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LBOs: loan fees deductible.

In a case with potentially wide ramifications, the bankruptcy court ruled expenses incurred in obtaining loans for a leveraged buyout (LBO) were ordinary and necessary business expenses (U.S.v. Kroy Ltd., U.S. Bankruptcy Court, District of Arizona, 2/14/92). Because the LBO created an economic benefit to the business beyond the year in which the loan fees were incurred, the court ruled the expenses were eligible to be amortized over the term of the loan.

The Internal Revenue Service argued the loan acquisition costs were capital expenditures because the purchase of stock merely affected the company's capital structure and was not meaningful to its ability to carry on its business. The court, however, disagreed. It found the expenses were to obtain loans that assisted the LBO, which (in this case) created substantial employee company ownership. Employee ownership, in turn, has the potential to enhance a corporation's ability to operate its business more profitably.

The court also did not accept the argument that the loan fees were nondeductible under tax code section 162(k), which disallows expenses incurred in connection with stock redemption. (The LBO, structured as a "reverse cash merger," was regarded, for tax purposes, as a stock redemption under revenue ruling 78-25.)

Section 162(k) was considered inapplicable because

* While the LBO's objective was to take the company private, it was not done to fend off an imminent hostile corporate takeover.

* Section 162(k) was enacted to overrule the decision in Five Star Manufacturing Co. (355 F.2d 724, 5th Cir., 1966) and' to clarify that redemption costs are not deductible. The section was not intended to change the tax treatment of loan acquisition costs.

* The fees were deductible under the "origin of transaction" doctrine. The loan was the origin of the transaction, and the court could not consider the 1oan's purpose, which was, of course, the redemption of stock.

Observation: As with breakup fees, the bankruptcy court has given another taxpayer-friendly decision. However the facts in Kroy are somewhat narrow. If the LBO had not featured substantial employee ownership or had been the product of a hostile takeover, the court might not have reached the same conclusion.
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Title Annotation:leveraged buyouts
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Jul 1, 1992
Words:362
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