Tax Court Fails to Find Taxable Transfer of Goodwill Between Related Companies
In a recent decision, Bross Trucking, Inc. et al. v. Commissioner, the Tax Court rejected the government’s argument that there had been a taxable transfer of goodwill between related, family-owned businesses. The case is significant because it distinguishes between goodwill of a corporation and goodwill of a corporation’s shareholder. The case also illustrates the propensity of the IRS to argue that related taxpayers have made a taxable transfer of valuable intangibles between themselves, when in fact no taxable transfer has occurred.
Facts of the case
Chester Bross, a resident of the state of Missouri, owned various companies, including Bross Construction and Bross Trucking. Bross Trucking, inter alia, provided services to various companies owned by Mr. Bross and members of his family, including Bross Construction. In the late 1990s, Bross Trucking was the subject of various regulatory investigations by the State of Missouri, and, in September 1998, the company received an “unsatisfactory” motor carrier safety rating from the State of Missouri. The unsatisfactory rating jeopardized the long-term viability of the company’s business.
After consulting with an attorney, the family decided to form a new trucking company, LWK Trucking (“LWK”), which was organized in October 2003. The majority of the shares of LWK were owned by Mr. Bross’ sons, and Mr. Bross had no financial interest in the new company. Bross Trucking remained in business, however. LWK hired some of the employees and independent contractors of Bross Trucking, and some customers of Bross Trucking became customers of LWK. LWK offered its customers a wider range of services than those provided by Bross Trucking, and it was successful.
After audits of Bross Trucking, Mr. Bross and his wife, the IRS issued a notice of deficiency asserting that, in 2004, Bross Trucking had distributed certain appreciated intangible assets to Mr. Bross and that Mr. Bross had made a gift of those intangible assets to his sons in connection with the formation of LWK. The notice of deficiency issued to Bross Trucking identified intangible assets with the following “attributes:” (1) goodwill, (2) established revenue stream, (3) developed customer base, (4) transparency of the continuing operations between the entities, (5) established workforce including independent contractors, and (6) continuing supplier relationships.
Under section 311(b) of the Code, when a corporation distributes appreciated assets to its shareholders, the corporation recognizes taxable gain. Thus, according to the IRS, Bross Trucking was liable for tax on gain realized when intangibles enumerated in the IRS notice of deficiency were distributed to Mr. Bross. The IRS also asserted the Mr. Bross owed gift tax as a result of the transfer of the enumerated intangibles to his sons.
Opinion of the Tax Court
The Tax Court interpreted the government’s position to be that Bross Trucking had distributed a single intangible asset, goodwill, to Mr. Bross, who then made a gift of the goodwill to his sons. Referring to the case law, the Tax Court defined goodwill as the expectation of continued customer patronage. The Tax Court also concluded that the attributes enumerated by the government in its notice of deficiency were “apparently the separate interests or rights that [the IRS] believes made up Bross Trucking’s goodwill.”
Reviewing the case law concerning goodwill of closely held corporations, the Tax Court drew a distinction between goodwill of a corporation and goodwill of a corporation’s shareholder. The Tax Court found that although Bross Trucking may have had goodwill in the past, most of that goodwill had been lost by the time LKW was formed because of Bross Trucking’s regulatory infractions. According to the Tax Court, the only attribute of goodwill that Bross Trucking might have owned and potentially transferred to LKW was workforce in place.
The Tax Court also found:
“any established revenue stream, developed customer base, or transparency of continuing operations was a direct result of Mr. Bross’ personal efforts and relationships. . . . Bross Trucking may have had a developed revenue stream, but only as result of Mr. Bross’ having personal relationships with the customers.”
Finally, the Tax Court found that Mr. Bross did not transfer his personal goodwill to Bross Trucking, and that Mr. Bross was not involved in LKW’s business. The Tax Court therefore concluded “it is true that LWK Trucking’s and Bross Trucking’s customers were similar, but it does not mean the Bross Trucking transferred goodwill; instead the record shows that LWK Trucking’s employees created their own goodwill.”
The strategy followed by the IRS in Bross Trucking is reminiscent of the strategy the IRS has followed in attacking other related-party transactions, including section 936 exits and cost sharing arrangements. The IRS identifies a range of intangible assets, ascribes value to those assets and argues that a taxable transfer has been made to a related business entity. Based on the public record, this strategy appears to have been less successful than the government has hoped. In some cases, as with cost sharing, the law has not been on the government side. In this case, the taxpayer’s facts were unfavorable to the government. Perhaps one day the IRS will litigate an intangibles case having both the facts and the law in the government’s favor.
 T.C. Memo 2014-107 (June 5, 2014) (“Bross Trucking”). See, e.g., Third IRS Industry Director Directive on Section 936 Exit Strategies, LMSB-04-0809-031 (8/19/09). Section 482 Buy-in Adjustments, LMSB-04-0907-62 (9/27/07). See, Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009), nonacq. Action on Decision 2010-49.KEYWORD: Transfer Pricing
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