Non-facilitative integration costs?

Technical topics regarding tax preparation.
#1
Nilodop  
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Client paid substantial professional fees for planning and implementing a restructuring for purposes of simplifying an existing S corporation/partnership structure. Included were many discrete transactions, including S corporation mergers, section 721 transactions, and section 351 transactions that together might be considered one restructuring transaction. There were no changes in ownership.

Client wants to treat the costs as non-facilitative integration costs. Here is the relevant reg., 1.263(a)-5(c)
(6)Integration costs. An amount paid to integrate the business operations of the taxpayer with the business operations of another does not facilitate a transaction described in paragraph (a) of this section, regardless of when the integration activities occur.


A footnote in a BNA Portfolio says that internal restructuring costs may be non-facilitative integration costs within the meaning of 1.263(a)-5(c)(6). Not a real strong statement. And 1.263(a)-5(a) can be read pretty clearly to require capitalization of the types of fees they paid; thus my concern.
(a)General rule. A taxpayer must capitalize an amount paid to facilitate (within the meaning of paragraph (b) of this section) each of the following transactions, without regard to whether the transaction is comprised of a single step or a series of steps carried out as part of a single plan and without regard to whether gain or loss is recognized in the transaction:
(Emphasis added). Two of those "following transactions" are:
(4) A restructuring, recapitalization, or reorganization of the capital structure of a business entity (including reorganizations described in section 368 and distributions of stock by the taxpayer as described in section 355).

Here's an article on the area but frankly I did not get much out of it on my question. http://woodllp.com/Publications/Article ... uccess.pdf

(5) A transfer described in section 351 or section 721 (whether the taxpayer is the transferor or transferee).


I think their professional fees are deductible as non-facilitative integration costs because there is no acquisition involved, just a re-arrangement. But it would be nice to find a more specific authority.
 

#2
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Bump. This is a question about deducting or capitalizing, under section 263 and its regs., the expenses of restructuring a complicated structure of companies for the purpose of simplifying the structure, where there is no acquisition and no change in ownership. I think it's deductible, but I can see a potential challenge. Any input?
 

#3
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Have you seen Notice 2004-18?
 

#4
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Thank you. If I have, I don't remember it. But now I have seen and read it. I gather that the admirable goals expressed here have not yet been achieved.
To reduce the prospect of future controversy, the Service and Treasury Department intend to propose regulations to address the treatment of amounts that facilitate certain tax-free and taxable transactions and other restructurings and that are required to be capitalized under § 263(a) and § 1.263(a)–5. The Service and Treasury Department intend to develop a set of rules that are clear and administrable.


More to the point, though, I still have my question, because Notice 2004-18 seems to limit its scope to amounts that create an intangible asset and that are required to be capitalized, thus begging the question about non-facilitative integration costs (the ones in my OP). Following are excerpts from the Notice on which I base my understanding of its scope.

On December 22, 2003, the Treasury Department and Internal Revenue Service issued final regulations (T.D. 9107, 2004–7 I.R.B. 447 [69 FR 436]) under § 263(a) of the Internal Revenue Code requiring capitalization of certain amounts that facilitate the creation or acquisition of an intangible asset and under § 167 providing a 15-year safe harbor amortization period for certain intangible assets described in § 263(a). The final regulations under § 263(a) also provide guidance on the treatment of amounts required to be capitalized under § 263(a) in certain acquisitions of a trade or business.


The final regulations under § 263(a) do not address the treatment of amounts required to be capitalized in certain other transactions to which the regulations apply ...


The Service and Treasury Department are aware that there is continuing controversy as to the proper treatment of certain costs that facilitate certain tax-free and taxable transactions and other restructurings and that are required to be capitalized ...


The Service and Treasury Department are considering the treatment of capitalized costs that facilitate the following transactions:
...
. (It lists 11 types of transactions, several of which were involved in OP restructuring).

But what the Notice does not do is address or ask for comments about how to distinguish non-facilitative integration costs that can be expensed from facilitative costs that have to be capitalized.
 

#5
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And maybe I have been overlooking that restructuring costs for the purpose of simplification may not be integration costs at all, but rather capitalizable costs paid to facilitate the ongoing operations in a simpler fashion, and not ordinary and necessary expenses under 162. Just look at the list of "transactions" in 1.263(a)-5(a)(1) through (10).

And we have Indopco too. https://www.law.cornell.edu/supremecourt/text/503/79. The Supremes stated in that case
Courts long have recognized that expenses such as these, " 'incurred for the purpose of changing the corporate structure for the benefit of future operations are not ordinary and necessary business expenses.' " General Bancshares Corp. v. Commissioner, 326 F.2d, at 715 (quoting Farmers Union Corp. v. Commissioner, 300 F.2d 197, 200 (CA9), cert. denied, 371 U.S. 861, 83 S.Ct. 117, 9 L.Ed.2d 99 (1962)). See also B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, pp. 5-33 to 5-36 (5th ed. 1987) (describing "well-established rule" that expenses incurred in reorganizing or restructuring corporate entity are not deductible under § 162(a)). Deductions for professional expenses thus have been disallowed in a wide variety of cases concerning changes in corporate structure.
 

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But what the Notice does not do is address or ask for comments about how to distinguish non-facilitative integration costs that can be expensed from facilitative costs that have to be capitalized.

Sec 351 and 721 transactions are listed in -5(a) and are not covered transactions that are listed in -5(e).

Sec 368 transactions are listed in -5(a) and are also covered transactions that are listed in -5(e).

With respect to the 351/721 transactions, we look to -5(b) only in making the facilitative or not determination. It seems to me, all of the costs associated with these transactions require capitalization, regardless of when they were incurred throughout the timeline, because they were paid in the process of investigating/pursuing. (But maybe I’m wrong about that…maybe all costs prior to the firm decision require capitalization, but costs thereafter do not, since those would be to actually effectuate the transaction. But that doesn’t make much sense). Also note that -5(a) says, “without regard to whether the transaction is comprised of a single step or a series of steps carrieed out as part of a single plan…”

With respect to 368 transactions, which are covered transactions, we look to -5(b) and -5(e). Under -5(e) the general rule is that costs associated with covered transactions can be expensed prior to Date X and must be capitalized after Date X. But there’s an exception for “inherently facilitative” amounts. These types of costs must be capped no matter when they were incurred. One cost here, under (ii), is structuring the transaction.

It seems to me that your costs, which are professional fees, will be caught up in the above capitalization web. If that’s right, it’s a hard pill to swallow, since all parties were already related.

It doesn’t seem that any of the costs in question are integration costs. The types of costs that show up in Example 6 of the Regulation, as integration costs, are completely different than the professional fees you mention.
 

#7
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As usualalways, a helpful and coherent analysis. Thank you. I will ponder it over the weekend.

I agree these are not integration costs as described in Ex. 6. I will ask more questions, in case they are not all professional fees.

The "hard pill to swallow" is exactly what troubles the client. No ownership change. But the regs. don't mean we no longer look at Indopco itself, right?
 

#8
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A friend sent me this footnote from the BNA portfolio. I'm not sure how, if at all, it affects our analysis.

The origin-of-the-claim doctrine also preserves the character of reported income.45 As discussed above, capitalization largely reflects concerns about timing, but the origin-of-the-claim doctrine has been applied in recognition of the fact that, by capitalizing certain costs, capitalization can also avoid distortions in the character of income. In particular, where an immediate deduction of costs would reduce ordinary income but the costs originate in transactions producing capital income, like the sale of a capital asset, the doctrine has required capitalization for selling costs through an offset to sale proceeds in order to avoid character mismatching.46 The doctrine preserves character by reducing the net capital gain reported from the sale.47 Similarly, where costs originate in a nontaxable transaction, the doctrine precludes a current deduction of the costs under §162 in order to avoid reducing taxable income by costs originating in a transaction that produces income exempt from tax.48Thus, capitalization principles, grounded in the origin-of-the-claim doctrine, may seek to preserve character in addition to fulfilling timing objectives for cost recovery. These general capitalization principles have given meaning to a provision with one of the longest lineages in the Code.49 They have resolved some of the innumerable controversies that have arisen about deductible expenses, despite their lack of definite parameters, and continue to influence modern thinking about tax accounting. Moreover, these principles have guided the formation of and are reflected in final, temporary and proposed regulations for costs attributable to tangible and intangible property and business transactions, as discussed throughout this Portfolio.
That doctrine is not one I'd have associated with our facts. Here's a good article on the origin of the claim doctrine. http://hbtlj.org/articlearchive/v15i1/1 ... TaxLJ1.pdf
 

#9
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I also wonder about moving costs. If the physical layouts, locations, placement of people and machinery, etc. are significantly changed in order to operate the businesses more efficiently, would the moving costs and the planning, etc. be deductible? They always used to be. Have the regs. changed that? If not, how is a structural change not analogous? Could the physical changes I describe here be deductible while the structural change is not, even though both have the same purpose and in both there is no ownership change.
 


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