Acquisition-related compensation not capitalized under INDOPCO.

• Author: Conjura, Carol

The IRS National Office has concluded in Letter Rulings, (TAMs) 9540003 and 9527005 that certain payments made to employees in connection with a reorganization are not required to be capitalized under INDOPCO, Inc., 503 US 79 (1992), even though the payments were made as a consequence of and were a condition of the reorganization. These rulings reflect the position that not all expenses in the context of a reorganization should be capitalized, and that the Service will allow a current deduction for expenses not directly related to investigating and negotiating the acquisition, if the expenses have their origin in something else (such as the employment relationship). The rationale in these rulings would also appear applicable to other types of acquisition-related expenses (other than those directly related to the acquisition), such as severance payments, training and other types of corporate integration expenses that necessarily follow a reorganization.

Origin of Claim Doctrine Applied

In TAM 9540003, prior to and independent of the reorganization, a target company had adopted "Management Incentive Plans," which entitled key employees to stock options and stock appreciation rights (SARs). In connection with the acquisition of its stock, the target company agreed to cancel the stock option and SAR plans and make all cancellation payments originally required by the plans, and to make additional settlement payments for the Federal income taxes imposed on the recipients. In addition, the acquiring company agreed to make a payment to the target to enable it to make the cancellation payments.

The IRS challenged the target's treatment of the payments as currently deductible compensation. The examining agent argued that the portion of the option cancellation payments representing a premium created by the tender offer and the entire payments for the SAR cancellations were directly attributable to the reorganization and, therefore, were subject to capitalization under INDOPCO.

The IRS National Office concluded that the examining agent's application of INDOPCO was overbroad. The mere fact that a takeover resulted in an expenditure was not enough to render an expense capital in nature Instead, the National Office reasoned that the payments were outside the scope of INDOPCO; they were in satisfaction of a preexisting (rather than a new) obligation generated by the reorganization, and were compensatory in nature. Even though the cancellation payments were...