Taxability of fees in financing a stock redemption.

• Author: Goergen, Glenn N.

On Oct. 29, 1992, the Arizona District Court reversed a lower Bankruptcy Court decision that allowed corporations to amortize and deduct loan-related fees (including attorneys' fees and other loan commitment fees), over the life of a loan incurred in financing a stock redemption. The district court in In re Kroy (Europe) Limited, DC Ariz., 1992, rev'g Bankr. D. Ariz., 1992, held that Sec. 162(k) does not allow a corporation to deduct any loan and administrative fees incurred in connection with a corporation's redemption of its stock. Previously, the courts and the IRS had determined that a corporation may amortize and deduct loan fees related to acquiring a loan over the life of the loan. Now, the district court has found that Sec. 162(k) supersedes this prior case law and requires the taxpayer to capitalize any expenditures causally related to a stock redemption. The court's decision in this case overturned over 30 years of precedent that had mandated examination of the costs' origin, rather than the taxpayer's purpose, in ascertaining the deductibility of corporate expenditures. Unfortunately, the court did not fairly consider the judicial or legislative history of Sec. 162(k) in arriving at its decision. The Service now has complete discretion in determining which expenditures are related to a redemption and which are not. Further, the court has given taxpayers no real guidance in this matter.

Kroy became a private company in a leveraged buy-out transaction when it merged with another company to form a new Kroy. Bankers Trust assisted in obtaining $78 million in loans for the stock buyback and charged subsequent debtor Kroy advisory fees of $1.8 million and a placement fee of $655,000. Additionally, debtor Kroy incurred other fees equaling $2.27 million for accounting, legal and other services, for a total of $4.1 million in amortizable loan costs relating to the stock buyback. Kroy treated $1.825 million (the costs incurred in the actual course of the stock redemption) as nondeductible capital expenditures.

The IRS argued that Sec. 162(k) prevented Kroy from deducting the financing and service costs of procuring the loan because Kroy paid these costs in connection with the redemption of its stock. The proper treatment of these costs, according to the Service, was capitalization without any amortization.

Sec. 162(k) provides that "no deduction, otherwise allowable, shall be allowed under this chapter for any amount paid or incurred by a...