15-year amortization for covenant not to compete in redemption acquisition.

• Author: O'Driscoll, David

Corp. sells and services new and used vehicles. R Corp. purchases and operates automobile dealerships and provides consulting services to those dealerships. S is R's president and participated in Y's management from 1987-1994. R purchased all of Y's stock in 1987. Y hired M, one of S's long-term employes, to be its executive manager. From 1987-1994, R allowed M to purchase 25% of Y's stock. By Aug. 1, 1994, R owned 75% and M owned 25% of Y's stock.

Y redeemed its stock owned by R under a stock sale agreement effective on Aug. 1, 1994. Because of the redemption, M became Y's sole shareholder. R, S and Y also entered into a noncompetition agreement ("covenant"), also effective on Aug. 1, 1994. It stated that R and S would not compete with Y for five years. Y agreed to pay R and S $22,000 per month for five years as consideration for the covenant. Y used funds borrowed from GMAC. Without the covenant, Y may not have been able to raise capital or pay its GMAC loan.

Y claimed that the covenant should be amortized for five years, over the life of the agreement, and not under the Sec. 197 15-year amortization period. The only issue is whether Y must amortize the covenant under Sec. 197.

Analysis

Sec. 197(d)(1)(E) provides that a Sec. 197 intangible includes "... any covenant not to compete entered into in connection with an acquisition (directly or indirectly) of an interest in a trade or business or substantial portion thereof." As a matter of first impression, the Tax Court held that the covenant was a Sec. 197 intangible, because Y entered into it in connection with the indirect acquisition of a trade or business. The Tax Court applied the plain meaning of Sec. 197, using dictionary definitions of "acquisition" and "redemption" and concluded that Y's redemption was an acquisition under Sec. 197, because Y regained possession and control over 75% of its stock.

Y argues that it did not acquire an interest in a trade or business in the redemption, because, both before and after the redemption, it was engaged in the same trade or business and acquired no new assets.

There are three problems with Y's arguments. First, Y's argument reads a. requirement into Sec. 197 that taxpayers must acquire an interest in a new trade or business. Sec. 197, however, only requires taxpayers to...