i. Amortization of intangibles Present Law Taxpayers may take depreciation or amortization deductions for the exhaustion, wear, tear, and obsolescence of property (sec. 167(a)). No such deductions are allowed, however, with respect to property that is not a wasting asset or property whose useful life cannot be estimated with reasonable accuracy. Deductions are generally allowed for the costs attributed to such intangible assets as patents or other statutory or contract rights that exist for a specific, non-extendible period of time. However, because goodwill does not have a determinable useful life, no depreciation deduction is allowed with respect to that intangible asset. Accordingly, the portion of the purchase price of a business that is allocated to goodwill may not be amortized or depreciated. Goodwill has been defined as the expectancy of continued patronage, for whatever reason, or as "the probability that old customers will resort to the old place". Taxpayers frequently take the position that a substantial portion of the purchase price of a business is allocable to certain intangible assets other than goodwill, for which they attempt to establish a limited useful life and claim depreciation. The value of such other assets is often described as the value obtained from the existing customer base and the useful life is often said to be the time period over which that base may erode as customers move away or withdraw their level of patronage. Such assets include, for example, customer and subscription lists; patient or other client records; the existing "core" deposits of banks; insurance in force in the case of an insurance company; advertising relationships and customer or circulation base in the case of a broadcast or newspaper business; and existing market share in the case of any business. In many instance, courts have refused to permit the amortization of such assets. The IRS has successfully argued that these items may be viewed as "mass assets" in that particular customers may be lost but others may be expected to replace them. Deductions have also been denied in many cases for such intangible assets as customer or client information that facilitates the business of serving customers. Such records have been described as simply an integral part of the goodwill of the business. In some other cases, however, courts have permitted deductions for such items as customer lists or client information, stating that such assets are of use primarily as a resource for serving customers of the business but are not the same as goodwill. Still other cases have denied the deductions claimed in the particular case, but have suggested that if the taxpayers had presented better statistical evidence of the period over which the existing customer base declined, amortization might be permitted. The cases permitting or suggesting the possibility of a deduction have not always indicated wheth er it is necessary to take into account any expectation or evidence that new customers will replace those that die, move away, or otherwise sever their customer relationships. Generally, costs attributable to the creation or acquisition of an asset that has a useful life of more than a year may not be currently deducted, but must be capitalized. Goodwill typically would have a life extending beyond one year and costs that can be related to its creation, such as those of certain extraordinary advertising campaigns, are required to be capitalized. However, it is possible that many taxpayers deduct currently costs that may contribute to the creation of goodwill, such as ordinary advertising or other ongoing business expenses. This may occur in part because of the difficulties of separately identifying which ordinary and necessary business expenses have created goodwill, and of determining when or whether "new" goodwill has been created. Possible Proposals 1. Deny amortization or depreciation deductions for intangible assets representing the value of the existing customer base or market share. 2. Permit amortization of such intangible assets if a deduction might arguably be claimed under present law, but permit the deduction only over a uniform, prescribed period of substantial duration (e.g., 40 years). Pros and Cons Arguments for the proposals 1. Assets similar to goodwill, such as intangible assets reflecting the value of a customer base or market share should not be amortized more rapidly than goodwill. 2. The key factors that make goodwill a nondepreciable asset are also present in the case of other intangible assets representing the value of the customer base or market share. One is the difficulty of determining a useful life. Although it is possible that goodwill may diminish over time if it is not continually renewed, it is extremely difficult to determine the extent to which "old" goodwill is retained or "new" goodwill is created, through ongoing business operations. This difficulty exists as well for other assets related to the value of the customer base or market share. Likewise, taxpayers that seek to amortize the costs of acquiring such intangibles, on the grounds that they are "wasting" assets with a determinable useful life extending beyond a year, may be capitalizing little if any of their ongoing business expenses as costs of creating the new "customer" base or market share that replaces the one that they have written off. Arguments against the proposals 1. Present law with respect to goodwill may be unduly restrictive because goodwill may erode over time if it is not continually renewed. Taxpayers should thus be permitted to accomplish a result similar to a deduction for goodwill by attempting to establish a de terminable useful life for such significant portion of the intangible asset value related to customer base or market share. 2. Taxpayers should not be precluded from attempting to establish a limited useful life for any asset. j. Disallow interest deductions allocable to tax-exempt installment sales of property to State or local governments Present Law Installment sales to State and local governments Under present law, if a taxpayer sells property to a State or local government in exchange for an installment obligation, interest on the obligation may be exempt from tax. If an installment obligation is received in exchange for certain types of property (including most dealer property and certain real property held for use in a trade or business or for the production of rental income), then use of the installment method by the seller is limited under a formula that allocates a portion of the taxpayer's indebtedness among the taxpayer's installment obligations. Disallowance of interest deductions Present law provides that no deduction is allowed for interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is not subject to tax. Under present law, in the case of a corporation other than a financial institution or a dealer in tax-exempt obligations, interest on the corporation's indebtedness generally is not disallowed where during a taxable year the average amount of the corporation's taxexempt obligations does not exceed 2 percent of the average total assets held in the active conduct of a trade or business. In many cases, such taxpayers may hold tax-exempt obligations that exceed 2 percent of their assets, yet take the position that none of their interest expense is disallowed. For example, such taxpayers may rely on an Internal Revenue Service ruling (Revenue Procedure 72-18) under which interest on such a corporation's indebtedness is not disallowed where the corporation acquires nonnegotiable tax-exempt obligations in the ordinary course of business for services performed for, or goods supplied to, State or local governments. Although the IRS has issued a private letter ruling indicating that a tax-exempt obligation would be treated as nonnegotiable for these purposes only if the obligation cannot be sold, many taxpayers take the position that nonnegotiable obligations are those obligations that are so treated under the Uniform Commercial Code (U.C.C.). Present law provides that, in the case of a financial institution, no deduction is allowed for the portion of interest expense that is allocable to tax-exempt interest. In general, the allocation of the interest expense of the financial institution for this purpose is based on the ratio of the average adjusted bases of the tax-exempt obligations acquired after August 7, 1986, to the average adjusted bases of all assets of the taxpayer. Possible Proposals 1. Where a taxpayer sells property to a State or local government and receives an obligation of such government the interest on which is exempt from tax, a portion of the taxpayer's interest deductions could be denied based on an allocation of the taxpayer's indebtedness to such obligation. The denial could or could not be dependent upon whether the taxpayer accounts for its income with respect to the sale on the installment method. The allocation of the taxpayer's debt to the obligations received from the State or local government could be based on either a pro rata allocation among the taxpayer's assets determined on a yearly basis, or based on the somewhat different allocation formula employed for purposes of limiting the use of the installment method. 2. The IRS position, that a tax-exempt obligation must be nonsaleable in order to be treated as nonnegotiable, could be codified. In addition, the 2-percent de minimis rule could be repealed. Pros and Cons Arguments for the proposals 1. In general, permitting the holding of tax-exempt obligations without limiting the deductibility of interest expense may be viewed as a tax subsidy. This tax subsidy may create a competitive advantage for large manufacturers who sell equipment to State and local government over taxpayers who are either smaller in size or who only provide financing for State and local governments to purchase equipment (and are therefore less likely to benefit from the 2 percent de minimis exception). 2. Pro rata allocation of indebtedness among assets (either in the manner prescribed for financial institutions or for purposes of the installment sale rules) avoids the difficult and often subjective inquiry relating to when indebtedness is incurred or continued to purchase or carry tax-exempt obligations. If the taxpayer uses the installment method to account for gain from the sale to the State or local government, the taxpayer already may be required to allocate indebtedness to the installment obligation in the manner prescribed by the installment sale rules. 3. The original exception for nonnegotiable instruments was intended for a narrower class of obligations than those that are nonnegotiable under the U.C.C. (which was not in effect at the time that the exception was carved out). Arguments against the proposals 1. To the extent that the benefit of any tax subsidy is passed along to the State or local government, the proposal may have the effect of raising the financing costs for a State or local government in the same manner as partially or fully taxing the interest on the government's obligation. 2. The proposal to allocate debt among tax-exempt obligations received in exchange for property sold by the taxpayer may have the |