Tax Consequence of a Proposes Acquisition of the Assets and Assume Certain Liabilities

May 12, 1988 BIR RULING NO. 206-88 29 (f) 000-00 206-88 Gentlemen : This refers to your letter dated April 21, 1988 stating that your client, Tanduay, Inc. (Buyer) proposes to acquire the assets and assume certain liabilities of Tanduay Distillery, Inc. Elizalde International (Philippines),Inc. and Elizalde & Co.,Inc. (Sellers);that included in the purchase price are the following: property plant and equipment, trademarks of certain products, royalties for the exclusive use of certain brand names, formulas of the products, non-competition contracts and goodwill; and that the assumption of certain liabilities (bank loans and trade payables) will be netted against the agreed price to arrive at the cash price to be given to the Sellers. cdti In connection therewith, you now request confirmation of your opinion viz: "1. That it is acceptable for tax purposes to depreciate the assigned cost on the plant and equipment over the remaining useful lives of the assets as determined at the time of purchase; "2. That the value assigned on the trademarks which is computed on the basis of future sales may be discounted to its present value at the time of acquisition and may be amortized for tax purposes over the average remaining lives of the different trademarks purchased; "3. That the royalties to be paid on the basis of future sales may be discounted to determine the present values and may be paid at said discounted or present value at the time of acquisition and that it is acceptable for tax purposes to amortize the said present values (i.e.,the cash price as discounted) over the agreed period (say 5 to 8 years) when royalties will have to be paid. That said royalties payment is subject to the final withholding tax of 20%; "4. That the cost of the different formulas may also be amortized over the (a) remaining life of the trademarks purchased or (b) the expected period within which the client proposes to continue manufacturing said products using the said formulas; "5. That the value agreed between our client and the seller for the seller not to compete over a period of years (non-competition agreement/contracts) may also be amortized over the agreed period wherein the seller may not compete in the same line of business that was sold to our client; "6. That any amount of goodwill paid for by our client may not be deducted for tax purposes unless the same business or the assets related to the said goodwill is sold by our client." In reply, thereto, please be informed as follows: 1. Business and income producing property other than land, generally depreciates or loses its usefulness and value with the passage of time. A deduction for such depreciation is allowed in computing taxable income. (par. 5500, 34 Am. Jur. 2d Federal Taxation 1976) As such, your opinion that the assigned cost on the plant and equipment over the remaining useful lives of the assets as determined at the time of purchase can be depreciated for tax purposes is hereby confirmed; 2. Goodwill, including trademarks, trade names, and trade brands, are not such property as are subject to exhaustion. (par. 22,085, CCH-Standard Federal Tax Reports) Accordingly, the value assigned on the trade marks which is computed on the basis of future sales cannot be discounted to its present value at the time of acquisition and cannot be amortized for tax purposes over the average remaining lives of the different trade marks purchased; 3. Right to receive royalties over a given term is depreciable. (par 22, 081, CCH-Standard Federal Tax Reports. par. 5515, 34 Am. Jur. 2d Federal Taxation 1976) Accordingly, your opinion that the royalties to be paid on the basis of future sales may be discounted to determine the present values and may be paid at said discounted or present value at the time of acquisition and that it is acceptable for tax purposes to amortize the said present values (i.e., the cash price as discounted) over the agreed period (say 5 to 8 years) when royalties will have to be paid is hereby confirmed. Moreover, said royalty payment is subject to the 20% final withholding tax under Sec. 24(c) of the Tax Code, as amended; 4. Formulas are not subject to annual depreciation. If, however, after acquisition, a formula is found to be worthless, its cost may be deducted in full as a loss for the year in which the formula is abandoned as being worthless. (par. 23.80, Vol. 4 Mertens Law of Federal Income Taxation) Accordingly, the cost of the different formulas cannot be amortized over the (a) remaining life of the trademarks purchased or (b) the expected period within which your client proposes to continue manufacturing said products using the said formulas; 5. Amounts paid for an agreement not to compete in a trade or business, where the taxpayer can prove the existence of such an agreement, are capital expenditures and subject to allowances for depreciation ratably spread over the period mentioned in the agreement but only where the elimination of competition is for a definite and limited term may the cost be exhausted over such a term. (par. 23.68, Vol. 4 Mertens Law of Federal Income Taxation) Accordingly, your opinion that the value agreed between your client and seller for the seller not to compete over a period of years (non-competition agreement/contracts) may also be amortized over the agreed period wherein the seller may not compete in the same line of business that was sold to your client is hereby confirmed; 6. Goodwill is not such property as is subject to exhaustion. (par. 22, 085, CCH-Standard Federal Tax Reports) Accordingly, your opinion that any amount of goodwill paid for by your client may not be deducted for tax purposes unless the same business or the assets related to the said goodwill is sold by your client is hereby confirmed. cdtech Very truly yours, (SGD.) EUFRACIO D. SANTOS Deputy Commissioner