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Decisions — Auctioning the airwaves

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Spotty reception? Maybe your airwaves were sold. The April 2017 spectrum auction by the Federal Communications Commission was intended to improve and expand wireless communication services in the US and may have meant television channels that you watch were changed. The auction also had tax consequences for broadcasters.

In letter ruling 2018-21012, a diversified global media and entertainment company with operations in television broadcasting wanted to know if the gain on auction proceeds could be deferred.

The taxpayer conducts most of the company’s US media and entertainment business operations. The taxpayer’s US television stations are operated pursuant to licenses and permits issued by the Federal Communications Commission, which authorize each station to deliver video, audio, data, and other content over its channels.

The taxpayer, through a number of disregarded entities, owns an entity that is disregarded for federal income tax purposes, which in turn owns the Federal Communications Commission licenses with the related spectrum rights.

The Federal Communications Commission conducted an auction in connection with which television broadcast licensees relinquished all or a portion of their broadcast spectrum usage rights to the Federal Communications Commission in exchange for incentive payments.

The disregarded entity owned by the taxpayer filed applications to participate in the auction, and the Federal Communications Commission agreed to purchase the spectrum licensed to the taxpayer with respect to three stations. The taxpayer received the auction proceeds.

Unless the taxpayer relinquished the spectrum rights in the auction, the taxpayer would likely have been “repacked” to different frequencies which would have forced it to operate with different facilities, on different and less valuable frequencies, and with possibly reduced protected service areas, all of which would harm the future revenue potential and economic value of the three stations.

Post-auction, the taxpayer only retains the Federal Communications Commission broadcasting licenses for the three television stations. No spectrum rights are retained.

The taxpayer wanted to know if the auction qualified as a condemnation (meaning the sale of the spectrum rights resulted in a gain that could be deferred).

The law

From internal revenue code section 1033: A taxpayer (either an individual or a business) can make a timely election and a timely replacement to defer gain on property following an involuntary conversion. Involuntary conversions include destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof.

One of the circumstances in which a section 1033 requisition or condemnation occurs is where a taxpayer’s property is subjected to a compensable governmental taking for public use under the Fifth Amendment of the U.S. Constitution.



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Right answer!
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In the present case, the Federal Communications Commission’s repacking process is functionally equivalent to a direct physical taking of private property for a public use without the consent of the property owner because it effectively deprives the taxpayer of its assets.

The taxpayer’s choice to participate in the auction was not a meaningful choice. Choosing to forego the auction would have subjected the taxpayer to the repacking process. Due to the taxpayer’s unique circumstances, if the taxpayer did not participate in the auction with respect to the three stations, it was likely that the taxpayer would have been repacked into a different channel.

A voluntary sale qualifies as an involuntary conversion under internal revenue code section 1033 if the threat or imminence of condemnation is present at the time of sale. The threat need not be a certainty. A threat exists if the taxpayer may reasonably believe from representations of the government and surrounding circumstances that a forced sale is likely to take place.

The Federal Communications Commission has provided the taxpayer with notice of its intent to acquire the type of spectrum rights that the taxpayer possesses in the three stations.

Under its unique circumstances, it is reasonable for the taxpayer to believe that if it did not participate in the auction, it was likely that the Federal Communications Commission would take the taxpayer’s spectrum rights in each of its three stations, and then force the taxpayer to relocate its stations to a different frequency.

Accordingly, the taxpayer’s sales of spectrum rights with respect to the three stations to the Federal Communications Commission pursuant to the auction constitutes a disposition under the threat or imminence of condemnation for purpose of section 1033 of the internal revenue code.

We therefore conclude that the sales of the spectrum rights with respect to the three stations by the taxpayer to the Federal Communications Commission in the auction constitute sales under a threat of involuntary conversion for purposes of internal revenue code section 1033.