Press Room: Tax Release
The Deductibility of Certain Investment Banking Fees
The IRS Large Business & International (LB&I) Directive provides that a taxpayer’s treatment of eligible milestone payments incurred in connection with a covered transaction should not be challenged in an IRS examination if certain conditions are met. Taxpayers should review prior treatment of milestone payments and consider implications for previously identified uncertain tax positions. The Directive only applies to amounts deducted on originally filed tax returns and not for claims made on amended returns.
A milestone payment is defined as one conditioned on the occurrence of an event as opposed to an amount payable on a specified date (e.g., December 31). It is uncertain how a payment based on the earlier of a specified date or an event such as the signing of a definitive agreement is treated. Taxpayers should carefully review the language in engagement letters with investment bankers to identify payments that meet the definition of milestone payments. For example, a payment due upon the execution of a definitive agreement is likely a milestone payment. However, a payment for a fairness opinion is not likely a milestone payment and instead capitalizable as an inherently facilitative cost.
The treatment of transaction costs incurred has long been the subject of controversy between IRS and taxpayers. In particular, the treatment of success-based fees has historically attracted scrutiny. Numerous disagreements have arisen regarding the type and extent of documentation required to establish that a portion of a success-based fee is allocable to activities that do not facilitate an acquisition. In an effort to reduce controversy, IRS issued Revenue Procedure 2011-29 which provides for a safe harbor for electing taxpayers to treat 70% of the success-based fee as an amount that does not facilitate the transaction. The remaining portion of the fee must be capitalized. The Revenue Procedure does not provide for a safe harbor for milestone payments.
A success-based fee is an amount paid that is contingent on the successful closing of a covered transaction. Milestone payments are typically made prior to the successful closing of a transaction and are generally nonrefundable amounts paid contingent on the achievement of a milestone or event occurring in the course of certain acquisitions. The terms of the engagement letter with the investment banker often provide that milestone payments are creditable against the total success-based fee. IRS has previously taken the position in CCA 201234027 that milestone payments are not success-based fees eligible for the safe harbor election pursuant to Revenue Procedure 2011-29. On April 29, 2013, the IRS LB&I issued a Directive that states a taxpayer’s treatment of eligible milestone payments should not be challenged in an examination if the taxpayer has not deducted more than 70% of any eligible milestone payment and certain other conditions are met.
The Directive applies only to investment banker fees incurred by either an acquiring corporation or a target corporation. This Directive applies only for the amounts deducted on original timely filed returns, and not for claims, whether formal or informal.
The term “covered transaction” is a transaction described in § 1.263(a)-5(e)(3) of the Income Tax Regulations: (i) a taxable acquisition by the taxpayer of assets constituting a trade or business; (ii) a taxable acquisition of an ownership interest in a business entity if immediately after the acquisition, acquirer and the target are related within the meaning of I.R.C. § 267(b) or § 707(b); and (iii) a reorganization described in § 368(a)(1)(A), (B), or (C), or a reorganization described in §368(a)(1)(D) in which stock or securities of the corporation to which the assets are transferred are distributed in a transaction qualifying under § 354 or § 356.
The term “milestone” means an event occurring in the course of a covered transaction (whether the transaction is ultimately completed or not), provided that the event is (i) the execution of an agreement described in § 1.263(a)-5(e)(1)(i) (i.e., a letter of intent, exclusivity agreement or similar written communication (other than a confidentiality agreement)), (ii) an event described in §1.263(a)-5(e)(1)(ii) (the authorization or approval of a transaction (as tentatively agreed to by representatives of the acquirer and the target) by the taxpayer's board of directors (or committee of the board of directors)), or (iii) some other specified event (other than the successful closing of the transaction), provided that the event does not occur prior to the first occurrence of an event described in § 1.263(a)-5(e)(1)(i) or (ii).
The term “milestone payment” means a non-refundable amount that is contingent on the achievement of a milestone. Any amount that would be paid or incurred even if the milestone is not achieved is not contingent on the achievement of a milestone and is, therefore, not includable in a milestone payment, notwithstanding that the parties’ agreement may provide that such amount is creditable against or otherwise offsets the amount due on the milestone payment.
The term “eligible milestone payment” means a milestone payment paid for investment banking services that is creditable against a success-based fee.
Planning and Examination Guidance:
In an effort to balance current resources and workload priorities, LB&I examiners are directed not to challenge a taxpayer’s treatment of its eligible milestone payments if the taxpayer satisfies the conditions described in I or II below.
I. For Taxable Years Ended on or After April 8, 2011
Treatment of Eligible Milestone Payment Incurred in a Transaction for which Taxpayerelects the Safe Harbor in Rev. Proc. 2011-29
The taxpayer must –
(1) have qualified for and timely elected the Rev. Proc. 2011-29 safe harbor for the covered transaction;
(2) not have deducted more than 70% of any eligible milestone payment incurred in connection with the respective success-based fee on its original tax return for the year in which the taxpayer's liability for the eligible milestone payment accrued; and
(3) not be contesting its liability for the eligible milestone payment.
Treatment of Eligible Milestone Payment Incurred in Tax Years before Taxpayer can Elect the Safe Harbor in Rev. Proc. 2011-29.
In instances where a covered transaction spans multiple years, a taxpayer may make eligible milestone payments in tax years preceding the tax year in which the success-based fee would be paid (and, therefore, also preceding the tax year in which the taxpayer could qualify for and timely elect the Rev. Proc. 2011-29 safe harbor) if the transaction successfully closes.
In those situations, the taxpayer must –
(A) satisfy (2) and (3) above,
(B) have documented, for example in its books and records, that in the year in which the eligible milestone payments were made, the taxpayer intended to elect Rev. Proc. 2011-29 with regard to the respective success-based fee, and
(C) if the transaction successfully closed, have in fact made the Rev. Proc. 2011-29 election for the success-based fee that was paid or incurred. This documentation should be made available to the examiner upon request.
II. For Taxable Years Ended Before April 8, 2011
The taxpayer’s return position must meet the requirements of the LB&I Directive 04-0511-012 with regard to success-based fees paid or incurred in taxable years ended before April 8, 2011, and the taxpayer must satisfy (2) and (3) above.