Originally published in June 2003
TABLE OF CONTENTS
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PART ONE I. INTRODUCTION |
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PART TWO I. Transfer of Interest in Assets Followed by Partnership Formation |
PART ONE: INTRODUCTION
I. INTRODUCTION
A. Enacted as part of the Omnibus Budget Reconciliation Act of 1993, P.L. 103-66 Stat. 312, section 197 1 governs the tax treatment of acquired intangible assets.
B. Section 197 comes into play whenever there is an allocation of consideration to an acquired amortizable section 197 intangible. In partnership transactions, the possibility of abuse arises upon the contribution of assets to a partnership, the transfer of an interest in a partnership, or the termination of a partnership.
C. PART ONE of this Outline provides an introduction to section 197, as it relates to partnerships. PART TWO illustrates the application of section 197 in various partnership transactions.
II. SECTION 197
A. Application of Section 197
1. Section 197 and its 15-year amortization period apply to any "amortizable section 197 intangible."
2. Section 197(c) defines the term "amortizable section 197 intangible" as a section 197 intangible that is
b. held in connection with the conduct of a trade or business or an activity described in section 212. See Treas. Reg. § 1.197-2(d)(1).
3. The term amortizable section 197 intangible does not include certain section 197 intangibles created by the taxpayer (self-created intangibles). See Section 197(c)(2); Treas. Reg. § 1.197-2(d)(2)(i).
b. The following self-created intangibles are excluded from the definition of amortizable Section 197 intangibles:
(i) goodwill;
(ii) going concern value;
(iii) workforce in place;
(iv) information-based intangibles;
(v) know-how intangibles;
(vi) customer-based intangibles;
(vii) supplier-based intangibles; and
(viii) any similar items.
Section 197(c)(2), (d)(1).
c. The exception for self-created intangibles does not apply, however, if the intangible is created in connection with a transaction involving the acquisition of assets constituting a trade or business or a substantial portion thereof. Section 197(c)(2); see Treas. Reg. § 1.197-2(d)(2)(iii)(B). Thus, intangibles created in connection with such an acquisition will be treated as amortizable section 197 intangibles.
(i) 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). Treas. Reg. § 1.197-2(e)(1).
(ii) Whether acquired assets constitute a "substantial portion" of a trade or business is based on all the relevant facts and circumstances. Treas. Reg. § 1.197-2(e)(4).
d. Pre-Section 197 law continues to control the tax treatment of assets excluded from section 197.
B. Nonrecognition Transfers
1. If a section 197 intangible is acquired in a nonrecognition transaction (e.g., section 721 or 731), the transferee generally stands in the shoes of the transferor to the extent of the transferor's basis for purposes of section 197.
2. Section 197 would apply to the extent that there is a step-up in basis in connection with the nonrecognition transaction.
C. Partnership Transactions
1. A transaction in which a taxpayer acquires an interest in a partnership that owns an intangible will be treated as an acquisition of a section 197 intangible only to the extent that the taxpayer obtains a basis greater than the partnership's basis for the asset. See section 197(f)(9)(E).
2. The acquiring partner will step into the shoes of the selling partner as to the remaining pre-existing basis in any such intangible owned by the partnership.
3. If a section 197 intangible is transferred or deemed to be transferred due to a termination under section 708(b)(1), 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. Treas. Reg. § 1.197-2(g)(2)(iv).
4. Newly finalized section 197 regulations provide rules for the application of sections 704(c), 732(d), 734(b), and 743(b) to section 197. Treas. Reg. § 1.197-2(g)(3) and (4). See Treas. Reg. § 1.197-2(k), Exs. 13-19.
D. Anti-Churning Rules
1. Extensive anti-churning rules are intended to prevent pre-existing non-amortizable intangibles from being converted into section 197 intangibles in transactions where the user does not change or where related parties are involved. Unlike the proposed regulations, the final regulations expressly state this purpose of the anti-churning rules and provide that the rules are to be applied in a manner that carries out their purpose. Treas. Reg. § 1.197-2(h)(1)(ii). A broad anti-abuse rule disqualifies any asset acquired in a transaction designed to avoid the effective date limitation discussed below.
2. An amortization deduction under section 197 may not be taken for an asset that, but for section 197, would not be amortizable if (1) it was acquired after August 10, 1993, and (2) either (i) the taxpayer or a related person held or used the intangible at any time on or after July 25, 1991 and on or before August 10, 1993 (the "Interim Period"), (ii) the intangible was acquired from a person that held the intangible during the Interim Period and the user of the intangible does not change, or (iii) the taxpayer grants a former owner (who owned the intangible during the Interim Period) the right to use the intangible. See Treas. Reg. § 1.197-2(h)(2).
3. The anti-churning rules do not apply to deductions otherwise allowable under section 1253(d) or Treas. Reg. § 1.162-11. See Treas. Reg. § 1.197- 2(h)(3).
4. The anti-churning rules do not apply to the acquisition of any intangible by a taxpayer if the basis of the intangible in the hands of the taxpayer is determined under section 1014(a). Treas. Reg. § 1.197-2(h)(5)(i).
5. For purposes of the anti-churning rules, a person is related to another person if (i) the person bears a relationship to that person which would be specified in section 267(b) (and, by substitution, section 267(f)(1)) or 707(b)(1) if such sections were amended by substituting 20 percent for 50 percent, or (ii) the persons are engaged in trades or businesses under common control. See Treas. Reg. § 1.197-2(h)(6).
b. The regulations provide that in the case of a series of related transactions (or a series of transactions that together comprise a qualified stock purchase under section 338), the relationship is tested immediately before the earliest transaction and immediately after the last such transaction. Treas. Reg. § 1.197-2(h)(6)(ii)(B). For purposes of determining whether persons are related, transitory relationships are disregarded. Treas. Reg. § 1.197-2(h)(6)(iii).
c. In order to determine whether the anti-churning rules apply with respect to any increase in basis of partnership property under section 732, 734, or 743, each partner is to be treated as having owned or used such partner's proportionate share of the partnership property. See Section 197(f)(9)(E); Treas. Reg. § 1.197-2(h)(12)(i).
(i) The regulations provide that the anti-churning rules do not apply to an increase in basis of partnership property under section 732(d) (or section 743(b)) if the distributee partner, (or acquiring partner) was not related to the person transferring the partnership interest. See Treas. Reg. § 1.197-2(h)(12)(iii), (v).
(a) Query whether the anti-churning rules do not apply to a section 743(b) basis increase if the acquirer owns more than a 20-percent interest in the partnership prior to the acquisition, and, if the anti-churning rules do not apply, whether such acquiring partner could be allowed to amortize goodwill such acquiring partner originally contributed to the partnership.
(b) Discussions with Service officials indicate that an acquiring partner that already owns a greater than 20 percent interest in the partnership should be allowed to amortize all goodwill attributable to a section 743(b) adjustment, even if some of that goodwill was originally unamortizable and contributed by such acquiring partner to the partnership. However, such discussions also indicate that if the contribution of such unamortizable goodwill and the acquisition that results in the section 743(b) adjustment are part of a series of related transactions, the anti-churning rules will apply to deny amortization with respect to the goodwill contributed by the acquiring partner. It is unclear, however, how the regulations can be read to provide such an exception to the general rule that an acquiring partner may amortize goodwill attributable to a section 743(b) adjustment if such partner is not related to the selling partner.
(ii) The Service issued proposed regulations on the treatment of basis adjustments under sections 732(b) and 734(b) in January 2000. In November 2000, the Service finalized the proposed regulations, with some modifications. T.D. 8907 (effective November 20, 2000).
(a) For purposes of applying the anti-churning rules to basis adjustments under section 732(b), the final regulations provide that the distributee partner is deemed to acquire the distributed intangible directly from the continuing partnership. Treas. Reg. § 1.197-2(h)(12)(ii). The regulations contain a favorable stacking rule that treats the distributee partner as acquiring the intangible first from the continuing partners for whom transfers would not be subject to the anti-churning rules. Id.; Preamble to Proposed section 197 regulations, 65 Fed. Reg. at 3,904.
(b) Under the final regulations, the anti-churning rules generally do not apply to a continuing partner's share of a section 734(b) basis increase. Treas. Reg. § 1.197-2(h)(12)(iv).
i) A partner's share of a section 734(b) basis increase is equal to:
a) The total basis increase under section 734(b) allocable to the intangible, multiplied by:
b) the amount of the continuing partner's post-distribution capital account, over the total amount of the post-distribution capital accounts of all continuing partners. Capital accounts are determined immediately after the distribution in accordance with the capital accounting rules of Treas. Reg. § 1.704-1(b)(2)(iv).
ii) Note: The final regulations substantially changed the second part of this calculation. The proposed regulations focussed on the unrealized appreciation from the intangible that would have been allocated to the continuing partner if the partnership had sold the intangible immediately before the distribution. That yielded incorrect results, because in many situations, all of the unrealized appreciation would be allocated to the noncontinuing partner.
(c) If a distribution that results in a section 734(b) adjustment is undertaken as part of a series of related transactions that include a contribution of the intangible to the partnership by the continuing partner, the anti-churning rules will apply to deny amortization with respect to the contributed intangible. Treas. Reg. § 1.197-2(h)(12)(iv)(E)(2).
(iii) The final regulations address the situation where a partner is or becomes a user of a partnership intangible. If an anti-churning partner becomes (or remains) a user of an intangible that is treated as transferred in the transaction, the anti-churning rules apply to the proportionate share of such intangible. Treas. Reg. § 1.197-2(h)(12)(vi)(A).
(a) The anti-churning partner is generally a partner that acquired an interest in the partnership before August 10, 1993 (with respect to intangibles held by the partnership before that date), or a partner that acquired an interest in the partnership before the partnership acquired the intangible (with respect to intangibles acquired after August 10, 1993). Treas. Reg. § 1.197-2(h)(12)(vi)(B).
(b) For example, assume that A and B form a partnership. A transfers a non-amortizable section 197 intangible in exchange for a 60-percent interest, and B transfers cash in exchange for a 40-percent interest. A licenses the intangible from the partnership. The partnership makes a section 754 election. A subsequently sells its interest to unrelated C. Ordinarily, the anti-churning rules would not apply to an increase in the basis of partnership property under section 743(b). However, because A is an anti-churning partner that remains a user of the intangible, the anti-churning rules will apply. See Treas. Reg. § 1.197-2(k), Ex.27.
(iv) Curative and remedial allocations under section 704(c).
(a) Under the final regulations, where the intangible is amortizable by the contributing partner, the anti-churning rules do not apply to the curative or remedial allocations of amortization with respect to a section 197 intangible. Treas. Reg. § 1.197- 2(h)(5)(ii); Treas. Reg. § 1.197-2(h)(12)(vii)(A).
(b) Where the intangible is nonamortizable by the contributing partner, the final regulations do not permit curative allocations. However, the regulations do allow remedial allocations of amortization under section 704(c), unless the partner is related to the partner that contributed the intangible or, as part of a series of related transactions that includes the contribution of the intangible to the partnership, the contributing parter or a related person (other than the partnership) becomes or remains a direct user of the contributed intangible. Treas. Reg. § 1.197-2(h)(12)(vii)(B).
(c) Note: The final regulations permit remedial allocations and not curative allocations because, under section 704(c), remedial allocations treat the amortizable portion of contributed property like newly purchased property, with a new holding period and determinable allocation of tax items. See Preamble to Treas. Reg. § 1.197-2. However, curative allocations are not determined as if the applicable property were newly purchased property. Id.
6. The anti-churning rules do not apply to any section 197 intangible that is acquired from a person with a less than 50 percent relationship to the acquirer if (i) the seller elects to recognize gain on the disposition of the intangible, and (ii) the seller agrees, notwithstanding any other provision of the Code, to pay a tax on such gain which, when added to any other Federal income tax imposed on such gain, equals the product of the gain and the highest rate of tax imposed by the Code. Treas. Req. § 1.197- 2(h)(9).
7. Any section 197 intangible acquired by a taxpayer from another person is subject to a general anti-abuse rule.
b. Note: The Small Business Job Protection Act of 1996 ("Small Business Act") clarified that if a taxpayer and related parties make an election to apply the amortization rules to acquisitions after July 25, 1991, "the anti-churning rules do not apply when property acquired from an unrelated party after July 25, 1991 (and not subject to the anti-churning rules in the hands of the acquiring party) is transferred to a taxpayer related to the acquirer . . . ." House Committee Report to Small Business Job Protection Act, reprinted at CCH ¶ 10,915; see Small Business Act, at section 1703(l).
c. International trademarks reacquired by a corporation are not subject to the anti-churning rules and are amortizable intangibles. See P.L.R. 9630015 (Apr. 26, 1996) (ruling that trademarks sold to an unrelated buyer and later reacquired from such buyer's subsidiary, after the seller had itself been acquired by the buyer were amortizable intangibles).
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