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In PLR 202410009, the IRS granted a request for an extension of time to make the safe harbor election under Revenue Procedure 2011-29 for a success-based fee paid upon the completion of a merger. Notably, the entity making the late election is a wholly owned subsidiary of the legal acquirer and not a party to the transaction.

Facts

Taxpayer is the common parent of an affiliated group of corporations and uses an overall accrual method of accounting. Taxpayer also is a wholly owned indirect subsidiary of a foreign entity (F). Pursuant to an Agreement and Plan of Merger (Agreement), a member of Taxpayer's group (A) acquired the shares of another entity (B or Target) through a merger of C, a wholly owned subsidiary of A, into B with B surviving as a wholly owned subsidiary of A (the Transaction). As a result of the Transaction, B became a member of Taxpayer's group.

Taxpayer represents that D, wholly owned by A, incurred costs in connection with the acquisition of B (Transaction Costs). After the acquisition, B operated within the same line of business as D, and D is the legal entity responsible for this business.

F entered into an agreement with a financial advisor to provide services related to the acquisition of B. The agreement indicated the advisor would receive a success-based fee and a separate discretionary fee. The discretionary fee was dependent upon F's assessment of the quality of the services provided by the advisor and was based on the advisor's "negotiation support, valuation support and other factors."

After the acquisition, the advisor invoiced F for both the success-based fee and separate discretionary fee (collectively, the Success Fees). The costs for a fairness opinion were also included in the invoice, but no separate charge was stated for the fairness opinion. Taxpayer claimed the discretionary fee is a success-based fee under Revenue Procedure 2011-29, and the advisor would not have been paid for any services related to the Transaction had the Transaction not closed, including for the fairness opinion. F paid the fees in its local currency to the advisor. Taxpayer represents that the advisor fees were paid on behalf of D and were reimbursed by D.

Taxpayer reported the Success Fees on its consolidated federal income tax return as 70% deductible and 30% capitalizable pursuant to the safe harbor election under Revenue Procedure 2011-29. While preparing the following year's tax return, Taxpayer's Director of Tax Compliance (Director) discovered that D and Taxpayer failed to file the election statement required by Revenue Procedure 2011-29. The Director also discovered that D, erroneously, deducted 70% of all the Transaction Costs and capitalized the remaining 30% into B's stock basis.

Ruling

The IRS granted an extension of time under Treas. Reg. Section 301.9100-1 and 301.9100-3 (9100 relief) to make the safe harbor election as it found Taxpayer acted reasonably and in good faith and granting relief would not prejudice the government's interests.

In its ruling, the IRS considered rules under Treas. Reg. Section 1.263(a)-5. Under Treas. Reg. Section 1.263(a)-5, a taxpayer must capitalize costs incurred to facilitate certain transactions. Generally, an amount facilitates a transaction if it is paid in the process of investigating or otherwise pursuing the transaction. Determining whether an amount is paid to investigate or pursue a transaction depends on the facts and circumstances underlying the cost. Further, the IRS explained that Treas. Reg. Section 1.263(a)-5(e) provides certain transactions, such as the stock acquisition in the PLR, are considered "covered" and able to apply certain rules, such as the "bright-line" date. In addition to the "bright-line" date, taxpayers with a covered transaction are also able to apply the safe harbor under Revenue Procedure 2011-29 to their success-based fees. The revenue procedure provides that a success-based fee (i.e., one that is contingent on the consummation of the transaction) may be treated a 70% non-facilitative and 30% facilitative of the transaction. On review of the facts, the IRS granted the Taxpayer's extension of time to make the election under Revenue Procedure 2011-29 as it concluded that the Taxpayer met the requirements for 9100 relief.

Finally, the IRS provided the following caveat, "Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter, including whether the discretionary fees and the unstated portion of the fee associated with obtaining an appraisal are success-based fees or otherwise eligible for the [Revenue Procedure] 2011-29 safe harbor. No opinion is expressed on the appropriate amount of the success-based fee eligible for the safe harbor (emphasis added)."

Implications

Location

By granting the 9100 relief request, the IRS appears to have implicitly agreed that an entity that is not a party to the transaction may be eligible to take certain transaction costs into account and elect the safe harbor under Revenue Procedure 2011-29. Here, D, a member of Taxpayer's group was not a party to the acquisition. The legal acquirer was A, but D incurred costs in connection with the Transaction, including the Success Fees.

The transaction costs rules under Treas. Reg. Section 1.263(a)-5 do not appear to be broadly applicable to any party that may incur expenses related to a transaction; instead, the rules specifically contemplate that the taxpayer is a party to the transaction. In the case of a stock acquisition, Treas. Reg. Section 1.263(a)-5 contemplates that the party is either the acquirer or the target. Specifically, the transactions that fall within the ambit of Treas. Reg. Section 1.263(a)-5 include: (1) an acquisition by the taxpayer of an ownership interest in a business entity if, immediately after the acquisition, the taxpayer and the business entity are related within the meaning of IRC Sections 267(b) or 707(b); and (2) an acquisition of an ownership interest in the taxpayer (other than an acquisition by the taxpayer of an ownership interest in the taxpayer, whether by redemption or otherwise). Moreover, the bright-line date rule in Treas. Reg. Section 1.263(a)-5(e), which provides the principal exception to the capitalization of transaction costs and the definition of a "covered transaction," is precisely drafted so that the exception for transaction costs applies only to transactions meeting the definition of a "covered transaction," to identify the specific parties to the transaction to whom that provision applies. For example, a "covered transaction" includes "a taxable acquisition of an ownership interest in a business entity (whether the taxpayer is the acquirer in the acquisition or the target of the acquisition) (emphasis added)." Thus, in the case of a taxable stock acquisition, the literal language of Treas. Reg. Section 1.263(a)-5(e)(3)(ii) appears to be limited to the acquirer or target.

In general, courts and the IRS weigh three factors in determining the proper entity to take an expense into account, including whether the entity (1) had the legal liability to pay, (2) bore the economic burden, and (3) benefitted from the cost. Although the IRS did not evaluate whether D was the proper entity to take the Transaction Costs into account, it implicitly agreed by granting D an extension of time to make the election. As discussed above, the IRS stated in the Facts section of the ruling that "[t]he B acquisition was of an entity that operated within the E line of business and D is the legal entity responsible for this business." As such, it is reasonable to infer that the IRS considered the benefit that D received from the Transaction, and related costs, as it was in the same line of business as B before and after the Transaction. D also bore the economic burden of the Success Fees by reimbursing F for the amount invoiced. F had the legal liability as the party that engaged the financial advisor, but legal liability alone is not determinative. Based on the conclusion of the ruling, it appears the IRS considered these location factors, with particular emphasis on benefit, when granting D an extension of time to elect the safe harbor on the Success Fees.

While this outcome appears inconsistent with the literal language of the covered transaction regulations described above, which refer to the taxpayer as the acquirer or target, one possible interpretation might be that the IRS applied a single entity approach to the covered transaction regulations since A (the acquirer) and D are members of the same consolidated group.

The ruling confirms that taxpayers should continue to carefully examine their specific facts and circumstances when determining which party to a transaction is the appropriate entity to take transaction costs into account.

Capitalizable Costs

While the IRS granted the 9100 relief request, allowing D to elect the safe harbor for the Success Fees, it noted that D incorrectly deducted 70% of all the Transaction Costs (i.e., both the Success Fees and non-success based fees) and capitalized 30% into B's stock basis. The IRS was likely referring to application of the safe harbor election to the non-success fees as erroneous; however, capitalization of the costs to B's stock basis is also improper because B's stock is not an asset held by D. Presumably, the capitalizable costs should be capitalized by D to a separate non-amortizable intangible asset, as there is no specific asset held by D to which it would be capitalized into. Note, if the Transaction Costs were taken into account by A as the legal acquirer of B stock, the capitalization of the costs into B's stock basis would be proper.

The IRS did not express an opinion on the non-success based fees, but the improper treatment could be remedied through an amended return or accounting method change request depending on the facts and circumstances.

Discretionary Fees

The IRS granted 9100 relief to apply Revenue Procedure 2011-29 to the Success Fees, which included a discretionary fee. While the IRS granted 9100 relief to make a late safe harbor election (presumably on the success-based fee and discretionary fee), it stated that it was expressing no opinion on "whether the discretionary fees and the unstated portion of the fee associated with obtaining an appraisal are success-based fees or otherwise eligible for the [Revenue Procedure] 2011-29 safe harbor." Thus, it is unclear whether the IRS views a discretionary fee as a success-based fee.

As discussed above, the financial advisor fees included (1) a success-based fee, (2) a discretionary fee and (3) costs for the fairness opinion (not separately stated on the invoice). Pursuant to Treas. Reg. Section 1.263(a)-5(f), a success-based fee is an amount paid that is contingent on the successful closing of a transaction. The discretionary fee was dependent on F's assessment of the quality of services provided by G, and Taxpayer represented that it was a success-based fee. Taxpayer also represented that it would not have paid for any services provided by the financial advisor, including the fairness opinion, if the transaction had not closed.

While the amount of the fee may be discretionary, an inherent aspect of a discretionary fee may be that it would not have been paid if the transaction did not successfully close. However, there may be ambiguity depending on the nature of the fee as defined in the engagement agreement. As such, it is important to understand the circumstances under which the fee would be paid to determine whether it is eligible for the Revenue Procedure 2011-29 safe harbor election.

Additionally, it's important to note that a fairness opinion fee generally is not eligible for the safe harbor election if it is defined as a separate fee for the fairness opinion in the engagement agreement. Services related to a fairness opinion are inherently facilitative requiring capitalization under Treas. Reg. Section 1.263(a)-5(e)(2). In this case, it appears the fairness opinion fee was not separately stated but was embedded in the success-based fee. As such, it was appropriate to apply the safe harbor election to the success-based fee, even though it included costs for the fairness opinion.