DocketNumber: Docket No. 268-89
Citation Numbers: 95 T.C. 495, 68 Rad. Reg. 2d (P & F) 540, 1990 U.S. Tax Ct. LEXIS 105, 95 T.C. No. 36
Judges: Goffe
Filed Date: 11/7/1990
Status: Precedential
Modified Date: 11/14/2024
*105 Petitioner purchased cable television systems and amortized the amount attributable to the franchise cost under
*495 The Commissioner determined deficiencies in petitioner's Federal income tax for the taxable year 1978 in the amount of $ 897,436. In addition to disputing the deficiency, petitioner claims an overpayment of $ 318,239 for that year.
The issues for*106 decision are whether a cable television franchise is a "franchise" for purposes of
Both parties have agreed that another issue, involving a net operating loss carryback from petitioner's 1981 taxable year to its 1978 taxable year, should be severed from the current litigation. The proper*107 calculation of the disputed carryback is dependent upon the calculation of taxable income or loss for petitioner's 1981 taxable year which the parties stipulate is not possible at this time.
FINDINGS OF FACT
Some of the facts in this case have been stipulated by the parties. The stipulation of facts and the exhibits attached thereto are incorporated by this reference.
Tele-Communications, Inc., petitioner, is a Delaware corporation with its principal office in Denver, Colorado, at the time of the filing of its petition.
During the taxable year in issue, petitioner was the third largest cable television operator in the United States, serving over 500,000 subscribers.
A cable television system *108 Broadcast signals from distant cities are usually picked up by a cable television system through the use of tall towers and sophisticated antennae and, at times, are brought to the system via microwave relay systems or satellite transmission; in addition, programming on separate *497 channels is sometimes generated by the system itself. Cable television systems typically distribute the radio and television signal to each user through a wire attached to utility poles. The cable company enters into a pole attachment agreement with the utility company that owns the poles. At each residence, a portion of the combined television signal is extracted by a device called a "tap" which is analogous to a tap on a water line. The cable from the tap is fed into a subscriber's house and attached to the television set, thereby permitting the subscriber to receive the radio and television signal. TCI Cablevision, Inc., a Nevada corporation, was a wholly owned subsidiary of petitioner in 1978 and was a member of petitioner's consolidated group. For purposes of this opinion, we will refer to TCI Cablevision, Inc., as petitioner. Athena Communications Corp. (Athena) is the parent corporation*109 of Athena Cablevision Corp. (Athena Cablevision). Athena was a publicly held corporation which was formed by Gulf & Western in 1971. In three separate transactions in December 1971 and January 1972, Athena issued its common stock, preferred stock, warrants, and a note to Gulf & Western in exchange for all of the capital stock of Athena Cablevision. In July 1972, petitioner acquired all of the outstanding Athena preferred stock and warrants and 16.8 percent of the common stock. The remaining common stock was distributed to the shareholders of Gulf & Western. Generally, Athena officers and directors were either officers or directors, or both, of petitioner or one of its subsidiary or affiliated companies. Petitioner and Athena were also parties to a management agreement whereby petitioner's management provided administrative services and assumed managerial responsibility for Athena's cable television systems. This agreement was entered into on October 31, 1973, and was in effect through the end of 1978. Athena Cablevision, although a wholly owned subsidiary of Athena, had several wholly owned subsidiaries of its own, including North Brevard Cable Television Co., Inc., which owned*110 and operated a cable television system in Titusville, Florida (the Titusville system), and in the contiguous areas *498 of Brevard County (the Brevard County system); *111 of the four systems sold to petitioner are involved in the issues presented in this case, specifically, the Titusville, Jefferson City, and the Moberly systems. For reasons not disclosed by the record, petitioner no longer contends it is entitled to amortize the fourth system, located in Columbia, South Carolina. The aggregate consideration petitioner paid to Athena for the four systems was $ 10,400,000, consisting of $ 6,700,000 in cash and the cancellation of $ 3,700,000 of Athena's indebtedness to TCI and its subsidiaries. Petitioner financed the acquisition through various sources. First, petitioner obtained a loan of $ 8 million from the Bank of New York and the Philadelphia National Bank, with the Bank of New York acting as the principal lender. Second, Cablevision agreed to lend Athena Cablevision $ 3 million. Finally, Cablevision obtained a noninterest-bearing obligation from Port Arthur Cablevision, Inc., one of petitioner's subsidiaries, for $ 1,700,000, due on January 1, 1985. The construction and operation of a cable television franchise system requires the permission, called a "franchise," by the local governmental unit which is typically*112 a municipality. This agreement between the governing body (franchisor) and the cable television system operator (franchisee) is established by enacting an ordinance. Petitioner believed permission was required from the municipalities to operate a cable television system and the operation of a *499 system by petitioner was never contemplated unless a franchise was granted. On April 21, 1971, the City Council of Jefferson City passed ordinance 8356. This ordinance was in effect during the taxable period in issue and permitted petitioner to establish and operate the cable television system for 10 years, subject to numerous concessions to the franchisor. Among the various conditions in the agreement, the municipality prohibited petitioner from assigning any rights granted by the ordinance without prior approval of the city council. Also, the franchisor set the maximum which petitioner could charge for basic cable service and set the specific channels which were required to be carried as a part of basic cable service. Petitioner was required to pay the franchisor 5 percent of its annual gross operating revenues from its service under the franchise, *113 or a minimum of $ 10,000. In addition, petitioner posted a $ 50,000 bond to guarantee that cable television service would be properly furnished and maintained in the community. Further, the franchisor prescribed specific construction standards for petitioner's facilities, as well as the minimum number of television channels, mandatory free FM radio signal service, free service for certain public buildings, and particular programming which petitioner was prohibited from offering to its customers. On February 6, 1978, the City Council of Moberly enacted ordinance 5587. This ordinance was in effect during the taxable period in issue and permitted petitioner to establish and operate the cable television system for 10 years, subject to numerous concessions to the franchisor. Among the various conditions in the agreement, the municipality prohibited petitioner from assigning any rights granted by the ordinance without prior approval of the city council. Also, the franchisor set the maximum which petitioner could charge for basic cable service and required free FM radio signal service to subscribers. *500 Petitioner was required to pay the franchisor*114 3 percent of its gross annual basic subscriber revenues under the franchise, with a provision for an increase to 5 percent of those revenues. In addition, petitioner was required to maintain a local office with regular business hours where subscribers could visit or telephone with complaints. Further, the franchisor prescribed specific construction standards for petitioner's facilities and required free service for certain public buildings. The franchisor also prohibited petitioner from entering into any service contract with a subscriber and required petitioner to provide television signals in color if technically feasible. On June 14, 1966, the City Council of Titusville promulgated ordinance 44-1966. This ordinance was in effect during the taxable period in issue and permitted petitioner to establish and operate the cable television system for 15 years, subject to numerous concessions to the franchisor. Among the various conditions in the agreement, the municipality prohibited petitioner from assigning any rights granted by the ordinance without prior approval of the city council. Also, the franchisor set the maximum which petitioner could*115 charge for basic cable television service, as well as the minimum number of channels required to be carried as a part of basic cable service, and required that petitioner provide a color television signal. Petitioner was required to pay the franchisor a 5-percent gross revenue tax, with an escalation to 8 percent over the life of the franchise. In addition, petitioner was to make available to the franchisor all of its plans and contracts, as well as its engineering, accounting, financial, statistical, customer, and service records relating to the operation of the franchise. Further, the franchisor prescribed specific construction standards for petitioner's facilities, as well as free service for certain public buildings. Also, the franchisor set out technical specifications and limited certain programming and business activity under which petitioner was to operate. In addition, petitioner was required to maintain a local office with regular business hours open to the public, and *501 one of petitioner's officers or principal stockholders was required to be a resident manager of the system. On August 20, 1973, the government of Brevard *116 County passed ordinance 73-18. This ordinance was in effect during the taxable period in issue and permitted petitioner to establish and operate the cable television system for 15 years, subject to numerous concessions to the franchisor. Among the various conditions to the agreement, the ordinance prohibited petitioner from assigning any rights granted without prior approval. Also, the franchisor retained the right to establish and change the rates which petitioner could charge for its cable television service. Petitioner was required to pay the franchisor 3 percent of its annual gross revenue under the franchise. In addition, petitioner was to make available to the franchisor all of its plans and contracts, as well as its engineering, accounting, financial, statistical, customer, and service records relating to the operation of the franchise. Further, the franchisor prescribed specific construction standards for petitioner's facilities, as well as the minimum number of channels and free service for certain public buildings. In addition, petitioner was required to maintain a local office with regular business hours open to the public, and one member of petitioner's management *117 staff was required to be a resident manager of the system. The cable television industry is capital-intensive in the same manner as the gas, telephone, electric, water, and other public utilities. The capital-intensive nature of the cable industry generally precludes situations in which a second cable operator constructs another cable system to serve and compete for the same subscribers in the same franchise area. Such competition would generally result in neither cable television system operator earning a fair return on its investment. Thus, competing cable systems are generally not constructed, even in areas where the franchising authority desires a second cable system. *502 Although each franchise in question did not provide an "exclusive" right for petitioner to operate a cable television system, in economic reality there was no possibility that a competitor could construct and operate another cable system with any realistic hope of financial success. Petitioner, therefore, enjoyed a de facto or natural monopoly for its services in each area in which it held a franchise because, if a resident of the municipality wanted "cable television," i.e., distant*118 television station signals or system-originated programming, the resident would have to subscribe to petitioner's cable system. At the time petitioner acquired the Jefferson City and Titusville cable systems, there were a large number of subscriber complaints because Athena's poor financial condition prevented it from making the investment necessary to provide a satisfactory level of service in those communities. Customer satisfaction, or lack of it, was not a factor petitioner considered when valuing a cable system before purchasing it. In fact, the poor reputation of an existing franchisee often works to the buyer's advantage because the buyer then has the opportunity to improve the system. Petitioner's acquisition of the Moberly, Jefferson City, Titusville, and Columbia, South Carolina, cable systems constituted an arm's-length transaction at a price which represented the fair market value of each system. The purchase agreement allocated the $ 10,400,000 purchase price among the four cable systems which petitioner acquired, as follows:The Moberly system $ 1,215,000 The Jefferson City system 2,112,885 The Titusville system 2,747,115 The Columbia, S.C., system 4,325,000 10,400,000
*119 After deducting the Columbia, South Carolina, system, the remaining $ 6,075,000 was allocated among the Moberly, Jefferson City, and Titusville systems on the basis of their miles of cable as of September 30, 1977. On that date, the Jefferson City system had approximately 120 miles of cable, the Moberly system, 69, and the Titusville system, 156.
The tangible assets of a cable television system include, principally, various electronic devices which make up what *503 is called the "head-end." These electronic components are necessary to receive the signals of broadcast television stations or other programming sources offered by the cable system. Additional tangible assets include coaxial cable, amplifiers, converters, and other hardware. The tangible assets of the systems as of the acquisition date had an aggregate fair market value of $ 3,326,000, allocated as follows:
The Moberly system | $ 623,000 |
The Jefferson City system | 1,477,000 |
The Titusville system | 1,226,000 |
3,326,000 |
In the course of the Commissioner's examination of petitioner's Federal income tax return for its 1978 taxable year, petitioner requested an amortization deduction of $ 662,998 which the Commissioner*120 refused to allow. Such a deduction, if permitted, would have resulted in a decrease of petitioner's taxable income by that amount and an overpayment of tax of $ 318,239. In its petition, petitioner claimed a cost basis for amortization of the franchises of $ 3,994,000. Petitioner requested the amortization deduction from the Commissioner under the provisions of
OPINION
The first issue we must decide is whether a cable television franchise is a "franchise" as that term is used in
*504
(a) General Rule. -- A transfer of a franchise, trademark, or*121 trade name shall not be treated as a sale or exchange of a capital asset if the transferor retains any significant power, right, or continuing interest with respect to the subject matter of the franchise, trademark, or trade name.
(b) Definitions. -- For purposes of this section -- (1) Franchise. -- The term "franchise" includes an agreement which gives one of the parties to the agreement the right to distribute, sell, or provide goods, services, or facilities, within a specified area. (2) Significant power, right, or continuing interest. -- The term "significant power, right, or continuing interest" includes, but is not limited to, the following rights with respect to the interest transferred: (A) A right to disapprove any assignment of such interest, or any part thereof. (B) A right to terminate at will. (C) A right to prescribe the standards of quality of products used or sold, or of services furnished, and of the equipment and facilities used to promote such products or services. (D) A right to require that the transferee sell or advertise only products or services of the transferor. (E) A right to require that the transferee purchase substantially all of his supplies*122 and equipment from the transferor. (F) A right to payments contingent on the productivity, use, or disposition of the subject matter of the interest transferred, if such payments constitute a substantial element under the transfer agreement.
* * * *
(d) Treatment of Payments by Transferee. -- (1) * * * (2) Other payments. -- If a transfer of a franchise, trademark, or trade name is not (by reason of the application of subsection (a)) treated as a sale or exchange of a capital asset, any payment not described in paragraph (1) which is made in discharge of a principal sum agreed upon in the transfer agreement shall be allowed as a deduction -- (A) in the case of a single payment made in discharge of such principal sum, ratably over the taxable years in the period beginning with the taxable year in which the payment is made and ending with the ninth succeeding taxable year or ending with the last taxable year beginning in the period of the transfer agreement, whichever period is shorter;
The proposed regulations promulgated under
Petitioner argues that it is entitled to amortize its costs in acquiring the Titusville, Jefferson City, and Moberly franchises pursuant to
the consideration for the franchise * * * was paid to the prior franchisee, the franchisor was a party to the transaction because the franchisor's consent was required to effect the transfer. The franchise rights run from the franchisor to the new franchisee, and the franchisor retains a significant power, right, or continuing interest. * * * [
Respondent argues, instead, that "cable television franchises" were never contemplated by Congress and, therefore, were simply not intended for the amortization provisions in
Before turning to the arguments on each issue, it may be helpful to clarify some confusion on the particular mechanics in applying
*506
Upon the conclusion that the rights acquired constitute a "franchise" as defined, then the full import of
If capital gain treatment is denied under
Respondent asserts that the definition of "franchise" in
Respondent acknowledges the general rule that reference to legislative history is prohibited when the statute is clear on its face but argues that this rule has substantial limits.
Each of the cases relied upon by respondent is distinguishable from the instant situation. In
*507 words are inexact tools at best, and for that reason there is wisely no rule of law forbidding resort to explanatory legislative history no matter how "clear the words may appear on 'superficial examination.'"
In
There is, of course, no more persuasive evidence of the purpose of a statute than the words by which the legislature undertook to give expression to its wishes. Often these words are sufficient in and of themselves to determine the purpose of the legislation. In such cases we have followed their plain meaning. When that meaning has led to absurd or futile results, however, this Court has looked beyond the words to the purpose of the act. Frequently, however, even when the plain meaning did not produce absurd results but merely an unreasonable one "plainly at variance with the policy of the legislation as a whole" this Court has followed that purpose, rather than the literal words. When aid to construction of the meaning of words, as used in the statute, is available, there certainly can be no "rule of law" which forbids its use, however clear the words may appear on "superficial examination." * * * [
In the instant case, the plain meaning of
*508 Respondent argues that petitioner's position, taken to its logical end, would mean that Congress intended
It is true that electric, gas, and telephone utilities are generally operated under a monopoly in that there is usually only one of these types of businesses in a community, but beyond this observation, respondent fails to provide this Court with any authority as to why this distinction makes a difference in the interpretation of
We cannot accept respondent's argument that the economic difference between cable television and other forms of businesses should play a factor in determining coverage under
The conclusion that cable television franchises are included in the
*131 The Tax Court cases relied upon by respondent are also inapposite. In
The term "franchise" in
In
In the instant case, however, Congress has provided a clear definition for the term "franchise." A franchise, for
Respondent does not argue that the various aspects of this definition are vague or ambiguous. In fact, respondent states that the definition is certainly clear enough. Rather, respondent argues that the ambiguity lies not in the definition, but in what is being defined, specifically, the term "franchise." We reject this argument as being internally inconsistent and logically circular.
The definition of "franchise" in
Mindful of Gertrude Stein's poetic admonition that a "Rose is a rose is a rose," the fact that cable television franchises are commonly called "franchises" also has no *510 importance because Congress has the power to define the term as it pleases. The arrangement may well have been called a mere contract, but when the three elements under
We disagree with respondent that resort to legislative history is appropriate in this instance because the term being defined is somehow vague. As previously noted, respondent readily admits that the statutory definition of "franchise" is clearly worded and *134 unambiguous. We feel that Congress understood that the statute's language cut a broad stroke so Congress attempted to limit its impact where it desired, e.g., the exclusion for the transfer of "professional football, basketball, baseball, or other professional sport" franchises.
The plain language of a statute is the source of its interpretation. When that language is not ambiguous, it is conclusive, absent a clearly expressed legislative intent to the contrary.
Prior to the instant case, respondent has also recognized and applied the plain meaning of
*511 In any event, respondent's resort to legislative intent does not further the position that Congress intended to exclude cable television franchises from the burdens and benefits of
Respondent argues that cable television franchises are "public" franchises and are, therefore, excluded from
Respondent states that the impetus behind the enactment of
In an effort to define a business franchise, as distinguished from a cable franchise, respondent presented William B. Cherkasky, President of the International Franchise Association, to point out three main differences between the two types of franchises. According to Mr. Cherkasky, a business franchise, such as a McDonald's or Burger King restaurant, involves (1) the licensing of a protected trademark, (2) no negotiability on the part of the franchisee, and (3) ongoing interaction between the franchisor and the franchisee.
Respondent argues*137 that Mr. Cherkasky's definition of a "franchise" was that which Congress had in mind when it fashioned
Nothing appears in the legislative history to limit the scope of
Once an arrangement satisfies the three elements set forth in
In examining the legislative history pertinent to the definition provisions of*139
The term "franchise" is defined by the bill to mean a franchise, distributorship, or other like interest. This would include subfranchises, subdistributorships, and other similar exclusive type contract arrangements *513 to operate or conduct a trade or business. * * * [H. Rept. 91-413 (1969),
The Senate report is more expansive:
The committee amendments also provide that the term "franchise" includes an agreement which gives one of the parties to the agreement the right to distribute, sell, or provide goods, services, or facilities, within a specified area. This would include distributorships or other similar exclusive-type contract arrangements to operate or conduct a trade or business within a specified area, such as a geographical area to which the business activity of the transferee is limited by the agreement. However, the committee amendments provide that the new rules are not to apply to the transfer of a franchise to engage in a professional sport. This exception applies only to franchises for teams to participate in a professional sports league, *140 and would not apply to other franchised sports enterprises, such as a franchise to operate a golfing, bowling, or other sporting enterprise as a trade or business * * * [S. Rept. 91-552 (1969),
Respondent points to a dictionary definition of "franchise" to highlight the multiple connotations of that term. It is argued that the myriad of meanings in the dictionary underscores respondent's contention that there is more than one commonly accepted understanding of "franchise" and, thus, the term itself is inherently ambiguous.
Used alone, the term "franchise" is certainly susceptible to multiple interpretations. In
In Webster's less technical unabridged dictionary, among the numerous definitions provided, a franchise is "a right to do business conferred by a government." Webster's Third New International Dictionary, Unabridged 902 (3d ed. *514 1981). This is precisely the type of franchise under which petitioner operates. Thus, the counter argument is equally plausible that Congress intended to include all government-granted (or "public") franchises under
Congress enacted the exceptions to the statute it wished to make.
Therefore, because
Our inquiry, however, does not end here. We must now decide whether petitioner is entitled to the amortization benefits under
A nonexhaustive list of six items is provided under
The Moberly, Jefferson City, and Titusville franchises vary somewhat, but contain substantially similar language for purposes of
All of the franchises prescribe minimum construction standards which involve the standard of quality factor in
Petitioner was required to make a percentage payment on each franchise depending upon its productivity.
The actual exercise of these controls by the franchisors is not questioned by respondent. We conclude that the franchisor in each franchise retained a significant power, right, or continuing interest as required under
We have been urged to consider petitioner's alternative argument by treating the instant case as a test case for the cable television industry and examining the applicability of
We turn now to the remaining issue before us for resolution. We must calculate the proper value of the franchise itself apart from the total consideration paid by petitioner for purposes of
Petitioner claimed an amortization deduction based upon its assertion that it has a cost basis in the franchises totaling $ 3,994,000. The parties have stipulated, however, that of the $ 10,400,000 contract price, $ 4,325,000 was allocated to the South Carolina cable system which is no longer part of this dispute. The $ 6,075,000 remaining after the exclusion of the purchase price allocated to the South Carolina system is further reduced by the tangible assets in each of these franchises which, in the aggregate, total $ 3,326,000. Thus, the total amount available as petitioner's basis in the franchises cannot be more than $ 2,749,000 and not $ 3,994,000 as petitioner asserts in its petition.
In addition, we hold that petitioner has failed to carry its burden with respect to the $ 2,500 for accounting services. This amount was originally deducted as an expense and disallowed by the Commissioner. Petitioner concedes that the amount should have been capitalized but has not demonstrated whether these services were in fact related to *517 the acquisition of the franchises and, if so, how*147 they should be allocated amongst them, particularly in light of the severance of the Columbia, South Carolina, franchise from this action. Petitioner simply makes no further mention of the $ 2,500 expenditure and, without more, we must sustain the Commissioner's disallowance of the claimed deduction. Rule 142(a).
Valuation issues present questions of fact that can be resolved only by weighing all of the evidence.
As we have already concluded, the total amount available to petitioner for franchise amortization is $ 2,749,000. Petitioner offered the testimony of two valuation firms to establish a basis in the franchises.
Petitioner's experts are Dr. Thomas E. Doerfler (Dr. Doerfler) and Mr. Jeffrey W. Traenkle (Mr. Traenkle), both from Arthur D. Little, Inc. (ADL), and Mr. William B. Shew (Mr. Shew) of the National Economic Research Associates, Inc. (NERA). Dr. Doerfler has a B.S. in mathematics from the University of Dayton, and an M.S. and Ph.D., both in statistics, from Iowa State University. Mr. Traenkle holds a B.S. in engineering from Princeton University and an M.B.A. from Harvard University. Mr. Shew holds a B.A. and an M.A. in economics from the University of Chicago.
Petitioner's experts conclude that the cost bases of the franchises are as follows: *518
ADL | NERA | |
Moberly franchise | $ 519,905 | $ 229,243 |
Jefferson City franchise | 459,035 | 449,699 |
Titusville franchise | 1,403,189 | 1,294,201 |
2,382,129 | 1,973,143 |
*149 ADL and NERA allocated $ 366,872 and $ 775,857, respectively, to other intangible assets to make up the difference between their franchise basis calculations and the potential cost basis of $ 2,749,000. (Because we find that Commissioner's disallowance of $ 2,500 for accounting expenses was proper, that amount should be added to petitioner's total cost basis for acquiring the four franchises.)
Respondent presented as his expert Dr. Gary L. French (Dr. French) of Nathan Associates, Inc. (Nathan Associates). Dr. French holds a B.B.A., an M.A. in economics, and a Ph.D. in economics from the University of Houston.
Dr. French's valuation report begins from a different premise than those of petitioner's experts. Although the parties have stipulated without objection that the $ 10,400,000 purchase price for the four cable television systems (including the Columbia, South Carolina, system) was on a "miles of cable" basis, Dr. French does not believe this allocation accurately reflects the value of each cable system.
Instead, Dr. French advocates a dollars-per-subscriber approach which reallocates the purchase price among the four systems. This method, Dr. French contends, is more accurate*150 in reflecting each system's fair market value, but he admits that even the dollars-per-subscriber allocation method is not without its flaws. For example, a cable system in a community with a large population would be worth the same as one with a small population if both had the same number of current subscribers, even though the larger community may have more room for expansion and growth.
This reallocation by Dr. French does not account for the stipulated fact that the Columbia, South Carolina, franchise has been severed from the instant case and its value should not have been included among the three systems currently under examination. Although Dr. French makes an arguably credible observation, it is an undisputed stipulated fact that the allocation of the purchase price among the individual *519 cable television systems was at arm's length. We see no reason to disregard the stipulations and, therefore, reject Dr. French's reallocation of the purchase price of the cable television systems and hold that the parties are bound by the amounts stipulated without objection. Rule 91(e).
Respondent contends that the cost bases of the franchises are much lower, specifically:
Moberly franchise | $ 125,354 |
Jefferson City franchise | 261,155 |
Titusville franchise | |
522,310 |
Respondent maintains that the discrepancy between the cost bases of the franchises is due to petitioner's failure to account for goodwill in its calculation.
*152 Petitioner, on the other hand, contends that, although there may be an element of going concern value, each franchise benefited by operating in a de facto monopoly which, by its nature, does not allow for the existence of "goodwill." Thus, petitioner argues that after deducting the tangible assets and going concern value, whatever is left is an intangible asset of the cable television franchise, an asset that can be amortized under
Respondent counters that goodwill could exist because there was no true "monopoly." The franchises were "nonexclusive" in nature and, at least in theory, another cable operator could enter the market and compete, thereby destroying the alleged monopoly. Further, respondent argues that it has never been established that a franchise is necessary to construct and operate a cable television system.
Petitioner responds that State law generally requires the franchises to be nonexclusive, but this provision in the *520 franchise ordinance simply does not reflect business reality in the cable television industry. Petitioner never contemplated entering a local jurisdiction and constructing a cable system without permission from the appropriate*153 authorities.
In economic theory, petitioner's status is accurately termed a "natural" monopoly because the capital-intensive nature of the cable television industry necessarily results in it delivering its service most efficiently through a single entity, thereby precluding additional cable systems. P. Samuelson & W. Nordhaus, Economics 588 (13th ed. 1989). As we have observed, even if a local government wanted a second cable television company to construct another system for purposes of competition, it is extremely unlikely that another operator would enter the market when the return on the investment simply would not justify the expenditure. The remote possibility that another cable system would have been constructed to compete with the existing system does not reflect the business reality at the time petitioner constructed and operated its cable systems.
The local government can control cable access under its general police powers reserved to it by the U.S. Constitution because the cable television operator must place its cable along public right-of-way.
We must also conclude that respondent's argument for the existence of goodwill in a cable television franchise is unfounded. Indeed, no valuation expert in this case assigns a value to goodwill. Petitioner's experts flatly reject the existence of goodwill in a monopolistic environment.
Goodwill is an elusive concept and is widely considered to be the "most intangible of intangibles." G. Smith & R. Parr, Valuation of Intellectual Property and Intangible Assets 88 (1989). In tax law, it is well established that the "nature of goodwill is the expectancy that 'old customers will resort to the old place.'"
On the basis of the facts presented, the concept of goodwill has no application. Potential cable television subscribers have no alternative but to go to the possessor of the right to deliver cable television services and, therefore, goodwill does not exist in the traditional sense.
Respondent contends that cable television simply has not risen to the level of a necessity in the same manner as electricity, gas, water, or telephone service. Respondent *522 argues that a family can do without cable*157 television and, in fact, many do. Respondent misses the point.
If a television viewer in petitioner's franchise area wishes the unique package which makes up cable television, i.e., distant television signals or local origination programming, then a viewer has no choice but to subscribe to petitioner's service. When a business is conducted pursuant to rights granted it by a governmental body and economically is exclusive, as is the case here, it cannot have any goodwill separate and distinct from the value of its monopolistic franchise.
Although there may be an absence of goodwill in a monopolistic environment, it is clear that an operating business has a value which is defined as the element "which attaches to property by reason of its existence as part of a going concern." G. Smith & R. Parr,
As we discuss below, the valuation by ADL most accurately reflects petitioner's franchise costs. ADL characterized going concern value as a nondepreciable capital asset and deducted this amount from the aggregate available to petitioner for amortization under
Respondent's expert calculated petitioner's subscriber assets on an income method, but used a residual technique to place a value on the franchises. The report of Dr. French of Nathan Associates is flawed due to a fallacy in its underlying premise. When petitioner's purchase price was gratuitously reallocated, figures upon which Dr. French performed his calculations were inflated. *159 Thus, respondent's conclusions are inherently unreliable.
*523 Using detailed subscriber data from each cable system, ADL based its calculations on the income method of valuation. Its analysis most accurately reflects the franchise values because it makes use of subscriber data, thereby increasing the reliability of its assumptions. ADL makes its projections based upon the value of two subassets which make up the main asset, the franchise itself.
Respondent's expert believes that, although the franchise may be an asset, it is an asset which is separate and apart from the subscriber assets. The subscriber assets, according to Dr. French, consist of "base" and "future" subscribers and can be valued independently of the franchise. This premise is inconsistent with the monopolistic environment in which these franchises operated. Without the franchise, there are no subscribers. It is, therefore, impossible to construct a value for the subscribers without valuing the franchise itself.
The two subassets which ADL identified as making up the franchise are (1) the number of subscribers who were actually on hand at the time petitioner received the franchise, and (2) the potential*160 of the cable system to attract new customers over time. ADL terms this second subasset "marketing rights." The term "marketing rights" is interchangeable with future subscribers.
The basic methodology which ADL used is logical and easily stated, even if its individual components are mathematically and statistically complex. ADL began by determining the value of each tangible asset which comprised petitioner's cost of acquiring the franchises. Then, ADL identified what intangibles had been purchased by petitioner and concluded that only two were acquired: going concern value and franchise value. Franchise value is the sum of the value of the current and the future subscribers.
ADL employed the income or discounted cash-flow method of valuation. Looking to the projected stream of cash through to the terminal year (last year of the franchise), ADL took this amount and discounted the future dollars to present value. The discount rate was derived using the widely accepted capital asset pricing model.
The going concern value was calculated using the difference between the current cash-flow and the cash-flow which would have resulted if the system were reconstructed. Dr. Doerfler *161 calculated the franchise subasset values, current *524 and future subscribers, by using a "lifing" study performed on a statistical sampling of subscribers. This study provided a means of determining the length of time from which petitioner could expect the stream of income from the subscribers.
The lifing study utilized a factor to account for the discontinuation of service over the life of the franchise by some of the subscribers. This factor was derived by taking a 10-percent random sample from the actual subscriber rolls maintained by the cable system on a monthly basis from January 1974 through December 1978. Over this 47-month period, called the observable time frame, subscribers were grouped according to the length of time they were customers of the system: less than 5 months, 6 to 10 months, 11 to 20 months, 21 to 30 months, and more than 30 months.
Dr. Doerfler then applied the law of probability to calculate the survival/disconnect rate exhibited by the subscribers. The results were demonstrated with the graph of a decay pattern to forecast the time in which a current subscriber continues to remain a subscriber. Thus the probability of cancellation by the subscriber, *162 by the customer's choice, or termination of the subscriber, e.g., for nonpayment, is connected to a corresponding point in time.
This method enabled ADL to predict, with mathematical precision, the length of time a subscriber would generate revenue for the system. The probability law calculation used in the lifing study is more accurate because, unlike alternative methods such as straight-line depreciation or the Iowa Curve, it recognizes a decrease in the probability of cancellation as a subscriber becomes more mature. It also provides for a statistically valid means of determining the value of current subscribers and, utilizing the discount rate, the present value of future subscribers. The current and future subscribers are the subassets that, when combined, total the value of the franchise.
ADL attributed the $ 366,872 difference between petitioner's $ 2,749,000 aggregate purchase price for the systems and the $ 2,382,129 which it determined to be the franchise value to either going concern value or an unidentifiable, nonamortizable asset. This approach comports with the residual method of computing going concern value, because *525 all other tangible and intangible assets*163 have been identified.
In any event, ADL presents a clearly reasoned and properly supported valuation of petitioner's cost basis in its cable television franchises. Accordingly, we hold that petitioner has met its burden in establishing that $ 2,382,129 is the proper amount for
1. Unless otherwise indicated, all section numbers refer to the Internal Revenue Code in effect for the taxable year 1978, and Rule numbers refer to the Rules of Practice and Procedure of this Court.↩
2. A cable television "system" includes the tangible assets of the operation as well as the franchise granted by the local governmental authority. A "franchise" means only the intangible right to maintain and operate the system within the local government's jurisdiction.↩
3. The Titusville cable system actually included two separate franchises, one for the City of Titusville pursuant to an agreement dated Dec. 21, 1967, for a 15-year period and one for the contiguous unincorporated areas of Brevard County, Florida, granted by the Board of County Commissioners on Aug. 15, 1974, also for a period of 15 years. In referring to the "Titusville system," we will include the Brevard County system unless otherwise stated.↩
4. Hearings on S. 1739, S. 1801, S. 1886, and S. 2303 Before a Subcomm. of the Senate Comm. on Interstate and Foreign Commerce, 86th Cong., 1st Sess. (1959).↩
5. Respondent states separate values for the Titusville franchise of $ 105,246 and the Brevard County franchise of $ 30,555 which total $ 135,801. This separate treatment is not important to our decision.↩
6. We note that each expert presented calculations which arrived at a basis lower than the cost basis for the franchises alleged by petitioner in its petition. Although petitioner claims a higher franchise cost basis, we feel this amount is unrealistic in light of the reports submitted by the valuation firms in this matter. ADL and NERA both started with $ 2,749,000 while Nathan Associates used $ 3,850,717.↩
7. See also
Immigration & Naturalization Service v. Cardoza-Fonseca , 107 S. Ct. 1207 ( 1987 )
City of Omaha v. Omaha Water Co. , 30 S. Ct. 615 ( 1910 )
United States v. Dickerson , 60 S. Ct. 1034 ( 1940 )
United States v. American Trucking Associations , 60 S. Ct. 1059 ( 1940 )
Commissioner v. Court Holding Co. , 65 S. Ct. 707 ( 1945 )
Crooks v. Harrelson , 51 S. Ct. 49 ( 1930 )
united-states-v-richard-p-cornish-and-de-etta-s-cornish-appelleees , 348 F.2d 175 ( 1965 )
Edwards v. Slocum , 44 S. Ct. 293 ( 1924 )
Los Angeles Gas & Electric Corp. v. Railroad Commission , 53 S. Ct. 637 ( 1933 )
Commissioner of Internal Revenue v. Maurice L. Killian , 314 F.2d 852 ( 1963 )
Des Moines Gas Co. v. City of Des Moines , 35 S. Ct. 811 ( 1915 )
Jack Daniel Distillery, Lem Motlow, Prop., Inc. v. The ... , 379 F.2d 569 ( 1967 )
United States v. Naftalin , 99 S. Ct. 2077 ( 1979 )
Consumer Product Safety Commission v. GTE Sylvania, Inc. , 100 S. Ct. 2051 ( 1980 )
Seymour Silverman v. Commissioner of Internal Revenue , 538 F.2d 927 ( 1976 )
R. M. Smith, Inc. v. Commissioner of Internal Revenue , 591 F.2d 248 ( 1979 )
Harrison v. Northern Trust Co. , 63 S. Ct. 361 ( 1943 )
Silco, Inc. v. United States , 779 F.2d 282 ( 1986 )
Winn-Dixie Montgomery, Inc. v. United States , 444 F.2d 677 ( 1971 )