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By David S. Raab, Esq., Lisa G. Watts, Esq., and Kevin J. Brogan, Esq.
Latham & Watkins LLP, New York, NY
On April 8, 2011, the Internal Revenue Service (the IRS) issued Rev. Proc. 2011-29, which provides taxpayers with a safe harbor pursuant to which they may deduct 70% of success-based fees paid in connection with certain business acquisitions and reorganizations. As the volume of M&A activity in the information technology (IT) industry continues to increase, IT companies would be well advised to understand this taxpayer-favorable guidance and position themselves to take advantage of it.
Current Treatment of Facilitative Costs
Taxpayers are generally required to capitalize, rather than deduct, fees paid to "facilitate" a wide range of business acquisitions and reorganizations.1 Amounts are considered to "facilitate" a transaction where, based on all of the facts and circumstances, they are paid in the process of investigating or otherwise pursuing such transaction. If a fee is not paid to facilitate a transaction, then such fee is generally deductible. Existing Treasury regulations provide a number of factors to be considered and presumptions to be made in determining whether and how much of a given fee was paid to facilitate a transaction. One such presumption treats a fee that is contingent on the closing of a transaction (a "success-based fee") as facilitating the transaction (and therefore required to be capitalized), unless the taxpayer maintains detailed documentation, including supporting records, that establishes a portion of the success-based fee is allocable to activities other than facilitating the transaction.
Revenue Procedure 2011-29
Noting that the properly deductible portion of success-based fees paid in the context of "covered transactions" has been a source of controversy between taxpayers and the IRS, the IRS issued Rev. Proc. 2011-29. "Covered transactions" generally include the taxable acquisition of assets constituting a trade or business, the taxable acquisition of ownership interests in an entity where the taxpayer and entity are considered related after the transaction and certain tax-free reorganizations.2 The safe harbor contained in Rev. Proc. 2011-29 allows taxpayers to treat 70% of a success-based fee incurred in connection with a covered transaction as deductible as long as the remaining 30% of the fee is treated as facilitative of the transaction and capitalized. Compliance with the safe harbor provided in Rev. Proc. 2011-29 offers taxpayers the assurance that their deductions of success-based fees paid in connection with a covered transaction will be respected and relieves taxpayers of the burdensome documentation requirements otherwise required to establish the deductibility of success-based fees.
In order to elect the safe harbor, taxpayers must attach an identifying statement to their federal income tax return for the year in which the success-based fee is paid or incurred. The safe harbor has to be elected for each covered transaction entered into by a taxpayer and, once elected, is irrevocable and applies to all success-based fees paid with respect to a given covered transaction. Accordingly, IT companies contemplating an acquisition should carefully review this guidance.
Rev. Proc. 2011-29 is effective for all success-based fees paid or incurred in taxable years ending on or after April 8, 2011.
For more information, in the Tax Management Portfolios, see Maule, 504 T.M., Deduction Limitations: General, and in Tax Practice Series, see ¶2920, Capital Expenditures.
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