INDOPCO and the tax treatment of reorganization costs.

Overview

Section 162(a) of the Internal Revenue Code allows a deduction for all "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business...." Section 263, however, prohibits deductions for amounts "paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate." Such items must be capitalized.

The line between what items may be deducted and what items must be capitalized has long been a question for debate in the tax field.(1)(*) In INDOPCO, Inc. v. Commissioner,(2) the Supreme Court held that expenditures incurred by a target corporation in the course of a friendly takeover are nondeductible capital expenditures. Although INDOPCO clarified the law as it pertains to target corporations in successful friendly takeovers, issues remain regarding the deductibility of expenses related to failed or abandoned transactions, expenses related to fighting hostile takeovers, expenses related to searching for white knights, expenses related to divisive reorganizations, expenses related to proxy fights, and costs of obtaining financing to redeem shares to prevent a hostile takeover, among others. This article addresses those issues. (The authorities discussed in this article are summarized in Exhibit 1--see page 39.)

Costs for Uncontested Acquisitions

A. Costs Incurred by Target Corporations: National Starch and INDOPCO

1. Early Revenue Rulings. In Rev. Rul. 67-125,(3) the Internal Revenue Service held that legal fees for advice on the tax significance of a potential reorganization must be capitalized. The IRS ruled first that legal fees incurred for services performed in drafting a merger agreement must clearly be capitalized as incident to a reorganization, since the merger changes the capital structure of the corporation. The IRS went on to explain that legal fees for advice on the tax ramifications of such reorganization are "just as necessary in effecting a reorganization as those for the actual drafting of the reorganization agreement."(4)

In Rev. Rul. 73-580,(5) the IRS held that compensation paid for services performed by employees relating to reorganizations should be treated the same as fees paid for similar services performed by outsiders. Thus, under the analysis set forth in Rev. Rul. 67-125, the portion of compensation paid to employees in connection with services relating to a reorganization must be capitalized.

2. National Starch. In National Starch and Chemical Corp. v. Commissioner,(6) the Third Circuit, in affirming a Tax Court decision, held that a corporation must capitalize consulting fees, legal fees, and other expenses incurred in deciding whether to accept a friendly takeover bid. Unilever, the acquirer, was a U.S. company that was owned by a foreign company. Wanting to increase its U.S. revenues relative to its overall revenues, the foreign company directed Unilever to approach National Starch, one of Unilever's suppliers, to determine whether National Starch was interested in being the target of a friendly takeover. Unilever made it clear that it was only interested in a friendly takeover.

To accommodate the principal shareholders of National Starch, the transaction was consummated in two steps. In step one, shareholders of National Starch were given the opportunity to exchange each share of National Starch common stock for one share of nonvoting preferred stock of a newly formed subsidiary of Unilever. This transaction was intended to be tax free under section 351.(7) In step two, a transitory subsidiary of the Unilever subsidiary was merged into National Starch, and any National Starch common stock not exchanged under step one was converted into cash (a "reverse subsidiary cash merger").

National Starch hired independent investment bankers and attorneys to assist in valuations and to ensure that the board of directors did not breach any fiduciary duties. In addition, National Starch incurred miscellaneous fees such as accounting, printing, proxy solicitation, and SEC fees in connection with the transaction. National Starch deducted these fees, but upon audit the IRS concluded that they should be capitalized.

National Starch argued that the Supreme Court's holding in Commissioner v. Lincoln Savings & loan Association(8) established a rule that an expense is a capital expense only if a separate and distinct additional asset is created or enhanced by the expense. Since there was no separate asset created under the merger, National Starch contended, the fees should not be capitalized. Thus, the corporation should be allowed to deduct the expenses under section 162(a). Furthermore, National Starch argued that Lincoln Savings specifically rejected looking to the presence of a future benefit to determine whether expenditures were ordinary and necessary.

The Tax Court and Third Circuit in National Starch rejected with the taxpayer's arguments. The Third Circuit held that Lincoln Sauings did not establish a "separate and distinct asset" test and that an expense may be a capital expense, even though there is no separate and distinct asset. Although the court stated that no single factor controls the deduction/capitalization distinction, the Third Circuit seemed to adopt a "future benefits" test. Under this test, an expense must be capitalized if such expense produces benefits for the future.(9) Whether or not an expense will produce a future benefit is a question of fact.

3. INDOPCO. The Supreme Court in INDOPCO affirmed the Third Circuit's decision in National Starch.(10) The Court held that the fees noted above "produced significant benefits to National Starch that extended beyond the tax year in question....(11) Thus, they must be capitalized. The Court held that the fees not creating or enhancing a separate and distinct additional asset under Lincoln Savings "is not controlling."(12) Lincoln Savings did not hold that only expenditures that create or enhance separate and distinct assets are to be capitalized, just that those that do must be capitalized. The Court in INDOPCO concluded that investment banker fees, legal fees, proxy costs, and SEC fees incurred by a target corporation in a friendly takeover must be capitalized if the takeover produces significant future benefits.(13)

Regarding the future benefits test, the Court stated that "although the mere presence of an incidental future benefit...may not warrant capitalization, a taxpayer's realization of benefits beyond the year in which the expenditure is incurred is undeniably important" in determining whether the costs must be capitalized.(14) Thus, the Supreme Court did not literally establish a future benefits test. Rather, it provided only that such a benefit is "undeniably important" in determining whether an expenditure must be capitalized.(15) Subsequent cases, however, use future benefits as the touchstone in determining whether an expense may be deducted.(16)

4. Payments to Employees Terminating Unexercised Stock Options. Corporations that are acquired in reorganizations often must make payments to employees holding unexercised stock options in order to facilitate the transaction. In Rev. Rul. 73-146,(17) the IRS held that payments to target employees to terminate unexercised stock options, as a condition of a reorganization, are compensation to the employees, and deductible by the corporation. The IRS ruled that the cancellation of the options was not in satisfaction of a new obligation generated by the reorganization, but in satisfaction of a pre-existing obligation of a compensatory nature. Thus, payment to employees was deductible as an ordinary and necessary business expense under section 162.(18)

Another issue arises concerning amounts paid to employees to terminate unexercised stock options that are in excess of amounts that would have been paid to the employees had a pending takeover not influenced the stock price. In one technical advice memorandum (TAM),(19) the IRS addressed this issue in the context of both stock options and stock appreciation rights. The IRS held that such payments "are substantially the same as the payments that were analyzed by the IRS in Rev. Rul. 73-146."(20)

Although the revenue agent had contended that the excess over the amount that would have been paid to employees barring the pending takeover should be capitalized, the IRS National Office concluded that the distinction is not controlling. The IRS explained that such a premium may have been present in Rev. Rul. 73-146. In addition, the premium was merely the fair market value of the stock at that time, and compensation to the employee would rise along with the fair market value. The IRS also said that a deductible expense is not converted to a capital expenditure solely because the expense is incurred as part of a reorganization.

As opposed to these rulings, in Jim Walter Corp. v. United States,(21) the Fifth Circuit held that a corporation could not deduct an amount paid to repurchase warrants. The exercise of a warrant entitled the holder to one share of common stock and two 26.9-percent subordinated bonds. The corporation in Jim Walter wanted to repurchase the warrants because it was conducting a separate public offering of securities, and the underwriters feared that the warrants might be exercised, thereby causing the issuance of substantial debt obligations and shares of common stock, which in turn would generate large interest payments and a serious dilution of shareholder equity and earnings per share.

The court in Jim Walter stated that the repurchase of warrants was a recapitalization expense associated with the public offering, and held that expenses incurred in connection with the acquisition or issuance of corporate stock are nondeductible capital expenditures. The court implied that it might reach a different result if the repurchase of the warrants had been necessary for the corporation's survival. Although the Jim Walter decision seems contrary to Rev. Rul. 73-146, taxpayers presumably should be allowed to follow the IRS's guidance and deduct costs related to payments to employees to terminate unexercised stock options and warrants.

B. Costs Ineurred by Acquiring Corporations

Although INDOPCO technically only applies to costs of a target corporation pursuant to a reorganization, the principles of the case should apply to the acquisition costs of acquirers. In United States u. Hilton Hotels Corp.,(22) the Supreme Court held that litigation expenses incurred by an acquirer in connection with the valuation of stock because of a hotel merger were capital expenditures rather than business deductions.

In Hilton, the acquirer hired a consulting firm to prepare a merger study to determine a fair rate of exchange of stock. The target's dissenting shareholders disagreed with the consulting firm's result and initiated appraisal proceedings following the merger. The acquirer deducted fees paid to the consulting firm for the merger study, and the cost of legal and professional services arising out of the appraisal proceeding. The Supreme Court reasoned that expenses of litigation arising out of the acquisition of a capital asset are capital expenses. The Court further stated that the primary purpose of the transaction is not relevant to such determination.

In Woodward v. Commissioner,(23) a companion decision to Hilton, the Supreme Court stated that a test based upon the taxpayer's purpose in undertaking litigation "would encourage resort to formalisms and artificial distinctions."(24) Thus, if litigation expenses are directly related to the purchase of stock, such expenses must be capitalized.

Accounting fees paid by an acquiring company to investigate the financial condition of a target, incurred in connection with the acquisition of such target's stock, also must be capitalized. Thus, in Ellis Banking Corp. u. Commissioner,(25) the court held that "expenses of investigating a capital investment are properly allocable to that investment and must therefore be capitalized."(26)

Although the foregoing authorities suggest that all expenditures related to a reorganization must be capitalized, some authorities hold otherwise. In Rev. Rul. 67408,(27) an acquirer became obligated to pay severance payments to employees of a target who were terminated due to the merger; the obligation arose from agreements with railroad unions in order to facilitate the merger. The IRS ruled that the satisfaction of the acquirer's obligation constituted ordinary and necessary business expenses that are deductible under section 162.(28) The payments would not have been made but for the prior employment relationship between the target and the employees.

In TAM 9326001 (March 18, 1993), a target had severance payment provisions in contracts with officers pursuant to which payments would be made to such officers in the event the officers were terminated as a result of a merger. Following a merger, the acquiring corporation entered into new agreements with the officers that were substantially similar to the old agreements. The officers were then terminated prior to the expiration of the new agreements, and the acquirer paid the amounts designated in the new agreements.

The IRS ruled that the acquirer could deduct the amounts paid to the officers, because the payments related to the employment relationship, not the reorganization. The payments were merely coincidental to the reorganization, inasmuch as they "had their basis in the longstanding employment relationship with [the target], not the reorganization itself."(29)

C. Costs Incurred by Shareholders

1. Effect of INDOPCO. The authorities relating to costs incurred by shareholders conclude that reorganization costs must be capitalized. While INDOPCO is not specifically applied in these cases, the analysis appears to be much the same. In Woodward, the shareholders of a corporation were required by state law to purchase the interest of dissenting shareholders who did not agree with a change in the corporation's charter. The non-dissenting and dissenting shareholders could not agree on a price for the purchase of such shares. Thus, the non-dissenting shareholders brought an action to appraise the value of the stock. In holding that the litigation expenses must be capitalized, the Supreme Court stated that the origin of the claim was founded in the purchase of stock, a capital event. The litigation expenses were part of the process of acquisition.

The holding in Woodward also applies to costs incurred by minority shareholders who incur legal fees to appraise their minority stock interest. In Third National Bank United States,(30) the court held that the Supreme Court in Woodward "clearly intended" its ruling to apply to sellers of stock in addition to purchasers of stock. Furthermore, Rev. Rul. 67-411(31) makes clear that brokerage, legal, accounting, and related expenses of a target corporation that are paid by its shareholders pursuant to a "C" reorganization must be capitalized by the shareholders and are not deductible under section 212. The shareholders increased their basis in the stock acquired pursuant to the reorganization.

Costs may be deducted, however, if they are not related to a reorganization. In Picker v. United States,(32) shareholders of a closely held corporation hired investment counselors to help diversify their investments. Although the counselors did suggest that the shareholders merge their company with a listed company, the shareholders found a company on their own and merged without the investment counselors' help. The Court of Claims in Picker held that the purpose of hiring the investment counselors was to improve the shareholders' capacity to produce income. Thus, their fees were deductible under section 212, since the services rendered were either unrelated to the eventual merger or related only to abandoned transactions.

Based on the foregoing, it seems likely that future decisions related to expenses incurred by shareholders pursuant to a reorganization will cite INDOPCO and reach a similar result.

2. Personal Guarantees. Personal guarantees by shareholders given to acquiring corporations in order to facilitate a merger must also be capitalized if ultimately paid. In Estate of McGlothin v. Commissioner,(33) a shareholder of a target corporation guaranteed an acquiring corporation that property would yield a minimum amount of profits within two years. When such property did not yield the minimum amount, the shareholder was required to pay the acquiring corporation the guaranteed amount.

The court held that the shareholder must capitalize the amount paid as part of the guarantee because it was part of the purchase price of the acquiring company's stock. In essence, the shareholder received the acquiring company's stock in exchange for target stock plus the guarantee. Thus, the guarantee was part of the cost of acquisition of a capital asset.

D. Public Comments on INDOPCO

In January 1996, the IRS invited the public to comment on the approaches it should consider in addressing issues under section 162 and section 263 in light of INDOPCO.(34) To date, numerous commentators have urged the IRS to provide general guidance on capitalization issues, rather than providing piecemeal guidance over time through the issuance of letter rulings.(35) The IRS placed this issue on its 1996 business plan, stating that it would provide "[g]uidance, as appropriate, in response to comments received pursuant to Notice 96-7 regarding capitalization issues."(36)

Abandoned Transactions

A. In General

In general, expenses incurred by taxpayers in the course of a reorganization that is eventually abandoned are deductible in the year the reorganization is abandoned. In Doernbecher Manufacturing Co. v. Commissioner,(37) the court held that amounts paid to investigate the possibility of a merger are deductible in the year in which the merger is abandoned.

The rule allowing a deduction for costs incurred in an abandoned transaction, however, does not affect the initial capital nature of an expense.(38) The allowed deductions following an abandoned transaction are deductible as a loss under section 165, as opposed to deductible as an ordinary and necessary business expense under section 162(a).(39) Thus, expenses incurred in investigating a possible capital investment must be capitalized, even though the taxpayer has not made a final investment decision.(40)

Expenditures "made with the contemplation that they will result in the creation of a capital asset cannot be deducted as ordinary and necessary business expenses even though that expectation is subsequently frustrated or defeated....(41) If the taxpayer subsequently abandons the project, the preliminary capitalized expenditures may then be deducted as a loss under section 165.

In Rev. Rul. 67-125,(42) the IRS ruled that capitalized legal fees attributable to a proposed distribution in redemption of stock are deductible in the year the redemption is abandoned. The IRS did not, however, address whether such deduction falls under section 165 or section 162(a). Subsequently, the IRS held in Rev. Rul. 73-580(43) that although compensation paid to employees in connection with a reorganization must be capitalized, amounts paid with respect to abandoned mergers or acquisitions are deductible in the year of abandonment. The IRS specifically said that such deduction falls under section 165.

B. Multiple Separate and Distinct Transactions and Multiple Alternatives

There is an important distinction between multiple separate and distinct transactions, and multiple alternatives to the same transaction. If there are multiple separate and distinct transactions, costs allocated to abandoned transactions are deductible in the year of abandonment under section 165.(44)

For example, in TAM 9402004 (September 10, 1993), a taxpayer wanted to deduct 6/7ths of the costs incurred to find a buyer for their corporation, because it received seven offers and accepted only one. The taxpayer argued that six of the seven transactions were abandoned. The IRS held, however, that the corporation could accept only one purchaser, and thus there was only several alternatives to one possible transaction: the sale of the corporation.(45) Because the corporation carried out one of the alternatives, all costs associated with finding a buyer must be capitalized. Effectively, this TAM stands for the proposition that, if multiple transactions are not mutually exclusive (i.e., the corporation can carry out more than one offered transaction), then the transactions are treated as multiple separate and distinct transactions. As such, costs related to each transaction may be deducted when abandoned. On the other hand, if the transactions are mutually exclusive (i.e., the corporation can accept only one transaction), the transactions will be treated as mere alternatives to one transaction. Thus, costs related to the transactions will not be considered abandoned unless none of the alternatives is accepted.

Costs for Contested Acquisitions:Hostile Takeovers

A. Resisting Unwanted Acquirers

1. In General. Paying legal fees in connection with a lawsuit that could affect the financial safety of a business is "the common and accepted means of defense against attack," and such fees are thus deductible under section 162.(46) Under analogous reasoning, professional fees incurred by a taxpayer to defend against a hostile takeover should also be deductible. The IRS, however, has struggled with this issue, issuing issued numerous TAMs on this topic from 1985 through 1991, each one seemingly reversing the preceding one.(47)

The IRS's most recent TAM on resisting unwanted corporate raiders--TAM 9144042 (July 1, 1991)--holds that investment banking, legal, tax, and media professional fees incurred to defend against a hostile takeover must be capitalized if they result in a long-term benefit to the target corporation. The IRS stated that the nature of a takeover, whether friendly or hostile, is not determinative of the proper tax treatment. The "proper inquiry...is whether the target corporation obtained a long-term benefit as a result of making the expenditures."

As a result, TAM 9144042 concludes that professional fees incurred in resisting a takeover attempt "will not uniformly be classified as either currently deductible under section 162 of the Code or capitalizable under section 263 of the Code." Each situation will be analyzed on its own specific facts and circumstances. Under the facts of the TAM, amounts paid by a target to repurchase its stock from a corporate raider had to be capitalized.(48) Amounts paid to reimburse the raider for expenses incurred in connection with a failed takeover attempt also had to be capitalized .(49)

In addition, the IRS issued an industry specialization program (ISP) paper on April 24, 1991, relating to costs incurred by corporations in defending themselves against hostile takeovers, including when a corporation is taken over in a leveraged buyout.(50) The ISP Paper provides that "[n]o absolute rules apply universally: each takeover defense is factually unique... [and] will have to be separately analyzed....,"(51)

TAM 9144042 and the ISP Paper seem to have reached a different conclusion from that announced in TAM 9043003 (July 9, 1990). The latter TAM, however, did not expressly overrule the earlier one. In TAM 9043003, the IRS stated that expenses incurred by a corporation to resist an unfriendly takeover attempt are deductible as ordinary and necessary business expenses under section 162. The IRS noted that since the target corporation resisted the takeover and decided, in its best judgment, that the merger was detrimental to the company, there would be no future benefit to the target corporation.

The IRS distinguished National Starch in TAM 9043003, stating that there was no resistance to the merger in such case, thus showing that the merger yielded a future benefit. If the corporation in TAM 9043003 had accepted the merger offer, then the IRS would have held that the expenses must be capitalized. In characterizing the expenses as "ordinary and necessary," the IRS said the target knew "from experience that payments for such a purpose...are the common and accepted means of defense against attack."(52)

2. Fees Paid to White Knights. The IRS has ruled that fees incurred in order to facilitate a friendly merger with a white knight are akin to the fees at issue in National Starch, and thus must be capitalized.(53) Such a merger would presumably result in a future benefit to the target. At least one court, however, has held that expenses incurred to break-up a merger through the use of a white knight may be deducted. In re Federated Department Stores, Inc.(54) involved a target that (i) resisted a corporate raider, (ii) incurred expenses to find a white knight, (iii) was subsequently bought out by the corporate raider, and (iv) thus did not merge with the white knight, which (v) was consequently paid break-up fees.(55)

In the end, the target's board of directors actually approved the merger with the corporate raider. Nevertheless, the court held that the fees associated with resisting the merger with the corporate raider were deductible business expenses. The court concluded that, even though the merger ultimately occurred, no synergy between the two companies was created like that in INDOPCO, and thus there was no long-term benefit. The merger was effectively forced on the target, and the court believed that there was no long-term benefit inasmuch as the corporate raider "was inexperienced in the...field."(56)

The court also held that the break-up fees paid to the white knight were deductible as a business expense under section 162, noting that "costs incurred to defend a business against attack are ordinary and necessary expenses."(57) Furthermore, the court concluded that break-up fees were deductible as a loss under section 165, because loss deductions are allowed for abandoned capital transactions. The court specifically noted that its decision is consistent with INDOPCO.

B. Recent Tax Court Holdings on Unsuccessful Defenses Against Hostile Takeovers

Recently, the Tax Court has decided two cases involving corporations that eventually agreed to merge with a hostile entity. In Victory Markets, Inc. v. Commissioner,(58) a target corporation incurred costs in evaluating whether to accept a merger offer from an acquiring corporation. The target rejected the offer initially, but eventually accepted after the acquirer increased the amount it would pay for target shares.

Although the target argued that the takeover was "hostile," the Tax Court held that the acceptance of the offer showed that the merger was "friendly," and thus the costs must be capitalized under INDOPCO. The court noted that the acquirer never attempted to circumvent the board of directors by making a tender offer to the shareholders directly. Furthermore, a long-term benefit inured to the target, inasmuch as it would not have accepted the offer of merger if it had not been advantageous to the company.(59)

Similarly, in A.E. Staley Manufacturing Co. v. Commissioner,(60) the Tax Court held that investment banking fees and printing costs incurred in response to hostile offers were capital expenditures, since the offers were eventually approved. The target in A.E. Staley rejected two offers from the acquirer before eventually accepting a plan of merger. Although the target "did not at first welcome" the offers of the acquirer, it eventually accepted an offer that was "fair" and in its "best interest."(61)

In contrast to Victory Markets, the court in A.E. Staley concluded that the initial takeover offer was hostile, but that it did not matter because the board eventually accepted an offer of merger. Thus, there was a long-term benefit in connection with a change in corporate structure, which must be capitalized.(62) The court distinguished Federated Department Stores, noting that there was no failed white knight transaction in A.E. Staley and explaining that the court in Federated did not rely on whether the takeover attempt was hostile but rather on the targets not obtaining "any significant future benefits" owing to the merger.(63) In A.E. Staley, the court noted, there were significant future benefits to the target. The court implied that, if there were no future benefits to the target in A.E. Staley, deductions would have been allowed under the theory set forth in Federated for fees incurred to resist the takeover, even though the board eventually approved the merger.

C. Costs Incurred in Pac-Man Defenses 

Under the "Pac-Man" defense, a target acquires an acquirer pursuant to a counter-tender offer. The IRS has ruled that costs associated with such counter-tender offers would be "considered part of the cost of acquiring the stock" and would thus be capital in nature.(64) If the counter-tender offer were abandoned, however, the costs would be deductible under section 165 in the year of abandonment.

D. Poison Pills 

A "poison pill" is a right issued by a corporation to its existing shareholders to buy stock at a below market price if a corporate raider purchases a certain percentage of the corporation's stock. The IRS has ruled that expenses incurred in issuing a poison pill are nondeductible capital expenditures, because expenses incurred by a corporation in making distributions to its shareholders (in this case, contingent stock rights) are generally capital in nature, especially when the rights pertain to the capital structure of the corporation.(65)

E. Redemptions of Stock

1. Introduction. In order to prevent hostile takeovers, corporations often will incur expenses to redeem shares of their stock. The target typically offers to purchase the acquirer's target stock for amounts above the fair market value of the stock (usually referred to as "greenmail") in order to end the threat of a hostile takeover. In Five Star Manufacturing Co. v. Commissioner,(66) a corporation redeemed stock from a shareholder that refused to pay a debt it owed to the corporation. The corporation made such redemption in order to collect the funds owed and facilitate a future business arrangement vital to the corporation with a party that refused to enter into such business arrangement if the indebted shareholder remained with the corporation. The court held that expenses related to the redemption were deductible under section 162. As a result of Five Star Manufacturing, some corporate taxpayers took the position that greenmail payments were deductible.(67) To prevent this result, Congress enacted section 162(k) of the Code.

2. Section 162(k). As enac$ed in 1986, section 162(k) disallows a deduction for any amount "paid or incurred by a corporation in connection with the redemption of its stock."(68) Amounts encompassed by section 162(k) include amounts paid to repurchase stock, fees incurred in connection with such repurchase (i.e., legal, accounting, appraisal, and brokerage fees), and any other expenditures necessary or incidental to the repurchase.(69) Interest expense incurred as part of a redemption, however, is excepted from the disallowance under section 162(k).

In the Small Business Job Protection Act of 1996, Congress amended section 162(k) to include not just redemption expenses, but expenses incurred in any acquisition of previously outstanding stock of the corporation or any related person. Section 162(k) now states that no deduction is allowed for amounts paid or incurred by a corporation in connection with "the reacquisition of its stock or of the stock of any related person...."(70) Thus, the section 162(k) rules now apply to transactions treated as a reorganization, a dividend, a sale of stock, or any other transaction involving a corporation's acquisition of its own stock.(71) The 1996 amendment applies to amounts paid or incurred after September 13, 1995.

The scope of this amendment to section 162(k) is not entirely clear. The new language seemingly broadens the statute to reach those transactions that are a reacquisition of company stock, but not technically a redemption under section 317(b).(72) For example, section 162(k) now seems to cover costs incurred in the recapitalization of a corporations stock, where the corporation issues new company stock to shareholders in exchange for old company stock.(73) Because stock in the corporation is not "property" under section 317(a), such a recapitalization is not technically a redemption under section 317(b). Old section 162(k) presumably would not have covered such a transaction.(74)

3. Costs of Obtaining Financing to Redeem Shares. In general, expenses incidental to securing a loan are nondeductible, but amortizable over the life of the loan.(75) Before the 1996 amendment of section 162(k), however, there were divergent authorities on whether costs incurred by a target in obtaining loans to purchase target stock were amortizable over the term of the loan.

In In re Kroy,(76) the Ninth Circuit held that loan fees incurred in obtaining a loan for a leveraged buyout (LBO) could be amortized and deducted over the term of the loan. The corporation in Kroy decided to go private through an LBO. Since the corporation did not have the funds to purchase its stock, it borrowed $60.6 million from a bank to finance the LBO. In obtaining the loan, the corporation incurred advisory fees, placement fees, credit arrangement and facility fees, closing fees, bank agent fees, and legal and accounting fees.

The IRS in Kroy argued that the phrase "in connection with the redemption of stock" in section 162(k) (prior to its change in 1996) includes loan fees incurred in order to borrow funds to finance a stock redemption. The court, however, reasoned that, although the term "in connection with the redemption of stock" is critical, the fees were incurred as compensation for services rendered in a "separate and independent" borrowing transaction, and not in a redemption transaction. Thus, the court followed the "origin of the claim" test established by the Supreme Court in United States v. Gilmore.(77)

Under the origin-of:the-claim test, the fees in Kroy had their "origin" in the borrowing transaction, and were incurred as compensation for services rendered to the corporation by its investment banker and lenders. The court in Kroy thus noted that there were two transactions: a stock redemption transaction and a borrowing transaction. Section 162(k) does not apply to fees incurred in borrowing funds where the loan proceeds are used to redeem stock.

In Fort Howard Corp. v. Commissioner,(78) the Tax Court disagreed with the decision in Kroy, and held that costs incurred in debt financing an LBO (other than interest costs) are nondeductible under section 162(k) (prior to its change in 1996), as well as nonamortizable. The court noted that there would be no reason to have an interest exception in section 162(k) if financing costs were not related to redemptions. Furthermore, the court in Fort Howard stated that the term "in connection with" clearly implied that financing costs fall under the ambit of section 162(k).(79) The court also argued that the origin-of-the-claim test is inapplicable in this situation. The IRS has stated that it agrees with the result in Fort Howard.(80)

The amendment to section 162(k) included in the 1966 tax bill effectively overruled Fort Howard. In fact, following the enactment of the Small Business Job Protection Act, the Tax Court has issued a new opinion in Fort Howard, ruling that the statutory amendment does not preclude the taxpayer in Fort Howard from deducting and amortizing its financing costs and fees over the term of the loan.(81) New section 162(k)(2)(A)(ii) provides that the disallowance rules of section 162(k)(1) shall not apply to any "deduction for amounts which are properly allocable to indebtedness and amortized over the term of such indebtedness."(82) Thus, corporations are now permitted to amortize costs attributable to obtaining debt financing for reacquiring its own (or a related party's) stock and deduct them over the term of the loan. This new exception applies to amounts paid or incurred after February 28, 1986.(83)

4. Self-Tender Offers. A self-tender offer is undertaken by a target to buy its own stock in the face of a hostile takeover. The analysis for costs incurred in obtaining a loan in order to facilitate a self-tender offer was the same as under Fort Howard and Kroy prior to the recent amendment of section 162(k). The IRS had ruled that a self-tender offer is treated as a stock redemption.(84) Thus, costs associated with self-tender offers were not deductible under section 162(k), prior to its change. The new exception to section 162(k), however, should allow corporations to amortize costs incurred in financing a self-tender offer.

5. Qualified Stock Purchases under old Section 338. In TAM 9609004 (November 6, 1995), a question arose whether section 162(k) would apply to costs incurred in a section 338 transaction structured as a stock purchase and redemption. In the TAM, P owned TA, and X owned T. TA purchased the T stock for cash. TA then merged into T, with T surviving. P filed a section 338(g) election. In order to pay for the T stock, P contributed cash to TA and TA borrowed funds from a bank. As a result of the subsequent merger of TA into T, T assumed TA's debt.

The taxpayer in the TAM acknowledged that, if it had not made a section 338 election, the transaction would have been in part a redemption and, consequently, section 162(k) would have denied a deduction of any of the expenditures incurred in connection with the redemption.(85) The taxpayer argued, however, that the section 338(g) election vitiates the redemption and the stock purchase and converts the transaction into an asset purchase.

The IRS countered that section 162(k) applied because section 338 does not change the character of the entire transaction. It merely treats the stock purchase as an asset purchase. The redemption was a transaction separate from a Qualified Stock Purchase.(86)

Costs Incurred in Divisive Reorganizations

A. General Rule

Costs incurred in connection with divisive reorganizations under section 355 presumably must be capitalized under the same general "future benefit" theory espoused in INDOPCO.(87) No case, however, has specifically applied INDOPCO to such reorganizations, and some cases decided prior to INDOPCO have allowed deductions for expenses incurred in a partial liquidation required by a statute or court order.

B. Divestiture Required by Law

Several cases in the divisive reorganization area involve partial liquidations and reorganizations that are required by a statute or court. For example, in United States v. General Bancshares Corp.,(88) a bank holding company proceeded to divest itself of non-banking assets in order to comply with the newly enacted Bank Holding Act of 1956. The company decided to organize Newco and transfer all non-banking assets to Newco in exchange for Newco stock. The company then distributed such Newco stock pro-rata to its shareholders. The company incurred accounting fees, transfer agent fees, transfer taxes, and the costs of documentary stamps. The court held that such expenses were deductible business expenses, because the "dominant aspect" of the company's divestiture plan was the liquidation of its non-banking assets, and not a reorganization of the company.(89)

The dominant aspect test was adopted in Gravois Planning Mill Co. v. Commissioner,(90) and provides that where "a partial liquidation is accompanied by the corporations recapitalization or reorganization, the transaction is to be viewed as a whole and its dominant aspect is to govern the tax character of the expenditures." The court in Gravois went on to provide that where a corporation "has what is essentially `a change in the corporate structure for the benefit of future operations' there is no deduction" available.(91)

In General Bancshares, the court concluded that the dominant aspect of the corporation's plan of divestment was the liquidation of non-banking assets, and any reorganization "was incidental to such liquidation."(92) Any distribution or liquidation of assets effects some change in corporate structure. Such a change, however, must be "of some benefit, tangible or intangible, to the taxpayer in its future operations before it can be deemed more than incidental to the distribution or liquidation."(93)

In United States v. Transamerica Corp.,(94) the Ninth Circuit held that expenses incurred in connection with a partial liquidation and spin-off were deductible, for the same reasons as in General Bancshares. As in General Bancshares, the corporation in Transamerica was carrying out a plan of divestment in compliance with the Bank Holding Company Act of 1956. The court held that the change in corporate structure was incidental to the liquidation.

In The El Paso Co. v. United States,(95) a gas pipeline company incurred legal, accounting, and consulting fees in order to comply with an antitrust decree requiring the company to divest itself of certain assets. The corporation in El Paso divested itself of such assets by transferring them to Newco for Newco stock, and distributing such Newco stock to its shareholders. As in General Bancshares and Transamerica, the court held that there was no benefit to the corporation in liquidating its holdings and spinning them off. Thus, the expenses were deductible.(96)

C. Future Benefits and the Application of INDOPCO

The application of INDOPCO to divisive reorganizations is less clear than its application to acquisitive reorganizations. The argument that there is a "future benefit" to a corporation that incurs costs in a section 355 transaction is less convincing than in an acquisitive transaction, because a divisive reorganization does not create a new asset. Although INDOPCO provides no requirement that a distinct new asset be formed in order for costs to be capitalizable, it is more difficult to pinpoint a specific future benefit when a company divests itself of a portion of its business.

If a corporation decides to divest itself of a part of its business (barring a statutory or court induced divestment requirement), however, there presumably is some benefit to the corporation.(97) In any event, whether INDOPCO will apply to require the capitalization of costs incurred in divisive reorganizations is an issue that still must be addressed by the IRS and the courts. It does not seem that the application of INDOPCO in the divisive reorganization area would yield a result much different from the previous holdings in this area, E.I. DuPont de Nemours and Farmers Union Corp.(98)

Costs Attributable to Proxy Fights

Expenses incurred by a corporation in a proxy fight, including legal fees, solicitors' fees, and public relations fees are generally deductible under section 162.99 Expenditures for proxy fights concerned with a question of corporate policy are ordinary and necessary, and deductible by a corporation.(100) The IRS has stated, however, that it will "continue to scrutinize costs incurred in proxy fights to determine if the costs are made "primarily for the benefit of the interests of individuals rather than in connection with questions of corporate policy."(101) If proxy costs are for the benefit of individuals, deductions will be disallowed.(102)

Conclusion

Fees incurred by a target corporation in a friendly takeover must generally be capitalized, because such takeovers usually produce significant long-term benefits. Although the Supreme Court in INDOPCO did not explicitly adopt a future benefits" test, most courts have used such a test in determining whether a taxpayer must capitalize costs incurred in reorganizations. Expenses by an acquirer or a shareholder pursuant to a friendly takeover must also generally be capitalized, unless such expenses are incurred due to a prior employment relationship. Furthermore, personal guarantees given by shareholders of a target to an acquiring corporation in order to facilitate a reorganization must be capitalized if paid.

Expenses incurred in connection with a reorganization that is eventually abandoned, however, are generally deductible as a loss under section 165 in the year the reorganization is abandoned. In addition, payments to employees terminating unexercised stock options in order to facilitate a reorganization are generally deductible under section 162. Expenses incurred by a corporation in a proxy fight are also generally deductible.

Expenses incurred to defend against a hostile takeover may generally be deducted, because they do not normally result in a long-term benefit to the target corporation. Some cases, however, have held to the contrary.(103) At least one court has held that break-up fees paid to a white knight are deductible as a business expense under section 162.(104) Furthermore, the IRS has stated that costs incurred in Pac-Man defenses or in poison pill plans must be capitalized.

Amounts paid by a corporation in connection with the reacquisition of its stock must generally be capitalized.(105) Thus, greenmail payments must be capitalized. Before enactment of the Small Business Job Protection Act of 1996 there was a question whether costs of obtaining financing in order to redeem stock is incurred "in connection with" the redemption of its stock.(106) As amended by that legislation, however, section 162(k) now specifically allows a corporation to amortize costs of obtaining financing in order to reacquire its stock.

Although costs incurred in connection with divisive reorganizations must generally be capitalized, some authorities have allowed deductions in situations where corporations are required to divest themselves of certain assets. Apparently, the courts believe that in such situations there is no long-term benefit derived from the transaction. Another way to describe this situation is that the dominant aspect of the transaction is the liquidation of assets, rather than reorganization.

As a practical matter, the divisive reorganization authorities use the same "future benefit" test as did the Court in INDOPCO (although the divisive reorganization cases pre-date INDOPCO), and, thus, cases will be decided on their facts and circumstances. It remains to be seen, however, whether the courts will explicitly adopt INDOPCO in analyzing costs incurred in connection with divisive reorganizations.

Notes

(1) See Thompson v. Commissioner, 9 B.T.A. 1342 (1928) (holding that expenditures for surveys, geological opinions, legal opinions settlements of suits involving title to lands, and abstracts of title are not deductible as ordinary and necessary expenses, but are capital expenditures to be added to cost of property).

(2) 503 U.S. 79 (1992).

(3) 1967-1 C.B. 31.

(4) Rev. Rul. 67-125, 1967-1 C.B. 31, 32.

(5) 1973-2 C.B. 86.

(6) 918 F.2d 426 (3d Cir. 1990), aff'g 93 T.C. 67 (1989), aff'd, INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992).

(7) In the transaction, 179 of National Starch's shareholders, holding approximately 21 percent of National Starch's common stock exchanged their shares for shares in the Unilever subsidiary

(8) 403 U.S. 345 (1971).

(9) The future benefits test is not a new one. Courts have recognized in the past that expenses like those above "`incurred for the purpose of changing the corporate structure for the benefit of future operations are not ordinary and necessary business expenses."' General Bancshares Corp. v. Commissioner, 326 F.2d 712 (8th Cir. 1964 (quoting Farmers Union Corp. v. Commissioner, 300 F.2d 197 (9th Cir. 1962). See Mid-State Products Co. v. Commissioner, 21 T.C. 696 (1954) (disallowing deductions for attorneys fees because reorganization expenses result in continuing benefit to successor corporation).

(10) 503 U.S. 79 (1992). Prior to the Supreme Court's decision, National Starch and Chemical Corporation changed its name to INDOPCO, Inc.

(11) Id. at 88.

(12) Id. at 90.

(13) The Southern District of Ohio in In re Federated Department Stores, Inc., 171 Bankr. 603, 94-2 U.S.T.C. [paragraph] 50,430 (S.D. Ohio 1994), concluded that INDOPCO does not stand for the proposition that any expenditure "that merely preserves the existing corporate structure or policy must be capitalized." As a threshold issue, costs must be incurred in connection with the reorganization for the rules under INDOPCO to apply. See United States v. Gilmore, 372 U.S. 39 (1963). Thus, in Technical Advice Memorandum (TAM 9402004 (September. 10, 1993), the IRS ruled that costs incurred by a target corporation related to acquiring five years of liability insurance for claims against the target's officers and directors which insurance was required by the acquirer prior to purchase were immediately deductible. Although the target's normal business practice was to purchase insurance on a yearly basis, the IRS reasoned that such insurance costs would have been incurred by the target eventually, whether the merger went through or not Furthermore, in TAM 9641001 (May 31, 1996), the IRS concluded that premiums paid to debt holders in repurchasing their debt, in order to obtain the shareholders' consent to a merger, was not a capital expenditure. The IRS reasoned that the early retirement of the debt was not an integral part of the merger, but payment on an already existing debt. The corporation was not required to purchase the debt as part of the merger. The IRS ruled, however, that consent solicitation payments to the shareholders must be capitalized, since these payments had their origin in the merger.

(14) INDOPCO, 503 U.S. at 87.

(15) The IRS has stated that INDOPCO "did not change the fundamental legal principles for determining whether a particular expenditure may be deducted or must be capitalized." See Notice 96-7 1996-6 I.R.B. 22. Furthermore, the IRS has ruled that INDOPCO did not alter the deductibility of advertising costs (Rev. Rul. 92-80 1992-2 C.B. 57), incidental repair costs (Rev. Rul. 94-12, 1994-1 C.B. 36), or severance payments (Rev. Rul. 94-77, 1994-2 C.B. 19) All these expenses are generally deductible under section 162, even though they may have some future effect on business activities. There may be circumstances, however. where such costs must be capitalized. For example, if advertising is directed towards obtaining future benefits "significantly beyond those traditionally associated with ordinary product advertising," a taxpayer must capitalize the advertising costs. Rev. Rul. 92-80, supra.

(16) See, e.g, Victory Markets, Inc. v. Commissioner, 99 T.C. 648 (1992); A.E. Staley Mfg. Co. v. Commissioner, 105 T.C. 166 (1995).

(17) 1973-1 C.B. 61.

(18) See TAM 9438001 (April 21, 1994) (acquiring corporation purchases stock options from target employees indistinguishable from Rev. Rul. 73-146).

(19) TAM 9540003 (June 30, 1995).

(20) Id.

(21) 498 F.2d 631 (5th Cir. 1974).

(22) 397 U.S. 580 (1970).

(23) 397 U.S. 572 (1970).

(24) See also Jim Walter Corp. v. United States, 498 F.2d 631 (5th Cir. 1974) (agreeing with the court's reasoning in Woodward).

(25) 688 F.2d 1376 (11th Cir. 1982). 26 Id. at 1382.

(27) 1967-2 C.B. 84.

(28) Rev. Rul. 67-408, 1967-2 C.B. 84.

(29) TAM 9326001 (March 18, 1993). See Private Letter Ruling (PLR) 9527005 (date) (holding that amounts paid as bonuses" to make up for terminated stock options are deductible, because the amounts arose in the employment relationship).

(30) 427 F.2d 343 (6th Cir. 1970).

(31) 1967-2 C.B. 124.

(32) 371 F.2d 486 (Ct. Cl. 1967).

(33) 370 F.2d 729 (5th Cir. 1976).

(34) Notice 96-7, 1996-6 I.R.B. 22.

(35) See, e.g, Comment of Tax Executives Institute, 96 TNT 60-19; Comment of American Bar Association Section of Taxation, 96 TNT 104-71; Comment of National Retail Federation, 96 TNT 127-21; Comment of American Bankers Association, 96 TNT 98-28; and Comment of Financial Executives Institute, 96 TNT 120-19.

(36) IRS and Treasury 1996 Business Plan, 96 TNT 44-1.

(37) 30 B.T.A. 973 (1934).

(36) Ellis Banking Corp. v. Commissioner, 688 F.2d 1376 (11th Cir. 1982).

(39) At least one Tax Court case, however, implies that expenditures attributable to abandoned transactions may be deducted as an ordinary and necessary business expense under section 162. In Sibley, Lindsay & Curr, Co. v. Commissioner, 15 T.C. 106 (1950), the Tax Court held that expenses attributable to abandoned reorganizations are "a deductible expense." Although the court implied that such expenses are ordinary and necessary business expenses, it did not explicitly say so. Thus, because of the other authorities in this area, expenses incurred by taxpayers in the course of a reorganization that is eventually abandoned should be deducted as a loss under section 165.

(40) Ellis Banking Corp. v. Commissioner, 688 F.2d at 1382.

(41) Union Mutual Life Insurance Co. v. United States, 570 F.2d 382, 392 (1st Cir. 1978).

(42) 1967-1 C.B. 31.

(43) 1973-2 C.B. 86.

(44) See Sibley, Lindsay & Curr, Co. v. Commissioner, 15 T.C. 106 (1950).

(45) TAM 9402004 (September 10, 1993)

(46) Welch v. Helvering, 290 U.S. 111 (1933).

(47) See, e.g., TAM 89845003 (August 1, 1989); TAM 9043003 (July 9, 1990); and TAM 9144042 (July 1, 1991).

(48) The TAM does not address the effect of section 162(k), which is discussed in the text that follows, because the year in issue in the TAM was 1994, and section 162(k) was not effective until 1986. See Tax Reform Act of 1986, [section] 613.

(49) Although INDOPCO had not been decided when the IRS issued TAM 9144042, the IRS did cite National Starch in deciding whether tees incurred to resist a hostile takeover must be capitalized or could be deducted currently.

(50) Leveraged Buyout (LBO) ISP Coordinated Issued Paper: Costs Incurred in a Hostile Takeover Defense. 91 TNT 90-34 (April 24, 1991) (hereinaher "ISP Paper").

(51) Id.

(52) TAM 9043003 (July 9, 1990). The IRS has made clear that, in order to deduct any fees incurred in resisting hostile takeovers, the taxpayer must show which expenses directly relate to resisting the takeover. If the taxpayer cannot prove that specific funds relate to deductible fees, all amounts must be capitalized. See TAM 9043003 ISP Paper.

(53) TAM 9043003.

(54) 171 Bankr. 603, 94-2 U.S.T.C. [paragraph] 50,430 (S.D. Ohio 1994).

(55) In re Federated Dep't Stores, Inc., 171 Bankr. 603. 94-2 U.S.T.C. [paragraph] 50,430 (S.D. Ohio 1994).

(56) Id. at 609.

(57) Id. at 610. Some may find this reasoning illogical, since the corporation is paying the break-up fees after it has already agreed to merge with the raider. Thus, the corporation does not seem to be "defending" itself against attack when the payment is made to the white knight. An argument can be made, however, that the corporation was defending itself when it signed the contract with the white knight that it would pay break-up fees should the merger between the corporation and the white knight fall through. Either way, such costs should at least be deductible under section 165.

(58) 96 T.C. 648 (1992).

(59) This second argument seems to run counter to that made by the court in Federated Department Stores, where the board approved a merger but there was no long-term benefit. The Tax Court in Victory Markets suggests that since the board approved the merger, it would result in a long-term benefit, inasmuch as the board has a fiduciary duty to do what is best for the company.

(60) 105 T.C. 166 (1995).

(61) Id.

(62) See General Bancshares Corp. v. Commissioner, 326 F.2d 712 (8th Cir. 1964).

(63) A.E. Staley, 105 T.C. at 199.

(64) ISP Paper.

(65) Id.

(66) 355 F.2d 724 (5th Cir. 1966).

(67) See Staff of the Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1986, at 277 (1987). Although not entirely clear, even before the enactment of section 162(k) greenmail payments were presumably nondeductible. See Stokely-Van Camp, Inc. v. United States, 21 Cl. Ct. 731 (1990) (stating that enactment of section 162(k) provides no inference that greenmail payments were deductible prior to such section, and holding that greenmail payments must be capitalized), Wrangler Apparel Corp. v. United States 78 A.F.T. F.2d [paragraph] 96-5168 (M.D.N.C. 1996) (same); H.R. Rep. No. 426, 99th Cong., 1st Sess. 249 (1985) (clarifying that greenmail payments are nonamortizable capital expenditures).

(68) This language applied prior to a change in the Small Business Job Protection Act of 1996.

(69) See H.R. Rep. No. 426, 99th Cong., 1st Sess. 249 (1985); S. Rep. No. 313, 99th Cong., 2d Sess. 223 (1986).

(70) As stated in the text, old section 162(k) used the term "the redemption of its stock" instead of the quoted language.

(71) House Committee Report on the Small Business Job Protection Act of 1996, at CCH [paragraph] 11,055 (hereinafter "1996 House Report").

(72) The IRS has held that section 317(b) has general application, applying to reorganizations and other transactions, in addition to Part I of subchapter C (sections 301 to 318) of the Code. TAM 9627003 (February 28, 1996).

(73) A question arises, however, about what types of costs would be incurred in such cases, and whether such costs would be required to be capitalized anyway, under INDOPCO and similar cases.

(74) Another transaction that new section 162(k) could cover is a section 355 divisive "split-off" transection. Under such a reorganization, a corporation distributes stock in a subsidiary to a shareholder in exchange for the shareholder's stock in the corporation. Under section 355, this transaction is tax-free, and not technically a redemption. The transaction, however, is a reacquisition of corporate stock that new section 162(k) should cover, and that old section 162(k) presumably would not.

(75) See Rev. Rul. 70-360, 1970-2 C.B. 103. See also McCrory Crop. v. United States, 651 F.2d 828 (2d Cir. 1981) (noting that expenses in connection with raising capital are nondeductible).

(76) 27 F.3d 367 (9th Cir. 1994).

(77) 372 U.S. 39 (1963).

(78) 103 T.C. 345 (1994)

(79) Fort Howard Corp. v. Commissioner, 103 T.C. 345 (1994).

(80) ISP Paper.

(81) Fort Howard Corp. v. Commissioner, 107 T.C. No. 12 (1996).

(82) I.R.C. [section] 162(k)(2)(A)(ii)

(83) 1996 House Report. The two new amendments to section 162(k) have different effective dates.

(84) ISP Paper.

(85) A transaction is classified as a redemption if a purchaser borrows funds, merges into a target with the target surviving, and such target assumes the liability for the borrowed funds. See TAM 9645003 (July 12, 1996). If the benefits and burdens of a loan are borne by the parent of a corporation that merges into a target and the target does not have any responsibility to pay off the loan, however, the transaction will be treated as a purchase and not a redemption. Id.

(86) It is not clear whether this ruling would also apply to a section 338(h)(10) election.

(87) See E.I. DuPont de Nemours v. United States, 432 F.2d 1052 (3d Cir. 1970) (disallowing expenses incurred in non pro-rata split-off as expenses resulted in benefit expected to produce returns for many years in future); Farmers Union Corp. v. Commissioner, 300 F.2d 197 (9th Cir. 1962) (denying deduction for legal, escrow, and accounting expenses incurred in partial liquidation because taxpayer could not prove that such expenses did not change corporate structure for benefit of future operations).

(88) 388 F.2d 184 (8th Cir. 1968).

(89) Id. at 191.

(90) 299 F.2d 199 (8th Cir. 1962).

(91) Id. at 208. See Mills Estate v. Commissioner, 206 F.2d 244 (2d Cir. 1953).

(92) 388 F.2d at 191.

(93) Id. at 191. The court in General Bancshares did hold that costs of making new engraving plates and the printing of new stock certificates in connection with the change of the corporation's name following the reorganization were nondeductible capital expenditures. The court reasoned that the corporation did not have to change its name and such expenditures were incurred in connection with acquiring a capital asset: a business name. Id.

(94) 392 F.2d 522 (9th Cir. 1968).

(95) 694 F.2d 703 (Fed. Cir. 1982).

(96) A question arises whether new section 162(k) will affect the deductibility of expenses incurred in divesting as required by a court or statute. Presumably, section 162(k) will require a corporation to capitalize such expenses if the divestment mechanism used is a split-off, where the corporation distributes a subsidiary's stock to a shareholder of the corporation in exchange for the shareholder's stock in the corporation.

(97) In order to qualify under section 355, a corporation must have a corporate business purpose. Such business purpose presumably results in a benefit to the corporation. See Rev. Proc. 96-30. Appendix A, 1996-19 I.R.B. 8.

(98) See note 87 supra.

(99) Locke Mfg. Co. v. United States. 237 F. Supp. 80 (D. Conn. 1964); Rev. Rul. 67-1, 1967-1 C.B. 28; see Rev. Rul. 64-236, 1964-2 C.B. 64 (allowing deductions of proxy fight costs for individual shareholders under section 212); cf Dyer v. Commissioner, 352 F.2d 948 (8th Cir. 1965) (denying deduction because on facts, proxy fight would not affect dividend income or stock value).

(100) Rev. Rul. 67-1, 1967-1 C.B. 28.

(101) Id.

(102) Amounts paid by a corporation to both the losers and the winners of a proxy fight in order to reimburse them are also deductible under section 162 as an ordinary and necessary business expense. Central Foundry Co. v. Commissioner, 49 T.C. 234 (1967).

(103) See, e.g, A.E. Staley Mfg. Cop. v. Commissioner, 105 T.C. 116 (1995).

(104) See In re Federated Dep't Stores, Inc., 171 Bankr. 603, 94-2 U.S.T.C. [paragraph] 50,430 (S.D. Ohio 1995).

(105) I.R.C. [section] 162(k).

(106) See In re Kroy, 27 F.3d 367 (9th Cir. 1994), and Fort Howard Corp. v. Commissioner, 103 T.C. 345 (1994).

MARK J. SILVERMAN is a partner and chairs the tax and ERISA group at Steptoe & Johnson LLP, where ANDREW J. WEINSTEIN is an associate. Mr. Silverman is a frequent speaker at educational programs sponsored by Tax Executives Institute.