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TAX CLINIC

required to be capitalized when paid to its rights and obligations arising from that was or would have been capital
terminate an agreement so that a second, capital transactions, which brought the assets in the taxpayer’s hands had the
mutually exclusive capital transaction amounts within the scope of Sec. 1234A, transactions been completed.
may be pursued. discussed below. The amount of capital loss is deter-
The taxpayer argued that capitaliza- mined by dividing the value of the prop-
tion was not required and the payments The losses were capital under erty that was or would have been capital
were therefore deductible Sec. 162 ex- Sec. 1234A assets in the taxpayer’s hands by the total
penses because there was no second, mu- The CCA summarized the requirements value of the property and then multiply-
tually exclusive transaction that caused for a transaction to be subject to Sec. ing the loss by that fraction (see Watson,
the merger agreement to be terminated. 1234A as: 345 U.S. 544 (1953), and Williams v.
In rejecting this interpretation of the ■ There is gain or loss attributable to McGowan, 152 F.2d 570 (2d Cir. 1945)).
rule, the IRS noted that the absence of an extinguishing event (i.e., cancel- Importantly, the CCA notes that, for
a mutually exclusive transaction simply lation, lapse, expiration, or other purposes of applying Sec. 1234A, the
means that this particular rule does not termination); term “capital asset” does not include cer-
apply, and the taxpayer must look to ■ That event extinguishes a contractual tain trade or business property described
other provisions of the law to determine right or obligation; in Sec. 1221(a)(2) even if the property is
the treatment of termination payments. ■ The contractual right or obligation subject to Sec. 1231, which might shield
Similarly, the CCA concluded that concerns underlying property that is a significant portion of the losses from
the Santa Fe and Federated cases cited by a capital asset in the taxpayer’s hands potentially unfavorable capital loss treat-
the taxpayer did not support treating the (or that would be a capital asset if ment, depending on the taxpayer’s facts
termination fee payments as deductible the property were acquired by the (see CRI-Leslie, LLC, 882 F.3d 1026
Sec. 162 business expenses under the taxpayer); and (11th Cir. 2018)).
taxpayer’s facts. According to the IRS, ■ There is a “with respect to” nexus
these cases do not address the key issue or connection between the right or Implications
of whether the taxpayer’s termination obligation and the underlying capital This CCA serves as an important re-
payments were properly classified as asset. minder to take transaction costs, includ-
losses versus expenses. Furthermore, the As applied to the taxpayer’s facts, ing significant contingent amounts such
conclusion reached in these cases that the CCA concluded that these “plain as termination fees, into account when
the termination payments might be de- language” Sec. 1234A requirements were structuring and planning mergers and
ductible Sec. 162 expenses was based on satisfied. Specifically, as indicated in the acquisitions. While the tax treatment of
facts that did not apply to the taxpayer’s facts, the transaction agreements cre- transaction costs should not be the sole
situation because the taxpayer’s fees were ated contractual rights and obligations or primary consideration when structur-
not ordinary and necessary business that were extinguished upon termina- ing mergers and acquisitions, the ability
expenses of defending against unwanted tion of those agreements. Pursuant to deduct or accelerate the deduction of
attacks on the taxpayer’s trades or busi- to the authorities summarized above, transaction costs is often a key negotiat-
nesses (e.g., hostile takeover attempts). the termination of those rights and ing point between the parties when
Finally, the IRS determined that obligations resulted in Sec. 165 losses the amounts involved are significant.
the taxpayer provided “little evidence” equal to the termination fees and the Although it may not be used or cited as
to support its claim that the termina- capitalized expenses incurred to facilitate precedent, this CCA provides valuable
tion payments were solely intended to the transactions. insight to taxpayers planning or nego-
compensate the parties for their transac- Furthermore, the extinguished con- tiating merger-and-acquisition transac-
tion costs and were therefore Sec. 162 tractual rights — and the Sec. 165 losses tions as to how the IRS applies the rules
business expenses deductible under the that resulted from them — pertained all to termination fees paid in connection
“origin of the claim” doctrine established or in part to assets that were or would with an abandoned asset acquisition.
in Gilmore, 372 U.S. 39 (1963). The IRS have been capital in the taxpayer’s hands Significantly, the CCA confirms
consequently dismissed this argument had the agreements not been terminated. that a transaction structured as an asset
and further noted that, even if a portion Accordingly, the taxpayer’s Sec. 165 acquisition may allow all or a significant
of the payment may have compensated losses resulting from the termination of portion of losses stemming from some
the target for its transaction costs, this the transaction agreements were treated transaction costs to be classified as ordi-
did not alter the fact that the taxpayer as capital under Sec. 1234A to the extent nary and currently deductible, depending
paid the termination fees to dispose of the losses were attributable to property on the facts (e.g., the nature of the assets

16 October 2022 The Tax Adviser