In CCA 201624021 the IRS considered whether the success-based fee safe harbor election under Revenue Procedure 2011-29 is available to a taxpayer to allocate success-based fees between actions that facilitate a transaction (expenses which must be capitalized) and those that do not (and may be currently be expensed) when the taxpayer elects to treat a stock sale as an asset sale under IRC §338(h)(10).

The election under IRC §338(h)(10) treats an acquisition of the stock of a target corporation as the purchase of the underlying assets from the acquired corporation, with the acquired corporation recognizing a gain immediately before the transaction. The election is available if the acquired corporation is:

A member of a selling consolidated group
A selling affiliate or
An S corporation

Regulation §1.263(a)-5 outlines costs that must be capitalized to intangible assets. As the IRS notes in the letter ruling:

A taxpayer must capitalize amounts paid to facilitate certain enumerated business transactions, regardless of whether the transactions are 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 transactions. Treas. Reg. § 1.263(a)-5(a). The list of enumerated business transactions includes, but is not limited to, “an acquisition of assets that constitute a trade or business (whether the taxpayer is the acquirer in the acquisition or the target of the acquisition).” Treas. Reg. § 1.263(a)-5(a)(1)-(10).

An amount paid that is contingent on the closing of the transaction is referred to as a “success -based fee” described in Reg. §1.263(a)-5(f). Generally such fees are presumed to facilitate the transaction in question and must be capitalized rather than expensed unless the taxpayer maintains documentation to show the portion of the fee that does not facilitate the transaction.

Revenue Procedure 2011-29 provides that, for a covered transaction as defined by Reg. §1.263(a)-5(e), a taxpayer may elect to treat 70% of the costs as not facilitating the transaction, generally freeing the costs up for an immediate deduction.

In the case in question stock of a target corporation had been acquired. A deemed asset sale was created via a §338(h)(10) election. The target corporation incurred certain success based costs and elected the application of Revenue Procedure 2011-29 to allow an immediate deduction for 70% of those costs, allowing the seller to use those costs to offset the gain incurred.

The National Office ruled that the transaction was not one which was eligible for the election under Revenue Procedure 2011-29. The ruling notes that Reg. §1.263(a)-5(e)(3) lists three transactions as “covered transactions” noting:

Target cannot, however, treat the Transaction as a “covered transaction.” Treas. Reg. § 1.263(a)-5(e)(3)(i) uses the phrase “taxable acquisition by the taxpayer,” which means that the provision only applies to acquiring taxpayers and not to acquired taxpayers. Nowhere in Treas. Reg. § 1.263-5(e)(3)(i) is there language like the parenthetical “(whether the taxpayer is the acquirer in the acquisition or the target of the acquisition),” which is found in Treas. Reg. § 1.263(a)-5(a). Accordingly, with regard to an asset acquisition, the term “covered transaction” under Treas. Reg. § 1.263(a)-5(e)(3)(i) only applies to the acquiring taxpayer and not the acquired taxpayer.

The National Office therefore concludes:

Accordingly, Target is not eligible to elect safe-harbor treatment under Rev. Proc. 2011- 29 for its success-based fees paid in 2012. Taxpayer must capitalize the successbased fees that it claimed as a current expense on its 2012 return, unless it establishes through documentation that a portion of the costs are allocable to activities that do not facilitate the transaction. Treas. Reg. § 1.263(a)-5(f).