Possible impact of INDOPCO decision on business start-up expenditures.

• Author: Grassi, Carl J.

The amortization of start-up expenditures under Sec. 195 may be adversely affected by a recent Supreme Court decision, INDOPCO (formerly National Starch), 2/26/92, aff'g 918 F2d 426 (3d Cir. 1990). The Supreme Court unanimously held that investment banking, legal fees and related expenses incurred by a taxpayer to evaluate a friendly takeover by another corporation were not deductible as current business expenses, but rather had to be capitalized.

The Supreme Court dismissed the taxpayer's argument that a separate and distinct asset must be created for an amount to be classified as a capital expenditure. In doing so, the Court rejected a line of circuit court cases that generally held otherwise. (See NCNB Corp., 684 F2d 285 (4th Cir. 1982); Briarcliff Candy Corp., 475 F2d 775 (2d Cir. 1973); Central Texas Savings & Loan Ass'n, 731 F2d 1181 (5th Cir. 1984).)Instead, the Supreme Court stated that "the creation of a separate and distinct asset well may be a sufficient but not a necessary condition to classification as a capital expenditure."

Justice Blaekmun stated that "the mere presence of an incidental future benefit... may not warrant capitalization." However, a "taxpayer's realization of benefits beyond the year in which the expenditure is incurred is undeniably important in determining whether the appropriate tax treatment is immediate deduction or capitalization."

In applying this reasoning to the expenditures at issue in INDOPCO, the Supreme Court concluded that the takeover expenses produced significant benefits to the taxpayer beyond the tax year in question by enabling the taxpayer to have access to the considerable resources of the acquiror.

The potentially broad-reaching significance of this decision is that it establishes that the determination of whether an expenditure is capital or deductible is dependent on the existence of a benefit beyond the current tax year, not the creation of a separate and distinct asset. As a result, it is possible the IRS will aggressively apply this decision's rationale to areas beyond the merger and acquisition arena.

The Service may assert that if an expenditure produces a future benefit that is more than just incidental, it should be capitalized. Such a position may directly undermine the operation of Sec. 195, which is premised on the fact that start-up expenditures (eligible for amortization over 60 months or more) include only those items that would be currently deductible if incurred in an...