108 T.C. No. 7
UNITED STATES TAX COURT
MEREDITH CORPORATION & SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18248-95. Filed February 27, 1997.
P moved for partial summary judgment, claiming that it is entitled to a $1,555,428 ordinary deduction in its TYE 1990 stemming from contingent asset acquisition costs that became fixed in that year, after the expiration of the useful life of the asset to which they correspond. R objected to P's motion and filed a cross-motion for partial summary judgment, arguing: (1) the contingent asset acquisition costs were not attributable to the subscriber relationships asset but must be allocated to nonamortizable intangibles; and, in the alternative, (2) the expiration of the useful life of the subscriber relationships bars any further cost recovery by P. Held: The contingent acquisition costs at issue are allocable to the basis of the subscriber relationships in P's TYE 1990. Meredith Corp. & Subs. v. Commissioner, 102 T.C. 406 (1994), followed. Held, further, P is entitled to an ordinary deduction in full in its TYE 1990 for contingent asset - 2 -
acquisition costs incurred in that year, after the underlying asset had been fully amortized. Arrowsmith v. Commissioner, 344 U.S. 6 (1952) and sec. 1.338(b)- 3T, Temporary Income Tax Regs., 51 Fed. Reg. 3592 (Jan. 29, 1986), applied.
James L. Malone III, for petitioner.
Lawrence K. Letkewicz and Jan E. Lamartine, for respondent.
OPINION
NIMS, Judge: This matter is before the Court on
petitioner's motion and respondent's cross-motion for partial
summary judgment filed pursuant to Rule 121 on July 26, 1996, and
November 8, 1996, respectively. Petitioner moves for partial
summary judgment in its favor, arguing that it is entitled to
deduct contingent acquisition costs incurred after the asset to
which they pertain has been completely amortized. Respondent
objects to petitioner's motion and also moves for partial summary
judgment in her favor, arguing in part that the expiration of the
useful life of the asset bars any further cost recovery by
petitioner. For the reasons detailed below, we shall grant
petitioner's motion, and deny respondent's cross-motion for
partial summary judgment.
Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure. All section
references are to sections of the Internal Revenue Code in effect
as of the date of the initial transaction underlying the dispute. - 3 -
At the time the petition was filed, petitioner's principal
place of business was Des Moines, Iowa.
A motion for summary judgment or for partial summary
judgment may be granted if no genuine issue of material fact
exists and the decision can be rendered as a matter of law. Rule
121; Sundstrand Corp. & Consol. Subs. v. Commissioner, 98 T.C.
518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994); Shiosaki v.
Commissioner, 61 T.C. 861, 862-863 (1974). In their respective
Statements of Undisputed Facts, the parties have agreed to fully
incorporate the stipulation of facts that is part of the record
in Meredith Corp. & Subs. v. Commissioner, 102 T.C. 406 (1994)
(Meredith I). The parties have also agreed to fully incorporate
the facts as set forth in the Court's Opinion in Meredith I.
This reference incorporates herein the Statements of Undisputed
Facts and attached exhibits. As such, there is no genuine issue
of material fact, and this matter is ripe for resolution by means
of summary judgment. We shall repeat the facts as necessary to
clarify the ensuing discussion.
Background
Meredith Corporation (petitioner or Meredith) was organized
in 1902. It is a diversified media company involved in magazine
and book publishing, television broadcasting, real estate
marketing, franchising, and until recently, printing. Meredith
has continued to expand its operations in the media industry over - 4 -
the years through internal growth and acquisitions. Petitioner
is an accrual basis taxpayer that keeps its books and records,
and files its Federal income tax returns, on a taxable year
ending (TYE) June 30th.
In connection with its January 3, 1986, purchase of the
magazine Ladies' Home Journal (LHJ), Meredith assumed certain
contingent obligations of the seller, Family Media, Inc. (FMI),
relating to an intangible asset designated "subscriber
relationships". Meredith agreed to produce and deliver copies of
LHJ to subscribers already existent on the acquisition date for
the remainder of their subscription terms, necessarily entailing
fulfillment costs for which Meredith was to receive no
reimbursement from FMI. Such costs included, but were not
limited to, expenses associated with paper, printing, editorial
salaries, and delivery (editorial costs). The fulfillment costs
were contingent for two reasons: (1) The costs were variable;
and (2) LHJ subscribers were permitted to request cash refunds
for the remaining terms of their subscriptions at any time, for
which FMI remained solely liable. The contingent expenditures at
issue herein were editorial costs incurred by Meredith during its
TYE 1990.
The years before the Court in Meredith I were petitioner's
TYE 1986 and TYE 1987. Meredith I addressed the issues of
petitioner's entitlement to amortization deductions with - 5 -
respect to three intangible assets acquired in its purchase of
LHJ: (1) A noncompetition agreement; (2) an employment
relationship; and (3) the subscriber relationships.
The parties stipulated in Meredith I that the useful life of
the subscriber relationships was 42 months. In addition, the
parties stipulated that the actual editorial costs incurred by
Meredith through June 30, 1991, stemming from its assumption of
FMI's fulfillment obligation, were as follows:
Present Value FYE Editorial Costs Discounted at 14%
6/30/86 $8,324,660 $8,056,386 6/30/87 7,827,573 6,866,292 6/30/88 2,869,118 2,207,693 6/30/89 1,462,368 987,057 6/30/90 807,267 477,967 6/30/91 321,780 167,122 21,612,766 18,762,517
On March 14, 1994, this Court issued its Opinion in Meredith
I, and on June 16, 1994, a decision was entered. In the Opinion,
we decided that the assumed editorial costs composed part of the
purchase price of the subscriber relationships, but that the
costs could not be included in petitioner's basis of that asset
as of the acquisition date due to their contingency. Instead, we
held that such costs (plus the present value of tax savings
resulting from the amortization of such costs) must be added to
the "basis of the subscriber relationships in the years in which
* * * [they] are incurred". Meredith Corp. & Subs. v.
Commissioner, supra at 455. The Court then permitted those costs - 6 -
incurred in petitioner's TYE 1986 and TYE 1987 to be amortized
over whatever remained of the stipulated 42-month useful life of
the subscriber relationships. Id. at 462-463. No appeal was
taken from the Court's decision.
On April 9, 1993, Meredith filed a petition in this Court
involving the same subscriber relationships issue for its TYE
1988. Meredith Corp. & Subs. v. Commissioner, docket No. 7166-93
(Meredith II). Meredith and respondent filed a Joint Motion for
Continuance (Joint Motion) in Meredith II since the Meredith I
opinion was not anticipated prior to the Meredith II trial date.
In the Joint Motion, the parties stated:
The amortization issues in the above-captioned case relate to the years subsequent to the year of the initial transaction, 1986, and as such, the parties anticipate that resolution of the amortization issues in the 1986 and 1987 taxable years will form the basis for settlement of the issues in this case.
Meredith II was thereafter settled by the parties, using the
exact methodology set forth by the Court in Meredith I. This
Court entered a decision in Meredith II on October 4, 1994.
The same issue arising in Meredith's TYE 1989 was
subsequently settled with the IRS Appeals Office in Des Moines,
Iowa, applying, without dispute, the identical method used in
Meredith I and Meredith II. In a letter to petitioner dated June
29, 1995, respondent notified Meredith that the Joint Committee
on Taxation (Joint Committee) had officially informed her that it - 7 -
had reviewed and "taken no exception" to the settlement reached
by the parties for Meredith's TYE 1989.
Meredith timely filed a Federal income tax return for its
TYE 1990 prior to the Court's decision in Meredith I. Based on
Meredith I, petitioner later claimed an ordinary deduction for
that year of $1,555,428 ($807,267 editorial costs plus tax
savings) relating to the acquisition of the subscriber
relationships. On August 29, 1995, respondent issued a statutory
notice of deficiency to Meredith in which, among other
adjustments to income, Meredith's claimed deduction of $1,555,428
for its TYE 1990 was disallowed completely, and a deficiency of
$744,852 was determined.
Discussion
We must adjudge the proper tax treatment for contingent
editorial costs and correlated tax savings that were allocable to
the basis of the subscriber relationships in Meredith's TYE 1990.
The issue of whether these costs should be allocated to the basis
of that particular asset was resolved affirmatively in Meredith
I. Meredith Corp. & Subs. v. Commissioner, 102 T.C. at 455.
However, the subscriber relationships were completely amortized
after the end of their stipulated 42-month useful life.
In Meredith I, this Court established a methodology for
determining Meredith's tax basis in its subscriber relationships.
Critical to this method--and the current imbroglio--was our - 8 -
conclusion that the fulfillment obligation assumed by Meredith on
January 3, 1986, was contingent.
The Court calculated petitioner's initial basis in the
subscriber relationships asset as of January 3, 1986, by first
finding that its value was $40,300,000 (including value
attributed to tax savings). This was determined by using the
income approach of petitioner's expert (Grabowski), and by
assuming an exclusion during the first 35 months of a portion of
the advertising revenues of LHJ attributable to the efforts of
the magazine's editor-in-chief (editor advertising exclusion).
Using Grabowski's amortization factor of .37634, we calculated
this value to be approximately $25,133,500 prior to the addition
of tax savings. The Court thereafter decreased this pretax
savings figure by the present value of the stipulated editorial
costs through June 30, 1991 (approximately $18,762,500) since
these costs were contingent, and increased the resulting figure
by the present value of the 35 months of the editor advertising
exclusion (which we computed to be approximately $2,760,000). We
thus found petitioner's initial basis to be $14,641,000, after
the addition of tax savings of $5,510,000. Meredith Corp. &
Subs. v. Commissioner, supra at 463. The Court reasoned that, to
be consistent with the parties' stipulation requiring
capitalization of the editorial costs and with the income
approach, the proper treatment of the amounts was to charge them
against revenues in determining petitioner's initial basis and to - 9 -
add such amounts to the basis in the years in which they were
incurred. Meredith Corp. & Subs. v. Commissioner, supra at 454-
455.
Petitioner claims that respondent erred in disallowing the
ordinary amortization deduction of $1,555,428 in its TYE 1990,
inasmuch as the deduction reflects the portion of the LHJ
purchase price and corresponding tax savings attributable to the
acquired subscriber relationships for that year. Since the 42-
month useful life of the subscriber relationships had expired,
Meredith argues that the entire additional purchase price
becoming fixed during its TYE 1990 should be deducted in that
year in order for it to adequately recover the cost of its
investment.
Respondent contends, on the other hand, that Meredith's
annual recovery of the total cost of the subscriber relationships
must be terminated. Thus, respondent argues that petitioner is
not permitted to deduct $1,555,428 in its TYE 1990 and that at
least $807,267 (actual editorial costs exclusive of tax benefits)
represents a nonamortizable capital expenditure. She proposes
June 30, 1989, as the cut-off date for petitioner's recovery of
costs, even though not all of the costs of the subscriber
relationships had been incurred as of that date. Respondent
states in the notice of deficiency:
The court determined that the subscriber relationships acquired on January 3, 1986 had a useful life of 42 months in Meredith Corp. and Subs. v. - 10 -
Commissioner, 102 T.C. 406 (1994). As a result of the opinion and as a result of the determination of the Commissioner, it has been determined that the deduction * * * claimed as an amortization deduction with respect to amounts allocated to a subscription list included in the intangible assets acquired in the purchase of Ladies['] Home Journal, is disallowed in full because the amount paid was for non-amortizable intangibles, having an indeterminate useful life under Section 167 of the Internal Revenue Code.
We agree with petitioner. Among other things, respondent
misconstrues our holding in Meredith I regarding the contingent
nature of all of the editorial costs described above and the
resulting impact on petitioner's tax basis in the subscriber
relationships. She also disregards general principles of tax law
concerning the treatment of contingent asset acquisition costs
incurred after an asset has been disposed of or has exceeded its
useful life.
I. Meredith I Unequivocally Reasoned That Contingent Editorial Costs Were To Be Added to the Tax Basis of the Subscriber Relationships When They Were Incurred
Respondent posits that the post-June 30, 1989, contingent
costs do not increase petitioner's basis in the amortizable
subscriber relationships, but "instead are allocated to the basis
of going concern value or goodwill, neither of which is
amortizable". (The underlying transaction occurred prior to the
effective date of section 197, as enacted by Omnibus Budget
Reconciliation Act of 1993, Pub. L. 103-66, section 13261(a), 107
Stat. 532.) - 11 -
It is true, as respondent points out, that the allocable
purchase price exceeded the fair market value of the acquired
tangible and amortizable intangible assets of LHJ. That does not
dictate, however, that editorial costs incurred after the
expiration of the 42-month useful life must be assigned to
nonamortizable goodwill or going concern value. As we stated in
Meredith I, "the sole reason why the subscriber relationships are
not treated as goodwill is that they can be valued and have a
limited useful life which can be estimated with reasonable
accuracy". Meredith Corp. & Subs. v. Commissioner, 102 T.C. at
460. The aforementioned editorial costs were found to constitute
part of the value of that asset, and not of goodwill. In arguing
to the contrary, respondent ignores our rationale in Meredith I
that such contingent costs were to be added "to the basis of the
subscriber relationships in the years in which such amounts are
incurred". Id. at 455 (emphasis added).
The Court initially subtracted from Grabowski's income
approach valuation of the subscriber relationships the present
value of all of the stipulated editorial costs (including costs
incurred during Meredith's TYE 1990 and TYE 1991) due to their
contingency, and then prescribed adjustments for TYE 1986 and TYE
1987 based on the actual costs incurred by Meredith in each of
those years. Id. at 463. It would be inconsistent with the
analysis in Meredith I to deny petitioner an increase in the - 12 -
basis of its subscriber relationships for the editorial costs and
associated tax benefits becoming fixed in its TYE 1990.
II. Meredith I Does Not Preclude Petitioner's Deduction for Editorial Costs Incurred During Its TYE 1990
Respondent alternatively contends that "Nothing in the
Court's Opinion in Meredith I even remotely suggests that
Petitioner is entitled to an ordinary deduction [in its TYE
1990]" for additional contingent costs becoming fixed in that
year. Nothing, however, in our Opinion suggests otherwise.
Respondent nonetheless claims that "strictly speaking, the
Court's Opinion [in Meredith I] precludes the deduction claimed
by * * * [Meredith] for the taxable year ended June 30, 1990
* * * [because of the expiration of the stipulated 42-month
useful life]". She cites the following language from Meredith I
to support her proposition:
The amounts are not subject to a new depreciation schedule, but, rather, are to be depreciated over the remaining useful life of the subscriber relationships based on a useful life ending 42 months after the acquisition of the subscribers. * * * Meredith Corp. & Subs. v. Commissioner, 102 T.C. at 462-463.
However, the language above is inapposite to Meredith's TYE 1990
at issue in the instant matter. Placed in context, the words
"the amounts" refer to the 1986 and 1987 additions to basis only.
The penultimate sentence before the quotation computes dollar
amounts for 1986 and 1987. Moreover, the sentence before the
quoted language refers to "these amounts", meaning the 1986 and
1987 sums. - 13 -
In Meredith I, we reasoned that contingent acquisition costs
incurred through TYE 1991 were to be added to the cost basis of
the subscriber relationships when they became fixed, and we held
only that those costs attributable to Meredith's TYE 1986 and TYE
1987 were amortizable over whatever remained of the 42-month
useful life ending June 30, 1989. We did not address the
deductibility of editorial costs incurred in any year after TYE
1987 because such years were not before the Court.
III. Contingent Acquisition Costs Attributable to Fully Amortized Assets Are Deductible as Incurred
Furthermore, the expiration in mid-1989 of the useful life
of the subscriber relationships does not foreclose a deduction
for those editorial costs incurred by Meredith during subsequent
taxable years. General tax law principles enounced in
regulations and case law provide that contingent asset
acquisition costs that become fixed after the relevant asset is
fully amortized are deductible as they are incurred.
Section 1.338(b)-3T, Temporary Income Tax Regs., 51 Fed.
Reg. 3592 (Jan. 29, 1986), as adopted in T.D. 8072, 1986-1 C.B.
111, concerns the treatment of adjustments to adjusted grossed-up
basis (AGUB) for contingent events that occur after the close of
a new target's first taxable year in certain stock acquisitions.
If an acquisition date asset has been disposed of, or fully
depreciated, amortized, or depleted before a contingent amount is
taken into account in determining AGUB, the contingent amount - 14 -
otherwise allocable to such asset is treated "under principles of
tax law applicable when part of the cost of an asset (not
previously reflected in its basis) is paid after the asset has
been disposed of, depreciated, amortized or depleted." Sec.
1.338(b)-3T(d)(2), Temporary Income Tax Regs., 51 Fed. Reg. 3593
(Jan. 29, 1986).
Section 1.338(b)-3T(j), Example (1)(vi), Temporary Income
Tax Regs., 51 Fed. Reg. 3595 (Jan. 29, 1986) considers the
disposition of stock (a capital asset) before a liability became
fixed and determinable. Since the stock had been disposed of
prior to the contingent liability's becoming fixed, no amount of
the increase in AGUB attributable to such asset was allocable to
any other asset, including goodwill and going concern value. See
discussion supra pp. 13-14. Instead, the example directs the
taxpayer to deduct the liability as a capital loss under the
principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952).
In Arrowsmith, a corporation liquidated, and its
shareholders reported their gain as capital. In a later year, a
judgment was rendered against the former corporation. The
erstwhile shareholders paid the judgment for the corporation
because they were transferees of its assets. They deducted the
entire amount paid as an ordinary loss. However, the Supreme
Court determined that the losses that resulted from the payment
of the judgment stemmed from a legal obligation arising out of
the prior liquidation. Since the original transaction was a - 15 -
capital one, the Court held that the related transaction was also
capital. Arrowsmith v. Commissioner, supra at 8.
Respondent gainsays the applicability of the foregoing
discussion to the issue herein because, among other reasons,
section 1.338(b)-3T, Temporary Income Tax Regs., 51 Fed. Reg.
3592 (Jan. 29, 1986), postdates Meredith's purchase of LHJ's
assets, and Arrowsmith does not directly address the
deductibility of contingent asset acquisition costs.
We agree with respondent that the regulations and case law
are not controlling authority. Nevertheless, we think the
general principles espoused therein comport equally well with the
increase in basis of fully amortized subscriber relationships as
they do with adjustments to AGUB of fully amortized or disposed
assets under section 338. For present purposes, we descry no
reason to distinguish the two situations.
Moreover, these tax law principles antedate petitioner's
purchase of the assets of LHJ and are thus appropriately
considered by the Court. The Secretary states:
These [section 1.338(b)-3T] rules provide for the incorporation of general principles of tax law which are applicable to the determination of the basis of assets acquired in actual asset purchases. * * *
* * * * * * *
For example, an amount of adjusted grossed-up basis otherwise allocable to a disposed of capital asset may be deducted by new target as a capital loss. [T.D. 8072, 1986-1 C.B. 111, 114; citation omitted.] - 16 -
The Secretary cites Arrowsmith v. Commissioner, supra, a case
decided well before petitioner's acquisition of LHJ, as authority
for that assertion. See T.D. 8072, supra.
We now apply the preceding analysis to the facts before us.
Meredith is entitled to an increase in the basis of the
subscriber relationships due to contingent acquisition costs
becoming fixed in its TYE 1990. The section 338 regulations
supra provide a template for petitioner to treat the fully
amortized subscriber relationships asset as if it had been
disposed of before the increase in basis, and to determine the
character of the resulting deduction pursuant to Arrowsmith v.
Commissioner, supra. Since the added basis would have resulted
in ordinary amortization deductions if it had been included in
the original acquisition cost, we hold that petitioner is
entitled to an ordinary deduction in its TYE 1990 of the entire
amount of the contingent editorial costs becoming fixed in that
year. See Meredith Corp. & Subs. v. Commissioner, 102 T.C. at
IV. A Deduction for Contingent Costs Incurred During TYE June 1990 Does Not Result in Excessive Cost Recovery for Petitioner
Finally, respondent contends that, "implicit" in the Court's
calculation of petitioner's initial basis in the subscriber
relationships in Meredith I is a "maximum" "fair market value
[basis] * * * as of January 3, 1986 of $44,725,488" and that
since petitioner has already deducted $48,798,243, "over $4 - 17 -
million more than what its initial basis would have been if the
Court had not excluded the present value of the assumed editorial
costs," any additional deduction is unwarranted. However,
respondent's argument misses the mark. As discussed earlier, we
held that the tax basis of this intangible asset was $14,641,000
as of January 3, 1986 and was to be increased as fulfillment
costs were thereafter incurred, through petitioner's TYE 1991.
Id. at 455. What "would have been" if we had decided differently
is irrelevant.
Moreover, if we had determined in Meredith I that the
editorial costs were not contingent subscriber expenditures, such
that the "maximum" tax basis that respondent theorizes in fact
applied, Meredith would have been entitled to amortize the entire
amount of its editorial costs and associated tax savings through
its TYE 1991 over the stipulated 42-month useful life of the
asset. Id. at 445. The present controversy never would have
materialized. In Meredith I, respondent inveighed against such a
result and prevailed. Respondent cannot have it both ways.
To reflect the foregoing,
An appropriate order
granting petitioner's motion
for partial summary judgment
and denying respondent's - 18 -
cross-motion for partial
summary judgment will be
issued.