A Little M&A Talk for Your Wednesday Morning: How Does a “Go Shop” Provision Impact the Treatment of Transaction Costs?
When finalized in 2003, the Section 263(a) regulations governing the treatment of transaction costs changed the way we treat expenses incurred by both an acquiring and target company pursuant to an acquisition. Under these regulations — specifically, Treas. Reg. §1.263(a)-2T(c)(3) — the general rule is that no deduction is allowed for an amount paid to acquire or create an intangible, which under Treas. Reg. §1.263(a)-4(c)(1)(i), includes an ownership interest in a corporation or other entity.
Stated in a more simple manner, if you own a business that is either acquiring another business or being acquired, any expenses incurred by the business as part of investigating, pursuing or closing the transaction are generally not deductible. [i]
The regulations provide an exception to this general rule, however. If certain transaction costs are incurred prior to a “bright-line test date,” provided those costs are not “inherently facilitative” to the transaction [ii], the business can deduct the costs currently.
The key, then, is what constitutes the “bright-line test date.” The regulations at Treas. Reg. §1.263(a)-5 define this date as the earlier of:
1. the date on which a letter of intent, exclusivity agreement, or similar written communication is executed by representatives of the acquirer and target, or
2. the date on which the material terms of the transaction are authorized by the taxpayer’s board of directors.
So, in summary, all costs before the earlier of those two dates may be deducted, provided they are not inherently facilitative. Once you hit that point of no return, however, all costs incurred in pursuit of the transaction must be capitalized.
Last Friday, in CCA 201234026 the IRS addressed the impact a “go shop” provision has on this bright-line test date. In the Ruling, an acquirer and target had set the terms of an agreement in a merger agreement that was executed by representatives of both corporations and approved by both corporations boards. In other words, the bright-line test date had been reached.
The agreement, however, also contained a “go shop” provision that provided that after the date of the merger agreement, Target was permitted to seek better offers from potential acquirers. If Target found a better deal, Target could cancel the merger agreement and choose the better option, or the acquirer could match the terms of the better deal.
The taxpayers argued that the “go shop” provision extended the bright-line test date until the time that the provision expired and the deal was consummated. The IRS disagreed.
The “go shop” provision is only one of the terms of the merger agreement and does not serve to negate the document’s execution, nor does it trump the approval of those terms by the corporations’ boards of directors. Therefore, the bright-line date is the date of the merger agreement’s execution and its approval by the corporations’ board of directors.
[i] See also Treas. Reg. §1.263(a)-5(a).
[ii] Amounts are inherently facilitative if they are paid to: (1) secure an appraisal, formal written evaluation, or fairness opinion; (2) structure the transaction (including the negotiation of the structure and the obtaining of tax advice on the structure); (3) prepare and review the documents that effectuate the transaction; (4) obtain regulatory approval for the transaction; (5) obtain shareholder approval for the transaction; or (6) convey property between the parties. General due diligence costs are not considered inherently facilitative but, rather, are to be analyzed under the bright-line date rule.
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