Merger termination fee deductible.

• Author: Thornton, David A.

The Tax Court recently held in Santa Fe Pacific Gold Co., 132 T.C. No. 12 (2009), that a termination fee paid by the taxpayer to cancel a merger agreement in order to consummate a more lucrative merger was deductible. In reaching this conclusion, the court determined that the termination fee did not produce any significant long-term benefits for the taxpayer and that the terminated merger represented an abandoned transaction. While the IRS has historically sought to disallow deductions for merger termination fees paid under these circumstances, the decision reinforces the importance of the underlying facts and circumstances in making this determination.

Background

Santa Fe (the taxpayer) was a small mining company spun off as a separate and independent corporation by its former parent, a railroad company. Santa Fe owned significant land holdings containing valuable mineral rights, which it mined. Santa Fe sought to expand its business into a larger, more fully integrated mining operation. However, Santa Fe was aware that it would likely be the target of hostile takeover attempts by larger mining companies due to its attractive mineral deposit holdings.

In April 1996, Newmont USA Limited (Newmont), a prominent mining company, approached Santa Fe about a possible business combination and was rebuffed by Santa Fe. However, when it became evident that Newmont might launch a hostile takeover attempt, Santa Fe was forced to consider its strategic alternatives. Among these alternatives was to explore a potential combination with Newmont or seek a "white knight" merger candidate that might be more compatible with Santa Fe's business aspirations.

While in the process of exploring the consequences of a merger with Newmont, Santa Fe began secretly negotiating a possible merger with Homestake Mining Co. (Homestake), a smaller mining company that Santa Fe viewed as friendly to its overall business objectives. On November 21, 1996, Newmont submitted an offer to acquire Santa Fe. Homestake also submitted an offer one day later. Santa Fe's management and board determined that it was in the company's best interest to pursue the combination with Homestake. Upon being notified of its rejected offer, Newmont immediately began taking actions to thwart the Homestake merger and launch a hostile takeover of Santa Fe.

On December 8, 1996, the boards of both Santa Fe and Homestake unanimously approved and executed a merger agreement. The agreement included a fiduciary-out clause, allowing Santa Fe to consider superior offers if not doing so would violate its fiduciary duty to shareholders, and a termination fee clause that required Santa Fe to pay Homestake a fee of $65 million if Santa Fe terminated the merger agreement.

Notwithstanding the Santa Fe-Homestake merger agreement and the termination fee clause, Newmont proceeded with an increased offer to acquire Santa Fe. Santa Fe's board determined that rejecting the more lucrative...