In Private Letter Ruling 202308010 (PLR 20230810), the Internal Revenue Service (IRS) determined that a contingent sell-side advisory fee (the Fee) was incurred by the private equity fund majority seller (the PE Seller), rather than by a subsidiary of its corporate portfolio company (the portfolio company and its subsidiaries, the Target), and accordingly denied the Target's request for relief to make a late success-based fee election and deduct 70 percent of the Fee pursuant to Revenue Procedure 2011-29.

It is common in M&A transactions for the parties to reduce the consideration payable to the sellers by the amount of a target company's transaction costs. Typically, one of the most significant transaction costs are sell-side success fees payable to financial advisors that are contingent on completion of the transaction. It is relatively common for the parties to agree that the tax deductions corresponding to such success fees will be reported as incurred by a target in the tax period ending on or before the closing date and elect to apply the Safe-Harbor (defined below).

Generally, a taxpayer must capitalize expenditures that facilitate acquisitions and similar transactions. A success-based fee is generally presumed to facilitate a transaction and therefore must be capitalized unless otherwise established. A taxpayer may rebut such presumption by producing sufficient documentation to establish the portions of the success-based fee that are allocable to activities that did not, in fact, facilitate the closing of the transaction. In an effort to eliminate the controversy over the allocation of success-based fees and corresponding documentation requirements, in Revenue Procedure 2011-29, the IRS provided taxpayers with a safe-harbor election for allocating 70 percent of success-based fees paid or incurred in a covered transaction described in Treasury Regulation Section 1.263(a)-5(e)(3) to activities that do not facilitate the transaction (the Safe-Harbor). The remaining 30% of the success-based fees must be capitalized as an amount that facilitates the transaction. Taxpayers that choose not to make the Safe-Harbor election must maintain documentation under Treasury Regulation Section 1.263(a)-5(f) to establish that a portion of the success-based fees is allocable to activities that do not facilitate the transaction.

A covered transaction includes a "taxable acquisition of an ownership interest in a business entity (whether the taxpayer is the acquirer in the acquisition or the target of the acquisition) if, immediately after the acquisition, the acquirer and the target are related within the meaning of section 267(b) or 707(b)."

Treasury Regulations Section 301.9100-3 offers non-automatic relief for failure to file elections whose due dates are set by regulations (not by statute). The relief is granted on a case-by-case basis (Section 9100 Relief). The IRS has granted Section 9100 Relief for failure to file Safe-Harbor elections multiple times.2 However, in PLR 20238010, the IRS denied the request for Section 9100 Relief made by the Target for an extension of time to make a Safe-Harbor election with respect to the Fee. The IRS concluded that the Fee was incurred by the PE Seller rather than by the Target and, therefore, the Target was not eligible to make the Safe-Harbor election. More specifically, the IRS held that the transaction was not a covered transaction described in Treasury Regulation Section 1.263(a)-5(f), but rather was described in Treasury Regulation Section 1.263(a)-1(e), which addresses costs incurred by a property owner to facilitate the sale of the property.

The IRS decision in PLR 20238010 is perplexing and concerning since the underlying facts appear to be similar to many typical M&A transactions.3 The financial advisor was initially engaged by the Target to explore strategic alternatives with respect to the Target. The Target contracted with the financial advisor and agreed to pay the Fee. The Target's management and executives took the lead in communication with the financial advisor during the deal process and later worked with the PE Seller on the transaction. The applicable stock purchase agreement between the PE Seller, the other Target shareholders (together with the PE Seller, the Selling Shareholders) and the buyer (the SPA) required certain transaction expenses, including the Fee, to be paid out of the proceeds otherwise payable to the Selling Shareholders. Additionally, the SPA required the Target to make a Safe-Harbor election with respect to success-based fees incurred in the transaction. Pursuant to a management consulting agreement between the Target and the PE Seller, the Target was required to pay directly or reimburse the PE Seller for any amounts paid in connection with the consulting services, including services rendered by investment bankers or financial advisors. The Selling Shareholders accounted for the Fee by reducing their gain from the sale of the stock of the Parent by the amount of the Fee. The Target failed to make a timely Safe-Harbor election with respect to the Fee and accordingly requested Section 9100 Relief.

The Target argued that it incurred the Fee and pointed to its contract with the financial advisor. The Target further asserted that the PE Seller paid the Fee on its behalf, that it primarily benefited from the services of the financial advisor and that the benefits to the Selling Shareholders from such engagement were incidental. According to the ruling, the Target's position was based in part on certain previously issued private letter rulings that it claimed involved similar circumstances and in part on other non-precedential Large Business & International (LB&I) training material.4

The IRS arguments denying the request are hardly compelling. One such argument was that the fee reduced the amount payable to the Selling Shareholders and thus was an expense of the Selling Shareholders. But that is true of any expense or obligation of a target company that reduces the purchase price. That the shareholders receive less because a target has a liability that reduces the equity value does not transform a company liability to a shareholder expense. Another IRS argument was that a deduction would bestow a double benefit — a deduction at the corporate level and reduced gain at the shareholder level. Again, that is true of any company-level deductible expense that reduces the purchase price, such as transaction bonus payments to employees. The IRS also focused on the flow of funds and the related language in the SPA, but none of that appeared inconsistent with the parties' intended treatment.

That being said, the line is admittedly murky as to when an expense should be treated as a shareholder-level cost incurred to facilitate a sale governed by Treasury Regulation Section 1.263(a)-1(e), which would not be deductible by a corporate target, or a corporate-level expense incurred in connection with a sale of the corporation's equity that is a covered transaction described in Treasury Regulation Section 1.263(a)-5(e). As noted above, the IRS in numerous private rulings had previously held that advisory fees incurred by a target corporation in connection with a sale of the target fit into the latter category. PLR 20238010 could be a sign that the IRS is rethinking that approach on a wholesale basis, or it could be a narrow ruling based on the particular facts at issue. Until there is further clarity, taxpayers would be advised to ensure that the contractual arrangements and the flow of funds are carefully considered to better position eligibility for the Safe-Harbor election. In addition, taxpayers should try to timely make the Safe-Harbor election and avoid the need to request Section 9100 Relief.


2. See, e.g., PLR 201908013, PLR 201945010, PLR 202224005, PLR 202052002, PLR 202301006, PLR 202240001 and PLR 201942003. Based on our research, the IRS has granted such relief at least 138 times.

3. We assume, as is typical, that the buyer and Target were related immediately after the closing.

4. See IRS, LB&I Directive, File No. CDA/P/225_03-01, Allocation of Success-Based Fees in a Covered Transaction (PDF) (06/04/2019).

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