1031 Exchange of FCC Radio and TV Station Licenses
Journal of Taxation
NEW IRS RULING ON SWAP OF INTANGIBLES -- FCC RADIO AND TV STATION LICENSES ARE LIKE-KIND PROPERTY
Christian M. McBurney
© Copyright 2000 RIA; Christian M. Mcburney
[Reprinted by permission of Mr. Mcburney]
In TAM 200035005, the Service ruled that an exchange of Federal Communications Commission (FCC) radio station licenses were of 'like kind' with an FCC television station license for purposes of Section 1031. This technical advice memorandum constitutes one of the few IRS rulings concerning what constitutes like-kind intangible property under Section 1031, and it is the first ruling to deal expressly with the electromagnetic spectrum in the context of a Section 1031 exchange.
Intangibles and Section 1031
Section 1031(a) provides that neither gain nor loss is recognized if qualifying property is exchanged for other qualifying property of a 'like kind.' Under Reg. 1.1031(a)-1(b), 'the words "like kind" have reference to the nature or character of property and not to its grade or quality.' Thus, '[o]ne kind or class of property may not, under [Section 1031], be exchanged for property of a different kind or class.' Reg. 1.1031(a)-2(c) ('the intangibles Regulation') addresses the like-kind requirement as applied to the exchange of intangible assets: 'Whether intangible personal property is of a like kind to other intangible personal property generally depends on the nature or character of the rights involved (e.g., patent or a copyright) and also on the nature or character of the underlying property to which the intangible personal property relates.
Thus, whether intangible assets are of a like-kind is based on a two-part test:
1. Whether the 'nature or character' of the rights involved' are similar.
2. Whether the 'nature or character' of the underlying property to which the intangible personal property relates' is similar.
The intangibles Regulation includes two examples. In the first one, taxpayer K exchanges a copyright on a novel for a copyright on a different novel. The properties exchanged were found to be of a like kind. In Example 2, taxpayer J exchanges a copyright on a novel for a copyright on a song. The properties exchanged were found not to be of a like kind.
The Exchange Transaction
In TAM 200035005, the taxpayer entered into an asset exchange agreement with another party, in which the taxpayer surrendered three radio stations in three different cities and acquired a television station in yet another city. The facts suggest that both AM and FM radio stations were transferred by the taxpayer.
On its tax return for the year of the exchange, the taxpayer reported the exchange of the radio stations for the television station as qualifying for nonrecognition. In particular, the taxpayer treated the exchange of FCC radio station licenses for the FCC television station license as an exchange of like-kind property under Section 1031(a).
In addition, as part of the asset exchange agreement, the taxpayer transferred radio broadcast equipment and received television broadcast equipment. The taxpayer also treated the exchange of such property as an exchange of like-kind property under Section 1031(a).
On audit, the IRS agent challenged the treatment of the exchange of FCC radio and television licenses as qualifying under Section 1031(a). This issue was submitted to the National Office for technical advice. The agent did not challenge the taxpayer's nonrecognition treatment for the broadcast equipment.
FCC Licenses and the Spectrum
An FCC radio or television station license authorizes the broadcasting of programming (in the form of broadcast signals) over the electromagnetic spectrum at a certain power in a designated geographic area free of charge to the public. The electromagnetic spectrum is public property. It is divided for specified uses at particular frequencies. A portion is assigned to radio and television broadcasting, another portion to satellite transmissions, yet another to cellular communications, and other portions are assigned to many other uses.
The usable radio frequencies of the electromagnetic spectrum range from about 30,000 hertz to 30 gigahertz. Radio station broadcasts can be transmitted over frequencies as low as 30-300 kilohertz (low frequency) to 300-3,000 megahertz (ultra high frequency or UHF). Television station broadcasts can be transmitted over frequencies as low as 30-3000 megahertz (very high frequency or VHF) to 300-3,000 megahertz (UHF).
The broadcast licenses are issued and regulated by the FCC, which has the power 'to assign frequencies for each individual station and determine the power which each station shall use and the time during which it may operate.' An FCC license to broadcast radio programming cannot be used to broadcast television programming, and vice-versa. License holders have a statutory mechanism for protecting their rights to broadcast free from interference.
The Rights Involved
In the TAM, the IRS applied the first prong of the intangibles Regulation, i.e., whether the 'nature or character of the rights involved' are similar. The Service ruled that the rights conferred on FCC radio and television licensees are 'basically the same':
'[E]ach of the FCC licenses confers a right to use ... radio transmitting apparatus to broadcast on a designated channel and frequency range, at designated hours of operation, at designated geographic locations, at a maximum effective radiated power, and using antenna with certain antenna system specifications. This right is specifically enumerated in each FCC license, regardless of whether the license relates to a television station, an FM radio station, or an AM radio station. Other than the different labels, the only differences between the various FCC licenses are the specific operating parameters (such as frequency, operating hours, power, and antenna information) and geographic location. These differences do not change the nature or character of the rights granted in the licenses, but are merely differences in grade or quality.'
The IRS was influenced by the fact that even though the titles of the FCC broadcast licenses were different (e.g., 'Television Broadcast Station License,' 'AM Broadcast Station License,' and 'FM Broadcast Station License '), the rights conferred in each of the FCC licenses were virtually identical. The Service probably also was influenced by the fact that many of the same provisions of the federal statutory framework and the FCC regulations deal with both radio and television stations and licenses.
The Underlying Property
The second prong of the test in the intangibles Regulation requires a comparison of the 'nature or character of the underlying property to which the intangible personal property relates.' The Regulation provides little guidance as to how to determine the 'underlying property' to which the intangible personal property 'relates.' In the circumstance of the FCC radio and television station licenses, the Service found that the application of this test was not clear.
Not the broadcast business. The IRS agent contended that the underlying property to which the FCC licenses related was the 'bundle of rights' represented by the entire array of underlying tangible and intangible properties. In the agent's view, the property underlying an FCC broadcast license was all of the station's radio or television property. This property would include items such as programming content, *292 advertising contracts, market growth, and talent contracts. The agent further argued that the assets of radio and television stations were very different.
The National Office properly rejected the agent's argument. The TAM states that the agent's approach would be contrary to the Service's current approach in Regulations and Revenue Rulings to analyze the exchange of businesses as an exchange of underlying assets on an asset-by-asset basis. Prior rulings had adopted the approach of comparing overall businesses, but this approach has been replaced by the 'asset-by-asset' approach.
Not the broadcast equipment. The taxpayer argued that the underlying property to which the FCC broadcast licenses related was the tangible personal property referred to in the licenses themselves--the radio transmitting apparatus consisting of transmitters, towers, and antennas. Each of the FCC licenses submitted by the taxpayer expressly stated that 'the licensee is hereby authorized to use and operate the radio transmitting apparatus herein described.' The taxpayer further argued that using this broadcast equipment related to the 'essence' of the licenses and therefore should be treated as the 'underlying property.' According to the taxpayer, such broadcast equipment was like-kind property under the Regulations and, therefore, the underlying property had a similar nature or character.
The IRS agreed with the taxpayer's approach that in identifying the appropriate underlying property, the FCC licenses themselves should be reviewed. Nevertheless, the Service did not concur that the underlying property was the radio transmitting apparatus, even though it was expressly referred to in the licenses. The IRS found that an FCC broadcast license 'principally relates' to the use of the radio transmitting apparatus, rather than to the apparatus itself. The TAM explains that '[a]n FCC license does not authorize the licensee to own or possess radio transmitting apparatus; the licensee would not need an FCC license for the apparatus unless it wanted to use that apparatus to broadcast over the electromagnetic spectrum.'
It's the electromagnetic spectrum. The TAM states that an 'FCC license reflects the FCC's decision to assign a specific frequency of the electromagnetic spectrum to a particular licensee in a given broadcast area. ' The National Office concluded that 'we think that the assigned frequency of the electromagnetic spectrum referred to in each license is the underlying property to which the license relates.' The Service appeared to have applied the standard that an FCC license 'principally relates' to the use of the electromagnetic spectrum.
The radio vs. TV issue.
As a final step in its analysis, the IRS had to determine whether the 'differences between a frequency assigned for television broadcasts and a frequency assigned for radio broadcasts are differences in nature or character or are merely differences in grade or quality.'
The Service then discussed the meaning of the like-kind standard, quoting a court's statement that 'the distinction intended and made by the statute is the broad one between classes and characters of property, for instance, between real and personal property.' The IRS went on to note, however, that published Rulings in the area of tangible personal property have been 'more restrictive' in interpreting the like-kind standard. The Service stated that these authorities indicated that 'functional differences between seemingly similar properties' can be relevant in determining whether two properties are like kind.
The TAM then described some of the differences between a radio frequency and a television frequency: '[R]adio and television broadcasts are assigned to different frequency bands of the usable radio frequency spectrum. Television broadcasts require a considerably larger bandwidth than audio only radio broadcasts. Moreover, a licensee would be in violation of its license if it used a television frequency to broadcast radio transmissions and vice versa.'
The Service observed that 'even the narrowest interpretation of the like kind standard does not require that one property be identical to another or that they be completely interchangeable.' The IRS concluded that 'the differences in the assigned frequencies are not differences in nature or character, but are merely differences in grade or quality.'
Accordingly, the taxpayer's exchange of FCC radio station licenses for the FCC television station license qualified as a like-kind exchange under Section 1031.
TAM 200035005 has implications for all taxpayers, not just the one obtaining the ruling or others in the broadcasting industry.
The copyright example. To the Service's credit, in coming to its decision it did not rely on the second copyright example in the intangibles Regulation. As noted above, in that example a copyright on a novel was determined not to be of like kind to a copyright on a song. A superficial analysis might have applied this example, reasoning that a novel and a song are not like kind because a novel involves reading with the eyes and a song involves listening with the ears, and, similarly, that an FCC television station license and an FCC radio station license are not like kind because watching television programs is done with the eyes and listening to radio programs is done with the ears. Such an analogy would not be apt.
The novel-and-song-copyright example might have been relevant if the taxpayer had exchanged a copyright on a radio program for a copyright on a television program. The TAM, however, involved the exchange of FCC broadcast licenses. The copyrights in the example involved underlying properties--a song and a novel--that clearly were different. By contrast, the property underlying FCC radio and television licenses was the same--the electromagnetic spectrum. In the TAM, the IRS determined that the underlying property was the electromagnetic spectrum and properly did not seriously consider the agent's suggestion that the underlying property was the programming content.
The copyright example was not apt for still another reason--the FCC licenses are part of a different aspect of the broadcasting business operations than a copyright for a novel and a copyright for a song. Such copyrights are end products of a creative process. By contrast, FCC licenses are of part of a distribution process. Broadcasting is a unique distribution process--the physical transmission of broadcast signals over the electromagnetic spectrum.
The applicable underlying property. The IRS also must be given credit for ruling that the electromagnetic spectrum was the property underlying the FCC licenses. The Service certainly was correct in declining to rule that the broadcast business itself was the underlying property. Such a ruling would have been inconsistent with recent IRS Rulings and Regulations, and would have instituted a vague, open-ended, and ultimately unworkable standard of comparing entire lines of business.
Moreover, a radio or television station license to broadcast programming over the electromagnetic spectrum is not equivalent to a license to operate a broadcasting business. An FCC license does not confer rights to conduct aspects of the broadcasting business, such as a right to enter into talent contracts, to purchase or produce programming content, or to attract advertising. Instead, an FCC license relates to one aspect of the broadcast business (albeit a crucial one): the physical transmission of broadcast signals over the electromagnetic spectrum.
It would have been easy for the IRS to rule that the broadcasting equipment was the underlying property. Such a determination would have been justifiable, given that the FCC broadcast licenses themselves expressly authorized the use of broadcasting equipment to transmit and receive broadcast signals.
Instead, the Service went beyond the easy choice for the correct one. Determining that the property underlying the FCC radio and television licenses included the electromagnetic spectrum was correct, given that the essence of an FCC license is the exclusive use of a portion of the electromagnetic spectrum. The Service demonstrated some courage in arriving at this conclusion, because it is by no means clear how far the TAM can be applied in other contexts. There are no natural divisions within the electromagnetic spectrum. The allocations of its uses by the FCC are in many ways arbitrary. This may mean that many or perhaps all types of FCC licenses are of like kind to each other. Despite this possibility, the IRS ruled that the electromagnetic spectrum itself was the underlying property.
Lack of identity.
In ruling that an FCC radio station license and an FCC television station license have the same 'nature or character' for purposes of Section 1031, the IRS must further be credited in not interpreting the like-kind standard in an overly restrictive manner. The Service confirmed that even though such licenses have some differences, the like-kind standard did not require that the properties be identical.
Other exchanges of FCC licenses.
The TAM deals with only an exchange of FCC radio station licenses for an FCC television station license. Yet by identifying the electromagnetic spectrum as the property underlying these FCC licenses, the TAM raises the question of whether exchanges of other types of FCC licenses would constitute a like-kind exchange.
The Service's analysis suggests that FCC licenses that involve similar (even though not identical) distribution systems that use the electromagnetic spectrum are of like kind. For example, an FCC license to use a cellular communications system should be like kind to an FCC license to use a personal communications service (PCS) system, even though each license permits a use of a different portion of the electromagnetic spectrum.
The question also arises as to whether any FCC license to use a portion of the electromagnetic spectrum is like kind to any other FCC license to use a portion of the spectrum. For example, is an FCC license to use a cellular communications system like kind to an FCC broadcast license? Not surprisingly, the IRS does not provide many answers as to how broadly the TAM should be interpreted.
In analyzing an exchange of FCC licenses, as with the licenses addressed in the TAM, the two-part test of the intangibles Regulation must be applied. The first prong is whether the 'nature or character of the rights involved' are similar. In the TAM, the IRS was influenced by the fact that FCC radio station and FCC television station licenses are 'basically the same' in that each license permits the holder to broadcast programming to the public on a designated channel within a designated geographic area, subject to similar parameters. By contrast, for example, an FCC license to operate a cellular communications system typically involves the sporadic use *296 of the spectrum from a single point to another single point using two-way communications, and does not involve broadcasting to the general public. Furthermore, in the TAM the IRS may have been influenced by the fact that federal statutes and regulations deal with radio and television broadcasting in many of the same provisions. This is true with some, but not necessarily all, uses of the electromagnetic spectrum. This analysis suggests that an FCC cellular communications system license may not be like kind with an FCC broadcast station license.
Nonetheless, regardless of the different types of uses of the electromagnetic spectrum and its regulation by the FCC, the language in the Section 1031 Regulations makes the task of distinguishing between uses of the electromagnetic spectrum difficult. Reg. 1.1031(a)-2(c)(1) first tests 'the nature or character of the rights involved (e.g., a patent or a copyright). ' This language suggests that all patents would have a similar nature or character, even though there are many different types of patents. The crucial factor would appear to be that a patent is an exclusive right to exploit an invention granted by the government. The same analysis would appear to apply to all copyrights. Similarly, all FCC licenses are licenses for the exclusive use of a portion of the electromagnetic spectrum in a designated geographic area granted by the government. Accordingly, the first prong of the intangibles Regulation arguably would be satisfied in the event of an exchange of an FCC cellular communications system license for an FCC broadcast license.
The second prong in the intangibles Regulation requires a comparison of the 'nature or character of the underlying property to which the intangible personal property relates.' The TAM identified the electromagnetic spectrum as the underlying property in an FCC broadcast station license. Presumably, the same conclusion would apply to any FCC license to use the electromagnetic spectrum.
Finally, in TAM 200035005 the Service determined that FCC radio and television licenses had the same 'nature or character' and satisfied the like-kind requirement. The IRS mentioned a few differences between the use of the electromagnetic spectrum for purposes of radio station broadcasting and television station broadcasting, but determined that these were not differences in nature or character but only in grade or quality. Interestingly, in this part of the TAM the Service did not elaborate on what similarities were important (perhaps out of concern as to how far the TAM's approach could be extended).
Many uses of the electromagnetic spectrum are similar. For example, a wireless telephone is a radio. When a call is made using a wireless phone, the signal is sent to an antenna that then connects the call to the wireline network. As explained by the general counsel to the FCC, '[a] wireless operator has a license issued by the FCC granting it the exclusive right to use particular frequencies in a particular geographic area, just like radio stations and television stations.'
Arguably, any use of the electromagnetic spectrum is of a similar nature or character to any other use of the electromagnetic spectrum. After all, as previously noted, there are no natural divisions in the use of the spectrum. Indeed, portions of the spectrum used for certain VHF television channels are set between portions of the spectrum used for FM radio broadcasting. Furthermore, the FCC is planning to auction the portion of the electromagnetic spectrum currently devoted to channels 60 to 69 for television stations, with the expectation that the winners of the auction will receive licenses to provide wireless Internet service.
Arguably, the electromagnetic spectrum is 'real estate in the sky' and should be treated the same as real estate on the ground for Section 1031 purposes. Whether real property is zoned for commercial, industrial, or residential use is merely a 'grade or quality' difference. Similarly, whether the electromagnetic spectrum is 'zoned' for AM broadcasting, FM broadcasting, television broadcasting, cellular communications, satellite communications, or another use arguably is merely a 'grade or quality' difference.
In the TAM, the IRS determined that an FCC radio station license is like kind to an FCC television station license. The Service left open whether other FCC licenses to use portions of the electromagnetic spectrum will be of like kind to each other as well. The rationale of the TAM, however, logically would seem to extend to other FCC licenses.
A taxpayer planning an exchange of intangible properties intended to qualify for nonrecognition under Section 1031, where the properties involved are not already established as being of like kind, may draw some comfort from the Service's generous reasoning in TAM 200035005. While the IRS could simply have said that the 'nature or character of the underlying property' test was satisfied by the similarity of the broadcasting equipment used for both radio and television, the Service instead understood that underlying property was itself the intangible electromagnetic spectrum.
About the Author
Christian M. McBurney is a partner in the Washington, D.C., office of the law firm of Nixon Peabody LLP. He has frequently written for THE JOURNAL in the corporate and partnership tax areas, as well as on intangible asset tax issues. Mr. McBurney, with his partner Stefan Boshkov, represented the taxpayer in connection with the TAM discussed in this article. Copyright (C) 2000, Christian M. McBurney.
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