be

received is not specified. The IRS

invites comments on possible methods

of depreciation in these cases.

Because section 197 provides a

method of amortization and, except in

the case of certain covenants not to

compete, governmental licenses,

permits and other rights, and contracts

for the use of section 197 intangibles,

does not alter the rules for determining

the basis of an asset, section 197

generally does not apply to amounts

that would otherwise be deductible. For

example, section 197 does not generally

apply to the costs of advertising

because, in most cases, these costs are

deductible under other provisions of the

Code. See Rev. Rul. 92–80 (1992–2 C.B.

57). In addition, section 197 does not

apply to costs that would not, under

general principles of Federal income tax

law, be included in the basis of a section

197 intangible. For example, if a

taxpayer borrows money to purchase the

assets of a trade or business (including

amortizable section 197 intangibles) and

incurs fees in connection with the loan,

these costs are generally amortized over

the term of the loan rather than under

the rules of sections 167(f) and 197. As

a further example, if the amortizable

section 197 intangibles acquired in the

transaction include a favorable supply

contract, the amortizable basis in the

contract does not include amounts

required to be paid for goods to be

received pursuant to the contract. In addition, section 197 does not

apply to any amount for which a

deduction would be disallowed under

other provisions of the Code, such as

section 162(k) (relating to amounts paid

or incurred by a corporation in

connection with the acquisition of its

stock or the stock of a related person). No inference should be drawn from

any provision in the proposed

regulations concerning the classification

of any section197 intangible as property,

or whether any section 197 intangible is

treated as tangible or intangible

property, for other purposes of the Code.

Furthermore, no inference should be

drawn from any provision in the

proposed regulations regarding (a)

whether any section 197 intangible that

is not an amortizable section 197

intangible may be amortized or

depreciated under any provision of the

Code other than section 197, or (b) the

proper method for determining any

allowance therefor. Finally, no inference

should be drawn from any provision in

the proposed regulations concerning

whether any section 197 intangible (or

any interest therein) has been

purchased, leased, or licensed for

Federal income tax purposes.

2. Section 197 Intangibles

The proposed regulations define

section 197 intangibles (subject to

certain exceptions) as goodwill, going

concern value, workforce in place,

information base, know-how, customerand supplier-based intangibles,

governmental licenses and permits,

covenants not to compete and other

similar arrangements, franchises,

trademarks, trade names, and contracts

for the use of the foregoing assets.

A. Covenants Not to Compete

Some commentators in response to

Announcement 94–92 suggested that a

covenant not to compete relating to the

redemption of stock or a partnership

interest from a departing stockholder or

partner should be excluded from section

197 because this situation does not

involve the acquisition of a trade or

business. The legislative history

provides, however, that section 197

applies to a covenant not to compete

acquired with the assets of a trade or

business, the stock in a corporation, or

an interest in a partnership engaged in

a trade or business. Consequently, the

proposed regulations do not provide for

this exception. In this regard, the

proposed regulations provide that for

purposes of section 197(f)(1)(B), the

disposition or cancellation of redeemed

stock of a corporation will not cause the

covenant to be written off faster than

over the 15-year amortization period

provided for under section 197 (in the

case of a covenant to which section

162(k) does not apply).

B. Contracts for the Use of Section 197

Intangibles

Some commentators also requested

guidance on the extent to which

contracts for the use of section 197

intangibles would be subject to section

197, in some cases suggesting that an

intangible was not subject to section 197

unless the taxpayer obtained ownership

of property for Federal income tax

purposes. However, it is sometimes

difficult to determine whether the terms

of an agreement confer ownership, for

Federal income tax purposes, of

property, and the IRS and Treasury

believe that the purposes of section 197

could be circumvented through the use

of such agreements. Accordingly, the

proposed regulations provide that

contracts for the use of section 197

intangibles will also be treated as

section 197 intangibles. Contracts that

are so treated may, however, be

excluded under either section 197(e)(4)

(B) or (D) on the basis that they are

contracts for the receipt of property or

services, contracts having a fixed

duration, or contracts having a fixed

amount and recovered on a unit-ofproduction method or other similar

method.

3. Intangibles Excluded From Section

197

A. Computer Software

Section 197 intangibles do not

include computer software that is

readily available for purchase by the

general public, is subject to a

nonexclusive license, and has not been

substantially modified. The proposed

regulations provide a safe harbor for

purposes of determining whether

computer software has been

substantially modified. Under the safe

harbor, computer software has not been

substantially modified if its capitalized

cost does not exceed the greater of

$2,000 or 125 percent of the price at

which the unmodified version of the

software is readily available to the

general public.

The proposed regulations incorporate

some of the provisions of Revenue

Procedure 69–21 (1969–2 C.B. 303),

involving the treatment of costs of

computer software, and modify other

provisions to the extent necessary to

conform to the amortization rules

provided under sections 197 and 167(f).

Consequently, if costs for developing

computer software that the taxpayer has

elected to treat as deferred expenses
2338 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

under section 174(b) result in the

development of a self-created intangible

excluded under section 197(c)(2) and

subject to the allowance for depreciation

under section 167(a), deductions for the

unrecovered expenditures are subject to

section 167(f)(1). 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. The

proposed regulations also continue to

treat as currently deductible software

costs properly and consistently treated

as deductible (not capitalized) under

§ 1.162–11.

B. Certain Separately Acquired

Intangibles

Certain intangibles are excepted from

section 197 if they are not acquired as

part of a purchase of a trade or business.

The proposed regulations clarify 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. Temporary and proposed

regulations under section 1060, in turn,

provide that a group of assets

constitutes a trade or business for

purposes of section 1060 if the use of

such assets would constitute an active

trade or business for purposes of section

355. However, in appropriate cases,

even if the use of a group of assets

would not constitute an active trade or

business for purposes of section 355,

such assets may nevertheless constitute

a trade or business for purposes of

section 1060. See §1.1060–1T(b)(2).

The IRS intends to provide additional

guidance as to the circumstances under

which the acquisition of a group of

assets constitutes a trade or business for

purposes of section 1060 in regulations

under that section. Accordingly, the

proposed regulations do not provide

substantive guidance on this question,

except to the extent that the

considerations are unique to the

application of section 197. The IRS

invites comments on the extent to

which additional rules under section

197 may be necessary.

C. Certain Contracts and Governmental

Rights

While section 197 intangibles include

licenses, permits, and other rights

granted by a governmental unit or an

agency or instrumentality thereof

(section 197(d)(1)(D)), certain rights

granted by these governmental entities

are excluded from section 197 pursuant

to section 197(e)(4) (B) and (D), subject

to the conditions and limitations

therein. Because a particular right may

be described in two or more of these

provisions, the proposed regulations

provide guidance regarding the

potential conflict between, or overlap

with, these provisions. Thus, a right that

would be subject to section 197

pursuant to section 197(d)(1)(D) may

nevertheless be excluded if it is also

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

all of the requirements for exclusion.

Furthermore, a right that meets the

requirements of either section

197(e)(4)(B) or section 197(e)(4)(D) is

excluded from section 197 even if it

fails to meet one of the requirements for

the other exclusion. In addition, any

license, permit, or other right granted by

a governmental unit that otherwise

meets the definition of a franchise under

section 197(d)(1)(F), such as an FCC

broadcast license or cable television

franchise, is treated as a franchise under

the regulations. Accordingly, these

licenses do not qualify for any of the

exceptions from section 197 provided

under section 197(e)(4).

4. Special Rules of Application

A. Loss Disallowance Provisions

The proposed regulations contain

rules for the loss disallowance

provisions set forth in section 197(f)(1).

In particular, the proposed regulations

provide that a taxpayer may not

circumvent the loss disallowance rules,

for example, by transferring some

intangibles, whose adjusted basis is

greater than their fair market value, to

a corporation in exchange for stock in

the corporation in a transaction

described in section 351, while

retaining other intangibles acquired in

the same or related transaction, and

then selling the stock. Special rules are

also provided for the application of the

loss disallowance provisions in cases

where a taxpayer has disposed of all of

the amortizable section 197 intangibles

acquired in a single transaction but is

treated as having retained other

amortizable section 197 intangibles

solely by virtue of the retention of

amortizable section 197 intangibles by a

related person.

B. Transactions Involving Partnerships

The proposed regulations provide

rules and examples relating to the

treatment of section 197 intangibles

acquired or transferred in certain

partnership transactions, including

terminations under section 708(b)(1),

and the application of section 197 to the

special basis adjustments of partnership

property for which a section 754 or

section 732(d) election is in effect.

Guidance is also provided regarding the

effect of curative and remedial

allocations and the application of the

anti-churning rules to certain

partnership transactions.

In the case of the termination of a

partnership under section 708(b)(1)(B)

(relating to a sale or exchange of an

interest), the rules contained in the

proposed regulations are based on

recently proposed regulations under

that section, pursuant to which the new

partnership is treated as having directly

acquired the assets of the old

partnership in exchange for the

assumption of its liabilities and the

issuance of interests in the new

partnership. Accordingly, for purposes

of section 197, the consequences of the

termination of a partnership under

section 708(b)(1)(B) may not be the same

as the consequences of such a

termination under the rules in effect at

the time section 197 was enacted.

C. Treatment of Contingent Payments

The proposed regulations clarify that,

except in the case of contingent

payments, amounts paid for section 197

intangibles are treated as amounts

chargeable to capital account, and the

entire principal amount is amortized

ratably over the 15-year amortization

period beginning with the later of the

month in which the intangible is

acquired or the date on which the active

conduct of a trade or business begins.

Contingent payments for section 197

intangibles paid or incurred after the

taxable year in which the intangible is

acquired are added to basis at such time

and generally amortized ratably over the

remaining months in the 15-year period

as of the beginning of the month the

amount is paid or incurred. However, in

order to reduce the administrative

burden that may result from a

requirement to maintain separate

amortization schedules for each month

during the 15-year period, taxpayers are

permitted to use certain simplifying

conventions. In addition, 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 is amortized in full

immediately upon the inclusion of the

amount in the basis of the intangible.

The proposed regulations refer to

§1.461–1(a)(1) for rules governing the

time at which an amount may be taken

into account by a taxpayer using the

cash receipts and disbursements

method. They refer to §1.461–1(a)(2) for

rules governing the time at which a

liability is incurred and generally taken

into account (for example, by treating

the amount of the liability as a capital
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules 2339

expenditure) by an accrual basis

taxpayer.

5. Anti-Churning Rules

To be eligible for amortization,

section 197 intangibles must qualify as

amortizable section 197 intangibles.

Generally, amortizable section 197

intangibles are section 197 intangibles

that are acquired after August 10, 1993

(or acquired after July 25, 1991, and for

which the taxpayer made a proper

election under § 1.197–1T) and held in

connection with the conduct of a trade

or business or an activity described in

section 212.

The proposed regulations provide

anti-churning rules to prevent taxpayers

from converting into amortizable section

197 intangibles existing goodwill, going

concern value, and any other section

197 intangible for which amortization

would not have been allowable prior to

OBRA ’93 through the use of related

persons and certain other transactions.

The proposed regulations define the

term related person for purposes of

these rules.

The proposed regulations also contain

provisions for the exception to the antichurning rules in situations where the

seller elects to recognize gain and agrees

to pay a specified amount of tax. The

regulations reserve guidance on the

manner of making this election. The IRS

intends to issue a revenue procedure in

order to provide interim guidance to

taxpayers on the manner of making this

election, and the final regulations will

include the relevant provisions of this

revenue procedure.

The proposed regulations contain

both an anti-churning anti-abuse rule

and a general anti-abuse rule that

provide that the Commissioner may

recast any transaction if one of its

principal purposes is to avoid the

purposes of section 197.

6. Assumption Reinsurance

Transactions

Section 197(f)(5) provides special

rules for section 197 intangibles

resulting from assumption reinsurance

transactions. The proposed regulations

reserve guidance on certain aspects of

these transactions. The IRS invites

comments on the extent to which

additional guidance on the application

of section 197 to these transactions may

be necessary.

7. Proposed Effective Dates

The regulations for sections 167(f) and

197 are proposed to be effective 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)

are proposed to be effective 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).

8. Accounting Method Changes

A change in the method of

depreciation or amortization of

intangibles is a change in method of

accounting that requires the consent of

the Commissioner of Internal Revenue

under section 446(e). To obtain this

consent, a Form 3115, Application for

Change in Accounting Method,

generally must be filed within 180 days

after the beginning of the taxable year in

which the proposed change is to be

made. Taxpayers that have adopted a

method of accounting for certain

intangibles may need to change their

method of accounting to comply with

the final regulations.

9. Basis Allocation Rules

In separate notices the IRS and

Treasury are issuing temporary and

proposed amendments to the temporary

regulations under sections 1060 and

338(b). The existing temporary

regulations establish a four-class system

for allocating basis to individual assets

in the case of a direct acquisition of

assets constituting a trade or business or

a deemed acquisition of assets as the

result of an election under section 338.

Under this system, assets in the nature

of goodwill and going concern value are

included in Class IV, while other

intangible assets, whether or not

amortizable, are included in Class III.

Each successive class is allocated basis

under a residual method, subject to a

fair market value limitation for all

classes except Class IV. After basis has

been allocated to each class in the

aggregate, assets within each of the first

three classes are allocated basis on a

proportional method. This system is

inconsistent with the policies of section

197, which prescribes uniform

treatment for all amortizable section 197

intangibles. Accordingly, appropriate

modifications are being proposed.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a

significant regulatory action as defined

in EO 12866. Therefore, a regulatory

assessment 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, and, because the regulations

do not impose a collection of

information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue

Code, this notice of proposed

rulemaking will be submitted to the

Chief Counsel for Advocacy of the Small

Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations,

consideration will be given to any

comments that are submitted (in the

manner described in ADDRESSES)

timely to the IRS. All comments will be

available for public inspection and

copying.

A public hearing has been scheduled

for May 15, 1997, at 10 a.m. in the

Commissioner s Conference Room

(Room 3313), Internal Revenue

Building, 1111 Constitution Avenue

NW., Washington, DC 20224. Because of

access restrictions, visitors will not be

admitted beyond the Internal Revenue

Building lobby more than 15 minutes

before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons that wish to present oral

comments at the hearing must submit

comments and an outline of the topics

to be discussed and the time to be

devoted to each topic (in the manner

described in ADDRESSES) by April 16,

1997. A period of 10 minutes will be

allotted to each person for making

comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

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 in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

proposed to be 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). * * *
2340 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

Par. 2. Section 1.167(a)–3 is amended

by adding a sentence at the end to read

as follows:

§ 1.167(a)–3 Intangibles.

* * * See § 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. 3. 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 the date on which the final

regulations are published in the Federal

Register. See § 1.197–2 for amortization

of interests in patents and copyrights

that constitute amortizable section 197

intangibles.

* * * * *

Par. 4. 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, rights

of fixed duration or amount, and certain

mortgage servicing rights. Intangibles for

which an amortization amount is

determined under section 167(f) and

intangibles otherwise excluded from

section 197 (for example, self-created

intangibles described in § 1.197–2(d)(2))

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 adjusted

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 with 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 treated as currently

deductible (that is, not capitalized)

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.

(c) Certain interests or rights acquired

separately—(1) Certain rights to receive

tangible property or services. The

amount of the deduction for a separately

acquired right to receive tangible

property or services under a contract or

from a governmental unit (specified in

section 167(f)(2) and § 1.197–2(c)(6)) is

determined as follows:

(i) Amortization of fixed amounts.

The cost of acquiring a right to receive

a fixed amount of tangible property or

services is amortized for each taxable

year by multiplying the basis (as

determined under section 1011) 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 of

acquiring 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.

(iii) Amortization in other cases.

[Reserved]

(2) Rights of fixed duration or

amount. The amount of the deduction

for a separately acquired right 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 of a fixed amount. The cost

of acquiring a right of a fixed amount is

amortized for each taxable year by

multiplying the cost of the right by a

fraction, the numerator of which is the

amount received or delivered during the

taxable year and the denominator of

which is the total amount to be received

or delivered (including amounts

received or delivered prior to the close

of the taxable year) under the terms of

the contract or governmental grant.

(ii) Rights of unspecified amount and

fixed duration of less than 15 years. The

cost of acquiring a right of an

unspecified amount and 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. The

amount of the deduction for a separately

acquired interest in a patent or

copyright described in section 167(f)(2)

and § 1.197–2(c)(7) is equal to the

purchase price paid or incurred during

the year if the purchase price is payable

on at least an annual basis as either a
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules 2341

fixed amount per use or a fixed

percentage of the revenue derived from

the use of the patent or copyright.

Otherwise, the cost or other basis of a

separately acquired patent or copyright

(or an interest therein) is depreciated

ratably over its remaining useful life. If

a patent or copyright becomes valueless

in any year before its legal expiration,

the adjusted basis may be deducted in

that year.

(5) Applicable rules and conventions.

The period of amortization under

paragraphs (c)(1) through (c)(4) of this

section begins when the intangible is

placed in service. For other applicable

rules, see § 1.197–2(f).

(d) Mortgage servicing rights. 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. Mortgage servicing rights

are not depreciable to the extent the

rights are stripped coupons under

section 1286. An event that renders

mortgage servicing rights wholly

worthless is considered a disposition of

the rights. For purposes of determining

the deduction for mortgage servicing

rights and any loss from the sale,

exchange, or other disposition of the

rights, rights to service a pool of

mortgages are treated as a single asset.

Thus, if some (but not all) mortgages in

a pool prepay and the taxpayer retains

rights to service the remaining

mortgages in the pool, no loss is

recognized by reason of the prepayment.

The adjusted basis of the mortgage

servicing rights is not affected by the

unrecognized loss.

(e) Effective date. This section is

applicable on the date final regulations

are published in the Federal Register

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) are applicable

August 11, 1993 (or July 26, 1991, if a

valid retroactive election has been made

under § 1.197–1T).

Par. 5. 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.

(4) Relationship to other Internal Revenue

Code provisions.

(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) In general.

(ii) Separately acquired software.

(iii) Other exceptions.

(iv) Computer software defined.

(v) Readily available to the general public.

(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) Customer-based intangibles.

(3) Franchise, trademark, or trade name.

(i) In general.

(ii) Exceptions.

(4) Acquisitions to be included.

(5) Substantial portion.

(6) Deemed asset purchases under section

338.

(f) Computation of amortization deduction.

(1) In general.

(2) Treatment of contingent amounts.

(i) Amounts added to basis during 15-year

period.

(ii) Amounts becoming fixed after

expiration of 15-year period.

(iii) Time for including amounts in basis.

(3) Determination of amounts chargeable to

capital account in certain cases.

(i) Covenants not to compete, rights

granted by governmental units, and contracts

for the use of section 197 intangibles.

(A) In general.

(B) Time for taking amounts into account.

(ii) Franchises, trademarks, or trade names

and licenses, permits, and other rights

granted by governmental units.

(iii) Certain reinsurance transactions.

(4) Transactions subject to section 338 or

1060.

(g) Special rules.

(1) Treatment of certain dispositions.

(i) Loss disallowance rules.

(A) In general.

(B) 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) In general.

(A) Transfer disregarded.

(B) Application of general rule.

(ii) 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.

(D) Anti-churning rules.

(v) Distributions to which section 732(d)

applies.

(vi) Curative and remedial allocations

under section 704(c).

(3) Application of section 754 to

acquisitions of an interest in an intangible

held through a partnership.

(4) 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) Other acquisitions. [Reserved]

(5) Amounts paid or incurred for a

franchise, trademark, or trade name.

(6) Amounts properly taken into account in

determining the cost of property that is not

a section 197 intangible.

(7) Treatment of amortizable section 197

intangibles as depreciable property.

(i) In general.

(ii) Exceptions and limitations.

(A) Unstated interest and original issue

discount rules.

(B) Treatment of other parties to

transaction.

(h) Anti-churning rules.

(1) Conversions of existing goodwill, going

concern value, and certain other section 197

intangibles.

(2) Amounts deductible under section

1253(d).

(3) Transition period.

(4) Exceptions.

(5) Special partnership provisions.

(i) Basis increases.

(ii) Curative and remedial allocations

under section 704(c).
2342 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

(6) Related person.

(i) In general.

(ii) Time for testing relationships.

(iii) 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) Exception to anti-churning rules where

gain is recognized.

(i) In general.

(ii) Manner of making election. [Reserved]

(iii) Determination of highest marginal rate

of tax.

(A) Noncorporate taxpayers.

(B) Corporations and tax-exempt entities.

(iv) Special rule for pass-through entities.

(v) Coordination with other provisions.

(A) In general.

(B) Section 1374.

(C) Procedural and administrative

provisions.

(D) Installment method.

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

(11) Anti-churning anti-abuse rule.

(i) [Reserved].

(j) General anti-abuse rule.

(k) Examples.

(l) Effective dates.

Par. 6. 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 adjusted 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, antichurning 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.

Except as otherwise provided in section

197(f)(3) and paragraphs (b)(11) and

(f)(3) of this section, section 197 does

not apply to amounts that would be

currently deductible without regard to

section 197.

(4) Relationship to other Internal

Revenue Code provisions. Section 197

does not apply to any amount paid or

incurred for a section 197 intangible if

a deduction for the amount would be

disallowed under any provision of the

Code other than section 263. (See, for

example, section 162(k).)

(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

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 business books and

records, operating systems, and any

other information base, including lists

or other information of current or

prospective customers (regardless of the

method of recording the information).

Thus, the amount paid or incurred for

these items 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) 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
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules 2343

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, in paragraph (c)(8) of

this section for an interest under a lease

of tangible property, and in paragraphs

(c) (6) and (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

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 or the provision of property or

the use of property (other than property

of the acquired trade or business) 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 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. (See section 1253(b)(1).) The term

includes distributorships or other

similar contractual arrangements

pursuant to which the transferee is

permitted or licensed to operate or

conduct a trade or business within a

specific area. The term trademark

includes any word, name, symbol, or

device, or any combination thereof,

adopted and used by a manufacturer or

merchant to identify goods or services

and distinguish them from those

manufactured or sold by others. The

term trade name includes any name

used by a manufacturer or merchant 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)(5) of this

section.)

(11) Contracts for the use of, and term

interests in, other 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) and

paragraphs (b)(3) through (b)(7) of this

section. (See paragraph (g)(4) 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
2344 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

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 persons

indebtedness, or an interest under an

assumption reinsurance contract. (See

paragraph (g)(4) 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) In

general. 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 for the user.

Computer software will not be

considered to have been substantially

modified if its cost does not exceed the

greater of 125 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 is not treated as a

cost of the software.

(ii) Separately acquired software.

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 within the meaning of

paragraph (e) of this section.

(iii) Other exceptions. Neither section

197 nor section 167(f) apply in the

following cases:

(A) Any amount of the cost of an

interest in computer software that is

included, without being separately

stated, in the cost of the hardware or

other tangible property will be treated as

part of the cost of the hardware or other

tangible property.

(B) Any amount of the cost of an

interest in computer software that

would be deductible under any

provision other than section 167(f) or

197 may be deducted and is not

required to be capitalized.

(iv) Computer software defined. For

purposes of this section, computer

software is any program or routine (that

is, any sequence of machine-readable

code) that is designed to cause a

computer (as defined in section

168(i)(2)(B)(ii)) to perform a desired

function or set of functions, and the

documentation required to describe and

maintain those programs. 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.

(v) Readily available to the general

public. 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. The requirements of

this paragraph (c)(4)(v) can be met even

though the software is not available

through a system of retail distribution.

(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
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules 2345

application, or copyright that is not

acquired as part of a purchase of a trade

or business. (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

Code.

(13) Rights of fixed duration or

amount. (i) Section 197 intangibles do

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 business and not as part of a purchase

of a trade or business;

(B) Is not described in sections

197(d)(1) (A), (B), (C) (ii), (iv), or (vi),

(E), or (F); and

(C) 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 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 created by the taxpayer 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

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 improvements or

other modifications are treated as

separate section 197 intangibles 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)(4)(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
2346 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

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.

A 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) Customer-based intangibles.

Whether or not a group of assets is

otherwise described in paragraph (e)(1)

of this section, a group of assets

constitutes a trade or business or a

substantial portion thereof if the assets

include any customer-based intangibles

(as defined in paragraph (b)(6) of this

section) or are acquired in a transaction

or series of related transactions that

involve the creation of any customerbased intangibles.

(3) 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)(3)—

(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; and

(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.

(4) 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)(4),

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).

(5) 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

assets constitute a substantial portion of

a trade or business.

(6) Deemed asset purchases under

section 338. A qualified stock purchase

that is treated as a purchase of assets

under section 338 shall be 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.

(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 adjusted basis (for purposes of

determining gain) 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, the first day of the month

in which the active conduct of the trade

or business begins.

(ii) Except as otherwise provided in

this section, adjusted 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 this

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. Any reasonable convention may

be used to determine the month in

which the basis increase incurs,

provided that the method selected is

used consistently for all amortizable

section 197 intangibles acquired in the

same transaction (or series of related

transactions) and that it does not result

in any amount being added to basis

earlier than the midpoint of the period

(for example, annual, semi-annual, or

quarterly) selected.

(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) Time for including amounts in

basis. See § 1.461–1(a)(1) for rules

governing the time at which an amount

may be taken into account by a taxpayer

using the cash receipts and

disbursements method, and § 1.461–

1(a)(2) for rules governing the time at

which a liability is incurred and

generally taken into account (for

example, by treating the amount of the

liability as a capital expenditure) by an

accrual basis taxpayer.

(3) Determination of amounts

chargeable to capital account in certain

cases—(i) Covenants not to compete,

rights granted by governmental units,

and contracts for the use of section 197

intangibles—(A) In general. In the case

of a covenant not to compete or other

similar arrangement described in

paragraph (b)(9) of this section, any

license, permit, or other right granted by

a governmental unit or an agency or

instrumentality thereof described in

paragraph (b)(8) of this section, or a

contract for the use of a section 197

intangible described in paragraph

(b)(11) of this section, the amount

chargeable to capital account includes

all amounts required to be paid

pursuant to the agreement or right,

whether or not any amount would be

deductible under section 162 if the

agreement or right were not a section

197 intangible.

(B) Time for taking amounts into

account. For purposes of this paragraph

(f)(3), in applying the provisions of

§§ 1.461–1(a)(1) (in the case of a

taxpayer using the cash receipts and

disbursements method of accounting)

and § 1.461–1(a)(2) (in the case of a

taxpayer using an accrual method of
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules 2347

accounting), all amounts required to be

paid under an agreement described in

paragraph (b) (9) or (11) of this section

shall be treated as amounts payable

under the terms of a debt instrument

issued in exchange for property.

Contingent payments made under an

agreement described in paragraph (b) (9)

or (11) of this section will be included

in adjusted basis under the rules of

paragraph (f)(2) of this section.

(ii) Franchises, trademarks, or trade

names and licenses, permits, and other

rights granted by governmental units.

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.

(iii) Certain reinsurance transactions.

See paragraph (g)(4)(ii) of this section

for special rules regarding the adjusted

basis of an insurance contract acquired

through an assumption reinsurance

transaction.

(4) 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.

(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

acquired in a transaction or series of

related transactions in which the

taxpayer acquired other amortizable

section 197 intangibles if, after the

disposition, the taxpayer retains any of

the other amortizable section 197

intangibles, or the right to use, or an

interest in, any of the other amortizable

section 197 intangibles (the retained

intangibles). 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 the loss that is not

recognized solely by reason of this rule

and 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. 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.

(B) 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 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, the termination of several

mortgages (not qualifying for the

exception set forth in paragraph (c)(11)

of this section) from an acquired

mortgage pool, 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 a

trade or business, 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 that

trade or business. For example, a

covenant not to compete entered into in

connection with the purchase of stock

continues to be amortized on a 15-year

straight-line basis (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

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
2348 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

transactions—(i) In general—(A)

Transfer disregarded. Except as

otherwise provided in paragraph (h) of

this section, if a section 197 intangible

is transferred in a transaction described

in paragraph (g)(2)(ii) 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)(i)(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) of this section. The

rules of this paragraph (g)(2)(i) also

apply to any subsequent transfers of the

intangible in a transaction described in

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

(ii) Transactions covered. The

transactions described in this paragraph

(g)(2)(ii) are—

(A) Any transaction described in

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

(B) 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). Except as

otherwise provided in paragraph (h) of

this section, 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

transferee in a transaction that is not

subject to section 1031 or 1033. (See

paragraph (h) of this section for the

application of the anti-churning rules.)

(iv) Transfers under section

708(b)(1)—(A) In general. Paragraph

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

that is terminated pursuant to section

708(b)(1)(B) (relating to a 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 basis of

property of the terminated partnership

under section 743(b).)

(C) Other terminations. In applying

paragraph (g)(2)(i) 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.

(D) Anti-churning rules. See

paragraph (h) of this section for the

application of the anti-churning rules.

(v) Distributions to which section

732(d) applies. Paragraph (g)(2)(i) of this

section applies to a distribution of a

section 197 intangible to which section

732(d) (relating to special partnership

basis to transferee) applies. For

purposes of section 197, any increase in

the basis of the distributed intangible

under section 732(d) is taken into

account by a partner as if the increased

portion were attributable to the partner’s

acquisition of the underlying

partnership property on the date of

distribution from the transferor of the

partnership interest or the deceased

partner, as the case may be. For

purposes of the effective date and antichurning rules (paragraphs (d)(1) and

(h) of this section), 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). For

purposes of determining the

amortization period under section 197

with respect to any increased basis,

however, the intangible is treated as

having been acquired by the transferee

partner at the time of the distribution

described in section 732(a). (See

paragraph (h) of this section for the

application of the anti-churning rules.)

(vi) Curative and remedial allocations

under section 704(c). For purposes of

paragraph (g)(2)(i) of this section, if a

section 197 intangible is transferred to

a partnership in a transaction described

in section 721, the basis of the

intangible in the hands of the transferor

includes the amount of any curative or

remedial allocations of amortization that

are made to a noncontributing partner

with respect to the contributed

intangible under the curative or

remedial methods for making

allocations under section 704(c). Thus,

for example, if a contributed intangible

is not an amortizable section 197

intangible in the hands of the transferor,

any remedial allocations of amortization

made to a noncontributing partner with

respect to the intangible are not

amortizable under section 197. See

§ 1.704–3(c) and (d) for a description of

the curative and remedial methods.

(3) Application of section 754 to

acquisitions of an interest in an

intangible held through a partnership.

Any increase in the basis of partnership

property under section 734(b) (relating

to the optional adjustment to the basis

of undistributed partnership property)

or section 743(b) (relating to the

optional adjustment to the basis of

partnership property) is taken into

account under section 197 by a partner

as if the increased portion of the basis

were attributable to the partner’s

acquisition of the underlying

partnership property and as if the

property were acquired from the

distributee partner on the date of the
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distribution (in the case of a basis

increase under section 734(b)) or from

the transferor of the partnership interest

on the date of the transfer (in the case

of a basis increase under section 743(b)).

(See paragraph (h) of this section for the

application of the anti-churning rules.)

(4) 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)(4)(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) Other acquisitions. [Reserved]

(5) 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), the amount

is deductible under section 1253(d)(1)

and 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.

(6) 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.

(7) Treatment of amortizable section

197 intangibles as depreciable

property—(i) In general. 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 held for more than one year,

it generally qualifies under section 1231

as property used in a trade or business.

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)).

(ii) Exceptions and limitations—(A)

Unstated interest and original issue

discount rules. In the case of the

acquisition of any amortizable section

197 intangible in a transaction that

would not be treated as the sale or

exchange of property by the person from

which the intangible was acquired,

paragraph (g)(7)(i) of this section shall

not apply (and the amortizable section

197 intangible shall not be treated as

property) for purposes of—

(1) Section 483(c) (relating to

payments on account of the sale or

exchange of property); and

(2) Section 1274(c) (relating to debt

instruments given in consideration for

the sale or exchange of property).

(B) 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 paragraph (g)(7)(i)

of this section to any other party to the

transaction.

(h) Anti-churning rules—(1)

Conversions of existing goodwill, going

concern value, and certain other section

197 intangibles. Except as otherwise

provided in this paragraph (h),

goodwill, going concern value, or any

other section 197 intangible for which a

depreciation or amortization deduction

would not have been allowable prior to

the enactment of section 197 may not be

amortized as an amortizable section 197

intangible if the section 197 intangible

is acquired by a taxpayer after August

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

retroactive election pursuant to § 1.197–

1T has been made) and either—

(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 (or a

person related to that person) that held

or used the intangible at any time

during the transition period.

(2) Amounts deductible under section

1253(d). For purposes of paragraph

(h)(1) of this section, deductions

allowable under section 1253(d)(2) or

deductions allowable pursuant to an

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

either case as in effect prior to the

enactment of section 197) are treated as

deductions allowable for amortization.

(3) Transition period. For purposes of

this paragraph (h), the transition period

begins on July 25, 1991, and ends on

August 10, 1993, except that for

taxpayers that made a valid retroactive

election pursuant to § 1.197–1T, the

transition period is July 25, 1991.

(4) Exceptions. The anti-churning

rules of this paragraph (h) do not apply

to—

(i) The acquisition of an intangible by

a taxpayer if the basis of the intangible

is determined under section 1014(a); or

(ii) The acquisition of an intangible by

a taxpayer that is an amortizable section

197 intangible in the hands of the seller

(or transferor), but only if the

acquisition by the taxpayer or sale by

the seller (or transfer by the transferor)

was not part of a transaction or a series

of related transactions in which the

seller (or transferor) previously acquired

the intangible or interest therein.

(5) Special partnership provisions—(i)

Basis increases. In determining whether

the anti-churning rules of this paragraph

(h) apply to any increase in the basis of

partnership property under section 732,

734, or 743, the determinations are

made at the partner level and each

partner is treated as having owned and

used the partner’s proportionate share of

the partnership property. Thus, for

example, the anti-churning rules do not

apply to an increase in the basis of

partnership property under section

743(b) that occurs upon the acquisition

of an interest in a partnership that has

made a section 754 election if the

person acquiring the partnership

interest either is not related to the

person transferring the partnership

interest or acquired the interest upon

the death of the former partner.

Similarly, the anti-churning rules do not

apply to a continuing partner’s

proportionate share of an increase in the
2350 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

basis of partnership property under

section 734(b) that occurs upon the

distribution of property of a partnership

that has made a section 754 election if

the continuing partner is not related to

the distributee partner.

(ii) Curative and remedial allocations

under section 704(c). In determining

whether the anti-churning rules of this

paragraph (h) apply, any curative or

remedial allocation of amortization

made to a noncontributing partner

under the curative or remedial methods

for making allocations under section

704(c) is treated in the same manner as

a noncurative or nonremedial allocation

of amortization. Thus, for example, if

the anti-churning rules would apply to

a nonremedial allocation of

amortization to a noncontributing

partner, the anti-churning rules apply to

any remedial allocation of amortization.

See § 1.704–3 (c) and (d) for a

description of the curative and remedial

methods.

(6) Related person—(i) In general.

Except as otherwise provided in

paragraph (h)(6)(iii) 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 was

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. For

purposes of this paragraph (h), a person

is treated as related to another person if

the relationship exists—

(A) In the case of a single transaction,

immediately before or immediately after

the acquisition of the intangible

involved; or

(B) In the case of a series of related

transactions, at any time during the

period beginning immediately before

the earliest acquisition and ending

immediately after the last acquisition of

any intangible acquired in the series of

transactions.

(iii) De minimis rule—(A) In general.

Two corporations shall not be treated as

related persons for purposes of this

paragraph (h)(6) if—

(1) The corporations would (but for

the application of this paragraph

(h)(6)(iii)) 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 one 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)(iii), the beneficial

ownership interest of one corporation in

the stock of another corporation shall be

determined under the principles of

section 318(a), except that—

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

the 50 percent limitation contained

therein shall not be applied; and

(2) Section 318(a)(3)(C) shall be

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

property at any time during the

transition period and that is no longer

in existence is deemed to be in

existence for purposes of determining

whether the taxpayer that acquired the

property is related to the corporation,

partnership, or trust.

(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

that is treated as selling its assets as a

result of an election thereunder (old

target) is not considered related to the

corporation that is treated as purchasing

the assets (new target) if stock of old

target meeting the requirements of

section 1504(a)(2) is, or is deemed to

have been, acquired by purchase after

July 25, 1991. See § 1.338–2(d). Thus,

for example, if a corporation (the

purchasing corporation) makes a

qualified stock purchase of the stock of

another corporation (target) from

unrelated third parties in July 1997, and

a section 338 election is made by the

purchasing corporation, the deemed

asset purchase shall not be considered

as an acquisition between related

persons solely by virtue of the fact that

old target and new target are treated as

the same corporation for certain other

purposes of the Code or that 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 because old target

and new target are otherwise treated as

related parties within the meaning of

paragraph (h)(6) of this section.

(9) Exception to anti-churning rules

where gain is recognized—(i) In general.

If a taxpayer would not be subject to

paragraph (h) but for the substitution of

20 percent for 50 percent under

paragraph (h)(6)(i)(A) of this section and

the person (whether or not subject to

Federal income tax) from which the

taxpayer acquires the intangible elects

to recognize gain on the disposition of

the intangible and, notwithstanding any

other provision of the Internal Revenue

Code, agrees to pay an amount that,

when added to any other Federal

income tax, equals the gain on the

disposition multiplied by the highest

marginal rate of tax imposed by section

1 (for individuals, estates, or trusts) or

11 (for corporations), whichever is

applicable, for the taxable year in which

the gain is realized by the person from

which the taxpayer acquires the

intangible, then the anti-churning rules

described in this paragraph (h) only

apply to the extent the taxpayer s

adjusted basis in the intangible exceeds

the gain recognized.

(ii) Manner of making election.

[Reserved]

(iii) Determination of highest

marginal rate of tax. For the purpose of

determining the highest marginal rate of

tax applicable to the person from which

the taxpayer acquires the intangible, the

following rules shall apply:

(A) Noncorporate taxpayers. In the

case of an individual, estate, or trust, the

highest marginal rate of tax shall be the

highest marginal rate of tax in effect

under section 1, determined without

regard to section 1(h).

(B) 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 shall be 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.

(iv) Special rule for pass-through

entities. In the case of a partnership or

S corporation, the election under

paragraph (h)(9)(i) of this section—

(A) Shall be made by the entity rather

than by its owners or members; and

(B) Shall constitute an election by

each of the owners or members of the

entity (rather than the entity itself) to

pay a tax, determined as provided in

this paragraph (h)(9), on the portion of

the gain properly allocable to each such

owner or member.

(v) Coordination with other

provisions—(A) In general. For purposes
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules 2351

of applying any provision of chapter 1

or chapter 6 of the Code other than

section 197(f)(9)(B), both the amount of

gain subject to the tax determined under

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

the amount of the tax shall be

disregarded. Thus, for example, the

amount of the gain shall not be reduced

by any net operating loss deduction

under section 172(a), any capital loss

under section 1212, or any other similar

loss or deduction. The amount of tax

determined under paragraph (h)(9)(i) of

this section shall not be 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 recognized, and

any tax paid, under paragraph (h)(9)(i)

of this section shall not be taken into

account.

(B) Section 1374. No provision of

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

preclude the application of section 1374

(relating to a tax on certain built-in

gains of S corporations) to any gain with

respect to which the election described

in paragraph (h)(9)(i) of this section is

made. Neither paragraph (h)(9)(iv) nor

paragraph (h)(9)(v)(A) of this section

shall be treated as precluding 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)(i) of this section.

(C) Procedural and administrative

provisions. For purposes of subtitle F,

the amount determined under paragraph

(h)(9)(i) of this section 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)(v)(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.

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

person acquires a section 197 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

as a result of the transaction, the person

is or becomes related to any person

described in paragraph (h)(1) of this

section, the intangible ceases to be an

amortizable section 197 intangible in

the hands of the transferee unless the

exception provided in paragraph

(h)(4)(ii) of this section applies. If a

person acquires a section 197 intangible

in anticipation of becoming related to

any person described in paragraph (h)(1)

of this section, the intangible is not an

amortizable section 197 intangible in

the hands of the transferee.

(11) Anti-churning anti-abuse rule.

Section 197 does not apply to any

intangible acquired by a taxpayer if the

taxpayer acquires the intangible in a

transaction one of the principal

purposes of which is to avoid any of the

anti-churning rules for intangibles

described in paragraph (h)(1) of this

section. Thus, for example, if section

197 intangibles are acquired in a

transaction (or series of related

transactions) in which options to

acquire stock are 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.

(i) [Reserved].

(j) General anti-abuse rule. The rules

in this section shall be interpreted and

applied 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 can 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. 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 software was

not substantially modified for use by Y

within the meaning of paragraph (c)(4)(i) of

this section and was acquired directly by Y

from the developer. 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.

Accordingly, the software is not a section 197

intangible.

Example 2. 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. X incurs legal fees

and other costs for professional services in

the amount of $10x in connection with its

efforts to obtain these rights.

(ii) The rights granted by M are described

in section 197(e)(4)(B) and paragraph (c)(6) of

this section and, thus, are not a section 197

intangible. This exclusion applies

notwithstanding that the rights may not

qualify for exclusion under section

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

section or that they also may be described in

section 197(d)(1)(D) and paragraph (b)(8) of

this section and, as such, may not be treated

as self-created intangibles eligible for

exclusion under section 197(c)(2).

Example 3. Advertising costs. (i) Q

manufactures and sells consumer products

through a series of wholesalers and

distributors. In order to increase sales of its

product 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

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. Except for the possible

application of section 197, these costs would

be ordinary and necessary expenses

deductible under section 162.

(ii) The advertising costs are not subject to

amortization under section 197 pursuant to

paragraph (a)(3) of this section because they

are otherwise deductible.

Example 4. Covenant not to compete

acquired in connection with stock

redemption. (i) R, a corporation, redeems all

of its stock owned by A, an individual. R and

A have no business relationships with each

other except for the corporate-shartholder

relationship. In connection with the stock

redemption, R and A enter into an agreement

containing a covenant not to compete. Under

this agreement, A agrees that A will not

compete with the business of R within a

prescribed geographical territory for a period

of three years after the date on which the

stock redemption is completed. In exchange

for this agreement, R pays A consideration in

addition to the amount paid for the stock

redeemed by R.

(ii) Because the agreement was entered into

in connection with the reacquisition by R of

its stock, section 162(k) provides that no

deduction shall be allowed for any amount

paid or incurred pursuant to the agreement.

Accordingly, pursuant to paragraph (a)(4) of

this section, section 197 does not apply to

these amounts.

Example 5. Substantial portion of trade or

business. (i) S owns and operates 100

restaurants in various locations. Each of these

restaurants is operated using a wellestablished trade name made available to S
2352 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

under the terms of a franchise agreement

with F. S determined to cease operating one

of the franchised restaurants. Accordingly, S

sold to B all of the assets that it had used

exclusively in connection with the operation

of its restaurant at that location. B agreed to

extend an offer of employment to all of the

employees at that location. B acquired no

rights to the franchise or to any of the

trademarks or trade names that had been

used by S.

(ii) The transaction between B and S is a

transaction involving the acquisition of assets

constituting a trade or business or a

substantial portion thereof within the

meaning of paragraph (e) of this section,

notwithstanding that B did not acquire a

franchise from S or that the assets did not

represent a substantial portion of the assets

used by S in that trade or business.

Example 6. Separate acquisition of

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

for specialty coffees. On July 1, 1997, G

enters into an agreement 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, on a

monthly basis throughout the term of the

franchise, a specified percentage of gross

sales from the store. 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 to be paid by

G computed as a percentage of gross sales 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 7. 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. Assume that the amounts

payable to C under the agreement represent

the value of C’s obligations to B pursuant to

the covenant and that 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 other

than the covenant exceeds the sum of the

amount of Class I assets and the aggregate fair

market value of all Class II and Class III

assets and all Class IV assets other than the

covenant.

(ii) Because the covenant is acquired in an

applicable asset acquisition (within the

meaning of section 1060(c)), the basis of B in

the covenant cannot exceed its fair market

value. See § 1.1060–1T(e)(1). Under section

197(f)(3) and paragraphs (f)(3)(i) and (f)(4) of

this section, the adjusted basis of B in the

agreement, determined as of the date on

which the agreement is entered into, is

$225,000. B’s deduction for amortization

with respect to the amounts to be paid under

the agreement is $1,250 per month, or

$15,000 per year, for each year in the 15-year

period beginning on the date on which the

agreement is entered into. The excess of the

amounts payable pursuant to the agreement

over the amount allocated to the covenant

under § 1.1060–1T(e)(1), or $45,000, is

allocated to Class V assets.

Example 8. Breach of covenant not to

compete subsequent to acquisition. (i) The

facts are the same as in Example 7, except

that at the end of the second year of the

agreement, C breaches the agreement by

competing against B. B and C enter into a

settlement of all claims arising under the

agreement and the subsequent breach by C by

agreeing that B is not obligated to pay C the

final installment of $90,000.

(ii) Under paragraph (g)(1)(iii) of this

section, the covenant is not treated as having

been disposed of (or becoming worthless)

because C has not disposed of all interests in

the trade or business acquired in the same

transaction as the covenant. The covenant is

not a contingent income asset within the

meaning of § 1.1060–1T(f)(4)(i). Accordingly,

B must decrease the adjusted basis of any

asset acquired from C by $90,000 at the

beginning of the third year of the agreement

in the manner provided by § 1.1060–

1T(f)(3)(i). To the extent that any decrease is

allocated to an amortizable section 197

intangible, B must reduce the amount of its

deduction for amortization under section 197

accordingly.

Example 9. Loss disallowance rules

involving related persons. (i) Assume that X

and Y are treated as a single taxpayer for

purposes of paragraph (g)(1)(iv) 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

desired to acquire the assets used by Z at one

of the locations. Three years after the

acquisition, X sold all of the assets, including

amortizable section 197 intangibles, to an

unrelated purchaser 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 may not

recognize its loss on the sale of the

amortizable section 197 intangibles. Under

paragraph (g)(1)(iv) of this section, X must

amortize its disallowed loss under section

197, and Y may not increase its adjusted

basis in its amortizable section 197

intangibles by the amount of the realized loss

of X that is disallowed. X must amortize the

disallowed loss over the remainder of the

amortization period for the amortizable

section 197 intangibles it sold. Accordingly,

X must amortize the disallowed loss at the

rate of $10,000 per year (or $833 per month)

for each of the 12 years remaining in the 15-

year period.

Example 10. Disposition of retained

intangibles by related person. (i) The facts are

the same as in Example 9, except that 10

years after the acquisition of the assets by X

and Y and seven 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) Upon the sale of assets by Y, X may

recognize a loss equal to the unamortized

loss. Accordingly, pursuant to paragraph

(g)(1)(iv) of this section, X may recognize a

loss in the amount 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 of amortization

allowed for the fourth through the tenth years

($70,000).

Example 11. 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.

(ii) Pursuant to paragraph (h)(5)(i) of this

section, there is no change in the basis or

amortization of the intangible and 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 12. Acquisition of an interest in

partnership with a section 754 election. (i)

The facts are the same as in Example 11,

except that a section 754 election is in effect

for 2003.

(ii) Pursuant to section 197(f)(9)(E) and

paragraph (h)(5)(i) 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.
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules 2353

Example 13. Payment to a retiring partner

by partnership with a section 754 election. (i)

The facts are the same as in Example 11,

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.

A receives a payment under section 736 from

P of $1,600, all of which is in exchange for

A’s interest in the intangible asset owned by

P.

(ii) Pursuant to paragraph (h)(5)(i) 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 14. 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, 1994. On

January 1, 1999, 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. However, C does not realize

a special 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

deemed transfer of the asset to the new

partnership occurred.

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

754 election in effect for its taxable year in

which the deemed transfer of the asset to the

new partnership occurred, 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, at this time. 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

1999.

(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, 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 its section 197 intangible.

Under section 197(f)(2) and paragraph (g)(2)

of this section, the new partnership

continues to amortize the amortizable section

197 intangible over the 10 years remaining in

the original 15-year amortization period. No

additional amortization is allowable with

respect to this asset under section 197.

Example 15. Disguised sale to partnership.

(i) Assume that 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 $100x, to EF,

and F transfers $40x of cash to EF. E receives

a 60 percent interest in EF and the $40x of

cash contributed by F, and F receives a 40

percent interest in EF, under circumstances

in which the transfer by E is 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 $40x 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 intangible that E held

during the transition period (as defined in

paragraph (h)(3) of this section) is an

amortizable section 197 intangible pursuant

to paragraph (h)(1) of this section. Section

197(f)(9)(E) and paragraph (h)(5) 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 16. Acquisition by related person

in nonrecognition transaction. (i) A owns a

nonamortizable intangible that A acquired in

1990. In 1997, 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)(i) 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)(1)(i) 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, 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)(i) 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.

Example 17. Acquisition of partnership

interest following formation of partnership.

(i) The facts are the same as in Example 16

except that, in 1996, A formed P with an

affiliate and contributed the intangible to the

partnership and except that thereafter, in an

unrelated transaction, B purchases a 50

percent interest in P. P has a section 754

election in effect.

(ii) For the reasons set forth in Example

14(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.

Example 18. Acquisition by related

corporation in nonrecognition transaction. (i)

The facts are the same as Example 16, except

that P is a corporation.

(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)(i) and the antichurning rules of paragraph (h)(1)(i) 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 19. 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, 1997, X purchases

from Z section 197 intangibles that Z owned

during the transition period (as defined in

paragraph (h)(3) of this section).

(ii) Pursuant to paragraph (h)(6)(iii)(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 20. 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 intangibles that it owned during the

transition period and was not permitted to

amortize or depreciate under any other

provision of the Code. S had a basis of

$25,000 in the intangibles. In 1997, S sells
2354 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Proposed Rules

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 1997 pursuant to section 172(b). As

part of the transaction with B, S agrees to

make the gain recognition election pursuant

to section 197(f)(9)(B).

(ii) If the gain recognition election had not

been made, S would have taxable income of

$30,000 for 1997 and a tax liability of $4,500.

As the result of the election, S must pay a

total tax liability for the year of $17,500 (35

percent of $50,000), consisting of the sum of

its regular tax liability of $4,500 and the

additional amount of $13,000 pursuant to

section 197(f)(9)(B).

(iii) Pursuant to paragraph (h)(9)(v)(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 1997 but for the gain

recognition election may be used in 1998,

subject to the limitations of section 172.

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

197 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. The remaining basis may not be

amortized by B.

Example 21. Section 338 election. (i) P

corporation makes a qualified stock purchase

of the stock of T corporation from two

shareholders in July 1997, and a section 338

election is made by P. 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. No other

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) 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

section 197 intangible held by old target at

any time during the transition period is not

an amortizable section 197 intangible in the

hands of new target. However, a gain

recognition election under paragraph (h)(9)(i)

of this section may be made with respect to

this transaction.

(l) Effective dates. This section is

applicable on the date final regulations are

published in the Federal Register, except

that §1.197–2(c)(13) (exception from section

197 for separately acquired rights of fixed

duration or amount) is applicable August 11,

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

election has been made under §1.197–1T).

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 97–866 Filed 1–9–97; 2:53 pm]

BILLING CODE 4830–01–U

DEPARTMENT OF THE INTERIOR

Fish and Wildlife Service

50 CFR Part 24

RIN 1018–AD97

Endangered and Threatened Wildlife

and Plants; Designated Ports for

Listed Plants

AGENCY: Fish and Wildlife Service,

Interior.

ACTION: Proposed rule.

SUMMARY: The Fish and Wildlife Service

(Service) proposes to amend the

regulations that establish designated

ports for the importation, exportation,

and reexportation of plants by adding

the U.S. Department of Agriculture

(USDA) ports at Laredo, Texas; and Fort

Lauderdale, Jacksonville, and Panama

City, Florida, as designated ports for the

importation of saw-logs, sawn wood,

and veneers from trees listed as

endangered or threatened under the

Endangered Species Act of 1973, as

amended (the Act), or listed under the

Convention on International Trade in

Endangered Species of Wild Fauna and

Flora (CITES). The Service also

proposes to amend these same

regulations by adding the USDA port at

Port Huron, Michigan, as a port for the

importation from Canada and

exportation or reexportation to Canada

of plants listed as endangered or

threatened under the Act, or listed

under CITES. The USDA has adequate

facilities and personnel at these ports to

qualify the ports as designated ports for

the importation, exportation, and

reexportation of plants under the terms

of the Act and CITES. The addition of

these ports to the list of designated ports

would facilitate trade and the

enforcement of the Act and CITES.

Additionally, the Service proposes to

amend the regulations that establish

designated ports for the importation,

exportation, and reexportation of plants

by removing Laredo, Texas, from the list

of ports designated for the importation,

exportation, or reexportation of plants

listed as endangered or threatened

under the Act, or listed under CITES.

The USDA no longer operates Laredo as

a plant inspection station and has

proposed to remove it from the list of

plant inspection stations in its

regulations. Because the Laredo plant

inspection station has closed, it no

longer is used as a designated port for

the importation, exportation, or

reexportation of plants listed as

endangered or threatened under the Act,

or listed under CITES. However, the

USDA has sufficient staff in place in

Laredo for the Service to add it instead

as a designated port for the importation

of saw-logs, sawn wood, and veneers

from trees listed as endangered or

threatened under the Act, or listed

under CITES, as discussed in the above

paragraph.

DATES: Comments must be submitted on

or before March 17, 1997. Requests for

a public hearing must be received by

March 3, 1997.

ADDRESSES: Comments and materials

concerning this proposal should be sent

to Kenneth B. Stansell, Chief, Office of

Management Authority, U.S. Fish and

Wildlife Service, 4401 North Fairfax

Drive, Room 430, Arlington, Virginia

22203. Comments and materials may be

hand-delivered to the same address

between the hours of 8:00 a.m. and 4:00

p.m. Monday through Friday during the

comment period.

FOR FURTHER INFORMATION CONTACT:

Kenneth B. Stansell, Chief, Office of

Management Authority, U.S. Fish and

Wildlife Service, telephone (703) 358–

2093.

SUPPLEMENTARY INFORMATION:

Background

The Endangered Species Act of 1973,

as amended (the Act), requires, among

other things, that plants be imported,

exported, or reexported only at

designated ports or, under certain

limited circumstances, at nondesignated

ports. Section 9(f) of the Act (16 U.S.C.

1538[f]) provides for the designation of

ports. Under section 9(f)(1), the

Secretary of the Interior (Secretary) has

the authority to establish designated

ports based on a finding that such an

action would facilitate enforcement of

the Act and reduce the costs of that

enforcement. The United States

Department of Agriculture (USDA) and

the Secretary are responsible for

enforcing provisions of the Act and the

Convention on International Trade in

Endangered Species of Wild Fauna and

Flora (CITES) relating to the

importation, exportation, and

reexportation of plants listed as

endangered or threatened under the Act

or listed under CITES.

The regulations in 50 CFR part 24,

‘‘Importation and Exportation of

Plants,’’ are for the purpose of

establishing ports for the importation,

exportation, and reexportation of plants.

Plants listed as endangered or

threatened in 50 CFR 17.12 or in the

appendices to CITES in 50 CFR 23.23

are required to be accompanied by

documentation and may be imported,

exported, or reexported only at one of

the USDA ports listed in section

24.12(a) of the regulations. Certain other