Transaction cost considerations: Rev. Proc. 2011-29 and other related matters.

• Author: Mittman, Matthew J.

The treatment of success-based fees that are paid or incurred in connection with the successful closing of business acquisitions or reorganizations described in Regs. Sec. 1.263(a)-5(e)(3) (covered transactions) continues to be the subject of controversy between the IRS and taxpayers. Specifically, numerous disagreements have arisen regarding what documentation is necessary to establish that a portion of the success-based fee is allocable to activities that do not facilitate a business acquisition, which could result in an immediate deduction to the taxpayer.

In an effort to eliminate the controversy over the allocation of success-based fees and corresponding documentation requirements, the IRS issued Rev. Proc. 2011-29, providing taxpayers with a safe-harbor election for allocating 70% of success-based fees paid or incurred in a covered transaction described in Regs. Sec. 1.263(a)-5(e)(3) to activities that do not facilitate the transaction. The remaining 30% of the success-based fees must be capitalized as an amount that facilitates the transaction. The election is available for success-based fees paid or incurred in tax years ending on or after April 8,2011.

Taxpayers that choose not to make the election must maintain documentation under Regs. Sec. 1.263(a)-5(f) to establish that a portion of the success-based fees are allocable to activities that do not facilitate the transaction. As addressed below, the safe-harbor election under the revenue procedure attempts to eliminate the controversy over the allocation of success-based fees and the documentation requirements for only certain transactions.

Background

Under Sec. 263(a)(1) and Regs. Sec. 1.263(a)-2(a), capitalization is required and no immediate deduction is allowed for any amount paid for property that has a useful life substantially beyond the tax year of the taxpayer. In the case of an acquisition or reorganization of a business entity, acquisition costs that generate significant long-term benefits must be capitalized.

Under Regs. Sec. 1.263(a)-5, a taxpayer must capitalize amounts paid that facilitate transactions, including business acquisitions and reorganizations, described in Regs. Sec. 1.263(a)-5(a). An amount paid or incurred in the process of investigating or otherwise pursuing the transaction is an amount paid to facilitate a transaction described in Regs. Sec. 1.263(a)-5(a), unless the services were performed prior to the date the letter of intent was signed or the material terms of the transaction were agreed to by representatives of the acquirer and the target (this date is referred to as the bright-line date and is described in Regs. Sec. 1.263-5(e)(1)). (See Regs. Sec. 1.263-5(e)(2) for exceptions to Regs. Sec. 1.263-5(e)(l).)

A success-based fee paid or incurred on the closing of a transaction described in Regs. Sec. 1.263(a)-5(a) is presumed to facilitate the transaction under Regs. Sec. 1.263(a)-5(f). To rebut the presumption that a success-based fee paid or incurred is facilitative of a covered transaction, the taxpayer must maintain sufficient documentation in accordance with Regs. Sec. 1.263(a)-5(f). Covered transactions under 1.263(a)-5(e)(3) consist of:

* A taxable acquisition by the taxpayer of assets that constitute a trade...