Question

ABC Corporation is the object of a hostile takeover bid by XYZ Corporation. ABC incurs a total of $400,000 in attorneys’ fees, accounting fees, and printing costs for information mailed to ABC shareholders in its effort to defeat the XYZ takeover bid. XYZ finally concedes, and ABC remains a separate corporation. What is the appropriate tax treatment of the $400,000 in fees? Would that treatment be different if XYZ succeeds in acquiring ABC? Tax authorities you should consult include the following:

IRC Sec. 162

IRC Sec. 165

INDOPCO, Inc. v. Comm., 69 AFTR 2d 92-694, 92-1 USTC 50,113 (USSC, 1992)

U.S. v. Federated Department Stores, Inc., 74 AFTR 2d 94-5519, 94-2 USTC 50,418 (S.D. Ohio, 1994)

A.E. Staley Manufacturing Co. v. Comm., 80 AFTR 2d 97-5060, 97-2 USTC 50,521 (7th Cir., 1997)

Reg. Sec. 1.263(a)-5

Answer 1

Answer:-

This area of taxation has been subject to litigation for years and, most recently, to complex Treasury Regulations. A key question is whether these expenses qualify as ordinary and necessary business expenses under Sec. 162 (or, perhaps under Sec. 165, as costs of an abandoned transaction) or whether they must be capitalized.

The Supreme Court in INDOPCO, Inc. v. Comm., 69AFTR 2d 92-694, 92-1 USTC ¶50,113 (USSC, 1992), ruled in a friendly takeover situation that the target’s expenses associated with the takeover created long-term benefits for the business (such as the availability of the acquiring corporation’s resources and the opportunity for synergy) and accordingly had to be capitalized. The court in INDOPCO maintained that it was not necessary for the expenditures to create or enhance a separate or distinct asset to merit capitalizing the expense; all that is required is that the expenditure produce significant long-term benefits.

The Federated Department Stores, Inc., 74 AFTR 2d 94-5519, 94-2 USTC ¶50,418 (Ohio, 1994) case concerned a hostile takeover situation. In that case, the target enticed a “White Knight” into a takeover, but ultimately the hostile bid was accepted. The court allowed the target to deduct the costs of the efforts to avoid the takeover and reasoned that the target incurred fees to defend the corporation from attack and not to attain future benefits.

The 1995 Tax Court decision in A.E. Staley Manufacturing Co. v. Comm., 80 AFTR 2d 97-5060, 97-2 USTC ¶50,521 (7th Cir., 1997), required capitalization of most of the target’s expenditures in the effort to stave off a hostile takeover that ultimately was finalized. The Tax Court maintained that the relevant question was whether an identifiable loss had been sustained and whether the costs were incurred in connection with a change in ownership of the taxpayer that “portended strategic changes.” In 1997, the Seventh Circuit (80 AFTR 2d 97-5060, 97-2 USTC ¶50,521) reversed the Tax Court and allowed Staley to deduct most of the expenses of fighting the takeover, reasoning that the costs were to defend the status quo and not to attain future benefits.

The Sec. 263 regulations are complex, but Examples 11 and 12 of Reg. Sec. 1.263(a)-5 are especially helpful. These examples indicate that, if the takeover does not occur, the expenditures can be deducted. If the takeover is finalized, the general rule is that only the expenditures that occur after the earlier of (1) the date on which a letter of intent is signed or (2) the date on which material terms of the acquisition are authorized must be capitalized. Generally, items incurred before this date can be deducted. However, a number of other items are considered to always be incurred to facilitate the merger, such as the cost of the investment broker’s fee to determine whether the offer is fair to the target’s shareholders. These items must be capitalized regardless of when they are incurred.