Canterbury v. Comm'r of Internal Revenue
| Decision Date | 17 August 1992 |
| Docket Number | 14540–89,10551–89,15038–89 and 16033–89.,14849–89,13576–89,15037–89,31478–88,31477–88,Nos. 38037–87,31479–88,s. 38037–87 |
| Citation | 99 T.C. 223,99 T.C. No. 12 |
| Parties | Charles D. CANTERBURY and Diane M. Canterbury, et al.,1 Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
N. Jerold Cohen and J.D. Fleming, Jr., for petitioners.
Jack E. Prestrud and J. Scott Broome, for respondent.
Petitioners are McDonald's franchisees in the San Diego, California, and Cleveland, Ohio, areas. Petitioners each acquired their franchises as part of the purchase of an existing McDonald's restaurant operation from either a McDonald's franchisee or from one of McDonald's wholly owned subsidiaries, collectively referred to as McDonald's Operating Co. (McOpCo).2 These purchases were made during the period 1972 to 1984. Petitioners each allocated a portion of the purchase price to the tangible assets which they purchased. They allocated the remaining purchase price to the McDonald's franchise and deducted a portion of that amount pursuant to section 1253(d)(2)(A).3
The parties agree that petitioners properly identified and valued the tangible assets associated with each restaurant and that the remainder of the purchase price is allocable to intangible assets. The parties also agree that the amounts properly allocable to the franchises are amortizable under section 1253(d)(2)(A); the parties disagree over what that amount is. We must decide what portion of the purchase price of each McDonald's restaurant is to be allocated to the franchise for purposes of amortization under section 1253(d)(2)(A).4
Some of the facts have been stipulated and are so found. The stipulation of facts, first and second supplemental stipulation of facts, and attached exhibits are incorporated herein by this reference.
A McDonald's franchise encompasses the rights to occupy and operate a McDonald's restaurant at a specific location owned or controlled by McDonald's Corp., to utilize all attributes of the McDonald's system, including the trademarks and other identifying features which belong to McDonald's Corp., and to receive ongoing advice and support from McDonald's Corp. with regard to the McDonald's restaurant business, in return for the payment of certain fees and conformance with certain rules established by McDonald's Corp. The franchise agreement between McDonald's and the franchisee is embodied in the franchise letter agreement to which a license agreement and an operator's lease are attached and incorporated by reference. The license agreement and operator's lease for a restaurant are always for the same term.
The following table identifies the McDonald's restaurants that petitioners purchased, the date of purchase, the purchase price, and petitioners' allocation of the purchase price between tangible assets and the franchise.
+-------------------------------------------------------------------------+
¦Restaurant Location ¦ ¦Purchase -¦Tangible =¦Franchise¦
+--------------------------------+--------+----------+----------+---------¦
¦and Acquisition ¦Date ¦Price ¦Assets ¦Value ¦
+--------------------------------+--------+----------+----------+---------¦
¦Clark, Ave., Cleveland, OH ¦4/15/78 ¦$453,418 ¦$ 52,951 ¦$400,467 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Detroit Ave., Cleveland, OH ¦4/1/79 ¦450,000 ¦65,072 ¦384,928 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Mayfield Rd., Mayfield Hts., OH ¦7/1/79 ¦460,000 ¦72,100 ¦387,900 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Richland Ave., Athens, OH ¦6/30/72 ¦330,000 ¦120,000 ¦210,000 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Bealle Ave., Wooster, OH ¦11/21/75¦398,351 ¦78,439 ¦319,912 ¦
+--------------------------------+--------+----------+----------+---------¦
¦High Street, Wadsworth, OH ¦11/21/75¦564,851 ¦127,160 ¦437,691 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Mira Mesa Blvd., Mira Mesa, CA ¦12/22/80¦398,422 ¦74,000 ¦324,422 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Cuyamaca St., Santee, CA ¦9/30/78 ¦340,000 ¦80,000 ¦260,000 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Lake Murray Blvd., San Diego, CA¦12/1/81 ¦324,750 ¦290,000 ¦34,750 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Garnet Ave., San Diego, CA ¦10/31/78¦235,000 ¦–0– ¦235,000 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Broadway, Lemon Grove, CA ¦12/29/81¦365,000 ¦125,000 ¦240,000 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Fletcher Pkwy., El Cajon, CA ¦3/31/82 ¦272,372 ¦110,259 ¦162,113 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Mira Mesa Blvd., Mira Mesa, CA ¦1/31/83 ¦734,743 ¦53,000 ¦681,743 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Main Street, Ramona, CA ¦12/31/84¦386,717 ¦181,786 ¦204,931 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Cuyamaca St., Santee, CA ¦1/23/83 ¦473,605 ¦76,629 ¦396,976 ¦
+--------------------------------+--------+----------+----------+---------¦
¦Lake Murray Blvd., San Diego, CA¦1/21/83 ¦346,180 ¦93,781 ¦252,399 ¦
+-------------------------------------------------------------------------+
I. The History and Philosophy of McDonald's Franchising System
McDonald's Corp. (McDonald's or the Company) was started by Ray Kroc in 1955. Prior to beginning the Company, Mr. Kroc observed the restaurant franchising industry first hand as a vendor for multimixer malt machines. Mr. Kroc believed that the restaurant franchising industry was flawed in a number of respects. The most serious flaws stemmed from the franchisors' focus on quick up-front profits that resulted in the franchisors' failure to work for the long-term success of their franchisees. The restaurant franchising industry was in the practice of charging significant up-front franchise fees for large territorial franchises while, at the same time, assuming few, if any, ongoing obligations toward the franchisees after the sale. Mr. Kroc felt that when a franchisor made significant profit prior to a restaurant's opening, there was little incentive to oversee or monitor its franchisees' operations.
Mr. Kroc also believed that high up-front franchise fees could prevent franchisees from making a reasonable profit. The initial franchise fee charged by McDonald's was $950 until 1960, $12,500 between 1960 and 1987, and $22,500 since 1987. McDonald's has not increased its initial franchise fee to reflect increased sales. For instance, while the franchise fee remained $12,500 between 1960 and 1987, the average gross sales of McDonald's restaurants in those years rose from $249,099 to $1,350,000.
Another problem Mr. Kroc perceived with the restaurant franchising industry was the franchisor's practice of requiring the franchisee to buy equipment and products from the franchisor. Mr. Kroc believed that the franchisor created a conflict by profiting from the sale of goods to franchisees. In addition, Mr. Kroc felt that the practice of selling to franchisees encouraged franchisors to concentrate their efforts on equipment and product sales rather than on the performance of their restaurants. Consistent with this belief, McDonald's has never sold equipment or products to its franchisees.
Mr. Kroc believed that the sale of territorial franchises would lead to loss of control over the quality of McDonald's restaurants. If a marginal or poor franchisee operated numerous McDonald's restaurants in a given area, the impact on the Company and its other franchisees would be magnified and could be disastrous. Since 1969, every franchise granted has been limited to operations at a specific street address. By franchising one restaurant at a time (as opposed to granting territorial franchises), McDonald's has retained the right to choose the franchisee who operates each restaurant, without limiting its opportunity to expand in a given geographical area.
When Mr. Kroc opened the first McDonald's restaurant in Illinois in 1955, he had in mind the type of person he wanted to become partners with and whom he hoped to attract to the McDonald's franchising system (the system). Mr. Kroc believed that the Company's success depended upon its franchisees' being hands-on operators who would expect to earn their livelihood at the business and devote full time to protecting their investments. Those willing to give up their jobs, invest their life savings, and borrow money for the chance to own their own businesses would also be willing to devote the time necessary to run a profitable McDonald's restaurant. The people Mr. Kroc sought were not wealthy investors. McDonald's maintains a corporate policy requiring its franchisees to be hands-on operators, rather than passive investors.
Mr. Kroc believed that he could establish a restaurant-franchising system that would succeed where others had failed. Central to his vision were the concepts that McDonald's would enter into a mutually beneficial relationship with each of its franchisees to strive for uniformity and quality in food products and service, and that if its franchisees became financially successful, McDonald's success would follow.
II. The McDonald's SystemA. An Overview
McDonald's is the exclusive owner of the McDonald's system, the trade name McDonald's, the Golden Arches trademark, and all other trademarks, service marks, and other intellectual property rights associated with McDonald's restaurants.5 The McDonald's system is a...
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