United States

Court provides guidance for buyer’s treatment of assumed liabilities

TAX ALERT  | 

In AmerGen Energy Co. v. U.S., 113 Fed. Cl. 52 (2013), the Court of Federal Claims ruled that an accrual-method purchaser of certain assets could not rely on Reg. section 1.461-4(d)(5) in including fixed liabilities assumed as part of the purchase of the assets in its cost basis at the time of acquisition. Although the assumed liabilities at issue were fixed and determinable at the time of the acquisition (and were thus only contingent with respect to the timing of when the taxpayer would actually incur the costs), the court ruled that because the liabilities would not meet the economic performance requirement until a later year, the taxpayer had to wait until such later year to include the liabilities in the cost basis of the acquired assets.  

The holding in AmerGen reflects our existing views on the ability of taxpayers to include assumed liabilities in the basis of assets acquired in taxable transactions and will impact all taxpayers that have previously relied on Reg. section 1.461-4(d)(5) in arguing that assumed, fixed liabilities are includable in basis at the time of acquisition. Taxpayers that have assumed or will be assuming any liabilities (whether contingent or not) as part of the purchase price of taxable asset acquisitions should consult with their tax advisors to determine the timing of when such liabilities may be included in the basis of the acquired assets. 

Discussion

As part of the taxable acquisition of three nuclear power plants, AmerGen Energy Co. (the taxpayer) assumed significant liabilities for the future decommissioning of the plants. Because the liabilities were fixed and determinable at the time of the acquisition, the taxpayer argued that it should currently include them in the capitalized basis of the acquired assets even though the plants were fully operational and any decommissioning activities would not occur until future years. The taxpayer argued that even if the economic performance requirement of section 461 was applicable to the determination of when an assumed liability may be included in the cost basis of assets acquired, under Reg. section 1.461(d)(5), the taxpayer should treat economic performance as occurring at the time of the asset acquisition. 

The court first rejected any argument that section 461’s all-events test (including economic performance) does not apply to the determination of when a liability may be included in an asset’s cost basis. The court stated that the plain language of section 461(h) (requiring economic performance to occur prior to taking into account a liability), as well as the relevant legislative history, illustrates that section 461 principles are applicable for determining when an item is incurred for all purposes of the Code (and not just the timing of recognizing deductions).1

The court further rejected the taxpayer’s argument that the economic performance prong of the all-events test was met at the time the liability was assumed under Reg. section 1.461-4(d)(5). Reg. section 1.461-4(d)(5) provides that “if, in connection with the sale or exchange of a trade or business by a taxpayer, the purchaser expressly assumes a liability arising out of the trade or business that the taxpayer but for the economic performance requirement would have been entitled to incur as of the date of the sale, economic performance with respect to that liability occurs as the amount of the liability is properly included in the amount realized on the transaction by the taxpayer.” The taxpayer argued that since the decommissioning liabilities were fixed and determinable as of the date of the sale, under Reg. section 1.461-4(d)(5) the taxpayer should treat economic performance as occurring in the taxable year of the acquisition since this is the year in which the seller would take into account any amounts realized. 

The court, however, stated that this section only relates to the treatment of liabilities for the seller of an asset and not the purchaser. Thus, according to the court, the regulation provided no authority for the taxpayer (as the purchaser) to treat the assumed liabilities as incurred within the meaning of section 461 at the time of purchase. The court instead concluded that because the decommissioning liabilities required the taxpayer to provide services (i.e., the decommissioning activities), economic performance would only occur as the taxpayer incurs costs in connection with providing the services under Reg. section 1.461-4(d)(4)(i).2

Thus, the court ruled that the assumed liabilities could not be included in the taxpayer’s basis of the acquired assets until the liabilities became fixed and determinable and economic performance occurred – a determination for which the taxpayer could not rely on Reg. section 1.461-4(d)(5). Although the liabilities were fixed and determinable at the time of the acquisition, because they related to future services to be provided by the taxpayer, economic performance would not occur until the costs of performing the services were actually incurred (i.e., when the services to deactivate and decommission the plants were provided). Therefore, since the decommissioning activities would not occur until a future year, the assumed liabilities could not be taken into account at the time of acquisition as part of the taxpayer’s basis in the acquired assets.

Implications

The court’s holding reflects the IRS’s position that accrual-basis taxpayers that assume liabilities as part of asset acquisitions may only include the liabilities in basis once the all-events test under section 461 is met and that purchasers may not rely on Reg. section 1.461-4(d)(5) in determining when the economic performance prong of the test is satisfied. Thus, the court’s holding will impact all taxpayers that have previously relied on Reg. section 1.461-4(d)(5) in arguing that assumed, fixed liabilities are includable in basis at the time of acquisition. In light of AmerGen, taxpayers that have entered into or will be entering into taxable asset acquisitions that include the assumption of contingent and/or non-contingent liabilities should consult with their tax advisors to determine the proper timing of when such liabilities are includable in the basis of the acquired assets.

[1] Interestingly, the court averted the issue of how this ruling would affect cash-basis taxpayers. As the taxpayer pointed out, if an assumed liability must be “incurred” within the meaning of section 461 before it can be included in the cost basis of an asset, cash-basis taxpayers would be treated differently since they are not subject to the economic performance requirement of section 461. However, the court refused to address the impact of its holding on cash-basis taxpayers by essentially stating that it was a moot question since the taxpayer at issue was an accrual-basis taxpayer.

[2] The court also referenced example 1 in Reg. section 1.461-4(d)(7), the facts of which the court stated were analogous to the decommissioning liabilities. That example provides that an oil company taxpayer’s liability to dismantle an offshore drilling platform will not meet the economic performance requirement until the taxpayer incurs the costs to dismantle the platform (e.g., when the taxpayer’s employees or an independent contractor provides the removal services).


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