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Breakup fees found deductible.

In a case of first impression, the U.S. Bankruptcy Court (S.D. Ohio) concluded that breakup fees paid in connection with a failed white-knight defense to a hostile takeover are deductible. The case, In the matter of Federated Department Stores and Allied Stores Corp. (1/8/92), did not address the consequences of expenses incurred by a successful defense strategy.

The deductions were allowed because the costs were not compensated (by insurance or otherwise) and were incurred in connection with an abandoned transaction that did not produce any "lasting benefits." Thus, under well-established tax law doctrine, the costs were deductible as a loss under tax code section 165(a).

The IRS argued that the costs of terminating a capital contract in order to enter into another are capital expenditures of the accepted contract and, therefore, not deductible. The court rejected this notion because in each of the cases in which this rule applied, the tax-payer caused the termination of an existing contract so it could enjoy a more beneficial arrangement.

For good measure, the court also concluded the expenses were deductible under tax code section 162(a) as ordinary and necessary business expenses. The expenses were necessary because, in the tax-payer's business judgment, they were appropriate and helpful. Moreover, because a white-knight defense was both common and accepted, the expenses were indeed ordinary in the context of a hostile takeover battle. Finally, the costs weren't capital expenditures because the failed white-knight merger conferred no benefit.

Observation: Although the decision is welcome, the case has relatively narrow facts. Unanswered is the question of deductibility when the defense strategy is successful or when the hostile transaction does not produce the diastrous results visited on Federated and Allied.
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Title Annotation:paid resulting from failure of a white knight hostile takeover defense
Author:Kral, Kenneth
Publication:Journal of Accountancy
Date:Jun 1, 1992
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