Capitalization of intangibles.

• Author: Smith, Annette B.
• Position: Intangible assets

In January, the Treasury and the IRS released an Advanced Notice of Proposed Rulemaking (ANPRM), providing the framework for comprehensive proposed regulations they intend to issue on the deductibility and capitalization of expenditures incurred in acquiring, creating or enhancing intangible assets. The ANPRM's purpose is to reduce disputes on capitalization issues related to intangible assets. It does not address the treatment of costs related to tangible assets (such as repair costs).

Treasury and IRS Concessions

In the ANPRM, Treasury and the IRS conceded three critical issues:

* The government accepted the "one-year rule" adopted by the Seventh Circuit in U.S. Freightways, 270 F3d 1137 (7th Cir. 2001), for certain prepaid expenditures (such as insurance).

* The forthcoming guidance is expected to reverse the long-standing position that internal compensation costs incurred in connection with a transaction must be capitalized (as stated in Rev. Rul. 73-580). Rather, such costs (other than bonuses and commissions related to the transaction) would be deductible currently; this result would be consistent with the holdings in PNC Bancorp, 212 F3d 822 (3rd Cir. 2000), and Wells Fargo, 224 F3d 874 (8th Cir. 2000).

* Expenditures incurred in connection with intangible assets, rights or benefits not specifically identified in the advance notice are presumed to be deductible currently, contrary to the position in INDOPCO, Inc., 503 US 79 (1992). According to the notice, only in "rare and unusual circumstances" would such costs have to be capitalized.

The presumption that expenditures that the advance notice does not identify or discuss would be deductible may necessitate reviewing prior Service guidance, with the possibility of revoking or modifying any existing guidance to the contrary. Such guidance could include Rev. Rul. 89-23, which addressed the tax accounting treatment of package design costs. It is anticipated that the proposed regulations will not only specify the types of expenditures that would be capital, but will also include examples of deductible expenditures to illustrate the operation of this presumption.

Treatment of Other Costs

Under the forthcoming guidance, taxpayers must capitalize amounts paid as consideration to purchase, originate or otherwise acquire a security, option or other financial interest described in Sec. 197(e)(1), as well as any debt. Also, amounts paid to another person to acquire intangible property (such as...