Fees paid to investment bankers or private equity firms contingent upon the successful closing of a transaction (i.e. stock purchase, asset purchase, merger, etc.) have been the subject of recent blog posts (see our previous blog, IRS Issues Favorable Guidance on Success-Based Fees.)
- In May 2011, the IRS issued favorable guidance (Revenue Procedure 2011-29) allowing a taxpayer to treat 70 percent of the success-based fees as an amount that does not facilitate the transaction, thus a deductible expense.
- Then in August of 2011, the IRS issued a directive to its Revenue Agents not to challenge a taxpayers treatment of success-based fees, essentially allowing for early application of the Revenue Procedure (see our previous blog, IRS Issues Directive for Examiners Regarding Success-Based Fees).
- Last week, the IRS released Chief Counsel Advice (CCA) 201234027 that provides additional clarification on what constitutes a "success-based fee" under Treasury Regulation 1.263(a)-5(a).
The example cited in the CCA is as follows:
A taxpayer retains an investment banker to provide services as part of a "covered transaction," the sale of the taxpayers business. Pursuant to an engagement letter, the investment banker will receive $10 million upon the successful closing of the transaction. Further, the taxpayer must make certain milestone payments along the way. The taxpayer will pay $1 million upon the signing of the merger agreement and another $1 million upon shareholder approval of the transaction. These milestone payments are creditable toward the $10 million that will be owed upon the closing of the transaction. If the transaction does not close, the taxpayer will not owe the investment banker the additional $8 million, but the $2 million of milestone payments are not refundable.
In the CCA, the IRS states that the $2 million of milestone payments which are nonrefundable are guaranteed payments and do not qualify as success-based fees. The remaining $8 million would still qualify under the Revenue Procedure. Taxpayers contemplating a purchase or sale of a business need to be aware of this guidance and closely examine their engagement letter with their investment banker.
Do you have a question about the application of this guidance to your specific facts? Contact our Transaction Advisory Services Group by leaving a message below, or by calling 440-449-6800.