United States

Fact that merger necessitated costs no obstacle to tax deductions

IRS agent’s claim rebuffed in Chief Counsel Advice


Companies involved in mergers or acquisitions often face the question addressed in CCA 201713010. The company has incurred merger and acquisition transaction-related costs such as employee bonuses, customer promotion, or public relations costs, for example. But for the merger or acquisition, the company would not have incurred those costs. Does it necessarily follow that the company must capitalize these costs, rather than deducting them when incurred or paid? The answer is no.  

It is sometimes easy for an IRS agent (or a taxpayer) to convince him or herself that a ‘but for’ causation standard governs the tax treatment of an expenditure. That’s what happened to the IRS agent auditing the taxpayer addressed in CCA 201713010. The agent described four categories of costs and claimed that they must all be capitalized because the taxpayer would not have incurred the costs but for its acquisition of another company. The IRS’ Office of Chief Counsel, however, rebuffed the agent’s claims.

Regulated industry acquisition

The taxpayer in the CCA has subsidiaries operating businesses in a regulated industry. It proposed a merger in which it would acquire another company operating in the same industry. Approval of a regulatory board was needed to complete the merger.

After a six-month process involving an application, submissions and hearings, the regulatory board approved the merger, subject to four conditions:

  1. A rate credit to certain customers
  2. A contribution to a customer investment fund
  3. Payments to a state government
  4. A commitment to make charitable contributions and provide related community support

Must taxpayer’s costs of complying with the regulatory conditions be capitalized?

On examination, the IRS agent claimed that costs incurred related to these four conditions must all be capitalized as part of the taxpayer’s tax basis in the stock of the acquired company. The rationale was that the costs would not have been incurred but for the acquisition.  

The IRS’ Office of Chief Counsel was asked whether this but for causation sufficed to require capitalization of these costs, and its answer was no. The CCA notes that the agent’s but for argument ran against both the governing regulations and the preamble of the Treasury Decision that issued the regulations. The regulations, Reg. section 1.263-5(b)(1), and the preamble (T.D. 9107, 67 Fed. Reg. 77701), both clearly indicate that but for causation is relevant, but by itself insufficient to require capitalization.

The examining agent argued that the costs described above should be treated as costs of obtaining regulatory approval for the merger, since the costs related to conditions of the regulatory approval. The Office of Chief Counsel disagreed. Here, the costs of obtaining regulatory approval included the costs of preparing for and appearing before the regulatory board, but did not include the four categories of costs at issue. Instead, as noted in the CCA, these costs were predominantly in the nature of either annual operating or investment expenditures or payments for intangible property.

Similar but for questions arise in situations where a company incurs what would otherwise represent ordinary necessary costs such (e.g., financial statement audits and similar professional fees required due to securities and exchange commission rules), and this CCA may help delineate between capitalization and deductibility in such cases.


But for analyses often are not determinative of tax treatment; certainly they are not determinative when it comes to merger and acquisition transaction-related costs. Companies should keep this in mind when considering and documenting the tax treatment of their costs. The situation described in CCA 201713010 is not unusual; a but for argument can seem so appropriate that its proponent may overlook regulations, case law or other precedent to the contrary. The CCA provides insight into this complex area of taxation and you should seek tax advice in the event you incur merger and acquisition transaction-related costs.


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