Regs on Intangible Asset Acquisitions

 [4830-01-u]

[2] ACTION: Final and temporary regulations.

[3] SUMMARY: This document amends the temporary regulations under sections 1060 and 338(b) of the Internal Revenue Code (Code) relating to purchase price allocations in taxable asset acquisitions and deemed asset purchases. The amendments revise the treatment of intangible assets in such acquisitions to take into account the enactment of section 197 by the Omnibus Budget Reconciliation Act of 1993. This document also makes conforming amendments to the final regulations under section 338. The regulations provide guidance regarding taxable asset acquisitions and deemed asset purchases resulting from elections under section 338. The text of the temporary regulations herein also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking on this subject in the Proposed Rules section of this issue of the Federal Register.

[4] EFFECTIVE DATE: These regulations are effective February 14, 1997.

[5] For dates of applicability, see sections 1.338(b)-2T(c)(4) and 1.1060-1T(a)(2)(ii).

[6] FOR FURTHER INFORMATION CONTACT: Brendan P. O'Hara, Office of Assistant Chief Counsel (Corporate), (202) 622-7530 (not a toll- free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

[7] These regulations amend the current temporary regulations under sections 1060 (section 1.1060-1T) and 338(b) (sections 1.338(b)-2T and 1.338(b)-3T) (the current regulations) with respect to the treatment of acquired intangible assets. They also amend related examples in the final regulations under section 338. Section 1060 provides for the allocation of purchase price among the assets of a trade or business under regulations. Section 338(b) provides for a similar allocation, also under regulations, for a deemed purchase of assets under section 338. The current regulations employ a residual method of allocation. The legislative history of section 1060, adopted in 1986, noted with approval the use of the residual method under the section 338(b) regulations and required that the same method be used pursuant to regulations to be prescribed under section 1060. S. Rep. No. 99-313, 99th Cong., 2d Sess. 253, 254 (1986); 1986-3 C.B. Vol. 3, 253-54.

[8] The current regulations place each acquired asset into one of four asset classes. The purchase price is allocated among the classes in priority order. No asset in any class except for the last class is allocated more than its fair market value. If the aggregate purchase price allocable to a particular class is less than the aggregate fair market value of the assets within the class, each asset is allocated an amount in proportion to its fair market value and nothing is allocated to any junior class.

[9] The four classes under the current regulations are as follows:

Class I -- Cash and cash equivalents;

Class II -- Certificates of deposit, U.S. government securities, readily marketable stock or securities, and foreign currency;

Class III -- All assets not in Class I, II, or IV; and

Class IV -- Intangible assets in the nature of goodwill and going concern value.

[10] Section 197 was enacted as part of the Omnibus Budget Reconciliation Act of 1993, Public Law 103-66, 107 Stat. 312 (1993) (the 1993 Act). Prior to the 1993 Act, acquired goodwill and going concern value were not amortizable, but other acquired intangible assets were amortizable if they could be separately identified and their useful lives determined with reasonable accuracy. Section 197 responded to policy and administrative concerns regarding the treatment of acquired intangibles by providing similar treatment for goodwill, going concern value, and certain other intangible assets acquired in a taxable acquisition and held in connection with a trade or business. The 1993 Act allows taxpayers to amortize certain acquired intangible assets (amortizable section 197 intangibles) over 15 years, subject to certain exceptions.

[11] The report of the House Committee on Ways and Means accompanying the 1993 Act states that:

It is expected that the present [regulations under sections 338 and 1060] will be amended to reflect the fact that [section 197] allows an amortization deduction with respect to intangible assets in the nature of goodwill and going concern value. It is anticipated that the residual method specified in the regulations will be modified to treat all amortizable section 197 intangibles as Class IV assets and that this modification will apply to any acquisition of property to which [section 197] applies.

H.R. Rep. 111, 103d Cong., 1st Sess. 760, 776 (May 23, 1993), 1993-3 C.B. 336, 352.

[12] The current regulations have not yet been amended in accordance with the legislative history of section 197. These new temporary regulations accomplish that change, with slight modifications, as discussed below.

EXPLANATION OF PROVISIONS

[13] The temporary and final regulations are amended to conform to the legislative history of the 1993 Act by placing all amortizable section 197 intangibles other than goodwill and going concern value in Class IV.

[14] However, the new regulations also include nonamortizable section 197 intangibles in Class IV. Some section 197 intangibles are amortizable by the buyer though they were not amortizable by the seller. Other section 197 intangibles may not be amortizable because of the application of the anti-churning rules of section 197(f)(9). Although sections 338(b) and 1060 do not require conformity between the buyer and seller on purchase price allocations, they reflect strong policies encouraging conformity, including mandatory application of the rule of Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), cert. denied, 389 U.S. 858 (1967), in cases where the parties have agreed to an allocation, and a reporting system designed to reveal situations where the parties' allocations are inconsistent. These policies favoring conformity are best served by requiring both parties to include the same assets in each class. Moreover, this rule is also more consistent with section 1060(b) as amended by the 1993 Act. Section 1060(b)(1) requires the parties to report, under regulations, "the amount of consideration received for the assets which is allocable to section 197 intangibles." The term SECTION 197 INTANGIBLES is more inclusive than amortizable section 197 intangibles. The goals of consistency, simplification, and administrability will be better achieved with respect to allocations to section 197 intangibles if all such assets are removed from Class III and isolated in a junior class (or classes). Accordingly, these regulations classify all section 197 intangibles (other than goodwill and going concern value) as Class IV assets.

[15] To reconcile the original intention of Congress in requiring the residual method of allocation for goodwill and going concern value with the legislative history of the 1993 Act, these regulations provide that goodwill and going concern value will be assigned to a true residual class, Class V. This method is consistent with the policies of section 197 (which regards many intangible assets as the functional equivalent of goodwill and going concern value and thus treats them uniformly) as well as the original intention of the Tax Reform Act of 1986, Public Law 99-514, 100 Stat. 2085 (1986) (that goodwill and going concern value not be valued separately for purchase price allocation purposes). Allocating goodwill and going concern value to Class V avoids the need for determining the value of goodwill and going concern value through a non-residual method. Although this approach places some section 197 intangibles in Class V instead of Class IV, it carries out the expectation set forth in the legislative history of the 1993 Act by making section 197 intangibles junior to all other assets in the allocation scheme. The practical significance of placing goodwill and going concern value in Class V is generally limited to circumstances in which fewer than all of the amortizable section 197 intangibles acquired in a single transaction are subsequently disposed of at a gain. Those situations, in any case, require some method of allocation among the intangibles.

EFFECTIVE DATE

[16] These regulations are effective for applicable asset acquisitions, as defined in section 1060(c), completed on or after February 14, 1997, and for acquisition dates, as defined in section 338(h)(2), on or after February 14, 1997.

[17] As described above, the current regulations have been in conflict with the 1993 Act legislative history concerning the classification of amortizable section 197 intangibles other than goodwill and going concern value since August 10, 1993, generally (the date of enactment of section 197), and, in some cases, since 1991.

[18] The legislative history to the 1993 Act clearly contemplates that changes to the classification system would be made by amended regulations. In the absence of such amendments, the only system available under regulations was the four-class system established before the enactment of section 197. Further, the IRS revised Form 8594, Asset Acquisition Statement under Section 1060, in January of 1996 in a manner consistent with the legislative history, i.e., by placing all amortizable section 197 intangibles in Class IV. For acquisition dates before February 14, 1997, if section 197 applies to any asset acquired or deemed acquired, the taxpayer (and all related parties) may consistently (in all transactions in which AGUB, ADSP, MADSP, or consideration must be allocated under section 338 or 1060) --

(i) apply these new rules in full as written;

(ii) apply the current temporary regulations as written; or

(iii) apply the current temporary regulations as written, but treat all amortizable section 197 intangibles as Class IV assets.

SPECIAL ANALYSES

[19] It has been determined that this Treasury decision 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 Code, these regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

[20] The principal author of these regulations is Brendan P. O'Hara, Office of the Assistant Chief Counsel (Corporate), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS IN 26 CFR PART 1

[21] Income taxes, Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

[22] Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

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

Par. 2. In section 1.338-0, entries for section 1.338(b)- 2T(b)(2)(v) and section 1.338(b)-2T(c)(4) are added to read as follows:

SECTION 1.338-0 OUTLINE OF TOPICS.

* * * * *

SECTION 1.338(b)-2T ALLOCATION OF ADJUSTED GROSSED-UP BASIS AMONG TARGET ASSETS (TEMPORARY).

* * * * *

(b) * * *

(2) * * *

(v) Class V assets.

(c) * * *

(4) Effective dates.

* * * * *

Par. 3. Section 1.338-3 is amended by:

1. Revising paragraph (b)(4).

2. Revising paragraph (d)(8)(ii) Example 1, paragraph (e); Example 2, paragraphs (a), (b), and (d); Example 3, paragraph (d); and Example 4, paragraphs (d) and (f).

The revisions read as follows:

SECTION 1.338-3 DEEMED SALE AND AGGREGATE DEEMED SALE PRICE.

(b) * * *

(4) CLASSES OF ASSETS. The classes of assets are defined in section 1.338(b)-2T(b).

* * * * *

(d) * * *

(8) * * *

(ii) * * *

 EXAMPLE 1. * * *

1. Revising paragraphs (b)(2), (c)(1), and (c)(3)(iii).

2. Adding paragraph (c)(4).

3. Revising paragraph (d) Example 1, paragraphs (vi) and (x) through (xiii).

4. Revising paragraph (d) Example 2, paragraphs (vi) through (viii).

The revisions and addition read as follows:

SECTION 1.338(b)-2T ALLOCATION OF ADJUSTED GROSSED-UP BASIS AMONG TARGET ASSETS (TEMPORARY).

* * * * *

(b) * * *

(2) OTHER ASSETS -- (i) IN GENERAL. Subject to the limitations and other special rules of paragraph (c) of this section, adjusted grossed-up basis (as reduced by Class I assets) is allocated among Class II assets of target held at the beginning of the day after the acquisition date in proportion to their fair market values at such time, then among Class III assets so held in such proportion, then among Class IV assets so held in such proportion, and finally to Class V assets.

(ii) CLASS II ASSETS. Class II assets are certificates of deposit, U.S. Government securities, readily marketable stock or securities (within the meaning of section 1.351-1(c)(3)), foreign currency, and other items designated in the Internal Revenue Bulletin by the Internal Revenue Service.

(iii) CLASS III ASSETS. Class III assets are all assets of target other than Class I, II, IV, and V assets.

(iv) CLASS IV ASSETS. Class IV assets are all section 197 intangibles, as defined in section 197, except those in the nature of goodwill and going concern value.

(v) CLASS V ASSETS. Class V assets are section 197 intangibles in the nature of goodwill and going concern value.

(c) * * *

(1) BASIS NOT TO EXCEED FAIR MARKET VALUE. The amount of adjusted grossed-up basis allocated to an asset (other than Class V assets) shall not exceed the fair market value of that asset at the beginning of the day after the acquisition date. For modification of this fair market value limitation with respect to certain contingent income assets, see section 1.338(b)-3T(g).

* * * * *

(3) * * *

(iii) ALLOCATION OF ADJUSTED GROSSED-UP BASIS. Subject to the limitations in paragraphs (c)(1) and (2) of this section, adjusted grossed-up basis (after reduction by the amount of Class I assets) is allocated among Class II, III, IV, and V assets of target held at the beginning of the day after the acquisition date in proportion to their fair market values at such time. For this purpose, the fair market value of Class V assets is deemed to be the excess, if any, of the hypothetical purchase price over the sum of the amount of the Class I assets and the fair market values of the Class II, III, and IV assets.

(4) EFFECTIVE DATES. This section applies for acquisition dates on or after February 14, 1997. For acquisition dates before February 14, 1997, if section 197 does not apply to any asset deemed acquired, the provisions of the regulations in effect before February 14, 1997, apply (see section 1.338(b)-2T as contained in 26 CFR part 1 revised April 1, 1996). For acquisition dates before February 14, 1997, if section 197 applies to any asset deemed acquired, the taxpayer (and all related parties) may consistently (in all transactions in which AGUB, ADSP, MADSP, or consideration must be allocated under section 338 or 1060) --

(i) Apply the provisions of this section;

(ii) Apply the provisions of this section as in effect before February 14, 1997 (see section 1.338(b)-2T as contained in 26 CFR part 1 revised April 1, 1996); or

(iii) Apply the provisions of this section as in effect before February 14, 1997 (see section 1.338(b)-2T as contained in 26 CFR part 1 revised April 1, 1996), but treat all amortizable section 197 intangibles as Class IV assets.

(d) * * *

EXAMPLE 1. * * *

 (vi) T has no Class IV assets. The amount allocated to T's

1. Revising paragraphs (e)(1), (f)(1), and (f)(2).

2. In paragraph (j), redesignating Example (1) through Example (8) as Example 1 through Example 8.

3. Revising the following newly designated examples in paragraph (j): Example 1; Example 2; Example 3, paragraph (i) and paragraphs (v) through (vii); and Example 6 through Example 8.

The revisions read as follows:

SECTION 1.338(b)-3T SUBSEQUENT ADJUSTMENTS TO ADJUSTED GROSSED-UP BASIS (TEMPORARY).

* * * * *

(e) * * *

(1) IN GENERAL. If adjusted grossed-up basis was allocated in accordance with the rules of section 1.338(b)-2T(b)(2), a decrease in adjusted gross-up basis (as determined under paragraph (c)(3) of this section) is allocated in the following order: first, as a reduction in the bases of target's Class V acquisition date assets, second, as a reduction of the bases of target's Class IV acquisition date assets in proportion to their fair market values at the beginning of the day after the acquisition date, third, as a reduction of the bases of target's Class III acquisition date assets in proportion to their fair market values at the beginning of the day after the acquisition date, and finally, as a reduction of the bases of target's Class II acquisition date assets in proportion to their fair market values at the beginning of the day after the acquisition date. The decrease in adjusted grossed-up basis allocated to an asset shall not exceed the adjusted grossed-up basis of target previously allocated to that asset. If adjusted grossed-up basis was allocated among target's assets pursuant to section 1.338(b)-2T(c)(3), a decrease in adjusted grossed-up basis (as determined under paragraph (c)(3) of this section) is accounted for in accordance with the rules of paragraph (f) of this section.

* * * * *

(f) * * *

(1) SCOPE. This paragraph (f) applies if adjusted grossed-up basis was allocated among new target's Class II, III, IV, and V assets in accordance with section 1.338(b)-2T(c)(3) and an adjustment event occurs after the close of the new target's first taxable year.

(2) ALLOCATION OF INCREASES (DECREASES) IN ADJUSTED GROSSED-UP BASIS. If an adjustment event after the close of new target's first taxable year increases (or decreases) adjusted grossed-up basis, the following items shall be redetermined, taking into account such adjustment event: the hypothetical purchase price, the deemed fair market value of Class V assets, and the adjusted grossed-up basis allocable to each acquisition date asset under section 1.338(b)- 2T(c)(3) (the redetermined (c)(3) amount). (The redetermination of the deemed fair market value of Class V assets under this paragraph (f)(2) is made by taking into account the target's Class I assets and the fair market values of its Class II, III, and IV assets at the beginning of the day after the acquisition date.) If the redetermined (c)(3) amount for an acquisition date asset exceeds the amount of adjusted grossed-up basis previously allocated to such asset (taking into account prior adjustments under this paragraph (f)), an amount of adjusted grossed-up basis equal to such excess shall be allocated to such asset. If the amount of the adjusted grossed-up basis previously allocated to an acquisition date asset (taking into account prior adjustments under this paragraph (f)) exceeds the redetermined (c)(3) amount for that asset, an amount equal to such excess shall be allocated as a reduction in the basis of such asset. The rules of paragraph (d)(2) of this section (or paragraph (e)(2) of this section) apply for the treatment of amounts allocable under this paragraph (f) to an acquisition date asset that has been disposed of, depreciated, amortized, or depleted.

* * * * *

(j) * * *

 EXAMPLE 1. (i)(A) T's assets other than goodwill and going

1. Designating the text of paragraph (a)(2) following the heading as paragraph (a)(2)(i), adding a heading to newly designated paragraph (a)(2)(i), and adding paragraph (a)(2)(ii).

2. In paragraph (a)(3), revising the outline of topics entries for (a)(2), (b)(2) and (h)(3).

3. Revising the seventh sentence of paragraph (b)(4).

4. Revising paragraphs (d)(2), (e)(1), and (f)(3)(i).

5. Revising the following examples in paragraph (g): EXAMPLE 1; EXAMPLE 2; EXAMPLE 3, paragraphs (i), (viii), and (xi); and EXAMPLE 4.

5. Revising paragraph (h)(3).

The additions and revisions read as follows:

SECTION 1.1060-1T SPECIAL ALLOCATION RULES FOR CERTAIN ASSET ACQUISITIONS (TEMPORARY)

(a) * * *

(2) EFFECTIVE DATE -- (i) IN GENERAL. * * *

(ii) ALLOCATION OF CONSIDERATION. Paragraphs (d) and (h)(3) of this section and conforming amendments to other provisions of this section apply to applicable asset acquisitions completed on or after February 14, 1997. For applicable asset acquisitions completed before February 14, 1997, if section 197 does not apply to any of the acquired assets, the provisions of the regulations in effect before February 14, 1997 apply (see section 1.1060-1T as contained in 26 CFR part 1 revised April 1, 1996). For applicable asset acquisitions completed before February 14, 1997, if section 197 applies to any of the acquired assets, the taxpayer (and related parties) may consistently (in all transactions in which AGUB (as defined in section 1.338(b)-1), ADSP (as defined in section 1.338-3), MADSP (as defined in section 1.338(h)(10)-1), or consideration must be allocated under section 338 or 1060) --

(A) Apply the provisions of this section;

(B) Apply the provisions of this section as in effect before February 14, 1997 (see section 1.1060-1T as contained in 26 CFR part 1 revised April 1, 1996); or

(C) Apply the provisions of this section as in effect before February 14, 1997 (see section 1.1060-1T as contained in 26 CFR part 1 revised April 1, 1996), but treat all amortizable section 197 intangibles as Class IV assets.

(3) * * *

(a) * * *

(2) Effective date.

(i) In general.

(ii) Allocation of consideration.

* * * * *

(d) * * *

(2) Assets other than Class I assets.

(i) In general.

(ii) Class II assets.

(iii) Class III assets.

(iv) Class IV assets.

(v) Class V assets.

* * * * *

(h) * * *

(3) Interim procedures for Form 8594.

(b) * * *

(4) * * * The money and other property that are treated as transferred in exchange for the like-kind property (and which are excluded from the assets to which section 1060 applies) are considered to come from the following assets in the following order: first from Class I assets, then from Class II assets, then from Class III assets, then from Class IV assets, and then from Class V assets. * * *

(d) * * *

(2) ASSETS OTHER THAN CLASS I ASSETS -- (I) IN GENERAL. Subject to the limitations and other special rules of paragraph (e) of this section, consideration (as reduced by the amount of Class I assets) is allocated among Class II assets transferred by the seller in proportion to the fair market values of such Class II assets on the purchase date, then among Class III assets transferred by the seller in proportion to the fair market values of such Class III assets on that date, then among Class IV assets transferred by the seller in proportion to the fair market values of such Class IV assets on that date, and finally to Class V assets.

(ii) CLASS II ASSETS. Class II assets are certificates of deposit, U.S. government securities, readily marketable stock or securities (within the meaning of section 1.351-1(c)(3)), foreign currency, and other items designated in the Internal Revenue Bulletin by the Internal Revenue Service.

(iii) CLASS III ASSETS. Class III assets are all assets other than Class I, II, IV, and V assets.

(iv) CLASS IV ASSETS. Class IV assets are all section 197 intangibles, as defined in section 197, except those in the nature of goodwill and going concern value.

(v) CLASS V ASSETS. Class V assets are section 197 intangibles in the nature of goodwill and going concern value.

(e) * * *

(1) ALLOCATION NOT TO EXCEED FAIR MARKET VALUE. The amount of consideration allocated to an asset (other than Class V assets) shall not exceed the fair market value of that asset on the purchase date.

* * * * *

(f) * * *

(3) * * *

(i) IN GENERAL. A decrease in consideration is allocated in the following order: first, as a reduction in the amount previously allocated to Class V assets, second, as a reduction in the amount previously allocated to Class IV assets in proportion to their fair market values, third, as a reduction in the amount previously allocated to Class III assets in proportion to their fair market values, and finally, as a reduction in the amount previously allocated to Class II assets in proportion to their fair market values. Decreases in consideration allocated to an asset shall not exceed the amount of consideration previously allocated to that asset. Except as provided in paragraph (f)(4)(ii) of this section (relating to patents and similar property), the fair market value is the fair market value on the purchase date.

* * * * *

(g) * * *

 EXAMPLE 1. (i) On January 1, 1998, S, a sole proprietor,

(3) INTERIM PROCEDURES FOR FORM 8594. Until such time, if any, as Form 8594 is revised to require otherwise, the sum of the amounts allocated to Classes IV and V should be reported on Form 8594 as Class IV assets.