Selected Tax Accounting Issues in Mergers and...

Selected Timing Issues in Mergers and Acquisitions

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Agenda

• Section 1234A – Pilgrim’s Pride

• Contingent Liabilities – Amergen Energy Co.

– Veco Corp.

• Shareholder Litigation – Ash Grove

– PLR 201412002

• Costs Incurred in Connection with Redemptions (Section 162(k)) – Media Space, Inc. and IRS AOD

• Tax Opinion Insurance for Section 355 Spin-Off Transactions – Treatment of Premiums

• Rev. Proc. 2011-29 – 9100 Relief

– Updated Milestone Payment Directive

• “Covered Transaction” – PLR 201405009

• Section 195 Start-up Expenditures and Technical Terminations – Treas. Reg. §1.195-2(a)

• Accounting Method Changes After a Tax-Free Reorganization

• Employee Bonuses – FSA 20134301F

Section 1234A

Section 1234A – Termination Payments

► Section 1234A provides that gain or loss attributable to the cancellation, lapse, expiration, or other termination of – (1) a right or obligation (other than a securities futures contract as defined in section 1234B) with respect to property which is (or upon acquisition would be) a capital asset in the hands of the taxpayer, or (2) a section 1256 contract not described in (1) which is a capital asset in the hands of the taxpayer, shall be treated as gain or loss from the sale of a capital asset.

► Before 1997, section 1234A applied only to

► personal property of a type that is actively traded that is (or would be on acquisition) a capital asset in the hands of the taxpayer, except for stock that was not part of a straddle or of a corporation that was not formed or availed of to take positions which offset positions in personal property of its shareholders) and

► "section 1256 contracts" that were capital assets.

► In 1997, Congress amended section 1234A by substituting "property" for "personal property (as defined in sec. 1092(d)(1))".

Pilgrim’s Pride Corp. v. Comm’r 141 T.C. No. 17 (2013)

► Facts ► Taxpayer held preferred stock issued by Southern States with a basis of $

98.6 million

► Southern States made an offer to buy them back from the taxpayer for $ 20 million.

► The taxpayer rejected the offer and surrendered the securities for no consideration, reasoning that the tax savings it would realize by claiming an ordinary loss on abandonment were greater than the $ 20 million. (Also, the taxpayer doubted it could fully use the $ 78.6 million capital loss from the proposed sale to Southern States.)

► Taxpayer claimed an ordinary abandonment loss under section 165(a) with respect to the preferred stock

► Neither the IRS nor the taxpayer addressed section 1234A in their submissions to the Tax Court and the Tax Court requested that the parties file supplemental briefs on section 1234A.

► The Tax Court held that section 1234A applied to the transaction, treating the abandonment of the stock as the sale of a capital asset.


► Taxpayer made three arguments in support of its position that section 1234A did not apply:

► The phrase "right or obligation with respect to property" as used in section 1234A means a contractual and other derivative right or obligation with respect to property and not the inherent property rights and obligations arising from the ownership of the property.” Therefore, section 1234A did not apply to a direct ownership interest in preferred stock.

► Treas. Reg. 1.165-5(i), which provides that section 165(g) applies to securities that are abandoned, states that the abandoned security is a capital asset (and is not a worthless security of certain affiliated corporations described in section 165(g)(3)), the resulting loss is treated as a loss from the sale or exchange of a capital asset. This implies that the Treasury and IRS believe that section 1234A does not apply to the abandonment of securities.

► Application of section 1234A to direct property interests is inconsistent with Rev. Rul. 93-80, Situation 2, which holds that a partner can claim an ordinary abandonment loss under section 165 upon abandoning its partnership interest.


► The Tax Court rejected the taxpayer’s three arguments as follows:

► The plain meaning of the phrase "a right or obligation * * * with respect to property"

as used in section 1234A encompasses the property rights inherent in intangible

property as well as ancillary or derivative contractual rights.

► Treas. Reg. 1.165-5(i) gives effect to, and is consistent with, section 1234A and

section 165(g)(3).

► Rev. Rul. 93-80 was issued four years before section 1234A was amended in 1997

to apply to all property that is (or would be if acquired) a capital asset in the hands

of the taxpayer. Further, the ruling makes clear that, if a provision of the Code

requires the transaction to be treated as a sale or exchange, such as when there is

a deemed distribution attributable to the reduction in the partner's share of

partnership liabilities pursuant to section 752(b), the partner's loss is capital.

Contingent Liabilities

Amergen Energy Co. v. U.S. 113 Fed. Cl. 52 (2013) ► AmerGen had acquired nuclear power plants and assumed

contingent nuclear decommissioning liabilities.

► The cash payments for the three plants, according to plaintiff, totaled only $93,297,957, whereas the total decommissioning liabilities totaled $1,687,390,126.

► AmerGen included the nuclear decommissioning liabilities in its calculation of basis in the plants, using the increased basis calculations for amortization and depreciation of the plants.

► AmerGen sought and was denied PLRs regarding the inclusion of the liabilities in basis.

► IRS issued 3 FPAAs, denying the favorable tax treatment and AmerGen filed complaint.

Amergen Energy Co. v. U.S. 113 Fed. Cl. 52 (2013)

► Court of Claims held that Amergen did not get basis for the assumed

nuclear decommissioning liabilities until all the requirements of

section 461 were met, including economic performance.

► Although met fixed and determinable tests, economic performance

test had not been met.

► Although AmerGen had hired a decommissioning operations contractor, economic

performance only occurs when those services are performed. Section

461(h)(2)(A)(i).

► First case to explicitly hold that the economic performance

requirements apply to assumed liabilities. See and compare Treas.

Reg. 1.338-5(b)(2)(ii), Ex. 2 (holding that an assumed environmental

remediation obligation is not taken into account for purpose of AGUB

until economic performance occurs).

Veco Corp. v. Comm’r 141 T.C. No. 14 (2013) ► Accrual method taxpayer claimed accelerated deductions for

contractual liabilities occurring after the close of the tax year under a proposed new accounting method.

► Taxpayer deducted in tax year ending 3/31/2005 expenses attributable to services to be provided in tax year ending 3/31/2006. Contracts included: ► Service contracts with various providers for time periods beginning 4/1/2005.

► Insurance premium agreement for insurance policies with effective dates from 4/1/2005-3/31/2006.

► Real property leases attributable to periods beginning 4/1/2005.

► Portion of equipment lease attributable to period from 4/1/2005-12/15/2005.

► Expenses related to the contracts were reported on 3/31/2006 financial statements.

Veco Corp. v. Comm’r 141 T.C. No. 14 (2013)

► Taxpayer’s argument:

► Satisfied all events test because its execution of agreements and

assumption of binding legal obligations thereunder fixed the fact of

the liabilities.

► Satisfied economic performance under recurring item exception of

Section 461(h)(3).

Veco Corp. v. Comm’r 141 T.C. No. 14 (2013) ► Tax Court found that the all events test had not been met.

► The contractual obligations alone did not fix liabilities under §461 had not

occurred.

► An accrual method taxpayer may not deduct an expense attributable to a bilateral

service contract before performance of the services under the contract occurs. Nat'l

Bread Wrapping Mach. Co. v. Commissioner, 30 T.C. 550, 556 (1958)

► For purposes of the all events test, the deductibility of expenses under an

insurance contract generally is reviewed in the same manner as the deductibility of

expenses under a service contract. See, e.g., Rev. Rul. 2007-3

► The fact of the liability of a rental expense is established as each rent payment

becomes due. Consol. Foods Corp. v. Commissioner, 66 T.C. 436, 443 (1976); see

also Rod Realty Co. v. Commissioner, T.C. Memo. 1967-49.

► The expenses were material and the taxpayer did not meet the matching test

of the recurring item exception, so the recurring item exception did not apply.

► Materiality gleaned from fact of reporting items on financial statements.

Veco Corp. v. Comm’r 141 T.C. No. 14 (2013) ► Query: would these contracts be treated as an assumed liability in an asset acquisition?

► Generally executory contracts are not treated as assumed liabilities in an asset

acquisition (see PLR 200730014). This is likely due to the fact that the future

liability/obligation under an executory contract is not fixed at the time of the acquisition

and arises in the normal course of business post-acquisition.

► Although certain liabilities are treated as assumed liabilities even though such liabilities

are not fixed at the time of the acquisition (e.g., contingent liabilities arising from

pending lawsuits), these are generally distinguishable from executory contracts.

► With that said, in Veco Corp. v. Comm’r, the court stated that the terms of the

agreements are relevant in deciding when liabilities become fixed under the all events

test - suggesting that, depending on the language in the contract, the execution of a

contract may in fact fix the liability in certain circumstances (thus potentially rendering it

capable of being assumed)

► Careful consideration should be given to the terms of the contracts acquired in asset

acquisitions to determine whether any liabilities under such contracts are in fact “fixed”

as of the acquisition date. If so the contracts may be treated as an assumed liability.

Shareholder Litigation/Origin of the Claim

Ash Grove & PLR 201412002

Shareholder litigation

► Origin of the claim analysis – capitalize under Treas. Reg. §1.263(a)-5 v. deduct as ordinary and necessary under section 162.

► Ash Grove addressed whether legal fees paid by a corporation (Ash Grove) were capital expenditures under Treas. Reg. §1.263(a)-5 or deductible expenditures incurred in the ordinary course of business. The legal fees related to a lawsuit brought against Ash Grove’s officers and directors by its minority shareholders in connection with its acquisition of a target corporation. ► The minority shareholders alleged that the acquisition constituted

self-dealing and that the reorganization unfairly diluted the minority shareholder’s interest in Ash Grove stock.

Shareholder litigation (cont.)

► Ash Grove – District Court of Kansas

► Ash Grove argued that the legal expenses were incurred by honoring its indemnity

obligations to its directors and since indemnity expenses are ordinary and necessary

business expenses, they should be deductible, relying primarily on the Second Circuit

decision in Larchfield.

► Larchfield Corp. v. US (373 F.2d 159 (2d Cir. 1966) – the payment of litigation expenses

on behalf of a board of directors was deductible as a result of an indemnity from

Larchfield to its board members, even though lawsuit related to a capital transaction.

Held that amounts paid to indemnify board members by a corporation was analogous to

employee compensation and fringe benefits.

► In Larchfield the litigation expenses at question were related to a stockholders derivative action against a

director for a breach of fiduciary duty relating to a capital transaction whereby a director (a majority

shareholder) acquired stock in certain subsidiaries for well below market value.

► District Court rejected Ash Grove’s arguments as inconsistent with Woodward v.

Commissioner, 397 U.S. 572 (1970), and stated that the origin of the claim test does not

hinge on the parties to the litigation – the District court determined that Larchfield was not

controlling, predated Woodward by several years, and characterized it as being a

‘primary purpose’ test case, which was rejected in favor of ‘origin of the claim’ by

Woodward.


► Ash Grove – United States Court of Appeals, Tenth Cir. affirmed the district court decision

► Citing the Supreme Court's decision in Woodward v. Commissioner, 397 U.S. 572 (1970), the appeals court noted that, as a general rule, "costs incurred in the acquisition or disposition of a capital asset are to be treated as capital expenditures.“

► “Expenses of litigation that arise out of the acquisition of capital are capital assets, quite apart from whether the taxpayer's purpose in incurring them is the defense or perfection of title to property," the court pointed out (United States v. Hilton Hotels Corp., 397 U.S. 580 (1970).

► Again turning to Woodward, the court stated that "ancillary expenses incurred in acquiring or disposing of an asset are as much part of the cost of that asset as is the price paid for it."

► The Tenth Circuit pointed out the Larchfield court expressly stated "'the expenses of a suit against directors' are not 'always deductible.'" Ultimately, the Tenth Circuit applied the origin of the claim test to the facts in Ash Grove, "convinced that the present matter is one of those instances in which the expenses related to such a suit are not deductible."

► Ash Grove’s payments related to litigation expenses that proximately resulted from the capital transaction; the legal fees and settlement operated to defend and maintain the reorganization itself and thus were required to be capitalized.


► Does decision in Ash Grove call into question the continued vitality in Larchfield?

► District Court’s analysis of Larchfield as a “primary purpose” case is

inconsistent with the Second Circuit’s opinion in Larchfield which made clear that its decision was based on an origin of the claim analysis. ► The Second Circuit rejected the arguments advanced, and the cases relied on, by

the taxpayer specifically because they applied a “dominant purpose” test (the “primary purpose” test has also been referred to as the “dominant purpose” test).

► The Second Circuit stated that the taxpayer’s dominant purpose argument was in conflict with cases applying an origin of the claim analysis, including Iowa Southern Utilities Co. v. CIR, 333 F.2d 382 (8 Cir.), cert. denied, 379 US 946, 85 S. Ct. 438, 13 L. Ed. 2d 543 (1964).

► Moreover, both courts and the IRS have frequently cited Larchfield as representative of an origin of the claim case.

► In short, although the Tenth Circuit did not follow the Larchfield decision in Ash Grove, this does not necessarily call into question the continuing vitality of Larchfield. The Ash Grove decision merely re-affirms the applicability of an origin of the claim analysis and indicates that the determination of whether litigation expenses of officers and directors are deductible is based on the particular facts of each case.


► PLR 201412002

► Facts ► Taxpayer entered into a merger agreement with the target and subsequently

acquired target in a stock for stock transaction. Between the date of the merger agreement and the eventual acquisition, the taxpayer filed required securities filings under federal law

► Plaintiffs asserted that the taxpayer’s board of directors had not provided sufficient information with regard to the target in certain securities filings. They asserted that the misrepresentations and omissions harmed the value of their investment in the post-merger taxpayer.

► The plaintiffs did not challenge the validity of the merger or the price of the merger. Further, none of the plaintiffs’ claims were based upon taxpayer stock received in exchange for shares of target, and some of the plaintiffs acquired shares on the open market after the merger.

► Conclusion ► The ruling characterizes the amounts paid to settle these claims as not facilitating

the merger transaction within the meaning of Reg. §1.263(a)-5, and “not otherwise part of the price paid for target.”

► The ruling concludes the taxpayer may deduct as ordinary and necessary business expenses the amount it spent to settle the lawsuit, including legal fees and expenses.


► PLR 201412002 – applied origin of the claim –

► Payments made to settle lawsuits are currently deductible if the acts that gave rise to the litigation were performed in the ordinary course of the taxpayer’s business (Federation Bank & Trust Co. v. Commissioner, 27 T.C. 960 (1957))

► Litigation expenses are deductible if the litigation is directly connected to, or proximately results from, the conduct of the taxpayer’s business (Howard v. Commissioner, 22 B.T.A. 375 (1931))

► Litigation expenses that arise from a capital transaction constitute acquisition costs and must be capitalized (see Woodward v. Commissioner, 397 US 572 (1970), which applied the origin of the claim test). Under the origin of the claim test, the inquiry is whether the claims in the litigation had their origin in the conduct of the taxpayer’s ordinary and necessary business activities or whether the claims were rooted in a capital transaction.

► The court reasoned that “while the facts of the case involve a capital transaction, the origin of the claim here is in the manner and extent to which taxpayer’s board of directors provided information to shareholders in securities filings concerning the target”

Costs Incurred in Connection with Redemptions (Section 162(k))

► Narrow interpretation of the phrase "in connection with" as used in Code §162(k).

► Facts

► The taxpayer's corporate charter granted its preferred shareholders the right to compel redemption of their stock on or after 9/30/03 if a majority of the holders of the specific series elected redemption.

► Because state law could prohibit the redemption if it would impair the corporation's capital or the corporation might otherwise fail to redeem the shares upon proper demand, the charter required it to pay interest, which increased from 4 percent per annum by 0.5 percent at the end of each 6-month period until paid in full, subject to a maximum rate of 9 percent.

► On 9/30/03, the taxpayer and the preferred shareholders entered into a forbearance agreement, which was extended multiple times, under which the shareholders agreed to forbear from exercising their redemption rights for a period of time, and the corporation agreed to pay the shareholders a "forbearance amount" computed under an interest-like formula. The taxpayer deducted the forbearance amount payments as interest and the shareholders reported them as interest.

Media Space, Inc. v. Comm’r, 135 T.C. 424 (2010)

► IRS disallowed the deduction on the grounds that the payments were not interest because they were not paid on any indebtedness.

► Tax Court upheld the IRS's determination that the payments were not interest, but allowed deductions under §162 for the payment in all but one year.

► IRS argued that §162(k) precluded any deduction because the transaction was in substance a redemption. That is, the taxpayer, in substance exchanged the forbearance payments and new preferred stock with deferred redemption rights for old preferred stock with nondeferred redemption rights.

► Tax Court rejected this argument, stating that deferring the redemption right by a year or less at a time is such a significant change in the nature of the investment as to amount to a new investment. The nature and structure of the petitioner's business did not change as a result of the forbearance agreement, and the preferred stock retained all other rights, including receipt of the 8-percent dividend. Significantly, the fact that the payments at issue had some nexus to redemption rights was not enough to bring them within the purview of Code §162(k).

► Second Circuit vacated the Tax Court's decision, on jurisdictional grounds.

► IRS announced in an action on decision that it will not acquiesce to the Tax Court’s decision in Media Space, and will continue to assert non-deductibility against all forbearance payments.

► Indicates that IRS takes a broad view of the scope and application of Code §162(k).

Media Space, Inc. v. Comm’r, 135 T.C. 424 (2010)

Tax Opinion Insurance for Section 355 Spin-Off Transactions

Treatment of Insurance Premiums for Tax Opinion Insurance on Section 355 Spin-Off Transactions

► Recent IRS moratorium on PLRs for Section 355 spin-off transactions causing many to obtain tax opinion insurance. Such insurance covers tax liabilities (including interest and penalties) potentially arising from a subsequent IRS audit of the spin-off transaction.

► What is the proper treatment of the insurance premiums paid to obtain such policies? ► Non-deductible and non-capital?

► Capitalized to stock basis pursuant to Treas. Reg. §1.263(a)-5

► Deducted as an ordinary and necessary (12 month or less policy term) or capitalized and amortized over the term of the policy (greater than 12 month policy term)

• In general, insurance premiums are considered ordinary and necessary business expenses under section 162. Thus, they are generally deductible, subject to the economic performance rules under section 461(h) and the regulations thereunder and subject to capitalization rules for multi-year policies under Treas. Reg. §1.263(a)-4.

Treatment of Insurance Premiums for Tax Opinion Insurance on Section 355 Spin-Off Transactions – Cont’d

► With respect to tax opinion insurance on section 355 spin-off transactions, the first question that must be answered is whether the insurance premiums are capable of being deducted or capitalized. ► There is no formal guidance (either in case law or from the IRS) on whether premiums of a tax

insurance liability are deductible under section 162.

► Commentators are split on the treatment. Some argue that where sufficient risk shifting has occurred (i.e., that the premiums are NOT a mere prepayment of a tax liability), the premiums should be treated no differently than other insurance premiums used to transfer business risk to a 3rd party. Others argue that because the underlying liability being insured is a non-deductible tax liability, the premiums associated with the insurance policy should be non-deductible (or non-capital).

► Assuming that the insurance premiums are capable of being deducted or capitalized, what is the proper treatment given that the insurance policy is obtained in connection with a reorganization transaction? ► Is an origin of the claim type analysis required?

► PLR 9540003 (addressing the treatment of directory and officer liabilty insurance premiums incurred prior to an acquisition) suggests that there are factors that might cause insurance to be viewed as having its origins in the transaction (in which case premiums would be capitalized to the basis of the stock under Treas. Reg. §1.263(a)-5).

► Queary: If a fee paid to a law firm to write a tax opinion on the spin-off transaction is required to be capitalized under Treas. Reg. §1.263(a)-5 then wouldn’t the premium to insure that opinion also receive the same treatment?

Rev. Proc. 2011-29

9100 Relief Under Rev. Proc. 2011-29

Rev. Proc. 2011-29

► Safe harbor election for success-based fees

► 70% of the fees are non-facilitative costs

► 30% of the fees are facilitative costs

► Application

► Applies only to “covered transactions”

► Applies only to the transaction for which the election is made

► Applies to all the taxpayer’s success-based fees for that

transaction

► Election is irrevocable

Rev. Proc. 2011-29

► Requires election statement

► Attach to original federal income tax return for the tax year the fee

is paid or incurred

► Identify the transaction, and

► State the fee amounts that are deducted and capitalized

► Effective date

► Taxpayers may make election for success-based fees paid or

incurred in tax years ending on or after 8 April 2011

9100 Relief in general

► In cases of missed regulatory elections, the Commissioner

has discretion to grant a reasonable extension of time to

make the election (“9100 Relief”). Reg. §§ 301.9100-1

and 301.9100-3.

► A “regulatory election” includes an election whose due date is

prescribed by a revenue procedure (e.g., Rev. Proc. 2011-29).

► 9100 Relief process: A special type of PLR.

► 9100 Relief will be granted if: ► The taxpayer acted reasonably and in good faith, AND

► Such grant will not prejudice the interests of the Government.

► Impact of making missed election amended tax return?

Standards for 9100 Relief

► Taxpayer acted reasonably and in good faith if the taxpayer:

► Requested relief before the IRS discovered the failure

► Reasonably relied on a qualified tax professional, or

► After exercising reasonable due diligence, the taxpayer was unaware of the necessity for the election

► Taxpayer did NOT act reasonably and in good faith if the taxpayer:

► Used hindsight in requesting relief

► Sought to alter a return position for which an accuracy-related penalty was/ could be imposed, or

► Was informed, but chose not to file it

► The relief will prejudice the interests of the government if:

► Relief will give taxpayer a lower tax liability in the aggregate for all taxable years affected by the election, or

► The year the election should have been made (or years that would have been affected by a timely election) are closed

Recent PLRs

► PLR 201405010 (October 28, 2013), PLR 201338009, PLR 201338018 (both Sept. 20, 2013) and

PLR 201250015 (Sept. 17, 2012) granted 9100 Relief for the safe harbor election provided in Rev.

Proc. 2011-29.

► The taxpayers incurred success-based fees and, consistent with the Rev. Proc., capitalized 30% and

deducted 70% of the fees. The taxpayers, however, failed to attach the Statement.

► In the PLRs, the IRS concluded that the taxpayers acted reasonably and in good faith, and granted 9100

Relief, thereby allowing an extension to file their Statements.

► PLR 201418010 (May 2, 2014) granted 9100 Relief for the safe harbor election provided in Rev.

Proc. 2011-29.

► The taxpayers incurred success-based fees; however, unlike the PLR’s noted above, the Taxpayer capitalized

100% of the success based fees and did not deduct 70% of the fees in accordance with Rev. Proc. 2011-29.

Further the Taxpayer did not attach the required Statement.

► In the PLR, the IRS concluded that the taxpayers acted reasonably and in good faith, and granted 9100

Relief, thereby allowing the Taxpayer an extension of time to both file the election statement and claim 70% of

the previously capitalized success based fees as a deduction on an amended return.

► PLR 201418010 represents the first time that the IRS has granted 9100 for a missed election under Rev.

Proc. 2011-29 when a taxpayer also did not claim a deduction for the success-based fee on its return,

thereby implicitly confirming that claiming the deduction is part of making the election (i.e., part of 9100 relief)

rather than a requirement to be eligible for the election (i.e., not part of 9100 relief).

Recent PLRs – Cont’d

► Special considerations in 9100 Relief ruling process:

► User fee issues for multiple missed elections.

► Representations regarding milestone payments and the Next Day Rule vs.

caveats.

► What fact patterns will IRS consider (e.g., facts not identical to the PLRs)?

► What about the Boyle Case?

Boyle Case

36

► The leading case on the subject of reasonable reliance is United States v. Boyle,

469 U.S. 241 (1985).

► The executor of a mother's will retained an attorney to handle the estate.

► The executor provided the attorney with all relevant information and records for filing

a federal estate tax return, which was required to be filed within nine months of the

decedent's death.

► The executor inquired of the attorney from time to time as to the preparation of the

return, and was assured that it would be filed on time.

► But the return was filed three months late, apparently because of a clerical oversight

in omitting the filing date from the attorney's calendar. Acting pursuant to §

6651(a)(1) of the Code, which provides a penalty for failure to file a return when due

"unless it is shown that such failure is due to reasonable cause and not due to willful

neglect," the Internal Revenue Service assessed a penalty for the late filing.

Boyle Case (cont.)

37

► The executor paid the penalty and filed a suit in Federal District Court for a

refund, contending that the penalty was unjustified because his failure to file

the return on time was "due to reasonable cause," i.e., reliance on his

attorney. The District Court agreed and granted summary judgment for the

executor. The Court of Appeals affirmed.

► The Supreme Court reversed and held that the failure to make a timely filing

of a tax return is not excused by the taxpayer's reliance on an agent, and

such reliance is not "reasonable cause" for a late filing under § 6651(a)(1).

The Supreme Court in Boyle held that taxpayers cannot shift or delegate to

an agent the duty to timely file tax returns.

► No reasonable cause when reliance related to the ministerial task of filing

returns and paying taxes as in Boyle. The IRS often takes a broad reading

of the Boyle case and argues that no reasonable cause for missing deadline

based upon reliance of advisor

Boyle Case (cont.)

38

► Taxpayers, however, should be able to distinguish Boyle and argue reasonable cause

based on reasonable reliance when: (i) a taxpayer files or pays after the actual due

date but within the time erroneously advised by a tax professional, or (ii) related to a

tax professional’s substantive advice with respect to a matter of tax law.

► Often quoted paragraph from Boyle regarding reliance on accountant or advisor with

respect to tax advice: “When an accountant or attorney advises a taxpayer on a

matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to

rely on that advice. Most taxpayers are not competent to discern error in the

substantive advice of an accountant or attorney. To require the taxpayer to challenge

the attorney, to seek a "second opinion," or to try to monitor counsel on the provisions

of the Code himself would nullify the very purpose of seeking the advice of a

presumed expert in the first place. ‘Ordinary business care and prudence’ do not

demand such actions. By contrast, one does not have to be a tax expert to know that

tax returns have fixed filing dates and that taxes must be paid when they are due. In

short, tax returns imply deadlines.”

Updated Milestone Payment Directive

CCA 201234027 - July 16, 2012

► Facts:

► Taxpayer, a publicly traded company, engages an investment

bank to provide services as part of a covered transaction in which

the taxpayer is the target company. Pursuant to an engagement

letter, the investment banker will be paid a $10 million success fee

upon the successful closing of a transaction.

► In addition, the investment banker will receive $1 million upon the

signing of a merger agreement and an addition $1 million upon

the shareholders of the taxpayer approval of the transaction.

► The two $1 million fees will be creditable against the $10 million

success fee

► Conclusion: Non-refundable milestone payments are not

success based and are not eligible for the Safe Harbor

LB&I Directive

► Issued April 29, 2013 (updated January 27, 2014)

► Examining agents directed not to challenge treatment of

eligible milestone payments that are accounted for as part

of a success-based fee where an election under Rev.

Proc. 2011-29 has been made

► Must be paid or incurred in connection with a covered transaction

► Applies only to investment banking fees

► Deductions must be claimed on original timely filed returns

► Not guidance that can be relied upon by taxpayers.

PLR 201405009 / Definition of Covered Transactions

Bright Line Date Rule

► Non-inherently facilitative costs for pre-bright line services not capitalized if they relate to a covered transaction

► Covered transactions include:

► Taxable asset acquisition (only for the acquirer)

► Taxable equity transactions with a greater-than-50% relationship post-transaction

► Reorganizations described in §§368(a)(1)(A), (B), (C), and if §354 or §356 distributions, (D) reorganizations

► Bright line date is earliest of –

► Signing of letter of intent or exclusivity or similar agreement

► Board of director (or equivalent body in partnership) approval of tentatively agreed upon material terms

► Signing of binding contract

Bright Line Date Rule

► Bright line date is NOT triggered by the signing of a confidentiality

agreement or the submission of an indication of interest or a bid

► Inherently facilitative activities:

► Securing appraisal, formal written evaluation or fairness opinion

► Structuring the transaction, including negotiating the structure and

obtaining tax advice on the structure

► Preparing and reviewing the documents that effectuate the

transaction

► Obtaining regulatory approval

► Obtaining shareholder approval

► Conveying property between the parties

PLR 201405009

Target

PRS

Foreign

Subs

Trust

Seller

Taxpayer

Sub 1

Sub 2

• Seller, Target and TP enter into the

Agreement

• Under the Agreement, TP agreed to

acquire f% of Target and obtained the

right to acquire the remaining Target

interests (“Call Option”) – acquisition of

f% and the Call Option = “Step One

Acquisition”

• Immediately prior to Step One

Acquisition, Trust exchanges PRS

interest for Target interests

• “To effect the deemed acquisition by Sub1 of the f percent ownership interest in

Target, Taxpayer contributed cash and Taxpayer common stock through the

ownership chain to Sub2, which paid Seller for the purchase of the f percent

ownership interest”

• Taxpayer paid the transaction costs

PLR 201405009

► Rulings:

► For purposes of section 1563(e)(1), the Call Option is

characterized as an option to acquire a g percent interest in the

stock of each of the Foreign Subs

► As a result of the Call Option, Taxpayer and each of the Foreign

Corporate Subsidiaries are related, within the meaning of section

267(b)(3), immediately after the closing of the Step One

Acquisition, and thus, the Step One Acquisition is a "covered

transaction" within the meaning of section 1.263(a)-5(e)(3)(ii) with

respect to each of the Foreign Subs

Section 195 Start-up Expenditures and Technical Terminations

Treas. Reg. § 1.195-2(a)

► Under Code §195(b)(2) if a taxpayer completely disposed of a trade or business a trade or

business before the end of the 180 month amortization period, any unamortized start-up

expenses attributable to such trade or business may be deducted to the extent allowable

under Code §165.

► On July 23, 2014, the IRS issued final regulations that provide rules for applying Code

195(b)(2) in the case of a technical termination by a partnership described in Code

§708(b)(1)(B) or Reg. §1.708-1(b)(2). In general, a technical termination occurs if within a

12-month period there is a sale or exchange of 50 percent or more of the total interest in

partnership capital and profits.

► For tax purposes, the old partnership is terminated and a new partnership is formed.

Because the new partnership is generally considered to be a new taxpayer, elections made

by the terminated partnership are not applicable to the new partnership, which is free to make

new elections regarding accounting methods and other matters.

► However, Reg. §1.195-2(a) provides that a technical termination is not treated as resulting in

a disposition of the partnership's trade or business for purposes of section 195(b)(2).

Instead, the new partnership continues to amortize the start-up expenses of the old

partnership.

Accounting Method Changes After a Tax Free Reorganization

Accounting Method Changes After a Tax Free Reorganization

► If the transaction is a transaction described in section 381(a) and acquiring corporation will operate target’s trade or business as a separate and distinct trade or business, then accounting methods of each party carry-over. (unless the acquiring and target corporations integrate their trades or business, in which case a principal method analysis must be performed to determine the principal in which target or acquiring may be required to change its method using rules provided in section 381(c)(4) and (5) and the regulations thereunder).

► If the transaction is a transaction described in section 381(a) and acquiring corporation will not operate target’s trade or business as a separate and distinct trade or business (i.e., it will integrate), then a principal method analysis must be performed to determine which entity has the principal methods. The party that does not have the principal methods will be required to change to the principal method using the rules provided in section 381(c)(4) and (5) and the regulations thereunder.

► In the event the taxpayer wishes to change its method of accounting for a particular item after the section 381(a) transaction occurs, it may generally do so without any limitations (even where the section 481(a) adjustment includes the effect of pre-transaction occurrences of the “item”) . For example a change to expense previously capitalized costs, some of which were incurred prior to the transaction, can be made by filing a Form 3115 and computing a section 481(a) adjustment considering both pre and post transaction costs.

Accounting Method Changes After a Tax Free Reorganization – Cont’d

► If the tax free reorganization is not described in section 381(a) (e.g., a section 351 contribution to a newly formed corporation) then the transferee may generally adopt new methods of accounting and apply those methods prospectively. In the case of a newly formed corporation, this is true even if the corporation is a successor to a trade or business that used different methods of accounting (See Rev. Rul. 80-198)

► If this is true, what happens to the accounting methods for the actual items contributed in a section 351 transaction?

► The guidance is clear that depreciation and amortization methods carry over for certain assets contributed in a section 351 transaction (the “step in the shoes” rules of section 168(i)(7) and section 197(f)(9)). However the guidance is not as clear for other items contributed in a section 351 transaction.

► Hempt Bros., Inc. v. United States and Rev. Rul. 80-198 suggest that the “step in the shoes” treatment may apply to other items received in a section 351 transaction as well. Specifically, when the newly formed corporation receives an entire trade or business whereby the transferor used a method of accounting for certain items contributed in the section 351 transaction that differs from the method of accounting that the newly formed corporation chooses (or is required to) use for new occurrences of that same item. The guidance suggests that the methods of accounting for the contributed items in fact “carry-over” and run parallel to the new methods adopted for new occurrences of the item.

► Query: Does the “step in the shoes” treatment noted in Hempt Bros and Rev. Rul. 80-198 apply where only a portion of a trade or business is contributed in a section 351 transaction?

Accounting Method Changes After a Tax Free Reorganization – Cont’d

► Can a newly formed corporation in a section 351 transaction clean up/change impermissible methods associated with contributed items?

► With respect to depreciable/amortizable assets subject to the 168(i)(7) and section 197(f)(9), Rev. Proc. 2007-16, section 2.05 indicates it can. ► Query: Rev. Proc. 2007-16, Section 2.05 makes it clear that a Transferee can change an impermissible

depreciation method that was used by the Transferor, particularly where the Transferor took less than the allowable amount of depreciation. In that case the Transferee computes a 481(a) adjustment to claim the depreciation deductions that the Transferor missed. Rev. Proc. 2007-16 also suggests that the transferee can change an impermissible depreciation method where the Transferor took more than the allowable amount of depreciation. However, in that situation would the Transferee compute an unfavorable section 481(a) adjustment? If so, does that provide the Transferor with audit protection for years in which it over-depreciated the contributed asset?

► With respect to other items contributed, if under the Hempt Bros and Rev. Rul. 80-198 rational the method associated with the contributed item does in fact “carryover,” then it would appear, at first glance, that the Transferee taxpayer may be able to change the method via a method change and section 481(a) adjustment. ► This would appear to be logical in a situation where the Transferor had erroneously capitalized a

deductible expense. Such a situation may arise for certain taxpayers as they implement the tangible property regulations. That is, a Transferee in a section 351 transaction may have received basis in a repair expenditure that the Transferor erroneously capitalized. Can the transferee file a method change to recover the contributed basis as a repair deduction via a method change with a section 481(a) adjustment?

► Query: What if a Transferor deducted an expenditure that should have been capitalized as an improvement? Can the Transferee file a method change (with a section 481(a) adjustment) to begin capitalizing and depreciating the improvement? Would this provide the Transferor with audit protection?

Employee Bonuses

FSA 20134301F

► IRS addressed three fact patterns to illustrate the

application of the Code §461 rules.

► If a taxpayer has the unilateral right to modify or eliminate bonuses

at any time before payment, the liability to pay the bonus amounts

will not be considered fixed (and the amount will not be

determinable) until the bonuses are paid.

► So long as bonuses continue to be subject to board approval, the

all events test will not be considered to be met.

► For bonuses requiring subjective determinations such as

employee performance appraisals, the all events test will not be

met until all such subjective determinations have been made.

Q&A

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