FRANCIS M. ALLEGRA, District Judge.
This tax refund case is before the court following trial in Washington, D.C. There are two distinct issues presented in this case. The first involves the tax treatment of a swap of radio stations that occurred in 2000. More specifically, at issue is whether the agreed upon value of radio station KZLA-FM (KZLA), the Los Angeles station that plaintiff swapped in that transaction, included any component for goodwill. Plaintiff claims that the station, which was the only country station in Los Angeles at the time, possessed no appreciable goodwill; defendant contends otherwise. If plaintiff is correct, no additional taxes were owed on the swap, which otherwise qualified as a like-kind exchange under section 1031 of the Internal Revenue Code.
Based on its review of the record, and for the reasons that follow, the court finds that: (i) for purposes of the like-kind exchange provisions of section 1031 of the Code, plaintiff did not transfer appreciable goodwill as part of the KZLA exchange; and (ii) with the exception of certain air conditioning equipment, plaintiff has failed to demonstrate that the assets in question were improperly treated as non-residential buildings (or structural components thereof) for purposes of their depreciation under section 168 of the Code. Procedures for the issuance of an appropriate judgment are established.
Based upon the record, including the stipulation of facts, the court finds as follows:
Plaintiff, Deseret Management Corporation (Deseret or plaintiff), is a Utah corporation and a holding company for various subsidiaries. The latter include Bonneville International Corporation (BIC), which owns and operates radio stations in large markets throughout the United States. From 1998 to 2000 (the relevant time period), Bruce Reese was the president and Chief Executive Officer (CEO) of BIC. In tandem with a sister company, Bonneville Holding Company (BHC), BIC was in the business of owning and operating radio stations. Often, in purchasing a radio station, BHC would acquire and hold the station's Federal Communications Commission (FCC) license,
On April 3, 1998, BIC and BHC exchanged certain assets of radio station KBIG-FM with Chancellor Media Corporation for those of KZLA. Both stations broadcast in the Los Angeles, California radio market (the LA Market). Consistent with the pattern described above, BHC acquired KZLA's license, while BIC acquired all of the station's other assets. After acquiring KZLA, BIC kept the country format. From 1998 to 2000, David Ervin was the general manager of KZLA, and Richard Meacham its President. In 1998 and 1999, KZLA's revenue was $17.25 million and $16.57 million, respectively. In 2000, revenue was approximately $16.4 million.
KZLA was the only FM station that used a country music format in the LA Market between 1998 and 2000. Because this case turns upon a determination of what, if any, "goodwill" KZLA possessed in 2000, it is necessary to review some basic facts about the radio business and the LA Market.
During the time in question, Los Angeles was the second largest radio market in the country, and it was growing rapidly. Population in the LA Market grew from 13.2 million in 1998 to 13.6 million in 2000. Gross revenues for radio stations expanded from between $648.4 million and $658.2 million in 1998, to between $851 million and $914 million in 2000. By 2000, there were seventy stations in the market: seventeen Class A FM signals, twenty-two Class B FM signals, and thirty-one AM signals. FM signals tend to have greater clarity and coverage than AM signals. Within FM stations, Class A signals serve smaller areas or communities and have smaller coverage than Class B signals, which tend to cover larger metropolitan areas. One financial analyst reported that in 2000, only twenty-one of the LA stations were "viable FMs," that is, FM stations with ratings sufficiently "significant" to be considered "serious competitors."
In Los Angeles, the mountainous terrain adversely impacts the broadcast coverage of FM signals. This topography gives certain radio stations in the LA Market a few advantages over their competitors. The first of these, for some of these stations, is antenna location: the antenna farm located on Mt. Wilson offers the most elevated place in the LA Market from which to broadcast a radio signal. In 2000, of the approximately forty FM stations that were licensed to broadcast in the LA Market, only fourteen were licensed to transmit from this peak in the San Gabriel Mountains, including KZLA. A second advantage is enjoyed by stations that are exempt from FCC restrictions (dating to 1963) which limit the power stations can use to broadcast signals from elevated antenna locations such as Mt. Wilson. Seventeen Los Angeles FM stations were "grandfathered in" under those regulations because they were using power exceeding the restrictions when they were promulgated in 1963. KZLA, a Class B FM station broadcasting at a frequency of 93.9, was one of those 17 "superpower" stations. Its signal covered approximately 6,400 square kilometers, capable of reaching a population of more than 12.7 million listeners.
Like much of the country, the LA Market was dramatically impacted by the passage of the Telecommunications Act of 1996 (the Telecommunications Act). Prior to 1996, the FCC limited the number of stations that could be owned by a single entity in both a given market, as well as nationwide: a single entity could not own more than three AM stations and three FM stations in a large market such as Los Angeles, nor could it own more than thirty AM stations and thirty FM stations nationally. The Telecommunications Act relaxed these limits. After 1996, in a large market, like Los Angeles, a single entity could own up to eight commercial radio stations, so long as no more than five of them were either AM or FM. National ownership limitations were eliminated entirely. These changes prompted major consolidations within the radio industry — for instance, in March 1996, the two largest radio groups, Clear Channel and Jacor held 113 stations between them; by March 2001, they owned more than 1,200 stations. The Telecommunications Act also prompted owners to sell stations in one market and acquire them in another, seeking to consolidate their holdings.
During this same time, Spanish-language broadcasting blossomed as a driving economic force in the LA Market, with broadcasters in this genre showing an intense demand for LA stations with strong FM signals. This demographics-inspired sea change, combined with the Telecommunications Act's relaxation on ownership limits, created a demand for FCC licenses and radio stations that outpaced supply. Not surprisingly, prices for radio stations increased astronomically during this period.
A radio station is in the business of selling time to advertisers that are attempting to reach the station's listeners. Advertisers are interested in the size and demographics of a radio station's audience. Because listeners are drawn by the "format" of a radio station, a station may target specific demographics for their listener base by playing the music or other content it believes will appeal to those individuals. The station then looks to sell time to advertisers interested in reaching listeners within those demographics. The majority of radio advertising time is sold to advertising agencies, which buy on behalf of companies.
Several metrics are used to gauge the success of a radio station. One of these is market share. Arbitron is a nationally-recognized radio audience research firm. At the end of 2000, it had designated 278 different local geographic areas, or "Metros," in an attempt to reflect the audiences reached by local radio stations. One of these Metros was the LA Market, consisting of Los Angeles and Orange Counties, California. During the relevant time period, Arbitron reported the percentage of all radio listening in each Metro area. It did so by sampling the total persons twelve or older listening to the radio Monday through Sunday, 6:00 am to midnight. A station's percentage of all radio listening is referred to as its "audience share." Sometimes this share is adjusted to compare a station's audience to all commercial radio audiences in the market — the "adjusted share."
Duncan's Radio Market Guide reported that revenue for stations in the LA Market rose from $648.4 million in 1998 to $914 million in 2000. As reported in various Duncan publications, between 1985 and 2001, retail sales in the LA Market grew at a compound annual rate of 5.2 percent; between 1994 and 2000, radio station revenue in the LA Market grew at a compound annual rate of 12.2 percent. By comparison, from 1998 to 2000, KZLA's revenue stayed relatively flat, at approximately $16 million per year. According to Duncan, KZLA's adjusted audience share in 1998 was 2.6, which was the twentieth best share out of the thirty-five stations covered in the Duncan report for Los Angeles. In 1999, the share dropped to 2.4 (20th of 39), and in 2000, it went back up to 2.6 (17
Finally, a radio station's "power ratio" is obtained by dividing its revenue share by its adjusted audience share. The higher the power ratio, the better a station is performing suggesting either a superior performance in marketing the station to advertisers or an unusually desirable demographic. A power ratio of 1.0 indicates that the station is attracting the same share of advertiser spending as its share of the market audience. In some situations, the power ratio exceeds 1.0 by enough to make the station a "must buy" or "top tier"— a station so desirable that an advertising agency would be doing its clients a disservice if it did not purchase advertising.
In late 1999, Mr. Ervin (KZLA's general manager) hired Coleman Research (Coleman) to study KZLA's performance. Coleman does research and marketing for various media companies, primarily radio stations. Pursuant to that contract, Chris Ackerman, a vice president of Coleman, performed a "perceptual study" of KZLA in December 1999, designed to determine audience perception of the station, "brand image position," and how to improve audience share.
In early 2000, Mr. Reese negotiated a deal with Emmis Communications (Emmis) in which Emmis would acquire KZLA's assets. Emmis is an Indianapolis-based company that owns and operates radio and magazine entities throughout the country. In 2000, it owned approximately twenty radio stations, including KPWR-FM, a Class B FM station in Los Angeles. It also owned or had the right to acquire four stations in the St. Louis radio market — WRTAM, WIL-FM, WVRV-FM, and WKKX-FM (the St. Louis Stations). Jeff Smulyan was the president and CEO of Emmis; Doyle Rose was the president of Emmis Radio, a division of Emmis. Reese and Smulyan agreed to exchange the assets of the St. Louis Stations for the assets of KZLA. These assets included the respective FCC licenses for each of the radio stations.
On April 19, 2000, Mr. Reese briefed BHC regarding the progress of negotiations with Emmis. In a letter, he explained that BHC and BIC would give up KZLA, which, according to Mr. Reese, had increased in fair market value from the time it was acquired — from $155 million to between $225 and $250 million. The letter listed the principal hard assets of KZLA as the office building ($2.5 million), owned antenna and towers, and a leased transmitter site. The letter further noted that KZLA's cash flow was approximately $6.5 million in 1999 and $6.6 million in 2000. In exchange, BIC and BHC would acquire three or four St. Louis stations; depending on the stations provided, and their cash flows, there would also be an exchange of cash between the companies. "At the one extreme," Mr. Reese explained, "Emmis might end up giving [BIC and BHC] three stations plus $25-$35 million in cash. At the other end, [BIC and BHC] could get four stations and pay up to $25 million in cash." Mr. Reese asked BHC to authorize BIC management to proceed with negotiations, and recommended that tax advisors from both BIC and BHC review the structure of the proposed transactions.
On April 28, Mr. Reese wrote Messrs. Smulyan and Rose at Emmis outlining a proposal for exchanging the assets of KZLA for the assets of the St. Louis Stations. In this letter, Mr. Reese assessed that "the value of KZLA is well north of $200 million. . . . In fact, I suspect it might go for as much as $240-$250 million on the open market. This presumption is based on unsolicited but relevant inquiries since November, from both general market and Hispanic operators." However, because St. Louis was an "attractive opportunity," he concluded that "something less than an auction price is the right place for us to value KZLA." At trial, Mr. Smulyan testified that, during the negotiations, he did not believe that KZLA was worth as much as Mr. Reese thought and that Emmis viewed the transaction as acquiring a "stick" for an entry price.
On June 21, 2000, BIC, BHC, and Emmis executed a letter of intent setting forth the terms under which the exchange would occur.
As the Agreement envisioned, BIA performed an appraisal of the assets of KZLA as of October 6, 2000. That appraisal was completed and delivered after the transaction closed. BIA concluded therein that KZLA had a "Going Concern Value" of $156,000 and that its FCC license was worth $176,757,046. As used in the BIA report, going concern value included the value of KZLA's preexisting systems and procedures for finances, administration, technology, and sales, and "allows for the continued successful operation of the station." BIA valued KZLA's going concern as the "cost that would be required to replicate the systems and procedures in place and in use at the station." It calculated the value of the FCC license using the residual fair market value method — it subtracted the value of all other assets (tangible and intangible) from the exchange value (the $185 million), and assigned the difference (the residual) to the FCC license. BIA assigned no value to goodwill because: (i) as a matter of case law, "[i]t is well-established that broadcast stations do not possess any goodwill;" (ii) broadcast stations in general "do not enjoy any goodwill in the sense of either listener or advertiser loyalty;" and (iii) KZLA, in particular, "does not possess any other traditional manifestations of goodwill."
Following the transfer, Emmis continued to maintain KZLA's country format (and did so until sometime in 2006).
For each of the tax years 2000 through 2002, Deseret timely filed a consolidated federal income tax return on behalf of itself and its subsidiaries, including BIC. In 2000, Deseret reported the above-described exchange as a "like-kind" exchange and recognized gains owing to the exchange. It based its report of gains on the BIA appraisal, and therefore assigned no value to goodwill. Following an audit, on February 28, 2005, the IRS proposed an adjustment in Deseret's 2000 tax year with respect to the reporting of gain from the exchange. The IRS determined that KZLA possessed goodwill with a value of $73,311,046 on the date of the exchange. On May 6, 2005, the IRS issued to Deseret a thirty-day letter (IRS Form 950) with respect to tax years 2000 through 2002, which asserted a deficiency regarding 2000 and incorporated the conclusions previously set forth with respect to the value of the goodwill of KZLA.
In early 2008, Deseret and the IRS jointly executed an IRS Form 870-AD, on which Deseret agreed to the assessment and collection of deficiencies for the tax years in question, but also reserved "the right to timely file a claim for refund or credit or prosecute a timely claim." On December 15, 2008, Deseret did just that — it filed with the IRS an Amended U.S. Corporation Income Tax Return, Form 1120X (Claim for Refund) for the tax year 2000, seeking refund of what it alleged was an overpayment of $25,572,074, plus interest. On February 19, 2009, the IRS fully disallowed each item claimed in the Claim for Refund. On March 4, 2009, Deseret executed IRS Form 2297 — Waiver of Statutory Notification of Claim Disallowance and Form 3363 — Acceptance of Proposed Disallowance of Claim for Refund or Credit — and sent them, along with a letter, to the IRS. In these documents, Deseret acknowledged the IRS's disallowance of their claim, but expressly preserved its right to bring an action for refund of the disputed tax assessments.
The thirty-two assets at issue were placed into service by plaintiff between 1988 and 2000. These assets were originally classified by plaintiff as buildings or structural components of buildings, depreciable as nonresidential real estate over 39 or 31.5 years. Four of the assets are buildings which were used by BIC to store equipment and to house its transmitters. The other assets were air conditioning equipment and duct work; electrical wiring; partitions, walls, ceilings, windows, and millwork; and other leasehold improvements.
In 2002, BIC retained the accounting firm Deloitte and Touche (Deloitte) to review its fixed asset records and determine whether BIC was depreciating assets correctly. John Seabrook was the Deloitte partner primarily responsible for conducting the study. BIC provided Deloitte with an electronic download of its fixed asset records, which contained information on each of BIC's approximately 18,600 fixed assets. Those records described each asset, the date on which it was placed in service, the asset's location, its cost, and information regarding the depreciation of the asset, including original life and accumulated depreciation data. This data came from Capital Asset Addition Forms, which were completed by the BIC employee who had acquired the asset, and then submitted to BIC's corporate office for entry into the Fixed Asset System. In addition to reviewing this information, Mr. Seabrook viewed some assets and had conversations with BIC employees about others. At the end of his study, he concluded that BIC had been claiming less depreciation than was allowable under the Code with respect to 158 specific assets which had been placed into service between 1988 and 2000.
On or about September 10, 2002, Mr. Seabrook assisted BIC/Deseret in preparing and submitting an IRS Form 3115 — Application for Change in Accounting Method — to request a change in the method by which Deseret depreciated these assets, beginning in tax year 2001. The IRS and plaintiff agreed on the treatment of the wide majority of these assets, but disagreed as to the proper treatment of thirty-two of the assets described above. At Deloitte's suggestion, BIC reclassified them into one of two groups: (i) assets used in radio and television broadcasting as described in Asset Activity Class 48.2 of Revenue Procedure 87-56, 1987-2 C.B. 674, depreciable over five years, or (ii) office furniture and fixtures, and equipment included in Asset Class 0.11, also of Revenue Procedure 87-56, depreciable over seven years.
On April 29, 2009, Deseret filed this refund suit against the United States for recovery of income tax payments including, inter alia, those paid relating to the KZLA exchange and those relating to proper class lives of the BIC assets. Discovery was completed in May 2011. Trial in this case was held between February 23, 2012, and March 1, 2012.
In a refund suit, the assessment made by the IRS is presumed to be correct, placing an obligation on the taxpayer to come forward with evidence to rebut a presumption of correctness. United States v. Janis, 428 U.S. 433, 440-41 (1976); Welch v. Helvering, 290 U.S. 111, 115 (1933). Viewed in these terms, the presumption of correctness "is a procedural device which requires the taxpayer to come forward with enough evidence to support a finding contrary to the Commissioner's determination." Rockwell v. Comm'r of Internal Revenue, 512 F.2d 882, 885 (9th Cir. 1975), cert. denied, 423 U.S. 1015 (1975). In addition, a taxpayer in a refund suit also has the burden of proof — the ultimate burden of proving not only that it overpaid its taxes, but also the amount of the overpayment. See Helvering v. Taylor, 293 U.S. 507, 515 (1935); Lewis v. Reynolds, 284 U.S. 281, 283 (1932); Am. Airlines, Inc. v. United States, 204 F.3d 1103, 1108 (Fed. Cir. 2000).
This case presents two distinct issues. The first involves the proper treatment of the KZLA exchange under the like-kind exchange provisions of section 1031 of the Code. The second focuses on the proper classification of certain assets under the depreciation rules provided by sections 167 and 168 of the Code. The court will consider those claims seriatim.
Under section 1031 of the Code, a taxpayer may defer recognition of gain or loss from qualifying exchanges of like-kind property. 26 U.S.C. § 1031(a). A like-kind exchange occurs if property held for productive use in a trade or business or for investment is exchanged solely for property of like kind that is to be held either for productive use in a trade or business or for investment. Id.; see also 3 Michael D. Houser, Mertens Law of Federal Income Taxation § 20B:1 (2013) (hereinafter "Mertens"). Such an exchange allows the exchanger to delay recognizing gain on the exchanged property, as the tax basis of that property carries forward to the newly-acquired property. 26 U.S.C. § 1031(d); see also OcmulgeeFields, Inc. v. Comm'r of Internal Revenue, 613 F.3d 1360, 1364 (11
"Goodwill" is neither specifically referenced in section 1031 of the Code, nor defined in any Treasury Regulation thereunder. The term is employed elsewhere in the Code, most notably section 197, dealing with the amortization of intangible assets.
Qualitatively speaking, goodwill has been defined in the case law as "the expectation of continued patronage." Newark Morning Ledger Co. v. United States, 507 U.S. 546, 555-56 (1993) (quoting Boe v. Comm'r of Internal Revenue, 307 F.2d 339, 343 (9
Joseph Story, Partnerships § 99 (1841); see also DesMoines Gas Co. v. DesMoines, 238 U.S. 153, 165 (1915) (goodwill is "that element of value which inheres in the fixed and favorable consideration of customers, arising from an established and well-known and well-conducted business); Metro. Nat'l Bank of N.Y. v. St. Louis Dispatch Co., 149 U.S. 436, 446 (1893) (relying on the Story definition). Goodwill thus "provides a useful label with which to identify the total of all the imponderable qualities that attract customers to the business." Newark Morning Ledger, 507 U.S. at 556; see also L.A. Gas & Elec. Corp. v. R.R. Comm `n, 289 U.S. 287, 313 (1933).
Searching for more clarity, courts have also defined goodwill in quantitative terms, with an eye towards value. Thus, the Supreme Court, relying on the Story definition quoted above, has described goodwill as the value "beyond the mere value of the capital, stock, funds, or property employed therein" associated with continued patronage. Newark Morning Ledger, 507 U.S. at 555 (quoting Metro. Nat'l Bank, 149 U.S. at 446); see also Baker v. Comm'r of Internal Revenue, 338 F.3d 789, 793 (7
So, under these definitions, did KZLA possess goodwill at the time that it was transferred by plaintiff in exchange for the St. Louis Stations? There is no dispute that the enterprise value of KZLA in the swap transaction was $185 million. Likewise, the parties agree that, as of the date of the transaction, the value of KZLA's tangible assets was $3,384,637, and the value of its intangible assets (apart from the station's FCC license and any goodwill) was $4,858,317. But, what do we do with the residual — the $176,757,046 difference between the $185 million and the stipulated value of the other assets ($8,242,954)? More specifically, the question is whether any portion of that difference is attributable to KZLA's goodwill? Plaintiff claims the answer to that question is no — arguing that the station possessed no goodwill and that all the value associated with the residual should be attributed to the station's FCC license. Not so, defendant retorts, asserting that the value of the FCC license was much less than what plaintiff claims, and that what is left, when that reduced license value is subtracted from the residual, is the value of KZLA's goodwill. As to that amount, defendant argues, the exclusion under section 1031 is triggered, producing gain under section 1001(a) of the Code. Determining which of the parties is right presents several questions of fact that can be resolved only by weighing all the evidence, a matter to which this court now turns.
There are indications that KZLA may have possessed some degree of goodwill with respect to its audience and, relatedly, its advertisers. KZLA was the only Class B station with a country format in a market of nearly 13 million listeners. Listeners in portions of that market closely followed KZLA — a factor that Emmis considered in retaining KZLA's country format. Since the real customers of a radio station are its advertisers, it bears noting that KZLA's retention of a set of loyal listeners was reflected in the market share numbers that, in turn, led to advertising rates and ad placements. For KZLA, of course, those numbers reflected a mixed bag, with the station seemingly not performing to its potential, as reflected by its declining revenue share and power ratio during the relevant period. But, the record also hints at the notion that advertisers selling products that might be appealing to country listeners might have been more inclined to place ads with the dominant country station in the LA Market. Indeed, the evidence indicates that companies in the country music industry, as well as media buyers, viewed having a successful country station in Los Angeles — which at the time of the swap was the number one market for country record sales — as essential to the success of the format. Moreover, it is virtually undisputed that KZLA had a seasoned sales staff that had relationships with key advertising firms and that those relationships provided the station with a slight advantage over its competition.
In deciding that KZLA may have possessed some goodwill, the court is also mindful of the findings made by Coleman in its 1999 perceptual study of the station. In that study, Coleman found, inter alia, that KZLA listenership was "under-developed," and that the station lacked "brand depth" beyond music and an appropriate "image profile." The report indicated that the country format had the potential to support a top-five station in the important 25-54 age group, further asserting that if KZLA realized its full potential it could grow a full share point above its then rating. To aid KZLA in realizing these gains, Coleman made eleven separate recommendations, e.g., that KZLA "will need aggressive external marketing to raise its top of mind awareness and strengthen its format and music position," as well as take a variety of other steps to improve its "music image marketing" and "music image position." But, what exactly was the "brand depth" and "music image" that these extensive recommendations were designed to enhance — the enhancement of which would allegedly lead KZLA to realize its full potential as the dominant country station in the huge and burgeoning LA Market? In the court's view, for tax purposes, it appears that this "brand depth" and "music image" are reflective of the existence of some degree of goodwill, albeit perhaps underdeveloped. This depth and image appear to represent, to paraphrase Justice Story, an "advantage or benefit" beyond the value of KZLA's other assets "in consequence of the general public patronage and encouragement which [the station] receive[d] from constant or habitual customers." Presumably, the steps recommended by Coleman were designed to enhance the station's base of constant or habitual customers, with the expectation that a resulting increased market share would translate readily into enhanced advertising revenue.
Both plaintiff, and BIA before it, flatly contend that a radio station can never possess goodwill because audience loyalty is a matter of format and on-air personalities. That listeners might flee a station that suddenly changes its format or on-air personalities, however, does not prove plaintiff's point — any more than it would be true to say that other types of businesses cannot have goodwill because they would lose their customers if they fundamentally changed their business plans. Can it be that nationally-recognized restaurant chains lack goodwill because their customers might flee if they radically changed their menus; or that sporting goods stores lack goodwill because they might decide to sell only flowers; or that familiar chains of coffee purveyors lack goodwill because they would lose their current business if they sold only soda? One would think not. For a host of strategic business reasons, an acquiring entity may defenestrate the critical and identifying features that, either individually or collectively, gave the acquired entity the expectation of continued patronage. That it may choose to do so — perhaps hoping to gain still more patronage in a reformatted configuration — does not mean that the business it acquired lacked goodwill. Put another way, whether goodwill exists as part of the assets acquired in a transaction cannot depend upon whether the buyer concludes that it is in its best interests to sustain the prior business model — that the prior goodwill must be accounted for if the prior business model is maintained, but not if that model is modified.
Nor does this court believe that KZLA necessarily lacked goodwill because it was underperforming. There is undeniably a positive nexus between the existence of goodwill and the ability to generate profit — but that is to say neither that only profitable firms have goodwill, nor, especially, that only firms with profits above the norm possess that asset. See C.F. Hovey Co. v. Comm'r of Internal Revenue, 4 B.T.A. 175, 177-78 (1926). The proclivity of `"old customers . . . to resort to the old place,'" Houston Chronicle Publ'g Co. v. United States, 481 F.2d 1240, 1247 (5
In contending otherwise, plaintiff relies on several decisions of the Court of Claims. For example, it asseverates that Meredith Broadcasting established a per se rule that FCC-licensed broadcasting stations can never possess goodwill. In that case, the taxpayer acquired all the assets of a radio and a television station. At issue was whether a portion of the purchase price attributed to intangible assets should be attributed to television network contracts. The Court of Claims held that these contracts "were intangible assets of significant value" separate from all of the other intangible assets. Meredith Broad., 405 F.2d at 1224. In so doing, it acknowledged that "considerable confusion" has arisen in this area because of "the shifting meaning of the term `goodwill,'" which, in some instances was used to refer to the aggregate of all the intangibles of the business, and, in others, "in its narrow sense to refer to the traditional concept of goodwill as a matter of favorable customer relations." Id. The court held that the network contracts were assets separate and distinct from the narrower concept of goodwill. Id. at 1225-26. It was within this context that the court commented, in regard to television stations:
Id. at 1223. Ultimately, the court concluded that the network contracts were not an expectancy or form of goodwill, but rather were separate, identifiable, and distinct assets.
A fair reading of Meredith Broadcasting does not support the proposition that a licensed radio station can never have goodwill. Rather, the opinion appears to reflect nothing more than the court's view of the factual record as it related to the television broadcasting industry in the 1950s. There is no reason for this court, after its own trial, to attribute those same factual findings to a radio station broadcasting a half a century later — in the era of the internet, social networking, and satellite broadcasting. Nor is there any other basis for concluding that unlike other industries, radio stations universally lack any goodwill, at least as that concept is applicable herein. See also KFOX, Inc. v. United States, 510 F.2d 1365, 1377 (Ct. Cl. 1975) (dealing with case in which goodwill had been identified as an asset transferred with a radio station); Roy H. Park Broad., Inc. v. Comm'r of Internal Revenue, 56 T.C. 784, 813 (1971) (indicating that a radio station can have goodwill, albeit "little"). Rejection of this per se rule is significant because BIA, the company that appraised KZLA's assets following the swap, viewed Meredith as establishing such a rule in concluding, in its valuation report, that "[i]t is well-established that broadcast stations do not possess any goodwill." It was on the basis of this faulty premise that BIA, after assigning values to KZLA's tangible and intangible assets, as well as its going concern value, used the residual basis for allocating the remainder of the purchase price to KZLA's FCC license ($176,757,046). Although the consequences of using this approach remain to be seen, the decisional law plainly suggests that approach was legally erroneous.
Plaintiff likewise claims that the Court of Claims adopted its view of the law in Richard S. Miller & Sons, Inc. v. United States, 537 F.2d 446, 451 (Ct. Cl. 1976). But, that is untrue. To be sure, in cataloguing various definitions of goodwill, the court there observed that one of them "equates goodwill with a rate of return on investment which is above normal returns in the industry and limits it to the residual intangible asset that generates earnings in excess of a normal return on all other tangible and intangible assets." Id. (citing Note, "Amortization of Intangibles: An Examination of the Tax Treatment of Purchased Goodwill," 81 Harv. L. Rev. 859, 861 (1967-68)).
Contrary to plaintiff's claims then, it would seem that questions involving the presence of goodwill in a given transaction must be resolved on the basis of the facts in a particular case, not some bright-line rule of law. To be sure, goodwill can be viewed as the "premium" that is paid over and above what other assets of the business would be worth if bought individually. See R.M. Smith, Inc. v. Comm'r of Internal Revenue, 69 T.C. 317, 320-22 (1977), aff'd, 591 F.2d 248 (3d Cir.), cert. denied, 444 U.S. 828 (1979); Concord Control, Inc. v. Comm'r of Internal Revenue, 78 T.C. 742, 745-47 (1982). But, logic and common sense suggests that such a premium might be realized even where the acquired entity is not currently profitable — perhaps based upon the expectation that it will become profitable. Yet, plaintiff assumed the contrary in ascribing the residual of the price paid for KZLA, less the value of identifiable tangible and intangible assets, entirely to the station's FCC license. It made no attempt to determine independently the value of that license so as to allow for the possibility that some premium effectively was paid for KZLA beyond the value of its tangible and intangible assets, that is, for goodwill.
Plaintiff's reliance, moreover, on accounting conventions to support its per se rule is similarly misconceived. Accounting principles, which are designed to yield a conservative statement of current income, cannot be presumed to override the construct of the Internal Revenue Code. See Thor Power Tool Co. v. Comm'r of Internal Revenue, 439 U.S. 522, 542-43 (1979) (given their different objectives, "any presumptive equivalency between tax and financial accounting would be unacceptable"). Indeed, beginning in 2004, the Securities and Exchange Commission began requiring public radio stations to value directly their FCC licenses and assign the residual value to goodwill — a policy that caused companies, like Emmis, to identify and value the goodwill associated with their stations. See SEC Staff Announcement, "Use of Residual Method to Value Assets Other Than Goodwill" (Sept. 29, 2004) (citing Federal Accounting Board's Statement 141, paragraph 3).
So where does this leave us? In plaintiff's telling, the story here is black-and-white: KZLA possessed no goodwill based on bright-line legal distinctions applicable to all (or virtually all) broadcasting stations. The truth is more grey. There are a few indications that KZLA may have possessed some goodwill — albeit far less than some other radio stations, as various market metrics indicated. In the court's view, determining whether that goodwill was appreciable — or, alternatively, de minimis — requires an examination of the quantitative evidence that goodwill was transferred here. See Jefferson-Pilot Corp. v. Comm'r of Internal Revenue, 98 T.C. 435, 450 (1992), aff'd, 995 F.2d 530 (4
Hewing to its view that KZLA lacked goodwill, plaintiff never offered a value for KZLA's goodwill. Defendant, for its part, employed its own version of a residual method — not to calculate the value of KZLA's FCC license, as BIA had done, but rather to assess the value of the station's goodwill.
To determine the value of the license, defendant's expert, Ms. Flynn, employed a direct valuation method — the income or discounted cash flow (DCF) method — a method that has been used by public radio stations, appraisers and, ultimately, the courts in valuing stations. See Jefferson-Pilot, 98 T.C. at 450-55. Under this method, Ms. Flynn attempted to isolate the income attributable to the FCC license by performing a discounted cash flow analysis of the station, treating it as a start-up. She prepared projections for the revenue, operating cash flow, and net free cash flow that KZLA could reasonably be expected to achieve in the market, giving consideration to past performance, market operating and financial benchmarks, as well as the performance of other radio stations in the LA Market. The operating cash flow was derived by subtracting from the revenue flow future operating expenses; the net cash flow was derived by subtracting from the operating cash flow taxes, depreciation, capital expenditures and additions to working capital. Discounting the net free cash flow to present value, Ms. Flynn then isolated a value for KZLA's license.
Over time, Ms. Flynn further adjusted her calculations, each time reducing the value she ascribed to goodwill.
This all obliges the court to examine further several of the critical steps employed by Ms. Flynn in her DCF calculations. As presented at trial, those calculations incorporated the following steps/assumptions:
As noted, before trial, Ms. Flynn initially set the value of KZLA's FCC license at $131.4 million, leaving $45,391,000 in goodwill. At trial, however, she admitted that she had failed to include in her calculations all of KZLA's projected cash flow for 2009 and had incorrectly calculated working capital. Correcting for these errors, her estimate of KZLA's license value increased, correspondingly dropping her estimate of the station's goodwill to $36,510,000.
At trial, plaintiff's experts cited alleged errors in Ms. Flynn's tax computations that she did not correct before trial. They noted, for example, that she had failed to use the full value of KZLA's license in calculating the amortization deduction owed — instead, she used a proxy value of $80 million. While Ms. Flynn claimed that she could not set the value of the license, for tax amortization purposes, in the same calculation she was using to establish the value of that license, in fact, the spreadsheet she employed appeared to permit that functionality — using that spreadsheet, one could repeat the calculations until the value used for amortization and the final value derived matched. Apart from this, defendant admits that Ms. Flynn made two additional errors in her tax calculations: (i) she used a 40-year, rather than the 15-year, statutory period prescribed by section 197 of the Code, as the useful life of the license, see Treas. Reg. § 1.197-2(f); and (ii) she started the amortization of the license as of January 1, 2001, rather than as of October 2000, as section 197 requires. Plaintiff asserts that if one corrects for all three of these errors, i.e., the value of the license, the useful life, and the starting date, the value of KZLA's "stick" license increases to $179,626,000, leaving no portion of the $185 million purchase price left to be allocated to goodwill.
Logic suggests that the value of the license employed in determining the amortization deduction must closely approximate its actual value, lest the projected income stream from the license be understated, thereby causing the value of the FCC license to be understated.
With this in mind, the following are the specific errors that plaintiff demonstrated existed in Ms. Flynn's discount rate calculation: First, she based her risk-free rate on the average yield of 20-year U.S. Treasury bonds in the year 2000 (6.8 percent), rather than focusing on the yield of those bonds in October 2000 (6.04 percent). Consistent with the testimony of plaintiff's experts, the court believes that the 6.04 percent figure should be employed as the starting point for determining the cost of equity that would have been incurred by a start-up radio station looking to obtain equity financing in October 2000. This approach is consistent, inter alia, with how Ms. Flynn approached the debt component of her discount rate, which began with the prime rate as of October 2000. Second, while Ms. Flynn's cash flow projections were somewhat rosy as compared to KZLA's historical performance, indications are that the equity risk premium she used in calculating her cost of equity was too high.
As the chart indicates, making all three adjustments to Ms. Flynn's discount rate calculation reveals that her discount rate (the weighted average cost of capital or WACC) should have been 9.91 percent, rather than 11.71 percent.
While defendant's post-trial goodwill figure of $19.758 million reflects the 58 percent equity/42 percent debt ratio, it does not account for the other changes that must be made to correct Ms. Flynn's calculations. Specifically, her post-trial figure must be adjusted further to reflect: (i) a value of the license for amortization purposes that more closely corresponds to its actual value; and (ii) the new discount factor (9.91 percent), with an equity component that reflects a modified risk free rate of 6.04 rather than 6.8 percent and an equity risk premium of 6.0 rather than 8.1 percent. The following chart illustrates the impact of these changes in alternating scenarios by: (i) modifying (in column C) the amortization value of the FCC license, and (ii) showing (in column E) how the ultimate value of the license would be affected under four discount rate scenarios: (a) where the equity rate is the same as in defendant's calculation; (b) where the equity rate is adjusted to modify the risk-free rate; (c) where the equity rate is adjusted to modify the equity risk premium; and (d) where the equity rate is adjusted to modify the risk-free rate and the equity risk premium.
Several key findings flow from this chart. For one thing, it appears that KZLA's goodwill values (those listed in column F) fall below zero if the calculation is adjusted to reflect the two equity rate adjustments discussed above — even if the court continues to use defendant's extraordinarily low proxy value of $80 million for the license. If, instead, the amortization value of the license is increased toward its actual value — as can be seen by comparing the values in column C with those in column E — it appears that, even using Ms. Flynn's original discount factor of 11.71 percent, the value of KZLA's residual goodwill falls below zero at an amortization value for the license of around $156,742,000.
So what does this mean? Indisputably, the burden of proof here is on the plaintiff. See United States v. Janis, 428 U.S. 433, 440-41 (1976); see also Charron v. United States, 200 F.3d 785, 792 (Fed. Cir. 1999). Accordingly, to prevail, defendant need not prove that a positive value should be assigned to goodwill; rather, plaintiff must prove otherwise. But, that does not mean that the court must turn a blind eye to the results of defendant's shrinking attempts to value the goodwill supposedly present here in deciding whether plaintiff has met its burden of proof. Per contra. Having embraced the residual value method as the proper method of valuing goodwill here, defendant cannot avoid the results produced by that method when they turn negative. As other cases illustrate, the use of discount calculations to value goodwill represents a double-edged sword, in that the numbers can demonstrate either the presence or the absence of goodwill. See Jack Daniel Distillery, 379 F.2d at 579; Phila. Steel & Iron Corp. v. Comm'r of Internal Revenue, 344 F.2d 964 (3d Cir. 1965) (adopting the opinion of 23 T.C.M. (CCH) 558 (1964)); R.M. Smith v. Comm'r of Internal Revenue, 36 T.C.M. (CCH) 97, 112 (1977), aff'd, 591 F.2d 248 (5
The latter point bears a few additional words. A preponderance of the evidence suggests that the parties to the KZLA exchange did not intend to attribute any part of the exchange value to the station's goodwill — that Emmis did not provide, and plaintiff did not receive, anything for that goodwill as a part of the transaction. See Beeler, 73 T.C.M. at 1987. (for purposes of section 1031, transfer did not include business' goodwill or going concern value). The buyer (Emmis) determined the amount it was willing to pay BHC and BIC on the basis of the realities of the marketplace and its apparent analysis of the value residing in the assets or operations of KZLA. Under the circumstances of this case, KZLA's license was the heart and backbone of the station's value. While the rest of its tangible and intangible assets offered some value to Emmis, it would appear that Emmis parted with no appreciable value for the station's goodwill. This finding, again, is driven by the fact that no reasonable allocation of the exchange value — $185 million — leaves any room for assigning a transferred value to goodwill. It is not simply a matter of giving effect to the parties' expressed subjective intentions.
In analogous circumstances, when use of the residual value method left nothing to be allocated to goodwill, the Tax Court has held that a taxpayer need not allocate a separate value to assets in the nature of goodwill. See, e.g., Charles Schwab Corp. v. Comm'r of Internal Revenue, 122 T.C. 191, 214-15 (2004), supp. on other grounds, 123 T.C. 306 (2004); Monaghan v. Comm'r of Internal Revenue, 40 T.C. 680, 686 (1963); see also R.M. Smith, 36 T.C.M. at 112; see also Maseeh v. Comm'r of Internal Revenue, 52 T.C. 18, 24 (1969).
Now, of course, there is another possibility — that other errors in Ms. Flynn's calculations overstated the value of KZLA's license and, concomitantly, understated the value of KZLA's goodwill. But, neither party has identified those errors with any specificity and the court will not wade into this thicket on its own. That is particularly so because the notion that the value of the KZLA's FCC license was so great as to suggest that no goodwill was accounted for in the exchange is confirmed by the sale of a radio station that occurred less than a month after the KZLA transaction. Specifically, at trial, plaintiff showed that on November 3, 2000, radio station KFSG was sold at auction for $250 million. KFSG was similar to KZLA in several critical ways — it was, for example, a Los Angeles-based Class B station.
To recapitulate, the "[e]xistence of `good will' and the value thereof are primarily questions of fact which `must necessarily be considered in the light of [the] facts in each case.'" Miller v. Comm'r of Internal Revenue, 333 F.2d 400, 404 (8
The court now turns to the dispute concerning the proper class lives that should have been assigned to certain assets placed into service by plaintiff between 1988 and 2000. Section 167(a) of the Code provides "as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear . . . . of property used in the trade or business." 26 U.S.C. § 167(a). For the property in question, section 168 of the Code sets forth rules for determining the amount of the depreciation allowed under section 167(a). In pertinent part, section 168(c) provides the time period over which an asset is depreciated, a function accomplished by placing assets into particular classes of property. The class lives of depreciable assets can be found in a series of revenue procedures issued by the IRS. See Treas. Reg. §§ 1.167(a)-11 (b)(4)(ii); see also § 1.168-3, Proposed Income Tax Regs., 49 Fed. Reg. 5957 (Feb. 16, 1984). The revenue procedure in effect for the years in question was Rev. Proc. 87-56, 1987-2 C.B. 674. See Iowa 80 Grp., Inc. v. Internal Revenue Serv., 406 F.3d 950, 952 (8
In 2002, BIC retained Deloitte to determine whether it was properly depreciating its assets. As part of this process, Deloitte reviewed the electronic records associated with approximately 18,600 fixed assets. With a few exceptions, Deloitte did not review the individual assets or discuss them with BIC employees, but merely reviewed the catalog of information assembled by BIC. As part of this review, Deloitte determined that BIC was using an impermissible depreciation method with respect to 158 assets. Deloitte assisted BIC in preparing and submitting an IRS Form 3115 (Application for Change in Accounting Method), requesting a change in the method by which BIC depreciated those assets. The Commissioner allowed, in part, and disallowed, in part, the requested changes.
The disputed assets were originally classified by BIC as nonresidential real property with either a 39-year or 31.5-year life, depending upon when the asset was placed in service. Deloitte determined that these assets should be reclassified as various forms of personal property. The following table (drawn from one of plaintiff's briefs) summarizes plaintiff's claims with respect to these disputed assets:
Based on plaintiff's claims, these assets largely fall into three broad categories: (i) tenant improvements, such as x-ray machine (security) equipment, carpentry, glazing, millwork, painting, wallpaper, doors, hardware, and carpet; (ii) tenant improvements such as air conditioning units and associated duct work, and equipment to cool transmitters and associated support equipment, cable wire, and electrical work for broadcasting newsrooms; and (iii) special purpose structures located at transmitter sites used to house specialized equipment relating to such transmitters. Plaintiff claims that the assets in the first of these categories should be properly classified within asset type 0.11 — office furniture, fixtures, and equipment, and the latter two categories as within asset activity class 48.2 — radio and television broadcastings. See Rev. Proc. 87-56. The court will discuss each of the categories seriatim.
This first category contains ten assets that plaintiff believes should be in the revenue procedure's Class 0.11 Office Furniture, Fixtures, and Equipment category, which class has a ten-year class life and seven-year depreciation period.
As is true of many of the assets in question, plaintiff's factual assertions regarding the nature of the assets suffer from a relative dearth of supporting evidence, owing to a variety of reasons. Take, for example, plaintiff's claims regarding assets 21934, 21935, and 21936, which inexplicably relate to a single invoice that was split into three "assets." Plaintiff claims that this asset is an x-ray machine used for security at building entrances. But, that is not clear from the invoice in question, which does not refer to such a machine, but rather to "LABOR, EQUIPMENT, & MATERIALS FOR RADIOTOGRAPHY (X-RAYING) AND ELECTRICAL." Nor is it supported by BIC's records, which refer to this "asset" as "Building Xrays for Handrails." It appears that the invoice was not for an asset, but for a service, and thus does not support plaintiff's attempt to reclassify these three "assets" as office furniture, fixtures, and equipment.
As it turns out, more evidence exists with respect to these "assets" than as to many of the other assets at issue, for which the only document provided is the internal BIC form recording information about the asset and perhaps a receipt. In other instances, some evidence is provided, but it is impossible to tell the exact nature of what was procured — for example, attached to the BIC form for Assets 20456, 9555, and 9560 is a master schedule of hundreds of Deloitte adjustment that does not identify the particular asset(s) in question, which purportedly relate, in the case of Asset 20456, to the remodeling of an office, and in the case of Assets 9555 and 9560, to glazing and millwork, respectively. No other information — no invoice, work order, purchase order, pictures, descriptions, etc. — is provided to define these assets, leading the court to conclude that the evidence presented is insufficient to support plaintiff's claim. Other evidence in the record indicates that the remaining assets in this category were plainly structural components of a building, among them, Asset 22384 (which was a demising wall to subdivide existing space), as well as Assets 16284, 16285, and 19438 (which relate to leasehold improvements, such as partitions, carpentry, ceilings, electrical, millwork, and painting).
In seeking to reclassify many of these assets, plaintiff seems to proceed from the notion that all it needed to do, to prevail, was to introduce Mr. Seabrook's opinions that a given asset was eligible, occasionally with a bit of supporting testimony by Mr. Florence. However, many of the facts upon which Mr. Seabrook relied do not otherwise appear in the record. In this regard, Federal Rules of Evidence 703 and 705 indicate that the facts underlying an expert's opinion do not come into the record as substantive evidence, but rather are admitted only for the limited purpose of enabling the trier of fact to scrutinize the expert's reasoning. See 5860 Chi. Ridge, LLC v. United States, 104 Fed. Cl. 740, 766 n.42 (2012); see also United States v. Wright, 783 F.2d 1091, 1100 (D.C. Cir. 1986); United States v. Affleck, 776 F.2d 1451, 1457 (10th Cir. 1985); 29 Charles Alan Wright & Victor James Gold, Federal Practice and Procedure § 6273 (1997). The fact that the documentation may have once existed, but was subsequently lost or destroyed, does not relieve plaintiff of its burden of demonstrating that the Commissioner's determinations were erroneous. See Boddie-Noell Enters. v. United States, 36 Fed. Cl.722, 741 (1996) (noting that "summary appraisals based on non-contemporaneous records, or data reconstructed from accidentally lost or destroyed documents, are unpersuasive"); Jupiter Corp. v. United States, 2 Cl. Ct. 58, 71 (1983) (rejecting similar summaries prepared by an accounting firm).
Accordingly, the court denies plaintiff's claim as to all ten of the "assets" listed in this category.
This second category contains eighteen assets, including ventilation systems, air conditioning units and air handling systems, and related ductwork, filters, internal air blowers, motors, electrical work, construction, ceiling installation, and building upgrades that plaintiff contends were installed or completed specifically to protect broadcasting equipment.
Plaintiff contends that this equipment and construction are needed to meet the temperature, humidity, and other environmental requirements necessary for the proper functioning of the broadcast equipment. Defendant admits that five of these items (Nos. 22152, 7323, 7324, 7501 and 7502) fit this description. It contends that the remaining thirteen assets constitute structural components of the building.
Section 5.05 of Rev. Proc. 87-56 provides that a building can be included in an asset class if it is so closely related to the use of the property it houses that it can be expected to be replaced when the housed property is replaced. In setting forth this rule, the revenue procedure cites the regulations involving the investment tax credit provided in sections 38 and 48 of the Code.
Treas. Reg. § 1.48-1(e)(1). Under this regulation, a structure generally is not a building if: (i) it was specially designed to meet the demands of the equipment it houses; and (ii) it could not be economically used for other purposes. See L & B Corp. v. Comm'r of Internal Revenue, 862 F.2d 667, 674 (8
Treas. Reg. § 1.48-1(e)(1) treats the structural components of a building the same as the building itself. Treas. Reg. § 1.48(e)(2) defines such "structural components" to include —
See also Hosp. Corp. of Am. v. Comm'r of Internal Revenue, 109 T.C. 21, 54 (1997). Under this definition, an item can be a structural component of a building even if it is not permanent, as long as it functions as an integral part of the building. Consol. Freightways, 708 F.2d at 1390; Publix Supermarkets, Inc. v. United States, 26 Cl. Ct. 161, 175 (1992). Air conditioning equipment comes within the exception in Treas. Reg. § 1.48-1(e)(1), and is not treated as a structural component of a building under Treas. Reg. § 1.48-1(e)(2), if the primary motivation for installing the equipment is to allow other equipment to function, with only incidental benefit to employees and customers. See Publix Supermarkets, 26 Cl. Ct. at 175, 177; see also Albertson's Inc. v. Comm'r of Internal Revenue, 38 F.3d 1046, 1057 n.25 (9
Apart from the five assets specifically mentioned above, plaintiff's case as to this category is weak and overly relies upon uncorroborated factual assertions made by its expert witness. For example, Assets 21073, 21074, 2252, and 1986 relate to air conditioning equipment and duct work installed in several of plaintiff's radio studios, a duplication room, and a dubbing room. But the scant documentation attached to the BIC forms does not reveal the purpose of this equipment and, in particular, does not support plaintiff's claim that this equipment was used to meet temperature or humidity requirements for the operation of machinery in those studios (with only incidental benefit to the occupants). The documentation for other assets in this category (Assets 1981, 1982, 1983, and 1984) reveals that they constituted structural components of the building (e.g., the walls of a video taping room, the ceiling of a duplication room, electrical work) and thus were properly characterized by the Commissioner. The same can be said of Asset 16286, which, like some of the assets in the prior category, relates to leasehold improvements, such as partitions, carpentry, ceilings, electrical, millwork, and painting. The next two assets in this category (Assets 1927 and 18866) defy accurate description/characterization because they again are based upon broad descriptions of groups of items — the former based on the master schedule of Deloitte's adjustment discussed above, the latter on a generic description of improvements (e.g., "miscellaneous leasehold improvements including studio design and construction") — with little or no explanation as to how what is on the schedule relates to the asset description.
Based on defendant's concession, the court allows for the reclassification of Asset Nos. 22152, 7323, 7324, 7501, and 7502, but denies plaintiff's claims as to the remainder of the assets in this category based on a failure of proof.
This final category contains four assets allegedly designed and built to house and protect broadcast equipment.
As noted above, under the regulations, among the factors which indicate that a structure is a special purpose structure are "the fact that the structure is specifically designed to provide for the . . . demands of [the] property [which it houses] and the fact that the structure could not be economically used for other purposes." Treas. Reg. § 1.48-1(e)(1)(ii); see Bundy v. United States, 1986 WL 13364, at *5 (D. Neb. Nov. 19, 1986). In applying the regulation, courts typically have focused less on appearances, e.g., whether a structure has walls and a roof, and more on the function of the structure, e.g., does it provide shelter, or furnish working spaces. See King Radio Corp., Inc. v. United States, 486 F.2d 1091, 1096 (10
In the midst of this split, it would appear that the former Court of Claims was decidedly amongst those courts that focus more heavily on whether a structure provided working space for employees. Thus, in Brown-Forman, the Court of Claims, in holding that whiskey maturation facilities were not "buildings," held that the fact that a structure has features in common with a "building" is not determinative, finding instead that "a major inquiry [is] whether the structures provide working space for employees that that is more than merely incidental to the principal function or use of the structure." 499 F.2d at 1271. Later, in Consolidated Freightways, that court refined this standard, noting that "in deciding whether the human activity is merely incidental to the function or use of the structure or whether that structure functions to provide working space for employees, more than merely the amount of such activity must be considered." 620 F.2d at 871. After examining the case law, the court then concluded that —
Id. at 872-73. Employing this analysis, the court distinguished the loading docks that were the subject of its case from the whiskey maturation facilities in Brown-Forman, finding that the movement of freight that occurred on the former structure was fundamentally different from the chemical activity that occurred in the latter. Id. at 873. As to the loading docks, the court thus found that "[t]he essential human activity within the structures consists of the manual labor expended in moving the freight, temporarily staging the freight and checking for overages, shortages and damaged freight," adding that "[n]othing about the structure allowed for this basic function to occur without this essential human activity." Id. And, on this basis, the court found that the loading docks were a building and not subject to any of the exceptions in the regulations. Id. at 874; see also Consol. Freightways, 708 F.2d at 1388-89.
The scant evidence provided by plaintiff as to the four buildings in question (Assets 1047, 11063, 18867, and 23338) largely takes the form of excerpts from the Deloitte report excerpts that, at least in some instances, readily admit that further documentation about the nature of these assets is unavailable. This evidence does not demonstrate that these buildings were built to house particular assets or that they could not serve other purposes if the equipment therein was removed. In three instances (Assets 1047, 11063, and 23338), plaintiff has provided no photos, plans or detailed descriptions of these buildings — and there was little testimony from the witnesses who had seen these buildings. Plaintiff provided more detail as to Asset 18867 but that detail, indeed, revealed that this building contained not only transmitter facilities, but also restrooms, offices, storage rooms, and an apartment. This information hardly served to bolster plaintiff's claim that this building — which was built in 1939 — was a "special purpose" structure designed to house a modern transmitter. Plaintiff's documentation did include some very general information regarding the nature of human activity occurring in these buildings, most often described as maintenance work (e.g., a listing of the individuals who worked in the respective buildings, and an estimate of how many hours per month were spent working at the structure). But, this information, which took the form of unsworn answers to a set of Deloitte survey questions, is not detailed enough — let alone reliable enough — to allow the court to make the sort of fine distinctions that were made in Consolidated Freightways. That said, the raw number of hours reflected in these estimates — for one asset, 16-32 hours per month of maintenance and 128-144 hours per month of office time within the structure — readily serve to distinguish this case from those in which a special purpose structure was not deemed a building.
In sum, in the court's view, plaintiff's evidence as to these four assets falls far short of what is necessary to overcome the Commissioner's determinations.
Accordingly, based on defendant's concession, the court allows for the reclassification of Asset Nos. 22152, 7323, 7324, 7501, and 7502, but denies plaintiff's claims as to the remainder of the assets in question owing to a significant failure of proof.
The court need go no further. As to the exchange of KZLA, the court concludes plaintiff has established that KZLA did not possess any significant goodwill that was accounted for in that transaction. Rather, it would appear that KZLA's value was exclusively in its FCC license, as well as a few associated tangible and intangible assets. Regarding the reclassification issue, the court upholds plaintiff's claim with respect to the five assets identified above, but denies that claim as to the remainder of the assets at issue.
The court will withhold the entry of a judgment to permit the parties to submit computations consistent with the court's determination of the issues, showing the correct amount of the judgment to be entered herein. The following procedure (which loosely tracks Rule 155 of the U.S. Tax Court's Rules of Practice and Procedure) shall be employed:
A number of groups realized that they could use scale, the scale of mass, to become more efficient and also to become more effective, that they could translate a lot of their expertise into shares in markets other than where they were and expand their footprint in the markets where they were.
At that point we basically developed players and non-players. And people looked at where they were in a marketplace and determined whether it was worth it for them to stay there and try to acquire more stations or if it made more sense for them to sell what they owned to someone else and get out of dodge and basically go someplace else and consolidate their hold in that market.
The Besen Expert Report was drafted by Dr. Stanley Besen, an expert for defendant who did not testify at trial; the report, however, was received in evidence. Dr. Besen used a regression analysis in an attempt to calculate the value of KZLA's goodwill. His conclusion that between 8 to 13 percent of the total value in the exchange was attributable to goodwill was attacked by plaintiff and largely abandoned by defendant. In its post-trial briefs, defendant attempted to inject an entirely new argument into this case — that a significant portion of the value of the exchange related to going concern value. But, the parties previously stipulated that the value of all intangibles, except for goodwill, was $4,858,317. In the court's view, that stipulation, as well as defendant's failure to raise its going concern argument much earlier in the case, preclude it from relying on that argument at this late point.
This chart perhaps explains why Ms. Flynn could not use the actual license value for amortization purposes if she hoped to find a positive value for KZLA's goodwill. That is because the "break even" values for the license — the point at which the amortization and final values of the license are the same — all are too high to leave any value for goodwill.
Frank Lyon Co. v. United States, 435 U.S. 561, 583-84 (1978).
98 T.C. at 455-56; see also Meredith Broad., 405 F.2d at 1228.
