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IRS Rules on Capitalization of Management Termination Fees


June 2015

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Synopsis

In PLR 201518012 , the IRS determined whether a management termination fee should be capitalized under Treas. Reg. §1.263(a)-4(d)(7) and Treas. Reg. §1.263(a)-5. Treasury Reg. § 1.236(a)-4 provides rules for applying I.R.C. §263 and the treatment of costs related to acquired and created intangibles. Treasury Reg. §1.236(a)-4(d)(7)(i) requires a taxpayer to capitalize amounts paid to terminate certain agreements to another party. Treasury Reg. §1.263(a)-5 provides rules for applying I.R.C. §263 to amounts paid or incurred to facilitate certain transactions.

Issue

The taxpayer was a U.S. corporation and a party to a management services agreement. Under the agreement, the manager provided monitoring services on a regular basis to assist the taxpayer with governance and oversight of its business. As the taxpayer’s business began to flourish, the taxpayer and manager agreed to terminate the management services agreement upon completion of a successful public offering. The taxpayer agreed to pay the manager a termination fee for all amounts owed under the management services agreement.

The taxpayer did complete the initial public offering, and used the net proceeds from the IPO to pay the termination fee. The IRS ruled that, while the taxpayer’s obligation to pay the termination fee depended on whether the public offering occurred, the termination fee was not paid to facilitate the IPO.

“As the court ruled in A.E. Staley Manufacturing Co. v. Commissioner, 119 F.3d 482 (7th Circ. 1997), fees associated with general activities not directly related to the capital transaction must be treated differently (i.e., not capitalized).” Accordingly, the termination fee should not be capitalized under Treas. Reg. §1.263(a)-5 as facilitative of the IPO.

Contact

Richard Shevak, a CohnReznick director, at richard.shevak@cohnreznick.com or 862-245-5029.

To learn more about CohnReznick’s Tax Practice, please visit our webpage.


Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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