Although the cost of obtaining regulatory approval for a corporate transaction is identified as facilitative, a recent Chief Counsel Advice (CCA 2017-13-010, March 31, 2017) (the CCA) issued by the Internal Revenue Service (IRS) concluded that the costs of certain activities undertaken as part of the regulatory approval process may be non-facilitative.1 This CCA is significant because it refutes an assumption that all costs associated with facilitating the completion of a corporate transaction are non-deductible. It also serves as a reminder to carefully consider the tax treatment of corporate transaction costs.
The CCA addressed a regulated industry merger for which regulatory approval was subject to several conditions, including: (i) the taxpayer’s capital contribution to the acquired subsidiary to fund a rate credit for that subsidiary’s customers, (ii) a contribution to a customer investment fund to provide long-term benefits to the acquired subsidiary’s customers, (iii) payments to the state agency involved for development of intangible property, and (iv) a commitment to contribute amounts to charitable organizations and traditional local community support within the involved state. When its return was filed, the IRS challenged the tax treatment of these amounts.
In a corporate transaction, a taxpayer may not deduct its costs that facilitate the transaction regardless of “whether the transaction is comprised of a single step or a series of steps carried out as part of a single plan and without regard to whether gain or loss is recognized in the transaction.”2 A cost “facilitates” a corporate transaction if it is incurred “in the process of investigating or otherwise pursuing the transaction,” which includes amounts that are designated as “inherently facilitative.”3 Included in the scope of inherently facilitative amounts are costs paid for “obtaining regulatory approval.”4
Here, the IRS Examining Agent argued that all of the taxpayer’s costs associated with fulfilling the conditions for regulatory approval were facilitative of the corporate transaction. The Agent relied on a “but-for” analysis, that is, absent the merger, the taxpayer would not have incurred these costs. However, in the CCA, the IRS National Office made clear that the costs of obtaining regulatory approval are limited to “the costs of preparing for and appearing before a regulatory board”5 and that “regulatory approval should not be read so broadly that it includes any and all costs to address conditions that might be imposed by regulators.”6
It is significant that the CCA concluded that the facilitate standard is more narrow than a but-for standard. In reaching this result, the IRS National Office cited the transaction cost regulations, which provide that “[i]n determining whether an amount is paid to facilitate a transaction, the fact that the amount would (or would not) have been paid but for the transaction is relevant, but is not determinative.”7 The CCA also relied on a passage from the preamble to the proposed regulations as further support that “the facilitate standard is intended to be narrower in scope than a ‘but for’ standard....While some costs may not have been incurred but-for the merger, the costs do not facilitate the merger itself.”8
The CCA found that non-deductible facilitative costs are limited to deal costs paid to advisers for “financial, legal, investigatory, or administrative activities that are generally provided exclusively for the purpose of pursuing a transaction but which otherwise are not general operating costs.”9 The CCA concluded that the costs associated with the regulatory requirements were “in the nature of annual operating or investment expenses and not analogous to deal costs paid to service providers who assist with financing, investigating, documenting, or otherwise administratively facilitating the transfer of property.” Therefore, the CCA determined that these amounts are not required to be capitalized under Treas. Reg. § 1.263(a)-5.
Eversheds Sutherland Observation: The CCA clarified that simply because a cost relates to a facilitative activity (e.g., post bright-line diligence, securing a fairness opinion, structuring the transaction, obtaining shareholder approval, obtaining regulatory approval) that does not mean that the cost facilitates the corporate transaction. Here, the IRS National Office found that seemingly facilitative costs were not capitalized under Treas. Reg. § 1.263(a)-5. To the extent that these amounts are otherwise deductible (for example, annual operating expenses), this CCA indicated that such costs may still be deductible even if incurred in connection with an acquisitive transaction. Of course, these costs may relate to otherwise capitalizable activities, for example, the acquisition of a capital asset. Thus, although amounts may not be facilitative of a corporate transaction, these amounts may be otherwise capitalizable but may be subject to amortization or depreciation, and thus recoverable.
Further, because large corporate transactions may involve substantial facilitative costs, this CCA reinforced the importance of reviewing the tax treatment of transaction costs to identify deductible costs. Additionally, it is not uncommon for an IRS Examining Agents to set up adjustments treating transaction costs as non-deductible by applying a broad facilitate standard to prevent deductions. The CCA demonstrated that even if such an adjustment has been proposed, effective arguments can be established to refute proposed adjustments.