CCA 200850012: a company chose to be acquired, and that choice made a pay disclosure mandatory

Plain-English summary

Company X was a public company. It agreed to be bought by Company Y, and the merger agreement let Company Y name a majority of Company X's board. That single term set off an SEC rule. Rule 14f-1 requires an issuer to file a statement when it expects its board majority to change in connection with a tender offer, and that statement has to carry the same executive pay disclosure that Item 402 of Regulation S-K requires. Company X filed the statement on Date B. A few months later the acquisition closed.

The tax question is what that filing did to Company X's deductions for Year C. Section 162(m) caps what a publicly held corporation may deduct for pay to its "covered employees." Section 162(m)(3) makes the chief executive covered automatically, and makes the four highest paid other officers covered if their total compensation is required to be reported to shareholders under the Exchange Act. Section 1.162-27(c)(2)(ii) ties that test to the Compensation Disclosure Rules rather than to any named form.

Company X argued it had no covered employees at all, on two grounds. First, that the Rule 14f-1 filing was voluntary, because signing the merger agreement was voluntary. Second, that section 162(m) reaches a company only when it must file a proxy statement containing a summary compensation table, which Company X never filed.

The memorandum rejects both. On the first, it draws the line between the deal and the filing: entering the merger agreement was a choice, but once entered, "Company X's filing of the Rule 14f-1 Statement was mandatory." On the second, it says Company X has misread what triggers the cap. Company X had also pointed to a set of private letter rulings, which the memorandum reads back against it: those rulings held that a target has no covered employees because it ceases to exist and so reports nothing, not because a proxy statement in particular was missing. The sentence doing the work is nine words long. "The form of disclosure of compensation is irrelevant for § 162(m)." So Company X's CEO and its four highest paid other officers were covered employees for Year C, and the deduction cap applied.

Ruling snapshot

• Question: Whether any of Company X's officers were "covered employees" under section 162(m) for the Year C tax year, where the only executive pay disclosure Company X made was in a Rule 14f-1 statement filed because its merger partner could name a majority of its board.
• Outcome: Advice given. Yes. Company X was a publicly held corporation registered under section 12 of the Exchange Act on the last day of Year C, and it was required to disclose the pay of its chief executive and four highest paid other officers under the Compensation Disclosure Rules, so those officers were covered employees. Both of Company X's arguments were rejected: the filing was mandatory even though the merger was not, and the form the disclosure takes does not matter.
• Key authorities: Sections 162(m), 162(m)(2) and 162(m)(3); Sections 1.162-27(c)(1) and 1.162-27(c)(2)(ii); section 12 of the Securities Exchange Act of 1934; Item 402 of Regulation S-K, 17 CFR 229.402; Rule 14f-1, 17 CFR 240.14f-1; Item 8 of Schedule 14A of Regulation 14A, 17 CFR 240.14a-101.

Notes on the document as released

This is a four page Chief Counsel memorandum from CC:TEGE:EB:EC, numbered POSTU-132682-08, dated August 27, 2008 and released December 12, 2008. It is signed by John B. Richards, Acting Senior Technician Reviewer, and addressed to Erica Wu at CC:LM:CTM:LN. Neither name is redacted. The legend redacts five terms: Company X, Company Y, Date A, Date B and Year C. The text layer is machine generated, so this file records it with no OCR correction pass.

The memorandum never cites section 6110(k)(3). The count of that string in the scan is zero. In place of the ruling-letter formula it carries the Chief Counsel Advice sentence, "This Chief Counsel Advice responds to your request for assistance. This advice may not be used or cited as precedent." The not-precedent banner above is supplied by this corpus and is not quoted from this document.

Item 402 is named four times and described four different ways. Once as "item 402 of the SEC regulations" with a lowercase i, once as "Item 402 of the SEC regulations", twice as "Item 402 of Regulation S-K". The fourth is the sentence that states the holding, and it reads "Item 402 of the Exchange Act". Item 402 is a Regulation S-K item, codified at 17 CFR 229.402, which this same memorandum says in full twice. The fourth description is wrong against the document's own text. It is reproduced here as released and it is not listed separately in the code sections.

The filing is called a "Rule 14f-1 Statement" with a capital S nine times. The one place the document describes the actual filing Company X made on Date B, it drops to lowercase: "Company X filed the Rule 14f-1 statement on Date B."

One sentence loses agreement in number. "Section 162(m)(3) provides that two types of employees of a publicly held corporation are a "covered employee."" A plural subject takes a singular predicate. That sentence is also the only place in the document with straight quotation marks. The scan holds exactly two straight double quotes, both of them that pair, against seventeen curly opening quotes and seventeen curly closing quotes everywhere else. The straight pair also puts the period inside the closing mark, which the curly uses of the same phrase do not.

Two sentences apart, the plural of private letter ruling is spelled two ways. "None of the PLRs hold" is followed by "Instead, the PLR's hold", with an apostrophe standing in for the plural. The scan holds "PLRs" three times and the apostrophe form once.

The extraction shows three page breaks and one line break inside the running text. Each page break interrupts a sentence, and the running header "POSTU-132682-08" with its page number lands in the gap: after "disclose compensation of these officers", after "serving as the registrant's chief", and after "other officers pursuant to the Compensation". Separately, at the foot of the third page the token "Rule 14f-1" is split across two lines as "Rule 14f-" and "1 Statement". None of these are repaired here. The quotations in the summary above are drawn only from stretches that no break interrupts.

The left margin is not uniform. The first page is indented eleven spaces and every later page sits flush at zero, which matches the margin behaviour of other Chief Counsel memoranda in this corpus. The measured range across all non-blank lines is zero to eleven. The text is kept exactly as extracted rather than squared up.

No case is cited anywhere in this memorandum, and no revenue ruling. The counts of " v. ", "T.C.", "F.2d", "C.B." and "Rev. Rul." in the scan are all zero. The private letter rulings Company X relied on are discussed but never numbered, so there is nothing here for a citation check to confirm and none was run.

Full text (IRS public release)

```text
Office of Chief Counsel
Internal Revenue Service
Memorandum
Number: 200850012
Release Date: 12/12/2008
CC:TEGE:EB:EC
POSTU-132682-08

UILC: 162.36-02

date: August 27, 2008

 to:   Erica Wu
       CC:LM:CTM:LN

from: John B. Richards, Acting Senior Technician Reviewer
CC:TEGE:EB:EC

subject: Covered Employees Under Section 162(m)

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.


       LEGEND

       Company X = ---------
       Company Y = -----------
       Date A = --------------------------
       Date B = -----------------------
       Year C = ------

       ISSUE

       Whether any of Company X’s officers were “covered employees” under I.R.C. § 162(m)
       for the Year C tax year?


       CONCLUSION

       Company X had officers who were “covered employees” for the Year C tax year.
       Company X’s chief executive officer and four highest compensated officers (other than
       the chief executive officer) were “covered employees” because Company X was a
       publicly held corporation registered under section 12 of the Securities Exchange Act of
       1934 (Exchange Act) and was required to disclose compensation of these officers

POSTU-132682-08 2

pursuant to the executive compensation disclosure rules under the Exchange Act for the
Year C tax year.

FACTS

Company X, a calendar year taxpayer, was a publicly held corporation registered under
section 12 of the Exchange Act for the Year C tax year. On Date A, Company X
entered into a plan of merger agreement with Company Y, a publicly held corporation.
The agreement permitted Company Y to designate a majority of Company X’s directors.
Because Company Y had the authority to appoint the majority of Company X’s directors,
Company X was required to file a statement with the Securities and Exchange
Commission (SEC) pursuant to Rule 14f-1 of the SEC regulations. Rule 14f-1 required
Company X to disclose compensation for its executive officers for Year C pursuant to
the executive compensation disclosure rules in item 402 of the SEC regulations
(“Compensation Disclosure Rules”). Company X filed the Rule 14f-1 statement on Date
B. A few months later, Company Y completed its acquisition of Company X.

LAW AND ANALYSIS

Section 162(m) limits a publicly held corporation’s deduction of employee remuneration
paid to its covered employees.

Section 162(m)(2) defines a publicly held corporation as a corporation issuing any class
of common equity securities required to be registered under section 12 of the Exchange
Act. Section 1.162-27(c)(1) adds that whether a corporation is publicly held is
determined based solely on whether, as of the last day of its taxable year, the
corporation is subject to the reporting obligations of section 12 of the Exchange Act.

Section 162(m)(3) provides that two types of employees of a publicly held corporation
are a "covered employee." First, an employee is a “covered employee” if, as of the
close of the taxable year, the employee is the chief executive officer of the corporation
or is an individual acting in such capacity. Second, an employee is a “covered
employee” if the total compensation of such employee for the taxable year is required to
be reported to shareholders under the Exchange Act by reason of such employee being
among the four highest compensated officers for the taxable year (other than the chief
executive officer). Section 1.162-27(c)(2)(ii) interprets the statutory definition by
providing that whether an individual is a chief executive officer or among the four
highest compensated officers is determined pursuant to the Compensation Disclosure
Rules under the Exchange Act.

The Compensation Disclosure Rules under the Exchange Act are contained in Item
402 of the SEC regulations. See Item 402 of Regulation S-K, 17 CFR 229.402. For
the Year C tax year, the Compensation Disclosure Rules required, in relevant part,
executive compensation disclosure for (i) all individuals serving as the registrant’s chief
POSTU-132682-08 3

executive officer or acting in a similar capacity during the last completed fiscal year
(“CEO”) regardless of compensation level and (ii) the registrant’s four most highly
compensated executive officers other than the CEO who were serving as executive
officers at the end of the last completed fiscal year. Id.

Rule 14f-1 of the SEC regulations requires an issuer to file a Rule 14f-1 Statement with
the SEC if the issuer anticipates a change in the majority of its board of directors in
connection with a tender offer. 17 CFR 240.14f-1. The Rule 14f-1 Statement must
contain information that is substantially equivalent to the information required by Item 8
of Schedule 14A of Regulation 14A. Id. Item 8 of Schedule 14A of Regulation 14A
requires the issuer to furnish information required by Item 402 of Regulation S-K, which
contains the Compensation Disclosure Rules. 17 CFR 240.14a-101.

Company X was a publicly held corporation because on the last day of its taxable year it
was subject to the reporting requirements under section 12 of the Exchange Act.

Company X was required to file a Rule 14f-1 Statement and thus report the executive
compensation of its officers pursuant to the Compensation Disclosure Rules contained
in Item 402 of the Exchange Act. Therefore, Company X’s CEO and four highest
compensated officers (other than the CEO) are “covered employees” for purposes of
§ 162(m) for the Year C tax year.

Company X argues that it does not have any “covered employees” for the Year C
taxable year for two reasons. First, Company X claims that because filing the Rule 14f-
1 Statement was voluntary, any compensation disclosed in the Statement was not
“required to be reported” within the meaning of § 162(m). Company X maintains that
filing the Rule 14f-1 Statement was voluntary because it voluntarily entered into the plan
of merger agreement with Company Y. Second, Company X argues that it is not
subject to § 162(m) because it was not required to and did not file a proxy statement
containing a summary compensation table when filing the Rule 14f-1 Statement.

Company X’s first argument is without merit. Even though Company X voluntarily
entered into the plan of merger agreement with Company Y, Company X’s filing of the
Rule 14f-1 Statement was mandatory. Rule 14f-1 of the SEC regulations requires
certain issuers to file Rule 14f-1 Statements, which must include information on the
compensation of its officers pursuant to the Compensation Disclosure Rules.

Company X’s second argument is based on an incorrect assumption. In arguing that it
is not subject to § 162(m) because it was not required to and did not file a proxy
statement containing a summary compensation table when filing the Rule 14f-1
Statement, Company X assumes that a publicly held corporation is subject to § 162(m)
only when it is required to file a proxy statement containing a summary compensation
table. This assumption is incorrect. A publicly held corporation has “covered
employees” and is thus subject to § 162(m) when it is required to disclose executive
compensation of its chief executive and other officers pursuant to the Compensation
POSTU-132682-08 4

Disclosure Rules. See Reg. § 1.162-27(c)(2)(ii). As illustrated by the rules for filing a
Rule 14f-1 Statement, required disclosure of executive compensation pursuant to the
Compensation Disclosure Rules is not limited to proxy statements that contain summary
compensation tables.

Company X cites a number of PLRs in arguing that if an issuer is not required to file a
proxy statement containing a summary compensation table, then the issuer does not
have any “covered employees” for purposes of § 162(m). Generally these PLRs
address whether a Target corporation has “covered employees” for purposes of
§ 162(m) after being acquired by another corporation, and rule that the Target has no
“covered employees” because the Target ceases to exist after the acquisition and is
thus not required to file a proxy statement containing a summary compensation table.
None of the PLRs hold that an issuer has no “covered employees” because the issuer is
not required to file a proxy statement containing a summary compensation table.
Instead, the PLR’s hold that if an issuer is not required to report executive
compensation of its officers pursuant to the Compensation Disclosure Rules, then the
issuer does not have any “covered employees” for purposes of § 162(m). The form of
disclosure of compensation is irrelevant for § 162(m). If an issuer discloses executive
compensation of its officers pursuant to the Compensation Disclosure Rules, then the
issuer has “covered employees” subject to § 162(m).

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 622-6030 if you have any further questions.
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