Houston Tax Attorney Blog
Houston Tax Attorney
Just because businesses in a particular industry commonly use a term to describe a particular transaction or event, the industry term does not necessarily have any bearing on the Federal income tax consequences of the transaction or event. The court addresses this in Greenteam Materials Recovery Facility PN v. Commissioner, T.C. Memo. 2017-122, in the context of the sale of “franchises” under Sec. 1253. The substance of the case is interesting in its own right, but the case is mentioned in this article as a case to keep on hand should the IRS cite to an industry term as it often does.
What is a “Franchise?”
The question for the court was whether a sale of contracts to provide local governments with landfill, waste disposal, and recycling services is the sale of a “franchise.” The facts in the case can be summarized as follows: The taxpayer was in the waste disposal business and decided to sell its business to another party. The taxpayer sold all of its assets to the buyer, which included its local government contracts. The IRS said the gain was to be taxed at ordinary rates. The taxpayer said it was to be taxed at capital gains rates. For reference, the current long-term capital gains rates range from 0 to 20 percent; whereas, the current ordinary gain rates range from 10 to 39.6 percent. So the difference in tax between a capital and ordinary gain can be significant.
Local Government Contracts are Frachises
Section 1253 is usually thought of in terms of trademarks. It also applies to other intangible assets, such as franchises. Section 1253 defines the term “franchise” broadly to be “an agreement which gives one of the parties to the agreement the right to distribute, sell, or provide goods, services, or facilities, within a specified area.”
The IRS did not believe that the local government contracts met this definition. Instead, it argued that the industry defines the term “franchise” and the contracts in this case did not meet the industry definition:
The Commissioner, however, has a new argument: He argues that “franchise” in the California waste and recycling industry means only a contract that continues to renew until it’s terminated. The industry, contends the Commissioner, calls only these “evergreen” contracts “franchises.” When a contract between a company and a local government is to provide specific services for a limited time (usually between 7 and 10 years), it is instead a “municipal contract.” The Commissioner says that the California waste and recycling industry would classify these contracts as municipal contracts, so they can’t be “franchises” under section 1253.
The court did not agree with the IRS. It had no problem concluding that the local government contracts, like the ones at issue in this case, qualify as a “franchise” for purposes of Sec. 1253. This holding is consistent with the existing case law on point.
Industry Terms are Not Controlling
The case can be helpful when confronted with a situation where an industry term or definition is similar to language found in the tax code or regulations but the application of the industry term or definition would result in unfavorable tax treatment. This often comes up when a term in the tax code or regulations is ambiguous, i.e., the term could have more than one meaning or does not make sense in the context of the rule at hand. One usually has to decide whether to cite an industry term or definition or the plain language meaning (i.e., the dictionary meaning) for the term. This court case could be helpful for the position that something other than the industry term or definition applies.