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Federal Income Tax Tax Tax Loss

Can “Business Synergies” be an Asset that Increases a Tax Loss?


The tax consequence of a transaction often depends on how one characterizes or describes the transaction.

Business synergies are often cited as the rationale for merger and acquisition deals. In a M&A deal, are “business synergies” a separate asset for tax purposes?

Can you list “business synergies” as a separate asset and then take a Sec. 165 tax loss for the sale of the newly acquired business? Or is this simply a capitalized cost that one has to factor into their tax basis when computing the loss on the sale of the newly acquired business?

The Sec. 165 loss could produce a larger tax loss than simply computing the loss on the sale of the stock factoring in the capitalized costs.

This is an open question when there is a stock sale for the newly acquired business. The IRS addresses this in TAM 202004010.

Facts & Procedural History

In the IRS Memo, the taxpayer was a corporation. It acquired the stock of a second corporation (“Target”).

To complete the deal, the taxpayer paid fees to several law firms, investment firms, accounting firms, other professional firms, and the Securities and Exchange Commission.

It isn’t clear from the IRS memo whether the taxpayer’s return position resulted from strategic tax planning or an oversight.

But on its tax return, the taxpayer split the costs to complete the deal as facilitative fees under Reg. § 1.263(a)-5(a) and success-based fees under Reg. § 1.263(a)-5(f). This split is the correct way to report the costs. Facilitative costs are capitalized under I.R.C. § 263 and non-facilitative costs are deducted as business expenses under I.R.C. § 162.

But since the taxpayer did not amortize or deduct the facilitative costs, they remained an asset on the taxpayer’s books.

The taxpayer then decided to sell the Target to a third party. In doing so, it concluded that the facilitative costs were worthless and it reported a Sec. 165 tax loss for these costs. The sale was a stock sale to the third party.

The IRS auditor asked the IRS attorneys to weigh in on this Sec. 165 tax loss, which resulted in this IRS memorandum.

Business Synergy as a Separate Asset

The taxpayer argued that business synergy is a separate asset.

The IRS memo describes this argument as follows:

Taxpayer argues that Target paid these amounts to create a separate and distinct intangible asset in the form of the synergistic benefits that Target expected to receive from its combination with Taxpayer. Taxpayer contends that these benefits arose from Target’s access to Taxpayer’s markets, research, quality and innovation platforms, management approaches, and supply chain productivity tools. Under this analysis, Taxpayer argues that the administrative and professional fees paid by Target in connection with Taxpayer’s acquisition of its stock created a separate and distinct intangible asset that was properly capitalized by Target, but this asset became useless to Target at the termination of its relationship with the taxpayer, that is, when Taxpayer sold Target’s stock to Buyer.

The Target was a manufacturing company. According to the IRS’s version of the facts, the taxpayer believed the acquisition would result in “cost synergies that would generate long term growth and increased efficiencies for both entities’ shareholders, customers, and employees.”

The IRS concludes that business synergy is not a separate asset. It reached this conclusion based on the applicable regulations. Since these regulations do not specifically address stock sales, as this case involved a stock sale to a third party, the IRS relied on the landmark court case INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992).

INDOPCO stands for the proposition that costs incurred for the purpose of changing the corporate structure for the benefit of future operations. They are not costs to acquire an intangible asset. Thus, the expense is capitalized rather than deducted.

Sec. 165 Tax Loss vs. Loss When Calculating Gain

This matters because this case involved a stock sale. The Target business continued operating,

If the expense was a betterment that had to be capitalized, that asset continued to exist and transferred to the new buyer with the Target business. It would not be an asset that terminated for the taxpayer when the taxpayer sold the Target–which could then be written off as a Sec. 165 tax loss for the taxpayer. Thus, there would be no Sec. 165 tax loss for the taxpayer on the sale of the Target.

As a capitalized asset, the taxpayer would amortize the costs over time–allowing it to recover the costs over time via amortization deductions (these would be deductions available in prior years allowable on audit or by filing amended tax returns for the prior years). The remaining tax basis that was not amortized would add into the tax basis on the calculation of the loss on the sale. This would reduce the amount of the loss incurred on the sale of the Target.

So the taxpayer would get credit for missed amortization deductions in the prior years, but in the current year, it would not get a full Sec. 165 tax loss. It would compute its gain or loss realized on the sale, which would be a loss in this case that was reduced by its remaining unamortized facilitative fees. This tax loss computed based on the sale is presumably less than the Sec. 165 tax loss it took on its return.

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