Opinion ID: 569102
Heading Depth: 2
Heading Rank: 1

Heading: The Regulations, The Nature of Goodwill, and the Contentions of the Parties

Text: 14 I.R.C. § 167(a) allows as a depreciation deduction a reasonable allowance for exhaustion, wear and tear, and obsolescence of property, both tangible and intangible, used in a trade or business. Treasury Regulation 1.167(a)-3 elaborates on the depreciation of intangibles as follows: 15 If an intangible asset is known from experience or other factors to be of use in the business or in the production of income for only a limited period, the length of which can be estimated with reasonable accuracy, such an intangible asset may be the subject of a depreciation allowance. Examples are patents and copyrights. An intangible asset, the useful life of which is not limited, is not subject to the allowance for depreciation. No allowance will be permitted merely because, in the unsupported opinion of the taxpayer, the intangible asset has a limited useful life. No deduction for depreciation is allowable with respect to goodwill.... 16 26 C.F.R. § 1.167(a)-3 (emphasis added). 17 Case law interpreting this regulation has held consistently that, in order to qualify for depreciation of an intangible asset, a taxpayer must establish that the intangible asset (1) has an ascertainable value separate and distinct from goodwill, and (2) has a limited useful life, the duration of which can be ascertained with reasonable accuracy. See, e.g., Houston Chronicle Publishing Co. v. United States, 481 F.2d 1240, 1250 (5th Cir.1973), cert. denied, 414 U.S. 1129, 94 S.Ct. 867, 38 L.Ed.2d 754 (1974). 3 18 As we have noted, the Service essentially concedes that Morning Ledger has demonstrated that the paid subscribers have an ascertainable value and limited useful lives, and that it has presented a reasonably accurate estimate of these useful lives. In Morning Ledger's view, detailed infra, this concession should end the case. The Service argues, however, that Morning Ledger has ignored, and convinced the district court to ignore, the additional requirement that the value of the paid subscribers be shown to be separate and distinct from goodwill, consistent with the explicit statement in the regulations that [n]o deduction for depreciation is allowable with respect to goodwill. This prohibition against depreciating goodwill, the Service notes, is nearly as old as the income tax itself, its origin being traceable to a 1927 amendment to the predecessor regulation of § 1.167(a)-3. 4 19 The Service further argues that, once we recognize that the district court ignored this requirement, the error of permitting Morning Ledger to depreciate the net income stream to be generated by the 460,000 at-will subscribers becomes evident. Morning Ledger cannot demonstrate that this income stream is separate and distinct from goodwill, the Service contends, because, in fact, it is the essence of goodwill. Although goodwill is not defined in the regulations, 5 it has been repeatedly characterized in the case law as the expectancy that old customers will resort to the old place, Commissioner v. Killian, 314 F.2d 852, 855 (5th Cir.1963), and as the expectancy of continued patronage, for whatever reason, Boe v. Commissioner, 307 F.2d 339, 343 (9th Cir.1962). Because the projected stream of income to be generated by the 460,000 at-will subscribers is simply a quantification of Morning Ledger's expectation that these subscribers will continue their patronage, the Service submits that the amount is a portion of the total non-depreciable goodwill purchased from Booth. 20 We note in this regard, and the Service does not dispute, that the value of the paid subscribers would not constitute goodwill if Morning Ledger's expectation of continued patronage were contractually-based. See Commissioner v. Seaboard Finance Co., 367 F.2d 646, 649 (9th Cir.1966) ([G]oodwill [is] 'the probability that old customers will resort to the old place' without contractual compulsion.) (citation omitted). Thus, if the subscribers were contractually obligated to continue subscribing for some period of time, Morning Ledger clearly would be permitted to depreciate the value of those contracts over that time period. In such an event, continued patronage would not be a mere expectation, but a contractual right, and hence not goodwill. In the case at bar, however, all the subscribers are terminable-at-will. At the time of the acquisition of Booth, therefore, Herald merely expected continued patronage; it had no contractual right to demand it. Morning Ledger responds that it has not ignored the requirement that the paid subscribers be shown to have a value separate and distinct from goodwill. Rather, Morning Ledger contends, the Service has invoked the wrong definition of goodwill and thus has misconstrued the requirements of § 1.167(a)-3. Morning Ledger argues that, properly defined, goodwill is no more than the residual value that remains after all assets with determinable useful lives and ascertainable values have been accounted for. Thus, by converse reasoning, anything possessing a determinable useful life and an ascertainable value is not goodwill. 6 Under Morning Ledger's definition of goodwill, in other words, the requirement that an intangible asset be shown to have a value separate and distinct from goodwill adds nothing to the undisputedly satisfied requirement that the taxpayer demonstrate that the asset has a limited useful life and provide a reasonably accurate estimate of that life. 21 Although the district court apparently sought to reconcile the competing definitions of goodwill, it is clear from the following passage that ultimately the court accepted the definition advanced by Morning Ledger over that pressed by the Service: 22 [T]he court recognizes and accepts that goodwill is the expectancy that former customers will be retained--that there will be continued patronage. However, one must distinguish between a galaxy of customers who may or may not return, whose frequency is unknown, and whose quantity and future purchases cannot be predicted, against subscribers who can be predicted to purchase the same item, for the same price on a daily basis. Although newspaper subscribers are under no legal obligation to continue their subscriptions, expert opinion and the evidence presented coupled with common sense and experience leads inescapably to the conclusion that the income derived from such paying subscribers will recur, which, in turn, permits the ascertainment of value separate and apart from goodwill. The income derived from the subscribers permits the calculation of value over the useful lives of the subscriptions or subscribers, and renders the subscribers acquired subject to valuation as an asset separate and apart from goodwill. 23 Newark Morning Ledger Co. v. United States, 734 F.Supp. 176, 176-77 (D.N.J.1990).