Service Issues Field Service Advisory That Addresses A Failed Automobile Dealership's Inability to Claim Worthless Investment in Dealer's Franchise Rights
In Field Service Advisory 2011110F, issued by Chief Counsel’s Office on March 18, 2011, the Service stated that §197(f)(1) prohibits a worthless amortization deduction for a §197 intangible, in this case an automobile franchise contract, that was terminated by the manufacturer. Section 197(f)(1) prohibits a deductions for worthless §197 intangibles, including goodwill, where other amortizable §197 intangibles purchase as part of the same transaction remain in place. The amount of such worthless amortizable §197 intangible is included in the basis of the remaining §197 intangibles.
Under the facts of the FSA, a automobile dealership was granted a sales and services franchise under a franchise agreement. Then the dealership purchased certain assets of another auto dealer including the amount of $39x for goodwill related to such franchise rights (sales and servicing) for a particular make of automobile. The automobile dealer alleged that $4x of the amount was allocated to goodwill for the franchise agreement but such allocation was not contained in the agreement. Later, the automobile dealer was notified that the manufacturer was terminating its franchise to sell certain products and the sales franchise as well. The automobile dealer was paid 1.8% of $39x in consideration for the terminations as well as for certain releases, waivers and transfer to manufacturer of the dealership’s customer lists and service records. Thus, the automobile dealer claimed that the goodwill associated with the franchise rights became worthless.
Section 197(a), which was enacted into the Code in 1993, permits a taxpayer to amortize an amortizable §197 intangible asset, generally acquired by purchase after August 11, 1993, ratably over a 15 year period regardless of the assets’ MACRS period or useful life. See Frontier Chevrolet Co. v. Comm’r, 329 F.3d 1131, 1135 (9th Cir. 2003). In general, a §197 intangible includes goodwill and any franchise, trademark or trade name. See also §1253(b). Certain self-created intangibles are excluded from the definition of “an amortizable § 197 intangible”.
Under §1253(b)(1), a franchise includes an agreement that gives one of the parties the right to distribute, sell, or provide goods, services, or facilities within a specified area. Where there is a disposition of any §197 intangible or any such intangible becomes worthless, §197(f)(1) provides that in such instance were any one or more amortizable §197 assets acquired in such transaction or series of related transactions are retained: (i) no loss may be recognized, and (ii) appropriate basis adjustments must be made to the retained intangibles. See Treas. Reg. § 1.197-2(g)(1). The abandonment of an amortizable §197 intangible, or any other event rendering an amortizable §197 intangible worthless, is treated as a disposition of the intangible per §197(f)(1) and Treas. Reg. § 1.197-2(g)(1). See Treas. Reg. § 1.197-2(g)(1)(i)(B).
The taxpayer-automobile dealer contended that it was entitled to deduct the claimed amount of worthless goodwill based on two arguments. First that the asset purchase agreement separately stated a goodwill value for one of the franchises purchased and which one later became worthless. The Service felt that the evidence did not support this argument and that even if goodwill was separately stated for each franchise, §197(f)(1) still applies, as all of the goodwill was acquired in a single transaction or series of related transactions.
The automobile dealer further argued that §197(f)(1) does not apply to its special situation and that the “spirit” of §197(f)(1)(A)(i) did not contemplate automobile franchises.The Service found no indication in either the Code or the legislative history to §197 to support this thought or notion that automobile franchises were exempt from application of §197(f)(1).