Taxpayer received 45 days to elect the success-based-fee safe harbor

Plain-English summary

A taxpayer paid a success-based investment-banking fee in a corporate acquisition and capitalized the entire amount on its short-year return. It intended to elect the Revenue Procedure 2011-29 safe harbor, which generally treats 70 percent of such a fee as non-facilitative and potentially deductible while capitalizing the remainder, but its prior accounting firm omitted the election statement. The taxpayer represented that it knew of the safe harbor, believed the election had been filed, had no affected closed tax years, and was not using hindsight. The IRS found reasonable conduct, good faith, and no prejudice to the government. It granted 45 days to file the required election statement. The IRS did not decide whether the transaction or all included costs qualified for the safe harbor.

Ruling snapshot

• Question: Could the taxpayer make a late safe-harbor election for its acquisition success-based fee?
• Outcome: Approved, with 45 days to file the mandatory statement
• Key authorities: IRC § 263; Treas. Reg. §§ 1.263(a)-5 and 301.9100-1 through -3; Rev. Proc. 2011-29

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201418010
Third Party Communication: None
Release Date: 5/2/2014
Date of Communication: Not Applicable
Index Number: 9100.00-00
Person To Contact:
------------------------------------------------------------ ------------------------, ID No. ----------
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Telephone Number:
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---------------------------------------------------------- Refer Reply To:
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CC:ITA:B02
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PLR-129827-13
Date:
March 13, 2014

Legend

Taxpayer = ---------------------------------------------------------------------------------
Acquired Company = --------------------------------------
Investment Company = ------------------------------------
Year1 = -------
Date A = -------------------
X% = ----------
Taxable Year 1 = ---------------------------------------------------------------------------------
Y$ = ---------------

Dear ---- ----------:

Due to processing delays, this letter supersedes our prior letter dated January 9, 2014. This is in response to the letter dated June 17, 2013, submitted on your behalf by your authorized representative. In the letter, you request an extension of time to file an election and its accompanying statement to the Taxpayer’s originally filed federal tax return for Taxable Year 1. The election and accompanying statement were not made on Taxpayer’s originally filed federal tax return for Taxable Year 1 although it was required in order for Taxpayer to use a safe harbor method of accounting. The request is made in accordance with §§ 301.9100-1 and 301.9100-3 of the Procedure and Administration Regulations.

Taxpayer represents the following facts:

Taxpayer through a subsidiary purchased Acquired Company on Date B. The acquisition and merger were treated as a stock acquisition and a covered transaction. Merger compensation was paid directly to Acquired Company’s shareholders; no debt was incurred in the acquisition. Taxpayer assumed all outstanding liabilities of Acquired Company and refinanced the liabilities through
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its bank, capitalizing all the associated fees of the assumption of liabilities to the debt.

In order to facilitate the transaction, Taxpayer engaged Investment Company to provide investment banking services. Under the terms of the engagement letter, Investment Company would be paid, upon consummation of a transaction, a fee equal to X% of the total consideration paid by Taxpayer to complete the transaction. Out of pocket expenses were reimbursed, and no expenses were included in the success-based fee. On Date A, Taxpayer executed the stock purchase agreement and bought Acquired Company. As a result of the purchase, Taxpayer had a short tax year for the period Taxable Year 1.

Upon execution of the stock purchase agreement on Date B, Taxpayer paid Investment Company its success-based fee, X% of the total consideration, or Y$.
For the short tax year Taxable Year 1, consistent with its treatment for financial statement purposes prepared by a prior accounting firm, Taxpayer capitalized the success-based fees paid to Investment Company of Y$ in accordance with § 263 of the Internal Revenue Code and § 1.263(a)-2(a) and § 1.263(a)-5 of the Income Tax Regulations.

Taxpayer represents that it intended to take advantage of the safe harbor election under Revenue Procedure 2011-29, 2011-18 I.R.B. 746, for Taxable Year 1. Taxpayer represents that its prior accounting firm inadvertently failed to file the election (and thus to treat a portion of the success-based fees as deductible). Taxpayer represents that it was aware of the safe harbor and believed the election had been timely made; that there are no tax years closed that would be affected by granting of the proposed relief; and that Taxpayer’s decision does not involve hindsight.

Section 263(a)(1) and § 1.263(a)-2(a) provide that no deduction shall be allowed for any amount paid out for property having a useful life substantially beyond the taxable year. In the case of an acquisition or reorganization of a business entity, costs that are incurred in the process of acquisition and that produce significant long-term benefits must be capitalized. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 89-90 (1992); Woodward v. Commissioner, 397 U.S. 572, 575-576(1970).

Under § 1.263(a)-5, a taxpayer must capitalize an amount paid to facilitate a business acquisition or reorganization transaction described in § 1.263(a)-5(a). An amount is paid to facilitate a transaction described in § 1.263(a)-5(a) if the amount is paid in the process of investigating or otherwise pursuing the transaction.

Section 1.263(a)-5(f) provides that an amount that is contingent on the successful closing of a transaction described in § 1.263(a)-5(a) ( “success-based fee”) is presumed to facilitate the transaction, and thus must be capitalized. A taxpayer may rebut the presumption by maintaining sufficient documentation to establish that a portion of the
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fee is allocable to activities that do not facilitate the transaction, and thus may be deductible.

A taxpayer’s method for determining the portion of a success-based fee that facilitates a transaction and the portion that does not facilitate the transaction is a method of accounting under § 446.

Because the treatment of success-based fees was a continuing subject of controversy between taxpayers and the Service, the Service published Revenue Procedure 2011-

29. Revenue Procedure 2011-29 provides a safe harbor method of accounting for
    allocating success-based fees paid in business acquisitions or reorganizations described in regulations section 1.263(a)-5(e)(3). In lieu of maintaining the documentation required by section 1.263(a)-5(f), this safe harbor permits electing taxpayers to treat 70 percent of the success-based fee as an amount that does not facilitate the transaction (i.e., amounts that can be deducted). The remaining portion of the fee must be capitalized as an amount that facilitates the transaction.

Section 4.01 of Revenue Procedure 2011-29 allows the taxpayer to make a safe harbor election with respect to success-based fees. Section 4.01 provides that the Service will not challenge the taxpayer’s allocation of success-based fees between activities that facilitate a transaction described in § 1.263(a)-5(e)(3) (costs that must be capitalized) and activities that do not facilitate the transaction (cost that may be deductible) if the taxpayer does three things. First, the taxpayer must treat 70 percent of the amount of the success-based fee as an amount that does not facilitate the transaction and thus may be deductible. Second, the taxpayer must capitalize the remaining amount of the success-based fee as an amount which does facilitate the transaction. Finally, the taxpayer must attach a statement to its original federal income tax return for the taxable year the success-based feed is paid or incurred, stating that the taxpayer is electing the safe harbor, indentifying the transaction, and stating the success-based fee amounts that are deducted (treated as not facilitating the transaction) and capitalized (treated as facilitating the transaction).

Taxpayer requests permission to elect the safe harbor with respect to its success-based fees paid to Investment Company. With this ruling request, Taxpayer requests permission to elect the provisions of Section 4.01 of Revenue Procedure 2011-29 and attach the proper election statement by amending its original filed return and superseding it with a return where it will elect the safe harbor (deducting a portion of the success-based fees) and will attach the proper election statement.

Section 301.9100-1(c) provides that the Commissioner has discretion to grant a reasonable extension of time under the rules set forth in §§ 301.9100-2 and 301.9100-3 to make certain regulatory elections. Section 301.9100-1(b) defines a “regulatory election” as an election whose due date is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice or announcement
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published in the Internal Revenue Bulletin.

Sections 301.9100-1 through 301.9100-3 provide the standards the Commissioner will use to determine whether to grant an extension of time to make an election. Section 301.9100-2 provides automatic extensions of time for making certain elections. Section 301.9100-3 provides extensions of time for making elections that do not meet the requirements of § 301.9100-2.

Section 301.9100-3(a) provides that requests for relief under § 301.9100-3 will be granted when the taxpayer provides evidence to establish to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith, and that granting relief will not prejudice the interests of the government.

Section 301.9100-3(c)(1) provides that the interests of the government are prejudiced if granting relief would result in the taxpayer having a lower tax liability in the aggregate for all taxable years affected by the election than the taxpayer would have had if the election had been timely made. The interests of the government are ordinarily prejudiced if the taxable year in which the regulatory election should have been made, or any taxable years that would have been affected by the election had it been timely made are closed by the period of limitations on assessment.

Section 301.9100-3(c)(2) provides special rules for accounting method regulatory elections. Section 301.9100-3(c)(2) provides that the interests of the government are deemed prejudiced, except in unusual or compelling circumstances, if the accounting method regulatory election for which relief is requested is subject to the advance consent procedures for method changes, requires a § 481(a) adjustment, would permit a change from an impermissible method of accounting that is an issue under consideration by examination or in any other setting, or provides a more favorable method of accounting if the election is made by a certain date or taxable year.

CONCLUSION

Based upon our analysis of the facts, and on the representations made, Taxpayer acted reasonably and in good faith, and granting relief will not prejudice the interests of the government, and therefore the requirements of §§ 301.9100-1 and 301.9100-3 have been met.

Taxpayer is granted an extension of 45 days from the date of this ruling to file its mandatory statement as required by Section 4.01 of Revenue Procedure 2011-29, stating that it is electing the safe harbor for success-based fees, identifying the transaction, and stating the success-based fee amounts that are deducted and capitalized.
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The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. In particular, no opinion is expressed as to whether Taxpayer properly included the correct costs as its success-based fees subject to the retroactive election, or whether Taxpayer’s transaction was within the scope of Revenue Procedure 2011- 29.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter ruling.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

Thomas D. Moffitt
Branch Chief, Branch 2
(Income Tax & Accounting)

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