The following article is adapted and reprinted from the M&A Tax Report, Vol. 9, No. 12, July 2001, Panel Publishers, New York, NY.


By Robert W. Wood

I always get nervous every time I read that a case is one of "first impression." It seems after all of the years of complex tax law, and all of the volumes upon volumes of decisions, that hardly anything anymore would be a case never considered before. I feel this all the more so the topic is in an area as fundamental as covenants not to compete.

Yet, the Tax Court said that this is exactly what it was doing when it recently decided Frontier Chevrolet Co. v. Commissioner, 116 T.C. No. 23 (May 14, 2001), Tax Analysts Doc. No. 2001-13719, 2001 TNT 94-25. There, the Tax Court held that a company had to amortize over fifteen years a covenant not to compete because it was entered into within an indirect acquisition of an interest in a trade or business (the redemption of the company's stock). Fifteen year amortization, it will be recalled, came about in Section 197 not too many years ago. Let's look at Frontier's facts and how it got (unfortunately) into the fifteen year box.

Frontier Issue...

OK, not the best pun, but this is tax law. Frontier Chevrolet sold new and used cars. Roundtree Automotive Group purchased and operated car dealerships and provided consulting to them. Roundtree bought all of Frontier's stock in 1987. Frontier filled its executive manager position with a long-time Roundtree employee, Mr. Menholt. Menholt purchased 25 percent of Frontier's stock between 1987 and 1994. Mr. Stinson, president of Roundtree, received monthly payments for management services.

Before August 1, 1994, Roundtree owned 75 percent of Frontier, and Menholt owned 25 percent. In 1994 Frontier redeemed all of its stock from Roundtree with funds borrowed from General Motors Acceptance Corporation. After the stock sale, Menholt was the sole shareholder of Frontier. At the same time, Frontier entered into a noncompetition agreement with Stinson and Roundtree for five years. On its federal tax returns for 1994-1996, Frontier amortized the payments for the noncompetition agreement over 15 years. In 1999 Frontier filed a claim for a refund for 1995 and 1996 taxes, claiming the noncompetition agreement should be amortized over the life of the agreement.

The Tax Court noted that section 197(a) provides for amortization of intangibles acquired in connection with the conduct of a trade or business, and that a covenant not to compete entered into in connection with a direct or indirect acquisition on an interest in a trade or business is also a section 197 intangible. Dismissing Frontier's argument that the redemption was not an acquisition for section 197 purposes, the court concluded that the legislative history to section 197 contains no evidence that it meant for a stock purchase to be excluded from the term "acquisition" because it occurred in a redemption.

The court noted that Frontier's execution of the stock sale agreement caused it to indirectly acquire an interest (in the form of stock), in a corporation engaged in a trade or business. The Tax Court therefore concluded that the noncompetition agreement was entered into in connection with the acquisition of an interest in a trade or business, and the agreement had to be amortized over 15 years under section 197.


Amortization Covenants, Vol. 9, No. 12, The M&A Tax Report (July 2001), p. 6.