Franchise costs, including goodwill, deductible.

• Author: Bettin, John R.

The manner in which the purchase price of a trade or business is allocated between amortizable (e.g., noncompetition agreements) and nonamortizable (e.g., goodwill) intangible assets is currently the subject of great controversy. Costly battles continue to rage between taxpayers and the IRS, legislative proposals rise and fall, and tax advisers struggle in the midst of this uncertainty to provide clients with sound advice regarding these controversial allocations. For a brief moment, the Tax Court provided taxpayers with some measure of certainty in this area when it upheld a significant allocation of the purchase price of McDonald's franchises to amortizable franchise fees rather than to nonamortizable goodwill (Canterbury, 99 TC No. 12 (1992)). However, due to the narrow statutory basis on which the court rested its decision, the case is unlikely to have a meaningful effect on the numerous purchase price allocation disputes ongoing between taxpayers and the Service.

In Canterbury, the taxpayers purchased McDonald's restaurant operations from existing McDonald's franchisees or from subsidiaries of McDonald's Corp. The assets purchased in each case included McDonald's franchise rights, trademarks and trade names. The total price paid to purchase each of these restaurants exceeded the value of the tangible assets acquired in each transaction, and the excess was allocated to the McDonald's franchise rights. The taxpayers amortized the amounts allocated to the franchise rights over 10 years under Sec. 1253(d)(2)(a). (Note: Sec. 1253 (d)(2) has since been amended to provide that a 10-year amortization period is available only for franchises with a cost of $100,000 or less. Franchises with a cost in excess of $100,000 are generally not amortizable unless an election is made under Sec. 1253(d)(3) to amortize the franchise cost over a 25-year period.)

The IRS determined on audit that the taxpayers' allocations to the franchise rights acquired were excessive, and disallowed a portion of the taxpayers' deductions. At trial, the Service asserted three arguments to support its position: (1) the amount amortizable by the taxpayers was limited to the original cost of the McDonald's franchises (i.e., $12,500), since that was a "perfect" market comparable that established the value of all McDonald's franchises; (2) as a matter of law, Sec. 1253(d) does not permit subsequent franchisees to amortize an amount in excess of the original franchise cost; and...