Late success-fee safe harbor elections approved

Plain-English summary

An acquiring corporation and its target sought extra time to elect the safe harbor in Revenue Procedure 2011-29 for success-based transaction fees. Their return had allocated the fees under the safe harbor, generally deducting 70 percent and capitalizing 30 percent, but the required election statement was omitted and some fees were reported on the wrong taxpayer's return. The taxpayers requested relief before the IRS discovered the missing elections and represented that they had reasonably relied on a qualified tax professional. The IRS found that they acted reasonably and in good faith and that relief would not prejudice the government. It granted the target 60 days to file its statement and gave the acquirer until the later of 60 days from the ruling or 60 days after separate consolidated-return relief.

Ruling snapshot

• Question: Could the acquirer and target make late safe harbor elections for success-based acquisition fees?
• Outcome: approved
• Key authorities: IRC § 263(a); 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: 201648002                                              [Third Party Communication:
Release Date: 11/25/2016                                       Date of Communication: Month DD, YYYY]
Index Number: 9100.00-00
                                                               Person To Contact:
-------------------------                                      -----------------------, ID No. --------------
------------------------------------------------------------   Telephone Number:
----------                                                     ----------------------
--------------------------------------------------             Refer Reply To:
 -------------------------------------                         CC:ITA:B03
                                                               PLR-106397-16
                                                               PLR-106398-16
                                                               Date:
                                                               August 23, 2016


TY: -------

LEGEND:

Acquirer Taxpayer = -----------------------------------------------------------------------------------------
Target Taxpayer = ----------------------------------------------------
Acquirer Sub = -------------------------------------
Services = ------------------------------------------------------------------------------------------------------
---------------------------------
Firm 1 = ---------------------------
Firm 2 = --------------------------------
Person A = -----------------
Person B = ----------------
Person C = ----------------------
Person D = ----------------------
Accounting Firm X = ----------------------
Accounting Firm Y = -----------------------------------------
Year 1 = -------
Date 1 = --------------------
Date 2 = ----------------------------
Date 3 = ----------------------------
A = -----
B = ----
C = --------------
D = --------------
E = --------------
F = ------------
G = --------------
H = --------------
I = ------------
J = ----------
K = --------------
PLR-106397-16                               2

L = --------------

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

This is in response to your letter dated February 25, 2016 sent by your representatives.
In the letter, your representatives requested an extension of time to file the forms
necessary to make a safe harbor election under Rev. Proc. 2011-29 to allocate
success-based fees between facilitative and non-facilitative amounts incurred for a
covered transaction for Acquirer Taxpayer’s tax year ending Date 2 and for Target
Taxpayer’s short tax year ending Date 1. The request is based on sections 301.9100-1
and 301.9100-3 of the Procedure and Administrative Regulations.

FACTS

Target Taxpayer provides Services. On Date 1, Acquirer Taxpayer, through its wholly
owned subsidiary Acquirer Sub, acquired 100 percent of the outstanding shares of
Target Taxpayer’s common stock. Following the transaction Target Taxpayer became a
wholly owned subsidiary of Acquirer Sub and an indirect subsidiary of Acquirer
Taxpayer. The total consideration was approximately $A million.

Target Taxpayer engaged Firm 1 to provide various services with respect to the
transaction. Pursuant to the terms of the engagement letter, Firm 1 agreed to provide
investment banking services regarding the possible acquisition of some or all of Target
Taxpayer’s business. The engagement letter provided that Firm 1 would be paid a
transaction fee of B percent of the transaction value upon the closing date of a
transaction. Prior to the completion of the transaction, Firm 1 sent a letter to Target
Taxpayer to the effect that, if the acquisition was completed, Firm 1 would be paid a
success-based fee of $C, in accordance with the engagement letter. Target Taxpayer
represented that on Date 1, it provided Acquirer Taxpayer with $C from debt it took on
as part of the transaction, and Acquirer Taxpayer paid the $C to Firm 1 by wire transfer
upon closing of the transaction.

Also in conjunction with the transaction, Acquirer Taxpayer engaged Firm 2 to provide
consulting services associated with the transaction. These services included advice,
analysis, and assistance with respect to due diligence and other investigatory matters
related to Target Taxpayer, its subsidiaries, and its parent companies in conjunction
with the acquisition. Acquirer Taxpayer represented that it paid a total $D, of which $E
was for services to secure financing (and thus not an amount qualifying as a
success-based fee). Moreover, Acquirer Taxpayer also engaged two individuals,
Person A and Person B, who provided consulting services, including due diligence and
transaction structuring. Acquirer Taxpayer represented that it paid each of Person A
and Person B $F. The total success-based fees for Firm 2, Person A and Person B
were $G, payment of which was contingent upon the successful closing of the
PLR-106397-16                               3

transaction. Acquirer Taxpayer represented that it used funds transferred from Target
Taxpayer to make these payments.

Target Taxpayer had engaged Accounting Firm X for preparation of its federal tax
return for several years prior to the year in which the transaction occurred. Pursuant
to this engagement, Accounting Firm X prepared a Form 1120, U.S. Corporation
Income Tax Return, for a taxable year ending Date 2 on behalf of Target Taxpayer, a
period which included the acquisition transaction. On the Form 1120 with a Date 2
year-end, Accounting Firm X allocated the $C success-based fee paid to Firm 1 as
permitted under the safe-harbor election provided by Rev. Proc. 2011-29. Thus, that
Form 1120 reflected that 70 percent of the fee, or $H, was deducted, and 30 percent,
or $I, was capitalized. However, Accounting Firm X inadvertently did not include the
election statement required under Rev. Proc. 2011-29 to properly make the election.

Accounting Firm X also included the success-based fees paid to Firm 2, Person A and
Person B on Target Taxpayer’s Form 1120 with a Date 2 year-end. Those fees were
also allocated as permitted under Rev. Proc. 2011-29. However, Accounting Firm X
determined that the success-based fees were start-up costs under section 195, and
amortizable over 180 months. The amount deducted was $J, with the remaining $K to
be deducted over the remaining months of the amortization period.

The Form 1120 with a Date 2 year-end was presented to Person C, Executive Vice
President and Chief Financial Officer for Acquirer Taxpayer and Target Taxpayer; and
to Person D, formerly Controller, Treasurer, and Chief Accounting Officer for Target
Taxpayer. Person C delegated the detailed review and signature to Person D, who had
been responsible for signing Target Taxpayer’s tax returns in prior years and did so
again with respect to the Date 2 year-end return. At all times, Person C believed the
Form 1120 included a valid election under Rev. Proc. 2011-29 for the total amount of
success-based fees.

Target Taxpayer’s Form 1120 with a Date 2 year-end was timely filed. No return was
filed for Acquirer Taxpayer for the tax year ending Date 2. Subsequent to the filing of
Target Taxpayer’s Form 1120 with a Date 2 year-end, Target Taxpayer entered into an
engagement with Accounting Firm Y for the audit of its financial statements, as well as
for tax compliance and advisory services. During the course of performing the audit of
the Date 3 financial statements, Accounting Firm Y reviewed Target Taxpayer’s
Form 1120 with a Date 2 year-end. While doing so, Accounting Firm Y discovered that
the election statement required to make the safe-harbor election for success-based fees
was not included with that Form 1120, despite the fees being properly allocated as
permitted by Rev. Proc 2011-29. During the course of discussions with Accounting Firm
X and Accounting Firm Y, Person C determined that the best course of action would be
to request relief for an extension of time to file the elections under Rev. Proc. 2011-29
pursuant to the authority of Treas. Reg. §§ 301.9100-1 and -3.
PLR-106397-16                                 4

The Internal Revenue Service is examining Target Taxpayer’s Date 2 year-end return
and Acquirer Taxpayer’s Date 3 year-end return. In conjunction with the examinations,
it was determined that Target Taxpayer’s Form 1120 filed with a tax year ending Date 2
should instead have reflected that it was a short-period return ending on the date the
transaction closed, Date 1. It was also determined that the success-based fees for
Acquirer Taxpayer should have been reported on a return for the tax year ending on
Date 2 (which it did not file), not on Target Taxpayer’s return.

LAW AND ANALYSIS

Section 263(a)(1) of the Internal Revenue Code and section 1.263(a)-2(a) of the Income
Tax Regulations 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 section 1.263(a)-5, a taxpayer must capitalize an amount paid to facilitate a
business acquisition or reorganization transaction described in section 1.263(a)-5(a).
An amount is paid to facilitate a transaction described in section 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) of the Regulations provides that an amount that is contingent on
the successful closing of a transaction described in section 1.263(a)-5(a), or success-
based fee, is presumed to facilitate the transaction. 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.

To reduce controversy between the IRS and taxpayers over the documentation required
to allocate success-based fees alternatively to the regulatory presumption, the IRS
issued Rev. Proc. 2011-29, 2011-1 C.B. 746. The revenue procedure states that the
IRS would not challenge a taxpayer's allocation of a success-based fee between
activities that facilitate a transaction described in section 1.263(a)-5(e)(3) and activities
that do not facilitate the transaction if the taxpayer --

(1) treats 70 percent of the amount of the success-based fee as an amount that does
not facilitate the transaction;

(2) capitalizes the remaining 30 percent as an amount that does facilitate the
transaction; and

(3) attaches 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 safe
PLR-106397-16                                  5

harbor, identifying the transaction, and stating the success-based fee amounts that are
deducted and capitalized.

The revenue procedure applies to covered transactions described in section 1.263(a)-
5(e)(3), which include --

(i) A taxable acquisition by the taxpayer of assets that constitute a trade or business;

(ii) A taxable acquisition of an ownership interest in a business entity (whether the
taxpayer is the acquirer in the acquisition or the target of the acquisition) if, immediately
after the acquisition, the acquirer and the target are related within the meaning of
section 267(b) or section 707(b); or

(iii) A reorganization described in section 368(a)(1)(A), (B), or (C) or a reorganization
described in section 368(a)(1)(D) in which stock or securities of the corporation to which
the assets are transferred are distributed in a transaction which qualifies under section
354 or 356 (whether the taxpayer is the acquirer or the target in the reorganization).

Sections 301.9100-1 through 301.9100-3 of the Procedure and Administration
Regulations provide the standards the Commissioner uses to determine whether to
grant an extension of time to make a regulatory 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 section
301.9100-2.

Section 301.9100-1(b) defines the term “regulatory election” as an election whose due
date is prescribed by a regulation published in the Federal Register, or a revenue ruling,
procedure, notice or announcement published in the Internal Revenue Bulletin.

Section 301.9100-1(c) provides that the Commissioner may grant a reasonable
extension of time to make a regulatory election, or a statutory election (but no more than
six months except in the case of a taxpayer who is abroad) under all subtitles of the
Internal Revenue Code except subtitles E, G, H and I.

Section 301.9100-3 provides extensions of time to make a regulatory election under
Code sections other than those for which section 301.9100-2 expressly permits
automatic extensions. Requests for extensions of time for regulatory elections will be
granted when the taxpayer provides evidence (including affidavits described in the
regulations) to establish to the satisfaction of the Commissioner that the taxpayer acted
reasonably and in good faith, and granting relief will not prejudice the interests of the
government.

Section 301.9100-3(b)(1) states that a taxpayer will be deemed to have acted
reasonably and in good faith if the taxpayer --
PLR-106397-16                                  6


(i) requests relief before the failure to make the regulatory election is discovered by the
Service;

(ii) failed to make the election because of intervening events beyond the taxpayer’s
control;

(iii) failed to make the election because, after exercising due diligence, the taxpayer was
unaware of the necessity for the election;

(iv) reasonably relied on the written advice of the Service; or

(v) reasonably relied on a qualified tax professional, and the tax professional failed to
make, or advise the taxpayer to make the election.

Under section 301.9100-3(b)(3), a taxpayer will not be considered to have acted
reasonably and in good faith if the taxpayer --

(i) seeks to alter a return position for which an accuracy related penalty has been or
could be imposed under section 6662 at the time the taxpayer requests relief (taking
into account section 1.6664-2(c)(3)) and the new position requires or permits a
regulatory election for which relief is requested;

(ii) was informed in all material respects of the required election and related tax
consequences, but chose not to file the election; or

(iii) uses hindsight in requesting relief. If specific facts have changed since the original
deadline that make the election advantageous to a taxpayer, the Service will not
ordinarily grant relief.

Target Taxpayer and Acquirer Taxpayer in this case have represented that they have
requested relief before the failure to make the regulatory election was discovered by the
Service. Target Taxpayer and Acquirer Taxpayer has also represented that they
reasonably relied on a qualified tax professional, and the tax professional failed to
make, or advise Target Taxpayer and Acquirer Taxpayer to make the election. Thus,
under sections 301.9100-3(b)(1)(i) and 301.9100-3(b)(1)(v), Target Taxpayer and
Acquirer Taxpayer will be deemed to have acted reasonably and in good faith. Target
Taxpayer and Acquirer Taxpayer have also represented that none of the circumstances
listed in section 301.9100-3(b)(3) apply.

Section 301.9100-3(c)(1)(i) provides, in part, 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 (taking into account the time value of money).
PLR-106397-16                                7

Similarly, if the tax consequences of more than one taxpayer are affected by the
election, the Government’s interests are prejudiced if extending the time for making the
election may result in the affected taxpayers, in the aggregate, having a lower tax
liability than if the election had been timely made. Section 301.9100-3(c)(1)(ii) provides,
in part, that 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 under section 6501(a) before the taxpayer’s receipt
of a ruling granting relief.

Under these criteria, the interests of the government are not prejudiced in this case.
Target Taxpayer and Acquirer Taxpayer have represented that granting relief would not
result in a lower tax liability in the aggregate for either taxpayer for all taxable years
affected by the election than each taxpayer would have had if the election had been
timely made (taking into account the time value of money). Target Taxpayer and
Acquirer Taxpayer have also represented that granting relief would not result in a lower
tax liability in the aggregate for both taxpayers than if the election had been timely
made. Furthermore, the taxable years in which the regulatory election should have
been made and any taxable years that would have been affected had it been timely
made are not closed by the period of assessment.

CONCLUSION

Target Taxpayer’s and Acquirer Taxpayer’s elections are regulatory elections, as
defined under section 301.9100-1(b), because the due date of the election is prescribed
in Rev. Proc. 2011-29. In the present situation, the requirements of sections 301.9100-
1, 301.9100-3(b)(1)(i), and 301.9100-3(b)(1)(v) of the regulations have been satisfied.
The information and representations made by Target Taxpayer and Acquirer Taxpayer
establish that they both acted reasonably and in good faith. Furthermore, granting an
extension will not prejudice the interests of the Government. Target Taxpayer and
Acquirer Taxpayer represented that each will not have a lower tax liability in the
aggregate for all taxable years affected by the election if given permission to make the
election than they would have if the election were made by the original deadline for
making the election. Target Taxpayer also represented that the period of assessment
for the short tax year ending Date 1 will not be closed before receipt of a ruling.
Acquirer Taxpayer represented that the period of assessment for the tax year ending
Date 2 will not be closed before receipt of a ruling. Accordingly, Target Taxpayer is
granted an extension of time to file the statements required by section 4.01(3) of Rev.
Proc. 2011-29 until 60 days following the date of this letter. Acquirer Taxpayer is
granted an extension of time to file the statements required by section 4.01(3) of Rev.
Proc. 2011-29 until the later of 60 days following the date of this letter or until 60 days
after Office of the Associate Chief Counsel, Corporate grants Acquirer Taxpayer relief
under sections 301.9100-1 and 301.9100-3 of the Procedure and Administrative
Regulations to file a consolidated return for the tax year ending Date 2.
PLR-106397-16                                  8

No opinion is expressed in this letter as to whether it is appropriate for Acquirer
Taxpayer to file a consolidated tax return, whether Target Taxpayer may file an
amended return for the tax year ending Date 1, or the tax treatment of the $C
transferred by Target Taxpayer to Acquirer Taxpayer.

Except as expressly provided herein, no opinion is expressed or implied concerning the
federal income tax consequences of any aspect of any transaction or item discussed or
referenced in this ruling including whether Target Taxpayer or Acquirer Taxpayer
properly included the correct costs as its success-based fees subject to the election, or
whether the transaction was within the scope of Rev. Proc. 2011-29.

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

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

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.

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.


                                       Sincerely,



                                       Christopher F. Kane
                                       Chief, Branch 3
                                       (Income Tax & Accounting)




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