Bulletin No. 1997–13

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Text

March 31, 1997

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

EXCISE TAXES

Rev. Rul. 97–16, page 4.

Low-income housing credit; satisfactory bond; ‘‘bond

factor’’ amounts for the period January through

March 1997. This ruling announces the monthly bond

factor amounts to be used by taxpayers who dispose of

qualified low-income buildings or interests therein during

the period January through March 1997.

Notice 97–22, page 9.

A determination has been made to add diglycidyl ether

of bisphenol-A to the list of taxable substances in

section 4672(a)(3) of the Code.

T.D. 8710, page 4.

Final regulations relate to the consistency rules under

section 338 of the Code that apply to certain cases

involving controlled foreign corporations.

REG–209709–94, page 12.

Proposed regulations under sections 167 and 197 of

the Code relate to the amortization of certain intangible

property. A public hearing will be held on May 15, 1997.

EXEMPT ORGANIZATIONS

Announcement 97–27, page 30.

A list is given of organizations now classified as private

foundations.

Finding Lists begin on page 35.

Announcement of Disbarments and Suspensions begins on page 33.

ADMINISTRATIVE

Rev. Proc. 97–22, page 9.

Books and records; electronic storage; imaging. Guidance is provided for taxpayers that use an electronic

storage system (such as an imaging system) to maintain

books and records for purposes of section 6001 of the

Code.

Page 32.

Scenarios of disciplinary actions. The Office of Director of Practice sets forth scenarios of disciplinary

actions involving individuals who represent taxpayers

before the Internal Revenue Service. The Service invites

comments.

Mission of the Service

The purpose of the Internal Revenue Service is to

collect the proper amount of tax revenue at the least

cost; serve the public by continually improving the

quality of our products and services; and perform in a

manner warranting the highest degree of public

confidence in our integrity, efficiency and fairness.

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying

and administering the law in a reasonable,

practical manner. Issues should only be raised by

examining of ficers when they have merit, never

arbitrarily or for trading purposes. At the same

time, the examining officer should never hesitate

to raise a meritorious issue. It is also important

that care be exercised not to raise an issue or to

ask a court to adopt a position inconsistent with

an established Service position.

The function of the Internal Revenue Service is to

administer the Internal Revenue Code. Tax policy

for raising revenue is determined by Congress.

With this in mind, it is the duty of the Service to

carry out that policy by correctly applying the laws

enacted by Congress; to determine the reasonable

meaning of various Code provisions in light of the

Congressional purpose in enacting them; and to

perform this work in a fair and impartial manner,

with neither a government nor a taxpayer point of view.

Administration should be both reasonable and

vigorous. It should be conducted with as little

delay as possible and with great cour tesy and

considerateness. It should never try to overreach,

and should be reasonable within the bounds of law

and sound administration. It should, however, be

vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax

devices and fraud.

At the heart of administration is interpretation of the

Code. It is the responsibility of each person in the

Service, charged with the duty of interpreting the

law, to try to find the true meaning of the statutory

provision and not to adopt a strained construction in

the belief that he or she is ‘‘protecting the revenue.’’

The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

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 of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold on a

single-copy basis.

court decisions, rulings, and procedures 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.

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.

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).

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.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in

this part, none of these announcements are consolidated in the Cumulative Bulletins.

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,

The first Bulletin for each month includes an index for

the matters published during the preceding month.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin

of the succeeding quarterly and semi-annual 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, D.C. 20402.

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

Section 42.—Low-Income Housing

Credit

Rev. Rul. 97–16

Low-income housing credit; satisfactory bond; ‘‘bond factor’’ amount

for the period January through

March 1997. This ruling announces the

monthly bond factor amounts to be used

by taxpayers who dispose of qualified

low-income buildings or interests therein

during the period January through

March 1997.

In Rev. Rul. 90–60, 1990–2 C.B. 3,

the Internal Revenue Service provided

guidance to taxpayers concerning the

general methodology used by the Treasury Department in computing the bond

factor amounts used in calculating the

amount of bond considered satisfactory

by the Secretary under § 42(j)(6) of the

Internal Revenue Code. It further announced that the Secretary would pub-

lish in the Internal Revenue Bulletin a

table of ‘‘bond factor’’ amounts for

dispositions occurring during each calendar month.

This revenue ruling provides in Table

1 the bond factor amounts for calculating the amount of bond considered

satisfactory under § 42(j)(6) for dispositions of qualified low-income buildings

or interests therein during the period

January through March 1997.

Table 1

Rev. Rul. 97–16

Monthly Bond Factor Amounts for Dispositions Expressed

As a Percentage of Total Credits

Calendar Year Building Placed in Service

or, if Section 42(f)(1) Election Was Made,

the Succeeding Calendar Year

Month of

Disposition

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

Jan ’97

Feb ’97

Mar ’97

79.70

79.46

79.23

82.08

81.83

81.59

84.67

84.41

84.15

87.70

87.43

87.16

91.25

90.96

90.67

95.32

95.00

94.69

99.53

99.17

98.83

103.58

103.18

102.81

107.56

107.11

106.69

111.85

111.28

110.79

112.52

For a list of bond factor amounts

applicable to dispositions occurring during other calendar years, see the following revenue rulings: Rev. Rul. 90–60,

1990–2 C.B. 3, for dispositions occurring during calendar years 1987, 1988,

and 1989; Rev. Rul. 90–88, 1990–2 C.B.

7, for dispositions occurring during calendar year 1990; Rev. Rul. 91–67,

1991–2 C.B. 13, for dispositions occurring during calendar year 1991; Rev.

Rul. 92–101, 1992–2 C.B. 9, for dispositions occurring during calendar year

1992; Rev. Rul 93–83, 1993–2 C.B. 6,

for dispositions occurring during calendar year 1993; Rev. Rul. 94–71, 1994–2

C.B. 4, for dispositions occurring during

calendar year 1994; Rev. Rul. 95–83,

1995–2 C.B. 8, for dispositions occurring during calendar year 1995; Rev.

Rul. 96–16, 1996–1 C.B. 3, for dispositions occurring during the period January through March 1996; Rev. Rul.

96–33, 1996–27 I.R.B. 4, for dispositions occurring during the period April

through June 1996; Rev. Rul. 96–45,

1996–39 I.R.B. 5, for dispositions occurring during the period July through

September 1996; and Rev. Rul. 96–59,

1996–50 I.R.B. 4, for dispositions occurring during the period October

through December 1996.

DRAFTING INFORMATION

The principal author of this revenue

ruling is Jack Malgeri of the Office of

Assistant Chief Counsel (Passthroughs

and Special Industries). For further information regarding this revenue ruling,

contact Mr. Malgeri at (202) 622–3040

(not a toll-free call).

Section 338.—Certain Stock

Purchase Treated as Asset

Acquisitions

26 CFR 1.338–4: Asset and stock consistency.

T.D. 8710

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

Revisions of the Section 338

Consistency Rules With Respect to

Target Affiliates That Are Controlled

Foreign Corporations

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations relating to the consis-

tency rules under section 338 of the

Internal Revenue Code of 1986 that are

applicable to certain cases involving

controlled foreign corporations. The final regulations substantially revise and

simplify the stock and asset consistency

rules. The final regulations include the

provisions of the consistency rules applicable to controlled foreign corporations contained in recent proposed and

temporary regulations. The final regulations would affect taxpayers that own

controlled foreign corporations.

EFFECTIVE DATE: These regulations

are effective January 20, 1997.

FOR FURTHER INFORMATION CONTACT: Kenneth D. Allison at (202)

622–3860 (not a toll-free number).

SUPPLEMENTARY

INFORMATION:

Background

This document contains final Income

Tax Regulations (26 CFR part 1) under

section 338 of the Internal Revenue

Code.

On January 20, 1994, temporary regulations (T.D. 8516) were published in

the Federal Register (59 FR 2956)

under section 338 of the Internal Rev-

enue Code. See 1994–1 C.B. 119. A

notice of proposed rulemaking (INTL–

0177–90) cross-referencing the temporary regulations was published in the

Federal Register for the same day (59

FR 3045). See 1994–1 C.B. 818. The

temporary regulations provided rules to

replace the asset and stock consistency

rules of §§ 1.338–4T and 1.338–5T.

The temporary regulations included consistency rules applicable to certain cases

involving controlled foreign corporations

(CFCs).

No written comments responding to

the notice were received. No public

hearing was requested or held. The

proposed regulations under section 338

are adopted as revised by this Treasury

decision, and the corresponding temporary regulations are removed.

Explanation of Provisions

The preamble to the temporary and

proposed regulations (1994–1 C.B. 119)

contains a discussion of the provisions.

Changes to the temporary and proposed

regulations are noted below.

Section 1.338–4T(h)(3) of the temporary regulations is clarified by stating

that the basis of the stock of a controlled foreign corporate target affiliate

is not increased by section 1248 earnings attributable to the disposition of an

asset in which a carryover basis is taken

under this section.

Section 1.338–4T(h)(4) of the temporary regulations addresses a situation in

which the income or gain from the

disposition of a controlled foreign corporation target affiliate (CFC T affiliate)

asset is not subject to the consistency

rules of paragraph (h)(2). The regulation

states that if a CFC T affiliate pays a

dividend to a target (T) or a domestic T

affiliate wholly or partially out of the

earnings generated by the disposition of

that asset, and the dividend increases the

basis of the T stock under § 1.1502–32,

then the basis of the stock of the CFC T

affiliate is reduced by the amount of the

dividend that was paid from the earnings and profits resulting from the asset

disposition. This rule applies to any

actual dividend, amount treated as a

dividend under section 1248 (or that

would have been so treated but for

section 1291) or amount included in

income under section 951(a)(1)(B).

The final regulations retain this rule.

The final regulations also add a special

ordering rule, in § 1.338–4(h)(4)(ii),

clarifying that any such dividend is first

considered attributable to earnings and

profits resulting from the disposition of

the asset.

Section 1.338–4(h)(4)(ii) is clarified

to state that the basis of the stock of a

controlled foreign corporation may not

be reduced below zero under the carryover basis rules of § 1.338–4.

Section 1.338–4(h)(2)(iv)(A) and

§ 1.338–4(h)(4)(iii)(A) are added to allow the purchasing group in certain

instances to increase the basis of the

CFC T stock by the amount of either the

basis increase denied under § 1.338–

4(h)(2)(ii) or the basis reduction required under § 1.338–4(h)(4)(ii). The

rule applies when the purchasing group

disposes of an asset acquired from CFC

T that is subject to the consistency rules

to an unrelated party in a taxable transaction and includes in U.S. gross income the greater of (i) the income or

gain equal to the basis amount denied to

the asset under either § 1.338–4(h)(2)(i)

or § 1.338–4(g) and § 1.338–4(h)(4)(i),

respectively, or (ii) the gain recognized

on the asset.

Similarly, § 1.338–4(h)(2)(iv)(B) and

§ 1.338–4(h)(4)(iii)(B) are added to allow the purchasing group to increase the

basis of an asset acquired from CFC T

that is subject to the consistency rules

by the basis amount denied to the asset

under either § 1.338–4(h)(2)(i) or

§ 1.338–4(g) and § 1.338–4(h)(4)(i).

The rule applies when the purchasing

group disposes of the stock of CFC T to

an unrelated party in a taxable transaction and includes in U.S. gross income

the greater of (i) the gain equal to the

basis increase denied under § 1.338–

4(h)(2)(ii) or the basis reduction required under § 1.338–4(h)(4)(ii), respectively, or (ii) the gain recognized in the

stock.

Special Analyses

It has been determined that this final

regulation is not a significant regulatory

action as defined in EO 12866. Therefore, a regulatory assessment is not

required. It also has been determined

that section 553(b) of the Administrative

Procedure Act (5 U.S.C. chapter 5) does

not apply to these regulations, and because the notice of proposed rulemaking

preceding the regulations was issued

prior to March 29, 1996 the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does

not apply. Therefore, a regulatory flexibility analysis is not required. Pursuant

to section 7805(f) of the Internal Revenue Code, the notice of proposed

rulemaking preceding these regulations

was submitted to the Small Business

Administration for comment on its impact on small businesses.

Drafting Information

The principal author of these regulations is Kenneth D. Allison of the Office

of Associate Chief Counsel (International), IRS. However, other personnel

from the IRS and Treasury Department

participated in their development.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is

amended as follows: PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by removing the entry

for Section 1.338–4T(h) to read as follows:

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

Par. 2. In § 1.338–0, the outline of

topics is amended by revising the entry

for § 1.338–4(h) and removing the entry

for § 1.338–4T to read as follows:

§ 1.338–0 Outline of topics.

§ 1.338–4 Asset and stock consistency.

(h) Consistency for target affiliates

that are controlled foreign corporations.

(1) In general.

(2) Income or gain resulting from

asset dispositions.

(i) General rule.

(ii) Basis of controlled foreign corporation stock.

(iii) Operating rule.

(iv) Increase in asset or stock basis.

(3) Stock issued by target affiliate

that is a controlled foreign corporation.

(4) Certain distributions.

(i) General rule.

(ii) Basis of controlled foreign corporation stock.

(iii) Increase in asset or stock basis.

(5) Examples.

Par. 3. Section 1.338–4 is amended as

follows:

1. Paragraph (a)(5) is amended by

removing the language ‘‘Section 1.338–

4T(h)’’ and adding ‘‘Paragraph (h) of

this section’’ in its place.

2. Paragraph (c)(4) is amended by

removing the language ‘‘§ 1.338–

4T(h)(2)’’ and adding ‘‘paragraph (h)(2)

of this section’’ in its place.

3. Paragraph (d)(2)(iii) is amended by

removing the language ‘‘§ 1.338–

4T(h)(3)’’ and adding ‘‘paragraph (h)(3)

of this section’’ in its place.

4. Paragraph (g)(2) is amended by

removing the language ‘‘§ 1.338–

4T(h)(4)’’ and adding ‘‘paragraph (h)(4)

of this section’’ in its place.

5. Paragraph (h) is revised.

6. Paragraph (j)(3)9i)(A)(2) is

amended by removing the language

‘‘§ 1.338–4T(h)’’ and adding ‘‘paragraph (h) of this section’’ in its place.

The revision reads as follows:

§ 1.338–4 Asset and stock consistency.

(h) Consistency for target affiliates

that are controlled foreign corporations—(1) In general. This paragraph

(h) applies only if target is a domestic

corporation. For additional rules that

may apply with respect to controlled

foreign corporations, see paragraph (g)

of this section. The definitions and nomenclature of § 1.338–1(b) and (c) and

paragraph (e) of this section apply for

purposes of this section.

(2) Income or gain resulting from

asset dispositions—(i) General rule. Income or gain of a target affiliate that is

a controlled foreign corporation from

the disposition of an asset is not reflected in the basis of target stock under

paragraph (c) of this section unless the

income or gain results in an inclusion

under section 951(a)(1)(A), 951(a)(1)(C), 1291 or 1293.

(ii) Basis of controlled foreign corporation stock. If, by reason of paragraph

(h)(2)(i) of this section, the carryover

basis rules of this section apply to an

asset, no increase in basis in the stock

of a controlled foreign corporation under

section 961(a) or 1293(d)(1), or under

regulations issued pursuant to section

1297(b)(5), is allowed to target or a

target affiliate to the extent the increase

is attributable to income or gain described in paragraph (h)(2)(i) of this

section. A similar rule applies to the

basis of any property by reason of

which the stock of the controlled foreign

corporation is considered owned under

section 958(a)(2) or 1297(a).

(iii) Operating rule. For purposes of

this paragraph (h)(2)—

(A) If there is an income inclusion

under section 951 (a)(1)(A) or (C), the

shareholder’s income inclusion is first

attributed to the income or gain of the

controlled foreign corporation from the

disposition of the asset to the extent of

the shareholder’s pro rata share of such

income or gain; and

(B) Any income or gain under section 1293 is first attributed to the income or gain from the disposition of the

asset to the extent of the shareholder’s

pro rata share of the income or gain.

(iv) Increase in asset or stock basis—

(A) If the carryover basis rules under

paragraph (h)(2)(i) of this section apply

to an asset, and the purchasing corporation disposes of the asset to an unrelated

party in a taxable transaction and recognizes and includes in its U.S. gross

income or the U.S. gross income of its

shareholders the greater of the income

or gain from the disposition of the asset

by the selling controlled foreign corporation that was reflected in the basis of

the target stock under paragraph (c) of

this section, or the gain recognized on

the asset by the purchasing corporation

on the disposition of the asset, then the

purchasing corporation or the target or a

target affiliate, as appropriate, shall increase the basis of the selling controlled

foreign corporation stock subject to

paragraph (h)(2)(ii) of this section, as of

the date of the disposition of the asset

by the purchasing corporation, by the

amount of the basis increase that was

denied under paragraph (h)(2)(ii) of this

section. The preceding sentence shall

apply only to the extent that the controlled foreign corporation stock is

owned (within the meaning of section

958(a)) by a member of the purchasing

corporation’s affiliated group.

(B) If the carryover basis rules under

paragraph (h)(2)(i) of this section apply

to an asset, and the purchasing corporation or the target or a target affiliate, as

appropriate, disposes of the stock of the

selling controlled foreign corporation to

an unrelated party in a taxable transaction and recognizes and includes in its

U.S. gross income or the U.S. gross

income of its shareholders the greater of

the gain equal to the basis increase that

was denied under paragraph (h)(2)(ii) of

this section, or the gain recognized in

the stock by the purchasing corporation

or by the target or a target affiliate, as

appropriate, on the disposition of the

stock, then the purchasing corporation

shall increase the basis of the asset, as

of the date of the disposition of the

stock of the selling controlled foreign

corporation by the purchasing corporation or by the target or a target affiliate,

as appropriate, by the amount of the

basis increase that was denied pursuant

to paragraph (h)(2)(i) of this section.

The preceding sentence shall apply only

to the extent that the asset is owned

(within the meaning of section 958(a))

by a member of the purchasing corporation’s affiliated group.

(3) Stock issued by target affiliate

that is a controlled foreign corporation.

The exception to the carryover basis

rules of this section provided in paragraph (d)(2)(iii) of this section does not

apply to stock issued by a target affiliate

that is a controlled foreign corporation.

After applying the carryover basis rules

of this section to the stock, the basis in

the stock is increased by the amount

treated as a dividend under section 1248

on the disposition of the stock (or that

would have been so treated but for

section 1291), except to the extent the

basis increase is attributable to the disposition of an asset in which a carryover

basis is taken under this section.

(4) Certain distributions—(i) General

rule. In the case of a target affiliate that

is a controlled foreign corporation, paragraph (g) of this section applies with

respect to the target affiliate by treating

any reference to a dividend to which

section 243(a)(3) applies as a reference

to any amount taken into account under

§ 1.1502–32 in determining the basis of

target stock that is—

(A) A dividend;

(B) An amount treated as a dividend

under section 1248 (or that would have

been so treated but for section 1291); or

under section 951(a)(1)(B).

(ii) Basis of controlled foreign corporation stock. If the carryover basis rules

of this section apply to an asset, the

basis in the stock of the controlled

foreign corporation (or any property by

reason of which the stock is considered

owned under section 958(a)(2)) is reduced (but not below zero) by the sum

of any amounts that are treated, solely

by reason of the disposition of the asset,

as a dividend, amount treated as a

dividend under section 1248 (or that

would have been so treated but for

section 1291), or amount included in

income under section 951(a)(1)(B). For

this purpose, any dividend, amount

treated as a dividend under section 1248

(or that would have been so treated but

for section 1291), or amount included in

income under section 951(a)(1)(B) is

considered attributable first to earnings

and profits resulting from the disposition

of the asset.

(iii) Increase in asset or stock basis—(A) If the carryover basis rules

under paragraphs (g) and (h)(4)(i) of

this section apply to an asset, and the

purchasing corporation disposes of the

asset to an unrelated party in a taxable

transaction and recognizes and includes

in its U.S. gross income or the U.S.

gross income of its shareholders the

greater of the gain equal to the basis

increase denied in the asset pursuant to

paragraphs (g) and (h)(4)(i) of this section, or the gain recognized on the asset

by the purchasing corporation on the

disposition of the asset, then the purchasing corporation or the target or a

target affiliate, as appropriate, shall increase the basis of the selling controlled

foreign corporation stock subject to

paragraph (h)(4)(ii) of this section, as of

the date of the disposition of the asset

by the purchasing corporation, by the

amount of the basis reduction under

paragraph (h)(4)(ii) of this section. The

preceding sentence shall apply only to

the extent that the controlled foreign

corporation stock is owned (within the

meaning of section 958(a)) by a member

of the purchasing corporation’s affiliated

group.

(B) If the carryover basis rules under

paragraphs (g) and (h)(4)(i) of this section apply to an asset, and the purchasing corporation or the target or a target

affiliate, as appropriate, disposes of the

stock of the selling controlled foreign

corporation to an unrelated party in a

taxable transaction and recognizes and

includes in its U.S. gross income or the

U.S. gross income of its shareholders

the greater of the amount of the basis

reduction under paragraph (h)(4)(ii) of

this section, or the gain recognized in

the stock by the purchasing corporation

or by the target or a target affiliate, as

appropriate, on the disposition of the

stock, then the purchasing corporation

shall increase the basis of the asset, as

of the date of the disposition of the

stock of the selling controlled foreign

corporation by the purchasing corporation or by the target or a target affiliate,

as appropriate, by the amount of the

basis increase that was denied pursuant

to paragraphs (g) and (h)(4)(i) of this

section. The preceding sentence shall

apply only to the extent that the asset is

owned (within the meaning of section

958(a)) by a member of the purchasing

corporation’s affiliated group.

(5) Examples. This paragraph (h) may

be illustrated by the following examples:

Example 1. Stock of target affiliate that is a

CFC. (a) The S group files a consolidated return;

however, T2 is a controlled foreign corporation.

On December 1 of Year 1, T1 sells the T2 stock to

P and recognizes gain. On January 2 of Year 2, P

makes a qualified stock purchase of T from S. No

section 338 election is made for T.

(b) Under paragraph (b)(1) of this section,

paragraph (d) of this section applies to the T2

stock. Under paragraph (h)(3) of this section,

paragraph (d)(2)(iii) of this section does not apply

to the T2 stock. Consequently, paragraph (d)(1) of

this section applies to the T2 stock. However, after

applying paragraph (d)(1) of this section, P’s basis

in the T2 stock is increased by the amount of T1’s

gain on the sale of the T2 stock that is treated as a

dividend under section 1248. Because P has a

carryover basis in the T2 stock, the T2 stock is not

considered purchased within the meaning of section 338(h)(3) and no section 338 election may be

made for T2.

Example 2. Stock of target affiliate CFC; inclusion under subpart F. (a) The S group files a

consolidated return; however, T2 is a controlled

foreign corporation. On December 1 of Year 1, T2

sells an asset to P and recognizes subpart F

income that results in an inclusion in T1’s gross

income under section 951(a)(1)(A). On January 2

of Year 2, P makes a qualified stock purchase of T

from S. No section 338 election is made for T.

(b) Because gain from the disposition of the

asset results in an inclusion under section

951(a)(1)(A), the gain is reflected in the basis of

the T stock as of T’s acquisition date. See

paragraph (h)(2)(i) of this section. Consequently,

under paragraph (b)(1) of this section, paragraph

(d)(1) of this section applies to the asset. In

addition, under paragraph (h)(2)(ii) of this section,

T1’s basis in the T2 stock is not increased under

section 961(a) by the amount of the inclusion that

is attributable to the sale of the asset.

purchase of T, P acquires the T2 stock from T1 on

January 1 of Year 2, the results are the same for

the asset sold by T2. In addition, under paragraph

(h)(2)(ii) of this section, T1’s basis in the T2 stock

is not increased by the amount of the inclusion

that is attributable to the gain on the sale of the

asset. Further, under paragraph (h)(3) of this

section, paragraph (d)(1) of this section applies to

the T2 stock. However, after applying paragraph

(d)(1) of this section, P’s basis in the T2 stock is

increased by the amount of T1’s gain on the sale

of the T2 stock that is treated as a dividend under

section 1248. Finally, because P has a carryover

basis in the T2 stock, the T2 stock is not

considered purchased within the meaning of section 338(h)(3) and no section 338 election may be

made for T2.

(d) If P makes a qualified stock purchase of T2

from T1, rather than of T from S, and T1’s gain

on the sale of T2 is treated as a dividend under

section 1248, under paragraph (h)(1) of this section, paragraphs (h)(2) and (3) of this section do

not apply because there is no target that is a

domestic corporation. Consequently, the carryover

basis rules of paragraph do not apply to the asset

sold by T2 or the T2 stock.

Example 3. Gain reflected by reason of section

1248 dividend; gain from non-subpart F asset. (a)

The S group files a consolidated return; however,

T2 is a controlled foreign corporation. In Years 1

through 4, T2 does not pay any dividends to T1

and no amount is included in T1’s income under

section 951(a)(1)(B). On December 1 of Year 4,

T2 sells an asset with a basis of $400,000 to P for

$900,000. T2’s gain of $500,000 is not subpart F

income. On December 15 of Year 4, T1 sells T2,

in which it has a basis of $600,000, to P for

$1,600,000. Under section 1248, $800,000 of T1’s

gain of $1,000,000 is treated as a dividend.

However, in the absence of the sale of the asset by

T2 to P, only $300,000 would have been treated as

a dividend under section 1248. On December 30

of Year 4, P makes a qualified stock purchase of

T1 from T. No section 338 election is made for

T1. (b) Under paragraph (h)(4) of this section,

paragraph (g)(2) of this section applies by reference to the amount treated as a dividend under

section 1248 on the disposition of the T2 stock.

Because the amount treated as a dividend is taken

into account in determining T’s basis in the T1

stock under § 1.1502–32, the sale of the T2 stock

and the deemed dividend have the effect of a

transaction described in paragraph (g)(1) of this

section. Consequently, paragraph (d)(1) of this

section applies to the asset sold by T2 to P and P’s

basis in the asset is $400,000 as of December 1 of

Year 4.

and P’s basis in the T2 stock is $600,000 as of

December 15 of Year 4. Under paragraphs (h)(3)

and (4)(ii) of this section, however, P’s basis in

the T2 stock is increased by $300,000 (the amount

of T1’s gain treated as a dividend under section

1248 ($800,000), other than the amount treated as

a dividend solely as a result of the sale of the

asset by T2 to P ($500,000)) to $900,000.

§ 1.338–4T [Removed]

Par. 4. Section 1.338–4T is removed.

Par. 5. In § 1.338(i)–1, paragraphs (a)

and (b) are revised to read as follows:

§ 1.338(i)–1 Effective dates.

(a) In general. Sections 1.338–1

through 1.338–5 (except § 1.338–4(h)),

1.338(b)–1, and 1.338(h)(10)–1 generally are applicable for targets with acquisition dates on or after January 20,

1994. Section 1.338–4(h) is applicable

for targets with acquisition dates on or

after January 20, 1997. Section 1.338–

4T(h) (as contained in 26 CFR part 1 as

revised April 1, 1996) is generally applicable for targets with acquisition dates

on or after January 20, 1994, and before

January 20, 1997.

(b) Elective retroactive application. A

target with an acquisition date on or

after January 14, 1992 and before January 20, 1994 may apply §§ 1.338–1

through 1.338–5, 1.338–4T(h) (as contained in 26 CFR part 1 as revised April

1, 1996), 1.338(b)–1, and 1.338(h)(10)–1 by including a statement with its

return (including a timely filed amended

return) for the period that includes the

acquisition date to the effect that it is

applying all of these sections pursuant

to this paragraph (b). A target with an

acquisition date on or after January 14,

1992, and before January 20, 1997, may

choose to apply § 1.338–4(h) for the

period that includes the acquisition date

pursuant to paragraph (b) of this section.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved January 13, 1997.

Donald C. Lubick,

Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on

January 22, 1997, 8:45 a.m., and published in the

issue of the Federal Register for January 23, 1997,

62 F.R. 3458)

Part III. Administrative, Procedural, and Miscellaneous

Tax on Certain Imported

Substances; Notice of

Determination

Notice 97–22

This notice announces a determination, under Notice 89–61, 1989–1 C.B.

717, that the list of taxable substances in

§ 4672(a)(3) will be modified to include

diglycidyl ether of bisphenol-A. This

modification is effective April 1, 1992.

Background

Under § 4672(a), an importer or exporter of any substance may request that

the Secretary determine whether that

substance should be listed as a taxable

substance. The Secretary shall add the

substance to the list of taxable substances in § 4672(a)(3) if the Secretary

determines that taxable chemicals constitute more than 50 percent of the

weight, or more than 50 percent of the

value, of the materials used to produce

the substance. This determination is to

be made on the basis of the predominant

method of production. Notice 89–61 sets

forth the rules relating to the determination process.

Determination

On February 24, 1997, the Secretary

determined that diglycidyl ether of

bisphenol-A should be added to the list

of taxable substances in § 4672(a)(3),

effective April 1, 1992.

The rate of tax prescribed for

diglycidyl ether of bisphenol-A, under

§ 4671(b)(3), is $7.08 per ton. This is

based upon a conversion factor for benzene of 0.459, a conversion factor for

propylene of 0.494, a conversion factor

for chlorine of 0.833, and a conversion

factor for sodium hydroxide of 0.705.

The petitioner is Dow Chemical Company, a manufacturer and exporter of

this substance. No material comments

were received on this petition. The following information is the basis for the

determination.

HTS number: 3907.3

CAS number: 025085–99–8

Diglycidyl ether of bisphenol-A

(DGEBA) is derived from the taxable

chemicals benzene, propylene, chlorine,

and sodium hydroxide and produced

predominantly from epichlorohydrin and

bisphenol-A via a two-step reaction.

The stoichiometric material consumption formula for this substance is:

2 C6H6 (benzene) + 4 C3H6 (propylene) + 4 Cl2

(chlorine) + 6 NaOH (sodium hydroxide) + 2 O22

(oxygen)

-----.

(CH 3 ) 2 C(C 6 H 4 OC 3 H 5 0) 2

(DGEBA) + CH3COCH3 (acetone) + 2 HCl

(hydrogen chloride) + 6 NaCl (sodium chloride) +

5 H2O (water)

Diglycidyl ether of bisphenol-A has

been determined to be a taxable substance because a review of its

stoichiometric material consumption formula shows that, based on the predominant method of production, taxable

chemicals constitute 92.95 percent by

weight of the materials used in its

production.

The principal author of this notice is

Ruth Hoffman, Office of Assistant Chief

Counsel (Passthroughs and Special Industries). For further information regarding this notice contact Ruth Hoffman on

(202) 622–3130 (not a toll-free number).

except for farmers and wage-earners,

any person subject to income tax, or any

person required to file a return of information with respect to income, must

keep such books and records, including

inventories, as are sufficient to establish

the amount of gross income, deductions,

credits, or other matters required to be

shown by that person in any return of

such tax or information.

.03 Section 1.6001–1(e) provides that

the books or records required by § 6001

must be kept available at all times for

inspection by authorized internal revenue officers or employees, and must be

retained so long as the contents thereof

may become material in the administration of any internal revenue law.

SECTION 3. SCOPE

26 CFR 601.105 Examination of returns and

claims for refund, credits or abatement; determination of correct tax liability.

(Also Part I, Section 6001; 1.6001–1.)

Rev. Proc. 97–22

SECTION 1. PURPOSE

This revenue procedure provides

guidance to taxpayers that maintain

books and records by using an electronic storage system that either images

their hardcopy (paper) books and

records, or transfers their computerized

books and records, to an electronic

storage media, such as an optical disk.

Records maintained in an electronic

storage system that complies with the

requirements of this revenue procedure

will constitute records within the meaning of § 6001 of the Internal Revenue

Code.

SECTION 2. BACKGROUND

.01 Section 6001 provides that every

person liable for any tax imposed by the

Code, or for the collection thereof, must

keep such records, render such statements, make such returns, and comply

with such rules and regulations as the

Secretary may from time to time prescribe. Whenever necessary, the Secretary may require any person, by notice

served upon that person or by regulations, to make such returns, render such

statements, or keep such records, as the

Secretary deems sufficient to show

whether or not that person is liable for

tax.

.02 Section 1.6001–1(a) of the Income Tax Regulations provides that,

.01 This revenue procedure applies to

taxpayers who maintain books and

records using an ‘‘electronic storage

system.’’ An electronic storage system is

a system to prepare, record, transfer,

index, store, preserve, retrieve, and reproduce books and records by either:

(1) electronically imaging hardcopy

documents to an electronic storage media; or

(2) transferring

computerized

books and records to an electronic storage media using a technique such as

‘‘COLD’’ (computer output to laser

disk), which allows books and records

to be viewed or reproduced without the

use of the original program.

.02 The requirements of this revenue

procedure pertain to all matters under

the jurisdiction of the Commissioner of

Internal Revenue including, but not limited to, income, excise, employment,

and estate and gift taxes, as well as

employee plans and exempt organizations.

.03 A taxpayer’s use of a third party

(such as a service bureau or timesharing service) to provide the taxpayer

with an electronic storage system for its

books and records does not relieve the

taxpayer of the responsibilities described

in this revenue procedure.

.04 Except as otherwise provided in

this revenue procedure, all requirements

of § 6001 that apply to hardcopy books

and records apply as well to books and

records that are stored electronically

pursuant to this revenue procedure.

SECTION 4. ELECTRONIC

STORAGE SYSTEM

REQUIREMENTS

.01 General Requirements.

(1) An electronic storage system

must ensure an accurate and complete

transfer of the hardcopy or computerized

books and records to an electronic storage media. The electronic storage system must also index, store, preserve,

retrieve, and reproduce the electronically

stored books and records.

(2) An electronic storage system

must include:

(a) reasonable controls to ensure

the integrity, accuracy, and reliability of

the electronic storage system;

(b) reasonable controls to prevent and detect the unauthorized creation of, addition to, alteration of, deletion of, or deterioration of electronically

stored books and records;

evaluations of the electronic storage system including periodic checks of electronically stored books and records;

(d) a retrieval system that includes an indexing system (within the

meaning of section 4.02 of this revenue

procedure); and

(e) the ability to reproduce legible and readable hardcopies (within the

meaning of section 4.01(3) of this revenue procedure) of electronically stored

books and records.

(3) All books and records reproduced by the electronic storage system

must exhibit a high degree of legibility

and readability when displayed on a

video display terminal and when reproduced in hardcopy. The term ‘‘legibility’’ means the observer must be able to

identify all letters and numerals positively and quickly to the exclusion of all

other letters or numerals. The term

‘‘readability’’ means that the observer

must be able to recognize a group of

letters or numerals as words or complete

numbers. The taxpayer must ensure that

the reproduction process maintains the

legibility and readability of the electronically stored document.

(4) The information maintained in

an electronic storage system must provide support for the taxpayer’s books

and records (including books and

records in an automated data processing

system). For example, the information

maintained in an electronic storage system and the taxpayer’s books and

records must be cross-referenced in a

manner that provides an audit trail between the general ledger and the source

document(s).

(5) For each electronic storage system used, the taxpayer must maintain,

and make available to the Service upon

request, complete descriptions of:

(a) the electronic storage system,

including all procedures relating to its

use; and

(b) the indexing system (see section 4.02 of this revenue procedure).

(6) At the time of an examination,

or for the tests described in section 5 of

this revenue procedure, the taxpayer

must:

(a) retrieve and reproduce (including hardcopies if requested) electronically stored books and records; and

(b) provide the Service with the

resources (e.g., appropriate hardware

and software, personnel, documentation,

etc.) necessary to locate, retrieve, read,

and reproduce (including hardcopies)

any electronically stored books and

records.

(7) An electronic storage system

must not be subject, in whole or in part,

to any agreement (such as a contract or

license) that would limit or restrict the

Service’s access to and use of the

electronic storage system on the taxpayer’s premises (or any other place where

the electronic storage system is maintained), including personnel, hardware,

software, files, indexes, and software

documentation.

(8) The taxpayer must retain electronically stored books and records so

long as their contents may become material in the administration of the Internal Revenue laws under § 1.6001–1(e).

(9) The taxpayer may use more

than one electronic storage system. In

that event, each electronic storage system must meet the requirements of this

revenue procedure. Electronically stored

books and records that are contained in

an electronic storage system with respect to which the taxpayer ceases to

maintain the hardware and the software

necessary to satisfy the conditions of

this revenue procedure will be deemed

destroyed by the taxpayer, unless the

electronically stored books and records

remain available to the Service in conformity with this revenue procedure.

(10) Taxpayers may use reasonable

data compression or formatting technologies as part of their electronic storage system so long as the requirements

of this revenue procedure are satisfied.

.02 Requirements of an Indexing System.

(1) For purposes of this revenue

procedure, an ‘‘indexing system’’ is a

system that permits the identification

and retrieval for viewing or reproducing

of relevant books and records maintained in an electronic storage system.

For example, an indexing system might

consist of assigning each electronically

stored document a unique identification

number and maintaining a separate database that contains descriptions of all

electronically stored books and records

along with their identification numbers.

In addition, any system used to maintain, organize, or coordinate multiple

electronic storage systems is treated as

an indexing system under this revenue

procedure. The requirement to maintain

an indexing system will be satisfied if

the indexing system is functionally comparable to a reasonable hardcopy filing

system. The requirement to maintain an

indexing system does not require that a

separate electronically stored books and

records description database be maintained if comparable results can be

achieved without a separate description

database.

(2) Reasonable controls must be

undertaken to protect the indexing system against the unauthorized creation of,

addition to, alteration of, deletion of, or

deterioration of any entries.

.03 Recommended Practices. The

implementation of records management

practices is a business decision that is

solely within the discretion of the taxpayer. Records management practices

may include the labeling of electronically stored books and records, providing a secure storage environment, creating back-up copies, selecting an off-site

storage location, retaining hardcopies of

books or records that are illegible or

that cannot be accurately or completely

transferred to an electronic storage system, and testing to confirm records

integrity.

SECTION 5. DISTRICT DIRECTOR

TESTING

.01 The District Director may periodically initiate tests of a taxpayer’s

electronic storage system. These tests

may include an evaluation (by actual

use) of a taxpayer’s equipment and

software, as well as the procedures used

by a taxpayer to prepare, record, transfer, index, store, preserve, retrieve, and

reproduce electronically stored documents. In some instances, the District

Director may choose to review the internal controls, security procedures, and

documentation associated with the taxpayer’s electronic storage system.

.02 The tests described in section

5.01 of this revenue procedure are not

an ‘‘examination,’’ ‘‘investigation,’’ or

‘‘inspection’’ of the books and records

within the meaning of § 7605(b), or a

prior audit for purposes of § 530 of the

Revenue Act of 1978, 1978–3 (Vol.1)

C.B. 119, as amended by § 1122 of the

Small Business Job Protection Act of

1996, because these tests are not directly

related to the determination of the tax

liability of a taxpayer for a particular

taxable period.

.03 The District Director must inform

the taxpayer of the results of any tests

under this section.

SECTION 6. COMPLIANCE

.01 A taxpayer’s electronic storage

system that meets the requirements of

this revenue procedure will be treated as

being in compliance with the

recordkeeping requirements of § 6001

and the regulations thereunder.

.02 A taxpayer’s electronic storage

system that fails to meet the requirements of this revenue procedure may be

treated as not being in compliance with

the recordkeeping requirements of

§ 6001 and the regulations thereunder.

See section 9 of this revenue procedure

for applicable penalties. However, even

though a taxpayer’s electronic storage

system fails to meet the requirements of

this revenue procedure, the penalties

described in section 9 of this revenue

procedure may not apply if the taxpayer

maintains its original books and records,

or maintains its books and records in

micrographic form in conformity with

Rev. Proc. 81–46, 1981–2 C.B. 621.

SECTION 7. DESTRUCTION AND

DELETION OF ORIGINAL BOOKS

AND RECORDS

This revenue procedure permits the

destruction of the original hardcopy

books and records and the deletion of

the original computerized records (other

than ‘‘machine-sensible’’ records required to be retained by Rev. Proc.

91–59, 1991–2 C.B. 841), after the

taxpayer:

(1) has completed its own testing

of the electronic storage system that

establishes that hardcopy or computerized books and records are being reproduced in compliance with all the provisions of this revenue procedure; and

(2) has instituted procedures that

ensure its continued compliance with all

the provisions of this revenue procedure.

Attention: CP:EX

Internal Revenue Service

1111 Constitution Ave., NW

Washington, DC 20224

.02 Questions regarding the application of this revenue procedure to a

specific factual situation should be directed to the appropriate District Director.

SECTION 8. IMPACT ON

MACHINE-SENSIBLE RECORDS

SECTION 11. PAPERWORK

REDUCTION ACT

The provisions of this revenue procedure regarding electronically stored

books and records do not relieve taxpayers of the responsibility of retaining any

other books and records required to be

retained under § 6001. Such other

books and records may include

‘‘machine-sensible’’ records required to

be retained by Rev. Proc. 91–59 in

connection with the taxpayer’s use of an

automatic data processing (ADP) system.

The collections of information contained in this revenue procedure have

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control

number 1545–1533.

An agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information displays a valid control number.

The collections of information are in

sections 4 and 5 of this revenue procedure. This information is required to

ensure that records maintained in an

electronic storage system will constitute

records within the meaning of § 6001.

The collections of information are mandatory for a taxpayer who chooses to

electronically store its books and

records. The likely respondents are individuals, state or local governments,

farms, business or other for-profit institutions, federal agencies or employees,

nonprofit institutions, and small businesses or organizations.

The estimated total annual recordkeeping burden is 1,000,400 hours.

The estimated annual burden per

recordkeeper will vary from 20 hours to

22 hours, depending on individual circumstances, with an estimated average

of 20 hours. The estimated number of

recordkeepers is 50,000.

Books or records relating to a 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.

SECTION 9. PENALTIES

The District Director may issue a

Notice of Inadequate Records pursuant

to § 1.6001–1(d) if the taxpayer’s books

and records are available only as electronically stored books and records and

the taxpayer’s electronic storage system

fails to meet the requirements of this

revenue procedure. Taxpayers whose

electronic storage system fails to meet

the requirements of this revenue procedure may also be subject to applicable

penalties under subtitle F of the Code,

including the § 6662(a) accuracy-related

civil penalty and the § 7203 willful

failure criminal penalty.

SECTION 10. INTERNAL REVENUE

SERVICE OFFICE CONTACT

.01 Questions regarding this revenue

procedure should be directed to the

Office of the Assistant Commissioner

(Examination). The telephone number

for this office is (202) 622–5480 (not a

toll-free number). Written questions

should be addressed to: Assistant Commissioner (Examination)

Part IV. Items of General Interest

Notice of Proposed Rulemaking

and Notice of Public Hearing

Amortization of Intangible Property

REG–209709–94

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains

proposed regulations relating to the amortization of certain intangible property.

The proposed regulations reflect changes

to the law made by the Omnibus Budget

Reconciliation Act of 1993 (OBRA ’93),

and affect taxpayers who acquired intangible property after August 10, 1993, or

made a retroactive election to apply

OBRA ’93 to intangibles acquired after

July 25, 1991. This document also provides notice of a public hearing on the

proposed regulations.

DATES: Comments must be received

by April 16, 1997. Requests to appear

and outlines of oral comments to be

presented at the public hearing scheduled for May 15, 1997, must be received by April 24, 1997.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–209709–94),

room 5228, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be

hand delivered between the hours of 8

a.m. and 5 p.m. to: CC:DOM:CORP:R

(REG–209709–94), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, taxpayers may submit

comments electronically via the Internet

by selecting the ‘‘Tax Regs’’ option of

the IRS Home Page, or by submitting

comments directly to the IRS Internet

site at http:\\www.irs.ustreas.gov\prod\

tax_regs\comments.html. The public

hearing will be held in the Commissioner’s Conference Room (Room 3313),

Internal Revenue Building, 1111 Constitution Avenue NW, Washington, DC

20224.

FOR FURTHER INFORMATION

CONTACT: Concerning the regulations,

John Huffman at (202) 622–3110; concerning submissions and the hearing,

Michael Slaughter at (202) 622–8452

(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed

regulations under sections 167(f) and

197. These provisions were added to the

Internal Revenue Code of 1986 (the

Code) by section 13261 of OBRA ’93,

and apply to intangible property acquired after August 10, 1993 (or after

July 25, 1991, if a valid retroactive

election to apply OBRA ’93 to intangibles has been made pursuant to

§ 1.197–1T).

The proposed regulations provide

definitions and rules for amortization of

intangible property subject to sections

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

IRS published Announcement 94–92

(1994–28 I.R.B. 139) in the Federal

amortization of goodwill and certain

other intangibles that should be addressed in proposed regulations. The

IRS has reviewed these comments and

has addressed certain issues raised in the

comments in the proposed regulations.

However, because these comments were

received in anticipation of the issuance

of these proposed regulations, and because these regulations are subject to

further comment and a public hearing,

no attempt has been made to describe

all of the principal comments that are

not reflected in these regulations or the

reasons therefor.

Explanation of Provisions

1. General overview

Sections 167(f) and 197 provide comprehensive rules for the depreciation and

amortization of many intangible assets.

Intangible assets subject to section 197

are broadly defined to include most

intangible assets acquired in connection

with the acquisition of a trade or business and certain other separately acquired intangible assets. The adjusted

basis of an amortizable section 197

intangible must be amortized over a

15-year period. Certain other intangible

assets are excluded from section 197 for

various reasons. In some cases, such as

stock and partnership interests, the asset

is property of a character that is not

subject to an allowance for depreciation

because it represents a permanent investment that can only be recovered

through disposition of the asset (includ-

ing worthlessness). In other cases, such

as computer software, purchased mortgage servicing rights, service and supply

contracts, and certain other contracts or

rights with a fixed duration, other cost

recovery methods were prescribed by

the OBRA ’93 amendments. In still

other cases, such as motion picture

films, television series, books, and

sound recordings, other cost recovery

methods that were in effect prior to

OBRA ’93 are more appropriate under

the circumstances. Section 167(f) provides alternative methods of depreciation for certain of the intangibles excluded from the application of section

197.

The proposed regulations provide

guidance for certain intangible property

subject to sections 167(f) and 197. The

section 167(f) proposed regulations provide rules for intangible property subject

to the allowance for depreciation under

section 167 and specifically excluded

from section 197. These intangible assets include certain computer software,

rights to receive tangible property or

services, rights of fixed duration, patents, copyrights, and mortgage servicing

rights. These proposed regulations reserve guidance on the method of depreciating the cost of separately acquired

rights to receive tangible property or

services where the amount of the property or services to be received is not

specified. The IRS invites comments on

possible methods of depreciation in

these cases.

Because section 197 provides a

method of amortization and, except in

the case of certain covenants not to

compete, governmental licenses, permits

and other rights, and contracts for the

use of section 197 intangibles, does not

alter the rules for determining the basis

of an asset, section 197 generally does

not apply to amounts that would otherwise be deductible. For example, section

197 does not generally apply to the

costs of advertising because, in most

cases, these costs are deductible under

other provisions of the Code. See Rev.

Rul. 92–80 (1992–2 C.B. 57). In addition, section 197 does not apply to costs

that would not, under general principles

of Federal income tax law, be included

in the basis of a section 197 intangible.

For example, if a taxpayer borrows

money to purchase the assets of a trade

or business (including amortizable section 197 intangibles) and incurs fees in

connection with the loan, these costs are

generally amortized over the term of the

loan rather than under the rules of

sections 167(f) and 197. As a further

example, if the amortizable section 197

intangibles acquired in the transaction

include a favorable supply contract, the

amortizable basis in the contract does

not include amounts required to be paid

for goods to be received pursuant to the

contract.

In addition, section 197 does not

apply to any amount for which a deduction would be disallowed under other

provisions of the Code, such as section

162(k) (relating to amounts paid or

incurred by a corporation in connection

with the acquisition of its stock or the

stock of a related person).

No inference should be drawn from

any provision in the proposed regulations concerning the classification of

any section 197 intangible as property,

or whether any section 197 intangible is

treated as tangible or intangible property, for other purposes of the Code.

Furthermore, no inference should be

drawn from any provision in the proposed regulations regarding (a) whether

any section 197 intangible that is not an

amortizable section 197 intangible may

be amortized or depreciated under any

provision of the Code other than section

197, or (b) the proper method for determining any allowance therefor. Finally,

no inference should be drawn from any

provision in the proposed regulations

concerning whether any section 197 intangible (or any interest therein) has

been purchased, leased, or licensed for

Federal income tax purposes.

2. Section 197 intangibles

The proposed regulations define section 197 intangibles (subject to certain

exceptions) as goodwill, going concern

value, workforce in place, information

base, know-how, customer- and supplierbased intangibles, governmental licenses

and permits, covenants not to compete

and other similar arrangements, franchises, trademarks, trade names, and

contracts for the use of the foregoing

assets.

business. The legislative history provides, however, that section 197 applies

to a covenant not to compete acquired

with the assets of a trade or business,

the stock in a corporation, or an interest

in a partnership engaged in a trade or

business. Consequently, the proposed

regulations do not provide for this exception. In this regard, the proposed

regulations provide that for purposes of

section 197(f)(1)(B), the disposition or

cancellation of redeemed stock of a

corporation will not cause the covenant

to be written off faster than over the

15-year amortization period provided for

under section 197 (in the case of a

covenant to which section 162(k) does

not apply).

B. Contracts for the Use of Section 197

Intangibles

Some commentators also requested

guidance on the extent to which contracts for the use of section 197 intangibles would be subject to section 197,

in some cases suggesting that an intangible was not subject to section 197

unless the taxpayer obtained ownership

of property for Federal income tax purposes. However, it is sometimes difficult

to determine whether the terms of an

agreement confer ownership, for Federal

income tax purposes, of property, and

the IRS and Treasury believe that the

purposes of section 197 could be circumvented through the use of such

agreements. Accordingly, the proposed

regulations provide that contracts for the

use of section 197 intangibles will also

be treated as section 197 intangibles.

Contracts that are so treated may, however, be excluded under either section

197(e)(4)(B) or (D) on the basis that

they are contracts for the receipt of

property or services, contracts having a

fixed duration, or contracts having a

fixed amount and recovered on a unitof-production method or other similar

method.

3. Intangibles excluded from section

197

A. Computer Software

A. Covenants not to Compete

Some commentators in response to

Announcement 94–92 suggested that a

covenant not to compete relating to the

redemption of stock or a partnership

interest from a departing stockholder or

partner should be excluded from section

197 because this situation does not

involve the acquisition of a trade or

Section 197 intangibles do not include

computer software that is readily available for purchase by the general public,

is subject to a nonexclusive license, and

has not been substantially modified. The

proposed regulations provide a safe harbor for purposes of determining whether

computer software has been substantially modified. Under the safe harbor,

computer software has not been substantially modified if its capitalized cost

does not exceed the greater of $2,000 or

125 percent of the price at which the

unmodified version of the software is

readily available to the general public.

The proposed regulations incorporate

some of the provisions of Revenue

Procedure 69–21 (1969–2 C.B. 303),

involving the treatment of costs of computer software, and modify other provisions to the extent necessary to conform

to the amortization rules provided under

sections 197 and 167(f). Consequently,

if costs for developing computer software that the taxpayer has elected to

treat as deferred expenses under section

174(b) result in the development of a

self-created intangible excluded under

section 197(c)(2) and subject to the

allowance for depreciation under section

167(a), deductions for the unrecovered

expenditures are subject to section

167(f)(1). Computer software costs included, without being separately stated,

in the cost of the computer hardware

(bundled software) continue to be capitalized and depreciated as part of the

computer hardware. The proposed regulations also continue to treat as currently

deductible software costs properly and

consistently treated as deductible (not

capitalized) under § 1.162–11.

B. Certain Separately Acquired

Intangibles

Certain intangibles are excepted from

section 197 if they are not acquired as

part of a purchase of a trade or business.

The proposed regulations clarify that,

for purposes of section 197, a group of

assets constitutes a trade or business if

their use would constitute a trade or

business under section 1060; that is, if

goodwill or going concern value could

under any circumstances attach to the

assets. Temporary and proposed regulations under section 1060, in turn, provide that a group of assets constitutes a

trade or business for purposes of section

1060 if the use of such assets would

constitute an active trade or business for

purposes of section 355. However, in

appropriate cases, even if the use of a

group of assets would not constitute an

active trade or business for purposes

of section 355, such assets may nevertheless constitute a trade or business

for purposes of section 1060. See

§ 1.1060–1T(b)(2).

The IRS intends to provide additional

guidance as to the circumstances under

which the acquisition of a group of

assets constitutes a trade or business for

purposes of section 1060 in regulations

under that section. Accordingly, the proposed regulations do not provide substantive guidance on this question, except to the extent that the considerations

are unique to the application of section

197. The IRS invites comments on the

extent to which additional rules under

section 197 may be necessary.

C. Certain Contracts and Governmental

Rights

While section 197 intangibles include

licenses, permits, and other rights

granted by a governmental unit or an

agency or instrumentality thereof (section 197(d)(1)(D)), certain rights granted

by these governmental entities are excluded from section 197 pursuant to

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

the conditions and limitations therein.

Because a particular right may be described in two or more of these provisions, the proposed regulations provide

guidance regarding the potential conflict

between, or overlap with, these provisions. Thus, a right that would be

subject to section 197 pursuant to section 197(d)(1)(D) may nevertheless be

excluded if it is also described in section 197(e)(4) and meets all of the

requirements for exclusion. Furthermore,

a right that meets the requirements of

either section 197(e)(4)(B) or section

197(e)(4)(D) is excluded from section

197 even if it fails to meet one of the

requirements for the other exclusion. In

addition, any license, permit, or other

right granted by a governmental unit

that otherwise meets the definition of a

franchise under section 197(d)(1)(F),

such as an FCC broadcast license or

cable television franchise, is treated as a

franchise under the regulations. Accordingly, these licenses do not qualify for

any of the exceptions from section 197

provided under section 197(e)(4).

while retaining other intangibles acquired in the same or related transaction,

and then selling the stock. Special rules

are also provided for the application of

the loss disallowance provisions in cases

where a taxpayer has disposed of all of

the amortizable section 197 intangibles

acquired in a single transaction but is

treated as having retained other amortizable section 197 intangibles solely by

virtue of the retention of amortizable

section 197 intangibles by a related

person.

B. Transactions Involving Partnerships

The proposed regulations provide

rules and examples relating to the treatment of section 197 intangibles acquired

or transferred in certain partnership

transactions, including terminations under section 708(b)(1), and the application of section 197 to the special basis

adjustments of partnership property for

which a section 754 or section 732(d)

election is in effect. Guidance is also

provided regarding the effect of curative

and remedial allocations and the application of the anti-churning rules to certain partnership transactions.

In the case of the termination of a

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

(relating to a sale or exchange of an

interest), the rules contained in the proposed regulations are based on recently

proposed regulations under that section,

pursuant to which the new partnership is

treated as having directly acquired the

assets of the old partnership in exchange

for the assumption of its liabilities and

the issuance of interests in the new

partnership. Accordingly, for purposes of

section 197, the consequences of the

termination of a partnership under section 708(b)(1)(B) may not be the same

as the consequences of such a termination under the rules in effect at the time

section 197 was enacted.

C. Treatment of Contingent Payments

4. Special rules of application

A. Loss Disallowance Provisions

The proposed regulations contain

rules for the loss disallowance provisions set forth in section 197(f)(1). In

particular, the proposed regulations provide that a taxpayer may not circumvent

the loss disallowance rules, for example,

by transferring some intangibles, whose

adjusted basis is greater than their fair

market value, to a corporation in exchange for stock in the corporation in a

transaction described in section 351,

The proposed regulations clarify that,

except in the case of contingent payments, amounts paid for section 197

intangibles are treated as amounts

chargeable to capital account, and the

entire principal amount is amortized

ratably over the 15-year amortization

period beginning with the later of the

month in which the intangible is acquired or the date on which the active

conduct of a trade or business begins.

Contingent payments for section 197

intangibles paid or incurred after the

taxable year in which the intangible is

acquired are added to basis at such time

and generally amortized ratably over the

remaining months in the 15-year period

as of the beginning of the month the

amount is paid or incurred. However, in

order to reduce the administrative burden that may result from a requirement

to maintain separate amortization schedules for each month during the 15-year

period, taxpayers are permitted to use

certain simplifying conventions. In addition, any amount that is not properly

included in the basis of an amortizable

section 197 intangible until after the

expiration of the 15-year period is amortized in full immediately upon the inclusion of the amount in the basis of the

intangible. The proposed regulations refer to § 1.461–1(a)(1) for rules governing the time at which an amount may be

taken into account by a taxpayer using

the cash receipts and disbursements

method. They refer to § 1.461–1(a)(2)

for rules governing the time at which a

liability is incurred and generally taken

into account (for example, by treating

the amount of the liability as a capital

expenditure) by an accrual basis taxpayer.

5. Anti-churning Rules

To be eligible for amortization, section 197 intangibles must qualify as

amortizable section 197 intangibles.

Generally, amortizable section 197 intangibles are section 197 intangibles that

are acquired after August 10, 1993 (or

acquired after July 25, 1991, and for

which the taxpayer made a proper election under § 1.197–1T) and held in

connection with the conduct of a trade

or business or an activity described in

section 212.

The proposed regulations provide

anti-churning rules to prevent taxpayers

from converting into amortizable section

197 intangibles existing goodwill, going

concern value, and any other section

197 intangible for which amortization

would not have been allowable prior to

OBRA ’93 through the use of related

persons and certain other transactions.

The proposed regulations define the

term related person for purposes of

these rules.

The proposed regulations also contain

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

seller elects to recognize gain and

agrees to pay a specified amount of tax.

The regulations reserve guidance on the

manner of making this election. The IRS

intends to issue a revenue procedure in

order to provide interim guidance to

taxpayers on the manner of making this

election, and the final regulations will

include the relevant provisions of this

revenue procedure.

The proposed regulations contain both

an anti-churning anti-abuse rule and a

general anti-abuse rule that provide that

the Commissioner may recast any transaction if one of its principal purposes is

to avoid the purposes of section 197.

6. Assumption Reinsurance Transactions

Section 197(f)(5) provides special

rules for section 197 intangibles resulting from assumption reinsurance transactions. The proposed regulations reserve guidance on certain aspects of

these transactions. The IRS invites comments on the extent to which additional

guidance on the application of section

197 to these transactions may be necessary.

basis to individual assets in the case of

a direct acquisition of assets constituting

a trade or business or a deemed acquisition of assets as the result of an election

under section 338. Under this system,

assets in the nature of goodwill and

going concern value are included in

Class IV, while other intangible assets,

whether or not amortizable, are included

in Class III. Each successive class is

allocated basis under a residual method,

subject to a fair market value limitation

for all classes except Class IV. After

basis has been allocated to each class in

the aggregate, assets within each of the

first three classes are allocated basis on

a proportional method. This system is

inconsistent with the policies of section

197, which prescribes uniform treatment

for all amortizable section 197 intangibles. Accordingly, appropriate modifications are being proposed.

Special Analyses

7. Proposed Effective Dates

The regulations for sections 167(f)

and 197 are proposed to be effective on

the date on which the final regulations

are published in the Federal Register.

Regulations to implement section

197(e)(4)(D) (separately acquired contracts of fixed duration or amount) are

proposed to be effective August 11,

1993, for property acquired after August

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

retroactive election has been made under

§ 1.197–1T).

8. Accounting Method Changes

A change in the method of depreciation or amortization of intangibles is a

change in method of accounting that

requires the consent of the Commissioner of Internal Revenue under section

446(e). To obtain this consent, a Form

3115, Application for Change in Accounting Method, generally must be

filed within 180 days after the beginning

of the taxable year in which the proposed change is to be made. Taxpayers

that have adopted a method of accounting for certain intangibles may need to

change their method of accounting to

comply with the final regulations.

9. Basis Allocation Rules

In separate notices the IRS and Treasury are issuing temporary and proposed

amendments to the temporary regulations under sections 1060 and 338(b).

The existing temporary regulations establish a four-class system for allocating

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It also has been

determined that section 553(b) of the

Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these

regulations, and, because the regulations

do not impose a collection of information on small entities, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does

not apply. Pursuant to section 7805(f) of

the Internal Revenue Code, this notice

of proposed rulemaking will be submitted to the Chief Counsel for Advocacy

of the Small Business Administration for

comment on its impact on small business.

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

apply to the hearing.

Persons that wish to present oral

comments at the hearing must submit

comments and an outline of the topics

to be discussed and the time to be

devoted to each topic (in the manner

described in ADDRESSES) by April 16,

1997. A period of 10 minutes will be

allotted to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal author of these regulations is John Huffman, Office of Assistant Chief Counsel (Passthroughs and

Special Industries), IRS. However, other

personnel from the IRS and Treasury

Department participated in their development.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an

entry in numerical order to read as

follows:

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

Section 1.197–2 also issued under 26

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

Par. 2. Section 1.167(a)–3 is amended

by adding a sentence at the end to read

as follows:

Comments and Public Hearing

§ 1.167(a)–3 Intangibles.

Before these proposed regulations are

adopted as final regulations, consideration will be given to any comments

that are submitted (in the manner described in ADDRESSES) timely to the

IRS. All comments will be available for

public inspection and copying.

A public hearing has been scheduled

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

Commissioner’s Conference Room

(Room 3313), Internal Revenue Building, 1111 Constitution Avenue NW,

Washington, DC 20224. Because of access restrictions, visitors will not be

admitted beyond the Internal Revenue

Building lobby more than 15 minutes

before the hearing starts.

* * * See §§ 1.197–2 and 1.167(a)–14

for amortization of goodwill and certain

other intangibles acquired after August

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

valid retroactive election under § 1.197–

1T has been made.

Par. 3. Section 1.167(a)–6 is amended

by adding two sentences at the end of

paragraph (a) to read as follows:

§ 1.167(a)–6 Depreciation in special

cases.

(a) * * * See § 1.167(a)–14(c)(4) for

depreciation of a separately acquired

interest in a patent or copyright described in section 167(f)(2) acquired

after the date on which the final regula-

tions are published in the Federal Register. See § 1.197–2 for amortization of

interests in patents and copyrights that

constitute amortizable section 197 intangibles.

Par. 4. Section 1.167(a)–14 is added

to read as follows:

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

197.

(a) Overview. This section provides

rules for the amortization of certain

intangibles that are excluded from section 197 (relating to the amortization of

goodwill and certain other intangibles).

These excluded intangibles are specifically described in § 1.197–2(c)(4), (6),

(7), (11), and (13) and include certain

computer software and certain other

separately acquired rights, such as rights

to receive tangible property or services,

patents and copyrights, rights of fixed

duration or amount, and certain mortgage servicing rights. Intangibles for

which an amortization amount is determined under section 167(f) and intangibles otherwise excluded from section

197 (for example, self-created intangibles described in § 1.197–2(d)(2)) are

amortizable only if they qualify as property subject to the allowance for depreciation under section 167(a).

(b) Computer software—(1) In general. The amount of the deduction for

computer software described in section

167(f)(1) and § 1.197–2(c)(4) is determined by amortizing the adjusted basis

of the computer software using the

straight line method described in

§ 1.167(b)–1 (except that its salvage

value is treated as zero) and an amortization period of 36 months beginning

with the month that the computer software is placed in service. If costs for

developing computer software that the

taxpayer properly elects to defer under

section 174(b) result in the development

of property subject to the allowance for

depreciation under section 167, the rules

of this paragraph (b) will apply to the

unrecovered costs. In addition, this paragraph (b) applies to the cost of separately acquired computer software where

these costs are separately stated and the

costs are required to be capitalized under section 263(a).

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

this section does not apply to the cost of

computer software properly and consistently treated as currently deductible

(that is, not capitalized) under § 1.162–

11. The cost of acquiring an interest in

computer software that is included,

without being separately stated, in the

cost of the hardware or other tangible

property is treated as part of the cost of

the hardware or other tangible property

that is capitalized and depreciated under

other applicable sections of the Internal

Revenue Code.

receive tangible property or services.

The amount of the deduction for a

separately acquired right to receive tangible property or services under a contract or from a governmental unit (specified in section 167(f)(2) and § 1.197–

2(c)(6)) is determined as follows:

(i) Amortization of fixed amounts.

The cost of acquiring a right to receive

a fixed amount of tangible property or

services is amortized for each taxable

year by multiplying the basis (as determined under section 1011) of the right

by a fraction, the numerator of which is

the amount of tangible property or services received during the taxable year

and the denominator of which is the

total amount of tangible property or

services received or to be received under the terms of the contract or governmental grant. For example, if a taxpayer

acquires a favorable contract right to

receive a fixed amount of raw materials

during an unspecified period, the taxpayer must amortize the cost of acquiring the contract right by multiplying the

total cost by a fraction, the numerator of

which is the amount of raw materials

received under the contract during the

taxable year and the denominator of

which is the total amount of raw materials received or to be received under the

contract.

(ii) Amortization of unspecified

amount over fixed period. The cost of

acquiring a right to receive an unspecified amount of tangible property or

services over a fixed period is amortized

ratably over the period of the right.

(iii) Amortization in other cases. [Reserved]

(2) Rights of fixed duration or

amount. The amount of the deduction

for a separately acquired right of fixed

duration or amount received under a

contract or granted by a governmental

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

§ 1.197–2(c)(13)) and not covered by

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

(i) Rights of a fixed amount. The cost

of acquiring a right of a fixed amount is

amortized for each taxable year by mul-

tiplying the cost of the right by a

fraction, the numerator of which is the

amount received or delivered during the

taxable year and the denominator of

which is the total amount to be received

or delivered (including amounts received

or delivered prior to the close of the

taxable year) under the terms of the

contract or governmental grant.

(ii) Rights of unspecified amount and

fixed duration of less than 15 years. The

cost of acquiring a right of an unspecified amount and a fixed duration of less

than 15 years is amortized ratably over

the period of the right.

(3) Application of renewals. (i) For

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

this section, the duration of a right

under a contract (or granted by a governmental unit) includes any renewal

period if, based on all of the facts and

circumstances in existence at any time

during the taxable year in which the

right is acquired, the facts clearly indicate a reasonable expectancy of renewal.

(ii) The mere fact that a taxpayer will

have the opportunity to renew a contract

right or other right on the same terms as

are available to others, in a competitive

auction or similar process that is designed to reflect fair market value and

in which the taxpayer is not contractually advantaged, will generally not be

taken into account in determining the

duration of such right provided that the

bidding produces a fair market value

price comparable to the price that would

be obtained if the rights were purchased

immediately after renewal from a person

(other than the person granting the renewal) in an arm’s-length transaction.

(iii) The cost of a renewal not included in the terms of the contract or

governmental grant is treated as the

acquisition of a separate intangible asset.

(4) Patents and copyrights. The

amount of the deduction for a separately

acquired interest in a patent or copyright

described in section 167(f)(2) and

§ 1.197–2(c)(7) is equal to the purchase

price paid or incurred during the year if

the purchase price is payable on at least

an annual basis as either a fixed amount

per use or a fixed percentage of the

revenue derived from the use of the

patent or copyright. Otherwise, the cost

or other basis of a separately acquired

patent or copyright (or an interest

therein) is depreciated ratably over its

remaining useful life. If a patent or

before its legal expiration, the adjusted

basis may be deducted in that year.

(5) Applicable rules and conventions.

The period of amortization under paragraphs (c)(1) through (4) of this section

begins when the intangible is placed in

service. For other applicable rules, see

§ 1.197–2(f).

(d) Mortgage servicing rights. The

amount of the deduction for mortgage

servicing rights described in section

167(f)(3) and § 1.197–2(c)(11) is determined by using the straight line method

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

the salvage value is treated as zero) and

an amortization period of 108 months.

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

stripped coupons under section 1286. An

event that renders mortgage servicing

rights wholly worthless is considered a

disposition of the rights. For purposes of

determining the deduction for mortgage

servicing rights and any loss from the

sale, exchange, or other disposition of

the rights, rights to service a pool of

mortgages are treated as a single asset.

Thus, if some (but not all) mortgages in

a pool prepay and the taxpayer retains

rights to service the remaining mortgages in the pool, no loss is recognized

by reason of the prepayment. The adjusted basis of the mortgage servicing

rights is not affected by the unrecognized loss.

(e) Effective date. This section is applicable on the date final regulations are

published in the Federal Register

except that § 1.167(a)–14(c)(2) (depreciation of the cost of certain separately acquired rights) and so much

of § 1.167(a)–14(c)(3) as relates to

§ 1.167(a)–14(c)(2) are applicable August 11, 1993 (or July 26, 1991, if a

valid retroactive election has been made

under § 1.197–1T).

Par. 5. Section 1.197–0 is added to

read as follows:

§ 1.197–0 Table of contents.

This section lists the headings that

appear in § 1.197–2.

§ 1.197–2 Amortization of goodwill and

certain other intangibles.

(a) Overview.

(1) In general.

(2) Section 167(f) property.

(3) Amounts otherwise deductible.

(4) Relationship to other Internal

Revenue Code provisions.

(b) Section 197 intangibles; in general.

(1) Goodwill.

(2) Going concern value.

(3) Workforce in place.

(4) Information base.

(5) Know-how, etc.

(6) Customer-based intangibles.

(7) Supplier-based intangibles.

(8) Licenses, permits, and other

rights granted by governmental units.

(9) Covenants not to compete and

other similar arrangements.

(10) Franchises, trademarks, and

trade names.

(11) Contracts for the use of, and

term interests in, other section 197 intangibles.

(12) Other similar items.

(1) Interests in a corporation, partnership, trust, or estate.

(2) Interests under certain financial

contracts.

(3) Interests in land.

(4) Certain computer software.

(i) In general.

(ii) Separately acquired software.

(iii) Other exceptions.

(iv) Computer software defined.

(v) Readily available to the general public.

(5) Certain interests in films, sound

recordings, video tapes, books, or other

similar property.

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

(7) Certain interests in patents or

copyrights.

(8) Interests under leases of tangible property.

(i) Interest as a lessor.

(ii) Interest as a lessee.

(9) Interests under indebtedness.

(i) In general.

(ii) Exceptions.

(10) Professional sports franchises.

(11) Mortgage servicing rights.

(12) Certain transaction costs.

(13) Rights of fixed duration or

amount.

(d) Amortizable section 197 intangibles.

(1) Definition.

(2) Exception for self-created intangibles.

(i) In general.

(ii) Created by the taxpayer.

(A) Defined.

(B) Contracts for the use of

intangibles.

(iii) Exceptions.

(3) Exception for property subject

to anti-churning rules.

(e) Purchase of a trade or business.

(1) Goodwill or going concern

value.

(2) Customer-based intangibles.

(3) Franchise, trademark, or trade

name.

(i) In general.

(ii) Exceptions.

(4) Acquisitions to be included.

(5) Substantial portion.

(6) Deemed asset purchases under

section 338.

(f) Computation of amortization deduction.

(1) In general.

(2) Treatment

contingent

amounts.

(i) Amounts added to basis during 15-year period.

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

(iii) Time for including amounts

in basis.

(3) Determination of amounts

chargeable to capital account in certain

cases.

(i) Covenants not to compete,

rights granted by governmental units,

and contracts for the use of section 197

intangibles.

(A) In general.

(B) Time for taking amounts

into account.

(ii) Franchises, trademarks, or

trade names and licenses, permits, and

other rights granted by governmental

units.

(iii) Certain reinsurance transactions.

(4) Transactions subject to section

338 or 1060.

(g) Special rules.

(1) Treatment of certain dispositions.

(i) Loss disallowance rules.

(A) In general.

(B) Certain nonrecognition

transfers.

(ii) Separately acquired property.

(iii) Disposition of a covenant

not to compete.

(iv) Taxpayers under common

control.

(A) In general.

(B) Treatment of disallowed

loss.

(2) Treatment of certain nonrecognition and exchange transactions.

(i) In general.

(A) Transfer disregarded.

(B) Application of general

rule.

(ii) Transactions covered.

(iii) Certain exchanged-basis

property.

(iv) Transfers under section

708(b)(1).

(A) In general.

(B) Termination by sale or exchange of interest.

(D) Anti-churning rules.

(v) Distributions to which section 732(d) applies.

(vi) Curative and remedial allocations under section 704(c).

(3) Application of section 754 to

acquisitions of an interest in an intangible held through a partnership.

(4) Treatment of certain reinsurance transactions.

(i) In general.

(ii) Determination of adjusted

basis.

(A) Acquisitions (other than

under section 338) of specified insurance contracts.

(B) Other acquisitions. [Reserved]

(5) Amounts paid or incurred for a

franchise, trademark, or trade name.

(6) Amounts properly taken into

account in determining the cost of property that is not a section 197 intangible.

(7) Treatment of amortizable section 197 intangibles as depreciable property.

(i) In general.

(ii) Exceptions and limitations.

(A) Unstated interest and

original issue discount rules.

(B) Treatment of other parties

to transaction.

(h) Anti-churning rules.

(1) Conversions of existing goodwill, going concern value, and certain

other section 197 intangibles.

(2) Amounts deductible under section 1253(d).

(3) Transition period.

(4) Exceptions.

(5) Special partnership provisions.

(i) Basis increases.

(ii) Curative and remedial allocations under section 704(c).

(6) Related person.

(i) In general.

(ii) Time for testing relationships.

(iii) De minimis rule.

(A) In general.

(B) Determination of beneficial ownership interest.

(7) Special rules for entities that

owned or used property at any time

during the transition period and that are

no longer in existence.

(8) Special rules for section 338

deemed acquisitions.

(9) Exception to anti-churning

rules where gain is recognized.

(i) In general.

(ii) Manner of making election.

[Reserved]

(iii) Determination of highest

marginal rate of tax.

(A) Noncorporate taxpayers.

(B) Corporations and taxexempt entities.

(iv) Special rule for pass-through

entities.

(v) Coordination with other provisions.

(A) In general.

(B) Section 1374.

(D) Installment method.

(10) Transactions subject to both

anti-churning and nonrecognition rules.

(11) Anti-churning anti-abuse rule.

(i) [Reserved].

(j) General anti-abuse rule.

(k) Examples.

(l) Effective dates.

Par. 6. Section 1.197–2 is added to

read as follows:

§ 1.197–2 Amortization of goodwill and

certain other intangibles.

(a) Overview—(1) In general. Section

197 allows an amortization deduction

for the capitalized costs of an amortizable section 197 intangible and prohibits

any other depreciation or amortization

with respect to that property. Paragraphs

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

rules and definitions for determining

whether property is a section 197 intangible, and paragraphs (d) and (e) of this

section provide rules and definitions for

determining whether a section 197 intangible is an amortizable section 197

intangible. The amortization deduction

under section 197 is determined by

amortizing adjusted basis ratably over a

15-year period under the rules of paragraph (f) of this section. Section 197

also includes various special rules pertaining to the disposition of amortizable

section 197 intangibles, nonrecognition

transactions, anti-churning rules, and

anti-abuse rules. Rules relating to these

provisions are contained in paragraphs

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

these provisions are contained in paragraph (k) of this section. The effective

date of the rules in this section is

contained in paragraph (l) of this section.

(2) Section 167(f) property. Section

167(f) prescribes rules for computing

the depreciation deduction for certain

property to which section 197 does not

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

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

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

description of the property subject to

section 167(f).

(3) Amounts otherwise deductible.

Except as otherwise provided in section

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

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

not apply to amounts that would be

currently deductible without regard to

section 197.

(4) Relationship to other Internal

Revenue Code provisions. Section 197

does not apply to any amount paid or

incurred for a section 197 intangible if a

deduction for the amount would be

disallowed under any provision of the

Internal Revenue Code other than section 263. (See, for example, section

162(k).)

(b) Section 197 intangibles; in general. Except as otherwise provided in

paragraph (c) of this section, the term

section 197 intangible means any property described in section 197(d)(1). The

following rules and definitions provide

guidance concerning property that is a

section 197 intangible unless an exception applies:

(1) Goodwill. Section 197 intangibles

include goodwill. Goodwill is the value

of a trade or business attributable to the

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

the name or reputation of a trade or

business or any other factor.

(2) Going concern value. Section 197

intangibles include going concern value.

Going concern value is the additional

value that attaches to property by reason

of its existence as an integral part of an

ongoing business activity. Going concern value includes the value attributable to the ability of a trade or business

(or a part of a trade or business) to

continue functioning or generating income without interruption notwithstanding a change in ownership, but does not

include any of the intangibles described

in any other provision of this paragraph

(b). It also includes the value that is

attributable to the immediate use or

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

the revenues or net earnings that otherwise would not be received during any

period if the acquired trade or business

were not available or operational.

(3) Workforce in place. Section 197

intangibles include workforce in place.

Workforce in place (sometimes referred

to as agency force or assembled

workforce) includes the composition of

a workforce (for example, the experience, education, or training of a

workforce), the terms and conditions of

employment whether contractual or otherwise, and any other value placed on

employees or any of their attributes.

Thus, the amount paid or incurred for

workforce in place includes, for example, any portion of the purchase price

of an acquired trade or business attributable to the existence of a highly-skilled

workforce, an existing employment contract (or contracts), or a relationship

with employees or consultants (including, but not limited to, any key employee contract or relationship).

Workforce in place does not include any

covenant not to compete or other similar

arrangement described in paragraph

(b)(9) of this section.

(4) Information base. Section 197 intangibles include business books and

records, operating systems, and any

other information base, including lists or

other information of current or prospective customers (regardless of the method

of recording the information). Thus, the

amount paid or incurred for these items

includes, for example, any portion of the

purchase price of an acquired trade or

business attributable to the intangible

value of technical manuals, training

manuals or programs, data files, and

accounting or inventory control systems.

Other examples include the cost of

acquiring customer lists, subscription

lists, insurance expirations, patient or

client files, or lists of newspaper, magazine, radio, or television advertisers.

(5) Know-how, etc. Section 197 intangibles include any patent, copyright,

formula, process, design, pattern, knowhow, format, package design, computer

software (as defined in paragraph (c)(4)

of this section), or interest in a film,

sound recording, video tape, book, or

other similar property. (See, however,

the exceptions in paragraph (c) of this

section.)

(6) Customer-based intangibles. Section 197 intangibles include any

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

market, market share, or other value

resulting from the future provision of

goods or services pursuant to contractual

or other relationships in the ordinary

course of business with customers.

Thus, the amount paid or incurred for

customer-based intangibles includes, for

example, any portion of the purchase

price of an acquired trade or business

attributable to the existence of a customer base, a circulation base, an undeveloped market or market growth, insurance in force, the existence of a

qualification to supply goods or services

to a particular customer, a mortgage

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

future provision of goods or services.

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

customer-based intangibles include the

deposit base and any similar asset of a

financial institution. Thus, the amount

paid or incurred for customer-based intangibles also includes any portion of

the purchase price of an acquired financial institution attributable to the value

represented by existing checking accounts, savings accounts, escrow accounts, and other similar items of the

financial institution. However, any portion of the purchase price of an acquired

trade or business attributable to accounts

receivable or other similar rights to

income for goods or services provided

to customers prior to the acquisition of a

trade or business is not an amount paid

or incurred for a customer-based intangible.

(7) Supplier-based intangibles. Section 197 intangibles include any

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

from the future acquisition, pursuant to

contractual or other relationships with

suppliers in the ordinary course of business, of goods or services that will be

sold or used by the taxpayer. Thus, the

amount paid or incurred for supplierbased 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 supplierbased intangibles does not include any

amount required to be paid for the

goods or services themselves pursuant to

the terms of the agreement or other

relationship. In addition, see the exceptions in paragraph (c) of this section,

including the exception in paragraph

(c)(6) of this section for certain rights to

receive tangible property or services

from another person.

(8) Licenses, permits, and other

rights granted by governmental units.

Section 197 intangibles include any license, permit, or other right granted by

a governmental unit (including, for purposes of section 197, an agency or

instrumentality thereof) even if the right

is granted for an indefinite period or is

reasonably expected to be renewed for

an indefinite period. These rights include, for example, a liquor license, a

taxi-cab medallion (or license), an airport landing or takeoff right (sometimes

referred to as a slot), a regulated airline

route, or a television or radio broadcasting license. The issuance or renewal of

a license, permit, or other right granted

by a governmental unit is considered an

acquisition of the license, permit, or

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

including the exceptions in paragraph

(c)(3) of this section for an interest in

land, in paragraph (c)(8) of this section

for an interest under a lease of tangible

property, and in paragraphs (c)(6) and

(13) of this section for certain rights

granted by a governmental unit. See

paragraph (b)(10) of this section for the

treatment of franchises.)

(9) Covenants not to compete and

other similar arrangements. Section 197

intangibles include any covenant not to

compete, or agreement having substantially the same effect, entered into in

connection with the direct or indirect

acquisition of an interest in a trade or

business or a substantial portion thereof.

For purposes of this paragraph (b)(9), an

acquisition may be made in the form of

an asset acquisition (including a qualified stock purchase that is treated as a

purchase of assets under section 338), a

stock acquisition or redemption, and the

acquisition or redemption of a partnership interest. An agreement requiring the

performance of services or the provision

of property or the use of property (other

than property of the acquired trade or

business) does not have substantially the

same effect as a covenant not to compete to the extent that the amount paid

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

of the property actually provided.

(10) Franchises, trademarks, and

trade names. (i) Section 197 intangibles

include any franchise, trademark, or

trade name. The term franchise includes

any agreement that provides one of the

parties to the agreement with the right

to distribute, sell, or provide goods,

services, or facilities, within a specified

area. (See section 1253(b)(1).) The term

includes distributorships or other similar

contractual arrangements pursuant to

which the transferee is permitted or

licensed to operate or conduct a trade or

business within a specific area. The term

trademark includes any word, name,

symbol, or device, or any combination

thereof, adopted and used by a manufacturer or merchant to identify goods or

services and distinguish them from those

manufactured or sold by others. The

term trade name includes any name

used by a manufacturer or merchant to

identify or designate a particular trade

or business or the name or title used by

a person or organization engaged in a

trade or business. A license, permit, or

other right granted by a governmental

unit is a franchise if it otherwise meets

the definition of a franchise. A trademark or trade name includes any trademark or trade name arising under statute

or applicable common law, and any

similar right granted by contract. The

renewal of a franchise, trademark, or

trade name is treated as an acquisition

of the franchise, trademark, or trade

name.

(ii) Notwithstanding the definitions

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

section, any amount that is paid or

incurred on account of a transfer, sale,

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

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

the basis of a section 197 intangible.

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

(11) Contracts for the use of, and

term interests in, other section 197

intangibles. Section 197 intangibles include any right under a license, contract,

or other arrangement providing for the

use of property that would be a section

197 intangible under any provision of

this paragraph (b) (including this paragraph (b)(11)) after giving effect to all

of the exceptions provided in paragraph

(whether outright or in trust) in such

property.

(12) Other similar items. Section 197

intangibles include any other intangible

property that is similar in all material

respects to the property specifically described in section 197(d)(1)(C) and

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

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

section for special rules regarding certain reinsurance transactions.)

does not include property described in

section 197(e). The following rules and

definitions provide guidance concerning

property to which the exceptions apply:

(1) Interests in a corporation, partnership, trust, or estate. Section 197

intangibles do not include an interest in

a corporation, partnership, trust, or estate. Thus, for example, amortization

under section 197 is not available for

the cost of acquiring stock, partnership

interests, or interests in a trust or estate,

whether or not the interests are regularly

traded on an established market. (See

paragraph (g)(3) of this section for special rules applicable to property of a

partnership when a section 754 election

is in effect for the partnership.)

(2) Interests under certain financial

contracts. Section 197 intangibles do not

include an interest under an existing

futures contract, foreign currency contract, notional principal contract, interest

rate swap, or other similar financial

contract, whether or not the interest is

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

apply to an interest under a mortgage

servicing contract, credit card servicing

contract, or other contract to service

another person’s indebtedness, or an

interest under an assumption reinsurance

contract. (See paragraph (g)(4) of this

section for the treatment of assumption

reinsurance contracts. See paragraph

(c)(11) of this section and § 1.167(a)–

14(d) for the treatment of mortgage

servicing rights.)

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

land. For this purpose, an interest in

land includes a fee interest, life estate,

remainder, easement, mineral right, timber right, grazing right, riparian right,

air right, zoning variance, and any other

similar right, such as a farm allotment,

quota for farm commodities, or crop

acreage base. An interest in land does

not include an airport landing or takeoff

right, a regulated airline route, or a

franchise to provide cable television

service. The cost of acquiring a license,

permit, or other land improvement right,

such as a building construction or use

permit, is taken into account in the same

manner as the underlying improvement.

(4) Certain computer software—(i) In

general. Section 197 intangibles do not

include any interest in computer software that is (or has been) readily available to the general public on similar

terms, is subject to a nonexclusive li-

cense, and has not been substantially

modified for the user. Computer software will not be considered to have

been substantially modified if its cost

does not exceed the greater of 125

percent of the price at which the unmodified version of the software is

readily available to the general public or

$2,000. For the purpose of determining

whether computer software has been

substantially modified—

(A) Integrated programs acquired in a

package from a single source are treated

as a single computer program; and

(B) Any cost incurred to install the

computer software is not treated as a

cost of the software.

(ii) Separately acquired software.

Section 197 intangibles do not include

an interest in computer software that is

not acquired as part of a purchase of a

trade or business within the meaning of

paragraph (e) of this section.

(iii) Other exceptions. Neither section

197 nor section 167(f) apply in the

following cases:

(A) Any amount of the cost of an

interest in computer software that is

included, without being separately

stated, in the cost of the hardware or

other tangible property will be treated as

part of the cost of the hardware or other

tangible property.

(B) Any amount of the cost of an

interest in computer software that would

be deductible under any provision other

than section 167(f) or 197 may be

deducted and is not required to be

capitalized.

(iv) Computer software defined. For

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

any sequence of machine-readable code)

that is designed to cause a computer (as

defined in section 168(i)(2)(B)(ii)) to

perform a desired function or set of

functions, and the documentation required to describe and maintain those

programs. It includes all forms and

media in which the software is contained, whether written, magnetic, or

otherwise. Computer programs of all

classes, for example, operating systems,

executive systems, monitors, compilers

and translators, assembly routines, and

utility programs as well as application

programs, are included. Computer software also includes any incidental and

ancillary rights that are necessary to

effect the acquisition of the title to, the

ownership of, or the right to use the

computer software, and that are used

only in connection with that specific

computer software. Such incidental and

ancillary rights are not included in the

definition of trademark or trade name

under paragraph (b)(10)(i) of this section. For example, a trademark or trade

name that is ancillary to the ownership

or use of a specific computer software

program in the taxpayer’s trade or business and is not acquired for the purpose

of marketing the computer software is

included in the definition of computer

software and is not included in the

definition of trademark or trade name.

Computer software does not include any

data or information base described in

paragraph (b)(4) of this section unless

the data base or item is in the public

domain and is incidental to a computer

program. For this purpose, a copyrighted

or proprietary data or information base

is treated as in the public domain if its

availability through the computer program does not contribute significantly to

the cost of the program. For example, if

a 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.

(v) Readily available to the general

public. Computer software will be

treated as readily available to the general public if the software may be

obtained on substantially the same terms

by a significant number of persons that

would reasonably be expected to use the

software. The requirements of this paragraph (c)(4)(v) can be met even though

the software is not available through a

system of retail distribution.

(5) Certain interests in films, sound

recordings, video tapes, books, or other

similar property. Section 197 intangibles

do not include any interest (including an

interest as a licensee) in a film, sound

recording, video tape, book, or other

similar property (such as the right to

broadcast or transmit a live event) if the

interest is not acquired as part of a

purchase of a trade or business. A film,

sound recording, video tape, book, or

other similar property includes any incidental and ancillary rights (such as a

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

the ownership of, or the right to use the

property and are used only in connection with that property. Such incidental

and ancillary rights are not included in

the definition of trademark or trade

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

section. For purposes of this paragraph

(c)(5), computer software (as defined in

paragraph (c)(4)(iv) of this section) is

not treated as other property similar to a

film, sound recording, video tape, or

book. (See section 167 for amortization

of excluded intangible property or interests.)

(6) Certain rights to receive tangible

property or services. Section 197 intangibles do not include any right to receive tangible property or services under

a contract or from a governmental unit

if the right is not acquired as part of a

purchase of a trade or business. Any

right that is described in the preceding

sentence is not treated as a section 197

intangible even though the right is also

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

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

to certain governmental licenses, permits, and other rights) and even though

the right fails to meet one or more of

the requirements of paragraph (c)(13) of

this section (relating to certain rights of

fixed duration or amount). (See

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

(7) Certain interests in patents or

copyrights. Section 197 intangibles do

not include any interest (including an

interest as a licensee) in a patent, patent

application, or copyright that is not

acquired as part of a purchase of a trade

or business. (See § 1.167(a)–14(c)(4)

for applicable rules.)

(8) Interests under leases of tangible

property—(i) Interest as a lessor. Section 197 intangibles do not include any

interest as a lessor under an existing

lease or sublease of tangible real or

personal property. In addition, the cost

of acquiring an interest as a lessor in

connection with the acquisition of tangible property is taken into account as

part of the cost of the tangible property.

For example, if a taxpayer acquires a

shopping center that is leased to tenants

operating retail stores, any portion of the

purchase price attributable to favorable

lease terms is taken into account as part

of the basis of the shopping center and

in determining the depreciation deduction allowed with respect to the shopping center. (See section 167(c)(2).)

(ii) Interest as a lessee. Section 197

intangibles do not include any interest

as a lessee under an existing lease of

tangible real or personal property. For

this purpose, an airline lease of an

airport passenger or cargo gate is a lease

of tangible property. The cost of acquiring such an interest is taken into account under section 178 and § 1.162–

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

lease of tangible property is acquired in

a transaction with any other intangible

property, a portion of the total purchase

price may be allocable to the interest as

a lessee based on all of the relevant

facts and circumstances.

(9) Interests under indebtedness—(i)

In general. Section 197 intangibles do

not include any interest (whether as a

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

acquired. Thus, for example, the value

attributable to the assumption of an

indebtedness with a below-market interest rate is not amortizable under section

197. In addition, the premium paid for

acquiring a debt instrument with an

above-market interest rate is not amortizable under section 197. See section

171 for rules concerning the treatment

of amortizable bond premium.

(ii) Exceptions. For purposes of this

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

existing indebtedness does not include

the deposit base (and other similar

items) of a financial institution. An

interest under an existing indebtedness

includes mortgage servicing rights, however, to the extent the rights are stripped

coupons under section 1286.

(10) Professional sports franchises.

Section 197 intangibles do not include

any franchise to engage in professional

baseball, basketball, football, or any

other professional sport, and any item

(even though otherwise qualifying as a

section 197 intangible) acquired in connection with such a franchise.

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

right described in section 197(e)(7)

(concerning rights to service indebtedness secured by residential real property

that are not acquired as part of a

purchase of a trade or business). (See

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

(12) Certain transaction costs. Section 197 intangibles do not include any

fees for professional services and any

transaction costs incurred by parties to a

transaction in which all or any portion

of the gain or loss is not recognized

under part III of subchapter C of the

Internal Revnue Code.

(13) Rights of fixed duration or

amount. (i) Section 197 intangibles do

not include any right under a contract or

any license, permit, or other right

granted by a governmental unit if the

right—

(A) Is acquired in the ordinary course

of business and not as part of a purchase of a trade or business;

(B) Is not described in sections

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

(E), or (F); and

(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-ofproduction method.

(ii) See § 1.167(a)–14(c)(2) and (3)

for applicable rules.

(d) Amortizable section 197 intangibles—(1) Definition. Except as otherwise provided in this paragraph (d), the

term amortizable section 197 intangible

means any section 197 intangible acquired after August 10, 1993 (or after

July 25, 1991, if a valid retroactive

election under § 1.197–1T has been

made), and held in connection with the

conduct of a trade or business or an

activity described in section 212.

(2) Exception for self-created intangibles—(i) In general. Except as provided in paragraph (d)(2)(iii) of this

section, amortizable section 197 intangibles do not include any section 197

intangible created by the taxpayer (a

self-created intangible).

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

by the taxpayer to the extent the taxpayer makes payments or otherwise incurs costs for its creation, production,

development, or improvement, whether

the actual work is performed by the

taxpayer or by another person under a

contract with the taxpayer entered into

before the creation, production, development, or improvement occurs. For example, a technological process developed specifically for a taxpayer under

an arrangement with another person pursuant to which the taxpayer retains all

rights to the process is created by the

taxpayer.

(B) Contracts for the use of intangibles. A section 197 intangible is not

created by the taxpayer to the extent

that it results from the entry into (or

renewal of) a contract for the use of an

existing section 197 intangible. Thus,

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

legal and other professional fees incurred by a licensee in connection with

the entry into (or renewal of) a contract

for the use of know-how or similar

property.

If an existing section 197 intangible is

improved or otherwise modified by the

taxpayer or by another person under a

contract with the taxpayer, the existing

intangible and the improvements or

other modifications are treated as separate section 197 intangibles for purposes

of this paragraph (d).

(iii) Exceptions. (A) The exception

for self-created intangibles does not apply to any section 197 intangible described in section 197(d)(1)(D) (relating

to licenses, permits or other rights

granted by a governmental unit),

197(d)(1)(E) (relating to covenants not

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

franchises, trademarks, and trade

names). Thus, for example, capitalized

costs incurred in the development, registration, or defense of a trademark or

trade name do not qualify for the exception and are amortized over 15 years

under section 197.

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

197 intangible created in connection

with the purchase of a trade or business

(as defined in paragraph (e) of this

section).

described in paragraph (h)(4)(ii) of this

section, the exception for self-created

intangibles does not apply to the reacquired intangible.

(3) Exception for property subject to

anti-churning rules. Amortizable section

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

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

this section apply.

(e) Purchase of a trade or business.

Several of the exceptions in section 197

apply only to property that is not acquired in (or created in connection with)

a transaction or series of related transactions involving the acquisition of assets

constituting a trade or business or a

substantial portion thereof. Property acquired in (or created in connection with)

such a transaction or series of related

transactions is referred to in this section

as property acquired as part of (or

created in connection with) a purchase

of a trade or business. For purposes of

section 197 and this section, the applicability of the limitation is determined

under the following rules:

(1) Goodwill or going concern value.

A group of assets constitutes a trade or

business or a substantial portion thereof

if their use would constitute a trade or

business under section 1060 (that is, if

goodwill or going concern value could

under any circumstances attach to the

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

purpose, all the facts and circumstances,

including any employee relationships

that continue (or covenants not to compete that are entered into) as part of the

transfer of the assets, are taken into

account in determining whether goodwill or going concern value could attach

to the assets.

(2) Customer-based

intangibles.

Whether or not a group of assets is

otherwise described in paragraph (e)(1)

of this section, a group of assets constitutes a trade or business or a substantial

portion thereof if the assets include any

customer-based intangibles (as defined

in paragraph (b)(6) of this section) or

are acquired in a transaction or series of

related transactions that involve the creation of any customer-based intangibles.

(3) Franchise, trademark, or trade

name—(i) In general. The acquisition of

a franchise, trademark, or trade name

constitutes the acquisition of a trade or

business or a substantial portion thereof.

(ii) Exceptions. For purposes of this

paragraph (e)(3)—

(A) A trademark or trade name is

disregarded if it is included in computer

software under paragraph (c)(4) of this

section or in an interest in a film, sound

recording, video tape, book, or other

similar property under paragraph (c)(5)

of this section; and

(B) A franchise, trademark, or trade

name is disregarded if its value is

nominal or the taxpayer irrevocably disposes of it immediately after its acquisition.

(4) Acquisitions to be included. The

assets acquired in a transaction (or series of related transactions) include only

assets (including a beneficial or other

indirect interest in assets where the

interest is of a type described in paragraph (c)(1) of this section) acquired by

the taxpayer and persons related to the

taxpayer from another person and persons related to that other person. For

purposes of this paragraph (e)(4), persons are related only if their relationship

is described in section 267(b) or 707(b)

or they are engaged in trades or businesses under common control within the

meaning of section 41(f)(1).

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

business is to be based on all of the

facts and circumstances, including the

nature and the amount of the assets

acquired as well as the nature and

amount of the assets retained by the

transferor. The value of the assets ac-

quired relative to the value of the assets

retained by the transferor is not determinative of whether the acquired assets

constitute a substantial portion of a trade

or business.

(6) Deemed asset purchases under

section 338. A qualified stock purchase

that is treated as a purchase of assets

under section 338 shall be treated as a

transaction involving the acquisition of

assets constituting a trade or business

only if the direct acquisition of the

assets of the corporation would have

been treated as the acquisition of assets

constituting a trade or business.

(f) Computation of amortization deduction—(1) In general. Except as provided in paragraph (f)(2) of this section,

the amortization deduction allowable under section 197(a) is computed as follows:

(i) The adjusted basis (for purposes

of determining gain) of an amortizable

section 197 intangible is amortized ratably over the 15-year period beginning

on the later of—

(A) The first day of the month in

which the property is acquired; or

(B) In the case of property held in

connection with the conduct of a trade

or business, the first day of the month in

which the active conduct of the trade or

business begins.

(ii) Except as otherwise provided in

this section, adjusted basis is determined

under section 1011 and salvage value is

disregarded.

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

(iv) The amortization deduction for a

short taxable year is based on the number of months in the short taxable year.

(2) Treatment of contingent amounts

—(i) Amounts added to basis during

15-year period. Any amount that is

properly included in the basis of an

amortizable section 197 intangible after

the first month of the 15-year period

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

section and before the expiration of this

period is amortized ratably over the

remainder of the 15-year period. For this

purpose, the remainder of the 15-year

period begins on the first day of the

month in which the basis increase occurs. Any reasonable convention may be

used to determine the month in which

the basis increase incurs, provided that

the method selected is used consistently

for all amortizable section 197 intangibles acquired in the same transaction

(or series of related transactions) and

that it does not result in any amount

being added to basis earlier than the

midpoint of the period (for example,

annual, semi-annual, or quarterly) selected.

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

that is not properly included in the basis

of an amortizable section 197 intangible

until after the expiration of the 15-year

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

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

in the basis of the intangible.

(iii) Time for including amounts in

basis. See § 1.461–1(a)(1) for rules

governing the time at which an amount

may be taken into account by a taxpayer

using the cash receipts and disbursements method, and § 1.461–1(a)(2) for

rules governing the time at which a

liability is incurred and generally taken

into account (for example, by treating

the amount of the liability as a capital

expenditure) by an accrual basis taxpayer.

(3) Determination of amounts chargeable to capital account in certain

cases—(i) Covenants not to compete,

rights granted by governmental units,

and contracts for the use of section 197

intangibles—(A) In general. In the case

of a covenant not to compete or other

similar arrangement described in paragraph (b)(9) of this section, any license,

permit, or other right granted by a

governmental unit or an agency or instrumentality thereof described in paragraph (b)(8) of this section, or a contract

for the use of a section 197 intangible

described in paragraph (b)(11) of this

section, the amount chargeable to capital

account includes all amounts required to

be paid pursuant to the agreement or

right, whether or not any amount would

be deductible under section 162 if the

agreement or right were not a section

197 intangible.

(B) Time for taking amounts into account. For purposes of this paragraph

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

§§ 1.461–1(a)(1) (in the case of a taxpayer using the cash receipts and disbursements method of accounting) and

§ 1.461–1(a)(2) (in the case of a taxpayer using an accrual method of accounting), all amounts required to be

paid under an agreement described in

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

shall be treated as amounts payable

under the terms of a debt instrument

issued in exchange for property. Contingent payments made under an agreement

described in paragraph (b)(9) or (11) of

this section will be included in adjusted

basis under the rules of paragraph (f)(2)

of this section.

(ii) Franchises, trademarks, or trade

names and licenses, permits, and other

rights granted by governmental units.

The costs paid or incurred for the

renewal of a franchise, trademark, or

trade name or any license, permit, or

other right granted by a governmental

unit or an agency or instrumentality

thereof are amortized over the 15-year

period that begins with the month of

renewal. Any costs paid or incurred for

the issuance, or earlier renewal, continue

to be taken into account over the remaining portion of the amortization period that began at the time of the

issuance, or earlier renewal. Any amount

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

trade name and chargeable to capital

account is treated as an amount paid or

incurred for a renewal.

(iii) Certain reinsurance transactions.

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

for special rules regarding the adjusted

basis of an insurance contract acquired

through an assumption reinsurance

transaction.

(4) Transactions subject to section

338 or 1060. In the case of a section

197 intangible deemed to have been

acquired as the result of a qualified

stock purchase within the meaning of

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

determined pursuant to section 338(b)(5)

and the regulations thereunder. In the

case of a section 197 intangible acquired

in an applicable asset acquisition within

the meaning of section 1060(c), the

basis shall be determined pursuant to

section 1060(a) and the regulations

thereunder.

(g) Special rules—(1) Treatment of

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

recognized on the disposition of an

amortizable section 197 intangible acquired in a transaction or series of

related transactions in which the taxpayer acquired other amortizable section

197 intangibles if, after the disposition,

the taxpayer retains any of the other

amortizable section 197 intangibles, or

the right to use, or an interest in, any of

the other amortizable section 197 intangibles (the retained intangibles). Except

as otherwise provided in paragraph

(g)(1)(iv)(B) of this section, the adjusted

basis of each of the retained intangibles

is increased by the product of the loss

that is not recognized solely by reason

of this rule and a fraction, the numerator

of which is the adjusted basis of the

retained intangible on the date of the

disposition and the denominator of

which is the total adjusted bases of all

the retained intangibles on that date. The

abandonment of an amortizable section

197 intangible, or any other event rendering an amortizable section 197 intangible worthless, is treated as a disposition of the intangible for purposes of

this paragraph (g)(1), and the abandoned

or worthless intangible is disregarded

(that is, it is not treated as a retained

intangible) for purposes of applying this

paragraph (g)(1) to the subsequent disposition of any other amortizable section

197 intangible.

(B) Certain nonrecognition transfers.

The loss disallowance rule in paragraph

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

when a taxpayer transfers an amortizable section 197 intangible from an

acquired trade or business in a transaction in which the intangible is

transferred-basis property and, after the

transfer, retains other amortizable section 197 intangibles from the trade or

business. Thus, for example, the transfer

of an amortizable section 197 intangible

to a corporation in exchange for stock in

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

partnership in a transaction described in

section 721, when other amortizable

section 197 intangibles acquired in the

same transaction are retained, followed

by a sale of the stock or partnership

interest received, will not avoid the

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

the transferred intangible at the time of

the sale exceeds its fair market value at

that time.

(ii) Separately acquired property.

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

not apply to an amortizable section 197

intangible that is not acquired in a

transaction or series of related transactions in which the taxpayer acquires

other amortizable section 197 intangibles (a separately acquired intangible).

Consequently, a loss may be recognized

upon the disposition of a separately

acquired section 197 intangible. However, the termination or worthlessness of

only a portion of an amortizable section

197 intangible is not the disposition of a

separately acquired intangible. For example, neither the loss of several customers from an acquired customer list,

the termination of several mortgages

(not qualifying for the exception set

forth in paragraph (c)(11) of this sec-

tion) from an acquired mortgage pool,

nor the worthlessness of only some

information from an acquired data base

constitutes the disposition of a separately acquired intangible.

(iii) Disposition of a covenant not to

compete. If a covenant not to compete

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

in connection with the direct or indirect

acquisition of an interest in a trade or

business, the disposition or worthlessness of the covenant or other arrangement will not be considered to occur

until the disposition or worthlessness of

all interests in that trade or business. For

example, a covenant not to compete

entered into in connection with the

purchase of stock continues to be amortized on a 15-year straight-line basis

(even after the covenant expires or becomes worthless) unless all the trades or

businesses in which an interest was

acquired through the stock purchase (or

all the purchaser’s interests in those

trades or businesses) also are disposed

of or become worthless.

(iv) Taxpayers under common control—(A) In general. Except as provided

in paragraph (g)(1)(iv)(B) of this section, all persons that would be treated as

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

are treated as a single taxpayer under

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

a loss is not recognized on the disposition of an amortizable section 197 intangible by a member of a controlled group

of corporations (as defined in section

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

member retains other amortizable section 197 intangibles acquired in the

same transaction as the amortizable section 197 intangible that has been disposed of.

(B) Treatment of disallowed loss. If

retained intangibles are held by a person

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

intangibles retained by the person incurring the disallowed loss is increased,

and only the adjusted basis of those

intangibles is included in the denominator of the fraction described in paragraph (g)(1)(i)(A) of this section. If

none of the retained intangibles are held

by the person incurring the disallowed

loss, the loss is allowed ratably, as a

deduction under section 197, over the

remainder of the period during which

the intangible giving rise to the loss

would have been amortizable, except

that any remaining disallowed loss is

allowed in full on the first date on

which all other retained intangibles have

been disposed of or become worthless.

(2) Treatment of certain nonrecognition and exchange transactions—(i) In

general—(A) Transfer disregarded. Except as otherwise provided in paragraph

(h) of this section, if a section 197

intangible is transferred in a transaction

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

section, the transfer is disregarded in

determining—

(1) Whether, with respect to so much

of the intangible’s basis in the hands of

the transferee as does not exceed its

basis in the hands of the transferor, the

intangible is an amortizable section 197

intangible; and

(2) The amount of the deduction under section 197 with respect to such

basis.

(B) Application of general rule. If the

intangible described in paragraph

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

hands of the transferor, the transferee

will continue to amortize its adjusted

basis, to the extent it does not exceed

the transferor’s adjusted basis, ratably

over the remainder of the transferor’s

15-year amortization period. If the intangible was not an amortizable section

197 intangible in the hands of the

transferor, the transferee’s adjusted basis, to the extent it does not exceed the

transferor’s adjusted basis, cannot be

amortized under section 197. In either

event, the intangible is treated, with

respect to so much of its adjusted basis

in the hands of the transferee as exceeds

its adjusted basis in the hands of the

transferor, in the same manner for purposes of section 197 as an intangible

acquired from the transferor in a transaction that is not described in paragraph

(g)(2)(ii) of this section. The rules of

this paragraph (g)(2)(i) also apply to any

subsequent transfers of the intangible in

a transaction described in paragraph

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

(ii) Transactions covered. The transactions described in this paragraph

(g)(2)(ii) are—

(A) Any transaction described in section 332, 351, 361, 721, or 731; and

(B) Any transaction between corporations that are members of the same

consolidated group immediately after the

transaction.

(iii) Certain exchanged-basis property. This paragraph (g)(2)(iii) applies to

property that is acquired in a transaction

subject to section 1031 or 1033 and is

permitted to be acquired without recognition of gain (replacement property).

Except as otherwise provided in paragraph (h) of this section, replacement

property is treated as if it were the

property by reference to which its basis

is determined (the predecessor property)

in determining whether, with respect to

so much of its basis as does not exceed

the basis of the predecessor property, the

replacement property is an amortizable

section 197 intangible and the amortization period under section 197 with respect to such basis. Thus, if the predecessor property was an amortizable

section 197 intangible, the taxpayer will

amortize the adjusted basis of the replacement property, to the extent it does

not exceed the adjusted basis of the

predecessor property, ratably over the

remainder of the 15-year amortization

period for the predecessor property. If

the predecessor property was not an

amortizable section 197 intangible, the

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

adjusted basis of the predecessor property, may not be amortized under section

197. In either event, the replacement

property is treated, with respect to so

much of its adjusted basis as exceeds

the adjusted basis of the predecessor

property, in the same manner for purposes of section 197 as property acquired from the transferee in a transaction that is not subject to section 1031

or 1033. (See paragraph (h) of this

section for the application of the antichurning rules.)

(iv) Transfers under section 708(b)(1)—(A) In general. Paragraph (g)(2)(i)

of this section applies to transfers of

section 197 intangibles that occur or are

deemed to occur by reason of the termination of a partnership under section

708(b)(1).

(B) Termination by sale or exchange

of interest. In applying paragraph

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

that is terminated pursuant to section

708(b)(1)(B) (relating to a sale or exchange of an interest), the terminated

partnership is treated as the transferor

and the new partnership is treated as the

transferee with respect to any section

197 intangible held by the terminated

partnership immediately preceding the

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

this section for the treatment of increases in the basis of property of the

terminated partnership under section

743(b).)

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

partnership that is terminated pursuant

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

sation of activities by a partnership), the

terminated partnership is treated as the

transferor and the distributee partner is

treated as the transferee with respect to

any section 197 intangible held by the

terminated partnership immediately preceding the termination.

(D) Anti-churning rules. See paragraph (h) of this section for the application of the anti-churning rules.

(v) Distributions to which section

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

this section applies to a distribution of a

section 197 intangible to which section

732(d) (relating to special partnership

basis to transferee) applies. For purposes

of section 197, any increase in the basis

of the distributed intangible under section 732(d) is taken into account by a

partner as if the increased portion were

attributable to the partner’s acquisition

of the underlying partnership property

on the date of distribution from the

transferor of the partnership interest or

the deceased partner, as the case may

be. For purposes of the effective date

and anti-churning rules (paragraphs

(d)(1) and (h) of this section), the

intangible is treated as having been

acquired by the transferee partner at the

time of the transfer of the partnership

interest described in section 732(d). For

purposes of determining the amortization period under section 197 with respect to any increased basis, however,

the intangible is treated as having been

acquired by the transferee partner at the

time of the distribution described in

section 732(a). (See paragraph (h) of

this section for the application of the

anti-churning rules.)

(vi) Curative and remedial allocations under section 704(c). For purposes

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

a section 197 intangible is transferred to

a partnership in a transaction described

in section 721, the basis of the intangible in the hands of the transferor

includes the amount of any curative or

remedial allocations of amortization that

are made to a noncontributing partner

with respect to the contributed intangible under the curative or remedial

methods for making allocations under

section 704(c). Thus, for example, if a

contributed intangible is not an amortizable section 197 intangible in the hands

of the transferor, any remedial allocations of amortization made to a noncontributing partner with respect to the

intangible are not amortizable under

section 197. See § 1.704–3(c) and (d)

for a description of the curative and

remedial methods.

(3) Application of section 754 to acquisitions of an interest in an intangible

held through a partnership. Any increase in the basis of partnership property under section 734(b) (relating to the

optional adjustment to the basis of undistributed partnership property) or section 743(b) (relating to the optional

adjustment to the basis of partnership

property) is taken into account under

section 197 by a partner as if the

increased portion of the basis were

attributable to the partner’s acquisition

of the underlying partnership property

and as if the property were acquired

from the distributee partner on the date

of the distribution (in the case of a basis

increase under section 734(b)) or from

the transferor of the partnership interest

on the date of the transfer (in the case

of a basis increase under section

743(b)). (See paragraph (h) of this section for the application of the antichurning rules.)

(4) Treatment of certain reinsurance

transactions—(i) In general. Section

197 applies to any insurance contract

acquired from another person through an

assumption reinsurance transaction. For

purposes of section 197, an assumption

reinsurance transaction is—

(A) Any arrangement in which one

insurance company (the reinsurer) becomes solely liable to policyholders on

contracts transferred by another insurance company (the ceding company);

and

(B) Any acquisition of an insurance

contract that is treated as occurring by

reason of an election under section 338.

(ii) Determination of adjusted basis—

(A) Acquisitions (other than under section 338) of specified insurance contracts. The amount taken into account

for purposes of section 197 as the

adjusted basis of specified insurance

contracts (as defined in section

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

reinsurance transaction that is not described in paragraph (g)(4)(i)(B) of this

section is equal to the excess of—

(1) The amount paid or incurred (or

treated as having been paid or incurred)

by the reinsurer for the purchase of the

contracts (as determined under § 1.817–

4(d)(2)); over

(2) The amount of the specified

policy acquisition expenses that are attributable to the reinsurer’s net positive

consideration for the reinsurance agreement (as determined under § 1.848–

2(f)(3)).

(B) Other acquisitions. [Reserved]

(5) Amounts paid or incurred for a

franchise, trademark, or trade name. If

an amount to which section 1253(d)

(relating to the transfer, sale, or other

disposition of a franchise, trademark, or

trade name) applies is described in section 1253(d)(1)(B) (relating to contingent serial payments), the amount is

deductible under section 1253(d)(1) and

is not included in the adjusted basis of

the intangible for purposes of section

197. Any other amount, whether fixed

or contingent, to which section 1253(d)

applies is chargeable to capital account

under section 1253(d)(2) and is amortizable only under section 197.

(6) Amounts properly taken into account in determining the cost of property that is not a section 197 intangible.

Section 197 does not apply to an

amount that is properly taken into account in determining the cost of property that is not a section 197 intangible.

The entire cost of acquiring the other

property is included in its basis and

recovered under other applicable Internal Revenue Code provisions.

(7) Treatment of amortizable section

197 intangibles as depreciable property—(i) In general. An amortizable

section 197 intangible is treated as property of a character subject to the allowance for depreciation under section 167.

Thus, for example, an amortizable section 197 intangible is not a capital asset

for purposes of section 1221, but if held

for more than one year, it generally

qualifies under section 1231 as property

used in a trade or business. Also, an

amortizable section 197 intangible is

section 1245 property and section 1239

applies to any gain recognized upon its

sale or exchange between related persons (as defined in section 1239(b)).

(ii) Exceptions and limitations—(A)

Unstated interest and original issue discount rules. In the case of the acquisition of any amortizable section 197

intangible in a transaction that would

not be treated as the sale or exchange of

property by the person from which the

intangible was acquired, paragraph

(g)(7)(i) of this section shall not apply

(and the amortizable section 197 intangible shall not be treated as property)

for purposes of—

(1) Section 483(c) (relating to payments on account of the sale or exchange of property); and

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

instruments given in consideration for

the sale or exchange of property).

(B) Treatment of other parties to

transaction. No person shall be treated

as having sold, exchanged, or otherwise

disposed of property in a transaction for

purposes of any provision of the Internal

Revenue Code solely by reason of the

application of paragraph (g)(7)(i) of this

section to any other party to the transaction.

(h) Anti-churning rules—(1) Conversions of existing goodwill, going concern value, and certain other section

197 intangibles. Except as otherwise

provided in this paragraph (h), goodwill,

going concern value, or any other section 197 intangible for which a depreciation or amortization deduction would

not have been allowable prior to the

enactment of section 197 may not be

amortized as an amortizable section 197

intangible if the section 197 intangible

is acquired by a taxpayer after August

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

valid retroactive election pursuant to

§ 1.197–1T has been made) and either—

(i) The taxpayer or a related person

held or used the intangible or an interest

therein at any time during the transition

period;

(ii) The taxpayer acquired the intangible from a person that held the intangible at any time during the transition

period and, as part of the transaction,

the user of the intangible does not

change; or

(iii) The taxpayer grants the right to

use the intangible to a person (or a

person related to that person) that held

or used the intangible at any time during

the transition period.

(2) Amounts deductible under section

1253(d). For purposes of paragraph

(h)(1) of this section, deductions allowable under section 1253(d)(2) or deductions allowable pursuant to an election

under section 1253(d)(3) (in either case

as in effect prior to the enactment of

section 197) are treated as deductions

allowable for amortization.

(3) Transition period. For purposes of

this paragraph (h), the transition period

begins on July 25, 1991, and ends on

August 10, 1993, except that for taxpayers that made a valid retroactive election

pursuant to § 1.197–1T, the transition

period is July 25, 1991.

(4) Exceptions. The anti-churning

rules of this paragraph (h) do not apply

to—

(i) The acquisition of an intangible

by a taxpayer if the basis of the intangible is determined under section

1014(a); or

(ii) The acquisition of an intangible

by a taxpayer that is an amortizable

section 197 intangible in the hands of

the seller (or transferor), but only if the

acquisition by the taxpayer or sale by

the seller (or transfer by the transferor)

was not part of a transaction or a series

of related transactions in which the

seller (or transferor) previously acquired

the intangible or interest therein.

(5) Special partnership provisions—

(i) Basis increases. In determining

whether the anti-churning rules of this

paragraph (h) apply to any increase in

the basis of partnership property under

section 732, 734, or 743, the determinations are made at the partner level and

each partner is treated as having owned

and used the partner’s proportionate

share of the partnership property. Thus,

for example, the anti-churning rules do

not apply to an increase in the basis of

partnership property under section

743(b) that occurs upon the acquisition

of an interest in a partnership that has

made a section 754 election if the

person acquiring the partnership interest

either is not related to the person transferring the partnership interest or acquired the interest upon the death of the

former partner. Similarly, the antichurning rules do not apply to a continuing partner’s proportionate share of

an increase in the basis of partnership

property under section 734(b) that occurs upon the distribution of property of

a partnership that has made a section

754 election if the continuing partner is

not related to the distributee partner.

(ii) Curative and remedial allocations

under section 704(c). In determining

whether the anti-churning rules of this

paragraph (h) apply, any curative or

remedial allocation of amortization

made to a noncontributing partner under

the curative or remedial methods for

making allocations under section 704(c)

is treated in the same manner as a

noncurative or nonremedial allocation of

amortization. Thus, for example, if the

anti-churning rules would apply to a

nonremedial allocation of amortization

to a noncontributing partner, the antichurning rules apply to any remedial

allocation of amortization. See § 1.704–

3(c) and (d) for a description of the

curative and remedial methods.

(6) Related person—(i) In general.

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

is related to another person for purposes

of this paragraph (h) if—

(A) The person bears a relationship

to that person that would be specified in

section 267(b) (determined without regard to section 267(e)) and, by substitu-

tion, section 267(f)(1), if those sections

were amended by substituting 20 percent for 50 percent; or

(B) The person bears a relationship to

that person that would be specified in

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

amended by substituting 20 percent for

50 percent; or

trades or businesses under common control (within the meaning of section

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

(ii) Time for testing relationships. For

purposes of this paragraph (h), a person

is treated as related to another person if

the relationship exists—

(A) In the case of a single transaction, immediately before or immediately

after the acquisition of the intangible

involved; or

(B) In the case of a series of related

transactions, at any time during the

period beginning immediately before the

earliest acquisition and ending immediately after the last acquisition of any

intangible acquired in the series of

transactions.

(iii) De minimis rule—(A) In general.

Two corporations shall not be treated as

related persons for purposes of this

paragraph (h)(6) if—

(1) The corporations would (but for

the application of this paragraph

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

solely by reason of substituting ‘‘more

than 20 percent’’ for ‘‘more than 50

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

(2) The beneficial ownership interest

of one corporation in the stock of the

other corporation represents less than 10

percent of the total combined voting

power of all classes of stock entitled to

vote and less than 10 percent of the

total value of the shares of all classes of

stock outstanding.

(B) Determination of beneficial ownership interest. For purposes of this

paragraph (h)(6)(iii), the beneficial ownership interest of one corporation in the

stock of another corporation shall be

determined under the principles of section 318(a), except that—

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

the 50 percent limitation contained

therein shall not be applied; and

(2) Section 318(a)(3)(C) shall be applied by substituting ‘‘20 percent’’ for

‘‘50 percent’’.

(7) Special rules for entities that

owned or used property at any time

during the transition period and that are

no longer in existence. A corporation,

partnership, or trust that owned or used

property at any time during the transi-

tion period and that is no longer in

existence is deemed to be in existence

for purposes of determining whether the

taxpayer that acquired the property is

related to the corporation, partnership,

or trust.

(8) Special rules for section 338

deemed acquisitions. In the case of a

qualified stock purchase that is treated

as a deemed sale and purchase of assets

pursuant to section 338, the corporation

that is treated as selling its assets as a

result of an election thereunder (old

target) is not considered related to the

corporation that is treated as purchasing

the assets (new target) if stock of old

target meeting the requirements of section 1504(a)(2) is, or is deemed to have

been, acquired by purchase after July

25, 1991. See § 1.338–2(d). Thus, for

example, if a corporation (the purchasing corporation) makes a qualified stock

purchase of the stock of another corporation (target) from unrelated third parties in July 1997, and a section 338

election is made by the purchasing corporation, the deemed asset purchase

shall not be considered as an acquisition

between related persons solely by virtue

of the fact that old target and new target

are treated as the same corporation for

certain other purposes of the Code or

that old target and new target are the

same corporation under the laws of the

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

of this paragraph (h) may nevertheless

apply to a deemed asset purchase resulting from a section 338 election because

old target and new target are otherwise

treated as related parties within the

meaning of paragraph (h)(6) of this

section.

(9) Exception to anti-churning rules

where gain is recognized—(i) In general. If a taxpayer would not be subject

to paragraph (h) but for the substitution

of 20 percent for 50 percent under

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

and the person (whether or not subject

to Federal income tax) from which the

taxpayer acquires the intangible elects to

recognize gain on the disposition of the

intangible and, notwithstanding any

other provision of the Internal Revenue

Code, agrees to pay an amount that,

when added to any other Federal income

tax, equals the gain on the disposition

multiplied by the highest marginal rate

of tax imposed by section 1 (for individuals, estates, or trusts) or 11 (for

corporations), whichever is applicable,

for the taxable year in which the gain is

realized by the pe

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