The IRS recently concluded in internal legal advice (available at http://www.irs.gov/pub/irs-lafa/111101f.pdf) that an automobile dealer could not deduct the cost of acquired goodwill when an automobile manufacturer terminated the dealer’s franchise. Although the advice specifically applied to a car dealer, it could apply equally in any franchise situation. As internal legal advice, it is not precedential but does reflect the thinking of the IRS.
The case involved a dealer who had bought out another car dealer. Part of the purchase price of the acquired dealership was for its customer goodwill. However, as happened to so many car dealers in recent years, the manufacturer later terminated the franchise to sell certain types of vehicles. The car dealer asserted that the customer goodwill acquired with the franchise had become worthless, so the dealer should be allowed to deduct what it had paid for the goodwill.
Internal Revenue Code section 197 provides special rules for certain intangibles, including goodwill, acquired as part of a business. All such intangibles have to be amortized for tax purposes over 15 years. This rule was enacted to put a stop to seemingly endless disputes between taxpayers and the IRS over allocation of the purchase price of an acquired business between goodwill and going concern value (which could not be amortized at all) and other intangibles such as workforce in place and favorable contracts with customers and suppliers (which, if a purchase cost was assigned to them, could often be written off in just a few years). Under the Code provision, all such intangibles are amortized over 15 years regardless of their actual useful life or, in the case of goodwill, the fact that it has no ascertainable useful life.
However, the 15-year rule is rigid. If a taxpayer disposes of only some of the acquired intangible assets within the 15-year period, no loss is allowed. Instead, the cost of those assets is assigned to the remaining acquired assets and continues to be amortized over the remaining part of the 15-year period.
This rule was applied by the IRS in the case. Even if the dealer’s acquired goodwill had become worthless when the franchise was terminated, the dealer could not deduct the remaining cost of the goodwill. Instead, that cost had to be allocated to the remaining intangible assets that had been acquired and had to continue to be amortized.
The situation would have been different if the dealer had in fact disposed of all of the intangible assets that it had acquired from the other dealer. In that case, the special rule requiring continuing amortization would not have applied.
This internal legal advice is of course not good news for any retailer with an acquired franchise that is terminated. However, the IRS appears to be correct in its analysis.
IRS Circular 230 Disclosure: To comply with certain U.S. Treasury regulations, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication, including attachments, was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding any penalties that may be imposed on such taxpayer by the Internal Revenue Service. In addition, if any such tax advice is used or referred to by other parties in promoting, marketing or recommending any partnership or other entity, investment plan or arrangement, then (i) the advice should be construed as written in connection with the promotion or marketing by others of the transaction(s) or matter(s) addressed in this communication and (ii) the taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor. To the extent that a state taxing authority has adopted rules similar to the relevant provisions of Circular 230, use of any state tax advice contained herein is similarly limited.