The IRS issued a Technical Advice Memorandum (TAM 202004010) stating that certain transaction costs paid by a target company in connection with the acquisition of its stock must be capitalized under Treas. Reg. Sec.1.263(a)-5(a) and are not a separate and distinct intangible asset under Treas. Reg. Sec.1.263(a)-4(b)(3). It also stated that such fees are not allowed to be deducted under Section 165(a) when all of the target company’s stock was sold to a different buyer.
According to the memorandum, the taxpayer acquired the stock of the target company in Year 1 in a taxable reverse triangular merger. To facilitate the sale of its stock to the taxpayer, the target made payments to a number of law firms, investment firms, accounting firms, other professional firms and the SEC. The target treated the portion of the fees required to be capitalized as costs of facilitating the acquisition of its trade or business under Treas. Reg. Sec.1.263(a)-5(a) (transaction costs) as an intangible asset on its tax books. Subsequently, the taxpayer decided to divest itself of the target’s business and entered into a stock purchase agreement with a buyer to sell the target. When calculating the separate taxable income of the target under Treas. Reg. Sec. 1.1502-12 on its consolidated corporate tax return, the taxpayer claimed a Section 165(a) loss deduction for the facilitative fees that were previously capitalized as an intangible asset by the target.
Treas. Reg. Sec. 1.263(a)-5(a)(3) provides that a taxpayer must capitalize an amount paid to facilitate an acquisition of an ownership in the taxpayer. Thus, the IRS stated that the treatment of the target’s facilitative fees was clearly within the purview of Treas. Reg. Sec.1.263(a)-5. Accordingly, it was not appropriate for the taxpayer to capitalize the costs as a separate and distinct intangible asset under Treas. Reg. Sec.1.263(a)-4(b)(3). However, because Treas. Reg. Sec. 1.263(a)-5(g) does not address the recovery of the target’s costs capitalized in a taxable stock acquisition, the IRS relied on the Supreme Court’s decision in INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992). Following the holding from INDOPCO, the IRS concluded that the target’s facilitative costs should be characterized as the costs of acquiring significant future benefits for the target’s business and operations, and such costs should remain capitalized for the life of that business -- generally, the duration of the target’s business enterprise.
With respect to the Section 165 loss deduction for the target’s capitalized transaction costs, the taxpayer argued that the asset that was created when the target capitalized these fees became worthless when the taxpayer sold the target’s stock to the buyer. The taxpayer argued that the announcement of its decision to divest in the target and eventual sale of the target’s stock to the buyer was evidence of the worthlessness of the capitalized transaction costs to the target. The taxpayer further argued that the divestiture was the objectively identifiable event that evidenced the closed transaction.
The IRS, again applying principles from INDOPCO, disagreed with the taxpayer’s position. The IRS stated that under INDOPCO, the fees paid by the target did not create or enhance an intangible asset separate and apart from the target’s business, but rather were paid to benefit the target’s trade or business. Citing INDOPCO, the IRS stated that a taxpayer would only be permitted to recover those costs upon dissolution of the business enterprise, or upon an occurrence of another event that ends the useful life of the business. In the facts of the TAM, the target did not abandon its business or dissolve its business operations. Consequently, the target’s loss deduction under Section 165 was disallowed.
Sharon Kay is the National Managing Partner of Grant Thornton LLP's Washington National Tax Office. Sharon has over 25 years of tax experience and primarily advises clients on federal income tax issues such as accounting method changes, income and expense recognition, inventories, tangible and intangible asset capitalization and recovery, and certain business credits.
Washington DC, Washington DC
- Strategic federal tax
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