Does Norwest expand INDOPCO's reach?

• Author: Conjura, Carol
• Position: Taxation

In Norwest Corp., 112 TC No. 9 (1999), the Tax Court determined that officers' salaries and legal fees incurred by a target company in a friendly acquisition were required to be capitalized, because they were sufficiently related to an event that produced a significant long-term benefit. Taxpayers should not be alarmed with the outcome in this case to the extent it requires the capitalization of a target's consulting fees related to a friendly acquisition, as that determination is consistent with the outcome in INDOPCO, Inc., 503 US 79 (1992). However, taxpayers should be concerned with the outcome in Norwest to the extent it expands INDOPCO's reach by requiring capitalization of otherwise deductible internal costs (i.e., officers' salaries) that would have been incurred notwithstanding the friendly acquisition.

Capitalization and INDOPCO

Sec. 263(a) provides that no deduction is allowed for capital expenditures. Regs. Sec. 1.263(a)-2 provides examples of capital expenditures and includes, among others, the cost of acquiring property with a useful life beyond the tax year. Thus, an expenditure generally must be capitalized under Sec. 263 if it is part of the cost of acquiring a tangible or intangible asset with a useful life greater than one year; see Lincoln Savings and Loan Association, 403 US 345 (1971). These costs are ordinarily recoverable through depreciation or amortization deductions over the asset's useful life. However, if the costs relate to an asset with an unlimited or indeterminate useful life, they may be recovered only on a disposition or cessation of the business.

In INDOPCO, the Supreme Court held that a target corporation undergoing a business restructuring must capitalize its professional fees. Even though the fees did not result in the creation of a separate and distinct asset, capitalization was required, because the expenditure resulted in future benefits to the taxpayer beyond the year in which the expenditure was incurred.

The Norwest Case

In Norwest, the taxpayer was a target company in a friendly acquisition. A portion of the taxpayer's officers' salaries and certain legal fees were attributed to the acquisition. The taxpayer argued that (1) the officers' salaries were ordinary and necessary business expenses (i.e., not capitalizable as part of the acquisition), because the officers' work on the transaction was tangential to their ordinary duties and (2) the legal fees were currently deductible, because they were primarily for "investigatory and due diligence services related to the expansion of its business which, for the most part, were incurred before management decided to...