Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board
Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board
Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board
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goodwill as a stated asset in the sales agreement with a specific price of $250,000.<br />
2. Whether either party is trying to repudiate an amount fixed by both parties as allocated to the<br />
covenant?<br />
This test concerns pre-1986 sales when there was a conflict between purchasers and sellers as<br />
to the classification of an asset as ordinary income or capital gains. Currently, the weight of<br />
this element is lessened.<br />
There is no proof that either party tried to repudiate an amount fixed by both parties as<br />
allocated to the covenant.<br />
3. Where there is no precise allocation in the agreement, did both parties nevertheless intend that<br />
some portion of the price be allocated to the covenant?<br />
The actions of the parties tend to show some portion of the price be allocated to the covenant.<br />
The balance sheet showed the assets to be $6,000,000. The price was $7,750,000.<br />
The covenant makes no provision for breach upon part of seller and appears to vest in seller at<br />
closing date.<br />
4. Whether there was economic reality behind the covenant?<br />
Economic reality in this context concerns reasonable buyers who have a genuine concern with<br />
their economic future to bargain for a covenant not to compete with the seller.<br />
The dealership’s financial statement shows net worth of $6,000,000. The purchase price was<br />
$7,750,000 and an additional $1,500,000 for covenant and consulting agreement.<br />
a. Use factors in Rev. Rul. 77-403 for post-1986 acquisitions to determine whether this<br />
agreement has any economic merit.<br />
1) Whether in the absence of the covenant the seller would desire to compete with the<br />
buyer?<br />
Unlikely. The seller was 69 years old and in failing health. The buyer knew of sellers<br />
intention not to compete.<br />
2) The ability of the seller to compete effectively with the buyer in the activity in<br />
question.<br />
Seller has expertise to compete, but likelihood of doing so in light of his age and health<br />
is extremely improbable.<br />
3) The feasibility in view of the business and market in question considering the time and area<br />
specified of effective competition by seller.<br />
15-3
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