## Facts

- Frontier Chevrolet Company operated a new and used automobile dealership in Billings, Montana.
- Roundtree Automotive Group, Inc. acquired 100% of Frontier’s stock in 1987; over time, Roundtree permitted Dennis Menholt to acquire 25%, leaving Roundtree with 75% by 1994.
- Effective August 1, 1994, Frontier redeemed Roundtree’s 75% block of Frontier stock using funds borrowed from GMAC, resulting in Menholt becoming Frontier’s sole shareholder.
- Contemporaneously, Frontier, Roundtree, and Roundtree’s president Frank Stinson executed a five-year covenant not to compete, under which Roundtree and Stinson agreed not to compete with Frontier’s dealership in exchange for monthly payments (about $22,000).
- Frontier amortized the covenant payments as a § 197 intangible on its 1994–1996 returns, then sought a refund claiming § 197 did not apply and that the covenant should be amortized over its five-year term.
- The Tax Court held the redemption was an indirect acquisition of an interest in a trade or business and that the covenant was a § 197 intangible subject to 15-year amortization.

## Issues

1. Whether Frontier’s redemption of its own stock from a 75% shareholder constituted a direct or indirect “acquisition of an interest in a trade or business” under I.R.C. § 197.
2. Whether a covenant not to compete executed in connection with that redemption was a § 197 intangible that must be amortized over 15 years rather than its five-year contractual term.

## Decision

- The Ninth Circuit affirmed the Tax Court.
- The court held that Frontier’s redemption of Roundtree’s controlling stock interest was an indirect acquisition of an interest in a trade or business for § 197 purposes.
- The court held that the covenant not to compete was entered into “in connection with” that acquisition and therefore was a § 197 intangible.
- Frontier was required to amortize the covenant’s cost over the 15-year period mandated by § 197, not over the covenant’s five-year term.

## Legal Principles

- I.R.C. § 197 requires 15-year straight-line amortization for specified acquired intangibles, including covenants not to compete entered into in connection with an acquisition of an interest in a trade or business.
- An “acquisition” for § 197 can be indirect; a transaction structured as a corporate stock redemption may qualify when it effectively transfers or eliminates a controlling ownership interest in the underlying business.
- Whether a covenant is “in connection with” an acquisition is informed by the transaction’s economic substance and the covenant’s role in inducing or protecting the value of the ownership transfer.
- A taxpayer may not amortize a covenant not to compete over a shorter contractual term when § 197 applies.

## Conclusion

The Ninth Circuit held that Frontier’s redemption of a 75% shareholder’s stock constituted an indirect acquisition of an interest in a trade or business under § 197, making the related covenant not to compete a § 197 intangible subject to mandatory 15-year amortization.


Frontier Chevrolet Co. v. Comm’r, 329 F.3d 1131 (9th Cir. 2003)