Frontier Chevrolet Co. v. Commissioner

116 T.C. No. 23
UNITED STATES TAX COURT
FRONTIER CHEVROLET CO., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19627-98. Filed May 14, 2001.
P entered into a stock sale agreement in which P
redeemed 75 percent of its outstanding stock from C in
exchange for monetary consideration. P also entered
into a noncompetition agreement in which P agreed to
make monthly payments to C and S for a period of 5
years so long as C and S agreed not to compete with P.
P argues that it is permitted to amortize the
noncompetition agreement payments over 60 months, the
life of the agreement.
Held: Sec. 197, I.R.C., requires that a covenant
not to compete entered into in connection with a direct
or indirect acquisition of an interest in a trade or
business be amortized over 15 years. The
noncompetition agreement was entered into in connection
with P’s redemption of its stock, which was an
acquisition of an interest in a trade or business. P
must amortize the noncompetition agreement payments
over 15 years.
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Peter T. Stanley, for petitioner.
James R. Robb and Virginia L. Hamilton, for respondent.
OPINION
RUWE, Judge: Respondent determined deficiencies in
petitioner’s Federal income taxes as follows:
Year Amount
1994 $28,996
1995 135,880
1996 110,320
After concessions,1 the issue for decision is whether petitioner
must amortize noncompetition agreement payments over 15 years
pursuant to section 197.2
Background
The parties submitted this case fully stipulated. The
stipulation of facts, stipulation of settled issues, and the
attached exhibits are incorporated herein by this reference.
Petitioner is a corporation that had its principal place of
business in Billings, Montana, at the time it filed its petition.
1
The parties filed a stipulation of settled issues in which
they resolved all the issues raised in the notice of deficiency.
The remaining issue related to sec. 197 was raised by petitioner
in its amended petition.
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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Petitioner is engaged in the trade or business of selling
and servicing new and used vehicles.3 Roundtree Automotive
Group, Inc. (Roundtree), is a corporation engaged in the trade or
business of purchasing and operating automobile dealerships and
providing consulting services to these dealerships.4 Frank
Stinson (Mr. Stinson) was involved in the operations of Roundtree
during the years 1987 through 1994.
Roundtree originally purchased all the stock of petitioner
in August of 1987. Consistent with Mr. Stinson’s and Roundtree’s
policy of management, petitioner filled the position of executive
manager of its dealership with one of Mr. Stinson’s long-term
employees, Dennis Menholt (Mr. Menholt). As part of his
employment by petitioner, Mr. Menholt was allowed to purchase,
from 1987 through 1994, 25 percent of the stock of petitioner.
In 1994, Mr. Menholt was the general manager of petitioner’s
automobile dealership located in Billings, Montana, and Mr.
Stinson was the president of Roundtree. Mr. Stinson participated
in the management of petitioner’s business, particularly in
advertising and sales training. Roundtree received monthly
payments of $22,000 for management services it performed for
3
Petitioner was formerly known as Frontier Chevrolet
Company. References to petitioner include events which occurred
when it was known as Frontier Chevrolet Company.
4
Roundtree was formerly known as FS Enterprises, Inc.
References to Roundtree include events which occurred when it was
known as FS Enterprises, Inc.
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petitioner. Prior to August 1, 1994, Roundtree owned 75 percent
of the stock in petitioner, and Mr. Menholt owned the remaining
25 percent.
Petitioner entered into a “Stock Sale Agreement” with
Roundtree. Effective August 1, 1994, petitioner redeemed all its
stock owned by Roundtree for $3.5 million. The funds to redeem
the stock were borrowed from General Motors Acceptance
Corporation (GMAC), with liens placed on all tangible assets of
petitioner. After the stock sale agreement, Mr. Menholt was the
sole remaining shareholder of petitioner.
Petitioner also entered into a “Non-Competition Agreement”
(noncompetition agreement) with Mr. Stinson and Roundtree,
effective August 1, 1994. The noncompetition agreement stated:
To induce * * * [petitioner] to enter into and
consummate the Stock Sale Agreement and to protect the
value of the shares of stock being purchased, Roundtree
and [Mr.] Stinson covenant, to the extent provided in
Section 1 hereof, that Roundtree and [Mr.] Stinson
shall not compete with * * * [petitioner’s] automobile
dealership, stock of which was sold to * * *
[petitioner] pursuant to the Stock Sale Agreement.
Section 1, entitled “Covenant Not to Compete”, provided that
Roundtree and Mr. Stinson would not compete with petitioner in
the car dealership business within Yellowstone County for a
period of 5 years. The agreement stated that the competition
restrictions against Mr. Stinson and Roundtree “are reasonable
and necessary to protect the business and interest which * * *
[petitioner] under the Stock Sale Agreement is acquiring pursuant
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to the Stock Sale Agreement”. As consideration for the
obligations of Roundtree and Mr. Stinson, petitioner agreed to
pay Roundtree and Mr. Stinson $22,000 per month for 60 months.
The consideration under the noncompetition agreement was in
addition to the consideration petitioner paid to redeem its
stock. In the event petitioner defaulted on the noncompetition
agreement payments, the entire amount of the remaining payments
would immediately become due and collectible, and the covenant
not to compete would terminate 90 days after such default. If
Roundtree and Mr. Stinson breached their obligations under the
agreement, petitioner was entitled to one-half of the net profits
for 5 years of any business conducted which breached the covenant
not to compete.
Due to the GMAC loan, petitioner was leveraged with large
interest expenses. In the summer of 1994, petitioner was below
the minimum working capital requirements of its franchisor and
had to obtain a special waiver of working capital requirements in
order to continue holding its franchise. There was no known
alternative to the noncompetition agreement with Roundtree and
Mr. Stinson in order to protect petitioner from their competition
in the Billings market. Without the agreement, it would have
been difficult for petitioner to raise capital or to pay its loan
from GMAC.
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On its Federal income tax returns for the years 1994 through
1996, petitioner amortized the noncompetition agreement payments
over 15 years. In 1999, petitioner filed a claim for refund for
the taxable years 1995 and 1996 on the basis that the
noncompetition agreement payments should be amortized over 60
months, the life of the agreement. In its amended petition,
petitioner claims that it is entitled to a deduction for the
years 1995 and 1996 for the same reasons set forth in its claim
for refund.
Discussion
The issue for decision is whether petitioner must amortize
noncompetition agreement payments to Roundtree and Mr. Stinson
over 15 years pursuant to section 197.
Section 197(a) provides that “A taxpayer shall be entitled
to an amortization deduction with respect to any amortizable
section 197 intangible.” The deduction is determined by
amortizing the adjusted basis of the intangible ratably over a
15-year period beginning with the month in which such intangible
was acquired. See sec. 197(a). An “amortizable section 197
intangible” is any section 197 intangible acquired by a taxpayer
after August 10, 1993,5 and held in connection with the conduct
5
See Omnibus Budget Reconciliation Act of 1993, Pub. L. 103-
66, sec. 13261(g), 107 Stat. 540, for effective date; see also
Spencer v. Commissioner, 110 T.C. 62, 87 n.30 (1998), affd.
without published opinion 194 F.3d 1324 (11th Cir. 1999).
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of a trade or business. Sec. 197(c)(1). A covenant not to
compete entered into in connection with a direct or indirect
acquisition of an interest in a trade or business is a section
197 intangible.6 See sec. 197(d)(1)(E).7
Petitioner argues that it did not acquire any interest in a
trade or business; therefore, the covenant not to compete is not
a section 197 intangible and petitioner is permitted to amortize
the payments over 60 months, the life of the covenant. This is
the first instance in which we have the opportunity to consider
the statutory requirements of section 197 as they relate to a
6
Under prior law, amounts paid for a covenant not to compete
were amortizable over the life of the covenant. See Newark
Morning Ledger Co. v. United States, 507 U.S. 546 (1993); Warsaw
Photographic Associates v. Commissioner, 84 T.C. 21, 48 (1985).
Sec. 197(b) provides that “Except as provided in subsection (a),
no depreciation or amortization deduction shall be allowable with
respect to any amortizable section 197 intangible.”
7
Sec. 197(d)(1) provides, in pertinent part:
SEC. 197(d). Section 197 Intangible.--For
purposes of this section--
(1) In general.--Except as otherwise
provided in this section, the term “section 197
intangible” means--
* * * * * * *
(E) any covenant not to compete (or
other arrangement to the extent such
arrangement has substantially the same effect
as a covenant not to compete) entered into in
connection with an acquisition (directly or
indirectly) of an interest in a trade or
business or substantial portion thereof * * *
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covenant not to compete.
Petitioner entered into a stock sale agreement with
Roundtree. Under the terms of that agreement, petitioner
redeemed 75 percent of its stock from Roundtree for $3.5 million.
Petitioner also entered into a noncompetition agreement with
Roundtree and Mr. Stinson. A purpose of the noncompetition
agreement was:
To induce * * * [petitioner] to enter into and
consummate the Stock Sale Agreement and to protect the
value of the shares of stock being purchased, Roundtree
and [Mr.] Stinson covenant, to the extent provided in
Section 1 hereof, that Roundtree and [Mr.] Stinson
shall not compete with * * * [petitioner’s] automobile
dealership, stock of which was sold to * * *
[petitioner] pursuant to the Stock Sale Agreement.
The noncompetition agreement prohibited Roundtree and Mr. Stinson
from competing with petitioner in the car dealership business
within Yellowstone County for a period of 5 years. The facts
establish, and petitioner does not dispute, that the
noncompetition agreement was entered into “in connection with”
the stock sale agreement.
Petitioner argues that it did not acquire an interest in a
trade or business pursuant to the stock transaction because, both
before and after the transaction, petitioner was engaged in
exactly the same trade or business and it acquired no other new
assets. Respondent argues that petitioner’s redemption of its
stock was an “acquisition” of an interest in a trade or business
within the meaning of section 197.
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Normally, we look to the plain language of a statute to
interpret its meaning. See Consumer Prod. Safety Commn. v. GTE
Sylvania, Inc., 447 U.S. 102, 108 (1980); Union Carbide Foreign
Sales Corp. v. Commissioner, 115 T.C. 423, 430 (2000). When a
statute is clear on its face, we require unequivocal evidence of
legislative purpose before interpreting the statute to override
the plain meaning of the words used therein. See Hirasuna v.
Commissioner, 89 T.C. 1216, 1224 (1987); Huntsberry v.
Commissioner, 83 T.C. 742, 747-748 (1984). The legislative
history of section 197 contains no evidence that Congress
intended a purchase of stock to be excluded from the meaning of
the term “acquisition” simply because the purchase occurred in
the form of a redemption.
The term “acquisition” is defined as “The gaining of
possession or control over something” and “Something acquired”.
Black’s Law Dictionary 24 (7th ed. 1999). The term “redemption”
is defined as “The act or an instance of reclaiming or regaining
possession by paying a specific price.”8 Id. at 1282.
Redemption, in the context of securities, is defined as “The
reacquisition of a security by the issuer.”9 Id. In the instant
8
See Boyle v. Commissioner, 14 T.C. 1382, 1390 n.7 (1950),
affd. 187 F.2d 557 (3d Cir. 1951), for a detailed discussion of
the origin and meaning of the term “redemption”.
9
We note that under sec. 317(b) (relating to corporate
distributions and adjustments), stock is treated as redeemed by a
(continued...)
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case, petitioner entered into a stock sale agreement in which it
redeemed 75 percent of its outstanding stock from Roundtree. As
a result of the stock sale agreement, petitioner regained
possession and control over its stock. On the basis of the plain
meaning of the statute, we conclude that the redemption was an
“acquisition” within the meaning of section 197 because
petitioner received 75 percent of its stock as a result of the
transaction with Roundtree.10
In order for section 197 to apply, petitioner must have
directly or indirectly acquired an “interest in a trade or
business”. The relevant legislative history of section 197
provides:
9
(...continued)
corporation if it acquires its stock from a shareholder in
exchange for property. See also Steffen v. Commissioner, 69 T.C.
1049, 1054 (1978) (redemption under sec. 317(b) is defined as a
corporation’s acquisition of its stock from a shareholder in
exchange for property).
10
Although not applicable to the instant case because the
noncompetition agreement was entered into before its effective
date, sec. 1.197-2(b)(9), Income Tax Regs., supports respondent’s
argument that the term “acquisition” includes a redemption of
stock. Sec. 1.197-2(b)(9), Income Tax Regs., provides, in
pertinent part:
Section 197 intangibles include any covenant not to
compete, or agreement having substantially the same
effect, entered into in connection with the direct or
indirect acquisition of an interest in a trade or
business or a substantial portion thereof. For
purposes of this paragraph (b)(9), an acquisition may
be made in the form of an asset acquisition * * * a
stock acquisition or redemption, and the acquisition or
redemption of a partnership interest. * * *
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The term “section 197 intangible” also includes
any covenant not to compete (or other arrangement to
the extent that the arrangement has substantially the
same effect as a covenant not to compete) entered into
in connection with the direct or indirect acquisition
of an interest in a trade or business (or a substantial
portion thereof). For this purpose, an interest in a
trade or business includes not only the assets of a
trade or business, but also stock in a corporation that
is engaged in a trade or business or an interest in a
partnership that is engaged in a trade or business.
[H. Rept. 103-111, at 764 (1993), 1993-3 C.B. 167, 340;
emphasis added.]
See also H. Conf. Rept. 103-213, at 677 (1993), 1993-3 C.B. 393,
555 (using language nearly identical to that used in the House
report). The legislative history explains that an “acquisition
of stock that is not treated as an asset acquisition” is treated
as “an indirect acquisition of a trade or business”. Id. at 694,
1993-3 C.B. at 572. Thus, the legislative history indicates that
an interest in a trade or business includes not only the direct
acquisition of the assets of the trade or business but also the
acquisition of stock in a corporation that is engaged in a trade
or business.
The noncompetition agreement provides that the covenant not
to compete was “reasonable and necessary to protect the business
and interest which * * * [petitioner] under the Stock Sale
Agreement is acquiring pursuant to the Stock Sale Agreement”.
Petitioner acquired 75 percent of its stock when it entered into
the stock sale agreement with Roundtree. Petitioner is a
corporation engaged in the trade or business of selling and
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servicing new and used vehicles. Thus, when petitioner executed
the stock sale agreement it indirectly acquired an interest, in
the form of stock, in a corporation engaged in a trade or
business.
Petitioner agrees that section 197 might apply if it had
acquired a new trade or business, but it contends that the
statute does not apply in the instant case because petitioner
continued the operation of its own existing business. Neither
the statute nor the legislative history contains any indication
that an interest in a new trade or business must be acquired in
order for section 197 to apply. Accordingly, we find that
petitioner acquired an “interest in a trade or business” within
the meaning of section 197 when it redeemed its stock from
Roundtree.
Finally, petitioner appears to argue that even if there was
an acquisition of an interest in a trade or business, it was by a
shareholder and not petitioner. Both the stock sale agreement
and the noncompetition agreement identify petitioner, Roundtree,
and Mr. Stinson, as the parties involved in the agreements.
Under the terms of the stock sale agreement, Roundtree agreed to
transfer the stock directly to petitioner, not to any
shareholders of petitioner. In its brief, petitioner states that
the noncompetition agreement was not entered into by any
shareholders of petitioner. Accordingly, petitioner’s argument
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lacks merit.
We find that the noncompetition agreement was entered into
in connection with an acquisition of an interest in a trade or
business. Therefore, we hold that petitioner must amortize the
noncompetition agreement payments to Roundtree and Mr. Stinson
over 15 years pursuant to section 197.
Decision will be entered
under Rule 155.