Target company received 60 days to make a late success-fee safe-harbor election

Plain-English summary

A privately held corporation was acquired through a taxable stock purchase and paid a financial adviser's contingent fee after the merger closed. Revenue Procedure 2011-29 offers a safe harbor that treats 70 percent of a qualifying success-based fee as nonfacilitative and 30 percent as facilitative, but the taxpayer's historic adviser did not tell it to make the required election on its original return. The merger agreement had assumed the election would be made, and the taxpayer said it lacked the internal expertise to question the return treatment. The IRS found that the taxpayer acted reasonably and in good faith and that late relief would not prejudice the government. It granted 60 days to file the safe-harbor statement identifying the transaction and the amounts deducted and capitalized. The IRS did not decide whether the taxpayer qualified for the safe harbor, whether the fee was deductible or capitalizable, whether it was a constructive dividend, or how the acquisition affected the buyer or selling shareholders.

Ruling snapshot

• Question: May the acquired corporation receive extra time to elect the Rev. Proc. 2011-29 safe harbor for a success-based transaction fee?
• Outcome: Approved, with 60 days to file the election statement
• Key authorities: IRC §§ 162 and 263(a); Treas. Reg. §§ 1.263(a)-5 and 301.9100-1 through 301.9100-3; Rev. Proc. 2011-29

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202349003 [Third Party Communication:
Release Date: 12/8/2023 Date of Communication: Month DD, YYYY]
Index Number: 9100.00-00, 263.00-00,
162.00-00 Person To Contact:
--------------------, ID No. ---------------
---------------------------------------------- Telephone Number:
---------------------------------------- ---------------------
---------------------------------------------- Refer Reply To:
------------------------------ CC:ITA:B01
PLR-105326-23
In Re: ---------------------------------------- Date:
----------------------- September 11, 2023

LEGEND

Date 1 = ------------------
Date 2 = ---------------------
Date 3 = -------------------
Date 4 = -------------------
Date 5 = ------------------
Date 6 = ------------------
Taxpayer = ----------------------------------------
Merger Sub = ----------------------------------------------
Buyer = --------------------------------------
Stockholder Representative = --------------------------
Company = -----------------------------------------------
Financial Advisor = ------------------------
Subsidiary = ------------------------------------------------
Historic Advisor = ----------------------------------------
Percent 1 = ----------
Percent 2 = ----------
Percent 3 = ----------
Percent 4 = ----------
Percent 5 = ----------
$a = -----------------
$b = ---------------
$c = -------------
PLR-105326-23 2

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

This letter responds to a request for a private letter ruling filed by Taxpayer with the
Internal Revenue Service (Service). In the letter ruling request and subsequent
submissions, you seek an extension of time for Taxpayer to make a late safe harbor
election under Rev. Proc. 2011-29, 2011-18 I.R.B. 746, effective for the taxable year
that ended on Date 1. The request is made in accordance with §§ 301.9100-1 and
301.9100-3 of the Procedure and Administration Regulations. Taxpayer’s request was
filed with our office on Date 2.

                                     FACTS

Taxpayer, a privately-held corporation, entered into a merger agreement dated as of
Date 3. Taxpayer employs an accrual method of accounting on a calendar year basis.
Taxpayer had no majority controlling shareholder prior to the merger between Taxpayer
and Merger Sub. Taking into account voting rights and relatedness, the top five
shareholders owned the following percentages of Taxpayer: Percent 1, Percent 2,
Percent 3, Percent 4, and Percent 5.

Buyer acquired Taxpayer by causing Merger Sub, a direct, wholly owned subsidiary of
Buyer, to merge with and into Taxpayer. Taxpayer survived the transaction as a
100 percent-owned subsidiary of Buyer. Buyer treated the transaction as a stock
purchase of Taxpayer by Buyer.

Merger Sub was a domestic corporation created to effectuate the merger. Merger Sub
did not engage in any activity other than to effectuate the merger and did not issue any
debt to effectuate the merger. Taxpayer represents that no funds of Taxpayer or its
affiliates were used to acquire Taxpayer’s stock. Additionally, Taxpayer represents that
it did not assume any debt of Merger Sub or Buyer and did not incur any debt that was
used to purchase Taxpayer stock in connection with Buyer’s acquisition.

Taxpayer, Buyer, Merger Sub, and Stockholder Representative (on behalf of selling
shareholders) entered into an Agreement and Plan of Merger (Merger Agreement) as of
Date 3. After the board of directors for Taxpayer recommended the Merger Agreement
to be in the shareholders’ best interest, the Merger Agreement was submitted to
Taxpayer’s shareholders for their approval. Pursuant to the Merger Agreement, Buyer
agreed to initial consideration of $ a to acquire Taxpayer’s stock plus $ b of earnout
consideration to be paid to the shareholders of Taxpayer.

Taxpayer represents that the acquisition was treated as a taxable acquisition of stock
pursuant to which, immediately after the acquisition, Buyer and Taxpayer were related
within the meaning of § 267(b) or § 707(b) (i.e., a covered transaction) of the Internal
Revenue Code (Code). There was no pre-existing agreement among the selling
PLR-105326-23 3

shareholders that enabled one or more selling shareholders to effectively control the
sale of Taxpayer stock.

On Date 4, Company and Financial Advisor entered into an agreement (Engagement
Letter) pursuant to which Financial Advisor would act as Company’s exclusive financial
advisor in connection with a possible transaction for the effective sale of the principal
business and operations of Company by its shareholders. The Engagement Letter
described a number of services that Financial Advisor was to perform for or on behalf of
Company in connection with the transaction.

Upon completion of the merger, advisory fees became payable to Financial Advisor
(“Contingent Fee”). According to the Engagement Letter, in the event a transaction was
agreed, Company was obligated to pay Financial Advisor the Contingent Fee payable in
cash or other immediately available funds upon completion of the transaction. The
contracted Contingent Fee was generally equal to a specified percentage of the
aggregate value of the transaction. On Date 5, Financial Advisor issued a $ c invoice to
Company for the Contingent Fee.

Taxpayer represents that the Engagement Letter appears to have referenced Company
in error. Rather, the invoice and the Engagement Letter should have referenced
Subsidiary, a wholly owned subsidiary of Taxpayer and a member of its consolidated
group. Taxpayer represents that, pursuant to the Engagement Letter, Subsidiary was
obligated to pay the contracted Contingent Fee.

Under the Merger Agreement, Buyer was obligated to pay (or to cause Taxpayer to pay)
the Contingent Fee and other unpaid company transaction expenses. Taxpayer directly
paid the Contingent Fee of $ c by wire transfer from its checking account on Date 6.

Historic Advisor was engaged to prepare Taxpayer’s return for the taxable year that
ended on Date 1. However, Historic Advisor represents that it did not advise Taxpayer
of the opportunity to make the safe harbor election provided under Rev. Proc. 2011-29.

The Merger Agreement provided that pre-closing date taxable income would be
calculated on the assumption that a Rev. Proc. 2011-29 election was made. However,
Taxpayer failed to make the election. Taxpayer represents that it relied upon, and did
not question, Historic Advisor’s treatment of the Contingent Fee as it did not have
sufficient internal expertise to do so.

Taxpayer represents that it was eligible to make the success-based fee election.
Taxpayer has not requested and the Service is not expressing an opinion on the tax
treatment of the Contingent Fee payment or any other matter not expressly ruled upon. 1

1
A list of specific caveats is set forth below.
PLR-105326-23 4

                              LAW AND ANALYSIS

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

Section 301.9100-3(a) provides extensions of time to make a regulatory election under
Code sections other than those for which § 301.9100-2 expressly permits automatic
extensions. 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(b)(1) states that a taxpayer will be deemed to have acted
reasonably and in good faith if the taxpayer: (1) requests relief before the failure to
make the regulatory election is discovered by the Service, (2) failed to make the election
because of intervening events beyond the taxpayer's control, (3) failed to make the
election because, after exercising due diligence, the taxpayer was unaware of the
necessity for the election, (4) reasonably relied on the written advice of the Service, or
(5) reasonably relied on a qualified tax professional, including a tax professional
employed by the taxpayer, and the tax professional failed to make, or advise the
taxpayer to make the election.

Under § 301.9100-3(b)(3), a taxpayer will not be considered to have acted reasonably
and in good faith if the taxpayer: (1) seeks to alter a return position for which an
accuracy-related penalty has been or could be imposed under § 6662 at the time the
taxpayer requests relief (taking into account § 1.6664-2(c)(3)) and the new position
requires or permits a regulatory election for which relief is requested, (2) was informed
in all material respects of the required election and related tax consequences, but chose
not to file the election, or (3) uses hindsight in requesting relief. If specific facts have
changed since the original deadline that make the election advantageous to a taxpayer,
the Service will not ordinarily grant relief.

Taxpayer has represented that it is not seeking to alter a return position for which an
accuracy-related penalty has been or could be imposed under § 6662 at the time
PLR-105326-23 5

Taxpayer requests relief, and was never informed of all material aspects of the required
election. Furthermore, Taxpayer has represented that it is not using hindsight in
requesting relief and that no specific facts have changed since the original deadline that
would make the election more advantageous to Taxpayer now than if made timely.

Section 301.9100-3(c)(1) provides that the Commissioner will grant a reasonable
extension of time only when the interests of the government will not be prejudiced by
the granting of relief. Section 301.9100-3(c)(1)(i) provides, in part, 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 (taking into account the
time value of money). Section 301.9100-3(c)(1)(ii) provides, in part, that 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 under § 6501(a) before the taxpayer’s receipt of a ruling granting relief.
Under these criteria, the interests of the government are not prejudiced in this case.

Section 263(a)(1) and § 1.263(a)-2(a) 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). In general, 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
amount is paid in the process of investigating or otherwise pursuing the transaction is
determined based on all the facts and circumstances. See § 1.263(a)-5(b)(1).

Section 1.263(a)-5(f) provides that an amount paid that is contingent on the successful
closing of a transaction described in § 1.263(a)-5(a) is presumed to facilitate the
transaction and, thus, must be capitalized. A taxpayer may rebut this 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. This
documentation must be completed on or before the due date of the taxpayer’s timely
filed original federal income tax return (including extensions) for the taxable year during
which the transaction closes.

To reduce controversy between the Service and taxpayers over the documentation
required to allocate success-based fees between the activities that facilitate the
transaction and activities that do not facilitate the transaction, the Service issued Rev.
Proc. 2011-29.
PLR-105326-23 6

Section 4.01 of Rev. Proc. 2011-29 states that the Service will not challenge a
taxpayer’s allocation of a success-based fee between activities that facilitate the
transaction described in § 1.263(a)-5(e)(3) and activities that do not facilitate the
transaction if the taxpayer: (1) treats 70 percent of the amount of the success-based fee
as an amount that does not facilitate the transaction; (2) capitalizes the remaining
30 percent as an amount that does facilitate the transaction; and (3) attaches a
statement to its original federal income tax return for the taxable year the success-
based fee is paid or incurred stating that the taxpayer is electing the safe harbor,
identifying the transaction, and stating the success-based fee amounts that are
deducted and capitalized.

The revenue procedure applies to covered transactions described in § 1.263(a)-5(e)(3),
which includes, inter alia, a taxable acquisition by the taxpayer of assets that constitute
a trade or business and 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 § 267(b) or § 707(b). See § 1.263(a)-5(e)(3)(i) and (ii).

Section 1.263(a)-1(e)(1) provides that commissions and other transaction costs paid to
facilitate the sale of property are not currently deductible under § 162 or § 212. Instead,
the amounts are capitalized costs that reduce the amount realized in the taxable year in
which the sale occurs or are taken into account in the taxable year in which the sale is
abandoned if a deduction is permissible. These amounts are not added to the basis of
the property sold or treated as an intangible asset under § 1.263(a)-4. Section
1.263(a)-5(b)(2) provides that an amount required to be capitalized by § 1.263(a)-1,
among other provisions, does not facilitate a transaction described in § 1.263(a)-5(a).
Thus, commissions and transaction costs that are paid to facilitate a sale reduce the
amount realized, and are, therefore, not also covered by § 1.263(a)-5, making Rev.
Proc. 2011-29 also not applicable.

Section 162(a) provides a deduction for all ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or business. To be deductible
as an ordinary and necessary expense, the cost must be “directly connected with” or
have “proximately resulted from” a taxpayer’s business activity. Kornhauser v. United
States, 276 U.S. 145, 153 (1928). In related party settings, the deductibility of a cost is
not necessarily controlled by the party that undertakes the legal obligation. Interstate
Transit Lines v. Commissioner, 319 U.S. 590, 594 (1943); Deputy v. du Pont, 308 U.S.
488, 496, (1940); Swed Distributing Company v. Commissioner, 323 F.2d 480, 483 (5th
Cir. 1963). In evaluating which related party is the appropriate party to take a § 162
deduction, courts generally focus on the connection of the expense to the respective
business of those parties. In denying an individual shareholder (owning about 16
percent of company stock) the ability to deduct a contracted cost that benefited the
shareholder, the Court in du Pont observed that implicit in the statutory words
“expenses paid or incurred in carrying on any trade or business” is a proximate
PLR-105326-23 7

relationship between the expense and business of the taxpayer. du Pont, 308 U.S. at
496.

The issue of whether an expense is that of a corporation or a controlling shareholder is
given heightened scrutiny. Hood v. Commissioner, 115 T.C. 172, 179 (2000). 2 Section
1.263(a)-5 expressly applies to costs paid or incurred by a target company. See, e.g.,
§ 1.263(a)-5(e)(3)(iii). The Service generally has not asserted that costs directly paid by
a non-majority controlled public target company must be treated as the costs of selling
shareholders so as to preclude a § 162 deduction by the target company. INDOPCO,
Inc. v. Commissioner, 503 U.S. 79 (1992) (the Service has, however, successfully
challenged a target company’s claim that it could deduct rather than capitalize
investment banking fee and legal fees paid by the target in its friendly takeover). In
INDOPCO, the taxpayer’s stock was publicly traded and listed on the New York Stock
Exchange and its ownership was diversified, with its largest shareholder owning
approximately 14.5 percent of its common stock. 3

                                         CONCLUSION

Based on the facts and representation submitted, we conclude that Taxpayer acted
reasonably and in good faith and granting relief will not prejudice the interests of the
government. Accordingly, 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 the
statement required by section 4.01(3) of Rev. Proc. 2011-29, stating that it is electing
the safe harbor for the Contingent Fee of $ c, identifying the transaction, and stating the
success-based fee amounts that are deducted and capitalized.

The ruling letter is based upon information and representations submitted by Taxpayer
and accompanied by penalty of perjury statements executed by the appropriate parties.
This office has not verified any of the materials submitted in support of the request for a
ruling and the information materials are subject to verification on examination.

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 on whether (a) Taxpayer is otherwise
eligible or otherwise qualifies to make the Rev. Proc. 2011-29 election; (b) the
Contingent Fee is properly treated, in whole or part, as a deductible or capitalizable cost
of Taxpayer; (c) the Contingent Fee is a success-based fee under Rev. Proc. 2011-29;

2
In this case, there was no controlling shareholder as the largest shareholder, taking into account related
party interests, had only a Percent 1 interest.
3
Although it did not reach a determination on the factual issue, the Chief Counsel’s Office has advised
against asserting that the payment of expenses by a public company target in defending against a hostile
takeover were constructive dividends paid for the primary benefit of its public shareholders. FSA, 1993
WL 1469586 (June 16, 1993).
PLR-105326-23 8

(d) Taxpayer’s payment of the constructive fee is a nondeductible constructive dividend,
or (e) the Contingent Fee is subject to §§ 162(k), 195 or any other Code provision or
regulation that would preclude the deduction or capitalization of the Contingent Fee.
Further, no opinion is expressed on the tax treatment of the selling shareholders or of
Buyer. Finally, no opinion is expressed on the application of § 1.263(a)-1(e)(1) to the
facts in this matter.

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.

A copy of this ruling should be attached to Taxpayer’s federal tax returns for the tax
years affected. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling.

                                           Sincerely,



                                           _________________________
                                           Patrick E. White
                                           Senior Counsel, Branch 1
                                           (Income Tax & Accounting)

cc: ----------------------------------

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