On April 8, 2011, the Internal Revenue Service (the “IRS”) released Revenue Procedure 2011-29. Revenue Procedure 2011-29 provides taxpayers with a safe harbor election for allocating successbased fees (e.g., fees paid to an investment banking firm that are contingent on the successful closing of certain business acquisitions or reorganizations) between activities that facilitate a transaction (which are generally required to be capitalized for tax purposes) and activities that do not facilitate a transaction (which are generally deductible for tax purposes). According to Revenue Procedure 2011- 29, the safe harbor election allows taxpayers to treat 70 percent of success-based fees as amounts that do not facilitate a transaction and capitalize 30 percent of success-based fees as amounts that do facilitate a transaction.
Treatment of Success-Based Fees
Treasury Regulations require that taxpayers capitalize professional fees paid to facilitate certain capital restructurings, acquisitions and reorganizations. However, fees not paid to facilitate a transaction are generally deductible.
“According to Revenue Procedure 2011-29, the safe harbor election allows taxpayers to treat 70 percent of success-based fees as amounts that do not facilitate a transaction and capitalize 30 percent of success-based fees as amounts that do facilitate a transaction.”
Success-based fees, such as investment banking fees that are contingent on the successful closing of a transaction, are characterized as facilitative (i.e., capitalized rather than deducted), except to the extent that taxpayers maintain sufficient documentation to establish that a portion of the success-based fees are allocable to activities that do not facilitate a transaction. The documentation must consist of more than merely an allocation between activities that facilitate a transaction and activities that do not facilitate a transaction, and must consist of supporting records (for example, time records, itemized invoices or other records) that identify:
- the various activities performed by the service provider;
- the amount of the fee (or percentage of time) that is allocable to each of the various activities performed;
- where the date the activity was performed is relevant to understanding whether the activity facilitated the transaction, the amount of the fee (or percentage of time) that is allocable to the performance of that activity before and after the relevant date; and
- the name, business address and business telephone number of the service provider.
Revenue Procedure 2011-29: Safe Harbor Election
Revenue Procedure 2011-29 states that the IRS will not challenge a taxpayer’s allocation of a successbased fee if the taxpayer:
- treats 70 percent of the success-based fee as an amount that does not facilitate a transaction;
- treats 30 percent of the success-based fee as an amount that does facilitate a transaction (i.e., capitalizes 30 percent of the fee); and
- makes the safe harbor election.
A taxpayer makes the safe harbor election by attaching a statement to its original federal income tax return for the taxable year in which the successbased fee is paid or incurred. The statement attached to the taxpayer’s original federal income tax return must state that the taxpayer is electing the safe harbor, identify the transaction, and state the success-based fee amount that is being deducted and the amount that is being capitalized.
The safe harbor election only applies to a transaction for which the safe harbor election is made and, once made, is irrevocable. Moreover, the safe harbor election applies to all success-based fees paid or incurred by a taxpayer in a transaction for which the safe harbor election is made.
Revenue Procedure 2011-29 is effective for successbased fees paid or incurred in taxable years ending on or after April 8, 2011.