Late success-based fee safe-harbor election allowed

Plain-English summary

A corporation paid a success-based advisory fee in connection with an acquisition and capitalized the entire amount on its timely filed return. A law firm's due-diligence analysis had identified part of the fee as eligible for the Revenue Procedure 2011-29 safe harbor, but that information did not reach the return preparer before filing. After the omission was discovered, the taxpayer promptly requested relief before the IRS identified the issue. The IRS found that the taxpayer acted reasonably and in good faith and granted 60 days to make the safe-harbor election. Under the safe harbor, 70 percent of an eligible success-based fee is treated as nonfacilitative and potentially deductible, while the remainder is capitalized. The IRS did not decide whether the identified costs were proper success-based fees or whether the transaction was within the revenue procedure's scope.

Ruling snapshot

• Question: May the taxpayer make a late safe-harbor election for success-based transaction fees?
• Outcome: Yes, within 60 days of the ruling.
• Key authorities: IRC §§ 263 and 446; Treas. Reg. §§ 1.263(a)-5 and 301.9100-3; Rev. Proc. 2011-29

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201606003                                            Third Party Communication: None
Release Date: 2/5/2016                                       Date of Communication: Not Applicable
Index Number: 9100.00-00
                                                             Person To Contact:
                                                             ------------------------------, ID
                                                             No. ----------------
------------------------                                     Telephone Number:
--------------------------------                             --------------------
------------------------                                     Refer Reply To:
---------------------------                                  CC:ITA:B02
-------------------------------------                        PLR-115871-15

                                                             Date:
                                                             November 02, 2015




TY: ------------------------------------------------------

Legend

Taxpayer =                                 --------------------------------------------------
Chief Accounting Officer =                 ------------------------
X=                                         -----------------------
Y=                                         ----------------------------------------------------------------
Z=                                         ----------------------------
Ltd =                                      ---------------------------
Corp1 =                                    -----------------------
Corp2 =                                    -----------------------------------------
Consultants =                              ----------------------------------------------------------------------
Law Firm =                                 ------------------------
CPA Firm =                                 -------------------------------------------------
Tax Preparer =                             ------------------------
Date1 =                                    ----------------
Date2 =                                    ---------------------
Date3 =                                    ---------------------------
Date4 =                                    ---------------------------
Date5 =                                    --------------------------
Date6 =                                    --------------------------
City1 =                                    ----------------------
City2 =                                    ----------------
State =                                    ------------------
a% =                                       -------
b% =                                       -----
c%=                                        --
PLR-115871-15


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

This is in response to a letter dated Date1, requesting an extension of time to make a
safe-harbor election under Rev. Proc. 2011-29, 2011-1 C.B. 746, to allocate success-
based fees between facilitative and non-facilitative amounts for Taxpayer’s transaction
during the taxable year ending Date3. This request is made in accordance with
§§ 301.9100-1 and 301.9100-3 of the Procedure and Administration Regulations.

FACTS AND REPRESENTATIONS

Taxpayer represents the following:

Taxpayer is a corporation, also known as X, and provides Y to its customers. Taxpayer
is headquartered in City1, and State. Prior to Date2, the date of the transaction
described below, Taxpayer was owned a% by Ltd, with the remaining percentage held
by minority shareholders. Taxpayer is currently a wholly-owned subsidiary of Corp2.

On Date2, Corp1 acquired b% of the shares of Taxpayer from its prior owners (the
Transaction). Subsequent to the Transaction, on Date3, Corp1 contributed b% of
Taxpayer’s stock to Corp2. Upon being contributed to Corp2, Taxpayer became a
member of Corp2’s consolidated group. Taxpayer filed its final stand-alone Form 1120
with a taxable year ending Date3, and now reports on Form 851 filed with Corp2’s Form
1120.

Taxpayer engaged Consultants for financial advisory and Z services, as well as
negotiation support, relating to the Transaction. Based on the engagement letter,
Consultants were to receive a fee of c% of any excess of the initial proposal made by
Corp1. An initial payment was due to Consultants upon execution of the consulting
agreement.

Taxpayer also engaged Law Firm to provide advice on, and to perform a due diligence
review of, the Transaction. During the review, Law Firm identified certain transaction
costs associated with Z and characterized these costs as success-based fees eligible
for the safe harbor treatment under Rev. Proc. 2011-29.

Subsequent to Corp1’s acquisition of Taxpayer, Corp1 engaged Tax Preparer, a tax
partner in CPA Firm’s City2 office. Tax Preparer assisted with the preparation of
Taxpayer’s Form 1120 for its taxable year ending Date3, the return on which the safe
harbor election under Rev. Proc. 2011-29 should have been made.

At the time the tax return was prepared, Tax Preparer understood that there were
consulting fees associated with the purchase of Taxpayer by Corp1. However, CPA


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Firm and Tax Preparer had previously been told by Taxpayer that the fees related to
general consulting services with no indication that any portion of the consulting fees was
a success-based fee contingent on the execution of the sale of the business. Law
Firm’s characterization of certain transaction costs associated with Z as success-based
fees during its due diligence review of the Transaction was not identified to CPA Firm or
to Tax Preparer during the course of the return preparation. The finalized return was
presented to Chief Accounting Officer for Taxpayer for review and signature. Chief
Accounting Officer did not identify that the consulting fees that were capitalized on the
return were eligible for the safe-harbor treatment under Rev. Proc. 2011-29, and in
reliance on CPA Firm, Chief Accounting Officer of Taxpayer signed Form 1120.
Consequently, at the time the return was filed, the entire amount of the consulting fees
was capitalized on Taxpayer’s return for taxable year ending Date3. Taxpayer’s return
for the taxable year ending Date3 was timely filed, pursuant to extension, on Date4.

After Taxpayer’s Form 1120 for taxable year ending Date3 had been filed, Law Firm
contacted CPA Firm on behalf of Taxpayer’s former shareholders. Law Firm inquired
about the treatment of the transaction costs and identified the success-based fees that
had been capitalized on the tax return. It was only at this point, on Date5, that the
transaction cost analysis conducted by Law Firm during its due diligence review of the
Transaction was brought to Tax Preparer’s and CPA Firm’s attention.

Subsequently, CPA Firm contacted its own transaction costs professionals to evaluate
whether Law Firm had correctly characterized the consulting fees as success-based
fees. CPA Firm concluded on Date6 that a portion of the Z fee was success-based and
thus eligible for the safe-harbor election under Rev. Proc. 2011-29.

Tax Preparer immediately informed Taxpayer’s Chief Accounting Officer that Taxpayer
qualified to elect the safe harbor treatment of allocating success-based fees pursuant to
Rev. Proc. 2011-29. CPA Firm informed Taxpayer of the need to file a request for an
extension of time to make a safe harbor election. Accordingly, Taxpayer is requesting
an extension of time to make a safe-harbor election under Rev. Proc. 2011-29 for
Taxpayer’s taxable year ending Date3. This request is made in accordance with
§§ 301.9100-1 and 301.9100-3 of the Procedure and Administration Regulations.
Taxpayer received no notification from the Internal Revenue Service that its Form 1120
for the taxable year ending Date3 is under examination. Taxpayer filed this request
before the failure to make the election was discovered by the Internal Revenue Service.

LAW AND ANALYSIS:

Section 263(a)(1) of the Internal Revenue Code and § 1.263(a)-2(a) of the Income Tax
Regulations generally 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


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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. Whether an amount is
paid in the process of investigating or otherwise pursuing the transaction is determined
based on all of the facts and circumstances. See § 1.263(a)-5(b)(1).

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
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 Rev. Proc. 2011-29. Rev.
Proc. 2011-29 provides a safe harbor method of accounting for allocating success-
based fees paid in business acquisitions or reorganizations described in § 1.263(a)-
5(e)(3). In lieu of maintaining the documentation required by § 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., an amount that can be deducted.
The remaining portion of the fee must be capitalized as an amount that facilitates the
transaction.

Section 4.01 of Rev. Proc. 2011-29 allows a taxpayer to make a safe harbor election
with respect to success-based fees. Section 4.01 provides that the Service will not
challenge a 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 (costs that may be deducted) 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 deducted. Second, the taxpayer must capitalize the remaining amount of the
success-based fee as an amount which does facilitate the transaction. Third, the
taxpayer must attach a statement to its original federal income tax return for the taxable
year the success-based fee is paid or incurred, stating that the taxpayer is electing the


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safe harbor, identifying 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).

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 301.9100-1(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
published in the Internal Revenue Bulletin.

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 any other setting, or provides a more favorable method
of accounting if the election is made by a certain date or taxable year.




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CONCLUSION:

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

Taxpayer is granted an extension of 60 days from the date of this ruling to file a safe
harbor election for success-based fees under Rev. Proc. 2011-29 with respect to the
Transaction for its taxable year ending Date3.

The rulings contained in this letter are based on information and representations
submitted by 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 is within the scope of Rev. Proc. 2011-29.

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

In accordance with the provisions of the power of attorney currently on file with this
office, a copy of this letter is being sent to your authorized representatives. We are also
sending a copy of this letter to the appropriate operating division director. Enclosed is a
copy of the letter ruling showing the deletions proposed to be made in the letter when it
is disclosed.




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

                                      Sincerely,


                                      NORMA C. ROTTUNO
                                      _________________________
                                      NORMA C. ROTUNNO
                                      Senior Technician Reviewer, Branch 2
                                      Office of Associate Chief Counsel
                                      (Income Tax & Accounting)




Enc: copy for § 6110 purposes



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