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Examination of Milestone Payments in the Acquisition of Businesses

LB&I Control No: LB&I-04-0413-002

 

April 29, 2013

MEMORANDUM FOR ALL LB&I EMPLOYEES
FROM: Heather C. Maloy
Commissioner, Large Business & International Division
SUBJECT: Examination of Milestone Payments in the Acquisition of Businesses

This Directive provides that if the requirements set forth below are satisfied, Large Business & International (LB&I) examiners should not challenge a taxpayer’s treatment of eligible milestone payments (as defined below) made or incurred in the course of a covered transaction described in Treas. Reg. § 1.263(a)-5(e)(3) with respect to which the taxpayer incurs a success-based fee (i.e., a payment that is contingent on the successful closing of the covered transaction).

This Directive is not an official pronouncement of law, and cannot be used, cited, or relied on as such. In addition, nothing in this Directive should be construed as affecting the operation of any other provision of the Internal Revenue Code, Treasury Regulations, or guidance thereunder.

Scope:

This Directive applies only to investment banker fees incurred by either an acquiring corporation or a target corporation. This Directive applies only for the amounts deducted on original timely filed returns, and not for claims, whether formal or informal.

Background:

On April 8, 2011, IRS issued Revenue Procedure 2011-29, 2011-18 I.R.B. 746, which provides a safe harbor for allocating success-based fees paid or incurred in covered transactions.  In lieu of maintaining the documentation required by Treas. Reg. § 1.263(a)-5(f) to support a deduction for a portion of a success-based fee, Rev. Proc. 2011-29 permits an electing taxpayer to treat 70 percent of a success-based fee as an amount that does not facilitate the covered transaction.  The remaining 30 percent of the fee must be capitalized as an amount that facilitates the covered transaction.

An election under Rev. Proc. 2011-29 applies to all success-based fees paid or incurred by a taxpayer in a covered transaction for which the election is made.   Once made, the election is irrevocable.  The Revenue Procedure does not provide a safe harbor for milestone payments.

Rev. Proc. 2011-29 applies by its terms only to success-based fees paid or incurred in taxable years ended on or after April 8, 2011.  In an LB&I Directive dated July 28, 2011 (Control Number LB&I-04-0511-012), LB&I examiners were directed not to challenge a taxpayer’s treatment of success-based fees paid or incurred in a covered transaction in taxable years ended before April 8, 2011, where the taxpayer’s original return position is to capitalize such fees to the covered transaction in an amount of at least 30 percent of the total success-based fees incurred by the taxpayer with respect to the covered transaction.  

Definitions:

The term “covered transaction” is a transaction described in § 1.263(a)-5(e)(3) of the Income Tax Regulations: (i) a taxable acquisition by the taxpayer of assets constituting a trade or business; (ii) a taxable acquisition of an ownership interest in a business entity if immediately after the acquisition, acquirer and the target are related within the meaning of I.R.C. § 267(b) or § 707(b); and (iii) a reorganization described in § 368(a)(1)(A), (B), or (C), or a reorganization described in § 368(a)(1)(D) in which stock or securities of the corporation to which the assets are transferred are distributed in a transaction qualifying under § 354 or § 356.

The term “milestone” means an event occurring in the course of a covered transaction (whether the transaction is ultimately completed or not), provided that the event is (i) the execution of an agreement described in § 1.263(a)-5(e)(1)(i) (i.e., a letter of intent, exclusivity agreement or similar written communication (other than a confidentiality agreement)), (ii) an event described in § 1.263(a)-5(e)(1)(ii) (the authorization or approval of a transaction (as tentatively agreed to by representatives of the acquirer and the target) by the taxpayer's board of directors (or committee of the board of directors)), or (iii) some other specified event (other than the successful closing of the transaction), provided that the event does not occur prior to the first occurrence of an event described in § 1.263(a)-5(e)(1)(i) or (ii).

The term “milestone payment” means a non-refundable amount that is contingent on the achievement of a milestone.  Any amount that would be paid or incurred even if the milestone is not achieved is not contingent on the achievement of a milestone and is, therefore, not includable in a milestone payment, notwithstanding that the parties’ agreement may provide that such amount is creditable against or otherwise offsets the amount due on the milestone payment.

The term “eligible milestone payment” means a milestone payment paid for investment banking services that is creditable against a success-based fee.

Planning and Examination Guidance:

In an effort to balance current resources and workload priorities, LB&I examiners are directed not to challenge a taxpayer’s treatment of its eligible milestone payments if the taxpayer satisfies the conditions described in I or II below.

I. For Taxable Years Ended on or After April 8, 2011

  • Treatment of Eligible Milestone Payment Incurred in a Transaction for which Taxpayer elects the Safe Harbor in Rev. Proc. 2011-29

The taxpayer must -

(1) have qualified for and timely elected the Rev. Proc. 2011-29 safe harbor for the covered transaction;

(2) not have deducted more than 70% of any eligible milestone payment incurred in connection with the respective success-based fee on its original tax return for the year in which the taxpayer's liability for the eligible milestone payment accrued; and

(3) not be contesting its liability for the eligible milestone payment.

  • Treatment of Eligible Milestone Payment Incurred in Tax Years before Taxpayer can Elect the Safe Harbor in Rev. Proc. 2011-29 

In instances where a covered transaction spans multiple years, a taxpayer may make eligible milestone payments in tax years preceding the tax year in which the success-based fee would be paid (and, therefore, also preceding the tax year in which the taxpayer could qualify for and timely elect the Rev. Proc. 2011-29 safe harbor) if the transaction successfully closes.  

In those situations, the taxpayer must -

(A) satisfy (2) and (3) above,

(B) have documented, for example in its books and records, that in the year in which the eligible milestone payments were made, the taxpayer intended to elect Rev. Proc. 2011-29 with regard to the respective success-based fee, and

(C) if the transaction successfully closed, have in fact made the Rev. Proc. 2011-29 election for the success-based fee that was paid or incurred.  

This documentation should be made available to the examiner upon request.

II. For Taxable Years Ended Before April 8, 2011

The taxpayer’s return position must meet the requirements of the LB&I Directive 04-0511-012 with regard to success-based fees paid or incurred in taxable years ended before April 8, 2011, and the taxpayer must satisfy (2) and (3) above.

UIL Code:

UIL Code 263.14-00 Allocation between Capital Expenditure and Expense.

Questions concerning this Directive should be directed to the Corporate Distributions and Adjustments Issue Practice Group.

cc:  Division Counsel, LB&I
      Commissioner, SBSE       
      Chief, Appeals

Page Last Reviewed or Updated: 18-Mar-2014