Rodeway Inns of America v. Comm'r of Internal Revenue
| Decision Date | 24 December 1974 |
| Docket Number | Docket No. 8311-72. |
| Citation | 63 T.C. 414 |
| Parties | RODEWAY INNS OF AMERICA, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
William L. Raby, for the petitioner.
Harry Beckhoff, for the respondent.
Rodeway granted to RIS, subject to certain conditions, the exclusive rights to construct or cause to be constructed Rodeway motels in a specified area. Subsequently, Rodeway became convinced that RIS was not performing sufficiently to enable Rodeway to maintain a competitive position within the motel industry. The agreement was canceled, and as consideration, Rodeway paid RIS $100,000. Held, such payment did not constitute a business expense within sec. 162(a), I.R.C. 1954, but was a capital expenditure under sec. 263(a), I.R.C. 1954, and amortizable under sec. 167(a), I.R.C. 1954.
The Commissioner determined a deficiency of $43,094.22 in the petitioner's 1968 Federal income tax. The issue to be decided is whether a payment made as consideration for canceling certain exclusive rights constituted a business expense under section 162(a) of the Internal Revenue Code of 1954 1 or whether it was a capital expenditure under section 263(a) and amortizable under section 167(a).
Some of the facts have been stipulated, and those facts are so found.
The petitioner, Rodeway Inns of America (Rodeway), is an Arizona corporation, which had its principal office at Dallas, Tex., at the time of filing its petition herein. Rodeway computes its income on a calendar year and uses the accrual method of accounting. Rodeway filed a consolidated corporate Federal income tax return for the year 1968 with the Western Service Center, Ogden, Utah.
Rodeway was in the business of operating a chain of motor hotels during 1968. In order to develop such chain, it made various ‘territorial Agreements.’ On July 1, 1964, Rodeway entered into a Territorial Agreement with Rodeway Inns of the Southwest (RIS), an unrelated corporation. By virtue of the agreement, RIS obtained the exclusive right to construct or cause to be constructed Rodeway motels within the States of California, Arizona, New Mexico, Colorado, and the city of El Paso, Tex., subject to the terms of the agreement.
RIS agreed to obtain sites which were to be approved by Rodeway for the construction of motor hotels and to construct, or cause to be constructed, motor hotels at such cites. The number of sites to be so obtained was specified. RIS was to pay Rodeway $7,500 for each approved site and 15 cents per day for each motel unit constructed during the original and first renewal term of the territorial agreement; thereafter, Rodeway was to be paid the same amounts as were being paid by other franchisees. Upon granting approval of a site offered by RIS and receiving the initial franchise fee of $7,500 (or such other amount as applicable), Rodeway was obligated to execute and deliver to RIS, or to a licensee selected by RIS, a franchise agreement for the site.
The territorial agreement provided for its expiration on June 30, 1966, unless previously terminated or renewed. RIS had the right to cancel the agreement at any time by giving 90 days' written notice to Rodeway. Rodeway could cancel the agreement by giving 90 days' written notice to RIS in the event RIS breached or failed to perform under the agreement, but Rodeway had no right to cancel the agreement for any cause other than the failure of RIS to comply with its construction and site approval requirements so long as RIS was substantially performing all other provisions of the agreement and was diligently prosecuting the correction of the default described in Rodeway's notice. In addition, the agreement obligated Rodeway not to unreasonably withhold its approval of sites selected by RIS. If RIS fulfilled the construction and site quotas, it was given options to renew the agreement at 2-year intervals. The agreement could be extended until July 1, 1994.
In the event Rodeway received from another person a bona fide offer of a site for the construction of a Rodeway motel, or for the purchase of a franchise for the operation of a Rodeway motel, within RIS's territory, and certain other conditions were met, Rodeway was to give RIS notice of such offer. RIS then had 60 days during which to secure such site or a comparable site and obtain approval for it. If RIS failed to follow such procedure, Rodeway was given the opportunity to make other arrangements for construction of a motel on the site. On several occasions, at Rodeway's request, RIS waived its right to develop sites within its territory and allowed Rodeway to make arrangements with others for development of such sites. As consideration for its waiver, RIS required that the motels thereby built be credited toward its quotas. The credits thus obtained enabled RIS to meet the quotas.
RIS had the right to assign or transfer the territorial agreement or any portion or rights thereunder, including the right to make subterritorial agreements. At one point during the life of the agreement RIS did transfer some of its rights under the agreement to Leonard M. Goldman. RIS could not itself issue a franchise for a Rodeway motel in its territory. RIS was not entitled to receive any portion of the franchise fees due Rodeway from its agreements with other motel operators in RIS's territory.
On May 10, 1965, Rodeway and RIS executed an amendment to the territorial agreement whereby RIS's rights to a portion of the territory were terminated in consideration of $15,000 which Rodeway paid RIS. RIS agreed that Rodeway had the exclusive and sole right to construct its motels in the territory surrendered. The quotas for construction and site approval in the remaining territory were reduced.
On August 30, 1968, Rodeway, RIS, and Mr. Goldman executed a cancellation agreement. In consideration of $100,000 which Rodeway paid to RIS and Mr. Goldman and the delivery to them of options to purchase 132 shares of Rodeway's common capital stock, RIS and Mr. Goldman released ‘all of their Franchisee's rights and privileges' under the territorial agreement. The options had no ascertainable fair market value at the time they were granted. By that time, RIS had exercised its option to renew for the second 2-year renewal period (July 1, 1968, through June 30, 1970) and was performing within the terms and provisions of the territorial agreement.
Rodeway canceled the territorial agreement because it believed that it could develop the territory more effectively than could RIS. Rodeway considered that RIS was not developing the territory as rapidly as was necessary for Rodeway to maintain its competitive position in the burgeoning motel industry. Without such development by Rodeway, the existence of a Rodeway chain of motels was threatened by the rapid expansion of similar chains. Choice motel locations in RIS's territory were rapidly disappearing in 1968. At that time, it appeared that all the choice sites in the RIS territory were likely to be taken within the succeeding 5 years. Rodeway also believed that canceling the agreement would enhance the value of its motels and yield greater profits from its operations in the long run.
Rodeway was unable unilaterally to terminate the territorial agreement since RIS was meeting its quotas and was otherwise performing its obligations under the agreement. The only way Rodeway could eliminate RIS's rights in its territory was to purchase those rights. After the cancellation of the agreement, Rodeway did not grant to any other parties the exclusive right to develop RIS's territory but has continued to market and grant its own franchises within the territory.
On its Federal income tax return for the year 1968, the petitioner deducted as a business expense the $100,000 it paid RIS and Mr. Goldman to terminate their rights under the territorial agreement. In his notice of deficiency, the Commissioner determined that the payment to RIS and Mr. Goldman was a capital expenditure and not subject to amortization. The petitioner has agreed to certain other adjustments made by the Commissioner in his notice of deficiency.
OPINIONSection 162(a) provides in part:
(a) IN GENERAL.— There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * * On the other hand, section 263(a) states in part:
(a) GENERAL RULE.— No deduction shall be allowed for—
(1) Any amount paid out * * * for permanent improvements or betterments made to increase the value of any property or estate. * * *
The main problem to be considered is whether Rodeway's payment to RIS and Mr. Goldman was an ‘expense’ as used in section 162(a) or whether it was capital in nature within the meaning of section 263(a). Should we conclude that the payment is capital in nature, we must then decide whether it may be amortized under section 167.
There have been a host of cases requiring the Court to distinguish between an expense and a capital expenditure; a recent one was Elgin B. Robertson, Jr., 6l T.C. 727 (1974). In that case, Robertson represented Burndy, a manufacturer of electronics products under an exclusive sales contract in Texas and part of Louisiana. Penzner represented Burndy under a similar arrangement in Oklahoma. Penzner and Robertson reached an agreement whereby Penzner terminated its representation of Burndy in Oklahoma and Robertson expanded its representation of Burndy into the vacated territory. The controversy concerned the tax treatment of the payment which Robertson made to Penzner for its customer lists and its rights in Oklahoma. The Court held that the payment constituted a capital expenditure because, in part, it was made to acquire a new business, representing Burndy in Oklahoma.
The payment made by the petitioner to secure a cancellation of the territorial agreement resembles in essence the payment made by Robertson to...
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