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IRS rules advertising deductible....

Earlier this year, the Supreme Court affirmed decisions of the Tax Court and the Third Circuit when it ruled that professional fees and other costs incurred by INDOPCO, Inc. (formerly National Starch and Chemical Corporation) in connection with its friendly takeover by Unilever U.S., Inc. were required to be treated as capital expenditures that could not be currently deducted (INDOPCO, Inc., 112 S. Ct. 1039 (1992), aff'g 918 F2d 426 (3d Cir. 1990), aff'g 93 TC 67 (1989)). The INDOPCO holding was not particularly surprising, since it merely confirmed the long-standing principle that expenses incurred to benefit future operations by reorganizing or restructuring a corporation are not currently deductible. In reaching its decision, the Supreme Court relied heavily on the Tax Court's finding that the transaction was entered into by National Starch primarily to obtain significant future benefits through access to Unilever's economic resources and technological know-how. The Court noted that National Starch expected to benefit from operational synergies because of the complimentary activities conducted by Unilever, and to obtain administrative efficiencies through a significant reduction in shareholder-related expenses due to the consolidation of its ownership in the hands of a single corporate shareholder.

National Starch, relying on the Supreme Court's decision in Lincoln Savings and Loan Assn, 403 US 345 (1971), argued that its reorganization expenses were not required to be capitalized because they did not "create or enhance a separate and distinct additional asset." This argument was firmly rejected by the Court, which held that Lincoln Savings and Loan stood for the proposition that, although the creation of a separate and distinct asset may be sufficient for classification as a capital expenditure, it is not a prerequisite to such classification.

Since the Supreme Court's decision, there has been considerable concern that IRS personnel would interpret INDOPCO as requiring the capitalization of expenditures unrelated to corporate reorganizations that have customarily been regarded by taxpayers as currently deductible. Practitioners feared that the Supreme Court's rejection of the "separate and distinct asset" standard for capitalizing expenses and its acceptance of a more nebulous future benefit" standard might cause the Service to challenge the deductibility of many recurring expenses that produce some future benefits. For instance, ordinary repairs and maintenance may protect an asset from deterioration and thus prolong its life, even though the primary purpose of the expenditure is to preserve the asset's current usefulness.

The IRS alleviated many of these concerns when it recently issued Rev. Rul. 92-80. The Service ruled that the INDOPCO decision did not affect the current deductibility of advertising costs under Sec. 162(a) and Regs. Sec. 1.162-20(a)(2), even though such expenditures may provide some future benefit to the business incurring the expense. The ruling states that "[o]nly in the unusual circumstance where advertising is directed towards obtaining future benefits significantly beyond those traditionally associated with ordinary product advertising or with institutional or goodwill advertising, must the costs of that advertising be capitalized." (Emphasis added.) Although the distinction between advertising "directed toward obtaining future benefits" and "ordinary product advertising" is not clearly explained, it appears reasonable to conclude that if the future benefit is only an incidental or secondary purpose of the advertising expenditure, a current deduction will be allowed.

The extension of this principle to expenses other than advertising is still somewhat uncertain. Rev. Rul. 92-80 suggests that the IRS intends to take a circumspect approach when applying the INDOPCO rationale to an expenditure that provides both future and current benefits. However, the Service was quick to apply INDOPCO-like reasoning in IRS Letter Ruling (TAM) 9240004, by requiring a taxpayer to capitalize costs incurred to remove asbestos insulation from certain manufacturing equipment.
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Title Annotation:INDOPCO, part 1; professional fees from advertising are deductible
Author:Addison, Emerson J., Jr.
Publication:The Tax Adviser
Date:Dec 1, 1992
Words:612
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