May 2020
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Deducting Previously-Capitalized Transaction Costs

It can be expensive to complete a major corporate transaction, and the parties usually wish to get the best possible tax treatment for their transaction costs. Some transaction costs can be deducted and some can be capitalized as amortizable assets, but some must be capitalized as nonamortizable assets. A recent IRS Chief Counsel Memorandum may have indicated that the IRS would object to a later write-off of such nonamortizable assets.

  What Is At Stake.

In various major business transactions, including acquisitions, stock issuances and borrowings, the law requires the taxpayer to determine the costs incurred that are "facilitative" of the transaction and to capitalize those costs. (Non-facilitative costs can be deducted if otherwise deductible under normal tax principles.)

Applicable authority provides rules for determining what expenditures are considered facilitative, defining when a transaction has advanced far enough that expenditures made with respect to it are considered facilitative (normally about the time a letter of intent or similar agreement is reached); providing safe harbors under which certain expenditures are never facilitative; and providing per se rules under which certain expenditures are always facilitative. Those rules provide taxpayers with a way of determining which costs to capitalize.

In some cases, such as asset acquisitions, the costs are capitalized as part the cost of the acquired assets, which allows amortization of the costs (generally over 15 years). In others, the costs are capitalized as costs of stock, in which case they increase the acquiror's basis in the acquired stock, but do not result in any amortization because stock is not an amortizable asset.

A subtler analysis is required in the case of nonamortizable assets other than corporate stock. For example, it is not uncommon in mergers and acquisitions for the acquired corporation to incur costs in the process of being acquired. That is, being acquired can benefit a corporation's business, and if such a benefit is expected, the corporation may incur costs to help the acquisition to take place. Another example would be a stock issuance transaction in which a corporation incurs costs to issue stock.

Those costs create assets that might be described as a "capital structure" assets. It generally would seem possible to write off the cost of such an asset once the asset was no longer in use and would no longer yield a benefit. For example, a corporation might be able to write off its capital structure asset resulting from a past acquisition if it were re-acquired by a new acquiror.

  The IRS's View.

The IRS Office of Chief Counsel recently issued an Advisory Memorandum (AM 2020-003, May 15, 2020) in which it addressed a corporation's attempt to write off costs previously incurred in issuing stock. The corporation had incurred those costs in becoming a publicly traded corporation, and when it later was "taken private," it argued that it would receive no further benefit from the costs it had incurred in going public and therefore should be allowed to write off the costs.

The main conclusion of the memorandum is not of primary interest here: the IRS disallowed the deduction on the ground that the taxpayer had no basis (that is, no amount invested) in the costs because the costs should have been treated as an offset to the capital it raised when it issued the stock.

More interestingly, and perhaps more importantly, the IRS went on to discuss whether the taxpayer could have written off its stock issuance costs if it had basis in those costs. The IRS's view was that it could not: "[n]o abandonment has occurred because Taxpayer continues to benefit from once being a publicly traded company even though it is now privately held." The IRS felt that the benefits of previously having raised capital through a stock issuance "are not an isolated item which Taxpayer can abandon. Rather, they have already affected Taxpayer's corporate structure and continue to provide benefits to Taxpayer."

Thus, the IRS seems to have taken the position that the costs incurred for the public offering created a "permanent asset." If taxpayers were required to follow such an approach, it could become nearly impossible to write off capital structure assets.

  Comments.

In considering the Advisory Memorandum, it is important to remember that the "permanent asset" approach represents only the IRS's position set forth in a non-citable document. That position has not been accepted by a court, and the Memorandum does not actually cite any authority supporting it.

Also, it is not clear how important the position is to the IRS's conclusion in the Memorandum. The Memorandum begins by determining that no deduction is available because of lack of basis; the discussion of the permanent asset approach is in the nature of commentary (although if called upon to litigate the issue, presumably the IRS would assert the position as an alternative to its main argument).

The permanent asset approach is based on IRS's assumption that the initial public offering created a permanent asset. The facts would not necessarily support that assumption. For example, the public offering could have been disastrous, creating great detriment to the business, with "taking private" constituting an attempt to salvage it rather than being a way to build on previous benefits.

Probably the most general criticism of the "permanent asset" approach is that every time a business acquires an asset, it hopes to use the asset to create benefits that last after the life of the asset. The Memorandum attempts to address that problem by asserting that the cost of a public offering does not create an "isolated item which Taxpayer can abandon." That is a very difficult definition to administer. Presumably everyone would agree that if a taxpayer buys an item of machinery, the taxpayer is entitled to write it off when it becomes useless. However, there are harder examples: for example, when a business incurs costs for a financing, it is hoping to use the borrowed money to build its business. If it is successful to the point that it pays off the financing early, it is permitted to write off any financing cost it has not previously deducted. It is not clear why a debt financing should be considered "isolated" when an equity financing is not.

Thus, taxpayers should not assume that it is always forbidden to write off a capital structure asset or that there is actual authority preventing such a write-off. However, they should be aware that the IRS may be inclined to object if they do so.

If you have questions about these issues or their effect on you or your business, please feel free to contact TaxGroup Partners at (213)873-1200 or e-mail us at info@TaxGroupPartners.com or visit our website at TaxGroupPartners.com.
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TaxGroup Partners is an independent "tax only" advisory firm that focuses solely on providing tax services including tax consulting on business tax matters; tax planning for major events such as mergers and acquisitions, financing transactions, insolvencies and joint ventures; tax services in connection with financial accounting; special tax analysis and tax optimization projects; and tax return preparation. By specializing in taxation, the firm is able to be uniquely responsive, efficient and cost-effective in serving its tax clients.
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