If a company acquires another company and pays a finders fee to the party who connected the two for the sale, is the finders fee deductible by the acquirer? This question touches on whether an expense is deductible if the real benefit is to another company. The court addresses this in Plano Holding LLC v. Commissioner, T.C. Memo. 2019-140.
Facts & Procedural History
The taxpayer is a subsidiary of a pension fund. The pension fund formed a subsidiary that purchased the operating company. The operating company was a plastics manufacturer.
In 2010, before the sale to the pension fund, the plastics manufacturer hired a financial advisor to advise on the sale of the business. In 2012, the financial advisor essentially introduced the pension fund as a possible buyer.
The plastics manufacturer then hired an investment bank to assist with the sale. The pension fund closed on the deal in 2012.
The pension fund’s holding company paid the investment banker and the plastic manufacturer’s prior financial advisor. The payment to the financial advisor was a finders fee. It was paid to make the connection–not to provide financial advice.
The holding company and plastics manufacturer filed a consolidated tax return and deducted 70% of the fee to the financial advisor. It capitalized the remaining 30% of the fee.
The IRS audited the tax return and disallowed the deduction. The question for the court was whether the expense paid by the acquiring company was deductible for the acquiring company when it benefited the target company.
Ordinary & Necessary Business Expenses
The court describes the general rule that “ordinary and necessary” business expenses are deductible. It then focuses on the line of court cases that address whether an expense is deductible by one business if the expense benefited the another business.
Expenses are typically deductible if by the payor even if they benefit a related entity. This is true if the:
- Payor benefited from the payment of the expense and
- Payment of the fee was an ordinary and necessary expense for the payee’s business.
Both tests have to be met for the expense to be deductible.
Indirect Benefits are Insufficient
The court focuses on who benefited from the payment. It noted that indirect benefits are not enough. A direct nexus between the purpose of the payment and the taxpayer’s business or income-producing activities has to be established.
In this case, the court held that the finders fee paid for by the parent for a subsidiary it acquired did not benefit the holding company. The court reasoned that the financial advisor’s services ended five months prior to the deal and, therefore, there was no direct nexus:
Although we recognize the significant role Baird played in the early days of the OTPP-Plano courtship, the services Baird rendered — which ended five months before the merger was consummated — do not supply Plano with a business purpose directly linked to the payment.
The court then focused on the second element.
What is the Payee’s Business?
The second element requires the payment be an ordinary and necessary expense for the payee’s business. The court notes that the taxpayer is the holding company and, according to the court, its business is manufacturing:
Plano’s business is manufacturing plastic goods, primarily storage items for outdoor sports. Holding fails to persuade us that such a payment qualifies as either ordinary or necessary in that line of business.
The court notes that if the pension fund had acquired the plastic manufacturer, its costs would have been deductible.
It isn’t entirely clear that the taxpayer holding company is in the plastics manufacturing business. It’s status as a holding company suggests that it is a pooled financing or risk spreading vehicle, much like the pension fund.
The Takeaway for Finders Fees for a Holding Company
This case is likely limited to its unique facts. Businesses typically do not pay finders fees that they are not 100% bound to pay.
But when they do, they have to satisfy both tests described in this case. This can be established with advanced tax planning, such as structuring the deal so there is some benefit for the payor holding company and the holding company is actually a holding company rather than an operating company.