Capitalization not required for payment to terminate management agreement prior to IPO.

Author:Meade, Kathleen
Position:Initial public offering

The IRS concluded in Letter Ruling 201518012 that a payment made to terminate a management services agreement did not create an intangible asset or facilitate a transaction and, therefore, did not have to be capitalized under Sec. 263.

Subsequent to undertaking an acquisition and bankruptcy reorganization, a group of corporations (Taxpayer) and an affiliate of the Taxpayer's sole owner (Manager) entered into a management services agreement under which, in exchange for a monthly fee, the Manager agreed to provide certain services (monitoring services) regularly to help the Taxpayer govern and oversee its business. These services included activities such as participation on the Taxpayers board and in monthly meetings; assistance to develop the Taxpayer's general corporate strategy and corporate governance functions; the provision of finance, tax, managerial, and operational oversight; mergers and acquisitions advice and support; and oversight and strategic support of the Taxpayer's internal and external legal services, facilities, sales, marketing, customer support, and human resources functions. The management services agreement, which was renewed for additional terms, did not prohibit the Taxpayer and the Manager from entering into contracts with other service providers or companies, so the management services agreement did not provide either party with an exclusive right.

Based on the Taxpayer's financial growth and rejuvenated business model, both the Taxpayer and the Manager eventually agreed to terminate the management services agreement. The termination agreement provided that upon the consummation of an underwritten (firm commitment) public offering resulting in the fisting or quotation of the Taxpayer's stock on one or more nationally recognized stock exchange or quotation systems, the Taxpayer would pay a termination fee to the Manager in consideration for all amounts owing under the management services agreement.

However, the Manager's receipt of the termination fee payment was not dependent upon a successful public offering. The termination fee was in part intended to compensate the Manager for having agreed to receive less than the amounts it would have ordinarily charged over the course of providing its services to the Taxpayer because the Taxpayer had just emerged from bankruptcy. In addition, the termination fee compensated the Manager for having successfully turned the Taxpayer's operations into a profitable business. No part...

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