Let’s say X Co. pays $10,000,000 to purchase the stock or assets of Y Co. Prior to closing on the transaction, X Co. utilizes attorneys to structure the deal, CPAs to advise on the tax implications, and an investment banking firm to help find Y Co.
Once the deal is consummated, X Co. pays a $500,000 fee to the investment bank as a success-based fee.
Why do you care about any of this?
Treasury Regulation S1.263(a)-5 provides that a taxpayer must capitalize any amount paid “to facilitate a business acquisition or reorganization transaction.” In general, an amount is paid to facilitate a transaction if the amount is paid in the process of investigating or otherwise pursuing the transaction.
These regulations also provide that an amount that is contingent on a successful transaction — such as X Co.’s $500,000 payment to the investment bank — is presumed to facilitate the transaction. X Co. is permitted to rebut this presumption and allocate a portion of the $500,000 fee to non-facilitative and potentially deductible expenses, but the regulations require that onerous documentation requirements be met to prove the costs were incurred for deductible purposes.
Last week, the IRS threw taxpayers a bone and greatly simplified the treatment of these success-based fees. Revenue Procedure 2011-29 provides a friendly safe harbor, allowing taxpayers to treat 70% of their success-based fee as deductible costs that do not facilitate the transaction, provided the remaining 30% is treated as facilitating the transaction and capitalized.
In our example above, rather than X Co. having to either 1) capitalize the entire $500,000 success-based fee, or 2) hope their documentation of the services performed by the investment bank is sufficient to support an allocation between deductible and non-deductible costs, X Co. can now simply elect to deduct $350,000 of the $500,000 fee and capitalize the remaining $150,000, with no onerous record-keeping necessary.
The safe harbor is effective for success-based fees paid or incurred in taxable years ending on or after April 8th, 2011. In order to elect the safe harbor, the taxpayer must attach a statement to its tax return for the year the success-based fee is paid or incurred, stating that the taxpayer is electing the safe harbor, identifying the transaction, and stating the success-based fee amounts that are deducted or capitalized.