LTR 201319009 seems to be an odd ruling, because the taxpayer sought a ruling that it had to capitalize certain costs of an acquisition through use of a double dummy structure. However, the taxpayer actually was limiting its capitalization by obtaining a ruling that a section 351 exchange with boot was a “covered transaction” for purposes of Reg. Section 1.263(a)-5(b).
Facts. Company 1 wanted to acquire Company 2. Company 1 created Parent. Parent created two mergersubs. One mergersub merged into Company 1 for Parent stock. The other mergersub merged into Company 2 for Parent stock and cash. The amount of cash is not stated but we know it had to be more than 20 percent of the consideration because the merger did not qualify under section 368(a)(2)(E).
The merger into Company 1 did qualify under section 368(a)(2)(E). The merger into Company 2 was a section 351 exchange with boot.
Issue. Reg. Section 1.263(a)-5(b) requires capitalization of the costs of acquisitions of property. Parent and Company 1 acquired Company 2. The regulation would apply. However, a subrule within the regulation provides a bright line based on time for when expenses of an acquisition become subject to capitalization. This rule applies to “covered transactions,” which include reorganizations and taxable acquisitions but not section 351 exchanges as such.
Somewhat surprisingly, the ruling held that the Company 2 acquisition was both a taxable acquisition because boot was paid, and a section 351 exchange. As a result its expenses were subject to the bright line test. Only expenses incurred after a letter of intent was signed, or other event occurred, had to be capitalized. Presumably Company 1 and Parent incurred significant expenses prior to that date.
Comment. The ruling is surprising. It states that normally the IRS does not rule on reorganizations under Rev. Proc. 2013-3. However, the no rule stated there relates only to section 368 and related subchapter C provisions, not section 263.
The ruling did not discuss why section 351 exchanges were left out of the covered transaction list. Perhaps the IRS thought that it should not have been left out, since both “real” taxable transactions and reorganizations were covered. However, there does not seem to be a policy reason why a section 351 exchange with 21-percent boot should be a covered transaction and an all stock exchange not.
Of course an all stock exchange would be a reorganization and reorganizations are covered. That reinforces the possibility that the IRS saw the ruling as plugging a hole in the regulation.
Written by Jack Cummings, Partner, Tax | Alston & Bird LLP
