Copyright (c) 1993 Tax Analysts

Tax Notes

 

JANUARY 18, 1993

 

LENGTH: 1249 words 

 

DEPARTMENT: Letters to the Editor (LTE) 

 

CITE: 58 Tax Notes 369 

 

HEADLINE: 58 Tax Notes 369 - ONCE MORE INTO THE MASS ASSETS. 

 

AUTHOR: Johnson, Calvin H. 

 

TEXT:

 

 To the Editor: 

 

   In his reply of January 4, 1992, Steven Gerard of Coopers & Lybrand argues against the mass asset rule and I here respond. These arguments are important, while the Supreme Court considers Newark Morning Ledger. 

 

   1. Haig-Simons. Gerard argues that the mass asset rule is based upon the rejected Haig-Simons definition of income. Under the historical cost convention, unrealized appreciation is not taxed, but it would be under Haig-Simons. 

 

   Response: There is no syllogism that basis must be amortized because appreciation is not taxed. We do not tax unrealized appreciation on corporate stock, but we also do not allow amortization of stock basis. The taxpayer's basis in customer base and other mass assets should not be amortized because the taxpayer's true investment is not being lost and that result is perfectly consistent with reporting the basis of customer base at its historical cost. Historical cost is a weak rule, for convenience, with many exceptions, and with no penumbra nor extraterritorial effect, but it is also not implicated here. 

 

   2. Effective tax rate. Gerard opposes 'signaling out of customer-based intangibles for 'economic-based' determination of taxable income.' 

 

   Response: Effective tax rate analysis is a worthy yardstick by which to measure and judge any proposed tax accounting rule. Effective tax rate analysis tells how taxes affect investments and investor decisions. When the effective tax rates are even, tax is a level playing field that does not discriminate between investments and does not give an advantage to high-bracket taxpayers. We truly understand what income is, moreover, by looking at interest earned on bank deposits and other debt. Effective tax rate analysis just comes from finding what interest the investment earns, before and after tax. When accounting income figures are inconsistent with interest, it is the accounting figures that are the bad theory. History and legislation sometimes do mandate uneven or wrong effective tax rates. But not here. 

 

   3. Keep up with expensed investment. Gerard argues that companies with purchased customer base should keep up with companies (like his company B) who have created their own customer base. All of the costs of attracting new customers are expensed when incurred, so that no company has stated capital investment (basis) in self- developed customer base. 

 

   Response: The ability to make capital investments with expensed and untaxed costs is a privilege under an income tax that is ordinarily as valuable as not having to pay tax on the income from the investment. Thus, Gerard is arguing for a doctrinal result that is like paying no tax on income -- which ought to be an uphill fight under a tax system that tries to tax income comprehensively. Expensed investments are in fact available, at least because of history and at least where tax law has had trouble identifying the investment aspects of a cost. But a purchase of an ongoing company is an identifiable investment. Everyone knows that identified investments are not to be expensed, whatever we do about the costs that we cannot identify as investments. 

 

   4. Two wrongs. Gerard argues that the mass asset rule denies amortization of old customers solely as rough justice to offset the deduction of the cost of attracting new customers. He argues that old customers are unrelated to new customers, that two wrongs do not make a right, and that expensing of the costs of attracting new customers is a permissible rule that does not need to be offset. 

 

   Response: A business does not lose its capital investment as old customers turn over and are replaced by new ones. Accounting does not care about the identity of customers, so long as the money rolls in. These accounting rules are not truths apart from the descriptive accuracy of the whole: it is only the net result that counts. Accountants write debits to offset erroneous credits or credits to offset debits all the time. There is no rule that says that offsets are impermissible. Newark Morning Ledger does not attack deduction of operating costs that attract new customers, but it does not follow that we must carve out something that is arguable like a lost cost for a taxpayer who concededly is not losing anything. If we did carve out lost amounts ignoring the whole, then land would become depreciable as harvests pass, stock would become amortizable as dividends come in, and intact bank accounts would be written off, as interest is withdrawn. 

 

   5. Temporary v. Permanent. Gerard argues that amortization of basis is just a timing difference that allows capital to be deducted a little early, but that denying amortization might lead to permanent disallowance of a cost, which would be windfall to the IRS. 

 

   Response: Permanent basis is a fine rule for permanent investments. Basis in stock or undeveloped land is nonamortizable because the investment in the stock and land does not disappear. The taxpayer in Newark will get use of basis when (and if) the investment  is sold or abandoned or a loss is otherwise realized. Nonamortization is not a windfall to anybody. It accurately describes capital investments like Newark's, which remain intact. 

 

   It is deduction of intact investments that is the strange rule in an income tax. Under the norms of an income tax, investments are made and continued only with after-tax hard money amounts. The ability to deduct costs that remain investments is inconsistent with the taxation of true income. 

 

   6. Financial Accounting. Gerard argues that the financial authorities recognize that capitalization and amortization of the costs of acquired customer base is 'the more theoretically correct approach.'

 

   Response: The Accounting Principles Board required amortization of the costs of acquired intangibles, not as a matter of theoretical correctness, but in order to control management's self-serving estimates and to discourage takeovers. (The project requiring amortization was undertaken in conjunction with restricting use of the pooling method of accounting.) Pure accounting theory, isolated from institutional concerns, would deny amortization when the investment remains. If the financial accounting literal result is to be served, then taxpayers would be prohibited from claiming lives for intangibles for tax purposes shorter than the 40 years they claim on financial books. But the deeper purposes of the current financial rule -- controlling management's self-serving estimates and discouraging takeovers -- is best served by a tax rule that denies amortization entirely. Accountants are misusing their expertise when they claim that financial accounting supports short-life tax writeoffs. 

 

   7. Double deductions. Gerard concludes that amortizing the cost of old customers, while expensing the costs of attracting new customers is not a double deduction. The taxpayer is only taking one deduction for each expenditure. 

 

   Response: The error of amortizing nondepreciating investments is not that a single expenditure has been deducted twice. That is not the argument for the mass asset rule.

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                                   Sincerely,

                                   Calvin H. Johnson

                                   University of Texas at Austin

                                   Austin, Texas

                                   January 10, 1993

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