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U.S. Supreme Court: reorganization expenses not deductible.

National Starch and Chemical Corporation, a publicly held company traded on the New York Stock Exchange, was acquired in 1978 by Unilever in a "friendly takeover" and became a wholly owned subsidiary of Unilever. (National Starch at a later date became known as INDOPCO.) The takeover qualified as a tax-free reorganization.

National Starch, which paid an investment banking firm and a law firm about $2.7 million in combined fees in connection with the takeover, tried to deduct the fees on its 1978 tax return as ordinary and necessary business expenses. The Internal Revenue Service disallowed the deductions.

The IRS argued the expenses could not be deducted currently but had to be capitalized, claiming the expenses created benefits lasting well beyond the current tax year. Both the Tax Court and the Third Circuit Court of Appeals held for the IRS.

National Starch argued that, although the expenses produced a benefit lasting beyond the current year, they could not be capitalized because they did not produce a separate asset. It based its argument on another Supreme Court case, Lincoln? Savings and Loan, in which certain extra premiums paid by S&Ls to the Federal Savings and Loan Insurance Corp. were held to be capital expenditures because they created a separate and distinct asset.

Three other circuit courts read the Lincoln ruling to mean what National Starch claimed it did: Creation of a separate asset was a sine qua non of capitalization treatment.

Result: For the IRS. The expenses must be capitalized, regardless of whether they produce a separate asset, because they produced significant benefits beyond the tax year incurred. The expenses do not qualify as ordinary and necessary business expenses. Lincoln Savings and Loan does not require creation of a separate asset to categorize a expense as a capital expenditure and not a current deduction.
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Publication:Journal of Accountancy
Date:May 1, 1992
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