In an Internal Revenue Memorandum (AM 2020-003) released May 15, 2020 (the IRM), the IRS concluded that a taxpayer cannot deduct previously capitalized costs that facilitated an initial public offering (IPO) as an abandonment loss under IRC Section 165 when the taxpayer later ceases to be a publicly traded company as a result of a "take-private" transaction. The taxpayer's costs should have been capitalized via netting against the proceeds from the stock issuance, so there is no amount to later recover.

Facts

In year 1, the taxpayer was a privately-held company. In year 2, the taxpayer completed an IPO to become a publicly traded company. The taxpayer incurred costs in connection with the IPO, which included legal, accounting, investment banking, underwriting, printing and regulatory and filing fees. The taxpayer capitalized the costs as a separate and distinct intangible asset, and did not net the costs against the proceeds from the stock issuance.

In year 3, the taxpayer ceased to be a publicly traded company because of a take-private transaction. The taxpayer then deducted the previously capitalized IPO costs as an abandonment loss under IRC Section 165 in the same year.

Analysis

Treas. Reg. Section 1.263(a)-5(a)(8) provides that a taxpayer must capitalize an amount paid to facilitate a stock issuance. While the regulations reserve on the treatment and recovery of such capitalized costs, the IRS's historical view is that stock issuance costs do not result in a separate intangible asset, and instead, are treated as a reduction in the proceeds of the stock sale.

Relying on INDOPCO v. Commissioner, 503 US 79 (1992), the taxpayer argued the facilitative IPO costs created a distinct, nonamortizable intangible asset. The taxpayer claimed that because the IPO costs resulted in future benefits to the company, they may be viewed the same as expenses incurred in an asset purchase. As such, the IPO costs created a separate and distinct asset in which it retained basis. Accordingly, the taxpayer asserted that because the synergistic and resource benefits it enjoyed as a public company (e.g., ability to quickly raise capital) ceased to exist as a result of the take-private transaction, the basis in the separate asset created by the IPO costs became recoverable as an abandonment loss under IRC Section 165 in year 3.

The IRS rejected the taxpayer's contention that INDOPCO overturned the longstanding view that capitalizable IPO costs are treated as an offset to proceeds raised. The IRS explained that the historical position is consistent with INDOPCO, which held that the creation of a separate and distinct intangible asset is not required for capitalization. Moreover, the IRS position "is not changed by [Treas. Reg. Section] 1.263(a)-5(g)(3) being reserved. While Notice 2004-18 solicited comments on the possible treatment of capitalized costs, including stock issuance costs, no regulations or separate guidance have been issued which allow for the recovery of such costs."

Additionally, the IRS noted that stock issuance costs related to an IPO are similar to commissions and other transaction costs paid to facilitate the sale of property, which are not currently deductible under IRC Sections 162 or 212. They are instead capitalized costs that reduce the amount realized in the tax year the sale occurs or when the sale is abandoned. "Even though the costs reduce the amount realized, they are still considered capitalized."

Further, the IRS cites IRC Sections 265 and 1032 to support its conclusion. IRC Section 1032 provides that no gain or loss is recognized by a corporation on the issuance of its stock. Correspondingly, IRC Section 265 provides that no deduction is allowed for any expense that is allocable to exempt income. The taxpayer argued that it did not receive an actual benefit by netting the IPO costs against the proceeds raised since the proceeds are not included in income under IRC Section 1032. In rejecting this argument, the IRS stated " … Taxpayer benefits by not including the proceeds in income. To allow Taxpayer to later recover the capitalized stock issuance costs would contravene the purpose of [IRC Section] 265, which was enacted to prevent a taxpayer from obtaining a double advantage by offsetting taxable income by expenses allocable both to taxable and to tax-free income."

Because the IPO costs are treated as an offset to proceeds, the IRS concluded there is no amount to later recover under IRC Section 165. Treas. Reg. Section 1.165-2(a) specifies that a loss is deductible if it is "incurred in a business or in a transaction entered into for profit and arising from the sudden termination of the usefulness in such business or transaction of any nondepreciable property, in a case where such business or transaction is discontinued or where such property is permanently discarded from use therein."

Here, the taxpayer had nothing to abandon because it had no basis in the stock issuance costs. Further, the IRS noted that the stock issuance costs are never recoverable, except in instances where an IPO is abandoned because there are no proceeds available to offset. In this case, the taxpayer completed the IPO and received proceeds from the sale, which were offset by the taxpayer's expenditures for acquiring the proceeds. Therefore, the IRS determined that even if the taxpayer "had intangible assets to abandon, it would have no basis in them."

Additionally, the IRS reasoned that even if the taxpayer had basis in the intangible benefits resulting from the IPO, it still would not be entitled to an abandonment loss under IRC Section 165 upon completion of the take-private transaction. According to the IRS, no abandonment has occurred because the taxpayer continues to benefit from once being a publicly traded company (e.g., the ability to raise capital quickly to fund strategic acquisitions, an enhanced public profile, name recognition and the ability to attract management and employees). "Rather, [the benefits] have already affected Taxpayer's corporate structure and continue to provide benefits to Taxpayer."

Accordingly, the IRS determined that the taxpayer may not deduct the previously capitalized costs under IRC Section 165 when it no longer is a publicly traded company because of a take-private transaction.

Implications

The conclusion in the IRM is consistent with the IRS's longstanding position regarding the treatment and recovery of capitalized stock issuance costs.¹

Before the issuance of Treas. Reg. Section 1.263(a)-5, the weight of authorities held that stock issuance costs are treated as a reduction in the proceeds of the stock sale.² However, the fact that the final regulations reserved on the treatment of stock issuance costs raised questions as to whether the IRS was reconsidering its position that stock issuance costs are netted against the proceeds of the stock sale. As noted above, on February 28, 2004, the IRS issued Notice 2004-18,³ requesting comments on the treatment of capitalized costs in certain transactions, including stock issuance costs.⁴ However, no further guidance has been issued to date in response to the comments provided.

Despite the lack of guidance, there have been other indications that the IRS has not changed its position. In TAM 200503026, the IRS specifically rejected a position that stock issuance costs give rise to a separate intangible.⁵ Although this TAM dealt with years prior to the effective date of the final regulations, the IRS discussed the impact of the final regulations and Notice 2004-18 on the treatment of stock issuance costs:

Taxpayer also argues that prior precedent [requiring netting of stock issuance costs] is changed by the recent publication of [Treas. Reg. Section] 1.263(a)-5(a)(8) of the Income Tax Regulations, which requires that a taxpayer capitalize amounts paid to facilitate a stock issuance. [Treas. Reg.] Section 1.263(a)-5(a) lists what expenditures must be capitalized as opposed to being currently deducted. Stock issuance costs are listed to assure they are not construed to be currently deductible. Taxpayer also cites Notice 2004-18, 2004-11 I.R.B. 605, which solicits comments on the possible treatment of capitalized costs, including stock issuance costs, in future regulations. The Notice, however, does not change past precedent in regard to their treatment.

Additionally, on July 18, 2018, the IRS released an LB&I Process Unit on Transaction Costs (see Tax Alert 2018-1770). The Process Unit explains that costs facilitating a stock issuance must be capitalized, and the capitalized costs are considered nondeductible capital outlays that reduce the inflow of capital and may not be deducted when incurred or upon dissolution.⁶ While Process Units are not official pronouncements of law or directives and cannot be used, cited or relied upon as such, it does provide helpful insight into how the IRS is instructing exam teams to review transaction costs and how they may interpret the transaction costs rules.

Finally, it is notable that the IRS argued the taxpayer did not meet the requirements for abandonment under IRC Section 165 because it continued to benefit from once being a publicly traded company. This is consistent with the outcome in TAM 202004010 (see Tax Alert 2020-0230)in which the IRS concluded a target's previously capitalized transaction costs are not recoverable until the trade or business ceases or the target otherwise dissolves.

Taxpayers are encouraged to carefully analyze the treatment of their stock issuance costs. The conclusions in the IRM are only applicable to facilitative (i.e., capitalizable) costs; therefore, identification of non-facilitative (i.e., deductible) costs may generate a significant permanent tax benefit.

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ENDNOTES

¹ This is consistent with the treatment of selling costs generally. See Treas. Reg. Section 1.263(a)-1(e), commissions and other transaction costs paid to facilitate the sale of property are not currently deductible under IRC Section 162 or 212. Instead, the amounts are capitalized costs that reduce the amount realized in the tax year in which the sale occurs.

² See Barbour Coal Co. v. Commissioner, 74 F.2d 163, 164 (10th Cir. 1934) ("It [a commission paid for selling stock] merely reduces the net returns from the sale of the stock and reduces the available capital. It has no relation to operating expenses. It is equivalent for income tax purposes to the sale of stock at a discount."); Simmons Co. v. Commissioner, 33 F.2d 75, 76 (1st Cir. 1929) ("Commissions paid for marketing stock simply diminish the net return from the stock issue. Financially, they are equivalent to an issue of stock at a discount from par; the par value must be carried as a liability without an off-setting, equal, amount of cash or property."); Affiliated Capital Corp., 88 T.C. at 1166.

³ 2004-11 I.R.B. 605.

⁴ The IRS requested comments on whether capitalized costs should: (1) increase the basis of particular assets (and, if the basis of multiple assets should be increased, the methodology for allocating such costs); (2) give rise to a new, unamortizable asset; (3) give rise to a new amortizable asset; (4) reduce the amount realized; (5) be treated as an adjustment to equity; (6) to the extent the costs give rise to a new, amortizable asset, the useful life of the asset (i.e., 15 years); (7) the treatment of costs prior to the expiration of the amortization period (i.e., liquidation).

⁵ (10/26/04). Further, in IRS Letter Ruling 200851018 (9/17/08), the IRS apparently viewed underwriting fees incurred by a taxpayer in a public offering as an offset against the proceeds of the offering. At issue was whether, under Treas. Reg. Section 1.1502-13, an underwriting fee charged by one member of a consolidated group to another member for underwriting services in connection with a public offering was included in income. The IRS held that the underwriting fee was not taken into income because the corresponding item (the payment of the fee) was a noncapital, nondeductible expense. The IRS specifically stated that the payment of the underwriting fee is not deductible or amortizable now or in the future. Implicit in this statement is that the IRS viewed the underwriting fee as netted against the proceeds of the offering. See also IRS Letter Ruling 201828008 (4/16/18).

⁶ LB&I Process Unit on Transaction Costs, available here.