Acquisition fee safe-harbor election gets 60-day extension

Plain-English summary

A taxpayer incurred a contingent financial-adviser fee in acquiring an early-childhood education company. Internal information failures caused the tax department and outside accounting firm to treat the relevant transaction-advisory portion as outside the firm's review for acquisition costs, so no Rev. Proc. 2011-29 safe-harbor election was filed. The mistake was discovered when the tax department later reconciled the analysis to the general ledger and obtained the adviser-fee allocation email. The IRS concluded that the taxpayer acted reasonably and in good faith and that late relief would not prejudice the government's interests, including the special rules for accounting-method elections. It granted 60 days to file the safe-harbor election for the success-based transaction-advisory fee.

Ruling snapshot

• Question: May the taxpayer make a late Rev. Proc. 2011-29 election for the success-based acquisition advisory fee?
• Outcome: approved; a 60-day extension was granted
• Key authorities: IRC §§ 263(a), 446, 481(a); Treas. Reg. §§ 1.263(a)-5, 301.9100-1, 301.9100-3; Rev. Proc. 2011-29

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201702022 [Third Party Communication:
Release Date: 1/13/2017 Date of Communication: Month DD, YYYY]
Index Number: 9100.00-00
Person To Contact:
-------------- -----------------------, ID No. -------------------
--------------------------- ---------------------------------------------------
-------------------------------- Telephone Number:
------------------------------------ ----------------------
---------------------- Refer Reply To:
CC:ITA:B02
In Re: ----------------- PLR-113274-16
Date:
October 19, 2016

Dear:

TY: ------------------------------------------------

Taxpayer = --------------------------------
Taxpayer Group = -----------------------------------------------------------
W= -------------------------------------------
W Group = ------------------------------------------------------------------------
X= ---------------------------------------------------
Y= -------------------------------------
Bank = -------------------------------------
Financial Advisor = ----------------------------------
Z= ---------------------------------------------------
Accounting Firm = ------------------------------
Date1 = --------------------
Date2 = --------------------
Date3 = ----------------------
Date4 = ------------
Date5 = -----------------
Date6 = -----------------
Date7 = -------------------
Date8 = ------------------------
Date9 = ----------------------
Date10 = ----------------------
a% = -----
b% = --
c% = ----
d% = ----
$a = ------------------
$b = ------------------
PLR-113274-16 2

$c = ----------------
$d = ------------------
$e = --------------
$f --------------
$g = --------------
Year 1= ---------------------------------------------
State = --------------

Dear -------------:

   This is in response to a letter dated Date1, requesting an extension of time to

make a safe-harbor election under Rev. Proc. 2011-29, 2011-1 C.B. 746, to allocate
success-based fees between facilitative and non-facilitative amounts for Taxpayer’s
transaction during the taxable year ending Date2. This request is made in accordance
with §§ 301.9100-1 and 301.9100-3 of the Procedure and Administration Regulations.

FACTS AND REPRESENTATIONS

Taxpayer represents the following:

    Description of Taxpayer and W

   Taxpayer was formed on Date3 under the laws of State. Taxpayer was formed in

connection with the desired acquisition of W (the “W Acquisition”). Taxpayer is now the
common parent of an affiliated group of corporations that join in filing consolidated U.S.
federal income tax returns (the “Taxpayer Group”). Taxpayer uses the accrual overall
method of accounting and a Date4 taxable year end.

    W is a provider of early childhood care and educational services. W operates as

a holding company of various operating subsidiaries that make up the group (the “W
Group”). Prior to the W Acquisition, W, as the common parent of the W Group, filed
consolidated U.S. federal income tax returns using the accrual overall method of
accounting with a Date4 taxable year end. As a result of the W Acquisition, W’s former
consolidated group (i.e., W Group) terminated and a final short-period return was filed
for the period ended Date5.

    The W Acquisition

   On Date5, Taxpayer, through its wholly-owned subsidiary X, acquired a% of the

outstanding stock of W, an unrelated State corporation, for approximately $a of cash
consideration, including cash raised through the issuance of new debt. The W
Acquisition was structured as a reverse subsidiary merger, whereby Y, a wholly-owned
subsidiary of X, was first formed on Date3. Y then merged with and into W, with W
surviving. For U.S. federal income tax purposes, the formation of Y and its merger into
PLR-113274-16 3

W was disregarded. Instead, the transaction was treated for federal tax purposes as a
direct taxable purchase of stock of W by X. As a result of the W Acquisition, the W
Group terminated and the members of the W Group became members of the Taxpayer
Group beginning Date 6.

   In order to fund a portion of the consideration for the W Acquisition, Y and W, as

borrowers, entered into a credit agreement with a syndicate of lenders led by Bank.
The debt consisted of term loans with an aggregate principal balance of $b million (the
“Term Loans”). In addition, the lenders agreed to a revolving line of credit to be issued
from time to time on or after the W Acquisition with an aggregate principal balance of
$c. For purposes of the W Acquisition, however, $d million of the Term Loans was used
to finance the acquisition.

  Description of Financial Advisor Fees

   In connection with the W Acquisition, Financial Advisor provided the following

services to Taxpayer: (i) transaction advisory services related to the acquisition of W
(the “Transaction Advisory Services”); and (ii) financial and structural advice with
respect to debt financing of Taxpayer (the “Debt Related Services”). Collectively, these
services are hereinafter referred to as the “Services.”

   Financial Advisor was compensated for the Services with a Total Fee of $e

(“Total Fee”). This Total Fee represented b% of the total enterprise value of the W
Acquisition and this Total Fee was contingent upon the successful completion of the W
Acquisition.

    Pursuant to a Management Consulting Agreement (the “Management

Agreement”) entered into with Z, a State corporation and wholly-owned operating
subsidiary of W, Z agreed to pay, or cause to be paid, the Total Fee. Of the Total Fee,
a portion of the fee (which later turned out to be c% or $f) pertained to the Transaction
Advisory Services (“Transaction Advisory Services Fee”), and the remainder (which
later turned out to be d% or $g pertained to the Debt Related Services (“Debt Related
Services Fee”).

  The Missed Election

  During the period in question, Taxpayer’s accounting department and Taxpayer’s

tax department were both inundated with various matters related to the W Acquisition.
In addition, Taxpayer’s tax department consisted of only two individuals, neither of
whom was engaged in the day-to-day operations of the Taxpayer’s accounting
department. As a result, the election at issue (the “Rev. Proc. 2011-29 Election”) was
missed.
PLR-113274-16 4

   On Date7, Financial Advisor provided a breakdown of the Total Fee via email to

Taxpayer’s accounting department (the “Financial Advisor Fee Email”). This email, in
effect, allocated c% of the $e Total Fee to the Transaction Advisory Services Fee, and
the remainder to the Debt Related Services Fee. However, due to various issues, the
Financial Advisor Fee Email that was received by Taxpayer’s accounting department
was not contemporaneously shared with Taxpayer’s tax department.

   Nevertheless, this information was used by Taxpayer’s accounting department in

developing Taxpayer’s financial statements for the period ending Date2. For example,
Taxpayer’s accounting department entered the $f Transaction Advisory Services Fee
into one subsidiary ledger (the “Transaction Cost Ledger”) and entered the $g Debt
Related Services Fee into a separate subsidiary ledger (the “Debt-Related Services Fee
Ledger”).

  In early Year1, Taxpayer engaged Accounting Firm to analyze the U.S. federal

income tax treatment of the various transaction-related costs incurred in connection with
the W Acquisition. The scope of Accounting Firm’s analysis was limited to specific
transaction-related costs and did not include debt issuance costs. On or about Date8,
the Taxpayer’s accounting department provided to Accounting Firm the Transaction
Cost Ledger, but not the Debt-Related Services Fee Ledger.

   Included in the Transaction Cost Ledger was a certain line item. This line item, in

effect, provided the following ambiguous information with respect to the fee: Term
Loans $b – Financial Advisor b% Total Fee--$g.

   The individuals within the Taxpayer’s accounting department who were

overseeing the services performed by Accounting Firm had not been made privy to the
Financial Advisor Email and had no knowledge of the Transaction Advisory Services
Fee. Because the line item referenced the “Term Loans” with Bank, the individuals
overseeing the transaction cost analysis being carried out by Accounting Firm believed
that the $g fee that was mentioned in the notation related exclusively to debt issuance
costs for the Term Loans (and therefore constituted a Debt-Related Services Fee).
Accounting Firm was therefore advised that such fee was outside Accounting Firm’s
scope of review because, as previously noted, Accounting Firm was not engaged to
analyze debt issuance costs. Accordingly, the Transaction Advisory Services Fee was
never analyzed by Accounting Firm as part of its engagement.

   When preparing the return on which the Rev. Proc. 2011-29 election at issue was

required (the “Year 1 Return”), the Taxpayer’s tax department looked solely to
Accounting Firm’s transaction cost analysis for purposes of identifying deductible
transaction costs and incorrectly assumed that all costs not included therein were
ineligible Debt-Related Services Fees (or were unrelated to the W Acquisition). The
reliance by Taxpayer’s tax department on the transaction cost analysis prepared by
PLR-113274-16 5

Accounting Firm was due in part to the fact that the tax department had not been
involved with the transaction cost analysis and had not been provided with any other
information with respect to the Transaction Advisory Services Fee at that time.
Accordingly, none of the $f Transaction Advisory Services Fee was treated as eligible
for the relief provided by Rev. Proc. 2011-29. This resulted in the erroneous tax
accounting treatment of the Transaction Advisory Services Fee. Likewise, no election
statement (“Election Statement”) was filed pursuant to Rev. Proc. 2011-29 with the Year
1 Return.

   Accounting Firm reviewed the Year 1 Return prepared by Taxpayer’s tax

department, but, because Accounting Firm performed the transaction cost analysis with
respect to the W Acquisition and was not aware of the Transaction Advisory Services
Fee for reasons discussed above, Accounting Firm was not aware of the need for an
Election Statement. The Year 1 Return was filed on or about Date9.

  Discovery of Missed Election

   On or about Date10, Taxpayer’s tax department reconciled the Accounting Firm

analysis to the general ledger and, in consultation with its accounting department,
received the Financial Advisor Fee Email. Taxpayer’s tax department determined that
the $g line item, which represented the Debt-Related Services Fee, was actually part of
the Total Fee paid by Z to Financial Advisor that included both the $f Transaction
Advisory Services Fee and the $g Debt-Related Services Fee.

   Accounting Firm advised that Taxpayer request relief under Rev. Proc. 2016-1

and Treas. Reg. §§ 301.9100-1 and 301.9100-3 for the missing election statement.
Accordingly, Taxpayer is seeking relief to make an election for Year 1 under Rev. Proc.
2011-29 with respect to the Transaction Advisory Services Fee incurred in connection
with the services provided by Financial Advisor.

LAW AND ANALYSIS:

   Section 263(a)(1) of the Internal Revenue Code and § 1.263(a)-2(a) of the

Income Tax Regulations generally provide that no deduction shall be allowed for any
amount paid out for property having a useful life substantially beyond the taxable year.
In the case of an acquisition or reorganization of a business entity, costs that are
incurred in the process of acquisition and that produce significant long-term benefits
must be capitalized. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 89-90 (1992);
Woodward v. Commissioner, 397 U.S. 572, 575-576 (1970).

   Under § 1.263(a)-5, a taxpayer must capitalize an amount paid to facilitate a

business acquisition or reorganization transaction described in § 1.263(a)-5(a). An
amount is paid to facilitate a transaction described in § 1.263(a)-5(a) if the amount is
paid in the process of investigating or otherwise pursuing the transaction. Whether an
PLR-113274-16 6

amount is paid in the process of investigating or otherwise pursuing the transaction is
determined based on all of the facts and circumstances. See § 1.263(a)-5(b)(1).

    Section 1.263(a)-5(f) provides that an amount that is contingent on the

successful closing of a transaction described in § 1.263(a)-5(a) ("success-based fee") is
presumed to facilitate the transaction, and thus must be capitalized. A taxpayer may
rebut the presumption by maintaining sufficient documentation to establish that a portion
of the fee is allocable to activities that do not facilitate the transaction, and thus may be
deductible.

     A taxpayer's method for determining the portion of a success-based fee that

facilitates a transaction and the portion that does not facilitate the transaction is a
method of accounting under § 446.

   Because the treatment of success-based fees was a continuing subject of

controversy between taxpayers and the Service, the Service published Rev. Proc. 2011-

29. Rev. Proc. 2011-29 provides a safe harbor method of accounting for allocating
    success-based fees paid in business acquisitions or reorganizations described in §
    1.263(a)-5(e)(3). In lieu of maintaining the documentation required by § 1.263(a)-5(f),
    this safe harbor permits electing taxpayers to treat 70 percent of the success-based fee
    as an amount that does not facilitate the transaction. The remaining portion of the fee
    must be capitalized as an amount that facilitates the transaction.

     Section 4.01 of Rev. Proc. 2011-29 allows a taxpayer to make a safe harbor
    

    election with respect to success-based fees. Section 4.01 provides that the Service will
    not challenge a taxpayer's allocation of success-based fees between activities that
    facilitate a transaction described in § 1.263(a)-5(e)(3) and activities that do not facilitate
    the transaction if the taxpayer does three things. First, the taxpayer must treat 70
    percent of the amount of the success-based fee as an amount that does not facilitate
    the transaction. Second, the taxpayer must capitalize the remaining amount of the
    success-based fee as an amount which does facilitate the transaction. Third, the
    taxpayer must attach a statement to its original federal income tax return for the taxable
    year the success-based fee is paid or incurred. This statement should: state that the
    taxpayer is electing the safe harbor; identify the transaction; and state the success-
    based fee amounts that are treated as not facilitating the transaction and the success-
    based fee amounts that are treated as facilitating the transaction.

    Sections 301.9100-1 through 301.9100-3 provide the standards the
    Commissioner will use to determine whether to grant an extension of time to make an
    election. Section 301.9100-2 provides automatic extensions of time for making certain
    elections. Section 301.9100-3 provides extensions of time for making elections that do
    not meet the requirements of § 301.9100-2.

    Section 301.9100-1(c) provides that the Commissioner has discretion to grant a
    PLR-113274-16 7

reasonable extension of time under the rules set forth in §§ 301.9100-2 and 301.9100-3
to make certain regulatory elections. Section 301.9100-1(b) defines a "regulatory
election" as an election whose due date is prescribed by a regulation published in the
Federal Register, or a revenue ruling, revenue procedure, notice or announcement
published in the Internal Revenue Bulletin.

    Section 301.9100-3(a) provides that requests for relief under § 301.9100-3 will be

granted when the taxpayer provides evidence to establish to the satisfaction of the
Commissioner that the taxpayer acted reasonably and in good faith, and that granting
relief will not prejudice the interests of the Government.

    Section 301.9100-3(c)(1) provides that the interests of the Government are

prejudiced if granting relief would result in the taxpayer having a lower tax liability in the
aggregate for all taxable years affected by the election than the taxpayer would have
had if the election had been timely made. The interests of the Government are
ordinarily prejudiced if the taxable year in which the regulatory election should have
been made, or any taxable years that would have been affected by the election had it
been timely made, are closed by the period of limitations on assessment.

   Section 301.9100-3(c)(2) provides special rules for accounting method regulatory

elections. Section 301.9100-3(c)(2) provides that the interests of the Government are
deemed prejudiced, except in unusual or compelling circumstances, if the accounting
method regulatory election for which relief is requested is subject to the advance
consent procedures for method changes, requires a § 481(a) adjustment, would permit
a change from an impermissible method of accounting that is an issue under
consideration by examination or any other setting, or provides a more favorable method
of accounting if the election is made by a certain date or taxable year.

CONCLUSION:

   Based upon our analysis of the facts and representations provided, Taxpayer

acted reasonably and in good faith, and granting relief will not prejudice the interests of
the Government. Therefore, the requirements of §§ 301.9100-1 and 301.9100-3 have
been met.

  Taxpayer is granted an extension of 60 days from the date of this ruling to file a

Year 1 safe harbor election under Rev. Proc. 2011-29 with respect to the success-
based Transaction Advisory Services Fee discussed herein.

  The rulings contained in this letter are based on information and representations

submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.
PLR-113274-16 8

   Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. In particular, no opinion is expressed as to whether Taxpayer
properly included the correct costs as its success-based fees subject to the retroactive
election, or whether Taxpayer's transaction is within the scope of Rev. Proc. 2011-29.

   A copy of this letter must be attached to any income tax return to which it is

relevant. Alternatively, a taxpayer filing its return electronically may satisfy this
requirement by attaching a statement to its return that provides the date and control
number of the letter ruling.

    In accordance with the provisions of the power of attorney currently on file with

this office, a copy of this letter is being sent to your authorized representatives. We are
also sending a copy of this letter to the appropriate operating division director.
Enclosed is a copy of the letter ruling showing the deletions proposed to be made in the
letter when it is disclosed.

 This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the

Code provides that it may not be used or cited as precedent.

                                             Sincerely yours,


                                             ___________________________
                                             BRIDGET TOMBUL
                                             Chief, Branch 2
                                             Office of Associate Chief Counsel
                                             (Income Tax & Accounting)

Enclosure:

Copy for § 6110 purposes