Before, during and after any business acquisition, many variables must be taken into account, including the tax implications of the sale from the perspective of the buyer and the seller. In this case, we are talking about the treatment of intangible assets.
In a recent case in the United States Tax Court, owners of a business amortized non-competition over a twenty-four month period, while under section 197 of the Tax Code, relating to the amortization of certain intangible assets, the tax code stipulates that non-competition – competition must be amortized over a period of fifteen years when it is “in connection with the acquisition of an interest in a trade or business or a substantial part thereof. “In this case, however, the owners justified their expedited deductions because they did not believe that the non-compete was entered into under the above condition.
The United States Tax Court, however, ruled against the Company and in favor of the IRS. In doing so, they refused the deductions made by the owners of the Company almost ten years earlier.
The company in question was Recovery Group, a recovery and crisis management company. In 2002, one of the founders of Recovery Group, also a 23% shareholder, informed its chairman that he wanted to leave the company and buy back his shares. The agreement between him and Recovery Group provided for the Company to pay him a total of $ 805,363.33, in payment of which the Company gave him a check for $ 205,363.33 and a promissory note of $ 600,000 payable on three years, including $ 400,000 as payment for a “non-compete and non-solicitation agreement” that prohibited him from engaging in competitive activities for one year after closing.
The arguments of the Corporation Tax Court and the IRS boiled down to the semantics of the Section 197 code and what the word “thereof” in the sentence above referred to. . RGI’s contention was that the rule must be tied to a 100% transfer of interest, or a substantial part of an interest. The IRS, however, argued that the word of it altered the words trade or business and that in fact a non-competition gets a 15-year amortization if it is through the acquisition of all interest.
While it is possible to see a justification on both sides, the statement of facts and conclusions of the case emphasizes that as a general rule, “the determinations of the IRS are presumed to be correct, and the taxpayer bears the burden. to establish that the determinations in the notice of deficiency are in error. Likewise, the taxpayer has the burden of proving that he is entitled to any denied deduction that would reduce his deficit. Unfortunately for Recovery in this case, they were unable to do so and had to make the adjustments many years after the disputed deduction.
And if you thought it clarified the tax rules, it isn’t exactly. There is more confusion when it comes to a sale of assets than a sale of shares. When a non-competition is entered into in relation to an acquisition of shares, it constitutes a depreciable intangible asset under section 197. However, when it concerns a sale of assets, you must consult a tax expert to determine the appropriate tax treatment and whether the transfer is substantial and, therefore, could be subject to expedited deductions.
The case history can be read by click here
Additional Source: Article written June 1, 2010 written by Robert Willens, Founder and Director of Robert Willens LLC.