Other Records
In the example case, it was undisputed that Alpha was acquired in a transaction to which Regulation Section 1.263(a)-5(a) applies. Therefore, Alpha is required to capitalize the costs incurred to facilitate the transaction. Generally, in the case of a success-based fee, the documentation must consist of more than merely an allocation between activities that facilitate the transaction and activities that do not facilitate the transaction. What's more, those activities must consist of supporting records (for example, time records, itemized invoices, or other records) that identify the activities performed, the fee allocable to those activities, the date of performance, and the service provider. Moreover, the documentation must be completed on or before the due date of the taxpayer's (Alpha's) timely filed tax return — including extensions — for the taxable year during which the transaction closes.

Again, in the instant case, Alpha used the allocation provided in the general spreadsheets developed by Omega Accounting. The issue was whether the general spreadsheets developed by Omega, in conjunction with employees of both Corporation X and Beta Bank, qualified as other records. Indeed, the existence of other records can function to adequately distinguish the costs that facilitate the transaction from those that do not. In fact, last year in a Technical Advice Memorandum, the IRS ruled that the spreadsheets constituted other records.⁶

In reaching its conclusion, the IRS noted that, under Regulation Section 1.263(a)-5(f), records other than time records or itemized invoices can qualify as "other records" for purposes of substantiating the nonfacilitative portion of a success-based fee. Moreover, the term other records is not explicitly defined in the regulations; as a result, there are no limitations on the type or source of documents that can qualify. In fact, the IRS ruled that any document can serve to establish the deductible portion of a success-based fee. This is true, said the ruling, even where, as in the example case, the document was not directly prepared by the service provider.

Under the facts of this case, Corporation X and Beta Bank clearly engaged in activities that were nonfacilitative, and clearly engaged in those activities before the date on which the material terms of the transaction were approved by Alpha's board. Most notably, the IRS indicated that Regulation Section 1.263(a)-5(f) should not be read in a manner that would automatically preclude the deduction of Alpha's nonfacilitative costs simply because the company is unable to provide time records or itemized invoices.

What's more, the ruling concluded that the spreadsheets prepared by Omega Accounting (in conjunction with employees of Corporation X and Beta Bank) qualify as other records. Therefore, the IRS decreed that its auditor must take the spreadsheet into account (although it did not specify the probative weight to be accorded these other records) in determining whether Alpha maintained sufficient documentation to establish that a portion of the success-based fees remitted to Corporation X and Beta Bank are properly allocated to activities that do not facilitate the transaction.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.

Footnotes
¹ Regulation Section 1.263(a)-5(b).
² Regulation Section 1.263(a)-5(e)(1).
³ Regulation Section 1.263(a)-5(e)(2).
⁴ An amount is inherently facilitative if it is paid for (i) securing an appraisal or fairness opinion related to the transaction; (ii) structuring the transaction (including obtaining taxation advice with respect to the structure of the transaction); (iii) preparing and reviewing the documents that effectuate the transaction (for example, a merger agreement or purchase agreement);
(iv) obtaining regulatory approval of the transaction including preparing and reviewing regulatory filings; (v) obtaining shareholder approval of the transaction (for example, proxy costs, solicitation costs, and costs to promote the transaction to shareholders); or (vi) conveying property between the parties to the transaction (for example, transfer taxes and title registration costs).
⁵ Regulation Section 1.263(a)-5(f).
⁶ See LTR 201002036, September 21, 2009.

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