Payments for state-created loss-fund rights produce an amortizable section 197 intangible

Plain-English summary

A regulated company committed to make an initial contribution and later annual contributions to an optional fund created by state law after a specified damaging event. Participation gave it government-created rights to reimbursement for eligible losses, a favorable prudence-review standard, and a cap on repayment liability for losses found imprudent, subject to maintaining required contributions and certification. The taxpayer represented that all rights arose with the initial payment and that annual payments merely retained those rights. The IRS ruled that the initial contribution acquired an amortizable government-granted intangible under section 197(d)(1)(D). Each later contribution had to be capitalized as additional basis in the same intangible and amortized over the remainder of the original 15-year period.

Ruling snapshot

• Question: Did the initial and annual fund contributions create and add basis to an amortizable section 197 intangible?
• Outcome: approved (the initial payment created the intangible and annual payments were amortized over its remaining period)
• Key authorities: IRC §§ 197, 263, 461; Treas. Reg. §§ 1.197-2, 1.263(a)-4, 1.461-1

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202024002                                              Third Party Communication: None
 Release Date: 6/12/2020                                        Date of Communication: Not Applicable
 Index Number: 197.00-00
                                                                Person To Contact:
 ------------------                                             -------------------, ID No. -----------------
 ----------------------------                                   Telephone Number:
 ---------------------------                                    --------------------
 -------------------------------------                          Refer Reply To:
 ---------------------------------                              CC:ITA:B07
                                                                PLR-121265-19
                                                                Date:
                                                                March 09, 2020




LEGEND:

Taxpayer                   =        ----------------------------------------------------
P1                         =        ---------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------
State                      =        -------------
Business                   =        --------------------------------------------------------------
Companies                  =        -----------------------------------------------------
Commission1                =        -------------------------------------------------------
Commission2                =        ----------------------------------------------------------
Date1                      =        ------------------
Date2                      =        ---------------------------
Date3                      =        --------------------------
Act                        =        ----------------------------------------
Fund                       =        ------------------
Certificate                =        --------------------------------
Event                      =        -----------
Year                       =        -------
Day                        =        -------------
Period                     =        ---------------------------
$X                         =        ----------------
Amount                     =        ---------------------------------------------------------------------------------
         -------------------------------------------------------
Eligible Losses            =        ---------------------------------------------------------------------------------
         ------------------------------------------------------------------------------------------------------------
         -----------------------------------------------------------------------------------------------


Dear --------------:
PLR-121265-19                                  2

This letter is in response to a letter dated September 3, 2019, and subsequent
correspondence, submitted by your representative on behalf of Taxpayer, requesting
rulings under § 197 of the Internal Revenue Code.

                                           FACTS

Taxpayer represents that the facts are as follows:

Taxpayer, an accrual basis taxpayer, is a holding company, and is the common parent
of a consolidated group of corporations that includes P1 and that files a consolidated
return on a calendar year basis.

P1 is incorporated under the laws of State, and is primarily engaged in the Business in
State. P1 is regulated by Commission1 and Commission 2.

On Date 1, State enacted the Act to address the Event in State and the liabilities of the
Companies, including P1, resulting from the Event. The Act contains both mandatory
and optional provisions. Among the optional provisions are the availability of the
Certificate and the creation of the Fund. Under the Act, P1 may apply for and receive a
Certificate from Commission1 if it meets certain requirements. Upon receipt of the
Certificate, P1 is entitled to the benefit of a new standard of review under the Act for
purposes of determining whether P1 acted prudently with respect to the Event in State.

The Act allows Companies to agree to the creation of an optional Fund. P1 has
provided timely notification of its commitment to participate in the Fund. The Fund will
be capitalized with a $X financed by State and another approximately $X contributed by
Companies. The contributions will consist of initial and annual contributions, the
amount of which is determined as set forth in the Act. P1 has committed to make their
initial contributions by Date2, and annual contributions for Period after Year due by Day
for each calendar year. On Date3, P1 made its first annual contribution based on the
Fund’s allocation metric for P1. For subsequent years in the Period, P1 will make
annual contributions based on the Fund’s allocation metric as determined each year for
P1.

Provided P1 has received a current Certificate and made the initial and annual
contributions, it is eligible to participate in and receive certain rights under the Fund. In
the event of damages covered by the Act, the Fund will reimburse P1 for any Eligible
Losses. Once all rights to insurance or indemnification have been exhausted, P1 must
apply to Commission1 for a determination whether P1 acted prudently with respect to
the Eligible Losses reimbursed by the Fund. If P1 has a current Certificate, P1’s
conduct is deemed to have been reasonable unless a party to the proceeding creates a
serious doubt as to the reasonableness of P1’s conduct.
PLR-121265-19                                   3

To the extent Eligible losses of P1 are found to have been prudently incurred, P1 has no
obligation to reimburse the Fund. To the extent the Eligible Losses are found to have
been imprudently incurred, P1 is obligated to reimburse the Fund.

Even if Eligible Losses are found to have been imprudently incurred, P1 with a current
Certificate would enjoy the benefit of a limit on liability (Liability Cap). Under the Liability
Cap, the obligation of P1 to repay the Fund is limited to Amount under the Act. The
Liability Cap will be adjusted annually.

If P1 pays the initial contribution, but does not pay one or more annual contributions,
reimbursements to P1 for Eligible Losses may be reduced via set off or P1 may be
subject to a lien. In addition, in the event of an annual contribution default, P1’s
obligation for repayments to the Fund for Eligible Losses imprudently incurred by P1
would likely be denied the Liability Cap. The statutory prudency standard would
nevertheless continue to apply notwithstanding the failure to make annual contributions.

Taxpayer represents that the conveyance of the rights described above under the Fund
to P1 occurs upon the initial contribution. The subsequent payment of each required
annual contribution does not create or confer any additional or independent rights to P1,
but merely retains the rights granted upon the initial contribution. Such payment is
made in further payment for the rights created by the initial contribution. It is anticipated
that P1 will continue to hold the rights for an indeterminate number of years thereafter
making the initial contribution.

                                  RULINGS REQUESTED

Taxpayer requests the following rulings:

    1. The payment of the initial contribution by P1 will entitle P1 to receive from State
      an amortizable § 197 intangible within the meaning of § 197(d)(1)(D); and

    2. Each annual contribution will be treated as an additional payment to retain the
      rights obtained under the Fund that is subject to capitalization and the additional
      basis will be subject to amortization under § 197 over the remaining amortization
      period of the initial contribution.

                                    LAW AND ANALYSIS

Section 263(a) provides that no deduction is allowed for any amount paid out for new
buildings or for permanent improvements or betterments to increase the value of any
property or estate or any amount expended in restoring property or in making good the
exhaustion thereof for which an allowance is or has been made.

Section 1.263(a)-4(b)(1) of the Income Tax Regulations generally provides that a
taxpayer must capitalize an amount paid to acquire or create an intangible. Section
PLR-121265-19                                 4

1.263(a)-4(d)(1), in relevant part, provides that a taxpayer must capitalize amounts paid
to create an intangible, and the determination of whether an amount is paid to create an
intangible described in the subsection is to be made based on all of the facts and
circumstances.

Section 197(a) provides that a taxpayer shall be entitled to an amortization deduction
with respect to any amortizable § 197 intangible. Section 197(c)(1) provides that, in
general, the term “amortizable section 197 intangible” means any § 197 intangible which
is acquired after August 10, 1993, and which is held in connection with the conduct of a
trade or business or an activity described in § 212.

Section 197(c)(2) provides that the term “amortizable section 197 intangible” does not
include any § 197 intangible that is not described in § 197(d)(1)(D), (E), or (F), and that
is created by the taxpayer.

Section 197(d)(1)(D) provides that the term “section 197 intangible” means, among
other things, any license, permit, or other right granted by a governmental unit or an
agency or instrumentality thereof. Section 1.197-2(b)(8) provides that § 197 intangibles
include any license, permit, or other right granted by a governmental unit (including for
purposes of § 197, an agency or instrumentality thereof) even if the right is granted for
an indefinite period or is reasonably expected to be renewed for an indefinite period.
These rights include, for example, a liquor license, a taxi-cab medallion (or license), an
airport landing or takeoff right (sometimes referred to as a slot), a regulated airline
route, or a television or radio broadcasting license. The issuance or renewal of a
license, permit, or other right granted by a governmental unit is considered an
acquisition of the license, permit, or other right.

Section 197(e)(4) provides that the term “section 197 intangibles” does not include,
among other things, any right to receive tangible property or services under a contract
or granted by a governmental unit or agency or instrumentality thereof. The term also
does not include any right under a contract (or granted by a governmental unit or an
agency or instrumentality thereof) if (1) such right has a fixed duration of less than 15
years, or (2) is fixed as to amount and, without regard to § 197, would be recoverable
under a method similar to the unit-of-production method.

Section 1.197-2(d)(2)(ii)(A) provides that a § 197 intangible is created by the taxpayer to
the extent the taxpayer makes payments or otherwise incurs costs for its creation,
production, development, or improvement. Except as provided in § 1.197-2(d)(2)(iii), §
1.197-2(d)(2)(i) generally provides that amortizable § 197 intangibles do not include any
§ 197 intangible created by the taxpayer (a self-created intangible). However, § 1.197-
2(d)(2)(iii)(A) provides that the exception for self-created intangibles does not apply to
any § 197 intangible described in § 197(d)(1)(D), (E), or (F).

Section 1.197-2(f)(1)(i) provides, that except as provided in § 1.197-2(f)(2), the
amortization deduction allowable under § 197(a) is computed as follows: (i) the basis of
PLR-121265-19                                 5

an amortizable § 197 intangible is amortized ratably over the 15-year period beginning
on the later of (A) the first day of the month in which the property is acquired; or (B) in
the case of property held in connection with the conduct of a trade or business, the first
day of the month in which the conduct of the trade or business begins.

Section 1.197-2(f)(2) provides guidance on the treatment of contingent amounts.
Section 1.197-2(f)(2)(i) provides that any amount that is properly included in the basis of
an amortizable § 197 intangible after the first month of the 15-year period described in
§ 1.197-2(f)(1)(i) and before the expiration of that period is amortized ratably over the
remainder of the 15-year period. For this purpose, the remainder of the 15-year period
begins on the first day of the month in which the basis increase occurs.

Section 1.197-2(f)(2)(iii) directs taxpayers to §1.461-1(a)(1) and (2) for rules governing
the time for which certain contingent amounts are taken into account in determining the
basis of an amortizable § 197 intangible.

Section 1.461-1(a)(2) provides the general rule for the taxable year of deduction for
accrual-method taxpayers. Under an accrual method of accounting, a liability is
incurred, and generally taken into account for Federal income tax purposes, in the
taxable year in which all the events have occurred that establish the fact of the liability,
the amount of the liability can be determined with reasonable accuracy, and economic
performance has occurred with respect to the liability. Applicable provisions of the
Code, the Income Tax Regulations, and other guidance published by the Secretary
prescribe the manner in which a liability that has been incurred is taken into account.
For example, under § 263 or 263A, a liability that relates to the creation of an asset
having a useful life extending substantially beyond the close of the taxable year is taken
into account in the taxable year incurred through capitalization and may later affect the
computation of taxable income through depreciation or otherwise over a period
including subsequent taxable years, in accordance with applicable Internal Revenue
Code sections and guidance published by the Secretary.

In this case, Taxpayer represents that the conveyance of the rights described above
under the Fund to P1 occurs upon the initial contribution and continues for an indefinite
number of years. The subsequent payment of each required annual contribution does
not create or confer any additional or independent rights to P1, but merely retains the
rights granted upon the initial contribution.

Therefore, Taxpayer’s payments for these rights granted by State under the Act include
the initial contribution and the annual contributions. These payments are attributable to
the acquisition of an amortizable § 197 intangible under § 197(d)(1)(D) and § 1.197-
2(b)(8). Because the amounts of the annual contributions are contingent upon the
Fund’s allocation metric for P1 for each year during the Period, these amounts become
amortizable when added to the basis of the amortizable § 197 intangible.
PLR-121265-19                                    6

                                         CONCLUSION

Based solely on the facts and representations submitted and the relevant law and
analysis as set forth above, we conclude the following:

        1. The payment of the initial contribution by P1 will entitle P1 to receive from the
         State an amortizable § 197 intangible within the meaning of § 197(d)(1)(D); and

        2. Each annual contribution will be treated as an additional payment to retain the
         rights that is subject to capitalization and the additional basis will be subject to
         amortization under § 197 over the remaining amortization period of the
         amortizable § 197 intangible created by the initial contribution.

Except as specifically ruled upon above, no opinion is expressed or implied concerning
the tax consequences of the facts described above under any other provisions of the
Code.

The rulings contained in this letter are based upon information and representations
submitted by Taxpayer and accompanied by penalty of perjury statements executed by
an appropriate party. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter
ruling is being sent to your authorized representatives. We also are sending a copy of
this letter ruling to the appropriate operating division director.


                                          Sincerely,

                                          Kathleen Reed

                                          Kathleen Reed
                                          Branch Chief, Branch 7
                                          Office of Associate Chief Counsel
                                          (Income Tax & Accounting)

Enclosures (2):

Copy of this letter
Copy for section 6110 purposes

cc:      -