Tax Court allows $1.6 billion deduction for busted deal fee
The Tax Court allowed AbbVie, Inc.’s (AbbVie’s) $1.6 billion ordinary deduction in AbbVie, Inc. v. Commissioner.1 The IRS had contended that the $1.6 billion amount represented a less valuable capital loss.
Merger and acquisition (M&A) agreements sometimes provide for busted deal fees or break fees—fees payable if one party to backs out of the deal. From a tax point of view, however, not all busted deal fees are the same. The structure of a proposed M&A transaction may dictate the tax treatment of a break fee. While some break fees may be characterized under section 1234A as capital losses, AbbVie’s busted deal fee did not suffer that fate.
The Tax Court’s decision in AbbVie to treat the break fee as an ordinary deduction contrasts with recent (nonprecential) IRS guidance, which generally has treated break fees in M&A transactions as resulting in capital gain or loss under section 1234A in a variety of circumstances.2
Background
AbbVie and Shire agreed to recommend to their shareholders a combination of the two companies under a new foreign holding company. The proposed combination would be an “inversion” transaction intended to transfer ownership of a U.S. corporation to a foreign corporation and achieve U.S. federal (Federal) income tax benefits.
The companies signed agreements, including a Co-operation Agreement, specifying steps each company would take to work towards the proposed combination. AbbVie agreed in the Co-operation Agreement to pay Shire a significant break fee if it failed to carry out its responsibilities and the combination as a result failed to occur.
Three months later, AbbVie scuttled the proposed combination. By that time, the IRS had released Notice 2014-52 indicating that new regulations to be released at a later date that would retroactively eliminate or limit the tax benefits sought in the proposed combination. AbbVie chose not to recommend the combination to its shareholders. Instead, AbbVie and Shire agreed to terminate the deal, and AbbVie paid Shire a break fee of a little more than $1.6 billion.
AbbVie reported the fee as an ordinary business expense on its federal income tax return. The IRS asserted that the fee represented a capital loss under section 1234A and assessed additional tax of about $572 million. Characterizing the $1.6 billion fee as a capital loss reduced or eliminated its deductibility for the taxable year because corporate taxpayers may not deduct capital losses against ordinary income but may deduct those losses only to the extent they offset capital gain.
Tax Court dispute: section 1234A
Was AbbVie’s break fee properly characterized as a capital loss under section 1234A? That was the question in dispute.
Section 1234A is designed to provide capital gain or loss treatment for canceled or terminated transactions that, if completed, would have resulted in sales, potentially generating capital gain or loss. Congress was concerned that, under pre-section 1234A law, taxpayers could elect the most advantageous tax treatment available to them by selling certain contracts that increased in value (resulting in capital gain) and canceling or otherwise terminating similar contracts that decreased in value (resulting in ordinary loss).
Section 1234A(1) applies when these four requirements are met:
- First, the taxpayer must realize a gain or loss.
- Second, that gain or loss must be attributable to the cancellation, lapse, expiration, or other termination of a right or obligation.
- Third, the terminated right or obligation is “with respect to” property.
- Fourth, the property underpinning the terminated right or obligation is (or on acquisition would be) a capital asset in the hands of the taxpayer and is not a debt instrument.
The Tax Court found that the third requirement was not met—AbbVie’s rights and obligations under the terminated Co-operation Agreement were not rights with respect to property.
Previous cases had held that section 1234A applied to termination of derivative or contractual rights to buy or sell capital assets.3 For section 1234A to apply, the court concluded, the terminated contract must have involved an underlying transaction that included (had the transaction in fact occurred) a direct or indirect transfer of a property interest to or from the taxpayer.
In the proposed combination, the shareholders of AbbVie and Shire would have transferred their shares to a new foreign holding company. However, neither AbbVie nor Shire owned any of the property (i.e., their stock) that would have been exchanged in the transaction.
Further, the Co-operation Agreement between AbbVie and Shire focused on the companies’ rights and obligations to provide or perform services to clear the way for the shareholders’ proposed exchange of shares. For example, the Co-operation Agreement required AbbVie to pursue regulatory approvals, to recommend the combination to its shareholders, and to host a shareholder meeting before a specified date. These were not rights and obligations with respect to any direct or indirect transfer of property to or from AbbVie.
Since AbbVie did not pay the break fee as a result of its termination of rights or obligations “with respect to property” within the meaning of section 1234A, the fee did not represent a capital loss, and AbbVie was permitted a $1.6 billion ordinary business expense deduction under section 162(a) for the fee. If the terminated contract had instead provided that AbbVie would acquire Shire stock from Shire’s shareholders, a break fee paid by AbbVie could have given rise to a capital loss under section 1234A.
Conclusion
Takeaways from the AbbVie case include narrower and broader principles. More narrowly, for contract terminations, the capital gain or loss characterization under section 1234A is limited to terminations of contractual rights and obligations with respect to a transfer of property by or from the taxpayer. Instead, under AbbVie an agreement between parties to a transaction to take certain actions (or use “best efforts”) to facilitate an M&A transaction may relate to the performance of services (and constitute an ordinary deduction) instead of rights or obligations with respect to property under section 1234A.
More broadly, how an M&A transaction is structured is critical to the tax results in terminated deals just as it is in deals that make it to closing. M&A transactions that seem economically similar but utilize different forms or structures can have very different tax results. Parties to M&A deals should carefully analyze the tax treatment of each proposed structure and consider alternatives.
Footnotes:
1. 164 T.C. No. 10 (2025).
2. See CCA 201642035 (Feb. 9, 2016) (fee received by prospective acquirer from prospective target characterized as capital by the IRS; IRS acknowledged that result was contrary to the ordinary income conclusion provided on similar facts in PLR 200823012 (June 6, 2008)); FAA 20163701F (May 3, 2016) (facts similar to the AbbVie case, where a new company would acquire both parties to the terminated contract); and CCA 202224010 (Feb. 24, 2022) (fee paid to prospective target by prospective acquirer characterized as capital loss by the IRS).
3. CRI-Leslie, LLC v. Commissioner, 147 T.C. 217 (2016), aff’d, 882 F.3d 1026 (11th Cir. 2018); Pilgrim’s Pride Corp. v. Commissioner, 779 F.3d 311 (5th Cir. 2015), rev’g 141 T.C. 533 (2013).
