Investment adviser's inducement payments to shareholders are not intangibles.

• Author: Kay, Sharon A.

The IRS ruled in Letter Ruling 201736002 that an investment adviser's inducement payments to a target company's shareholders in a merger are deductible under Sec. 162 and are not required to be capitalized under Sec. 263.

The taxpayer, an investment adviser to the acquirer in a merger, is not a related party to the acquirer under Sec. 267(b). The taxpayer manages the acquirer under an investment management agreement (IMA). The IMA bases the taxpayer's management fees from the acquirer, in part, on the acquirer's total assets. The acquirer's board of directors or shareholders must approve the IMA at least annually, and either party may terminate it upon 60 days' written notice.

The acquirer entered into a merger agreement, subject to the target's shareholders' approval, to acquire the target in a transaction that would result in an indirect acquisition of all the target's assets. The taxpayer expected that its future fees under the IMA would increase due to the merger because the acquirer's asset size would increase. Therefore, to induce the target's shareholders to approve the merger, the taxpayer made a payment per share to the target's shareholders. The taxpayer did not receive any stock, cash, or other property from the acquirer, target, or any of their shareholders, employees, or affiliates.

The taxpayer only had a mere hope that its business would increase due to the merger. The taxpayer represented that it is common for investment advisers to provide financial inducements to attract and retain investors.

The taxpayer requested a ruling whether it could deduct the inducements to the target's shareholders as an ordinary and necessary business expense under Sec. 162 and whether it was required to capitalize the inducements under Sec. 263.

The IRS first analyzed whether the payments were ordinary and necessary under Sec. 162. The IRS stated that because the taxpayer represented that the inducement payments are typical in the industry, they are ordinary expenses under Sec. 162. Additionally, because the inducement payments would hopefully increase the fees paid to the taxpayer under the IMA, the IRS ruled that inducement payments help the development of the taxpayer's business and, therefore, are a necessary expense under Sec. 162.

The IRS next analyzed the applicability of Sec. 263(a) and Regs. Sec. 1.263(a)-4, which requires the capitalization of intangible assets. Generally, a taxpayer is required to capitalize:

1. An amount paid to...