Comments relating to the treatment of transaction costs required to be capitalized under section 263.
On March 15, 2004, the Treasury Department and Internal Revenue Service released Notice 2004-18 (2004-11 I.R.B. 605) inviting public comment on the treatment of transaction costs that are required to be capitalized under section 263(a) of the Internal Revenue Code and Treas. Reg. [section] 1.263(a)-5. The item is currently on the Priority Guidance Business Plan for the IRS and Treasury Department. On behalf of Tax Executives Institute, I am pleased to submit the following comments.
Background on Tax Executives Institute
Tax Executives Institute is the preeminent international association of business tax executives with 7,000 members representing 3,000 of the leading corporations in the United States, Canada, Europe, and Asia. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and the government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply.
Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the rules and standards that govern the application of section 263(a) to expenditures that facilitate taxable and nontaxable transactions.
Current Rules under Treas. Reg. [section] 1.263(a)-5
Treas. Reg. [section] 1.263(a)-5, which was issued in December 2003 together with Treas. Reg. [section] 1.263(a)-4 addressing the treatment of costs paid to create or acquire intangible assets, (1) requires taxpayers to capitalize amounts paid to facilitate the acquisition of a trade or business, a change in the capital structure of a business entity, and certain other transactions. The current regulations generally address the treatment of the costs of the acquirer in acquiring a controlling interest in a trade or business in a taxable asset or stock acquisition, but do not discuss costs incurred by the acquiring entity in tax-free acquisitions or the costs incurred by the target. In the preamble to Treas. Reg. [section] 1.263(a)-5, the Treasury Department and IRS said they intend to issue separate guidance addressing whether amounts required to be capitalized in acquisition transactions should be eligible for the 15-year safe-harbor amortization period prescribed by Treas. Reg. [section] 1.167(a)-3.
In Notice 2004-18, the IRS and the Treasury Department acknowledge continuing controversy with taxpayers about the proper treatment of costs facilitating tax-free and taxable transactions and restructurings that are required to be capitalized under section 263(a) and Treas. Reg. [section] 1.263(a)-5. The Notice invites comments on whether capitalized transaction costs in respect of 11 categories of transactions should (1) increase the basis of acquired assets (and the methodology for allocating such costs among multiple assets), (2) be treated as creating a new asset, (3) reduce the amount realized, or (4) be treated as an adjustment to equity. (2) To the extent that the costs are treated as creating a new asset, the Notice asks whether the asset should be amortized and the appropriate amortizable useful life. Comments are also requested on the treatment of unamortized costs in the event of certain events (e.g., liquidation) prior to the expiration of the amortization period. Finally, comments are requested whether, as a policy matter, transaction costs should be treated in the same fashion regardless of (1) which party (acquirer, seller (transferor), or target) incurs the costs and (2) whether the costs facilitate a tax-free transaction or taxable transaction.
TEI believes that, with only a few specified exceptions, transaction costs incurred in connection with taxable or tax-free transactions should be treated as giving rise to the creation of a new amortizable asset because tax administration will be simplified and factual disputes between taxpayers and the IRS minimized. In addition, by providing a uniform safe-harbor amortization period, the government will promote consistent treatment of similarly situated taxpayers and similar transactions.
To the extent that transaction costs are properly capitalized (rather than deducted or offset against sales proceeds as discussed in the exceptions to the general rule), the future benefits of transaction costs for acquisitions, reorganizations, restructurings, or similar transactions are analogous, and economically similar, to the future benefits associated with organizing a new trade or business, incorporating a business, and organizing a partnership under sections 195, 248, and 709, respectively. By establishing a 15-year period for recovery of organizational costs under those sections, Congress provided an appropriate benchmark for the IRS and Treasury in assigning a life to intangible costs associated with business restructuring or acquisition costs. Hence, TEI recommends that the IRS and Treasury Department establish a 15-year safe harbor amortization period for such costs under the authority of Treas. Reg. [section] 1.167(a)-3(b). TEI also recommends that, because of the salutary effect the new rule will have on tax administration, the safe-harbor recovery period be applied to all capitalized transaction costs incurred in open tax years. (3)
Transaction costs incurred in connection with the acquisition of a trade or business are generally paid to service providers such as accountants, lawyers, and investment bankers who report them as ordinary remuneration income regardless of the form and taxability of the underlying transaction. The consistent treatment of the transaction costs by such recipients contrasts with the potentially disparate treatment of the consideration paid to the seller or transferor for the stock or assets, which is treated as proceeds from the disposition of capital or trade or business assets. TEI submits that the treatment of transaction costs by the recipients as ordinary income without regard to the treatment of the transaction proceeds paid to the sellers (transferors) justifies treating such transaction costs, where they are required to be capitalized under section 263(a) and Treas. Reg. [section] 1.263(a)-5, as a separate asset.
Viewing the transaction costs separately from the consideration paid for the trade or business is also consistent with financial accounting requirements. Under Financial Accounting Standard 141, financial statement issuers must segregate transaction costs from amounts paid as consideration for the underlying business combination, expensing the former and capitalizing the latter.
Acquirer's Costs in Taxable Acquisitions. Under Treas. Reg. [section] 1.263(a)-5, transaction costs incurred in a taxable stock or asset acquisition must be capitalized by the acquirer. In the case of a taxable asset acquisition, the acquirer's costs will generally be allocated to the basis of the acquired assets under section 1060 and recovered either through a sale, depreciation, or amortization of the assets to which the basis is assigned or, under the residual allocation method, through 15-year amortization of a section 197 intangible. In the case of a taxable stock acquisition (and absent a section 338 or 338(h)(10) election converting a stock sale to a deemed asset sale), Treas. Reg. [section] 1.263(a)-5 requires the transaction costs paid by the acquirer to be capitalized to the basis of the acquired stock. Such costs will be recovered, if at all, only upon a subsequent taxable sale of the stock and may never be recovered if the company is liquidated under section 332. (4) The disparate treatment of the acquiring party's transaction costs depending on whether assets or stock are acquired in a taxable stock or asset acquisition is not supportable because, in either case, (1) the treatment of the consideration received by the sellers is unaffected by the treatment of the transaction costs and (2) the treatment of the transaction costs by the service providers is the same.
In order to achieve consistent treatment of the acquirer's transaction costs for taxable stock or asset acquisitions, a new amortizable asset should be established for transaction costs that are not otherwise deductible under the employee compensation, overhead, and de minimis conventions of Treas. Reg. [section] 1.263(a)-5.
Seller's Costs in Taxable Asset or Stock Sales. Generally, a seller's costs to dispose of the assets or stock of a target corporation are treated under current rules as a current deduction (similar to the costs of removal) or as a reduction in the amount of the sales proceeds. Since there is no future benefit associated with a seller's transaction costs and the current rules provide the proper matching of income with the seller's expenses of the sale, there is no reason to change the longstanding treatment of a seller's costs in respect of a taxable asset or stock sale. Hence, the regulations should be revised to confirm the current treatment of such costs. This is one of the exceptions to the general rule of establishing a new amortizable asset.
Target's Costs in a Taxable Sale of Target Stock. Treas. Reg. [section] 1.263(a)-5 reserves on the treatment of capitalized costs incurred by a target corporation in a taxable acquisition of the target's stock where no section 338 election is made. Hence, under current rules, the treatment of the target's transaction costs in a taxable sale of the target's stock requires a case-by-case analysis of each situation. Although taxpayers may have differing views, the costs are likely treated as giving rise to a separate intangible asset with an indefinite life. (5) TEI believes that adopting a consistent rule permitting capitalized costs to be amortized will ease administrative burdens and reduce controversies between taxpayers and the IRS, especially in respect of the treatment of a target's costs of disposition. Hence, we recommend that a target's costs in a taxable sale of the target stock be treated as giving rise to a new amortizable intangible asset.
Taxable vs. Tax-Free Transactions. Treas. Reg. [section] 1.263(a)-5 also reserves on the treatment of capitalized costs incurred by the acquirer and the target in a tax-free asset or stock acquisition. TEI does not believe that, as a policy matter, the treatment of capitalized costs should differ depending on the form of the transaction as taxable or tax-free. Amounts incurred as transaction costs (generally, legal, accounting, and investment banking fees) are separate from the consideration paid for the target stock or assets and are generally paid to a party other than the transferors of the assets or stock. Since the amounts paid are not treated as additional proceeds to the transferor, there is no potential whipsaw against the government in the treatment of the transaction costs as capital or ordinary. Hence, we recommend that the transaction costs incurred by the acquirer be treated as a separate amortizable asset.
To be consistent with the rules governing other dispositions, the costs incurred by the transferor should generally be treated as a deduction or an offset to the proceeds received. In the event that the IRS and Treasury conclude that the costs of the transferor in a tax-free transaction should be capitalized, the costs should be eligible for the 15-year safe harbor amortization period. Similarly, to the extent a target incurs costs in a tax-free reorganization they should likely be capitalized and eligible for the 15-year safe harbor amortization period. Depending on the form of the reorganization (e.g., an acquisitive type "C" stock-for-assets reorganization), however, the target may be liquidated immediately. Under such circumstances, the deduction for the target's costs should be accelerated. Indeed, the regulations should confirm that whenever a target company is liquidated or otherwise disposed of, the unamortized balance of capitalized transaction costs associated with its creation or acquisition may be deducted.
Other Transactions. In the case of other transactions, the best result would be to prescribe a single rule requiring capitalization of the transaction costs as long as the costs are eligible for the proposed 15-year safe-harbor amortization period. Thus, in respect of a divisive reorganization or section 355 distribution, capitalized costs should be recovered over a 15-year period. Similarly, in a section 351 or 721 transaction, the capitalized costs of the transferor and the transferee should be recovered over 15 years. Similarly, in the case of recapitalizations, reincorporations, stock issuances, and section 305 stock distributions, the capitalized costs should be recovered within 15 years.
15-Year Amortization Period
Under current rules, the timing and amount of recovery of transaction costs is dependent upon the form of the transaction as well as the methodology for allocating the costs to the assets acquired, and in some cases, the costs may never be recovered. By establishing a uniform recovery period for transaction costs that must be capitalized, the IRS and Treasury Department will eliminate the disparate treatment of transaction costs arising from different allocation methods, the type of transaction, or, in many cases, the party incurring the costs.
We believe the government has the authority under sections 446 and 167 (as well as section 7805(a)) to issue regulations treating capitalized transaction costs as recoverable over a 15-year period. Section 446(b) grants the government broad authority to prescribe methods of accounting that result in a clear reflection of income. Moreover, the policy underlying the clear reflection of income standard endeavors to match expenses with the period in which the income is earned. To deny taxpayers a deduction--or to effectively do so by indefinitely deferring a deduction until a subsequent future event such as a subsequent sale or dissolution of the entity--is inconsistent with the principle of matching the costs against the revenue produced by the trade or business acquired. Assigning a 15-year life to such costs would be consistent with the treatment of other long-lived intangibles under section 197 as well as the treatment of organizational expenditures under sections 195, 248, and 709.
Finally, we do not believe that section 197(e)(7) bars the issuance of the recommended rules. Section 197(e)(7) provides that "fees for professional services, and any transaction costs, incurred by parties to a transaction with respect to which any portion of the gain or loss is not recognized under Part III of subchapter C" are not subject to amortization under section 197. Although transaction costs cannot be amortized under section 197, we do not believe that section 197(e)(7) is inconsistent with the government's authority to issue regulations under sections 167 and 446, especially where doing so will promote simplification, ease administration of the law, and minimize disputes with taxpayers.
Other Comments on Treas. Reg. [section] 1.263(a)-5
We offer the following additional comments on the application of the intangible asset acquisition rules to acquisitive and other restructuring transactions.
First, the threshold for de minimis costs that are not required to be capitalized under Treas. Reg. [section] 1.263(a)-5(d) should be higher. Specifically, TEI recommends increasing the current $5,000 de minimis threshold for transaction costs to $25,000. Alternatively, the de minimis amount should be based on the size of the transaction, say, the greater of $5,000 or 0.1% of the consideration paid in the transaction.
Second, Treas. Reg. [section] 1.263(a)-5(e) establishes a bright line for distinguishing deductible costs from amounts that must be capitalized because they facilitate the transaction. Facilitative costs are deemed to be incurred at the earliest of the several events, including the date on which a letter of intent is executed by the representatives negotiating a potential acquisition. Letters of intent are frequently signed at a very early stage of a transaction--well before the parties have conducted sufficient due diligence to be committed to a binding transaction. If a brightline rule must be established, TEI believes it should be no earlier than the date the board of directors approves a transaction. (6)
Tax Executives Institute appreciates this opportunity to present our views on Treas. Reg. [section] 1.263(a)-5 as well as Notice 200418. These comments were prepared under the aegis of TEI's Federal Tax Committee whose chair is Susan Bauer. If you should have any questions, please do not hesitate to call either Ms. Bauer at 404.233.4533 (or email@example.com), or Jeffery P. Rasmussen of the Institute's legal staff at 202.638.5601 (or firstname.lastname@example.org).
(1.) T.D. 9107, 2007-7 I.R.B. 447.
(2.) The IRS and Treasury are considering the treatment of capitalized costs that facilitate the following transactions: (1) tax-free acquisitions (for example, reorganizations under section 368(a)(1)(A), (B), (C), (D), or (G)); (2) taxable asset acquisitions (including transaction costs addressed in Treas. Reg. [section] 1.263(a)-5(g)); (3) tax-free stock acquisitions or dispositions (e.g., reorganizations under section 368(a)(1)(B); (4) taxable stock acquisitions (including transaction costs addressed in Treas. Reg. [section] 1.263(a)-5(g)); (5) tax-free distributions of stock (for example, distributions to which section 305(a) or 355(a) applies; (6) tax-free distributions of property (e.g., distributions to which section 332 and 337 apply); (7) taxable distributions of property (e.g., distributions to which sections 331 and 336 apply and distributions of stock to which section 311 applies); (8) organizations of corporations, partnerships, and disregarded entities (for example, transfers described in section 351 or 721); (9) corporate recapitalizations (e.g., reorganizations under section 368(a)(1)(E)); (10) reincorporations of corporations in a different state (e.g., in a reorganization under section 368(a)(1)(F); and (11) issuances of stock.
(3.) In addition, where a target is liquidated in an open tax year the government should consider confirming (in the case of section 331 liquidation) or extending (in the case of a section 332 liquidation) a deduction for costs capitalized in the acquisition or creation of the target in a closed year.
(4.) Costs capitalized to the stock may or may not be recovered in the event of a distribution of the stock under section 355.
(5.) INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992).
(6.) Alternatively, the bright-line test should be eliminated in favor of a facts and circumstances analysis for determining whether the costs facilitate a transaction or are merely costs of investigating a potential target.
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|Date:||Jul 1, 2007|
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