IRS concludes that termination fee is capital loss under Section 1234A

The IRS concluded in field attorney advice (FAA 20163701F) that a fee related to the termination of a merger agreement resulted in a capital loss to a taxpayer under Section 1234A.

The advice involves a corporation (the taxpayer) that entered into a merger agreement with another company (the target). To facilitate the merger, the taxpayer formed a new corporation (Newco), and the taxpayer and the target would both become subsidiaries of Newco pursuant to the merger. The merger was based on the taxpayer’s board recommending the merger to its shareholders.

The U.S. Treasury Department issued a notice that adversely affected the expected tax benefits of the merger, and the taxpayer withdrew its recommendation for the merger. The taxpayer was required to pay a fee to the target when it withdrew its recommendation for the merger.

The IRS concluded that the taxpayer’s loss arising from the payment of the fee was characterized as a capital loss under Section 1234A. Under Section 1234A, taxpayers must recognize capital gain or loss related to the cancellation, lapse, expiration or other termination of a right or obligation (other than a securities futures contract as defined in Section 1234B) regarding property that is (or would be) a capital asset in the hands of the taxpayer.

The IRS asserted in the FAA that the merger agreement provided to the taxpayer “rights and obligations” related to the target’s stock and Newco’s stock. So the loss incurred by the taxpayer regarding the termination of the merger agreement should be a capital loss under Section 1234A, because such stock was a capital asset in the taxpayer’s hands upon acquisition.

Contact Andy Cordonnier
Partner, Washington National Tax Office
T +1 202 521 1502

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