The following article is adapted and reprinted from the M&A Tax Report, Vol. 10, No. 7, February 2002, Panel Publishers, New York, NY.


By Robert W. Wood

The question whether media rights acquired in connection with the acquisition of a professional sports franchise are separate and distinct from goodwill is the subject of Field Service Advice 200142007 (July 3, 2001). This ruling also addresses the logical follow-up question: Assuming the media rights do qualify as a separate and distinct asset, do they (or any part of them) qualify for depreciation or amortization?

Facts in Ruling

The taxpayer acquired a professional sports franchise in year one. An accounting firm was hired to value the acquired assets. Among the assets identified, valued and determined it to have a useful life were national television rights as well as local media rights (television and radio) to the games. The acquisition of the sports franchise admits the buyer into membership in the league.

That league membership carries substantial and valuable rights. One of the valuable rights is the right of a franchisee to share in league-wide revenue sources, including national television rights. This revenue sharing right is perpetual, existing as long as the franchise exists. Individual franchises do not have the right to separately negotiate a separate broadcast contract. The league shares the national broadcast revenues among its franchise members.

The home team retains local broadcast rights, and the away team retains the right to broadcast the game back to its home territory (except during playoff or championship matches). There are renewal provisions in the national media contracts calling for exclusive negotiation rights with respect to any further contract.

Certain rights are retained by the franchisee, however. The franchisee has the right to negotiate local television and radio broadcast contracts. The current contracts had one year remaining at the time of the acquisition, and include renewal language similar to the national broadcast contracts.

The accounting firm used a discounted cash flow analysis to value the media rights based on the present value of annual net cash flows. These annual net cash flows were computed by determining the net receipts from the identified media sources, less the allocated operating expenses. Net receipts were determined by taking into consideration the media contracts in place at the time of acquisition. Net receipts for all years beyond the current media contracts were based on a percentage increase in revenues to account for inflation. Useful lives were determined based on the contractually determined periods, plus expected renewals of the contracts.

Depreciation or Amortization?

The FSA analyzes both depreciation and amortization. Well, sort of. The Service quickly disposes of the amortization option, stating that Section 197(e)(6) of the Code expressly excludes from the definition of "Section 197 intangibles" a franchise to engage in professional sports, and any items acquired in connection with such a franchise. Thus, any broadcast or media rights acquired simply do not qualify for amortization under Section 197.

The depreciation question was a closer call, and occupies most of the fairly lengthy text of the FSA. The FSA begins its analysis with some of the history and rudiments of Section 167 and the nature of wasting assets. After some discussion of other cases, the Service turns to Newark Morning Ledger Co. v. U.S., 507 U.S. 546 (1993). There, the Supreme Court held that an intangible asset that would otherwise fall within the concept of goodwill, can still be depreciable. They key is that the asset must have an ascertainable value and a limited useful life that can be determined with reasonable accuracy.

In order to determine whether the intangible asset in question here satisfies this Newark Morning Ledger test, says the FSA, one must determine whether the media rights have an ascertainable value and a limited useful life. The key point, says the Service, is that the broadcast contracts are a part of the membership in the league. The membership in the league could cease only upon the elimination of the franchise as a member of the league or, alternatively, the demise of the league as an organization.

Yet, there still were separate broadcast contracts. Under the terms of the broadcast contracts, renewal is not automatic. Nevertheless, past practice within the industry demonstrates that the media contracts are always renewed, whether with the then current contracting network or with a competitor. Given this, the Service points out that the life of an asset is not limited if there is only a remote, speculative possibility that renewal of a contract might not occur. (See Richmond Television Corp. v. U.S., 354 F.2d 410 (4th Cir. 1965).

The FSA then goes on to analyze the existing contracts, noting that the taxpayer acquired various media rights, not merely acquiring the existing contracts. More than the contracts were acquired. Although the contracts in question do cover certain distinct, ascertainable periods (and later renewal periods), the asset these contracts represent was really the right to national and local broadcast revenue.

The revenue sharing rights did not have a limited useful life, and the Service points out that such rights cannot be considered wasting assets. These rights (both to broadcast nationally and to contract for local broadcast of games) are rights inherent in the franchise itself. These rights, therefore, have an indeterminate useful life, co-extensive with the life of the franchise itself.

Other Media Rights Valuation Cases

The FSA goes through a number of other cases which deal with media rights, valuation and amortization. Several of these cases are quite telling. In Cody Laird v. U.S., 556 F.2d 1224 (5th Cir. 1977); cert. denied, 434 U.S. 1014 (1978), television rights were to last as long as the Atlanta Falcons remained a member of the NFL. No amortization was allowed because of this indeterminate useful life. Similarly, First Northwest Industries v. Commissioner, 70 T.C. 817 (1978); rev'd and remanded on other grounds, 649 F.2d 707 (9th Cir. 1981), involved an NBA team's right to share in NBA broadcasts.

Because these rights under the contract were only a link in a continuing chain of national television income lasting as long as the team held an NBA franchise, the court found amortization to be unavailable. Another case, McCarthy v. U.S., 807 F.2d 1306 (6th Cir. 1986), also involved a basketball team with similar results. The FSA especially adopted language from the McCarthy opinion, noting that the rights to revenues were of indeterminate duration and linked to membership in the league.

The FSA then turns to the bellwether case of Newark Morning Ledger, noting that an intangible that would otherwise fall within the concept of goodwill can still be appreciable, provided that it has an ascertainable value and a limited useful life that can be determined with reasonable accuracy. This approach, however, does not change the Service's view that the media rights in question in the FSA were not the individual contracts, but rather the media rights underlying them. Furthermore, the FSA concludes that, notwithstanding the Newark Morning Ledger case, these media rights do not have a limited useful life and therefore simply are not depreciable.

The Newark Morning Ledger case involved a taxpayer who acquired groupings of paid subscribers to various newspapers, valuing the subscribers based on the estimate of future profit to be derived from the continuation of subscriptions into the future. Depreciating this value over the expected remaining life of current subscriptions therefore could be done with reasonable accuracy.

Newark Morning Ledger found the Supreme Court addressing for the first time the allowance of depreciation for so-called "customer-based" intangibles. While the taxpayer prevailed, the case's peculiar procedural background significantly affected its outcome and raises additional questions. A customer-based intangible is the value attributable to an acquired business' established customer base. In newspapers and other periodicals, this is represented by "paid subscribers." Other cases have raised similar issues.

For example, Bancorp deposits were considered in Citizens & Southern Corp., 91 T.C. 463 (1988). Animal medical records for pet owners were considered in Los Angeles Central Animal Hospital, Inc., 68 T.C. 269 (1977). Retail franchise contracts with food outlets were considered in Super Food Services, Inc. v. U.S., 416 F.2d 1236 (7th Cir. 1969). In all these cases, the basic issue was whether the intangible value of the established customer base could be distinguished from the nondepreciable goodwill. That was the issue the Supreme Court took on in Newark Morning Ledger. Various methods of looking at the paid subscriber base are evaluated, and the district court and the Third Circuit each had their own view.

When the matter reached the Supreme Court, it focused not so much on the lower court's views about the paid subscriber base as on the goodwill question itself. The correct definition of goodwill was the issue before the Supreme Court. Was it "expectation of continued patronage" (which almost automatically includes customer-based intangibles of a going concern), or merely what is left over after all the assets with ascertainable useful lives and values have been identified?

Import of Newark Morning Ledger

In 5-4 decision, the Supreme Court held for the taxpayer. According to the majority, if the taxpayer successfully demonstrates that an intangible asset has an ascertainable useful life that can be valued with reasonable accuracy, the entire justification for refusing to permit depreciation evaporates. By definition, such a separately identifiable asset is not goodwill, regardless of the fact that its value is related to the expectancy of continued patronage. Because the Court adopted a residual approach to defining goodwill, it was not troubled by the taxpayer's use of the income method of valuation (looking at the income stream represented by paid subscribers).

In considering the lasting impact of the Newark Morning Ledger case, it is important to review who argued what. The government was certainly hoping to convince the Court that customer-based intangibles of a going concern (such as paid subscribers), can never be distinguished from goodwill. As a result of this all-for-nothing go-for-broke approach, the government missed out on several opportunities to defeat the taxpayer. By not serious challenging the evidence supporting the estimated useful life of the paid subscriber base, the IRS appears to have surrendered to a significant factual premise which the taxpayer otherwise had the burden of proving.

As a result, more than a few observers have pointed out that Newark — which on the surface was a complete victory for the taxpayer — may not prove too helpful to other taxpayers. Certainly the FSA considered here (obviously not a court decision but nevertheless significant) does a more thorough job than the government did in arguing Newark Morning Ledger

The media rights in question in the FSA were clearly distinguishable, according to the Service. Newark Morning Ledger involved customer-based intangibles, while the media rights involved in the FSA were essentially unaffected by the execution of new and renewal contracts.

The user of the media rights considered in the FSA is not the source of the asset being valued. The source of the asset itself is the right to share in or receive broadcast revenue (from whatever broadcasts). This right, according to the view espoused in the FSA, is based on membership in the league, not on the execution of contracts. Individual contracts might end, but the right to broadcast and derive revenues is inherent in the franchise itself. That would continue to exist.

Writing on the Wall...

Let's return, then, to the two questions the FSA addresses. First, are the media rights acquired in connection with the acquisition of the professional sports franchise separate and distinct assets from goodwill? The Field Service Advice concludes as to the first question that the identified media rights likely do have an ascertainable value which is separate and distinct from goodwill of the target company. In reaching this conclusion, the FSA notes that the taxpayer utilized a valuation approach that was similar to the methodology allowed by Newark Morning Ledger v. U.S., 507 U.S. 546 (1993).

As to the second question, can the media rights (or any portion thereof) qualify for depreciation (amortization having been nixed by the language of Section 197)? Here, the above discussion should make clear that the Service painstakingly reviewed the facts and the authorities to answer this question in the negative.

As the question whether depreciation or amortization is allowable, the ruling concludes that as part of the acquisition, the taxpayer acquired certain media rights. Although the individual contracts in question cover certain distinct, ascertainable periods of time, as well as later renewal periods, the assets represented by the contracts are the franchise's right to national and local broadcast revenue. These rights to broadcast revenues (or media rights) do not have a limited useful life and are not wasting assets.

Indeed, the ruling concludes that the contracts themselves are merely links in a continuous, indefinite chain of media-related income. Although the term of a particular contract will expire, it will be either renewed with the current broadcaster or replaced with a contract with a competing broadcaster. The revenue flow is to continue and the taxpayer's right to share in or receive that revenue would also continue. It would be unaffected by changes in the contract or parties to the contract.

The asset, the FSA concludes, which is the right to broadcast revenue, is inherent in the franchise that was acquired, and has no determinable expiration. These rights are therefore not depreciable under Section 167 according to the FSA. Finally, the intangible media rights were acquired with the acquisition of the professional sports franchise and are specifically excluded from amortization under Section 197.

Media Rights for Sports Franchises: Separate Assets?, Vol. 10, No. 7, The M&A Tax Report (February 2002), p. 1.