Payments for Limited Use of a Supplier's Marks Need Not Be Capitalized

Third Party Communication: None

This responds to your request of August 29, 2012 for a private letter ruling concerning the proper treatment under § 1253 of the Internal Revenue Code of certain payments by Taxpayer.

Taxpayer and Supplier entered into the Agreement dated as of Date 1. Under the Agreement, Supplier authorizes Taxpayer to offer, sell, and distribute Product A through Retailers for a term of Period B. The Agreement provides Taxpayer with a limited license to use Supplier's marks in connection with the sale of Product A.

As of Date 4, the terms of the Agreement provided as follows: The total purchase price of Product A paid by the customer consists of the Type H Payment and Type J Payment. The Type J Payment is remitted from Taxpayer to Supplier. Supplier pays Taxpayer the Type A Payment, which is equal to K percent of the Type J payment from each unit of Product A sold by Retailers. The Agreement sets forth a negotiated stated target number of units to be sold for each year (the "Stated Target"). The Stated Target increases each year over the term of the Agreement. Taxpayer is required to pay Supplier a Type B Payment for each year, which is a per unit payment of $X for each unit of Product A sold by Retailers over the Stated Target for a given year. Taxpayer is also required to pay Supplier a Type C Payment for each year, which is a fixed annual amount corresponding to $Y times the Stated Target for that year. If, in any given year, the total Type J Payments for Product A sold through Retailers does not exceed $Z (the "Minimum Annual Sales Target"), Taxpayer is required to pay Supplier the Type D Payment, which is a fixed amount of $W. Taxpayer is required to pay Supplier the Type E Payment, which is a per unit payment of $V for each unit of Product A sold. The Type H Payment, reduced by the Type E Payment and the Type B Payment, is retained by Taxpayer and the Retailers (the "Taxpayer Retained Amount"). Amendment A made certain changes to the Agreement, including adding the Type A Payment, the Type C Payments and the Type D Payment, and extending the term of the Agreement to Date 6.

Either Taxpayer or Supplier may terminate the Agreement upon material breach, insolvency or bankruptcy of the other party, or, under certain circumstances, if a party ceases offering Products or Product A. If the Agreement is terminated before the end of its term, Taxpayer is obligated to pay only the Type C Payments that have accrued up to the date of termination. Additionally, if the Agreement is terminated, the obligation to pay the Type D Payment in the year of termination or any future year terminates.

Subsequent to Date 4, Taxpayer and Supplier entered into Amendment B, which makes certain changes to the Agreement, including (a) the Type C Payments for the period from Date 3 through Date 7 are reduced by $U per year; (b) beginning Date 7, the Type C Payments are eliminated; (c) Beginning Date 7, the Type B Payment is reduced from $X per unit sold of Product A to $T per unit sold, and applies to every unit sold (i.e. the Type B Payment will no longer apply only to sales in excess of the Stated Target); (d) beginning Date 7, the Type E Payment is eliminated; (e) Taxpayer shall retain the Type F Payment, which is an additional $R to $S per unit of Product A sold; (f) beginning Date 5, Supplier will pay to Taxpayer the Type G Payment, which is based on the total Type J Payments for Product A sold through Retailers for a given year ($R per unit for total Type J Payments between $P and $Q, and $M per unit for total Type J Payments above $Q; (g) beginning Date 7, the Type A Payment is eliminated; and (h) the term of the Agreement is extended to Date 8. In addition, Taxpayer and Supplier are considering an amendment to make certain additional changes to the Agreement, including clarifying the specific amount of the Type F Payment between $R and $S for particular Product A sales and that the Type D Payment will not apply to contract years beginning after Date 6.

All of the payments by Taxpayer to Supplier that are described in this FACTS section are made no less frequently than annually.

The Taxpayer makes the following representations:

Section 1253(b)(1) provides that the term "franchise" includes 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.

Section 1253(b)(2) provides that the term "significant power, right, or continuing interest" includes, but is not limited to, the following rights with respect to the interest transferred:

Section 1253(d)(1)(A) provides that, in general, any amount described in § 1253(d)(1)(B) which is paid during the taxable year on account of a transfer, sale, or other disposition of a franchise, trademark, or trade name shall be allowed as a deduction under § 162(a) of the Code (relating to trade or business expenses).

Section 1253(d)(1)(B) provides that an amount is described in § 1253(d)(1)(B) if it

The Tax Reform Act of 1969, P.L 91-172, added § 1253 to the Code. According to the Senate Committee Report, S. Rep. No. 91-552, "The committee amendments also provide that the term 'franchise' includes 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. This would include distributorships or other similar exclusive-type contract arrangements to operate or conduct a trade or business within a specified area, such as a geographical area to which the business activity of the transferee is limited by the agreement." The Report also states that

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter ruling.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.