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September 5, 2012

Nonrefundable Fee Was Not Success-Based; IRS Bars Safe Harbor Deduction Election (article)

IRS Chief Counsel has concluded that $2 million in nonrefundable milestone fees paid for services to facilitate a merger were not success-based fees and, therefore, did not qualify for the safe harbor deduction election under Rev. Proc. 2011-29 (CCA 201234027). Even if creditable to a success-based fee, such payments would not themselves be success-based fees. However, another $8 million in fees that were conditioned on accomplishing the merger did qualify for the safe harbor.

Comment: An amount paid to facilitate a business acquisition or reorganization (a "covered transaction") must be capitalized under Reg. §1.263(a)-5. An amount that is contingent on the successful closing of a covered transaction is known as a success-based fee. Under Rev. Proc. 2011-29, a taxpayer may treat 70 percent of a success-based fee as not facilitative (and therefore deductible) and 30 percent as facilitative (which must be capitalized).


The taxpayer, a corporation, hired an investment banker to provide services to facilitate a merger. The investment banker would receive $10 million on the successful closing of the transaction. The taxpayer also agreed to pay $1 million upon the signing of the merger agreement, and another $1 million on shareholder approval of the transaction. These amounts were credited against the $10 million fee payable upon closing. As a result, the taxpayer would pay $8 million to the banker at closing. If the transaction does not close successfully, the two $1 million "milestone" payments would be nonrefundable.

Applicable Regs

Under Reg. §1.263(a)-1T, no deduction is allowed for an amount paid to acquire an intangible, including an ownership interest in a corporation. An amount paid to facilitate the acquisition of an ownership interest must be capitalized, including amounts paid in the process of investigating or otherwise pursuing the transaction. Whether an amount is facilitative is based on the facts and circumstances.

Under Reg. §1.263(a)-5(e)(1), an amount is facilitative if the amount relates to activities performed on or after the bright-line date, which is the earlier of: (1) the execution of an agreement by the parties, or (2) the date on which the taxpayer's board of directors approves the terms of the transaction. Certain amounts are treated as facilitative even if paid for activities performed before the bright-line date.

A success-based fee is presumed to facilitate the transaction and would therefore have to be capitalized. However, a taxpayer may establish that a portion of the fee is not facilitative. Moreover, Rev. Proc. 2011-29 provides a safe harbor under which only 30 percent of success-based fees must be capitalized, and 70 percent can be deducted.

Chief Counsel's Analysis

Chief Counsel reiterated that a success-based fee is an amount that is contingent on the successful closing of an acquisition or reorganization. Chief Counsel concluded that a payment that is nonrefundable is not contingent on the successful closing of a transaction and therefore is not a success-based payment. Instead, the payment is a guaranteed amount incurred upon the occurrence of a specified milestone or some other date or event. Therefore, the two $1 million payments are not success-based payments and do not qualify for the Rev. Proc. 2011-29 safe harbor.

However, the $8 million fee payable upon closing is a success-based fee and qualifies for the safe harbor. The taxpayer may make a safe-harbor election under Rev. Proc. 2011-29 to deduct $5.6 million of the fee (70 percent) and capitalize the other $2.4 million of the fee (30 percent).

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