Deductibility of target's professional fees in a hostile takeover.

• Author: Baldasaro, P. Michael
• Position: INDOPCO, Inc. case

As the Supreme Court was preparing to hear oral arguments in INDOPCO, Inc., Sup. Ct., 1992 (formerly National Starch & Chemical Corp., 93 TC 67 (1989), all'd, 918 F2d 426 (3d Cir. 1990)), on the deductibility of professional fees in a friendly takeover, the IRS attempted to further erode taxpayers' ability to deduct professional fees related to a takeover or tender offer, this time in a hostile takeover setting. In IRS Letter Ruling (TAM) 9144042, the Service invoked the long-term benefit test applied in National Starch to fees incurred in a hostile takeover, stating unequivocally that the nature of the takeover (hostile or friendly) is not determinative of the proper tax treatment of such fees.

In the technical advice memorandum, X received an unsolicited tender offer from Z to purchase approximately 45% of its common stock. To assess the terms and impact of the tender offer, X's board of directors engaged a team of investment bankers, attorneys and tax and media professionals. Relying on their advice, X's board of directors rejected the tender offer, and instituted steps to defend against a takeover. These steps included a counter-tender offer for Z's shares, a self-tender offer for X's own shares, and a judicial challenge of Z's credit agreement and Z's obligations under a consent agreement with X. After a temporary restraining order was imposed on Z's takeover attempt, X and Z entered into a settlement and standstill agreement under which X agreed to pay Z for the repurchase of X's stock, and to reimburse Z for amounts incurred in connection with the tender offer. X claimed that the board's actions were taken pursuant to its fiduciary responsibility to its shareholders and, therefore, the professional fees were deductible as ordinary and necessary expenses under Sec. 162.

The IRS stated that the nature of a proposed corporate takeover (i.e., friendly or hostile)was not determinative of the proper tax treatment for professional fee expenditures. Rather, the expenditures had to be analyzed to ascertain whether the target corporation obtained a resultant long-term benefit. Moreover, while the Service did not specifically reach a conclusion on the deductibility or nondeductibility of the fees, it placed the burden of proof on the taxpayer to demonstrate that it did not obtain a long-term benefit as a result of these expenditures. This requires the allocation of the professional fees to the various services performed and an analysis of...