A corporation may not deduct previously capitalized costs that facilitated an initial public offering (IPO) even when it later ceases to be a publicly traded company, according to an internal memorandum by the Internal Revenue Service (IRS) made public last week. The memorandum is potentially relevant to any corporation that either has undergone, or may in the future undergo, an IPO.
In the example in AM 2020-03 (released May 15, 2020),1 the corporation was a private company in year one. In year two, it engaged in an IPO to become a publicly traded company, incurring legal, accounting, investment banking, underwriting, printing, and regulatory and filing fees in the process. The corporation did not net the costs against the proceeds from the stock issuance, but instead capitalized those costs as a separate and distinct asset. In year three, the corporation completed a take-private transaction (at that point ceasing to be a publicly traded company) and deducted, as an abandonment loss, the capitalized costs incurred in connection with the IPO from year two.
The corporation argued that the costs facilitating the IPO are required to be capitalized pursuant to the Supreme Court’s decision in INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992) and regulation § 1.263(a)-5, and that those authorities had overturned the IRS’s prior position that stock issuance costs are to be netted against the proceeds of the stock issuance. In INDOPCO, the Court held th/at certain professional investment, banking and legal costs incurred by a target in the course of a friendly takeover were required to be capitalized because the target expected long-term synergistic benefits from its combination with the buyer, even if those benefits didn’t give rise to a separate asset. Similarly, the corporation in the IRS memo argued that becoming a public company had resulted in future synergies and resource benefits, and therefore the costs facilitating the IPO should be viewed the same as expenses incurred in the purchase of an asset. It asserted that when it became privately held, these intangible benefits ceased to exist, and thus the asset was abandoned, giving rise to a deductible loss under Section 165 of the Internal Revenue Code.
Historically, the IRS has viewed costs that facilitate a pending stock issuance as giving rise to an intangible asset separate from the stock. If the stock is issued, however, the IRS has taken the position that the costs offset the proceeds of the stock sale. In that sense, the costs are like commissions paid in the process of selling securities, which serve to reduce the amount realized on the sale. See Rev. Rul. 79-2, 1979-1 C.B. 98 and Regulation § 1.263(a)-1(e), dictating that commissions and other transaction costs paid to facilitate the sale of property are capitalized and reduce the amount realized on the sale. The IRS has consistently maintained that the costs of the “asset” are recoverable as a Section 165 loss only if the stock issuance does NOT happen (i.e., the transaction is abandoned).
Consistent with that long-standing position, Regulation § 1.263(a)-5, which was issued about ten years after the INDOPCO decision, requires taxpayers to capitalize costs that facilitate a capital transaction, including a stock issuance (public or private). However, the regulations are silent as to how a taxpayer is to further treat such capitalized costs. In the memo, the IRS observed that INDOPCO required capitalization even absent a separate asset. The IRS further concluded that nothing about INDOPCO or regulation § 1.263(a)-5 changes the established treatment of capitalized stock issuance costs as reducing the amount realized by the corporation on the stock issuance.
At the same time, under Section 1032 of the tax code, corporations recognize no gain or loss on the issuance of their own stock. So, there is in effect no tax benefit derived from reducing the amount realized in an IPO by the amount of capitalized facilitative costs. The corporation in the memo highlighted this fact, but the IRS was unpersuaded. The IRS responded that the corporation received a benefit in the form of not having to report the proceeds of the IPO in income, and that giving the corporation a further benefit through a deduction for the capitalized costs would be inconsistent with Section 265, which disallows any deduction for costs allocable to tax-exempt income.
Moreover, the IRS concluded that no abandonment of assets occurred in the memo example. The IRS reiterated that “established precedent holds that costs incident to the sale of stock are never recoverable, except in instances where a planned public offering is abandoned,” and rejected the corporation’s argument that its take-private transaction was analogous to an abandoned IPO. The IRS reasoned that, in the case of an abandoned IPO, no proceeds are available to offset the costs incurred, but that is not the case when an IPO is successfully completed, even if the corporation later goes back to being privately held. Further, the IRS stated that even if the corporation had a basis in the intangible benefits from the IPO, the claimed abandonment loss would not be available after the take private-transaction because the corporation “continues to benefit from once being a publicly traded company.”
The AM is similar in certain respects to a technical advice memorandum (TAM) that the IRS released in January 2020, which concluded that a target company that had been required to capitalize costs that facilitated the acquisition of the target’s stock could not deduct those costs when the target is later sold by the acquiring corporation. Instead the TAM concluded that the target can only deduct such costs if and when it is liquidated. Thus, in both the TAM and the AM, the IRS took the view that a deduction of capitalized facilitative costs is not allowable simply because subsequent events “undo” the original capital transaction. That result seems clearer in the case of the AM than in the TAM. While an argument may exist regarding whether the benefits of being publicly held are lost after a take-private transaction, it seems clear that the corporation had no basis in the capitalized costs, and thus no Section 165 deduction is available for the costs when the company undertakes a take private-transaction. Further, and perhaps most importantly, the taxpayer did not abandon the IPO transaction. Rather, the taxpayer completed the IPO and then in a separate, unrelated transaction, took the company private, which is not the type of “termination” that Section 165 seeks to address. In contrast, in the TAM guidance, there was no offset of capitalized transaction costs against the amount realized as the taxpayer/target was being acquired. Thus, the target company had basis in the costs. It is arguable, depending on the facts, that the synergies created by the acquisition of a target truly do disappear upon a subsequent sale of it, which ought to yield a deduction.