Documenting deductions for investment banking fees.

• Author: Thornton, David A.

The Supreme Court's decision in INDOPCO, Inc., 503 US 79 (1992), held that fees for professional services (including investment banking services) incurred to facilitate a corporate acquisition have to be capitalized, because they produce a long-term benefit. However, the later decision in A.E. Staley Mfg. Co., 119 F3d 482 (7th Cir. 1997), clarified that investment banking fees paid in a successful merger transaction could be bifurcated into deductible and non-deductible components based on the nature of the underlying services. This division was allowed even though the investment banking fee was only to be paid on the merger's successful closing.

Sec. 263 Final Regs.

The bifurcation of investment banking fees has been a common practice in business acquisitions and was ultimately accepted in final regulations issued under Sec. 263. These rules provide guidance for capitalizing costs related to business acquisitions; generally, Regs. Sec. 1.263(a)-5(a) provides that costs incurred after a formal decision is made to pursue a transaction are facilitative and must be capitalized. Costs incurred before such date are generally deemed to be investigatory and, thus, deductible, subject to the special rule described below.

"Inherently Facilitative Amounts"

Regs. Sec. 1.263(a)-5(e)(2) provides an exception to the deductibility rule described above for "inherently facilitative amounts." Costs deemed to be inherently facilitative to a transaction are required to be capitalized, regardless of when incurred in the corporate acquisition timeline. These costs include professional or other fees incurred to structure the proposed transaction, to obtain regulatory or shareholder approval and to secure an appraisal, written evaluation or fairness opinion related to the transaction.

Success-Based Fees

Regs. Sec. 1.263(a)-5(f) specifies how the deductible portion of success-based fees (such as transaction-based investment banking fees) must be documented. This guidance imposes certain requirements on the nature and timing of the information supporting the deduction.

Required documentation: Regs. Sec. 1.263(a)-5(f) cautions that the support must consist of more than "merely an allocation between activities that facilitate the transaction and activities that do not facilitate the transaction, and must consist of supporting records (for example, time records, itemized invoices, or other records).... "These records must generally describe the activities performed by...