Deducting buyback costs.

A venerable tax law doctrine has been repudiated by the Tax Court's decision in Weisman (cite not available, 11/20/91).

In this case, a corporation's survival depended on renewing a Toyota distributorship agreement. As a condition for entering into the agreement, Toyota required the corporation to redeem a portion of its stock. The corporation deducted the cost of the buyback (and the associated expenses) under the authority of the Tax Court's decision in Five Star Manufacturing Co. (355 F.2d 724, 5th Cir., 1966), which has stood for the proposition that redemption costs incurred in the face of outside threats to corporate survival are deductible.

The Tax Court repudiated Five Star with this reasoning: Fundamentally, a buyback is an acquisition of a capital asset (the corporation's stock), and costs incurred in the acquisition of a capital asset are nondeductible capital expenditures. The flaw in Five Star was the court looked to the primary purpose for entering into the transaction to determine if an otherwise capital expenditure could be deducted. However, this line of inquiry is inappropriate in light of post-Five Star Supreme Court decisions such as Woodward (397 U.S. 572, 1970) and Arkansas Best (485 U.S. 212, 1988) the focused the inquiry on the nature of the transaction rather than on the reason for entering into it--the so-called origin-of-claim test.

On this basis, because a stock redemption is inherently a capital transaction, its costs are capital expenditures without taking into consideration the motives underlying the transaction.

Observation: This decision could adversely affect corporations that paid and deducted greenmail under a survival theory by threatening the deductibility of greenmail payments.