Deducting your hostile takeover battles.

According to the Tax Court in A. E. Staley Manufacturing Co. v. Commissioner, no. 96-1940 (CA-7, July 2, 1997), the investment advisory fees a company pays to fend off a hostile takeover are deductible, while those it pays to facilitate the ultimate merger must be capitalized. Staley paid $13 million to investment bankers (and other vendors) to evaluate an unsolicited tender offer. The advisers determined the offer was below the true value of the stock and recommended alternatives. A sweetened cash bid was accepted.

The Internal Revenue Service disallowed the deduction Staley claimed for the investment banking fees. The IRS asserted that the expense must be capitalized in accordance with Indopco Inc. v. Commissioner, 503 US 79 (1992). In Indopco, the U.S. Supreme Court required the target company to capitalize investment banking fees incurred in connection with a friendly takeover.

Reversing and remanding the Staley decision, the Seventh Circuit Court distinguished Staley from Indopco on the grounds that Staley was engaged in defending its business, while the tax-payer in Indopco spent money to produce a significant future benefit. The court did find that a small portion of the fees was paid for activities that facilitated the ultimate merger and should be capitalized.

Observation: Staley serves as the other bookend to Indopco. The Supreme Court is sure to be asked to resolve the question of whether fees incurred in a hostile takeover should be given different tax treatment from those incurred in a friendly takeover. The opportunity this presents the court to narrow (or widen) the Indopco precedent should affect IRS efforts to support capitalization of a wide variety of expenses. For now, many taxpayers will relish Staley's victory.

--Tracy Hollingsworth, Esq., staff director of tax councils at Manufacturers Alliance, Arlington, Virginia.