Source: https://www.bna.com/breakup-advice-irs-b73014447643/
Timestamp: 2017-02-27 22:38:50
Document Index: 60367640

Matched Legal Cases: ['§1234', '§1234', '§1234', '§1234', '§1234', '§1234']

Breakup Advice from the IRS: How to Treat Merger Breakup Fees | Bloomberg BNA
Breakup Advice from the IRS: How to Treat Merger Breakup Fees
/ by BREAKUP ADVICE FROM THE IRS: HOW TO TREAT MERGER BREAKUP FEES
Merger and acquisition (M&A) agreements
commonly contain a provision under which one party is obligated to pay a breakup
fee to the other party if it backs out of the deal. The amount of this fee is
often expressed in terms of a percentage of the sales price, normally in the
1%-3% range. For big transactions, the breakup
fee can run in the millions of dollars and, thus, the tax treatment of breakup
fees can be a significant issue for the parties to an M&A agreement. In recently
issued guidance, the IRS has changed its longstanding position on the tax
treatment of breakup fees. In the past, the IRS generally
treated the character of breakup fees as ordinary in nature. For example, in
TAM 200438038 and PLR 200823012 the IRS used similar reasoning in advising that
the party that receives a breakup fee must treat the fee as ordinary income. The
primary purpose of a breakup fee, according to the IRS, is to provide the
recipient with damages for the benefits it expected to receive under the
agreement. The IRS advised that such “expectation damages” are the equivalent
of lost profits and that there is ample authority for the position that a recovery
for lost profits is treated as ordinary income. Consistent with this IRS guidance
treating breakup fees as ordinary in nature for taxpayers receiving such fees, taxpayers
paying breakup fees have normally taken an ordinary deduction for the amount of
breakup fees paid. During 2016, the IRS changed course in
its treatment of breakup fees with two new pieces of guidance, FAA 20163701F
and CCA 201642035. In FAA 20163701F, the IRS advised that a taxpayer paying a breakup
fee must treat the amount of the fee paid as a capital loss. The IRS based this
conclusion on its determination that §1234A applies to breakup fees. Under
§1234A, any gain or loss attributable to the termination of a right or
obligation with respect to property that would be a capital asset in the hands
of the taxpayer is treated as a capital gain or loss. The IRS essentially determined
that (i) a taxpayer that is a party to an M&A agreement has rights and
obligations with respect to property – the property being the stock that would
be acquired under the agreement, (ii) the stock that would be acquired under
the agreement is property that would be a capital asset in the hands of the
taxpayer, (iii) the breakup fee is paid as a result of the termination of the
right or obligation to acquire the stock, and (iv) the gain or loss the
taxpayer recognizes with respect to the breakup fee is gain or loss attributable
to the termination of the taxpayer’s right or obligation to acquire the stock. Thus,
according to the IRS, the gain or loss a taxpayer recognizes with respect to a
breakup fee must be treated as a capital gain or loss. The IRS position in FAA 20163701F is
contrary to its earlier position in PLR 200823012, where it stated without
explanation that §1234A does not apply to breakup fees. With the IRS now taking
the position that §1234A applies to breakup fees, it has made clear its
position that taxpayers paying breakup fees may no longer treat the fees as
ordinary deductions, but must instead treat them as capital losses. CCA 201642035 addresses the tax treatment
of breakup fees from a different perspective – the perspective of taxpayers receiving
breakup fees. In its analysis of this issue, the IRS took the same position it
took in FAA 20163701F – that §1234A applies to breakup fees. Thus, according to
the IRS, taxpayers receiving breakup fees must treat the fees received as
capital gains. This position is contrary to the guidance the IRS previously
provided in TAM 200438038 and PLR 200823012, where it advised that taxpayers receiving
breakup fees must treat the fees received as ordinary income.
The IRS about-face on breakup fees and
the application of §1234A has the most significance for taxpayers paying
breakup fees. It effectively eliminates the ability of some taxpayers to deduct
breakup fees. As discussed above, taxpayers paying breakup fees must now treat
the fees as capital losses instead of ordinary deductions. Because capital
losses are deductible only to the extent of capital gains, taxpayers with
little or no capital gains will not be able to deduct large breakup fees. LEGAL BLOGS