Adviser error justified a late success-fee election

Plain-English summary

A corporation paid a success-based fee to a financial adviser in connection with a merger. Its outside CPA concluded that the safe harbor in Revenue Procedure 2011-29 did not apply because the fee was paid from closing proceeds, so the fee and election were omitted from the corporation's final return. A later adviser determined that the fee was the corporation's obligation and that the corporation could qualify for the safe harbor, which permits 70 percent of an eligible success-based fee to be treated as non-facilitative. The IRS found that the corporation reasonably relied on qualified tax professionals, did not use hindsight, sought relief before the government discovered the missed election, and would not prejudice the government's interests. It granted 60 days to file an amended return making the election.

Ruling snapshot

• Question: Could the corporation make a late Revenue Procedure 2011-29 safe-harbor election for a success-based merger fee?
• Outcome: approved, with 60 days to file an amended return
• Key authorities: IRC §§ 263(a), 446, 481(a), 6662; Treas. Reg. §§ 1.263(a)-5, 301.9100-1, 301.9100-3; Rev. Proc. 2011-29

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201732013                                              Third Party Communication: None
Release Date: 8/11/2017                                        Date of Communication: Not Applicable
Index Number: 9100.00-00
                                                               Person To Contact:
                                                               -------------------------------,
--------------------                                           ID No. ------------------
------------------------------                                 Telephone Number:
---------------------------                                    ----------------------
-------------------------------------------------              Refer Reply To:
---------------------------------                              CC:ITA:B02
-------------------------------                                PLR-126735-16

                                                               Date: May 4, 2017




TY: --------

Legend

Taxpayer =                          --------------------------------------------------------------
Taxpayer’s Subsidiary =             ---------------------------------------------------------------
Equity Firm =                       -----------------------
City =                              --------
Country =                           -------
Holding Company =                   ------------------------------------------------------------------
Sellers’ Representative =           -------------------------------------------------
Merger Subsidiary =                 -----------------------------
State Secretary =                   --------------------------------------
Spreadsheet =                       ----------------------------------------------------
President and CEO =                 -------------------------------------------------------------
Senior Director =                   ---------------------------------------------------------------------------------
                                    -----------------------------------------
Financial Advisor =                 ----------------------------
CPA =                               -----------------------------------------------------------------
Tax Advisor Firm =                  ------------------------------------------
Agreement=                          ---------------------------------------------------------------------------------
                                    ---------------------------------------------------------------------------------
                                    ---------------------------------------------------------------------------------
                                    ---------------------------------------------------------------------------------
                                    --------------------------------------------------------------
PLR-126735-16
Date1 =                             -----------------------
Date2 =                             ----------------------------
Date3 =                             ----------------------
Date4 =                             ---------------------------
Date5 =                             ----------------------------
Date6 =                             --------------------
Date7 =                             ---------------------------
Date8 =                             -----------------------
Month =                             ---------------
Year =                              -------
$a =                                --------------
$b =                                --------------
Taxable Year =                      ---------------------------------------------------------



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

This responds to the letter of Date1, filed on your behalf by your authorized
representative. In the letter, you requested an extension to time to a make a safe
harbor election under Rev. Proc. 2011-29, 2011-18 I.R.B. 746, to allocate success-
based fees between facilitative and non-facilitative amounts for a covered transaction
for Taxpayer’s Taxable Year. The 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:

         1. Statement of Taxpayer’s Business Operations and Ownership Structure

---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
------------------------------------ Taxpayer wholly owns Taxpayer Subsidiary located in City,
Country. Prior to the transaction described below, the shares of Taxpayer were
primarily held by Equity Firm.

         2. Facts Relating to the Request for Relief

             a. The Transaction

On Date2, the Agreement was executed by Taxpayer, certain of its stockholders and
option-holders, Holding Corporation, Merger Subsidiary, and Sellers’ Representative.


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PLR-126735-16
Pursuant to the terms of the Agreement, Holding Corporation remitted the merger
consideration to the Sellers’ Representative in exchange for the extinguishment of all of
Taxpayer’s outstanding shares and options. Buyer also remitted separate funds to pay
the Taxpayer’s outstanding liabilities, including Taxpayer’s transaction costs.
Taxpayer’s transaction costs were not considered part of the merger consideration and
were not remitted to the Sellers’ Representative. The Sellers’ Representative deducted
all of the shareholders’ and option holders’ transaction costs from the merger
consideration and distributed the remainder to the Taxpayer’s shareholders and option
holders pro rata. To effect the transaction, Holding Company formed Merger Subsidiary
into which Taxpayer merged. The transaction closed on Date3, and on that date the
Certificate of Merger of Taxpayer and Merger Subsidiary was filed with the State
Secretary.

Pursuant to an engagement letter of Date4, Taxpayer engaged Financial Advisor to
provide financial advisory services in conjunction with a potential sale of Taxpayer. The
Engagement Letter set forth a schedule of fees to be paid to Financial Advisor
contingent upon a successful sale of Taxpayer. As set forth in the engagement letter,
the success-based fees to be paid to Financial Advisor were in no case to be lower than
$a. In fact, the fee paid to Financial Advisor at the time of closing was $b. The amount
of the fee paid to Financial Advisor was included in the Spreadsheet dated, Date5. This
document reflected the amount of consideration paid with respect to the Transaction, as
well as associated expenses.

             b. Preparation of Form 1120 for Taxpayer and Discovery of the Missed
             Election

Taxpayer did not have its own internal tax department so it hired outside advisor, CPA.
Taxpayer relied on CPA for tax return preparation. Pursuant to their engagement, CPA
would prepare Taxpayer’s Forms 1120, U.S. Corporation Income Tax Return, and
following review, President and CEO would sign the returns. Consistent with this
arrangement, a final stand-alone Form 1120 was prepared by CPA for Taxpayer’s short
taxable year ending on Date3. The terms of the merger agreement provided that drafts
of all pre-closing period tax returns were to be delivered to Holding Company for its
review and approval at least thirty days prior to the due date of any of the returns. The
final Taxpayer’s return would be filed only after it had been reviewed by Holding
Company.

However, Taxpayer’s Form 1120 for Taxable Year was filed on Date6 without being
reviewed by Holding Company. While preparing the Form 1120 for Holding Company
for its taxable year ending Date7 (the year in which the Transaction occurred) the
Senior Director at Holding Company requested information from CPA regarding the
Taxable Year return for Taxpayer. On Date8, the President and CEO of Taxpayer
responded by forwarding certain correspondence from CPA regarding the transaction


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PLR-126735-16
costs and merger consideration. With respect to the merger consideration document,
CPA identified the success-based fees paid to Financial Advisor, but noted that he
deemed the safe harbor success- based fee deduction under Rev. Proc. 2011-29 not
applicable because the fees were remitted out of the closing proceeds. CPA did not
provide any additional advice with respect to making the safe harbor election to allocate
success-based fees. Taxpayer relied on CPA and the success-based fees were not
accounted for on Taxpayer’s final Form 1120.

The success-based fees paid to Financial Advisor were an obligation of Taxpayer as
reflected in the engagement letter Taxpayer executed with Financial Advisor. The costs
were recorded as a liability on the books of Taxpayer, and the Agreement provided that
the success-based fees would not be considered part of the merger consideration paid
to Taxpayer’s shareholders and option holders in exchange for the extinguishment of all
of the outstanding shares and options. After reviewing all the documents CPA sent to
Senior Director, Senior Director believed that Taxpayer was eligible to make the safe
harbor election under Rev. Proc. 2011-29. In that regard, Senior Director consulted with
Tax Advisor Firm in Month and Year to consider whether relief was available to make
the safe harbor election out of time. Upon being advised that such relief was available,
Taxpayer submitted this relief request in accordance with §§ 301.9100-1 and 301.9100-
3 of the Procedure and Administration Regulations.

Taxpayer’s Form 1120, for Taxable Year ending Date3, was electronically filed pursuant
to extension, on Date6. The Form 1120 for that year is not currently under examination
by the Internal Revenue Service.

Accordingly, Taxpayer is requesting an extension of time to make a safe harbor election
under Rev. Proc. 2011-29, to allocate success-based fees between facilitative and non-
facilitative amounts for Taxpayer’s transaction.

LAW:

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
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


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PLR-126735-16
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 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 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 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
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 of the Procedure and Administration
Regulations 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.



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PLR-126735-16


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.

In the present situation, Taxpayer has satisfied the requirements of §§ 301.9100-1 and
301.9100-3 of the Procedure and Administration Regulations. The information and
representations made by Taxpayer establish that it acted reasonably and in good faith.
The affidavits presented show that Taxpayer reasonably relied on qualified tax
professionals for the proper filing of Taxpayer’s federal return including the safe harbor
election for success-based fees under Rev. Proc. 2011-29. Taxpayer represents that
CPA‘s failure to make the safe harbor election on behalf of Taxpayer on Taxpayer’s
return was a legal error. Upon discovery of the error, Taxpayer filed for relief before the
government discovered the failure to properly make the regulatory election.

The information and representations presented establish that Taxpayer is not seeking to
alter a return position for which an accuracy-related penalty had been or could be
imposed under § 6662 at the time relief was requested. Taxpayer reasonably relied on


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CPA to file its income tax return properly, but CPA did not think Taxpayer was entitled to
use Rev. Proc. 2011-29 to account for the success-based fees. Senior Director,
however, believes that Taxpayer is eligible for the safe harbor election in Rev. Proc.
2011-29. Furthermore, Taxpayer is not using hindsight in requesting relief, and no
facts have changed since the time of the original filing deadline.

Finally, granting an extension will not prejudice the interests of the government. It is
represented that Taxpayer would not have a lower tax liability in the aggregate for all
taxable years affected by the safe harbor election under Rev Proc. 2011-29, if given
permission to make the election at this time than Taxpayer would have had if the safe
harbor election had been properly made by the original deadline for making the election.
Taxpayer has represented that the taxable years that would have been affected by the
election had it been timely made, are not closed by the period of limitations on
assessment. Finally, the Taxpayer was not under audit by the IRS before Taxpayer
filed for relief. Therefore, the granting of relief will not prejudice the government.

CONCLUSION:

Based upon our analysis of the facts as represented, 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 an
amended return electing safe harbor treatment for its success-based fees under Rev.
Proc. 2011-29.

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 Rev. Proc. 2011-29.

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.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to your authorized representatives. Enclosed is a copy of the letter ruling
showing the deletions proposed to be made in the letter when it is disclosed under
§ 6110 of the Code.

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


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PLR-126735-16


This ruling is based upon information and representations submitted by Taxpayer and
accompanied by a penalty of perjury statement executed by appropriate parties. 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,


                                     Bridget E. Tombul
                                     ______________________________
                                     BRIDGET E. TOMBUL
                                     Chief, Branch 2
                                     Office of Associate Chief Counsel
                                     (Income Tax & Accounting)



Enc: copy for § 6110 purposes




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