IRS addresses treatment of M&A transaction costs and success-based fees.

• Author: Conjura, Carol
• Position: Mergers and acquisitions

Taxpayers that incur costs relating to an acquisition or restructuring transaction must generally capitalize the costs that "facilitate" the transaction (Regs. Sec. 1.263 (a)-5(a)). The regulations provide guidelines for determining whether expenditures facilitate a transaction (Regs. Sec. 1.263 (a)-5(b)). For certain acquisitive transactions, this determination may be based on whether the costs were incurred prior to the "bright-line date." In addition, for "success-based fees"--payments to professional service providers that are contingent upon the successful closing of a transaction--taxpayers may apply a facts-and-circumstances test under Regs. Sec. 1.263 (a)-5(b)(1) or a safe harbor to determine the portion of the total fees that is deemed to facilitate the transaction.

Facts-and-Circumstances Test

Regs. Sec. 1.263(a)-5(a) requires a taxpayer to capitalize amounts paid to "facilitate" (i.e., paid in the process of investigating or otherwise pursuing) several types of "covered transactions," including an acquisition of an ownership interest in the taxpayer (but not an acquisition by the taxpayer of an ownership interest in the taxpayer itself, whether by redemption or otherwise). The determination of whether an amount is paid in the process of investigating or otherwise pursuing the transaction is based on all of the facts and circumstances. Except for certain inherently facilitative costs, such as costs of securing an appraisal, structuring and negotiating the transaction, preparing and reviewing the transaction documents, and obtaining regulatory and shareholder approval of the transaction (see Regs. Sec. 1.263 (a)-5(e)(2)), Regs. Sec. 1.263(a)-5(e) treats an expenditure as an amount that facilitates a covered transaction only if it relates to activities performed on or after a bright-line date.

A two-part test defines the bright-line date as the earlier of (1) the date on which a letter of intent, exclusivity agreement, or similar written communication (other than a confidentiality agreement) is executed by representatives of the acquirer and the target; or (2) the date on which the material terms of the transaction (as tentatively agreed to by representatives of the acquirer and the target) are authorized or approved by the taxpayer's board of directors (or committee of the board of directors) (Regs. Sec. 1.263(a)-5(e)(1)).

Covered transactions include, among other things, certain taxable acquisitions of an ownership interest in a...