Deducting acquisition costs incurred by a shareholder, but paid by the corporation.
In anticipation of initiating a hostile takeover of Square D Co., Schneider S.A. (Schneider), a French corporation, sought financing from two French banks. Schneider obtained a commitment letter from the banks, under which they agreed to provide acquisition financing; as consideration, Schneider agreed to pay a nonrefundable loan commitment fee and to indemnify the banks for any legal fees associated with the commitment of funds. The commitment letter specified that the loans would be made to a Schneider subsidiary organized to effectuate the acquisition. Thus, while Schneider obtained the commitment to finance, it never intended to be the borrower.
Subsequently, Schneider formed Acquisition Co., which entered into a bridge loan agreement (BLA) with the French banks, as contemplated by the commitment letter. Under the BLA, the banks agreed to lend Acquisition Co. the funds needed to effectuate the acquisition. As consideration, Acquisition Co. became liable for a commitment fee (and related legal fees). The BLA contained no provision (1) under which Acquisition Co. assumed Schneider's obligation under the original commitment letter to pay a loan commitment fee or (2) by which Schneider was relieved of its obligation to pay that fee. In August 1991, Acquisition Co. merged with and into Square D, with the latter surviving; the Square D shareholders exchanged their stock for cash. As the surviving corporation, Square D effectively assumed Acquisition Co.'s obligations under the BLA.
Following the merger, Schneider paid a commitment fee to the French banks, and sought reimbursement from Square D. In 1993, Square D paid Schneider the requested amount. In its court petition, Square D asserted entitlement to a deduction in 1991 for the reimbursement payment. In addition, in 1991 Square D reimbursed the French banks for legal fees incurred in the financing transaction and deducted this amount under Sec. 162(a) on its 1991 return.
The Service argued that Square D could not deduct either the commitment fee or the legal fee paid, because they were Schneider's legal obligation, but the Tax Court disagreed. The court found it persuasive that under the BLA, Acquisition Co. (and consequently, Square D, as the merger survivor) was obligated to pay the financing fees and related costs. Under the BLA, Square D and Schneider were jointly liable for these amounts (i.e., the BLA did not absolve Schneider of its legal obligation). Nevertheless, the court found that, under the BLA, because Square D reimbursed Schneider and paid the legal expenses directly, Square D was entitled to a current deduction.
The court further reasoned that although Schneider negotiated the financing and paid the associated expenses, these costs were incurred on Square D's behalf, to enable it to obtain the loan. As a result, the expenses provided a direct benefit to Square D and were its expenses.
This decision is interesting for various reasons. First, the court noted (in footnote 20) that, to the extent the commitment fee and related legal fees are treated as Square D's costs, they might be considered stock reacquisition costs, the deduction of which is generally barred by Sec. 162(k)(1). However, if Sec. 162(k)(1) applied, the fees Square D paid would likely constitute "amounts properly allocable to indebtedness and amortized over the term of such indebtedness" under Sec. 162(k)(2)(ii) and excepted from Sec. 162(k)(1). Ultimately, however, the parties did not raise this issue.
The court also pointed out that had the Service identified the costs incurred before the BLA was signed, Square D's deduction would have been limited to costs incurred from the date of the BLA forward. The court determined that Square D was not liable for costs until the BLA. The court noted preliminarily that the Service did not challenge Square D's characterization of the costs at issue as loan acquisition costs, which are appropriately capitalized as the cost of the loan and amortizable over its life.
Second, the court found that Acquisition Co. (and later Square D, as its successor) was entitled to a deduction, notwithstanding the fact that Acquisition Co. was a transitory subsidiary, which is usually deemed a nonentity for Federal income tax purposes. Moreover, the court found that Acquisition Co.'s entitlement to the deduction transferred to Square D, because the payments related to and benefitted Square D's business. The court reached this conclusion without considering whether the all-events test may have prevented Square D's deduction.
Third, the court found that although Schneider, not Square D, bore the legal obligation to pay the fees, this fact was not dispositive in determining which entity was entitled to the deduction. Specifically, the court noted that "the loan commitment and legal fees are deductible by [Square D] because Schneider incurred those costs on behalf of [Acquisition Co.], and by extension petitioner, so that petitioner could obtain the Bridge Loan." Thus, the court found the circumstances surrounding the payment of the expense controlling. When a taxpayer shows that the payment of another's expense protected or promoted its own business, the payment may result in a deduction. The court's conclusion that a taxpayer may look beyond a legal obligation to make a payment may expand when a company can properly deduct expenses incurred on its behalf.
Finally, as support for the deduction, the court concluded that Square D "directly benefited" from the payment and the costs related to an asset (the loan) related to Square D's business. Several facts supported the benefit Square D received from these payments. Although Schneider secured the financing commitment, it never intended to be the borrower. Further, even though Acquisition Co. did not exist when the commitment letter was signed, it was identified in that document as the borrower and received the loan proceeds. Moreover, Square D was initially hostile to the transaction, and some of the costs were incurred in response to its hostility. Because Square D ultimately approved the transaction and stepped into the shoes of Acquisition Co. (which benefited from the loan via its receipt and use of the loan proceeds), Square D benefitted from the loan proceeds through its merger with Acquisition Co. The court's expansive view of the benefits resulting from the expenditures was critical to its conclusion that Square D could deduct them.
FROM MARK YECIES, WASHINGTON, DC