These synopses are intended only as aids to the reader in

Agency decision

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What actually matters in this document.

Text

Bulletin No. 2000–7

February 14, 2000

Internal Revenue

bulletin

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

T.D. 8864, page 614.

Final and temporary regulations under section 274 of the Code

relate to the substantiation of certain business expenses.

T.D. 8865, page 589.

Final regulations under sections 167(f) and 197 of the Code

provide guidance concerning the amortization of goodwill

and certain other intangible property.

matically reduce an employee’s compensation by a certain

amount and have that amount contributed as an elective deferral to an employer’s section 401(k) plan. Rev. Rul. 98–30

amplified and superseded.

REG–113572–99, page 624.

Proposed regulations under section 132(f) of the Code provide guidance on qualified transportation fringe benefits provided by employers to employees. A public hearing is scheduled for June 1, 2000.

T.D. 8867, page 620.

Final regulations under section 1296 of the Code relate to

the new mark-to-market election for stock of a passive foreign investment company (PFIC) and define the term “marketable stock.”

EMPLOYEE PLANS

Rev. Rul. 2000–8, page 617.

ADMINISTRATIVE

REG–100163–00, PAGE 633.

Proposed regulations under section 197 of the Code provide guidance on how the anti-churning rules of section

197(f) apply to partnership transactions involving sections

732(b) and 734(b). A public hearing is scheduled for

May 24, 2000.

Cash or deferred arrangements; elective deferrals.

This ruling specifies the criteria to be met in order to auto-

Actions Relating to Court Decisions is on the page following the Introduction.

Finding Lists begin on page ii.

Department of the Treasury

Internal Revenue Service

The IRS Mission

Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities

and by applying the tax law with integrity and fairness to

all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents are consolidated semiannually into

Cumulative Bulletins, which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances

are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Part IV.—Items of General Interest.

This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a semiannual basis,

and are published in the first Bulletin of the succeeding semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

February 14, 2000

2000–7 I.R.B.

Actions Relating to Court Decisions

It is the policy of the Internal Revenue

Service to announce at an early date

whether it will follow the holdings in certain cases. An Action on Decision is the

document making such an announcement.

An Action on Decision will be issued at

the discretion of the Service only on unappealed issues decided adverse to the

government. Generally, an Action on Decision is issued where its guidance would

be helpful to Service personnel working

with the same or similar issues. Unlike a

Treasury Regulation or a Revenue Ruling,

an Action on Decision is not an affirmative statement of Service position. It is not

intended to serve as public guidance and

may not be cited as precedent.

Actions on Decisions shall be relied

upon within the Service only as conclusions applying the law to the facts in the

particular case at the time the Action on

Decision was issued. Caution should be

exercised in extending the recommendation of the Action on Decision to similar

cases where the facts are different. Moreover, the recommendation in the Action

on Decision may be superseded by new

legislation, regulations, rulings, cases, or

Actions on Decisions.

Prior to 1991, the Service published ac-

quiescence or nonacquiescence only in

certain regular Tax Court opinions. The

Service has expanded its acquiescence

program to include other civil tax cases

where guidance is determined to be helpful. Accordingly, the Service now may acquiesce or nonacquiesce in the holdings

of memorandum Tax Court opinions, as

well as those of the United States District

Courts, Claims Court, and Circuit Courts

of Appeal. Regardless of the court deciding the case, the recommendation of any

Action on Decision will be published in

the Internal Revenue Bulletin.

The recommendation in every Action

on Decision will be summarized as acquiescence, acquiescence in result only,

or nonacquiescence. Both “acquiescence” and “acquiescence in result only”

mean that the Service accepts the holding

of the court in a case and that the Service

will follow it in disposing of cases with

the same controlling facts. However, “acquiescence” indicates neither approval

nor disapproval of the reasons assigned

by the court for its conclusions; whereas,

“acquiescence in result only” indicates

disagreement or concern with some or all

of those reasons. “Nonacquiescence” signifies that, although no further review

was sought, the Service does not agree

with the holding of the court and, generally, will not follow the decision in disposing of cases involving other taxpayers. In reference to an opinion of a circuit

court of appeals, a “nonacquiescence” indicates that the Service will not follow

the holding on a nationwide basis. However, the Service will recognize the

precedential impact of the opinion on

cases arising within the venue of the deciding circuit.

The Actions on Decisions published in

the weekly Internal Revenue Bulletin are

consolidated semiannually and appear in

the first Bulletin for July and the Cumulative Bulletin for the first half of the

year. A semiannual consolidation also appears in the first Bulletin for the following January and in the Cumulative Bulletin for the last half of the year.

The Commissioner ACQUIESCES in

result only in the following decision:

Ahadpour v. Commissioner,1

T.C. Memo. 1999–9

T.C. Dkt. No. 4843–96

1 Acquiescence in result only relating to whether certain payments received by petitioners, pursuant to a sales agreement for real property, should be included in gross

income in the year received.

2000–7 I.R.B.

February 14, 2000

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 197.—Amortization of

Goodwill and Certain Other

Intangibles

26 CFR 1.197–2: Amortization of goodwill and

certain other intangibles.

T.D. 8865

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

Amortization of Intangible

Property

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations relating to the amortization of certain intangible property. The

final regulations reflect changes to the

law made by the Omnibus Budget Reconciliation Act of 1993 (OBRA ’93) and affect taxpayers who acquired intangible

property after August 10, 1993, or made a

retroactive election to apply OBRA ’93 to

intangibles acquired after July 25, 1991.

DATES: Effective Date: January 25,

2000.

Applicability Dates: These regulations

apply to property acquired after January

25, 2000]. Regulations to implement section 197(e)(4)(D) are applicable August

11, 1993, for property acquired after August 10, 1993 (or July 26, 1991, for property acquired after July 25, 1991, if a

valid retroactive election has been made

under §1.197–1T).

FOR FURTHER INFORMATION CONTACT: John Huffman at (202) 622-3110

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been

reviewed and, pending receipt and evaluation of public comments, approved by

the Office of Management and Budget

(OMB) under 44 U.S.C. 3507 and as-

2000–7 I.R.B.

signed control number 1545-1671.

The collection of information in this

regulation is in §1.197–2(h)(9). This information is required in order to provide

guidance on the time and manner of making the election under section

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

seller of a section 197 intangible may pay

a tax on the sale in order to avoid the application of the anti-churning rules of section 197(f)(9) to the purchaser. This information will be used to confirm the

parties to the transaction, calculate any

additional tax due, and notify the purchaser of the seller’s election. The likely

respondents are business or other forprofit institutions.

Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer

for the Department of the Treasury, Office

of Information and Regulatory Affairs,

Washington, DC 20503, with copies to the

Internal Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224. Comments on the collection of information should be received

by March 27, 2000. Comments are specifically requested concerning:

Whether the collection of information is

necessary for the proper performance of

the functions of the Internal Revenue Service, including whether the information

will have practical utility;

The accuracy of the estimated burden associated with the collection of information (see below);

How the quality, utility, and clarity of the

information to be collected may be enhanced;

How the burden of complying with the collection of information may be minimized,

including through the application of automated collection techniques or other forms

of information technology; and

Estimates of capital or start-up costs and

costs of operation, maintenance, and purchase of services to provide information.

Estimated total annual reporting burden:

1500 hours.

Estimated average annual burden hours

per respondent varies from 2 to 4 hours,

depending on individual circumstances,

with an estimated average of 3 hours.

Estimated number of respondents: 500

per year.

589

Estimated annual frequency of responses: 1

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless it displays a valid control number assigned by

the Office of Management and Budget.

Books or records relating to this collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

Background

On January 16, 1997, the IRS published

proposed regulations REG–209709–94,

1997–1 C.B. 731, in the Federal Register

(62 F.R. 2336) inviting comments under

sections 167(f) and 197. A public hearing

was held May 15, 1997. Numerous comments have been received. After consideration of all the comments, the proposed regulations are adopted as revised by this

Treasury decision.

Explanation of Provisions

Section 162(k) Application

Example 4 of the proposed regulation

§1.197–2(k) provided that amounts paid

for a covenant not to compete entered into

in connection with a redemption was

nondeductible under section 162(k) and

thus not subject to section 197. Commentators suggested that guidance on the application of section 162(k) to transactions

involving section 197 intangibles should

be addressed in regulations under section

162(k). No reference to section 162(k) is

made in the final regulations.

Purchase of a Trade or Business

Certain intangibles are excepted from

the application of section 197 if they are

not acquired as part of a purchase of a

trade or business. The proposed regulations provide that, for purposes of section

197, a group of assets constitutes a trade

or business if their use would constitute a

trade or business under section 1060 (that

is, if goodwill or going concern value

could, under any circumstances, attach to

the assets). In addition, the proposed regulations treat a group of assets as a trade

February 14, 2000

or business if they include any customerbased intangibles or, with certain exceptions, any franchise, trademark, or trade

name (the per se rules). The preamble of

the proposed regulations state that the IRS

intends to provide additional guidance on

the circumstances in which a group of assets is treated as a trade or business in regulations under section 1060.

Although a number of comments requested that the final regulations under

section 197 provide such additional guidance, the final regulations generally retain, without amplification, the rules in

the proposed regulations. The IRS and

Treasury Department will, however, continue to consider this issue during the development of final regulations under section 1060.

Commentators also requested modifications to the per se rules. In response to

these comments, the final regulations

limit the applicability of these rules to the

cases specifically described in the legislative history of section 197 (that is, the acquisition of a franchise, trademark, or

trade name). The final regulations retain

the proposed exceptions under which certain franchises, trademarks, and trade

names are disregarded in applying the per

se rules. In addition, the regulations clarify that a license of a trademark or trade

name is also disregarded in applying the

per se rules.

Computer Software

The final regulations contain rules that

supersede certain of the procedures set

forth in Revenue Procedure 69–21

(1969–2 C.B. 303), which provides

guidelines relating to costs incurred to develop, purchase, or lease computer software. Specifically, the final regulations

provide that purchased computer software

is amortizable over 15 years if section 197

applies and over 36 months if the software is not a section 197 intangible. In

addition, the regulations clarify that section 197 (rather than §1.162–11) applies

to certain costs incurred with respect to

leased software (that is, costs to acquire a

section 197 intangible that is a limited interest in software). Computer software

costs included, without being separately

stated, in the cost of the computer hardware (bundled software) continue to be

capitalized and depreciated as part of the

computer hardware. In addition, the final

February 14, 2000

regulations treat software costs as currently deductible (and not subject to section 197) if they are not chargeable to

capital account under the rules applicable

to licensing transactions (discussed

below) and are otherwise currently deductible. The final regulations clarify

that, for this purpose, an amount described in §1.162–11 is not currently deductible if, without regard to §1.162–11,

such amount is properly chargeable to

capital account. A proper and consistent

practice of taking software costs into account under §1.162–11 may, however, be

continued if the costs are not subject to

section 197.

A revenue procedure superseding Rev.

Proc. 69–21 and providing procedures

consistent with the rules in the final regulations will be issued in the near future.

In the meantime, taxpayers may not rely

on the procedures in Rev. Proc. 69–21 to

the extent they are inconsistent with section 167(f), section 197, or the final regulations.

Mortgage Servicing Rights

The proposed regulations treat mortgage servicing rights relating to a pool of

mortgages as a single asset under section

167(f) (relating to mortgage servicing

rights not acquired as part of a purchase

of a trade or business). Thus, if some but

not all mortgages in a pool prepay, no loss

is recognized. Commentators assert that

each right in the pool is a discrete asset,

and thus, taxpayers should be able to recognize a loss upon the prepayment of an

individual mortgage within the pool. The

Service and the Treasury Department believe this is generally inappropriate in

cases where depreciation is based on the

average useful life of the assets. See

§1.167(a)–8. Thus, the regulations retain

the rule that no loss is recognized if some

but not all mortgages in a pool prepay or

are sold or exchanged. The final regulations provide, however, that if a taxpayer

establishes multiple accounts within a

pool at the time of its acquisition, gain or

loss is recognized on the sale or exchange

of all mortgage servicing rights within

any such account.

When Section 197 Amortization Begins

The proposed regulations provide that

amortization begins the later of the first

day of the month in which the property is

590

acquired, or the first month in which the

active conduct of a trade or business begins. Commentators suggest that the literal language of section 197(a) allows

amortization beginning with the month

the intangible is acquired. Under section

197(c)(1), however, a section 197 intangible is amortizable only if it is held in connection with the conduct of a trade or

business or an activity described in section 212. Moreover, there is no suggestion in the legislative history that Congress intended to apply a rule differing

from those applicable under section 167

and former section 1253(d).

Former section 1253(d)(2) provided, in

language similar to that in section 197(a),

that the amortization of certain amounts

begins in the taxable year in which the

amounts are paid. Although section

1253(d)(2) did not contain any reference to

section 162 or to use in a trade or business,

it was nevertheless well established at the

time of the enactment of section 197 that

the provision embodied a trade or business

requirement and that amounts were not deductible thereunder unless the taxpayer

was operating or conducting a trade or

business after the amounts were paid.

Commentators suggest that it is significant that section 167 refers to “property

used in the trade or business” while property can qualify for amortization under section 197 if it is “held in connection with the

conduct of a trade or business.” Further,

commentators assert that the language

used in section 197 is closer to the “held in

connection with his trade or business” language used in section 174, which does not

require the current conduct of a trade or

business, than to the language of section

167. The different language used in these

provisions can be explained, however,

without departing from previous practice

under sections 167 and 1253(d) regarding

the time at which amortization commences. Broader language under section

197 is necessary because it applies to assets, such as goodwill, that although held

in connection with the conduct of a trade

or business are not commonly viewed as

being used in the trade or business. Further, modifying the language used in section 174 by adding the words “conduct of”

indicates that Congress did not intend to

change the longstanding trade or business

requirement for purposes of determining

when amortization commences.

2000–7 I.R.B.

Consequently, the final regulations retain the rule in the proposed regulations

that amortization begins no earlier than

the first day of the month in which the active trade or business or the activity described in section 212 begins.

Transactions Involving Partnerships

The final regulations relating to partnership transactions have been changed

from the proposed regulations in several

respects to reflect the recommendations

of commentators. Example 17 of the proposed regulation § 1.197-2(k) provided

that a partner may amortize a § 743 adjustment with respect to a section 197 intangible only if the formation of the partnership and the sale of the partnership

interest are “unrelated transactions.”

Commentators suggested that an unrelated transaction standard would create

significant confusion for taxpayers. According to the commentators, taxpayers

would have greater certainty with respect

to their transactions, and the government

still would be adequately protected, if

these transactions were analyzed under

general tax principles, including the step

transaction doctrine. The final regulations

remove the unrelated transaction requirement. However, if the transaction is

structured so that, under general principles of tax law, the transaction is not

properly characterized as a sale of a partnership interest, then section 197 will

apply to the transaction as recast to reflect

its true economic substance.

Certain commentators also requested

that Example 16 of proposed regulation §

1.197–2(k) be modified to allow a partnership to amortize an intangible contributed to the partnership under the

transferred basis rules under section

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

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

had owned the intangible during the transition period and, as part of an integrated

transaction, had sold the intangible to an

unrelated party before forming the partnership. The commentators suggested

that because section 197(f)(9)(E) generally permits amortization for the steppedup basis in a partnership transaction

under section 743 where a section 754

election was in effect, amortization also

should be allowed in a sale of an intangible followed by a contribution of the in-

2000–7 I.R.B.

tangible to a partnership, an economically similar transaction. This recommendation was not adopted. In general, a

partnership is treated as an entity separate

from its partners in characterizing related

party transfers. See, e.g., Section

707(b)(1) (specifically referenced in section 197(f)(9)(C)(i)(I)).

Section

197(f)(9)(E) does provide a special antichurning rule for certain partnership

transactions. However, this special rule

is not applicable in situations where a

partnership has a transferred basis in the

intangible under section 723. With respect to the analogy under section 743,

where a transferee is allowed to amortize

a section 743 basis step-up, it is only the

increase in basis that may be amortized,

and the amortization attributable to the

basis increase is segregated for use only

by the transferee partner. Neither of

these results necessarily follow from a

sale of property followed by a contribution of the property to the partnership.

The proposed regulations did not allow

partners to deduct, for federal income tax

purposes, curative or remedial amortization allocations from the partnership in

situations where the asset was a section

197(f)(9) intangible (and thus nonamortizable) in the hands of the contributing

partner. Commentators have suggested

allowing curative and remedial allocations under section 704(c). The final regulations generally permit a partnership to

make curative or remedial allocations to

its noncontributing partners of amortization relating to an asset that was amortizable (or a zero-basis intangible that otherwise would have been amortizable) in the

hands of the contributor. For assets that

were section 197(f)(9) intangibles (and

thus nonamortizable) in the hands of the

contributor, however, the partnership may

make deductible amortization allocations

to the noncontributing partners under the

remedial method only. The final regulations permit remedial allocations because,

under section 704(c), remedial allocations

treat the amortizable portion of contributed property like newly purchased

property, with a new holding period and

determinable allocation of tax items. This

result, which is similar to the result obtained for basis increases under section

743, does not follow under the curative

method because curative allocations are

not determined as if the applicable prop-

591

erty were newly purchased property. The

decision to allow amortization for remedial allocations in these regulations also is

consistent with the decisions regarding

fungibility of partnership interests that are

inherent in the recently finalized regulations under sections 743 and 755. Finally,

the rules governing section 704(c) allocations of amortization from section 197 intangibles contributed to a partnership in a

nonrecognition transaction are still subject to the anti-churning provisions. Accordingly, remedial allocations of deductible amortization expenses may not

be made to a partner who is related to a

partner that contributes an intangible subject to the anti-churning rules. Certain

problems may arise in maintaining capital

accounts where a partnership elects to

make remedial allocations, and the antichurning rules apply with respect to one

or more partners. These problems also

arise in the context of section 734(b) adjustments and are discussed in the preamble to the proposed regulations relating to

the application of the anti-churning rules

to basis adjustments under sections

732(b) and 734(b), which are being issued

at the same date as these final regulations.

Commentators requested that the final

regulations provide additional guidance

on how the special anti-churning rule of

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

in the basis of property under sections

732, 734, and 743. In accordance with

these comments, the final regulations provide rules for determining the amount of a

basis adjustment under sections 732(d)

and 743 that will be subject to the antichurning rules. The Treasury Department

and the IRS also are issuing, at the same

time as these final regulations, proposed

regulations addressing how to determine

the amount of a basis adjustment under

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

subject to the anti-churning rules.

Finally, the final regulations provide

that where, for purposes of the anti-churning rules, a partner is treated as holding its

proportionate share of partnership property under section 197(f)(9)(E), the continued or subsequent use (by license or

otherwise) of an intangible by a partner

could cause the anti-churning rules to

apply with respect to that partner’s share

of the intangible in situations where a

basis step-up under section 732(d) or

743(b) otherwise would be amortizable.

February 14, 2000

This rule is necessary in order to prevent

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

through the use of a partnership. The proposed regulations being issued in conjunction with these final regulations expand

the application of this rule to basis adjustments under sections 732(b) and 734(b).

Contracts for the Use of a Section 197

Intangible

The proposed regulations provide that

a right to use a section 197 intangible

pursuant to a license, contract, or other

arrangement is, itself, a section 197 intangible. The proposed regulations further provide that amounts paid for such a

right are chargeable to capital account,

whether or not the payments would have

been deductible (for example, as a royalty) if the right were not a section 197

intangible. Under the proposed regulations, the amount chargeable to capital

account is generally determined without

regard to sections 483 and 1274 (that is,

no part of the amount paid is recharacterized as unstated interest or original issue

discount). Finally, the proposed regulations treat the acquisition of a franchise,

trademark, or trade name as the acquisition of a trade or business, thereby preventing other intangibles acquired in the

same transaction or series of related

transactions from qualifying for any of

the exceptions applicable to separately

acquired property.

Commentators suggested that these

rules have negative consequences for

common cross-border and affiliate licenses, which frequently include, in addition to rights that would not be subject to

section 197 if not acquired as part of a

purchase of a trade or business, rights to

use a trademark or trade name. Under

prior law, amounts paid for these licenses

were generally currently deductible. The

proposed regulations, however, require

amortization over 15 years. In addition,

cost recovery over the 15-year period is

significantly backloaded because the licenses generally involve contingent payments that are not includible in basis until

the year in which they are paid or incurred and, in addition, the proposed regulations provide that sections 483 and

1274 are generally inapplicable.

After further consideration of this

issue in light of the concerns raised by

February 14, 2000

the commentators, the IRS and Treasury

Department have concluded that, particularly in the case of common licensing

transactions involving technology and

similar intangible property, a different

approach is appropriate. The clearest indication of Congressional intent on this

issue is the statement in the legislative

history to the effect that, with certain exceptions, section 197 generally does not

apply to amounts that were otherwise

currently deductible before the enactment

of section 197. Nevertheless, the IRS

and Treasury Department are also mindful that Congress directed the issuance of

such regulations as may be appropriate to

prevent avoidance of the purposes of section 197.

The final regulations generally provide

that royalty payments under a contract for

the use of section 197 intangibles unconnected with the purchase of a trade or

business are not required to be capitalized. Licensing transactions will, however, be closely scrutinized under the

principles of section 1235 for purposes of

determining whether the payments are, in

fact, deductible royalties or, instead, represent purchase price that should be

charged to capital account.

The final regulations also modify the

rule that treats the acquisition of a franchise, trademark, or trade name as the acquisition of a trade or business. Under the

final regulations, the acquisition of an interest in a trademark or trade name is disregarded in determining whether acquired

property is a trade or business if, under

the principles of section 1253, the grant of

the interest is not a transfer of all substantial rights in the trademark or trade name.

Thus, the acquisition of such an interest in

a trademark or trade name will not subject

other intangibles acquired in the same

transaction or series of related transactions to the generally less favorable rules

applicable to intangibles acquired as part

of a purchase of a trade or business.

To prevent abuses, the final regulations

provide that if the right to use a section

197 intangible is provided under a license

entered into as part of a purchase of a

trade or business, amounts paid for the

right are, as under the proposed regulations, chargeable to capital account. An

exception, not contained in the proposed

regulations, is provided for licenses of

technology, know-how, and other similar

592

items (including most types of information base). Royalties paid under these licenses are not required to be capitalized if

the taxpayer establishes that the payments

are, in fact, deductible royalties under

general tax principles and represent an

arm’s-length consideration for the transferred rights.

Finally, any amount otherwise chargeable to capital account with respect to a

section 197 intangible and payable after

the acquisition of the intangible to which

it relates is treated, in determining the tax

treatment of the purchaser, as an amount

payable under a debt instrument. Thus,

the extent to which such amounts are

treated as payments of principal and the

time at which the amount treated as principal is included in basis is determined

under generally applicable rules relating

to imputed interest and original issue discount. If, under these rules, a basis increase occurs after the beginning of the

15-year amortization period, the increase

is amortized over the remainder of the 15year period (or, in the case of an increase

occurring after the end of the amortization

period, is immediately deductible).

Anti-churning Rules

The anti-churning rules of section 197

prevent taxpayers from converting goodwill, going concern value, and similar assets held or used at any time during the

transition period into amortizable section

197 intangibles through transactions such

as transfers to related parties. The proposed regulations provide guidance on a

number of specific issues arising under

the anti-churning rules. The final regulations retain this guidance with certain

modifications and, in addition, set forth

the purpose of the anti-churning rules

(generally, to prevent the amortization of

certain intangibles that are not acquired

after the applicable effective date in a

transaction giving rise to a significant

change in ownership or use). The final

regulations further provide that the antichurning rules are to be applied in a manner that carries out their purpose. The

final regulations include a rule providing

that a transaction will be presumed to

have a principal purpose of avoiding the

anti-churning rules if it does not effect a

significant change in ownership or use.

The final regulations also provide addi-

2000–7 I.R.B.

tional guidance concerning the circumstances in which persons are treated as related for purposes of the anti-churning

rules. Section 197 provides that a relationship is tested for purposes of the antichurning rules both immediately before

and immediately after the acquisition.

The proposed regulations further provide

that, in the case of intangibles acquired in

a series of related transactions, testing begins immediately before the first acquisition and continues until immediately after

the last acquisition. Comments suggested

that momentary relationships created in

the course of the acquisition should be disregarded for purposes of the anti-churning

rules. Such relationships can arise, for example, in the course of a stock acquisition

followed by a liquidation or when assets

are contributed to a newly created subsidiary and, pursuant to a binding commitment, all stock of the subsidiary is sold to

an unrelated person or persons immediately after the contribution.

To address these and similar situations,

the final regulations provide that in the

case of a series of related transactions (or

a series of transactions that together comprise a qualified stock purchase within the

meaning of section 338(d)(3)) a person is

treated as related to another person if the

relationship exists immediately before the

earliest such transaction or immediately

after the last such transaction. In addition, any relationship created as part of a

series of related transactions in which a

person acquires stock of a corporation followed by a liquidation of the acquired

corporation under section 331 generally is

disregarded. Further, as with all other

provisions of the regulations relating to

the anti-churning rules, these provisions

are to be applied in a manner that carries

out the purpose of the anti-churning rules.

The final regulations also provide guidance on the exemption from the antichurning rules if the person from whom

the taxpayer acquires an intangible elects

to recognize gain and agrees to pay a

specified amount of tax. In general, these

rules are the same as those contained in

the proposed regulations, except that the

proposed regulations do not prescribe

procedures for making the election. The

final regulations provide guidance on the

manner of making the election, including

procedures that apply to persons not otherwise subject to Federal income tax.

2000–7 I.R.B.

Effective Dates

The regulations under sections 167(f)

and 197 were proposed to apply on the

date on which the final regulations are

published in the Federal Register (January 25, 2000). Regulations to implement

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

contracts of fixed duration or amount)

were proposed to apply August 11, 1993,

for property acquired after August 10,

1993 (or July 26, 1991, if a valid retroactive election has been made under

§1.197–1T). Comments suggested that

the applicability date should be modified

to clarify that the regulations (other than

the implementation of section

197(e)(4)(D)) apply only to property acquired on or after the date final regulations are published. This suggestion has

been adopted. Accordingly, the final regulations generally apply only to intangible

property acquired after January 25, 2000.

The applicability date of the rules implementing section 197(e)(4)(D) is similarly clarified. Thus, the final regulations

provide that these rules apply to property

acquired after August 10, 1993 (or July

25, 1991, if a valid retroactive election

has been made under §1.197–1T). The

regulations also provide consent for

changes in method of accounting to comply with the rules and automatic procedures for making the change.

In addition, the final regulations permit

taxpayers to apply the rules in the final

regulations to property acquired before

the applicability date of the final regulations (or to rely on the proposed regulations for such property) and provide similar consent and automatic change

procedures for taxpayers that choose to

apply the final regulations to pre-effective

date acquisitions.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It is hereby certified

that these regulations do not have a significant impact on a substantial number of

small entities. This certification is based

on the fact that the time required to prepare and file the election statement and

notify acquirers is minimal and will not

have a significant impact on those few

593

small entities that choose to make the election. Therefore, a Regulatory Flexibility

Analysis under the Regulatory Flexibility

Act (5 U.S.C. chapter 6) is not required. It

also has been determined that section

553(b) of the Administrative Procedure

Act (5 U.S.C. chapter 5) does not apply to

these regulations. Pursuant to section

7805(f) of the Internal Revenue Code, the

notice of proposed rulemaking was submitted to the Chief Counsel for Advocacy

of the Small Business Administration for

comment on its impact on small business.

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.

* * * * *

Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602

are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding an entry in

numerical order to read as follows:

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

Section 1.197–2 also issued under 26

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

Par. 2. Section 1.162–11 is amended

by adding a sentence at the end of paragraph (a) to read as follows:

§1.162–11 Rentals.

(a) * * * See §1.197–2 for rules governing the amortization of costs to acquire

limited interests in section 197 intangibles.

*****

Par. 3. Section 1.167(a)–3 is amended

by adding a sentence at the end to read as

follows:

§1.167(a)–3 Intangibles.

* * * See sections 197 and 167(f) and, to

the extent applicable, §§1.197–2 and

1.167(a)–14 for amortization of goodwill

and certain other intangibles acquired

after August 10, 1993, or after July 25,

1991, if a valid retroactive election under

§1.197–1T has been made.

Par. 4. Section 1.167(a)–6 is amended

by adding two sentences at the end of

paragraph (a) to read as follows:

February 14, 2000

§1.167(a)–6 Depreciation in special

cases.

(a) * * * See §1.167(a)–14(c)(4) for depreciation of a separately acquired interest in a patent or copyright described in

section 167(f)(2) acquired after January

25, 2000. See §1.197–2 for amortization

of interests in patents and copyrights that

constitute amortizable section 197 intangibles.

*****

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

read as follows:

§1.167(a)–14 Treatment of certain intangible property excluded from section 197.

(a) Overview. This section provides

rules for the amortization of certain intangibles that are excluded from section 197

(relating to the amortization of goodwill

and certain other intangibles). These excluded intangibles are specifically described in §1.197–2(c)(4), (6), (7), (11),

and (13) and include certain computer

software and certain other separately acquired rights, such as rights to receive

tangible property or services, patents and

copyrights, certain mortgage servicing

rights, and rights of fixed duration or

amount. Intangibles for which an amortization amount is determined under section 167(f) and intangibles otherwise excluded from section 197 are amortizable

only if they qualify as property subject to

the allowance for depreciation under section 167(a).

(b) Computer software—(1) In general.

The amount of the deduction for computer software described in section

167(f)(1) and §1.197–2(c)(4) is determined by amortizing the cost or other

basis of the computer software using the

straight line method described in

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

is treated as zero) and an amortization period of 36 months beginning on the first

day of the month that the computer software is placed in service. If costs for developing computer software that the taxpayer properly elects to defer under

section 174(b) result in the development

of property subject to the allowance for

depreciation under section 167, the rules

of this paragraph (b) will apply to the unrecovered costs. In addition, this paragraph (b) applies to the cost of separately

acquired computer software where these

costs are separately stated and the costs

are required to be capitalized under sec-

February 14, 2000

tion 263(a).

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

this section does not apply to the cost of

computer software properly and consistently taken into account under

§1.162–11. The cost of acquiring an interest in computer software that is included, without being separately stated, in

the cost of the hardware or other tangible

property is treated as part of the cost of

the hardware or other tangible property

that is capitalized and depreciated under

other applicable sections of the Internal

Revenue Code.

(3) Additional rules. Rules similar to

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

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

amortization deductions and the treatment

of contingent amounts) apply for purposes of this paragraph (b).

business—(1) Certain rights to receive

tangible property or services. The

amount of the deduction for a right (other

than a right acquired as part of a purchase

of a trade or business) to receive tangible

property or services under a contract or

from a governmental unit (as specified in

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

determined as follows:

(i) Amortization of fixed amounts. The

basis of a right to receive a fixed amount

of tangible property or services is amortized for each taxable year by multiplying

the basis of the right by a fraction, the numerator of which is the amount of tangible property or services received during

the taxable year and the denominator of

which is the total amount of tangible

property or services received or to be received under the terms of the contract or

governmental grant. For example, if a

taxpayer acquires a favorable contract

right to receive a fixed amount of raw materials during an unspecified period, the

taxpayer must amortize the cost of acquiring the contract right by multiplying the

total cost by a fraction, the numerator of

which is the amount of raw materials received under the contract during the taxable year and the denominator of which is

the total amount of raw materials received

or to be received under the contract.

(ii) Amortization of unspecified amount

over fixed period. The cost or other basis

of a right to receive an unspecified

amount of tangible property or services

594

over a fixed period is amortized ratably

over the period of the right. (See paragraph (c)(3) of this section regarding renewals).

(iii) Amortization in other cases. [Reserved]

(2) Rights of fixed duration or amount.

The amount of the deduction for a right

(other than a right acquired as part of a

purchase of a trade or business) of fixed

duration or amount received under a contract or granted by a governmental unit

(specified in section 167(f)(2) and

§1.197–2(c)(13)) and not covered by

paragraph (c)(1) of this section is determined as follows:

(i) Rights to a fixed amount. The basis

of a right to a fixed amount is amortized

for each taxable year by multiplying the

basis by a fraction, the numerator of

which is the amount received during the

taxable year and the denominator of

which is the total amount received or to

be received under the terms of the contract or governmental grant.

(ii) Rights to an unspecified amount

over fixed duration of less than 15 years.

The basis of a right to an unspecified

amount over a fixed duration of less than

15 years is amortized ratably over the period of the right.

(3) Application of renewals. (i) For

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

this section, the duration of a right under a

contract (or granted by a governmental

unit) includes any renewal period if,

based on all of the facts and circumstances in existence at any time during the

taxable year in which the right is acquired, the facts clearly indicate a reasonable expectancy of renewal.

(ii) The mere fact that a taxpayer will

have the opportunity to renew a contract

right or other right on the same terms as

are available to others, in a competitive

auction or similar process that is designed

to reflect fair market value and in which

the taxpayer is not contractually advantaged, will generally not be taken into account in determining the duration of such

right provided that the bidding produces a

fair market value price comparable to the

price that would be obtained if the rights

were purchased immediately after renewal from a person (other than the person granting the renewal) in an arm’slength transaction.

(iii) The cost of a renewal not included

2000–7 I.R.B.

in the terms of the contract or governmental grant is treated as the acquisition of a

separate intangible asset.

(4) Patents and copyrights. If the purchase price of a interest (other than an interest acquired as part of a purchase of a

trade or business) in a patent or copyright

described in section 167(f)(2) and

§1.197–2(c)(7) is payable on at least an

annual basis as either a fixed amount per

use or a fixed percentage of the revenue

derived from the use of the patent or

a taxable year is equal to the amount of

the purchase price paid or incurred during

the year. Otherwise, the basis of such

patent or copyright (or an interest therein)

is depreciated either ratably over its remaining useful life or under section

167(g) (income forecast method). If a

patent or copyright becomes valueless in

any year before its legal expiration, the

adjusted basis may be deducted in that

year.

(5) Additional rules. The period of

amortization under paragraphs (c)(1)

through (4) of this section begins when

the intangible is placed in service, and

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

apply for purposes of this paragraph (c).

(d) Mortgage servicing rights—(1) In

general. The amount of the deduction for

mortgage servicing rights described in

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

determined by using the straight line

method described in §1.167(b)–1 (except

that the salvage value is treated as zero)

and an amortization period of 108 months

beginning on the first day of the month

that the rights are placed in service.

Mortgage servicing rights are not depreciable to the extent the rights are stripped

coupons under section 1286.

(2) Treatment of rights acquired as a

pool—(i) In general. Except as provided

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

mortgage servicing rights acquired in the

same transaction or in a series of related

transactions are treated as a single asset

(the pool) for purposes of determining the

depreciation deduction under this paragraph (d) and any gain or loss from the

sale, exchange, or other disposition of the

rights. Thus, if some (but not all) of the

rights in a pool become worthless as a result of prepayments, no loss is recognized

by reason of the prepayment and the adjusted basis of the pool is not affected by

2000–7 I.R.B.

the unrecognized loss. Similarly, any

amount realized from the sale or exchange of some (but not all) of the mortgage servicing rights is included in income and the adjusted basis of the pool is

not affected by the realization.

(ii) Multiple accounts. If the taxpayer

establishes multiple accounts within a

pool at the time of its acquisition, gain or

loss is recognized on the sale or exchange

of all mortgage servicing rights within

any such account.

(3) Additional rules. Rules similar to

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

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

amortization deductions and the treatment

of contingent amounts) apply for purposes of this paragraph (d).

(e) Effective date — (1) In general.

This section applies to property acquired

after January 25, 2000, except that

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

cost of certain separately acquired rights)

and so much of §1.167(a)–14(c)(3) as relates to §1.167(a)–14(c)(2) apply to property acquired after August 10, 1993 (or

July 25, 1991, if a valid retroactive election has been made under §1.197–1T).

(2) Change in method of accounting.

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

changes in method of accounting for

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

Par. 6. Section 1.197–0 is added to

read as follows:

§1.197–0 Table of contents.

This section lists the headings that appear in §1.197–2.

§1.197–2 Amortization of goodwill

and certain other intangibles.

(a) Overview.

(1) In general.

(2) Section 167(f) property.

(3) Amounts otherwise deductible.

(b) Section 197 intangibles; in general.

(1) Goodwill.

(2) Going concern value.

(3) Workforce in place.

(4) Information base.

(5) Know-how, etc.

(6) Customer-based intangibles.

(7) Supplier-based intangibles.

(8) Licenses, permits, and other rights

granted by governmental units.

(9) Covenants not to compete and other

similar arrangements.

(10) Franchises, trademarks, and trade

names.

(11) Contracts for the use of, and term in-

595

terests in, other section 197 intangibles.

(12) Other similar items.

(1) Interests in a corporation, partnership,

trust, or estate.

(2) Interests under certain financial contracts.

(3) Interests in land.

(4) Certain computer software.

(i) Publicly available.

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

(iii) Other exceptions.

(iv) Computer software defined.

(5) Certain interests in films, sound

recordings, video tapes, books, or other

similar property.

(6) Certain rights to receive tangible property or services.

(7) Certain interests in patents or copyrights.

(8) Interests under leases of tangible property.

(i) Interest as a lessor.

(ii) Interest as a lessee.

(9) Interests under indebtedness.

(i) In general.

(ii) Exceptions.

(10) Professional sports franchises.

(11) Mortgage servicing rights.

(12) Certain transaction costs.

(13) Rights of fixed duration or amount.

(d) Amortizable section 197 intangibles.

(1) Definition.

(2) Exception for self-created intangibles.

(i) In general.

(ii) Created by the taxpayer.

(A) Defined.

(B) Contracts for the use of intangibles.

(iii) Exceptions.

(3) Exception for property subject to antichurning rules.

(e) Purchase of a trade or business.

(1) Goodwill or going concern value.

(2) Franchise, trademark, or trade name.

(i) In general.

(ii) Exceptions.

(3) Acquisitions to be included.

(4) Substantial portion.

(5) Deemed asset purchases under section

338.

(6) Mortgage servicing rights.

(7) Computer software acquired for internal use.

(f) Computation of amortization deduction.

(1) In general.

February 14, 2000

(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) Rules for including amounts in basis.

(3) Basis determinations for certain assets.

(i) Covenants not to compete.

(ii) Contracts for the use of section 197

intangibles; acquired as part of a trade or

business.

(A) In general.

(B) Know-how and certain information

base.

(iii) Contracts for the use of section 197

intangibles; not acquired as part of a trade

or business.

(iv) Applicable rules.

(A) Franchises, trademarks, and trade

names.

(B) Certain amounts treated as payable

under a debt instrument.

(1) In general.

(2) Rights granted by governmental units.

(3) Treatment of other parties to transaction.

(4) Basis determinations in certain transactions.

(i) Certain renewal transactions.

(ii) Transactions subject to section 338 or

1060.

(iii) Certain reinsurance transactions.

(g) Special rules.

(1) Treatment of certain dispositions.

(i) Loss disallowance rules.

(A) In general.

(B) Abandonment or worthlessness.

(ii) Separately acquired property.

(iii) Disposition of a covenant not to compete.

(iv) Taxpayers under common control.

(A) In general.

(B) Treatment of disallowed loss.

(2) Treatment of certain nonrecognition

and exchange transactions.

(i) Relationship to anti-churning rules.

(ii) Treatment of nonrecognition and exchange transactions generally.

(A) Transfer disregarded.

(B) Application of general rule.

(iii) Certain exchanged-basis property.

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

(A) In general.

(B) Termination by sale or exchange of

interest.

February 14, 2000

(3) Increase in the basis of partnership

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

743(b), or 732(d).

(4) Section 704(c) allocations.

(i) Allocations where the intangible is

amortizable by the contributor.

(ii) Allocations where the intangible is not

amortizable by the contributor.

(5) Treatment of certain reinsurance transactions.

(i) In general.

(ii) Determination of adjusted basis.

(A) Acquisitions (other than under section

338) of specified insurance contracts.

(B) Insolvent ceding company

(6) Amounts paid or incurred for a franchise, trademark, or trade name.

(7) Amounts properly taken into account

in determining the cost of property that is

not a section 197 intangible.

(8) Treatment of amortizable section 197

intangibles as depreciable property.

(h) Anti-churning rules.

(1) Scope and purpose.

(i) Scope.

(ii) Purpose.

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

(3) Amounts deductible under section

1253(d) or §1.162–11.

(4) Transition period.

(5) Exceptions.

(6) Related person.

(i) In general.

(ii) Time for testing relationships.

(iii) Certain relationships disregarded.

(iv) De minimis rule.

(A) In general.

(B) Determination of beneficial ownership interest.

(7) Special rules for entities that owned or

used property at any time during the transition period and that are no longer in existence.

(8) Special rules for section 338 deemed

acquisitions.

(9) Gain-recognition exception.

(i) Applicability.

(ii) Effect of exception.

(iii) Time and manner of election.

(iv) Special rules for certain entities.

(v) Effect of nonconforming elections.

(vi) Notification requirements.

(vii) Revocation.

(viii) Election Statement.

(ix) Determination of highest marginal

596

rate of tax and amount of other Federal income tax on gain.

(A) Marginal rate.

(1) Noncorporate taxpayers.

(2) Corporations and tax-exempt entities.

(B) Other Federal income tax on gain.

(x) Coordination with other provisions.

(A) In general.

(B) Section 1374.

(D) Installment method.

(xi) Special rules for persons not otherwise subject to Federal income tax.

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

(11) Avoidance purpose.

(12) Additional partnership anti-churning

rules

(i) In general.

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

(iii) Section 732(d) adjustments.

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

(v) Section 743(b) adjustments.

(vi) Partner is or becomes a user of partnership intangible.

(A) General rule.

(B) Anti-churning partner.

(vii) Section 704(c) elections.

(A) Allocations where the intangible is

amortizable by the contributor.

(B) Allocations where the intangible is

not amortizable by the contributor.

(viii) Operating rule for transfers upon

death.

(i) Reserved

(j) General anti-abuse rule.

(k) Examples.

(l) Effective dates.

(1) In general.

(2) Application to pre-effective date acquisitions.

(3) Application of regulation project

REG–209709–94 to pre-effective date acquisitions.

(4) Change in method of accounting.

(i) In general.

(ii) Application to pre-effective date

transactions.

(iii) Automatic change procedures.

Par. 7. Section 1.197–2 is added to

read as follows:

§1.197–2 Amortization of goodwill and

certain other intangibles.

(a) Overview—(1) In general. Section

2000–7 I.R.B.

197 allows an amortization deduction for

the capitalized costs of an amortizable

section 197 intangible and prohibits any

other depreciation or amortization with

respect to that property. Paragraphs (b),

(c), and (e) of this section provide rules

and definitions for determining whether

property is a section 197 intangible, and

paragraphs (d) and (e) of this section provide rules and definitions for determining

whether a section 197 intangible is an

amortizable section 197 intangible. The

amortization deduction under section 197

is determined by amortizing basis ratably

over a 15-year period under the rules of

paragraph (f) of this section. Section 197

also includes various special rules pertaining to the disposition of amortizable

section 197 intangibles, nonrecognition

transactions, anti-churning rules, and antiabuse rules. Rules relating to these provisions are contained in paragraphs (g), (h),

and (j) of this section. Examples demonstrating the application of these provisions are contained in paragraph (k) of

this section. The effective date of the

rules in this section is contained in paragraph (l) of this section.

(2) Section 167(f) property. Section

167(f) prescribes rules for computing the

depreciation deduction for certain property

to which section 197 does not apply. See

§1.167(a)–14 for rules under section 167(f)

and paragraphs (c)(4), (6), (7), (11), and

(13) of this section for a description of the

property subject to section 167(f).

(3) Amounts otherwise deductible.

Section 197 does not apply to amounts

that are not chargeable to capital account

under paragraph (f)(3) (relating to basis

determinations for covenants not to compete and certain contracts for the use of

section 197 intangibles) of this section

and are otherwise currently deductible.

For this purpose, an amount described in

§1.162–11 is not currently deductible if,

without regard to §1.162–11, such

amount is properly chargeable to capital

account.

(b) Section 197 intangibles; in general.

Except as otherwise provided in paragraph (c) of this section, the term section

197 intangible means any property described in section 197(d)(1). The following rules and definitions provide guidance

concerning property that is a section 197

intangible unless an exception applies:

(1) Goodwill. Section 197 intangibles

2000–7 I.R.B.

include goodwill. Goodwill is the value

of a trade or business attributable to the

expectancy of continued customer patronage. This expectancy may be due to the

name or reputation of a trade or business

or any other factor.

(2) Going concern value. Section 197

intangibles include going concern value.

Going concern value is the additional

value that attaches to property by reason

of its existence as an integral part of an

ongoing business activity. Going concern

value includes the value attributable to the

ability of a trade or business (or a part of a

trade or business) to continue functioning

or generating income without interruption

notwithstanding a change in ownership,

but does not include any of the intangibles

described in any other provision of this

paragraph (b). It also includes the value

that is attributable to the immediate use or

availability of an acquired trade or business, such as, for example, the use of the

revenues or net earnings that otherwise

would not be received during any period

if the acquired trade or business were not

available or operational.

(3) Workforce in place. Section 197 intangibles include workforce in place.

Workforce in place (sometimes referred

to as agency force or assembled workforce) includes the composition of a

workforce (for example, the experience,

education, or training of a workforce), the

terms and conditions of employment

whether contractual or otherwise, and any

other value placed on employees or any of

their attributes. Thus, the amount paid or

incurred for workforce in place includes,

for example, any portion of the purchase

price of an acquired trade or business attributable to the existence of a highlyskilled workforce, an existing employment contract (or contracts), or a

relationship with employees or consultants (including, but not limited to, any

key employee contract or relationship).

Workforce in place does not include any

covenant not to compete or other similar

arrangement described in paragraph

(b)(9) of this section.

(4) Information base. Section 197 intangibles include any information base,

including a customer-related information

base. For this purpose, an information

base includes business books and records,

operating systems, and any other information base (regardless of the method of

597

recording the information) and a customer-related information base is any information base that includes lists or other

information with respect to current or

prospective customers. Thus, the amount

paid or incurred for information base includes, for example, any portion of the

purchase price of an acquired trade or

business attributable to the intangible

value of technical manuals, training manuals or programs, data files, and accounting or inventory control systems. Other

examples include the cost of acquiring

customer lists, subscription lists, insurance expirations, patient or client files, or

lists of newspaper, magazine, radio, or

television advertisers.

(5) Know-how, etc. Section 197 intangibles include any patent, copyright, formula, process, design, pattern, know-how,

format, package design, computer software (as defined in paragraph (c)(4)(iv) of

this section), or interest in a film, sound

recording, video tape, book, or other similar property. (See, however, the exceptions in paragraph (c) of this section.)

(6) Customer-based intangibles. Section 197 intangibles include any customer- based intangible. A customerbased intangible is any composition of

market, market share, or other value resulting from the future provision of goods

or services pursuant to contractual or

other relationships in the ordinary course

of business with customers. Thus, the

amount paid or incurred for customerbased intangibles includes, for example,

any portion of the purchase price of an acquired trade or business attributable to the

existence of a customer base, a circulation

base, an undeveloped market or market

growth, insurance in force, the existence

of a qualification to supply goods or services to a particular customer, a mortgage

servicing contract (as defined in paragraph (c)(11) of this section), an investment management contract, or other relationship with customers involving the

future provision of goods or services.

(See, however, the exceptions in paragraph (c) of this section.) In addition,

customer-based intangibles include the

deposit base and any similar asset of a financial institution. Thus, the amount paid

or incurred for customer-based intangibles also includes any portion of the purchase price of an acquired financial institution attributable to the value represented

February 14, 2000

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 customerbased intangible.

(7) Supplier-based intangibles. Section

197 intangibles include any supplierbased intangible. A supplier-based 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,

February 14, 2000

or other right. (See, however, the exceptions in paragraph (c) of this section, including the exceptions in paragraph (c)(3)

of this section for an interest in land, paragraph (c)(6) of this section for certain

rights to receive tangible property or services, paragraph (c)(8) of this section for

an interest under a lease of tangible property, and paragraph (c)(13) of this section

for certain rights granted by a governmental unit. See paragraph (b)(10) of this section for the treatment of franchises.)

(9) Covenants not to compete and other

similar arrangements. Section 197 intangibles include any covenant not to compete, or agreement having substantially

the same effect, entered into in connection

with the direct or indirect acquisition of

an interest in a trade or business or a substantial portion thereof. For purposes of

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

be made in the form of an asset acquisition (including a qualified stock purchase

that is treated as a purchase of assets

under section 338), a stock acquisition or

redemption, and the acquisition or redemption of a partnership interest. An

agreement requiring the performance of

services for the acquiring taxpayer or the

provision of property or its use to the acquiring taxpayer does not have substantially the same effect as a covenant not to

compete to the extent that the amount

paid under the agreement represents reasonable compensation for the services actually rendered or for the property or use

of the property actually provided.

(10) Franchises, trademarks, and trade

names. (i) Section 197 intangibles include any franchise, trademark, or trade

name. The term franchise has the meaning given in section 1253(b)(1) and includes any agreement that provides one of

the parties to the agreement with the right

to distribute, sell, or provide goods, services, or facilities, within a specified area.

The term trademark includes any word,

name, symbol, or device, or any combination thereof, adopted and used to identify

goods or services and distinguish them

from those provided by others. The term

trade name includes any name used to

identify or designate a particular trade or

business or the name or title used by a

person or organization engaged in a trade

or business. A license, permit, or other

right granted by a governmental unit is a

franchise if it otherwise meets the defini-

598

tion of a franchise. A trademark or trade

name includes any trademark or trade

name arising under statute or applicable

common law, and any similar right

granted by contract. The renewal of a

franchise, trademark, or trade name is

treated as an acquisition of the franchise,

trademark, or trade name.

(ii) Notwithstanding the definitions

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

section, any amount that is paid or incurred on account of a transfer, sale, or

other disposition of a franchise, trademark, or trade name and that is subject to

section 1253(d)(1) is not included in the

basis of a section 197 intangible. (See

paragraph (g)(6) of this section.)

(11) Contracts for the use of, and term

interests in, section 197 intangibles. Section 197 intangibles include any right

under a license, contract, or other arrangement providing for the use of property

that would be a section 197 intangible

under any provision of this paragraph (b)

(including this paragraph (b)(11)) after

giving effect to all of the exceptions provided in paragraph (c) of this section.

Section 197 intangibles also include any

term interest (whether outright or in trust)

in such property.

(12) Other similar items. Section 197

intangibles include any other intangible

property that is similar in all material respects to the property specifically described in section 197(d)(1)(C)(i) through

(v) and paragraphs (b)(3) through (7) of

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

section for special rules regarding certain

reinsurance transactions.)

The term section 197 intangible does not

include property described in section

197(e). The following rules and definitions provide guidance concerning property to which the exceptions apply:

(1) Interests in a corporation, partnership, trust, or estate. Section 197 intangibles do not include an interest in a corporation, partnership, trust, or estate. Thus,

for example, amortization under section

197 is not available for the cost of acquiring stock, partnership interests, or interests in a trust or estate, whether or not the

interests are regularly traded on an established market. (See paragraph (g)(3) of

this section for special rules applicable to

property of a partnership when a section

754 election is in effect for the partner-

2000–7 I.R.B.

ship.)

(2) Interests under certain financial

contracts. Section 197 intangibles do not

include an interest under an existing futures contract, foreign currency contract,

notional principal contract, interest rate

swap, or other similar financial contract,

whether or not the interest is regularly

traded on an established market. However, this exception does not apply to an

interest under a mortgage servicing contract, credit card servicing contract, or

other contract to service another person’s

indebtedness, or an interest under an assumption reinsurance contract. (See paragraph (g)(5) of this section for the treatment of assumption reinsurance contracts.

See paragraph (c)(11) of this section and

§1.167(a)–14(d) for the treatment of

mortgage servicing rights.)

(3) Interests in land. Section 197 intangibles do not include any interest in land.

For this purpose, an interest in land includes a fee interest, life estate, remainder, easement, mineral right, timber right,

grazing right, riparian right, air right, zoning variance, and any other similar right,

such as a farm allotment, quota for farm

commodities, or crop acreage base. An

interest in land does not include an airport

landing or takeoff right, a regulated airline route, or a franchise to provide cable

television service. The cost of acquiring a

license, permit, or other land improvement right, such as a building construction or use permit, is taken into account in

the same manner as the underlying improvement.

(4) Certain computer software—(i)

Publicly available. Section 197 intangibles do not include any interest in computer software that is (or has been) readily

available to the general public on similar

terms, is subject to a nonexclusive license, and has not been substantially

modified. Computer software will be

treated as readily available to the general

public if the software may be obtained on

substantially the same terms by a significant number of persons that would reasonably be expected to use the software.

This requirement can be met even though

the software is not available through a

system of retail distribution. Computer

software will not be considered to have

been substantially modified if the cost of

all modifications to the version of the

software that is readily available to the

2000–7 I.R.B.

general public does not exceed the greater

of 25 percent of the price at which the unmodified version of the software is readily available to the general public or

$2,000. For the purpose of determining

whether computer software has been substantially modified—

(A) Integrated programs acquired in a

package from a single source are treated

as a single computer program; and

(B) Any cost incurred to install the

computer software on a system is not

treated as a cost of the software. However, the costs for customization, such as

tailoring to a user’s specifications (other

than embedded programming options) are

costs of modifying the software.

(ii) Not acquired as part of trade or

business. Section 197 intangibles do not

include an interest in computer software

that is not acquired as part of a purchase

of a trade or business.

(iii) Other exceptions. For other exceptions applicable to computer software, see

paragraph (a)(3) of this section (relating

to otherwise deductible amounts) and

paragraph (g)(7) of this section (relating

to amounts properly taken into account in

determining the cost of property that is

not a section 197 intangible).

(iv) Computer software defined. For

purposes of this section, computer software is any program or routine (that is,

any sequence of machine-readable code)

that is designed to cause a computer to

perform a desired function or set of functions, and the documentation required to

describe and maintain that program or

routine. It includes all forms and media

in which the software is contained,

whether written, magnetic, or otherwise.

Computer programs of all classes, for example, operating systems, executive systems, monitors, compilers and translators,

assembly routines, and utility programs as

well as application programs, are included. Computer software also includes

any incidental and ancillary rights that are

necessary to effect the acquisition of the

title to, the ownership of, or the right to

use the computer software, and that are

used only in connection with that specific

computer software. Such incidental and

ancillary rights are not included in the definition of trademark or trade name under

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

example, a trademark or trade name that

is ancillary to the ownership or use of a

599

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

word-processing program includes a dictionary feature used to spell-check a document or any portion thereof, the entire

program (including the dictionary feature)

is computer software regardless of the

form in which the feature is maintained or

stored.

(5) Certain interests in films, sound

recordings, video tapes, books, or other

similar property. Section 197 intangibles

do not include any interest (including an

interest as a licensee) in a film, sound

recording, video tape, book, or other similar property (such as the right to broadcast

or transmit a live event) if the interest is

not acquired as part of a purchase of a

trade or business. A film, sound recording, video tape, book, or other similar

property includes any incidental and ancillary rights (such as a trademark or trade

name) that are necessary to effect the acquisition of title to, the ownership of, or

the right to use the property and are used

only in connection with that property.

Such incidental and ancillary rights are

not included in the definition of trademark or trade name under paragraph

(b)(10)(i) of this section. For purposes of

this paragraph (c)(5), computer software

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

section) is not treated as other property

similar to a film, sound recording, video

tape, or book. (See section 167 for amortization of excluded intangible property or

interests.)

(6) Certain rights to receive tangible

property or services.

Section 197 intangibles do not include

any right to receive tangible property or

services under a contract or from a governmental unit if the right is not acquired

February 14, 2000

as part of a purchase of a trade or business. Any right that is described in the

preceding sentence is not treated as a section 197 intangible even though the right

is also described in section 197(d)(1)(D)

and paragraph (b)(8) of this section (relating to certain governmental licenses, permits, and other rights) and even though

the right fails to meet one or more of the

requirements of paragraph (c)(13) of this

section (relating to certain rights of fixed

duration or amount).

(See

§1.167(a)–14(c)(1) and (3) for applicable

rules.)

(7) Certain interests in patents or copyrights. Section 197 intangibles do not include any interest (including an interest as

a licensee) in a patent, patent application,

or copyright that is not acquired as part of

a purchase of a trade or business. A

patent or copyright includes any incidental and ancillary rights (such as a trademark or trade name) that are necessary to

effect the acquisition of title to, the ownership of, or the right to use the property

and are used only in connection with that

property. Such incidental and ancillary

rights are not included in the definition of

trademark or trade name under paragraph

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

(See

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

(8) Interests under leases of tangible

property—(i) Interest as a lessor. Section

197 intangibles do not include any interest as a lessor under an existing lease or

sublease of tangible real or personal property. In addition, the cost of acquiring an

interest as a lessor in connection with the

acquisition of tangible property is taken

into account as part of the cost of the tangible property. For example, if a taxpayer

acquires a shopping center that is leased

to tenants operating retail stores, any portion of the purchase price attributable to

favorable lease terms is taken into account as part of the basis of the shopping

center and in determining the depreciation

deduction allowed with respect to the

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

(ii) Interest as a lessee. Section 197 intangibles do not include any interest as a

lessee under an existing lease of tangible

real or personal property. For this purpose, an airline lease of an airport passenger or cargo gate is a lease of tangible

property. The cost of acquiring such an

interest is taken into account under section 178 and §1.162–11(a). If an interest

February 14, 2000

as a lessee under a lease of tangible property is acquired in a transaction with any

other intangible property, a portion of the

total purchase price may be allocable to

the interest as a lessee based on all of the

relevant facts and circumstances.

(9) Interests under indebtedness—(i) In

general. Section 197 intangibles do not

include any interest (whether as a creditor

or debtor) under an indebtedness in existence when the interest was acquired.

Thus, for example, the value attributable

to the assumption of an indebtedness with

a below-market interest rate is not amortizable under section 197. In addition, the

premium paid for acquiring a debt instrument with an above-market interest rate is

not amortizable under section 197. See

section 171 for rules concerning the treatment of amortizable bond premium.

(ii) Exceptions. For purposes of this

paragraph (c)(9), an interest under an existing indebtedness does not include the

deposit base (and other similar items) of a

financial institution. An interest under an

existing indebtedness includes mortgage

servicing rights, however, to the extent

the rights are stripped coupons under section 1286.

(10) Professional sports franchises.

Section 197 intangibles do not include

any franchise to engage in professional

baseball, basketball, football, or any other

professional sport, and any item (even

though otherwise qualifying as a section

197 intangible) acquired in connection

with such a franchise.

(11) Mortgage servicing rights. Section 197 intangibles do not include any

right described in section 197(e)(7) (concerning rights to service indebtedness secured by residential real property that are

not acquired as part of a purchase of a

trade or business). (See §1.167(a)–14(d)

for applicable rules.)

(12) Certain transaction costs. Section

197 intangibles do not include any fees

for professional services and any transaction costs incurred by parties to a transaction in which all or any portion of the gain

or loss is not recognized under part III of

subchapter C of the Internal Revenue

Code.

(13) Rights of fixed duration or

amount. (i) Section 197 intangibles do

not include any right under a contract or

any license, permit, or other right granted

by a governmental unit if the right—

600

(A) Is acquired in the ordinary course

of a trade or business (or an activity described in section 212) and not as part of a

purchase of a trade or business;

(B) Is not described in section

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

a customer-related information base, or

any other similar item; and

(D) Either—

(1) Has a fixed duration of less than 15

years; or

(2) Is fixed as to amount and the adjusted basis thereof is properly recoverable (without regard to this section) under

a method similar to the unit-of-production

method.

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

applicable rules.

(d) Amortizable section 197 intangibles—(1) Definition. Except as otherwise

provided in this paragraph (d), the term

amortizable section 197 intangible means

any section 197 intangible acquired after

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

a valid retroactive election under

§1.197–1T has been made), and held in

connection with the conduct of a trade or

business or an activity described in section 212.

(2) Exception for self-created intangibles—(i) In general. Except as provided

in paragraph (d)(2)(iii) of this section,

amortizable section 197 intangibles do

not include any section 197 intangible

created by the taxpayer (a self-created intangible).

(ii) Created by the taxpayer—(A) Defined. A section 197 intangible is created

by the taxpayer to the extent the taxpayer

makes payments or otherwise incurs costs

for its creation, production, development,

or improvement, whether the actual work

is performed by the taxpayer or by another person under a contract with the taxpayer entered into before the contracted

creation, production, development, or improvement occurs. For example, a technological process developed specifically

for a taxpayer under an arrangement with

another person pursuant to which the taxpayer retains all rights to the process is

created by the taxpayer.

(B) Contracts for the use of

intangibles. A section 197 intangible is

not a self- created intangible to the extent

that it results from the entry into (or renewal of) a contract for the use of an ex-

2000–7 I.R.B.

isting section 197 intangible. Thus, for

example, the exception for self-created

intangibles does not apply to capitalized

costs, such as legal and other professional

fees, incurred by a licensee in connection

with the entry into (or renewal of) a contract for the use of know-how or similar

property.

If an existing section 197 intangible is improved or otherwise modified by the taxpayer or by another person under a contract with the taxpayer, the existing

intangible and the capitalized costs (if

any) of the improvements or other modifications are each treated as a separate section 197 intangible for purposes of this

paragraph (d).

(iii) Exceptions. (A) The exception for

self-created intangibles does not apply to

any section 197 intangible described in

section 197(d)(1)(D) (relating to licenses,

permits or other rights granted by a governmental unit), 197(d)(1)(E) (relating to

covenants not to compete), or

197(d)(1)(F) (relating to franchises, trademarks, and trade names). Thus, for example, capitalized costs incurred in the development, registration, or defense of a

trademark or trade name do not qualify

for the exception and are amortized over

15 years under section 197.

(B) The exception for self-created intangibles does not apply to any section

197 intangible created in connection with

the purchase of a trade or business (as defined in paragraph (e) of this section).

(C) If a taxpayer disposes of a self-created intangible and subsequently reacquires the intangible in an acquisition described in paragraph (h)(5)(ii) of this

section, the exception for self-created intangibles does not apply to the reacquired

intangible.

(3) Exception for property subject to

anti-churning rules. Amortizable section

197 intangibles do not include any property to which the anti-churning rules of

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

section apply.

(e) Purchase of a trade or business.

Several of the exceptions in section 197

apply only to property that is not acquired

in (or created in connection with) a transaction or series of related transactions involving the acquisition of assets constituting a trade or business or a substantial

portion thereof. Property acquired in (or

2000–7 I.R.B.

created in connection with) such a transaction or series of related transactions is

referred to in this section as property acquired as part of (or created in connection

with) a purchase of a trade or business.

For purposes of section 197 and this section, the applicability of the limitation is

determined under the following rules:

(1) Goodwill or going concern value.

An asset or group of assets constitutes a

trade or business or a substantial portion

thereof if their use would constitute a

trade or business under section 1060 (that

is, if goodwill or going concern value

could under any circumstances attach to

the assets). See §1.1060–1T(b)(2). For

this purpose, all the facts and circumstances, including any employee relationships that continue (or covenants not to

compete that are entered into) as part of

the transfer of the assets, are taken into

account in determining whether goodwill

or going concern value could attach to the

assets.

(2) Franchise, trademark, or trade

name—(i) In general. The acquisition of

a franchise, trademark, or trade name constitutes the acquisition of a trade or business or a substantial portion thereof.

(ii) Exceptions. For purposes of this

paragraph (e)(2)—

(A) A trademark or trade name is disregarded if it is included in computer software under paragraph (c)(4) of this section or in an interest in a film, sound

recording, video tape, book, or other similar property under paragraph (c)(5) of this

section;

(B) A franchise, trademark, or trade

name is disregarded if its value is nominal

or the taxpayer irrevocably disposes of it

immediately after its acquisition; and

in a trademark or trade name is disregarded if the grant of the right or interest

is not, under the principles of section

1253, a transfer of all substantial rights to

such property or of an undivided interest

in all substantial rights to such property.

(3) Acquisitions to be included. The

assets acquired in a transaction (or series

of related transactions) include only assets (including a beneficial or other indirect interest in assets where the interest is

of a type described in paragraph (c)(1) of

this section) acquired by the taxpayer and

persons related to the taxpayer from another person and persons related to that

601

other person. For purposes of this paragraph (e)(3), persons are related only if

their relationship is described in section

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

trades or businesses under common control within the meaning of section

41(f)(1).

(4) Substantial portion. The determination of whether acquired assets constitute a substantial portion of a trade or

business is to be based on all of the facts

and circumstances, including the nature

and the amount of the assets acquired as

well as the nature and amount of the assets retained by the transferor. The value

of the assets acquired relative to the value

of the assets retained by the transferor is

not determinative of whether the acquired

assets constitute a substantial portion of a

trade or business.

(5) Deemed asset purchases under section 338. A qualified stock purchase that

is treated as a purchase of assets under

section 338 is treated as a transaction involving the acquisition of assets constituting a trade or business only if the direct

acquisition of the assets of the corporation

would have been treated as the acquisition

of assets constituting a trade or business

or a substantial portion thereof.

(6) Mortgage servicing rights. Mortgage servicing rights acquired in a transaction or series of related transactions are

disregarded in determining for purposes

of paragraph (c)(11) of this section

whether the assets acquired in the transaction or transactions constitute a trade or

business or substantial portion thereof.

(7) Computer software acquired for internal use. Computer software acquired

in a transaction or series of related transactions solely for internal use in an existing trade or business is disregarded in determining for purposes of paragraph

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

acquired in the transaction or series of related transactions constitute a trade or

business or substantial portion thereof.

(f) Computation of amortization deduction—(1) In general. Except as provided

in paragraph (f)(2) of this section, the

amortization deduction allowable under

section 197(a) is computed as follows:

(i) The basis of an amortizable section

197 intangible is amortized ratably over

the 15-year period beginning on the later

of—

(A) The first day of the month in which

February 14, 2000

the property is acquired; or

(B) In the case of property held in connection with the conduct of a trade or

business or in an activity described in section 212, the first day of the month in

which the conduct of the trade or business

or the activity begins.

(ii) Except as otherwise provided in

this section, basis is determined under

section 1011 and salvage value is disregarded.

(iii) Property is not eligible for amortization in the month of disposition.

(iv) The amortization deduction for a

short taxable year is based on the number

of months in the short taxable year.

(2) Treatment of contingent amounts—

(i) Amounts added to basis during 15year period. Any amount that is properly

included in the basis of an amortizable

section 197 intangible after the first

month of the 15-year period described in

paragraph (f)(1)(i) of this section and before the expiration of that period is amortized ratably over the remainder of the 15year period. For this purpose, the

remainder of the 15-year period begins on

the first day of the month in which the

basis increase occurs.

(ii) Amounts becoming fixed after expiration of 15-year period. Any amount

that is not properly included in the basis

of an amortizable section 197 intangible

until after the expiration of the 15-year

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

this section is amortized in full immediately upon the inclusion of the amount in

the basis of the intangible.

(iii) Rules for including amounts in

basis. See §§1.1275–4(c)(4) and

1.483–4(a) for rules governing the extent

to which contingent amounts payable

under a debt instrument given in consideration for the sale or exchange of an amortizable section 197 intangible are treated

as payments of principal and the time at

which the amount treated as principal is

included in basis. See §1.461–1(a)(1) and

(2) for rules governing the time at which

other contingent amounts are taken into

account in determining the basis of an

amortizable section 197 intangible.

(3) Basis determinations for certain assets—(i) Covenants not to compete. In

the case of a covenant not to compete or

other similar arrangement described in

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

covenant), the amount chargeable to capi-

February 14, 2000

tal account includes, except as provided

in this paragraph (f)(3), all amounts that

are required to be paid pursuant to the

covenant, whether or not any such

amount would be deductible under section 162 if the covenant were not a section

197 intangible.

(ii) Contracts for the use of section 197

intangibles; acquired as part of a trade or

business—(A) In general. Except as provided in this paragraph (f)(3), any amount

paid or incurred by the transferee on account of the transfer of a right or term interest described in paragraph (b)(11) of

this section (relating to contracts for the

use of, and term interests in, section 197

intangibles) by the owner of the property

to which such right or interest relates and

as part of a purchase of a trade or business

is chargeable to capital account, whether

or not such amount would be deductible

under section 162 if the property were not

a section 197 intangible.

(B) Know-how and certain information

base. The amount chargeable to capital

account with respect to a right or term interest described in paragraph (b)(11) of

this section is determined without regard

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

this section if the right or interest relates

to property (other than a customer-related

information base) described in paragraph

(b)(4) or (5) of this section and the acquiring taxpayer establishes that—

(1) The transfer of the right or interest

is not, under the principles of section

1235, a transfer of all substantial rights to

such property or of an undivided interest

in all substantial rights to such property;

and

(2) The right or interest was transferred

for an arm’s-length consideration.

(iii) Contracts for the use of section

197 intangibles; not acquired as part of a

trade or business. The transfer of a right

or term interest described in paragraph

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

property to which such right or interest relates but not as part of a purchase of a

trade or business will be closely scrutinized under the principles of section 1235

for purposes of determining whether the

transfer is a sale or exchange and, accordingly, whether amounts paid on account

of the transfer are chargeable to capital

account. If under the principles of section

1235 the transaction is not a sale or exchange, amounts paid on account of the

602

transfer are not chargeable to capital account under this paragraph (f)(3).

(iv) Applicable rules—(A) Franchises,

trademarks, and trade names. For purposes of this paragraph (f)(3), section 197

intangibles described in paragraph (b)(11)

of this section do not include any property

that is also described in paragraph (b)(10)

of this section (relating to franchises,

trademarks, and trade names).

(B) Certain amounts treated as payable

under a debt instrument—(1) In general.

For purposes of applying any provision of

the Internal Revenue Code to a person

making payments of amounts that are otherwise chargeable to capital account

under this paragraph (f)(3) and are

payable after the acquisition of the section

197 intangible to which they relate, such

amounts are treated as payable under a

debt instrument given in consideration for

the sale or exchange of the section 197 intangible.

(2) Rights granted by governmental

units. For purposes of applying any provision of the Internal Revenue Code to

any amounts that are otherwise chargeable to capital account with respect to a license, permit, or other right described in

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

to rights granted by a governmental unit

or agency or instrumentality thereof) and

are payable after the acquisition of the

section 197 intangible to which they relate, such amounts are treated, except as

provided in paragraph (f)(4)(i) of this section (relating to renewal transactions), as

payable under a debt instrument given in

consideration for the sale or exchange of

the section 197 intangible.

(3) Treatment of other parties to transaction. No person shall be treated as having sold, exchanged, or otherwise disposed of property in a transaction for

purposes of any provision of the Internal

Revenue Code solely by reason of the application of this paragraph (f)(3) to any

other party to the transaction.

(4) Basis determinations in certain

transactions—(i) Certain renewal transactions. The costs paid or incurred for the

renewal of a franchise, trademark, or

trade name or any license, permit, or other

right granted by a governmental unit or an

agency or instrumentality thereof are

amortized over the 15-year period that begins with the month of renewal. Any

costs paid or incurred for the issuance, or

2000–7 I.R.B.

earlier renewal, continue to be taken into

account over the remaining portion of the

amortization period that began at the time

of the issuance, or earlier renewal. Any

amount paid or incurred for the protection, expansion, or defense of a trademark

or trade name and chargeable to capital

account is treated as an amount paid or incurred for a renewal.

(ii) Transactions subject to section 338

or 1060. In the case of a section 197 intangible deemed to have been acquired as

the result of a qualified stock purchase

within the meaning of section 338(d)(3),

the basis shall be determined pursuant to

section 338(b)(5) and the regulations

thereunder. In the case of a section 197

intangible acquired in an applicable asset

acquisition within the meaning of section

1060(c), the basis shall be determined

pursuant to section 1060(a) and the regulations thereunder.

(iii) Certain reinsurance transactions.

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

special rules regarding the adjusted basis

of an insurance contract acquired through

an assumption reinsurance transaction.

(g) Special rules—(1) Treatment of

certain dispositions—(i) Loss disallowance rules—(A) In general. No loss

is recognized on the disposition of an

amortizable section 197 intangible if the

taxpayer has any retained intangibles.

The retained intangibles with respect to

the disposition of any amortizable section

197 intangible (the transferred intangible)

are all amortizable section 197 intangibles, or rights to use or interests (including beneficial or other indirect interests)

in amortizable section 197 intangibles (including the transferred intangible) that

were acquired in the same transaction or

series of related transactions as the transferred intangible and are retained after its

disposition. Except as otherwise provided in paragraph (g)(1)(iv)(B) of this

section, the adjusted basis of each of the

retained intangibles is increased by the

product of—

(1) The loss that is not recognized

solely by reason of this rule; and

(2) A fraction, the numerator of which

is the adjusted basis of the retained intangible on the date of the disposition and the

denominator of which is the total adjusted

bases of all the retained intangibles on

that date.

(B) Abandonment or worthlessness.

2000–7 I.R.B.

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.

The loss disallowance rule in paragraph

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

when a taxpayer transfers an amortizable

section 197 intangible from an acquired

trade or business in a transaction in which

the intangible is transferred basis property

and, after the transfer, retains other amortizable section 197 intangibles from the

trade or business. Thus, for example, the

transfer of an amortizable section 197 intangible to a corporation in exchange for

stock in the corporation in a transaction

described in section 351, or to a partnership in exchange for an interest in the

partnership in a transaction described in

section 721, when other amortizable section 197 intangibles acquired in the same

transaction are retained, followed by a

sale of the stock or partnership interest received, will not avoid the application of

the loss disallowance provision to the extent the adjusted basis of the transferred

intangible at the time of the sale exceeds

its fair market value at that time.

(ii) Separately acquired property.

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

not apply to an amortizable section 197

intangible that is not acquired in a transaction or series of related transactions in

which the taxpayer acquires other amortizable section 197 intangibles (a separately

acquired intangible). Consequently, a

loss may be recognized upon the disposition of a separately acquired amortizable

section 197 intangible. However, the termination or worthlessness of only a portion of an amortizable section 197 intangible is not the disposition of a separately

acquired intangible. For example, neither

the loss of several customers from an acquired customer list nor the worthlessness

of only some information from an acquired data base constitutes the disposition of a separately acquired intangible.

(iii) Disposition of a covenant not to

compete. If a covenant not to compete or

603

any other arrangement having substantially the same effect is entered into in

connection with the direct or indirect acquisition of an interest in one or more

trades or businesses, the disposition or

worthlessness of the covenant or other

arrangement will not be considered to

occur until the disposition or worthlessness of all interests in those trades or businesses. For example, a covenant not to

compete entered into in connection with

the purchase of stock continues to be

amortized ratably over the 15-year recovery period (even after the covenant expires or becomes worthless) unless all the

trades or businesses in which an interest

was acquired through the stock purchase

(or all the purchaser’s interests in those

trades or businesses) also are disposed of

or become worthless.

(iv) Taxpayers under common

control—(A) In general. Except as provided in paragraph (g)(1)(iv)(B) of this

section, all persons that would be treated

as a single taxpayer under section 41(f)(1)

are treated as a single taxpayer under this

paragraph (g)(1). Thus, for example, a

loss is not recognized on the disposition

of an amortizable section 197 intangible

by a member of a controlled group of corporations (as defined in section 41(f)(5))

if, after the disposition, another member

retains other amortizable section 197 intangibles acquired in the same transaction

as the amortizable section 197 intangible

that has been disposed of.

(B) Treatment of disallowed loss. If retained intangibles are held by a person

other than the person incurring the disallowed loss, only the adjusted basis of intangibles retained by the person incurring

the disallowed loss is increased, and only

the adjusted basis of those intangibles is

included in the denominator of the fraction described in paragraph (g)(1)(i)(A) of

this section. If none of the retained intangibles are held by the person incurring the

disallowed loss, the loss is allowed ratably, as a deduction under section 197,

over the remainder of the period during

which the intangible giving rise to the loss

would have been amortizable, except that

any remaining disallowed loss is allowed

in full on the first date on which all other

retained intangibles have been disposed

of or become worthless.

(2) Treatment of certain nonrecognition

and exchange transactions—(i) Relation-

February 14, 2000

ship to anti-churning rules. This paragraph (g)(2) provides rules relating to the

treatment of section 197 intangibles acquired in certain transactions. If these

rules apply to a section 197(f)(9) intangible (within the meaning of paragraph

(h)(1)(i) of this section), the intangible is,

notwithstanding its treatment under this

paragraph (g)(2), treated as an amortizable section 197 intangible only to the extent permitted under paragraph (h) of this

section.

(ii) Treatment of nonrecognition and

exchange transactions generally—(A)

Transfer disregarded. If a section 197 intangible is transferred in a transaction described in paragraph (g)(2)(ii)(C) of this

section, the transfer is disregarded in determining—

(1) Whether, with respect to so much of

the intangible’s basis in the hands of the

transferee as does not exceed its basis in

the hands of the transferor, the intangible

is an amortizable section 197 intangible;

and

(2) The amount of the deduction under

section 197 with respect to such basis.

(B) Application of general rule. If the

intangible described in paragraph

(g)(2)(ii)(A) of this section was an amortizable section 197 intangible in the hands

of the transferor, the transferee will continue to amortize its adjusted basis, to the

extent it does not exceed the transferor’s

adjusted basis, ratably over the remainder

of the transferor’s 15-year amortization

period. If the intangible was not an amortizable section 197 intangible in the hands

of the transferor, the transferee’s adjusted

basis, to the extent it does not exceed the

transferor’s adjusted basis, cannot be

amortized under section 197. In either

event, the intangible is treated, with respect to so much of its adjusted basis in

the hands of the transferee as exceeds its

adjusted basis in the hands of the transferor, in the same manner for purposes of

section 197 as an intangible acquired

from the transferor in a transaction that is

not described in paragraph (g)(2)(ii)(C) of

this section. The rules of this paragraph

(g)(2)(ii) also apply to any subsequent

transfers of the intangible in a transaction

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

this section.

(g)(2)(ii)(C) are—

February 14, 2000

(1) Any transaction described in section

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

(2) Any transaction between corporations that are members of the same consolidated group immediately after the

transaction.

(iii) Certain exchanged-basis property.

This paragraph (g)(2)(iii) applies to property that is acquired in a transaction subject to section 1031 or 1033 and is permitted to be acquired without recognition of

gain (replacement property). Replacement property is treated as if it were the

property by reference to which its basis is

determined (the predecessor property) in

determining whether, with respect to so

much of its basis as does not exceed the

basis of the predecessor property, the replacement property is an amortizable section 197 intangible and the amortization

period under section 197 with respect to

such basis. Thus, if the predecessor property was an amortizable section 197 intangible, the taxpayer will amortize the adjusted basis of the replacement property,

to the extent it does not exceed the adjusted basis of the predecessor property,

ratably over the remainder of the 15-year

amortization period for the predecessor

property. If the predecessor property was

not an amortizable section 197 intangible,

the adjusted basis of the replacement

property, to the extent it does not exceed

the adjusted basis of the predecessor

property, may not be amortized under section 197. In either event, the replacement

property is treated, with respect to so

much of its adjusted basis as exceeds the

adjusted basis of the predecessor property, in the same manner for purposes of

section 197 as property acquired from the

transferor in a transaction that is not subject to section 1031 or 1033.

(iv) Transfers under section

708(b)(1)—(A) In general. Paragraph

(g)(2)(ii) of this section applies to transfers of section 197 intangibles that occur

or are deemed to occur by reason of the

termination of a partnership under section

708(b)(1).

(B) Termination by sale or exchange of

interest. In applying paragraph (g)(2)(ii)

of this section to a partnership that is terminated pursuant to section 708(b)(1)(B)

(relating to deemed terminations from the

sale or exchange of an interest), the terminated partnership is treated as the transferor and the new partnership is treated as

604

the transferee with respect to any section

197 intangible held by the terminated

partnership immediately preceding the

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

section for the treatment of increases in

the bases of property of the terminated

partnership under section 743(b).)

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

partnership that is terminated pursuant to

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

of activities by a partnership), the terminated partnership is treated as the transferor and the distributee partner is treated

as the transferee with respect to any section 197 intangible held by the terminated

partnership immediately preceding the

termination.

(3) Increase in the basis of partnership

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

743(b), or 732(d). Any increase in the adjusted basis of a section 197 intangible

under sections 732(b) or 732(d) (relating

to a partner’s basis in property distributed

by a partnership), section 734(b) (relating

to the optional adjustment to the basis of

undistributed partnership property after a

distribution of property to a partner), or

section 743(b) (relating to the optional adjustment to the basis of partnership property after transfer of a partnership interest) is treated as a separate section 197

intangible. For purposes of determining

the amortization period under section 197

with respect to the basis increase, the intangible is treated as having been acquired at the time of the transaction that

causes the basis increase. The provisions

of paragraph (f)(2) of this section apply to

the extent that the amount of the basis increase is determined by reference to contingent payments. For purposes of the effective date and anti-churning provisions

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

for a basis increase under section 732(d),

the intangible is treated as having been

acquired by the transferee partner at the

time of the transfer of the partnership interest described in section 732(d).

(4) Section 704(c) allocations—(i) Allocations where the intangible is amortizable by the contributor. To the extent that

the intangible was an amortizable section

197 intangible in the hands of the contributing partner, a partnership may make

allocations of amortization deductions

with respect to the intangible to all of its

partners under either the curative or reme-

2000–7 I.R.B.

dial allocation methods described in the

regulations under section 704(c). See

§1.704–3(c) and (d).

(ii) Allocations where the intangible is

not amortizable by the contributor. To the

extent that the intangible was not an

amortizable section 197 intangible in the

hands of the contributing partner, the intangible is not amortizable by the partnership. However, if a partner contributes a

section 197 intangible to a partnership

and the partnership adopts the remedial

allocation method for making section

704(c) allocations of amortization deductions, the partnership generally may make

remedial allocations of amortization deductions with respect to the contributed

section 197 intangible in accordance with

§ 1.704–3(d). See paragraph (h)(12) of

this section to determine the application

of the anti-churning rules in the context of

remedial allocations.

(5) Treatment of certain reinsurance

transactions—(i) In general. Section 197

applies to any insurance contract acquired

from another person through an assumption reinsurance transaction. For purposes of section 197, an assumption reinsurance transaction is—

(A) Any arrangement in which one insurance company (the reinsurer) becomes

solely liable to policyholders on contracts

transferred by another insurance company

(the ceding company); and

(B) Any acquisition of an insurance

contract that is treated as occurring by

reason of an election under section 338.

(ii) Determination of adjusted basis—

(A) Acquisitions (other than under section 338) of specified insurance contracts.

The amount taken into account for purposes of section 197 as the adjusted basis

of specified insurance contracts (as defined in section 848(e)(1)) acquired in an

assumption reinsurance transaction that is

not described in paragraph (g)(5)(i)(B) of

this section is equal to the excess of—

(1) The amount paid or incurred (or

treated as having been paid or incurred)

by the reinsurer for the purchase of the

contracts (as determined under

§1.817–4(d)(2)); over

(2) The amount of the specified policy

acquisition expenses that are attributable

to the reinsurer’s net positive consideration for the reinsurance agreement (as determined under §1.848–2(f)(3)).

(B) Insolvent ceding company. The re-

2000–7 I.R.B.

duction of the amount of specified policy

acquisition expenses by the reinsurer with

respect to an assumption reinsurance

transaction with an insolvent ceding company where the ceding company and reinsurer have made a valid joint election

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

in determining the amount of specified

policy acquisition expenses for purposes

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

(6) Amounts paid or incurred for a

franchise, trademark, or trade name. If

an amount to which section 1253(d) (relating to the transfer, sale, or other disposition of a franchise, trademark, or trade

name) applies is described in section

1253(d)(1)(B) (relating to contingent serial payments deductible under section

162), the amount is not included in the adjusted basis of the intangible for purposes

of section 197. Any other amount,

whether fixed or contingent, to which section 1253(d) applies is chargeable to capital account under section 1253(d)(2) and

is amortizable only under section 197.

(7) Amounts properly taken into account in determining the cost of property

that is not a section 197 intangible. Section 197 does not apply to an amount that

is properly taken into account in determining the cost of property that is not a

section 197 intangible. The entire cost of

acquiring the other property is included in

its basis and recovered under other applicable Internal Revenue Code provisions.

Thus, for example, section 197 does not

apply to the cost of an interest in computer software to the extent such cost is

included, without being separately stated,

in the cost of the hardware or other tangible property and is consistently treated as

part of the cost of the hardware or other

tangible property.

(8) Treatment of amortizable section

197 intangibles as depreciable property.

An amortizable section 197 intangible is

treated as property of a character subject

to the allowance for depreciation under

section 167. Thus, for example, an amortizable section 197 intangible is not a capital asset for purposes of section 1221, but

if used in a trade or business and held for

more than one year, gain or loss on its disposition generally qualifies as section

1231 gain or loss. Also, an amortizable

section 197 intangible is section 1245

property and section 1239 applies to any

605

gain recognized upon its sale or exchange

between related persons (as defined in

section 1239(b)).

(h) Anti-churning rules—(1) Scope and

purpose—(i) Scope. This paragraph (h)

applies to section 197(f)(9) intangibles.

For this purpose, section 197(f)(9) intangibles are goodwill and going concern

value that was held or used at any time

during the transition period and any other

section 197 intangible that was held or

used at any time during the transition period and was not depreciable or amortizable under prior law.

(ii) Purpose. To qualify as an amortizable section 197 intangible, a section 197

intangible must be acquired after the applicable date (July 25, 1991, if the acquiring taxpayer has made a valid retroactive

election pursuant to §1.197–1T; August

10, 1993, in all other cases). The purpose

of the anti-churning rules of section

197(f)(9) and this paragraph (h) is to prevent the amortization of section 197(f)(9)

intangibles unless they are transferred

after the applicable effective date in a

transaction giving rise to a significant

change in ownership or use. (Special

rules apply for purposes of determining

whether transactions involving partnerships give rise to a significant change in

ownership or use. See paragraph (h)(12)

of this section.) The anti-churning rules

are to be applied in a manner that carries

out their purpose.

(2) Treatment of section 197(f)(9) intangibles. Except as otherwise provided

in this paragraph (h), a section 197(f)(9)

intangible acquired by a taxpayer after the

applicable effective date does not qualify

for amortization under section 197 if—

(i) The taxpayer or a related person

held or used the intangible or an interest

therein at any time during the transition

period;

(ii) The taxpayer acquired the intangible from a person that held the intangible

at any time during the transition period

and, as part of the transaction, the user of

the intangible does not change; or

(iii) The taxpayer grants the right to use

the intangible to a person that held or used

the intangible at any time during the transition period (or to a person related to that

person), but only if the transaction in

which the taxpayer grants the right and

the transaction in which the taxpayer acquired the intangible are part of a series of

February 14, 2000

related transactions.

(3) Amounts deductible under section

1253(d) or §1.162–11. For purposes of

this paragraph (h), deductions allowable

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

election under section 1253(d)(3) (in either case as in effect prior to the enactment of section 197) and deductions allowable under §1.162–11 are treated as

deductions allowable for amortization

under prior law.

(4) Transition period. For purposes of

this paragraph (h), the transition period is

July 25, 1991, if the acquiring taxpayer

has made a valid retroactive election pursuant to §1.197–1T and the period beginning on July 25, 1991, and ending on August 10, 1993, in all other cases.

(5) Exceptions. The anti-churning rules

of this paragraph (h) do not apply to—

(i) The acquisition of a section

197(f)(9) intangible if the acquiring taxpayer’s basis in the intangible is determined under section 1014(a); or

(ii) The acquisition of a section

197(f)(9) intangible that was an amortizable section 197 intangible in the hands of

the seller (or transferor), but only if the

acquisition transaction and the transaction

in which the seller (or transferor) acquired

the intangible or interest therein are not

part of a series of related transactions.

(6) Related person—(i) In general.

Except as otherwise provided in paragraph (h)(6)(ii) of this section, a person is

related to another person for purposes of

this paragraph (h) if—

(A) The person bears a relationship to

that person that would be specified in section 267(b) (determined without regard to

section 267(e)) and, by substitution, section 267(f)(1), if those sections were

amended by substituting 20 percent for 50

percent; or

(B) The person bears a relationship to

that person that would be specified in section 707(b)(1) if that section were

amended by substituting 20 percent for 50

percent; or

or businesses under common control

(within the meaning of section

41(f)(1)(A) and (B)).

(ii) Time for testing relationships. Except as provided in paragraph (h)(6)(iii)

of this section, a person is treated as related to another person for purposes of

this paragraph (h) if the relationship ex-

February 14, 2000

ists—

(A) In the case of a single transaction,

immediately before or immediately after

the transaction in which the intangible is

acquired; and

(B) In the case of a series of related

transactions (or a series of transactions

that together comprise a qualified stock

purchase within the meaning of section

338(d)(3)), immediately before the earliest such transaction or immediately after

the last such transaction.

(iii) Certain relationships disregarded.

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

of this section, if a person acquires an intangible in a series of related transactions

in which the person acquires stock (meeting the requirements of section

1504(a)(2)) of a corporation in a fully taxable transaction followed by a liquidation

of the acquired corporation under section

331, any relationship created as part of

such series of transactions is disregarded

in determining whether any person is related to such acquired corporation immediately after the last transaction.

(iv) De minimis rule—(A) In general.

Two corporations are not treated as related persons for purposes of this paragraph (h) if—

(1) The corporations would (but for the

application of this paragraph (h)(6)(iv))

be treated as related persons solely by reason of substituting “more than 20 percent” for “more than 50 percent” in section 267(f)(1)(A); and

(2) The beneficial ownership interest of

each corporation in the stock of the other

corporation represents less than 10 percent

of the total combined voting power of all

classes of stock entitled to vote and less

than 10 percent of the total value of the

shares of all classes of stock outstanding.

(B) Determination of beneficial ownership interest. For purposes of this paragraph (h)(6)(iv), the beneficial ownership

interest of one corporation in the stock of

another corporation is determined under

the principles of section 318(a), except

that—

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

the 50-percent limitation contained

therein is not applied; and

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

substituting “20 percent” for “50 percent”.

(7) Special rules for entities that owned

or used property at any time during the

606

transition period and that are no longer

in existence. A corporation, partnership,

or trust that owned or used a section 197

intangible at any time during the transition period and that is no longer in existence is deemed, for purposes of determining whether a taxpayer acquiring the

intangible is related to such entity, to be in

existence at the time of the acquisition.

(8) Special rules for section 338

deemed acquisitions. In the case of a

qualified stock purchase that is treated as

a deemed sale and purchase of assets pursuant to section 338, the corporation

treated as purchasing assets as a result of

an election thereunder (new target) is not

considered the person that held or used

the assets during any period in which the

assets were held or used by the corporation treated as selling the assets (old target). Thus, for example, if a corporation

(the purchasing corporation) makes a

qualified stock purchase of the stock of

another corporation after the transition

period, new target will not be treated as

the owner during the transition period of

assets owned by old target during that period even if old target and new target are

treated as the same corporation for certain

other purposes of the Internal Revenue

Code or old target and new target are the

same corporation under the laws of the

State or other jurisdiction of its organization. However, the anti-churning rules of

this paragraph (h) may nevertheless apply

to a deemed asset purchase resulting from

a section 338 election if new target is related (within the meaning of paragraph

(h)(6) of this section) to old target.

(9) Gain-recognition exception—(i)

Applicability. A section 197(f)(9) intangible qualifies for the gain-recognition exception if—

(A) The taxpayer acquires the intangible from a person that would not be related to the taxpayer but for the substitution of 20 percent for 50 percent under

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

(B) That person (whether or not otherwise subject to Federal income tax) elects

to recognize gain on the disposition of the

intangible and agrees, notwithstanding

any other provision of law or treaty, to

pay for the taxable year in which the disposition occurs an amount of tax on the

gain that, when added to any other Federal income tax on such gain, equals the

gain on the disposition multiplied by the

2000–7 I.R.B.

highest marginal rate of tax for that taxable year.

(ii) Effect of exception. The anti-churning rules of this paragraph (h) apply to a

section 197(f)(9) intangible that qualifies

for the gain-recognition exception only to

the extent the acquiring taxpayer’s basis

in the intangible exceeds the gain recognized by the transferor.

(iii) Time and manner of election. The

election described in this paragraph (h)(9)

must be made by the due date (including

extensions of time) of the electing taxpayer’s Federal income tax return for the

taxable year in which the disposition occurs. The election is made by attaching

an election statement satisfying the requirements of paragraph (h)(9)(viii) of

this section to the electing taxpayer’s

original or amended income tax return for

that taxable year (or by filing the statement as a return for the taxable year under

paragraph (h)(9)(xi) of this section). In

addition, the taxpayer must satisfy the notification requirements of paragraph

(h)(9)(vi) of this section. The election is

binding on the taxpayer and all parties

whose Federal tax liability is affected by

the election.

(iv) Special rules for certain entities.

In the case of a partnership, S corporation,

estate or trust, the election under this

paragraph (h)(9) is made by the entity

rather than by its owners or beneficiaries.

If a partnership or S corporation makes an

election under this paragraph (h)(9) with

respect to the disposition of a section

197(f)(9) intangible, each of its partners

or shareholders is required to pay a tax

determined in the manner described in

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

the amount of gain that is properly allocable to such partner or shareholder with respect to the disposition.

(v) Effect of nonconforming elections.

An attempted election that does not substantially comply with each of the requirements of this paragraph (h)(9) is disregarded in determining whether a section

197(f)(9) intangible qualifies for the gainrecognition exception.

(vi) Notification requirements. A taxpayer making an election under this paragraph (h)(9) with respect to the disposition of a section 197(f)(9) intangible must

provide written notification of the election on or before the due date of the return

on which the election is made to the per-

2000–7 I.R.B.

son acquiring the section 197 intangible.

In addition, a partnership or S corporation

making an election under this paragraph

(h)(9) must attach to the Schedule K-1

furnished to each partner or shareholder a

written statement containing all information necessary to determine the recipient’s

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

(vii) Revocation. An election under

this paragraph (h)(9) may be revoked only

with the consent of the Commissioner.

(viii) Election Statement. An election

statement satisfies the requirements of

this paragraph (h)(9)(viii) if it is in writing and contains the information listed

below. The required information should

be arranged and identified in accordance

with the following order and numbering

system:

(A) The name and address of the electing taxpayer.

(B) Except in the case of a taxpayer

that is not otherwise subject to Federal income tax, the taxpayer identification

number (TIN) of the electing taxpayer.

making the election under section

197(f)(9)(B).

(D) Identification of the transaction and

each person that is a party to the transaction or whose tax return is affected by the

election (including, except in the case of

persons not otherwise subject to Federal

income tax, the TIN of each such person).

(E) The calculation of the gain realized,

the applicable rate of tax, and the amount

of the taxpayer’s additional tax liability

under this paragraph (h)(9).

(F) The signature of the taxpayer or an

individual authorized to sign the taxpayer’s Federal income tax return.

(ix) Determination of highest marginal

rate of tax and amount of other Federal

income tax on gain—(A) Marginal rate.

The following rules apply for purposes of

determining the highest marginal rate of

tax applicable to an electing taxpayer:

(1) Noncorporate taxpayers. In the

case of an individual, estate, or trust, the

highest marginal rate of tax is the highest

marginal rate of tax in effect under section 1, determined without regard to section 1(h).

(2) Corporations and tax-exempt entities. In the case of a corporation or an entity that is exempt from tax under section

501(a), the highest marginal rate of tax is

607

the highest marginal rate of tax in effect

under section 11, determined without regard to any rate that is added to the otherwise applicable rate in order to offset the

effect of the graduated rate schedule.

(B) Other Federal income tax on gain.

The amount of Federal income tax (other

than the tax determined under this paragraph (h)(9)) imposed on any gain is the

lesser of—

(1) The amount by which the taxpayer’s Federal income tax liability (determined without regard to this paragraph

(h)(9)) would be reduced if the amount of

such gain were not taken into account; or

(2) The amount of the gain multiplied

by the highest marginal rate of tax for the

taxable year.

(x) Coordination with other

provisions—(A) In general. The amount

of gain subject to the tax determined

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

by any net operating loss deduction under

section 172(a), any capital loss under section 1212, or any other similar loss or deduction. In addition, the amount of tax

determined under this paragraph (h)(9) is

not reduced by any credit of the taxpayer.

In computing the amount of any net operating loss, capital loss, or other similar

loss or deduction, or any credit that may

be carried to any taxable year, any gain

subject to the tax determined under this

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

this paragraph (h)(9) is not taken into account.

(B) Section 1374. No provision of

paragraph (h)(9)(iv) of this section precludes the application of section 1374 (relating to a tax on certain built-in gains of

S corporations) to any gain with respect to

which an election under this paragraph

(h)(9) is made. In addition, neither paragraph (h)(9)(iv) nor paragraph

(h)(9)(x)(A) of this section precludes a

taxpayer from applying the provisions of

section 1366(f)(2) (relating to treatment

of the tax imposed by section 1374 as a

loss sustained by the S corporation) in determining the amount of tax payable

under paragraph (h)(9) of this section.

amount determined under this paragraph

(h)(9) is treated as a tax imposed by section 1 or 11, as appropriate.

(D) Installment method. The gain subject to the tax determined under paragraph

February 14, 2000

(h)(9)(i) of this section may not be reported under the method described in section 453(a). Any such gain that would,

but for the application of this paragraph

(h)(9)(x)(D), be taken into account under

section 453(a) shall be taken into account

in the same manner as if an election under

section 453(d) (relating to the election not

to apply section 453(a)) had been made.

(xi) Special rules for persons not otherwise subject to Federal income tax. If the

person making the election under this paragraph (h)(9) with respect to a disposition is

not otherwise subject to Federal income

tax, the election statement satisfying the requirements of paragraph (h)(9)(viii) of this

section must be filed with the Philadelphia

Service Center. For purposes of this paragraph (h)(9) and subtitle F, the statement is

treated as an income tax return for the calendar year in which the disposition occurs

and as a return due on or before March 15

of the following year.

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

person acquires a section 197(f)(9) intangible in a transaction described in paragraph (g)(2) of this section from a person

in whose hands the intangible was an

amortizable section 197 intangible, and

immediately after the transaction (or series of transactions described in paragraph

(h)(6)(ii)(B) of this section) in which such

intangible is acquired, the person acquiring the section 197(f)(9) intangible is related to any person described in paragraph

(h)(2) of this section, the intangible is,

notwithstanding its treatment under paragraph (g)(2) of this section, treated as an

amortizable section 197 intangible only to

the extent permitted under this paragraph

(h). (See, for example, paragraph

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

(11) Avoidance purpose. A section

197(f)(9) intangible acquired by a taxpayer after the applicable effective date

does not qualify for amortization under

section 197 if one of the principal purposes of the transaction in which it is acquired is to avoid the operation of the

anti-churning rules of section 197(f)(9)

and this paragraph (h). A transaction will

be presumed to have a principal purpose

of avoidance if it does not effect a significant change in the ownership or use of the

intangible. Thus, for example, if section

197(f)(9) intangibles are acquired in a

transaction (or series of related transac-

February 14, 2000

tions) in which an option to acquire stock

is issued to a party to the transaction, but

the option is not treated as having been

exercised for purposes of paragraph (h)(6)

of this section, this paragraph (h)(11) may

apply to the transaction.

(12) Additional partnership anti-churning rules—(i) In general. In determining

whether the anti-churning rules of this

paragraph (h) apply to any increase in the

basis of a section 197(f)(9) intangible

under section 732(b), 732(d), 734(b), or

743(b), the determinations are made at the

partner level and each partner is treated as

having owned and used the partner’s proportionate share of partnership property.

In determining whether the anti-churning

rules of this paragraph (h) apply to any

transaction under another section of the

Internal Revenue Code, the determinations are made at the partnership level,

unless under §1.701–2(e) the Commissioner determines that the partner level is

more appropriate.

(ii) Section 732(b) adjustments—Reserved.

(iii) Section 732(d) adjustments. The

anti-churning rules of this paragraph (h)

do not apply to an increase in the basis of

partnership property under section 732(d)

if the distributee partner was not related

(at the time of the transfer of the partnership interest) to the person who transferred the partnership interest with respect

to which the distribution is being made.

(iv) Section 734(b) adjustments— Reserved.

(v) Section 743(b) adjustments. The

anti-churning rules of this paragraph (h)

do not apply to an increase in the basis of

partnership property under section 743(b)

if the person acquiring the partnership interest is not related to the person transferring the partnership interest.

(vi) Partner is or becomes a user of

partnership intangible—(A) General

rule. If, as part of a series of related transactions that includes a transaction described in paragraph (h)(12) (iii) or (v) of

this section, an anti-churning partner or a

person related to an anti-churning partner

becomes (or remains) a user of an intangible that is treated as transferred in the

transaction (as a result of the partners

being treated as having owned their proportionate share of partnership assets), the

anti-churning rules of this paragraph (h)

apply to the proportionate share of such

608

intangible that is treated as transferred by

the anti-churning partner, notwithstanding

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

or (v) of this section.

(B) Anti-churning partner. For purposes of this paragraph (h)(12)(vi), antichurning partner means - (1) With respect to all intangibles held by

a partnership on or before August 10, 1993,

any partner, but only to the extent that

(i) The partner’s interest in the partnership was acquired on or before August 10,

1993, or

(ii) The interest was acquired from a

person related to the partner on or after

August 10, 1993, and such interest was

not held by any person other than persons

related to such partner at any time after

August 10, 1993 (disregarding, for this

purpose, a person’s holding of an interest

if the acquisition of such interest was part

of a transaction or series of related transactions in which the partner or persons related to the partner subsequently acquired

such interest),

(2) With respect to any section

197(f)(9) intangible acquired by a partnership after August 10, 1993, that is not

amortizable with respect to the partnership, any partner, but only to the extent

that

(i) The partner’s interest in the partnership was acquired on or before the date

the partnership acquired the section

197(f)(9) intangible, or

(ii) The interest was acquired from a

person related to the partner on or after

the date the partnership acquired the section 197(f)(9) intangible, and such interest was not held by any person other than

persons related to such partner at any time

after the date the partnership acquired the

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

for this purpose, a person’s holding of an

interest if the acquisition of such interest

was part of a transaction or series of related transactions in which the partner or

persons related to the partner subsequently acquired such interest), and

(3) With respect to any intangible, a

partner who received an interest in the

partnership in exchange for such intangible (or a portion thereof) or a related person who received such interest in the partnership from such a partner, but only to

the extent that the intangible (or portion

thereof) transferred by such partner is not

an amortizable section 197 intangible

2000–7 I.R.B.

with respect to the partnership.

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

this section, references to August 10,

1993, are treated as references to July 25,

1991, if the relevant party made a valid

retroactive election under §1.197–1T.

(vii) Section 704(c) allocations—(A)

Allocations where the intangible is amortizable by the contributor. The anti-churning

rules of this paragraph (h) do not apply to

the curative or remedial allocations of

amortization with respect to a section

197(f)(9) intangible if the intangible was an

amortizable section 197 intangible in the

hands of the contributing partner (unless

paragraph (h)(10) of this section applies so

as to cause the intangible to cease to be an

amortizable section 197 intangible in the

hands of the partnership).

(B) Allocations where the intangible is

not amortizable by the contributor.

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

section, where the section 197(f)(9) intangible was not an amortizable section 197

intangible in the hands of the contributing

partner, a partner may not receive remedial

allocations of amortization under section

704(c) that are deductible for Federal income tax purposes if that partner is related

to the partner that contributed the intangible. Taxpayers may use any reasonable

method to determine amortization of the

asset for book purposes, provided that the

method used does not contravene the purposes of the anti-churning rules under section 197 and this paragraph (h). A method

will be considered to contravene the purposes of the anti-churning rules if the effect

of the book adjustments resulting from the

method is such that any portion of the tax

deduction for amortization attributable to

section 704(c) is allocated, directly or indirectly, to a partner who is subject to the

anti-churning rules with respect to such adjustment.

(viii) Operating rule for transfers upon

death. For purposes of this paragraph

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

in a partnership is determined under section 1014(a), such partner is treated as acquiring such interest from a person who is

not related to such partner, and such interest is treated as having previously been

held by a person who is not related to

such partner.

(i) [Reserved]

(j) General anti-abuse rule. The Com-

2000–7 I.R.B.

missioner will interpret and apply the

rules in this section as necessary and appropriate to prevent avoidance of the purposes of section 197. If one of the principal purposes of a transaction is to achieve

a tax result that is inconsistent with the

purposes of section 197, the Commissioner will recast the transaction for Federal tax purposes as appropriate to

achieve tax results that are consistent with

the purposes of section 197, in light of the

applicable statutory and regulatory provisions and the pertinent facts and circumstances.

(k) Examples. The following examples illustrate

the application of this section:

Example 1. Advertising costs. (i) Q manufactures

and sells consumer products through a series of wholesalers and distributors. In order to increase sales of its

products by encouraging consumer loyalty to its products and to enhance the value of the goodwill, trademarks, and trade names of the business, Q advertises

its products to the consuming public. It regularly incurs costs to develop radio, television, and print advertisements. These costs generally consist of employee

costs and amounts paid to independent advertising

agencies. Q also incurs costs to run these advertisements in the various media for which they were developed.

(ii) The advertising costs are not chargeable to capital account under paragraph (f)(3) of this section (relating to costs incurred for covenants not to compete,

rights granted by governmental units, and contracts for

the use of section 197 intangibles) and are currently

deductible as ordinary and necessary expenses under

section 162. Accordingly, under paragraph (a)(3) of

this section, section 197 does not apply to these costs.

Example 2. Computer software. (i) X purchases

all of the assets of an existing trade or business from Y.

One of the assets acquired is all of Y’s rights in certain

computer software previously used by Y under the

terms of a nonexclusive license from the software developer. The software was developed for use by manufacturers to maintain a comprehensive accounting

system, including general and subsidiary ledgers, payroll, accounts receivable and payable, cash receipts

and disbursements, fixed asset accounting, and inventory cost accounting and controls. The developer

modified the software for use by Y at a cost of $1,000

and Y made additional modifications at a cost of $500.

The developer does not maintain wholesale or retail

outlets but markets the software directly to ultimate

users. Y’s license of the software is limited to an entity that is actively engaged in business as a manufacturer.

(ii) Notwithstanding these limitations, the software

is considered to be readily available to the general

public for purposes of paragraph (c)(4)(i) of this section. In addition, the software is not substantially

modified because the cost of the modifications by the

developer and Y to the version of the software that is

readily available to the general public does not exceed

$2,000. Accordingly, the software is not a section 197

intangible.

Example 3. Acquisition of software for internal

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

package-delivery service, purchases from S all rights

609

to software developed by S. The software will be used

by B for the sole purpose of improving its packagetracking operations. B does not purchase any other assets in the transaction or any related transaction.

(ii) Because B acquired the software solely for internal use, it is disregarded in determining for purposes of paragraph (c)(4)(ii) of this section whether

the assets acquired in the transaction or series of related transactions constitute a trade or business or substantial portion thereof. Since no other assets were

acquired, the software is not acquired as part of a purchase of a trade or business and under paragraph

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

Example 4. Governmental rights of fixed duration.

(i) City M operates a municipal water system. In order

to induce X to locate a new manufacturing business in

the city, M grants X the right to purchase water for 16

years at a specified price.

(ii) The right granted by M is a right to receive tangible property or services described in section

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

thus, is not a section 197 intangible. This exclusion

applies even though the right does not qualify for exclusion as a right of fixed duration or amount under

section 197(e)(4)(D) and paragraph (c)(13) of this section because the duration exceeds 15 years and the

right is not fixed as to amount. It is also immaterial

that the right would not qualify for exclusion as a selfcreated intangible under section 197(c)(2) and paragraph (d)(2) of this section because it is granted by a

governmental unit.

Example 5. Separate acquisition of franchise. (i) S

is a franchiser of retail outlets for specialty coffees. G

enters into a franchise agreement (within the meaning

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

permitted to acquire and operate a store using the S

trademark and trade name at the location specified in

the agreement. G agrees to pay S $100,000 upon execution of the agreement and also agrees to pay,

throughout the term of the franchise, additional

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

The agreement contains detailed specifications for the

construction and operation of the business, but G is

not required to purchase from S any of the materials

necessary to construct the improvements at the location specified in the franchise agreement.

(ii) The franchise is a section 197 intangible within

the meaning of paragraph (b)(10) of this section. The

franchise does not qualify for the exclusion relating to

self-created intangibles described in section 197(c)(2)

and paragraph (d)(2) of this section because the franchise is described in section 197(d)(1)(F). In addition,

because the acquisition of the franchise constitutes the

acquisition of an interest in a trade or business or a

substantial portion thereof, the franchise may not be

excluded under section 197(e)(4). Thus, the franchise

is an amortizable section 197 intangible, the basis of

which must be recovered over a 15-year period. However, the amounts that are deductible under section

1253(d)(1)are not subject to the provisions of section

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

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

Example 6. Acquisition and amortization of

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

of a trade or business from C, B and C enter into an

agreement containing a covenant not to compete.

Under this agreement, C agrees that it will not compete with the business acquired by B within a prescribed geographical territory for a period of three

years after the date on which the business is sold to B.

February 14, 2000

In exchange for this agreement, B agrees to pay C

$90,000 per year for each year in the term of the agreement. The agreement further provides that, in the

event of a breach by C of his obligations under the

agreement, B may terminate the agreement, cease

making any of the payments due thereafter, and pursue

any other legal or equitable remedies available under

applicable law. The amounts payable to C under the

agreement are not contingent payments for purposes

of §1.1275–4. The present fair market value of B’s

rights under the agreement is $225,000. The aggregate consideration paid for all assets acquired in the

transaction (including the covenant not to compete)

exceeds the sum of the amount of Class I assets and

the aggregate fair market value of all Class II, Class

III, Class IV, Class V, and Class VI assets by $50,000.

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

in each class.

(ii) Because the covenant is acquired in an applicable asset acquisition (within the meaning of section

1060(c)), paragraph (f)(4)(ii) of this section applies

and the basis of B in the covenant is determined pursuant to section 1060(a) and the regulations thereunder. Under §§1.1060–1T(c)(2) and 1.338–6T(c)(1),

B’s basis in the covenant cannot exceed its fair market

value. Thus, B’s basis in the covenant immediately

after the acquisition is $225,000. This basis is amortized ratably over the 15-year period beginning on the

first day of the month in which the agreement is entered into. Although the payments under the agreement ($270,000) exceed the amount allocated to the

covenant by $45,000, all of the remaining consideration ($50,000) is allocated to Class VII assets (goodwill and going concern value).

See

§§1.1060–1T(c)(2) and 1.338–6T(b).

Example 7. Stand-alone license of technology. (i)

X is a manufacturer of consumer goods that does business throughout the world through subsidiary corporations organized under the laws of each country in

which business is conducted. X licenses to Y, its subsidiary organized and conducting business in Country

K, all of the patents, formulas, designs, and know-how

necessary for Y to manufacture the same products that

X manufactures in the United States. Assume that the

license is not considered a sale or exchange under the

principles of section 1235. The license is for a term of

18 years, and there are no facts to indicate that the license does not have a fixed duration. Y agrees to pay

X a royalty equal to a specified, fixed percentage of

the revenues obtained from selling products manufactured using the licensed technology. Assume that the

royalty is reasonable and is not subject to adjustment

under section 482. The license is not entered into in

connection with any other transaction. Y incurs capitalized costs in connection with entering into the license.

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

197 intangible within the meaning of paragraph

(b)(11) of this section. It does not qualify for the exception in section 197(e)(4)(D) and paragraph (c)(13)

of this section (relating to rights of fixed duration or

amount) because it does not have a term of less than

15 years, and the other exceptions in section 197(e)

and paragraph (c) of this section are also inapplicable.

Accordingly, the license is a section 197 intangible.

(iii) The license is not acquired as part of a purchase of a trade or business. Thus, under paragraph

(f)(3)(iii) of this section, the license will be closely

scrutinized under the principles of section 1235 for

purposes of determining whether the transfer is a sale

February 14, 2000

or exchange and, accordingly, whether the payments

under the license are chargeable to capital account.

Because the license is not a sale or exchange under the

principles of section 1235, the royalty payments are

not chargeable to capital account for purposes section

197. The capitalized costs of entering into the license

are not within the exception under paragraph (d)(2) of

this section for self-created intangibles, and thus are

amortized under section 197.

Example 8. License of technology and trademarks

. (i) The facts are the same as in Example 7, except

that the license also includes the use of the trademarks

and trade names that X uses to manufacture and distribute its products in the United States. Assume that

under the principles of section 1253 the transfer is not

a sale or exchange of the trademarks and trade names

or an undivided interest therein and that the royalty

payments are described in section 1253(d)(1)(B).

(ii) As in Example 7, the license is a section 197 intangible. Although the license conveys an interest in

X’s trademarks and trade names to Y, the transfer of

the interest is disregarded for purposes of paragraph

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

sale or exchange of the trademarks and trade names or

an undivided interest therein. Accordingly, the licensing of the technology and the trademarks and trade

names is not treated as part of a purchase of a trade or

business under paragraph (e)(2) of this section.

(iii) Because the technology license is not part of

the purchase of a trade or business, it is treated in the

manner described in Example 7. The royalty payments for the use of the trademarks and trade names

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

section 197(f)(4)(C) and paragraph (b)(10)(ii) of this

section, are not chargeable to capital account for purposes of section 197. The capitalized costs of entering

into the license are treated in the same manner as in

example 7.

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

same as in Example 7, except that Y agrees to pay X,

in addition to the contingent royalty, a fixed minimum

royalty immediately upon entering into the agreement

and there are sufficient facts present to characterize the

transaction, for federal tax purposes, as a transfer of

ownership of the intellectual property from X to Y.

(ii) The purported license of technology is, in fact,

an acquisition of an intangible described in section

197(d)(1)(C)(iii) and paragraph (b)(5) of this section

(relating to know-how, etc.). As in Example 7, the exceptions in section 197(e) and paragraph (c) of this

section do not apply to the transfer. Accordingly, the

transferred property is a section 197 intangible. Y’s

basis in the transferred intangible includes the capitalized costs of entering into the agreement and the fixed

minimum royalty payment payable at the time of the

transfer. In addition, except to the extent that a portion

of any payment will be treated as interest or original

issue discount under applicable provisions of the Internal Revenue Code, all of the contingent payments

under the purported license are properly chargeable to

capital account for purposes of section 197 and this

section. The extent to which such payments are

treated as payments of principal and the time at which

any amount treated as a payment of principal is taken

into account in determining basis are determined

under the rules of §1.1275–4(c)(4) or 1.483–4(a),

whichever is applicable. Any contingent amount that

is included in basis after the month in which the acquisition occurs is amortized under the rules of paragraph

(f)(2)(i) or (ii) of this section.

610

Example 10. License of technology and customer

list as part of sale of a trade or business. (i) X is a

computer manufacturer that produces, in separate operating divisions, personal computers, servers, and peripheral equipment. In a transaction that is the purchase of a trade or business for purposes of section

197, Y (who is unrelated to X) purchases from X all

assets of the operating division producing personal

computers, except for certain patents that are also used

in the division manufacturing servers and customer

lists that are also used in the division manufacturing

peripheral equipment. As part of the transaction, X

transfers to Y the right to use the retained patents and

customer lists solely in connection with the manufacture and sale of personal computers. The transfer

agreement requires annual royalty payments contingent on the use of the patents and also requires a payment for each use of the customer list. In addition, Y

incurs capitalized costs in connection with entering

into the licenses.

(ii) The rights to use the retained patents and customer lists are contracts for the use of section 197 intangibles within the meaning of paragraph (b)(11) of

this section. The rights do not qualify for the exception in 197(e)(4)(D) and paragraph (c)(13) of this section (relating to rights of fixed duration or amount) because they are transferred as part of a purchase of a

trade or business and the other ex

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