The IRS recently issued a general legal advice memorandum (GLAM 2012-010) regarding the timing of certain corporate deductions for transaction costs under the consolidated return rules, including the next-day rule.
In the GLAM, the acquiring corporation (Acquiring) acquired stock of the target corporation (Target) when a subsidiary of Acquiring merged with and into Target, with Target surviving (the Acquisition). Acquiring was the common parent of an affiliated group of corporations that had elected to file a consolidated tax return for U.S. federal income tax purposes (the Acquiring Group). Target became a member of the Acquiring Group as a result of the Acquisition. Target incurred certain deductible costs that the IRS assumed became deductible on the date of the transaction (the Acquisition Date), including the following:
- Item 1: Payments to Target's employees for stock options and stock appreciation rights due upon a change in control of Target and that became fixed and determinable at the time of the Acquisition.
- Item 2: Payments to Target's financial advisers and investment banking firms for consulting advice rendered to Target in connection with the Acquisition that were contingent on the successful closing of the Acquisition.
- Item 3: Payments to retire certain debt belonging to Target. Target paid certain bondholders a premium over the adjusted issue price to retire certain of its outstanding bonds. The bondholders tendered the bonds two days before the Acquisition date, though Target was not obligated to purchase the tendered bonds. On the Acquisition date, but after the Acquisition had closed, Target accepted the tendered bonds for reacquisition. Later that day, Target retired the bonds at a premium, using its own funds or funds received from Acquiring.
Target was a standalone C corporation before the Acquisition. The Acquisition caused Target's standalone tax year to end on the Acquisition date. Target then became a member of the Acquiring Group on the day after the Transaction. Target must specifically allocate extraordinary items of income and deduction, such as the three items discussed previously, between its first short period, when it files a standalone tax return, and its second short period, when it files a tax return as a member of the Acquiring Group. The proper allocation of items 1, 2 and 3 is governed by the consolidated return rules under Treas. Reg. Sec. 1.1502-76(b).
The end-of-day rule under Treas. Reg. 1.1502-76(b)(1)(ii)(A) provides that, in general, if a corporation becomes or ceases to be a member of a consolidated group during a consolidated return year, the corporation becomes or ceases to be a member at the end of the day on which its status changes, and its tax year ends for all federal income tax purposes at the end of the day. This general rule, however, is subject to an exception, called the next-day rule.
The next-day rule under Treas. Reg. 1.1502-76(b)(1)(ii)(B) provides that if, on the day of the corporation's change in status as a group member, a transaction occurs that is properly allocable to the portion of the corporation's day after the event resulting in the change, the corporation must treat the transaction as occurring at the beginning of the following day. A determination as to whether a transaction can be properly allocated to the portion of the corporation's day after the event will be respected if the allocation is reasonable and consistently applied by all affected persons. Treas. Reg. Sec. 1.1502-76(b)(1)(ii)(B)(2) sets forth certain factors to determine whether an allocation is reasonable under the next-day rule.
The IRS applied the consolidated return rules to the facts in the GLAM and determined that Target's costs under items 1 and 2 were subject to the end-of-day rule and should be reported on Target's short-year standalone tax return. The IRS reasoned that the underlying obligations became "fixed and determinable upon closing." The IRS noted that although consummation of the Acquisition was the condition that fixed Target's liability to pay items 1 and 2, the corresponding deductions could not be attributed to any "transaction" on the Acquisition date other than the Acquisition itself. The IRS determined that Target's costs under Item 3 may be subject to the next-day rule and thus it may be reasonable to report the deduction on Target's return as part of the Acquired Group's consolidated tax return. The IRS noted that the deduction for retiring the bonds at a premium arose as a result of a post-Acquisition payment made after closing.
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