The Tax Court held in Plano Holding LLC v. Commissioner
(T.C. Memo. 2019-140
) that a success-based finder’s fee was not deductible by the target of an acquisition.
The taxpayer, Plano, was a corporation that was acquired by the Ontario Teachers’ Pension Plan Board (OTPP), a Canadian pension fund, in 2012. OTPP became aware of Plano when an investment bank, Robert W. Baird & Co., suggested Plano as an acquisition candidate. Baird sent an e-mail attempting to set up a lunch meeting between the OTPP and Plano’s controlling shareholder. Baird’s involvement with the transaction ceased after sending this e-mail, but OTPP and the controlling shareholder signed a merger agreement in November 2012.
Eight days after the signing of the merger agreement, OTPP entered into an agreement with Baird. Pursuant to that agreement, OTPP would pay Baird $1.5 million upon the successful closing of the transaction. The agreement stated that Baird’s services were rendered “solely for the benefit and use of OTPP’s management and directors in considering the transaction(s) to which they relate.” The agreement also specified that the parties’ obligations under the agreement could not be assigned by OTPP without Baird’s prior written consent.
When the transaction closed in December 2012, Plano paid Baird the $1.5 million fee. On its 2012 tax return, Plano deducted 70% of the fee and capitalized 30% of the fee, pursuant to an election under the Rev. Proc. 2011-29 safe harbor. The IRS challenged the deduction on the grounds that Plano was not the taxpayer that incurred the fee.
The Tax Court stated that Plano’s payment of the Baird fee was on behalf of another taxpayer because OTPP, not Plano, had agreed to pay Baird. Noting the general rule against deducting payment of another taxpayer’s expenses, the court applied an exception to that general rule in Lohrke v. Commissioner
, 48 T.C. 679 (1967), which allows a taxpayer to deduct the payment of another’s expense when 1) the taxpayer’s primary motive for paying the other’s obligation is to protect or promote the taxpayer’s own business; and 2) the expenditure is an ordinary and necessary expense of the taxpayer’s business.
The Tax Court held that Plano failed both prongs of the Lohrke
test. With respect to the first prong, the court concluded that Plano did not have the proper motive in making the payment, emphasizing that it was not required to pay the fee and that its business faced no consequences from failing to pay the fee. With respect to the second prong, the Tax Court held that the payment to Baird was in the nature of a finder’s fee, and that such a fee was more likely to be ordinary and necessary to a large institutional investor like OTPP than to a manufacturing company like Plano.
In its ruling, the Tax Court distinguished Square D Co. v. Commissioner
, 121 T.C. 168 (2003), a case that stands for the proposition that, in certain circumstances, a taxpayer can deduct an expense that is 1) incurred on its behalf; and 2) paid or reimbursed by the taxpayer. Stating that, “OTPP agreed to the Baird payment for its own reasons and on its own behalf,” the Tax Court held that the Square D decision did not apply because the $1.5 million fee was not incurred by OTPP on behalf of Plano.
Based on this analysis, the Tax Court denied the deduction Plano took with respect to the Baird fee. The court also upheld the 20% accuracy-related penalties assessed by the IRS.
This case demonstrates the necessity of carefully analyzing the facts surrounding each expense when determining which taxpayer should take transaction costs into account. Taxpayers should be especially careful when one taxpayer pays an expense that may have been incurred by another taxpayer.
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