Frontier Chevrolet Company v. Commissioner of Internal Revenue
329 F.3d 1131, 2003 Cal. Daily Op. Serv. 4425, 2003 Daily Journal DAR 5674 (2003)
Premium Feature
Subscribe to Lexplug to listen to the Case Podcast.
Rule of Law:
Under I.R.C. § 197, a covenant not to compete entered into in connection with a corporation's redemption of a substantial portion of its own stock constitutes an indirect acquisition of an interest in a trade or business, thus requiring the covenant to be amortized over a 15-year period.
Facts:
- Frontier Chevrolet Company (Frontier) was a corporation engaged in the trade or business of selling and servicing new and used vehicles in Billings, Montana.
- In 1987, Roundtree Automotive Group, Inc. (Roundtree) purchased all of Frontier’s stock, and its president, Frank Stinson, participated in Frontier's management.
- Between 1987 and 1994, Roundtree allowed Dennis Menholt (Menholt), a long-term employee of Stinson, to purchase 25% of Frontier’s stock as part of his employment.
- Before August 1, 1994, Roundtree owned 75% and Menholt owned 25% of Frontier’s stock.
- Effective August 1, 1994, Frontier entered into a 'Stock Sale Agreement' with Roundtree, redeeming the 75% of its stock owned by Roundtree using funds borrowed from General Motors Acceptance Corporation (GMAC).
- As a result of the redemption, Menholt became the sole shareholder of Frontier.
- In connection with the redemption, Roundtree, Stinson, and Frontier entered into a 'Non-Competition Agreement,' effective August 1, 1994, preventing Roundtree and Stinson from competing with Frontier in the car dealership business for five years.
- Frontier agreed to pay Roundtree and Stinson $22,000 per month for five years for the non-compete restrictions, which were deemed reasonable and necessary to protect the business interest Frontier was 'acquiring,' given Stinson and Roundtree's ability and knowledge to compete in the Billings market and Frontier's highly leveraged financial state.
Procedural Posture:
- Frontier Chevrolet Company amortized the covenant payments under I.R.C. § 197 on its 1994 through 1996 federal income tax returns.
- In 1999, Frontier filed a claim for refund for the 1995 and 1996 taxable years, asserting that the covenant should be amortized over the five-year life of the agreement and not under § 197.
- Frontier and the Internal Revenue Service (IRS) stipulated before the Tax Court that the only issue was whether Frontier must amortize the covenant not to compete under § 197.
- The Tax Court held that the covenant was a § 197 intangible because Frontier entered into it in connection with an indirect acquisition of a trade or business.
- Frontier Chevrolet Company (appellant) appealed the Tax Court's decision to the United States Court of Appeals for the Ninth Circuit.
Premium Content
Subscribe to Lexplug to view the complete brief
You're viewing a preview with Rule of Law, Facts, and Procedural Posture
Issue:
Does a corporation's redemption of 75% of its own stock, in connection with a covenant not to compete, constitute an 'indirect acquisition of an interest in a trade or business' under I.R.C. § 197, thereby requiring the covenant to be amortized over 15 years?
Opinions:
Majority - TROTT, Circuit Judge
Yes, a corporation's redemption of 75% of its own stock, in connection with a covenant not to compete, constitutes an 'indirect acquisition of an interest in a trade or business' under I.R.C. § 197, thereby requiring the covenant to be amortized over 15 years. The court affirmed the Tax Court's decision, finding that Frontier's redemption qualified as an 'acquisition' within the meaning of § 197 because Frontier regained possession and control over 75% of its stock. The court rejected Frontier’s argument that an acquisition under § 197 requires the taxpayer to acquire an interest in a new trade or business, emphasizing that the statute only requires acquisition of 'an' interest in a trade or business. The court highlighted that § 197’s legislative history clarifies that 'an interest in a trade or business includes not only the assets of a trade or business, but also stock in a corporation engaged in a trade or business.' It concluded that the substance of the transaction was to effect a change of controlling corporate stock ownership, a key indicator of an acquisition. Furthermore, Congress’s intent to simplify the treatment of intangibles by providing a single amortization period implies that stock acquisitions and redemptions should be treated similarly when they involve acquiring an interest in a trade or business through stock acquisition.
Analysis:
This case significantly clarifies the broad interpretation of 'acquisition' under I.R.C. § 197, establishing that a corporate stock redemption can trigger the 15-year amortization period for related covenants not to compete. The ruling prevents taxpayers from circumventing the statutory amortization period by structuring what is effectively a change in corporate control as a redemption rather than a direct acquisition. It underscores that the substance of a transaction, particularly a shift in controlling ownership, dictates its tax treatment under § 197, aligning with Congress's goal of simplifying and standardizing the amortization of intangibles. This precedent influences how businesses structure buy-sell agreements and other ownership transfer transactions involving non-compete clauses.
