Recent Developments in Tax Treatment of Success-Based Fees in M&A Transactions
posted Jan 16, 2012 in the Business Blog
The treatment of success-based fees has been the subject of much controversy between IRS and taxpayers for some time. The argument over whether a portion of such fees can be deducted, or at least amortized, centers on the type and extent of documentation that is required to establish an allocation of the fees to activities that do not facilitate the transaction. Some new developments in 2011 that have not gotten a lot of attention may offer taxpayers a bit more flexibility on the question.
First let’s understand what types of fees are at issue here. Success-based fees are amounts that are considered contingent on the successful completion of a transaction. Usually, that would encompass the investment banker or other financial advisory fee that is only payable after a successful closing. These fees are generally presumed to be facilitative to the completion of the transaction, and thus capitalizable, unless it can be documented that the fee encompassed other activities during the course of the engagement that turned out to be non-facilitative. Amounts paid for non-facilitative activities are generally deductible (or amortizable in a start up situation).
On April 8, 2011, IRS issued guidance in Revenue Procedure 2011-29 which permits taxpayers to elect to treat 70% of success-based fees as non-facilitative. Taxpayers would then have to capitalize the remaining 30% as an amount that facilitates the transaction. This revenue procedure is effective for all success-based fees paid or incurred in tax years ending after April 7, 2011. The election is made by attaching a statement to the return and, once made, is irrevocable.
In addition to the revenue procedure, the IRS also issued a recent directive to its Large Business and International (LB&I) examiners not to challenge the treatment of success-based fees incurred or paid in tax years ending before April 8, 2011, as long as the taxpayer capitalized at least 30% of the total success-based fees incurred on the transaction on its originally filed return.
The net result from these new developments is an opportunity for affected taxpayers to take a very practical, and less time-consuming, approach to determining the deductibility to these types of fees. For some taxpayers, a 70-30% allocation is a better result than they may be able to support through documentation. For others, a 70-30% split may not be the optimum answer that a taxpayer could achieve if they had the opportunity to develop the documentation necessary to support a more aggressive allocation. Nonetheless, this latter group of taxpayers should weigh the additional time and cost necessary to develop the documentation, as well as the potential increased audit risk.
The directive to LB&I field examiners may also present an opportunity for companies to reassess their previous measurement of uncertain tax positions relating to success-based fees for financial reporting purposes.
If you have any questions, don’t hesitate to contact me or anyone directly involved on your engagement.
KLR is one of the largest CPA firms in Boston, and offers assistance to venture capital firms. These include internal audit assessments as well as international tax services and specialized tax services such as cost segregation, research and development and energy studies. Due diligence for buyers and preparedness for sellers can also be provided during the acquisition process.