[Federal Register Volume 62, Number 11 (Thursday, January 16, 1997)]
[Rules and Regulations]
[Pages 2267-2275]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-656]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8711]
RIN 1545-AU82
Intangibles Under Sections 1060 and 338
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document amends the temporary regulations under sections
1060 and 338(b) of the Internal Revenue Code (Code) relating to
purchase price allocations in taxable asset acquisitions and deemed
asset purchases. The amendments revise the treatment of intangible
assets in such acquisitions to take into account the enactment of
section 197 by the Omnibus Budget Reconciliation Act of 1993. This
document also makes conforming amendments to the final regulations
under section 338. The regulations provide guidance regarding taxable
asset acquisitions and deemed asset purchases resulting from elections
under section 338. The text of the temporary regulations herein also
serves as the text of the proposed regulations set forth in the notice
of proposed rulemaking on this subject in the Proposed Rules section of
this issue of the Federal Register.
EFFECTIVE DATE: These regulations are effective February 14, 1997.
For dates of applicability, see Secs. 1.338(b)-2T(c)(4) and 1.1060-
1T(a)(2)(ii).
FOR FURTHER INFORMATION CONTACT: Brendan P. O'Hara, Office of Assistant
Chief Counsel (Corporate), (202) 622-7530 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
These regulations amend the current temporary regulations under
sections 1060 (Sec. 1.1060-1T) and 338(b) (Secs. 1.338(b)-2T and
1.338(b)-3T) (the current regulations) with respect to the treatment of
acquired intangible assets. They also amend related examples in the
final regulations under section 338. Section 1060 provides for the
allocation of purchase price among the assets of a trade or business
under regulations. Section 338(b) provides for a similar allocation,
also under regulations, for a deemed purchase of assets under section
338. The current regulations employ a residual method of allocation.
The legislative history of section 1060, adopted in 1986, noted with
approval the use of the residual method under the section 338(b)
regulations and required that the same method be used pursuant to
regulations to be prescribed under section 1060. S. Rep. No. 99-313,
99th Cong., 2d Sess. 253, 254 (1986); 1986-3 C.B. Vol. 3, 253-54.
The current regulations place each acquired asset into one of four
asset classes. The purchase price is allocated among the classes in
priority order. No asset in any class except for the last class is
allocated more than its fair market value. If the aggregate purchase
price allocable to a particular class is less than the aggregate fair
market value of the assets within the class, each asset is allocated an
amount in proportion to its fair market value and nothing is allocated
to any junior class.
The four classes under the current regulations are as follows:
Class I--Cash and cash equivalents;
Class II--Certificates of deposit, U.S. government securities, readily
marketable stock or securities, and foreign currency;
Class III--All assets not in Class I, II, or IV; and
Class IV--Intangible assets in the nature of goodwill and going concern
value.
Section 197 was enacted as part of the Omnibus Budget
Reconciliation Act of 1993, Public Law 103-66, 107 Stat. 312 (1993)
(the 1993 Act). Prior to the 1993 Act, acquired goodwill and going
concern value were not amortizable, but other acquired intangible
assets were amortizable if they could be separately identified and
their useful lives determined with reasonable accuracy. Section 197
responded to policy and administrative concerns regarding the treatment
of acquired intangibles by providing similar treatment for goodwill,
going concern value, and certain other intangible assets acquired in a
taxable acquisition and held in connection with a trade or business.
The 1993 Act allows taxpayers to amortize certain acquired intangible
assets (amortizable section 197 intangibles) over 15 years, subject to
certain exceptions.
The report of the House Committee on Ways and Means accompanying
the 1993 Act states that:
It is expected that the present [regulations under sections 338
and 1060] will be amended to reflect the fact that [section 197]
allows an amortization deduction with respect to intangible assets
in the nature of goodwill and going concern value. It is anticipated
that the residual method specified in the regulations will be
modified to treat all amortizable section 197 intangibles as Class
IV assets and that this modification will apply to any acquisition
of property to which [section 197] applies.
H.R. Rep. 111, 103d Cong., 1st Sess. 760, 776 (May 23, 1993), 1993-3
C.B. 336, 352.
The current regulations have not yet been amended in accordance
with the legislative history of section 197. These new temporary
regulations accomplish that change, with slight modifications, as
discussed below.
Explanation of Provisions
The temporary and final regulations are amended to conform to the
legislative history of the 1993 Act by placing all amortizable section
197 intangibles other than goodwill and going concern value in Class
IV.
However, the new regulations also include nonamortizable section
197 intangibles in Class IV. Some section 197 intangibles are
amortizable by the buyer though they were not amortizable by the
seller. Other section 197 intangibles may not be amortizable because of
the application of the anti-churning rules of section 197(f)(9).
Although sections 338(b) and 1060 do not require conformity between the
buyer and seller on purchase price allocations, they reflect strong
policies encouraging conformity, including mandatory application of the
rule of Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), cert.
denied, 389 U.S. 858 (1967), in cases where the parties have agreed to
an allocation, and a reporting system designed to reveal situations
where the parties' allocations are inconsistent. These policies
favoring conformity are best served by requiring both parties to
include the same assets in each class. Moreover, this rule is also more
consistent with section 1060(b) as amended by the 1993 Act. Section
1060(b)(1) requires the parties to report, under regulations, ``the
amount of consideration received for the assets which is allocable to
section 197 intangibles.'' The term section 197 intangibles is more
inclusive than amortizable section 197 intangibles. The goals of
consistency, simplification, and administrability will be better
achieved with respect to allocations to section
[[Page 2268]]
197 intangibles if all such assets are removed from Class III and
isolated in a junior class (or classes). Accordingly, these regulations
classify all section 197 intangibles (other than goodwill and going
concern value) as Class IV assets.
To reconcile the original intention of Congress in requiring the
residual method of allocation for goodwill and going concern value with
the legislative history of the 1993 Act, these regulations provide that
goodwill and going concern value will be assigned to a true residual
class, Class V. This method is consistent with the policies of section
197 (which regards many intangible assets as the functional equivalent
of goodwill and going concern value and thus treats them uniformly) as
well as the original intention of the Tax Reform Act of 1986, Public
Law 99-514, 100 Stat. 2085 (1986) (that goodwill and going concern
value not be valued separately for purchase price allocation purposes).
Allocating goodwill and going concern value to Class V avoids the need
for determining the value of goodwill and going concern value through a
non-residual method. Although this approach places some section 197
intangibles in Class V instead of Class IV, it carries out the
expectation set forth in the legislative history of the 1993 Act by
making section 197 intangibles junior to all other assets in the
allocation scheme. The practical significance of placing goodwill and
going concern value in Class V is generally limited to circumstances in
which fewer than all of the amortizable section 197 intangibles
acquired in a single transaction are subsequently disposed of at a
gain. Those situations, in any case, require some method of allocation
among the intangibles.
Effective Date
These regulations are effective for applicable asset acquisitions,
as defined in section 1060(c), completed on or after February 14, 1997,
and for acquisition dates, as defined in section 338(h)(2), on or after
February 14, 1997.
As described above, the current regulations have been in conflict
with the 1993 Act legislative history concerning the classification of
amortizable section 197 intangibles other than goodwill and going
concern value since August 10, 1993, generally (the date of enactment
of section 197), and, in some cases, since 1991.
The legislative history to the 1993 Act clearly contemplates that
changes to the classification system would be made by amended
regulations. In the absence of such amendments, the only system
available under regulations was the four-class system established
before the enactment of section 197. Further, the IRS revised Form
8594, Asset Acquisition Statement under Section 1060, in January of
1996 in a manner consistent with the legislative history, i.e., by
placing all amortizable section 197 intangibles in Class IV. For
acquisition dates before February 14, 1997, if section 197 applies to
any asset acquired or deemed acquired, the taxpayer (and all related
parties) may consistently (in all transactions in which AGUB, ADSP,
MADSP, or consideration must be allocated under section 338 or 1060)--
(i) apply these new rules in full as written;
(ii) apply the current temporary regulations as written; or
(iii) apply the current temporary regulations as written, but treat
all amortizable section 197 intangibles as Class IV assets.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and, because the regulations do
not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Code, these regulations will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.
Drafting Information
The principal author of these regulations is Brendan P. O'Hara,
Office of the Assistant Chief Counsel (Corporate), IRS. However, other
personnel from the IRS and Treasury Department participated in their
development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In Sec. 1.338-0, entries for Sec. 1.338(b)-2T(b)(2)(v) and
Sec. 1.338(b)-2T(c)(4) are added to read as follows:
Sec. 1.338-0 Outline of topics.
* * * * *
Sec. 1.338(b)-2T Allocation of adjusted grossed-up basis among
target assets (temporary).
* * * * *
(b) * * *
(2) * * *
(v) Class V assets.
(c) * * *
(4) Effective dates.
* * * * *
Par. 3. Section 1.338-3 is amended by:
1. Revising paragraph (b)(4).
2. Revising paragraph (d)(8)(ii) Example 1, paragraph (e); Example
2, paragraphs (a), (b), and (d); Example 3, paragraph (d); and Example
4, paragraphs (d) and (f).
The revisions read as follows:
Sec. 1.338-3 Deemed sale and aggregate deemed sale price.
* * * * *
(b) * * *
(4) Classes of assets. The classes of assets are defined in
Sec. 1.338(b)-2T(b).
* * * * *
(d) * * *
(8) * * *
(ii) * * *
Example 1. * * *
(e) The facts are the same as in paragraph (a) of this Example
1, except that T also has goodwill (a Class V asset) with an
appraised value of $10,000. The results are the same as in
paragraphs (b) and (c) of this Example 1. Because the ADSP does not
exceed the fair market value of the Class III asset, no amount is
allocated to the Class V assets (assets in the nature of goodwill
and going concern value).
Example 2. * * *
(a) P purchases all of the T stock for $140,000. On July 1 of
Year 1, T has liabilities (not including the tax liability for
deemed sale gain of its assets) of $50,000, cash (a Class I asset)
of $10,000, readily marketable securities (a Class II asset) with a
basis of $4,000 and a fair market value of $10,000, goodwill (a
Class V asset) with a basis of $3,000, and the following Class III
assets:
------------------------------------------------------------------------
Asset Basis FMV Ratio
------------------------------------------------------------------------
1. Land................................... $5,000 $35,000 .14
[[Page 2269]]
2. Inventory.............................. 10,000 50,000 .20
3. Equipment A (recomputed basis $80,000). 5,000 90,000 .36
4. Equipment B (recomputed basis $20,000). 10,000 75,000 .30
-----------------------------
Totals.............................. $30,000 $250,000 1.00
------------------------------------------------------------------------
(b) The ADSP exceeds $20,000. Thus, $10,000 of the ADSP is
allocated to the cash and $10,000 to the marketable securities.
Except as provided in section 7701(g), the amount allocated to an
asset (other than a Class V asset) cannot exceed its fair market
value. See Sec. 1.338(b)-2T(c)(1) (relating to fair market value
limitation).
* * * * *
(d) Because, under the preliminary calculations of the ADSP, the
amount to be allocated to the Class I, II, III, and IV assets does
not exceed their aggregate fair market value, no ADSP amount is
allocated to goodwill. Accordingly, the deemed sale of the goodwill
results in a capital loss of $3,000. The portion of the ADSP
allocable to the Class III assets is finally determined by taking
into account this loss as follows:
ADSPIII = (G - (I + II)) + L + TR x [(II - BII) +
(ADSPIII - BIII) + (ADSPV - BV)]
1ADSPIII = ($140,000 - ($10,000 + $10,000)) + $50,000 + .34 x
[($10,000 - $4,000) + (ADSPIII - $30,000) + ($0 - $3,000)]
ADSPIII = $160,820 + .34ADSPIII
.66ADSPIII = $160,820
ADSPIII = $243,666.67
* * * * *
Example 3. * * *
(d)(1) Based on the preliminary allocation, the ADSP is
determined as follows: (In the formula, the amount allocated to the
Class I assets is referred to as I, the amount allocated to the
Class II assets as II, and the amount allocated to the Class III
assets as III.)
ADSP = G + L + TR x [(II - BII) + (III - BIII) +
(ADSP - (I + II + III + BV))]
ADSP = $150,000 + $50,000 + .34 x [($10,000 - $4,000) + ($250,000
- $30,000) + (ADSP - ($10,000 + $10,000 + $250,000 + $3,000))]
ADSP = $200,000 + .34ADSP - $15,980 .66ADSP = $184,020
ADSP = $278,818.18
(2) Because the ADSP as determined exceeds the aggregate fair
market value of the Class I, II, III, and IV assets, the $250,000
amount preliminarily allocated to the Class III assets is
appropriate. Thus, the amount of the ADSP allocated to Class III
assets equals their aggregate fair market value ($250,000), and the
allocated ADSP amount for each Class III asset is its fair market
value. Further, because there are no Class IV assets, the allocable
ADSP amount for the Class V asset (goodwill) is $8,818.18 (the
excess of the ADSP over the aggregate ADSP amounts for the Class I,
II, and III assets).
Example 4. * * *
(d) Because the portion of the preliminary ADSP allocable to
Class III assets ($243,666.67) does not exceed their fair market
value ($250,000), no amount is allocated to Class V assets for T.
Further, this amount ($243,666.67) is allocated among T's Class III
assets in proportion to their fair market values. See paragraph (e)
of Example 2. Tentatively, $48,733.34 of this amount is allocated to
the T1 stock.
* * * * *
(f) The facts are the same as in paragraph (a) of this Example
4, except that the T1 inventory has a $12,500 basis and a $62,500
value, the T1 stock has a $62,500 value, and T owns 80% of the T1
stock. In preliminarily calculating ADSPIII, the T1 stock can be
disregarded but, because T owns only 80% of the T1 stock, only 80%
of T1 asset basis and value should be taken into account in
calculating T's ADSP. By taking into account 80% of these amounts,
the remaining calculations and results are the same as in paragraphs
(b), (c), (d), and (e) of this Example 4, except that the grossed-up
basis in T's recently purchased T1 stock is $44,455.00 ($35,564.00/
0.8).
Par. 4. Section 1.338(b)-2T is amended by:
1. Revising paragraphs (b)(2), (c)(1), and (c)(3)(iii).
2. Adding paragraph (c)(4).
3. Revising paragraph (d) Example 1, paragraphs (vi) and (x)
through (xiii).
4. Revising paragraph (d) Example 2, paragraphs (vi) through
(viii).
The revisions and addition read as follows:
Sec. 1.338(b)-2T Allocation of adjusted grossed-up basis among target
assets (temporary).
* * * * *
(b) * * *
(2) Other assets--(i) In general. Subject to the limitations and
other special rules of paragraph (c) of this section, adjusted grossed-
up basis (as reduced by Class I assets) is allocated among Class II
assets of target held at the beginning of the day after the acquisition
date in proportion to their fair market values at such time, then among
Class III assets so held in such proportion, then among Class IV assets
so held in such proportion, and finally to Class V assets.
(ii) Class II assets. Class II assets are certificates of deposit,
U.S. Government securities, readily marketable stock or securities
(within the meaning of Sec. 1.351-1(c)(3)), foreign currency, and other
items designated in the Internal Revenue Bulletin by the Internal
Revenue Service.
(iii) Class III assets. Class III assets are all assets of target
other than Class I, II, IV, and V assets.
(iv) Class IV assets. Class IV assets are all section 197
intangibles, as defined in section 197, except those in the nature of
goodwill and going concern value.
(v) Class V assets. Class V assets are section 197 intangibles in
the nature of goodwill and going concern value.
(c) * * *
(1) Basis not to exceed fair market value. The amount of adjusted
grossed-up basis allocated to an asset (other than Class V assets)
shall not exceed the fair market value of that asset at the beginning
of the day after the acquisition date. For modification of this fair
market value limitation with respect to certain contingent income
assets, see Sec. 1.338(b)-3T(g).
* * * * *
(3) * * *
(iii) Allocation of adjusted grossed-up basis. Subject to the
limitations in paragraphs (c)(1) and (2) of this section, adjusted
grossed-up basis (after reduction by the amount of Class I assets) is
allocated among Class II, III, IV, and V assets of target held at the
beginning of the day after the acquisition date in proportion to their
fair market values at such time. For this purpose, the fair market
value of Class V assets is deemed to be the excess, if any, of the
hypothetical purchase price over the sum of the amount of the Class I
assets and the fair market values of the Class II, III, and IV assets.
(4) Effective dates. This section applies for acquisition dates on
or after February 14, 1997. For acquisition dates before February 14,
1997, if section 197 does not apply to any asset deemed acquired, the
provisions of the regulations in effect before February 14, 1997, apply
(see Sec. 1.338(b)-2T as contained in 26 CFR part 1 revised April 1,
1996). For acquisition dates before February 14, 1997, if section 197
applies to any asset deemed acquired, the taxpayer (and all related
parties) may consistently (in all transactions in which AGUB, ADSP,
MADSP, or consideration must be allocated under section 338 or 1060)--
(i) Apply the provisions of this section;
(ii) Apply the provisions of this section as in effect before
February 14, 1997 (see Sec. 1.338(b)-2T as contained in 26 CFR part 1
revised April 1, 1996); or
[[Page 2270]]
(iii) Apply the provisions of this section as in effect before
February 14, 1997 (see Sec. 1.338(b)-2T as contained in 26 CFR part 1
revised April 1, 1996), but treat all amortizable section 197
intangibles as Class IV assets.
(d) * * *
Example 1. * * *
(vi) T has no Class IV assets. The amount allocated to T's Class
V assets (assets in the nature of goodwill and going concern value)
is $150, i.e., $2,500-$2,350.
* * * * *
(x) Assume that at the beginning of the day after the
acquisition date, T1's cash and the fair market values of its Class
III and IV assets are as follows:
------------------------------------------------------------------------
Fair
Asset class Asset market
value
------------------------------------------------------------------------
I............................ Cash............................ $50 *
III.......................... Equipment....................... 200
IV........................... Patent.......................... 350
--------
Total........................... $600
------------------------------------------------------------------------
* Amount
(xi) The amount of AGUB allocable to T1's Class III and IV
assets is first reduced by the $50 of cash.
(xii) Since the remaining amount of AGUB ($570) is an amount
which exceeds the fair market value of T1's only Class III asset,
the equipment, the amount allocated to the equipment is its fair
market value ($200). After that, the remaining amount of AGUB ($370)
exceeds the fair market value of T1's only Class IV asset, the
patent. Thus, the amount allocated to the patent is its fair market
value ($350).
(xiii) The amount allocated to T1's Class V assets (assets in
the nature of goodwill and going concern value) is $20, i.e.,
$570-$550.
Example 2.* * *
(vi) The amount of AGUB ($2,700) available to allocate to T's
assets is reduced by the amount of cash to $2,500, i.e.,
$2,700-$200. This $2,500 balance is then allocated among the Class
II, III, IV, and V assets in proportion to, and not in excess of,
their fair market values (as determined under Sec. 1.338(b)-
2T(c)(3)(iii)).
(vii) Under paragraph (c)(3) of this section, the fair market
value of the Class V assets is deemed to be $150, i.e., the $3,000
hypothetical purchase price minus $2,850 (the sum of T's cash, $200,
and the fair market value of its Class II, III, and IV assets,
$2,650). The allocation is as follows:
Portfolio of marketable securities............................. * $268
Inventory...................................................... 268
Accounts receivable............................................ 536
Building....................................................... 714
Land........................................................... 178
Investment in T1............................................... 402
Goodwill and going concern value............................... 134
--------
Total...................................................... $2,500
* All numbers rounded for convenience.
(viii) If the AGUB of T is increased (or decreased) as a result
of a subsequent adjustment, the hypothetical purchase price and the
deemed fair market value of the Class V assets shall be redetermined
and the increase (or decrease) in AGUB shall be allocated among T's
acquisition date assets pursuant to Sec. 1.338(b)-3T(f). The
increase (or decrease) in AGUB is allocated pursuant to
Sec. 1.338(b)-3T(f) even if the hypothetical purchase price, as
redetermined, no longer exceeds AGUB, as redetermined.
Par. 5. Section 1.338(b)-3T is amended by:
1. Revising paragraphs (e)(1), (f)(1), and (f)(2).
2. In paragraph (j), redesignating Example (1) through Example (8)
as Example 1 through Example 8.
3. Revising the following newly designated examples in paragraph
(j): Example 1; Example 2; Example 3, paragraph (i) and paragraphs (v)
through (vii); and Example 6 through Example 8.
The revisions read as follows:
Sec. 1.338(b)-3T Subsequent adjustments to adjusted grossed-up basis
(temporary).
* * * * *
(e) * * *
(1) In general. If adjusted grossed-up basis was allocated in
accordance with the rules of Sec. 1.338(b)-2T(b)(2), a decrease in
adjusted gross-up basis (as determined under paragraph (c)(3) of this
section) is allocated in the following order: first, as a reduction in
the bases of target's Class V acquisition date assets, second, as a
reduction of the bases of target's Class IV acquisition date assets in
proportion to their fair market values at the beginning of the day
after the acquisition date, third, as a reduction of the bases of
target's Class III acquisition date assets in proportion to their fair
market values at the beginning of the day after the acquisition date,
and finally, as a reduction of the bases of target's Class II
acquisition date assets in proportion to their fair market values at
the beginning of the day after the acquisition date. The decrease in
adjusted grossed-up basis allocated to an asset shall not exceed the
adjusted grossed-up basis of target previously allocated to that asset.
If adjusted grossed-up basis was allocated among target's assets
pursuant to Sec. 1.338(b)-2T(c)(3), a decrease in adjusted grossed-up
basis (as determined under paragraph (c)(3) of this section) is
accounted for in accordance with the rules of paragraph (f) of this
section.
* * * * *
(f) * * *
(1) Scope. This paragraph (f) applies if adjusted grossed-up basis
was allocated among new target's Class II, III, IV, and V assets in
accordance with Sec. 1.338(b)-2T(c)(3) and an adjustment event occurs
after the close of the new target's first taxable year.
(2) Allocation of increases (decreases) in adjusted grossed-up
basis. If an adjustment event after the close of new target's first
taxable year increases (or decreases) adjusted grossed-up basis, the
following items shall be redetermined, taking into account such
adjustment event: the hypothetical purchase price, the deemed fair
market value of Class V assets, and the adjusted grossed-up basis
allocable to each acquisition date asset under Sec. 1.338(b)-2T(c)(3)
(the redetermined (c)(3) amount). (The redetermination of the deemed
fair market value of Class V assets under this paragraph (f)(2) is made
by taking into account the target's Class I assets and the fair market
values of its Class II, III, and IV assets at the beginning of the day
after the acquisition date.) If the redetermined (c)(3) amount for an
acquisition date asset exceeds the amount of adjusted grossed-up basis
previously allocated to such asset (taking into account prior
adjustments under this paragraph (f)), an amount of adjusted grossed-up
basis equal to such excess shall be allocated to such asset. If the
amount of the adjusted grossed-up basis previously allocated to an
acquisition date asset (taking into account prior adjustments under
this paragraph (f)) exceeds the redetermined (c)(3) amount for that
asset, an amount equal to such excess shall be allocated as a reduction
in the basis of such asset. The rules of paragraph (d)(2) of this
section (or paragraph (e)(2) of this section) apply for the treatment
of amounts allocable under this paragraph (f) to an acquisition date
asset that has been disposed of, depreciated, amortized, or depleted.
* * * * *
(j) * * *
Example 1. (i)(A) T's assets other than goodwill and going
concern value, and their fair market values at the beginning of the
day after the acquisition date, are as follows:
------------------------------------------------------------------------
Fair
Asset class Asset market
value
------------------------------------------------------------------------
III.......................... Building........................ $100
III.......................... Stock of X (not a target)....... 200
--------
Total........................... $300
------------------------------------------------------------------------
(B) T has no liabilities other than a contingent obligation and
T does not use the elective formula under section 338(h)(11).
(ii)(A) On September 1, 1997, P purchases all of the outstanding
stock of T for $270 and makes an express election for T. The
grossed-up basis of the T stock and T's adjusted grossed-up basis
(AGUB) are both $270. The AGUB is ratably allocated among T's Class
III
[[Page 2271]]
assets in proportion to their fair market values as follows:
------------------------------------------------------------------------
Asset Basis
------------------------------------------------------------------------
Building ($270 x 100/300)...................................... $ 90
Stock ($270 x 200/300)......................................... 180
--------
Total.................................................... $270
------------------------------------------------------------------------
(B) No amount is allocated to the Class V assets. New T is a
calendar year taxpayer. Assume that the X stock is a capital asset
in the hands of new T.
(iii) On January 1, 1998, new T sells the X stock and uses the
proceeds to purchase inventory.
(iv) On June 30, 1999, the contingent liability of old T becomes
fixed and determinable. The amount of the liability is $60.
(v) T's AGUB increases by $60 from $270 to $330. This $60
increase in AGUB is first allocated among T's acquisition date
assets in accordance with the provisions of Sec. 1.338(b)-2T. Since
the redetermined AGUB for T ($330) exceeds the sum of the fair
market values at the beginning of the day after the acquisition date
of the Class III acquisition date assets ($300), AGUB allocated to
those assets is limited to those fair market values under
Sec. 1.338(b)-2T(c)(1). As there are no Class IV assets, the
remaining AGUB of $30 is allocated to goodwill and going concern
value (Class V assets). The amount of increase in AGUB allocated to
each acquisition date asset is determined as follows:
------------------------------------------------------------------------
Original Redetermined Increase in
Asset AGUB AGUB AGUB
------------------------------------------------------------------------
Building........................ $ 90 $100 $10
X Stock......................... 180 200 20
Goodwill and going concern value 0 30 30
---------------------------------------
Total..................... $270 $330 $60
------------------------------------------------------------------------
(vi) Since the X stock was disposed of before the contingent
liability became fixed and determinable, no amount of the increase
in AGUB attributable to such stock may be allocated to any T asset.
Rather, such amount, $20, is allowed as a capital loss to T for the
taxable year 1999 under the principles of Arrowsmith v.
Commissioner, 344 U.S. 6 (1952). In addition, the $10 increase in
AGUB allocated to the building and the $30 increase in AGUB
allocated to the goodwill and going concern value are treated as
basis redeterminations in 1999. See paragraph (d)(2) of this
section.
Example 2. (i) On January 1, 1998, P purchases all of the
outstanding stock of T and makes an express election for T. T does
not use the elective formula under section 338(h)(11). Assume that
the AGUB of T is $500 and is allocated among T's acquisition date
assets as follows:
------------------------------------------------------------------------
Asset class Asset Basis
------------------------------------------------------------------------
III.......................... Machinery....................... $150
III.......................... Land............................ 250
V............................ Goodwill and going concern value 100
--------
Total........................... $500
------------------------------------------------------------------------
(ii) On September 30, 1998, P filed a claim against the selling
shareholders of T in a court of appropriate jurisdiction alleging
fraud in the sale of the T stock.
(iii) On January 1, 2007, the former shareholders refund part of
the purchase price to P in a settlement of the lawsuit. This refund
results in a decrease of T's AGUB of $140.
(iv) Under paragraph (e)(1) of this section, the decrease in
AGUB is allocated among T's acquisition date assets. First, because
$100 was originally allocated to the Class V assets, $100 of the
decrease is allocated to those assets. As there were no Class IV
assets acquired, the remaining decrease in AGUB ($40) is allocated
to the Class III assets in proportion to their fair market values at
the beginning of the day after the acquisition date. Thus, $15 is
allocated to the machinery ($40 x 150/$400) and $25 to the land ($40
x 250/$400).
(v) Assume that, as a result of deductions under section 168,
the adjusted basis of the machinery immediately before the decrease
in AGUB is zero. The machinery is treated as if it were disposed of
before the decrease is taken into account. In 2007, T recognizes
income of $15, the character of which is determined under the
principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and the
tax benefit rule. No adjustment to the basis of T's assets is made
for any tax paid on this amount. Assume also that, as a result of
amortization deductions, the adjusted basis of the goodwill and
going concern value immediately before the decrease in AGUB is $40.
A similar adjustment to income is made in 2007 with respect to the
$60 of previously amortized goodwill and going concern value.
(vi) In summary, the basis of T's acquisition date assets, as of
January 1, 2007, is as follows:
------------------------------------------------------------------------
Asset Basis
------------------------------------------------------------------------
Machinery...................................................... $0
Land........................................................... 225
Goodwill and going concern value............................... 0
------------------------------------------------------------------------
Example 3. (i) Assume that the facts are the same as Example 2
of Sec. 1.338(b)-2T(d) except that the recently purchased stock is
acquired for $1,600 plus additional payments that are contingent
upon T's future earnings. Thus, T's AGUB, determined as of the
beginning of the day after the acquisition date (after reduction by
T's cash of $200), is $2,500 and is allocable among T's Class II,
III, IV, and V acquisition date assets pursuant to Sec. 1.338(b)-
2T(c)(3)(iii) as follows:
------------------------------------------------------------------------
Asset Basis
------------------------------------------------------------------------
Portfolio of marketable securities............................. *$268
Inventory...................................................... 268
Accounts receivable............................................ 536
Building....................................................... 714
Land........................................................... 178
Investment in T1............................................... 402
Goodwill and going concern value............................... 134
--------
Total.................................................... $2,500
------------------------------------------------------------------------
*All numbers rounded for convenience.
* * * * *
(v) Under Sec. 1.338(b)-2T(c)(3) the redetermined fair market
value of Class V assets is deemed to be $400, i.e., the hypothetical
purchase price, as redetermined, of $3,250 minus $2,850 (the sum of
T's cash, $200, and the fair market values of its Class II, III, and
IV assets, $2,650).
(vi) The amount of AGUB available to allocate to T's Class II,
III, IV, and V acquisition date assets is $2,700 (i.e., redetermined
AGUB reduced by cash). AGUB allocable to each of T's acquisition
date assets (i.e., the redetermined (c)(3) amount) is redetermined
using the deemed fair market value of the Class V assets from
paragraph (v) of this Example as follows:
Portfolio of marketable securities............................. *$266
Inventory...................................................... 266
Accounts receivable............................................ 531
Building....................................................... 708
Land........................................................... 177
Investment in T1............................................... 398
Goodwill and going concern value............................... 354
Total.................................................... $2,700
* All numbers rounded for convenience.
(vii) As illustrated by this example, the application of
paragraph (f) of this section results in a basis increase for some
assets and a basis decrease for other assets. The amount of increase
(or decrease) in AGUB allocated to each acquisition date asset is
determined as follows:
[[Page 2272]]
------------------------------------------------------------------------
Increase
Original Redetermined (or
Asset AGUB (c)(3) decrease)
amount in AGUB
------------------------------------------------------------------------
Portfolio of marketable.........
securities...................... $268 $266 $(2)
Inventory....................... 268 266 (2)
Accounts receivable............. 536 531 (5)
Building........................ 714 708 (6)
Land............................ 178 177 (1)
Investment in T1................ 402 398 (4)
Goodwill and going concern value 134 354 220
---------------------------------------
Total..................... $2,500 $2,700 $200
------------------------------------------------------------------------
* * * * *
Example 6. (i)(A) T has three assets (other than goodwill and
going concern value) whose fair market values as of the beginning of
the day after the acquisition date are as follows:
------------------------------------------------------------------------
Fair
Asset class Asset market
value
------------------------------------------------------------------------
III.......................... Building........................ $100
III.......................... Equipment....................... 50
IV........................... Secret process.................. 50
Total........................... $200
------------------------------------------------------------------------
(B) The secret process is a section 197 intangible. T has no
liabilities. Assume that no election under section 338 (h)(10) or
(h)(11) is in effect.
(ii) On January 1, 1998, P purchases all of the outstanding T
stock for $225 plus 50 percent of the net profits generated by the
secret process for each of the next three years, determinable and
payable on January 1 of each following year. P and T are calendar
year taxpayers.
(iii) As of the beginning of January 2, 1998, T's AGUB is $225,
allocated as follows:
------------------------------------------------------------------------
Asset class Asset Basis
------------------------------------------------------------------------
III.......................... Building........................ $100
III.......................... Equipment....................... 50
IV........................... Secret process.................. 50
V............................ Goodwill and going concern value 25
--------
Total........................... $225
------------------------------------------------------------------------
(iv) On January 1, 1999, $5 is paid by P for the T stock by
reason of the net profits from the secret process. The payments are
not attributable in any respect to any of T's other acquisition date
assets. As a result, T's AGUB on January 1, 1999 is increased by $5.
(v) Assume that on January 1, 1999, the fair market value of the
secret process is redetermined to be $52. (For purposes of this
redetermination, only those circumstances that resulted in the
increase to AGUB are taken into account.)
(vi) On January 1, 1999, only $2 of the $5 increase in AGUB is
allocated to the secret process because the increase in AGUB so
allocated cannot increase the basis of the secret process above its
redetermined fair market value ($52). The balance of the increase is
allocated to goodwill and going concern value because the fair
market value limitation of Sec. 1.338(b)-2T(c)(1) precludes
allocating additional AGUB to the Class III and IV assets.
(vii) The price for which old target is deemed to have sold the
secret process is increased to reflect the $2 increase allocated to
its basis to new target. See Sec. 1.338-3(d) and paragraph (h)(1) of
this section.
(viii) If the fair market value of the secret process as of
January 1, 1999, is unchanged from the fair market value as of the
beginning of the day after the acquisition date, then the $5
increase in AGUB is allocated to T's goodwill and going concern
value.
Example 7. (i) The facts are the same as in Example 6 except
that--
(A) The secret process is valued at $75 as of the beginning of
the day after the acquisition date; and
(B) P pays $250 for the T stock and the former T shareholders
agree to refund a portion of the purchase price to P for each of the
three years that the net income from the secret process is less than
$15 per year, determinable and payable on January 1 of the next
year.
(ii) Assume that the secret process in the hands of new T is an
amortizable section 197 intangible and, therefore, on January 1,
1999, new T's adjusted basis in the secret process is $70 (i.e.,
$75-$5 of allowable amortization).
(iii) Assume the net income from the process is less than $15
for 1998, and on January 1, 1999, P receives a refund that reduces
the stock purchase price by $3.
(iv) Assume that as of January 1, 1999, the fair market value of
the secret process is redetermined to be $65. (For purposes of this
redetermination, only those circumstances that resulted in the
decrease to AGUB are taken into account.)
(v) As of January 1, 1999, the AGUB of T is decreased by $3.
This decrease is allocated to the secret process, the basis of which
becomes $67 (i.e., $70-$3) and is amortizable over the remaining 14
years.
(vi) The price for which old target is deemed to have sold the
secret process is decreased to reflect the $3 decrease allocated to
its basis to new target. See Sec. 1.338-3(d) and paragraph (h)(1) of
this section.
Example 8. The facts are the same as in Example 6 except that
the intangible Class IV asset is a patent instead of a secret
process. The redetermination of the fair market value of the patent
on January 1, 1999, is made without regard to the decrease in the
remaining life of the patent because that is not a circumstance that
resulted in the increase in AGUB.
Par. 6. Section 1.1060-1T is amended by:
1. Designating the text of paragraph (a)(2) following the heading
as paragraph (a)(2)(i), adding a heading to newly designated paragraph
(a)(2)(i), and adding paragraph (a)(2)(ii).
2. In paragraph (a)(3), revising the outline of topics entries for
(a)(2), (b)(2) and (h)(3).
3. Revising the seventh sentence of paragraph (b)(4).
4. Revising paragraphs (d)(2), (e)(1), and (f)(3)(i).
5. Revising the following examples in paragraph (g): Example 1;
Example 2; Example 3, paragraphs (i), (viii), and (xi); and Example 4.
6. Revising paragraph (h)(3).
The additions and revisions read as follows:
Sec. 1.1060-1T Special allocation rules for certain asset acquisitions
(temporary).
(a) * * *
(2) Effective date--(i) In general. * * *
(ii) Allocation of consideration. Paragraphs (d) and (h)(3) of this
section and conforming amendments to other provisions of this section
apply to applicable asset acquisitions completed on or after February
14, 1997. For applicable asset acquisitions completed before February
14, 1997, if section 197 does not apply to any of the acquired assets,
the provisions of the regulations in effect before February 14, 1997
apply (see Sec. 1.1060-1T as contained in 26 CFR part 1 revised April
1, 1996). For applicable asset acquisitions completed before February
14, 1997, if section 197 applies to any of the acquired assets, the
taxpayer (and related parties) may consistently (in all transactions in
which AGUB (as defined in Sec. 1.338(b)-1), ADSP (as defined in
Sec. 1.338-3), MADSP (as defined in Sec. 1.338(h)(10)-1), or
consideration must be allocated under section 338 or 1060)--
(A) Apply the provisions of this section;
[[Page 2273]]
(B) Apply the provisions of this section as in effect before
February 14, 1997 (see Sec. 1.1060-1T as contained in 26 CFR part 1
revised April 1, 1996); or
(C) Apply the provisions of this section as in effect before
February 14, 1997 (see Sec. 1.1060-1T as contained in 26 CFR part 1
revised April 1, 1996), but treat all amortizable section 197
intangibles as Class IV assets.
(3) * * *
(a) * * *
(2) Effective date.
(i) In general.
(ii) Allocation of consideration.
* * * * *
(d) * * *
(2) Assets other than Class I assets.
(i) In general.
(ii) Class II assets.
(iii) Class III assets.
(iv) Class IV assets.
(v) Class V assets.
* * * * *
(h) * * *
(3) Interim procedures for Form 8594.
(b) * * *
(4) * * * The money and other property that are treated as
transferred in exchange for the like-kind property (and which are
excluded from the assets to which section 1060 applies) are considered
to come from the following assets in the following order: first from
Class I assets, then from Class II assets, then from Class III assets,
then from Class IV assets, and then from Class V assets. * * *
* * * * *
(d) * * *
(2) Assets other than Class I assets--(i) In general. Subject to
the limitations and other special rules of paragraph (e) of this
section, consideration (as reduced by the amount of Class I assets) is
allocated among Class II assets transferred by the seller in proportion
to the fair market values of such Class II assets on the purchase date,
then among Class III assets transferred by the seller in proportion to
the fair market values of such Class III assets on that date, then
among Class IV assets transferred by the seller in proportion to the
fair market values of such Class IV assets on that date, and finally to
Class V assets.
(ii) Class II assets. Class II assets are certificates of deposit,
U.S. government securities, readily marketable stock or securities
(within the meaning of Sec. 1.351-1(c)(3)), foreign currency, and other
items designated in the Internal Revenue Bulletin by the Internal
Revenue Service.
(iii) Class III assets. Class III assets are all assets other than
Class I, II, IV, and V assets.
(iv) Class IV assets. Class IV assets are all section 197
intangibles, as defined in section 197, except those in the nature of
goodwill and going concern value.
(v) Class V assets. Class V assets are section 197 intangibles in
the nature of goodwill and going concern value.
(e) * * *
(1) Allocation not to exceed fair market value. The amount of
consideration allocated to an asset (other than Class V assets) shall
not exceed the fair market value of that asset on the purchase date.
* * * * *
(f) * * *
(3) * * *
(i) In general. A decrease in consideration is allocated in the
following order: first, as a reduction in the amount previously
allocated to Class V assets, second, as a reduction in the amount
previously allocated to Class IV assets in proportion to their fair
market values, third, as a reduction in the amount previously allocated
to Class III assets in proportion to their fair market values, and
finally, as a reduction in the amount previously allocated to Class II
assets in proportion to their fair market values. Decreases in
consideration allocated to an asset shall not exceed the amount of
consideration previously allocated to that asset. Except as provided in
paragraph (f)(4)(ii) of this section (relating to patents and similar
property), the fair market value is the fair market value on the
purchase date.
* * * * *
(g) * * *
Example 1. (i) On January 1, 1998, S, a sole proprietor, sells
to P, a corporation, a group of assets which constitute a trade or
business under paragraph (b)(2) of this section. P pays S $2,000 in
cash and assumes $1,000 in liabilities. Thus, the total
consideration is $3,000.
(ii) Assume that P acquires no Class I assets and that on the
purchase date, the fair market values of the Class II, Class III,
and Class IV assets S sold to P are as follows:
------------------------------------------------------------------------
Fair
Asset class Asset market
value
------------------------------------------------------------------------
II........................... Portfolio of marketable $ 400
securities.
--------
Total Class II................ $ 400
III.......................... Furniture and fixtures.......... $ 800
Building........................ 800
Land............................ 200
Equipment....................... 400
Accounts receivable............. 100
--------
Total Class III................. $2,300
IV........................... Covenant not to compete......... $100
--------
Total Class IV.................. $100
------------------------------------------------------------------------
(iii) Under paragraphs (d)(1) and (2) of this section, the
amount of consideration allocable to the Class II, III, IV, and V
assets is the total consideration reduced by the amount of any Class
I assets. Since P acquired no Class I assets, the total
consideration of $3,000 is next allocated first to Class II, then to
Class III, and then to Class IV assets. Since the fair market value
of the Class II assets is $400, $400 of consideration is allocated
to the Class II assets. Since the remaining amount of consideration
is $2,600 ($3,000 - $400), an amount which exceeds the sum of the
fair market values of the Class III assets ($2,300), the amount
allocated to each Class III asset is its fair market value. Since,
after the allocation to Class III assets, the remaining amount of
consideration is $300 ($3,000 - ($400 + $2,300)), an amount which
exceeds the fair market value of the Class IV asset ($100), the
amount allocated to the Class IV asset is its fair market value.
Thus, the total amount allocated to the Class II assets is $400, the
total amount allocated to the Class III assets is $2,300, and the
total amount allocated to the Class IV asset is $100.
(iv) The amount allocated to the Class V assets (assets in the
nature of goodwill and going concern value) is $200 (i.e., $3,000 -
($400 + $2,300 + $100)).
Example 2. (i) Assume the same facts as in Example 1.Assume
further that P and S each use the calendar year as the taxable year
and that, on September 30, 1998, P files a claim against S alleging
fraud in the sale of all of the assets.
(ii) On January 1, 2007, S refunds $400 of the purchase price to
P in a settlement of the lawsuit.
(iii) Under paragraph (f)(3)(i) of this section, both S and P
take into account the $400 decrease in consideration and allocate it
among the assets. First, since $200 of consideration previously was
allocated to the assets in the nature of goodwill and going concern
value (Class V assets), $200 of the decrease in consideration is
allocated to those assets. Then, since $100 of consideration
previously was allocated to the only Class IV asset, the covenant
not to compete, the next $100 of the remaining decrease in
consideration ($200) is allocated to that asset. The remaining
decrease in consideration ($100) is then allocated to the Class III
assets in proportion to their fair market values on the purchase
date as follows:
[[Page 2274]]
------------------------------------------------------------------------
Decrease in
Fair Allocation consideration
Asset market fraction ($100 x Col.
value (2))
------------------------------------------------------------------------
Furniture and fixtures........ $800 800/2,300 $34.78
Building...................... 800 800/2,300 34.78
Land.......................... 200 200/2,300 8.70
Equipment..................... 400 400/2,300 17.39
Accounts receivable........... 100 100/2,300 4.35
-----------------------------------------
Total................... $2,300 $100.00
------------------------------------------------------------------------
(iv) In summary, the redetermined consideration that S received for
the group of assets is $2,600 after taking into account the decrease in
consideration. After allocating the decrease, P's and S's redetermined
consideration is as follows:
----------------------------------------------------------------------------------------------------------------
Original Decrease in Redetermined
Asset consideration consideration consideration
----------------------------------------------------------------------------------------------------------------
Portfolio of marketable securities........................... $400.00 $0.00 $400.00
Furniture and fixtures....................................... 800.00 34.78 765.22
Building..................................................... 800.00 34.78 765.22
Land......................................................... 200.00 8.70 191.30
Equipment.................................................... 400.00 17.39 382.61
Accounts receivable.......................................... 100.00 4.35 95.65
Covenant not to compete...................................... 100.00 100.00 0.00
Goodwill and going concern value............................. 200.00 200.00 0.00
--------------------------------------------------
Total.................................................. $3,000.00 $400.00 $2,600.00
----------------------------------------------------------------------------------------------------------------
(v) Assume that, as a result of deductions under section 168, P's
adjusted basis in the equipment immediately before the decrease in
consideration is zero. P, therefore, treats the equipment as if it were
disposed of before the decrease is taken into account. In 2007, P
recognizes income of $17.39, the character of which is determined under
the principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and
the tax benefit rule. No adjustment to the basis of P's assets is made
for any tax paid on this amount. Assume also that, as a result of
amortization deductions, the adjusted basis of the covenant not to
compete and the goodwill and going concern value immediately before the
decrease in consideration is $120. A similar adjustment to income is
made in 2007 with respect to the $180 of previously amortized covenant
not to compete and goodwill and going concern value.
Example 3. (i) On January 1, 1998, A transfers assets X, Y, and Z
worth $1,000 to B in exchange for assets D, E, and F, worth $100, plus
$1,000 cash.
* * * * *
(viii) A, as transferor of assets X, Y, and Z, received $100 that
must be allocated under section 1060 and paragraph (d) of this section.
Since A transferred no Class I, II, III, or IV assets to which section
1060 applies, the $100 is allocated to Class V assets (assets in the
nature of goodwill and going concern value).
* * * * *
(xi) B, as transferee of assets X, Y, and Z, gave A $100 that
must be allocated under section 1060 and paragraph (d) of this
section. Since B received from A no Class I, II, III, or IV assets
to which section 1060 applies, the $100 consideration is allocated
by B to Class V assets (assets in the nature of goodwill and going
concern value).
Example 4. (i) On January 1, 1998, S, a sole proprietor, sells
to P, a corporation, a group of assets which constitutes a trade or
business under paragraph (b)(2) of this section. S, who plans to
retire immediately, also executes a covenant not to compete in P's
favor. P pays S $3,000 in cash and assumes $1,000 in liabilities.
Thus, the total consideration is $4,000.
(ii) On the purchase date, P and S also execute a separate
agreement that states that the fair market values of the Class II,
Class III, and Class IV assets S sold to P are as follows:
------------------------------------------------------------------------
Fair
Asset class Asset market
value
------------------------------------------------------------------------
II........................... Portfolio of marketable $500
securities.
--------
Total Class II................ $500
III.......................... Furniture and fixtures.......... $800
Building...................... 800
Land.......................... 200
Equipment..................... 400
Accounts receivable........... 200
--------
Total Class III................. $2,400
IV........................... Covenant not to compete......... $900
--------
Total Class IV.................. $900
------------------------------------------------------------------------
(iii) P and S each allocate the consideration in the transaction
among the assets transferred under paragraph (d) of this section in
accordance with the agreed upon fair market values of the assets, so
that $500 is allocated to Class II assets, $2,400 is allocated to
Class III assets, $900 is allocated to Class IV assets, and $200
($4,000 total consideration less $3,800 allocated to asset classes
II, III, and IV is allocated to the Class V assets (assets in the
nature of goodwill and going concern value).
(iv) In connection with the examination of P's return, the
District Director, in determining the fair market values of the
assets transferred, may disregard the parties' agreement. Assume
that the District Director correctly determines that the fair market
value of the covenant not to compete was $100. Since the allocation
of consideration among Class II, III, and IV assets results in
allocation up to the fair market value limitation, the $800 of
unallocated consideration resulting from the District Director's
redetermination of the value of the covenant not to compete is
allocated to Class V assets (assets in the nature of goodwill and
going concern value).
(h) * * *
(3) Interim procedures for Form 8594. Until such time, if any, as
Form 8594 is revised to require otherwise, the sum of the amounts
allocated to Classes IV and
[[Page 2275]]
V should be reported on Form 8594 as Class IV assets.
Approved: December 20, 1996.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 97-656 Filed 1-9-97; 2:53 pm]
BILLING CODE 4830-01-U