At a meeting of the D.C. Bar Tax Section's Pass-Through Entities and Real Estate Committee, Lewis Fernandez, IRS deputy associate chief counsel (Income Tax and Accounting), and Andrew J. Keyso, the principal drafting attorney, reviewed some of the comments received on the proposed regs and highlighted positions that are being reconsidered.
The Proposed Rules
The proposed regulations require capitalization of transaction costs that facilitate the acquisition, creation, or enhancement of an intangible asset or that facilitate a restructuring or reorganization of a business entity or a transaction involving the acquisition of capital. The proposed regs also provide a 15-year safe harbor amortization period for costs to create intangible assets that do not have a readily ascertainable useful life; a "12-month rule" that permits deduction of the costs of intangible assets whose lives are of a short duration; de minimis rules that permit deduction of costs that do not exceed $5,000; a rule that permits deduction of employee compensation; and an overhead rule covering fixed and variable costs.
Bright Lines and Bad Dates
Most of the comments received concerned the bright-line test proposed for when acquisitive transaction costs must be capitalized, Keyso said. The critical dates picked in the proposed regs were after the earlier of the date on which the acquirer submits to the target a letter of intent, offer letter, or similar written communication proposing a merger, acquisition, or other business combination; or the date on which an acquisition proposal is approved by the taxpayer's board of directors.
Commenters have said it should be a facts and circumstances test, Keyso said. But if the IRS has to draw a bright line, the letter of intent date is much too early, they have insisted.
Based on the volume of comments received on the bright-line dates, Keyso said, this is an area under consideration. There is a good chance that the final regs will retain a bright-line date, he said, because the facts and circumstances approach creates so many audit problems.
Bright lines are more like cliffs, said Deloitte & Touche's Glenn Mackles. Acquirers may solve the problem by not using the words "letter of intent."
The board of approval date is more realistic than the letter of intent date, said Deloitte & Touche's Jennifer Giannattasio, but a facts and circumstances test is better. Sometimes -- especially with closely held corporations -- the approval date is "too far out," she said.
Accounting Method Changes
The proposed regs provide that any change in method of accounting to comply with the new rules must be made using an adjustment under section 481(a), taking into account only amounts paid or incurred after the final regs are issued, said Mackles. However, method changes may be filed not only to comply with the regs, but also to comply with current law, and may include amounts paid or incurred before the regs are effective, he said.
The proposed regs adopt a rule permitting the deduction of prepaid expenses in the year of payment, which is also consistent with U.S. Freightways, but this rule is not effective until the final regs are published, Mackles said, and asked about the taxpayers who have filed accounting method changes in response to case law.
"We thought we had a good reason for cutting it off" that way in the proposed rules, responded Fernandez. There is the potential for many 481 adjustments, which may affect the agents' ability to audit the changes, he said. In light of the number of comments on this point, however, the IRS will be reconsidering the rule, Fernandez said.
The proposed regs generally provide that an amount paid to terminate, or facilitate the termination of, an existing agreement is deductible. In written comments Deloitte & Touche pointed out that the proposed regs also provide a bright-line test that requires an amount to be capitalized if the transaction is "expressly" conditioned on the termination of an existing agreement.
Severance payments are routinely deductible based on the origin- of-the-claim rule, said Giannattasio, even though they are expressly conditioned on a merger's taking place. She asked why the bright-line termination fee rule is different than the severance fee rule.
The termination fee rule was not intended to apply to severance payments, said Keyso, but is intended to apply under much narrower circumstances. If there is confusion as to how the termination fee rule works regarding severance pay, a relevant example can be put in the final regs, he said.
A recently issued chief counsel notice provides that chief counsel attorneys may not take a position that is inconsistent with proposed regulations if there are no final or temporary regulations in force addressing a matter.
Giannattasio asked if, when a termination fee is not expressly conditioned on a transaction's taking place, the notice means the IRS should not say the termination fees are capital. Fernandez said it was a good question and he hopes the field would ask for advice going forward.
Keyso said the notice was issued to chief counsel employees, not to revenue agents.
Also Being Reconsidered
Concerning the lists of categories of intangible assets that have been determined to provide future benefits for which capitalization is required, the government is thinking about adding language in the final regs that says it will interpret those categories broadly, Fernandez said. It would not be an antiabuse rule.
The IRS is looking at where to draw the line so as not to require capitalization of fees associated with bankruptcies to resolve mass-tort claims, Keyso said. Lawyers from Kirkland & Ellis have argued that the proposed rules requiring capitalization of transaction costs are broad enough to apply to all bankruptcy reorganizations, regardless of the circumstances of the bankruptcy or of the debtor, he said.
The Service is also considering whether to extend the proposed regs' exception for employee compensation to amounts paid to independent contractors in some situations, according to Keyso.
Treasury and the IRS are striving to get the regs finalized by the end of the calendar year, and there will be more capitalization projects on next year's business plan, Fernandez said.
Copyright Tax Analysts 2003. Reprinted with permission.