Deductibility of fruitless IPO or SPAC preparation costs

ARTICLE | August 29, 2021

Authored by RSM US LLP

In the months leading up to April 2021 the number of SPAC (special purpose acquisition company) IPOs (initial public offering) were at record levels and the traditional IPO was strong. These going public transactions were particularly prevalent in industries such as technology, green energy, fintech (financial technology) and life sciences.

However, a significant slowdown has occurred in SPAC transactions and to a lesser extent traditional IPOs. The result of this slowdown is an increase in deferred or outright abandoned transactions.

For a company that has deferred or abandoned a SPAC or IPO transaction, the tax treatment of the costs incurred preparing for the transaction requires consideration. Unfortunately, there is no assurance of tax deductibility for the costs incurred in the process. This article will help companies understand factors affecting whether costs of a deferred or abandoned ‘Go Public’ transaction are deductible for U.S. federal income tax purposes.

Capitalization of IPO and SPAC transaction costs

Tax regulations set out some specific rules for capitalizing costs incurred in mergers, acquisitions and stock issuances.¹ Capitalized costs cannot be deducted as they are paid or incurred. Instead, depending on the situation and the nature of the costs, they may be deductible in the future, amortized over time or not deductible at all. 

Capitalization of costs generally is required if the costs facilitate the merger, acquisition or stock issuance.² The regulations provide additional guidance regarding what costs must be capitalized by describing the meaning of the word ’facilitate’  in this context.³

IPO and SPAC transaction plans that are abandoned or superseded

Mutually exclusive transactions

In a situation where the planned transaction is abandoned or superseded, and never takes place, the regulations still may limit deductibility. They address the situation where costs are paid or incurred to facilitate one transaction such as an acquisition or stock issuance (the First Transaction), and a different transaction (the Second Transaction) is later entered into instead of the First Transaction. Costs paid to incur to facilitate (or terminate) the First Transaction are treated as facilitating the Second Transaction only if the two transactions are mutually exclusive.⁴

For example, if a company abandons its IPO plan to pursue a mutually exclusive alternate transaction such as a private issuance of stock or a SPAC deal, costs of facilitating the abandoned IPO would be capitalized together with the costs of facilitating the private offering or SPAC transaction.⁵ In general, two transactions are mutually exclusive transactions generally are transactions that are contemplated with one another and where only one of the transactions is ultimately possible.

Abandonment or delay of a transaction plan

If a transaction plan – such as an IPO or SPAC transaction plan – is abandoned, costs of facilitating the planned transaction typically are deductible at the time the plan is abandoned.⁶ Whether and when abandonment occurs is determined under principles set out in case law. Abandonment generally requires intent to abandon, together with an overt act that is evidence of abandonment.⁷

On the other hand if the IPO or SPAC transaction is merely delayed, rather than abandoned, the costs incurred to facilitate the delayed transaction should be capitalized with regard to the later-completed transaction.⁸ For example, assume a company (Company 1) incurs costs intended to facilitate a merger with one SPAC (SPAC A), SPAC A acquires another target company (Company 2), and Company 1 then pursues and completes a merger with SPAC B. In this situation, Company 1’s costs intended to facilitate the SPAC A merger typically would be capitalized as a cost of facilitating the SPAC B merger.

However, the fact that the company subsequently enters into a similar transaction is not by itself enough to require continued cost capitalization. Once the standard for abandonment loss is met, the deductibility of costs relating to the abandoned transaction would not be affected by the Company’s subsequent entry into a similar but not mutually exclusive transaction.⁹ For example, the fact that a company is maintaining an option to go public eventually does not preclude a determination that the company abandoned its initial IPO effort.¹⁰

The federal income tax standard for abandonment of transaction costs requires a facts and circumstances-based inquiry. It does not depend on or refer to the analogous standard under GAAP (generally accepted accounting principles). We have seen instances where a change to transaction plans resulted in expensing of previously incurred costs under GAAP but was not treated as an abandonment permitting deduction of the costs for tax purposes. Factors that should be analyzed in determining whether an IPO or SPAC transaction has been abandoned may include: the engagement of investment bankers and other deal advisors with respect to a transaction, whether negotiations have terminated, whether the counterparties to the proposed transaction have been notified of the plan’s abandonment or termination, whether a termination of ‘breakup’ fee has be paid or incurred, and what role changing market conditions play with respect to the company’s decisions regarding pursuit of stock issuance, merger and/or acquisition transactions. 

Conclusion

Companies that have incurred costs relating to an IPO or SPAC transaction that did not take place as originally planned may be able to deduct those costs. The costs’ tax deductibility rests on the factors outlined in this article – whether the costs incurred were facilitative, whether the transaction was abandoned or delayed, and whether another, mutually exclusive transaction was pursued. Companies considering the tax deductibility of costs incurred in furtherance of an IPO or SPAC transaction should consult with their tax advisors.

¹ See generally Reg. section 1.263(a)-5.

² See Reg. section 1.263(a)-5(a).

³ See Reg. sections 1.263(a)-5(b), -5(c), and -5(d). Additional rules applicable to certain acquisitive transactions are set out in Reg. sections 1.263(a)-5(e).

⁴ Reg. section 1.263(a)-5(c)(8).

⁵ Reg. section 1.263(a)-5(a) and -5(c)(8). Case law predating the regulations also required similar capitalization results for costs relating to mutually exclusive transactions. See, e.g., United Dairy Farmers, Inc. v. United States, 267 F.3d 510 (6th Cir. 2001); Nicolazzi v. Comm’r, 79 T.C. 109 (1982), aff’d per curiam 722 F.2d 324 (6th Cir. 1983); Sibley, Lindsay & Curr Co. v. Comm’r, 15 T.C. 106 (1950). See also FAA 20133101F (Aug., 2, 2013) (summarizing case law and apparently addressing facts that apparently took place prior to the effective date of current tax regulations).

⁶ Reg. section 1.165-2(a); Rev. Rul. 79-2, 1979-1 C.B. 98.

⁷ See, e.g., CRST, Inc. v. Commissioner, 92 T.C. 1249, 1257 (1989), aff'd, 909 F.2d 1146 (8th Cir. 1990); A.J. Indus., Inc. v. United States, 503 F.2d 660 (9th Cir. 1974). Abandonment of an intangible property interest should be accomplished by some express manifestation. See Citron v. Comm’r, 97 T.C. 200 (1991). See also Rev. Rul. 2004-58, 2004-24 I.R.B. 1043.

⁸ See, e.g., Nicolazzi v. Comm’r, 79 T.C. 109 (1982); FRGC Investment, LLC v. Comm’r, T.C. Memo. 2002-276, aff'd without published opinion 89 Fed. Appx. 656 (9 Cir. 2004) (taxpayer’s subsequent acquisition of the property in question held inconsistent with the taxpayer’s claim that its project was abandoned).

⁹ See, e.g., Tobacco Products Export Corp. v. Comm’r, 18 T.C. 1100 (1952); Doernbecher Mfg. Co. v. Comm’r, 30 B.T.A. 973 (1934), aff'd, 80 F.2d 573 (9th Cir. 1935).

¹⁰ See, e.g., Trigon Ins. Co. v. United States, 215 F. Supp. 2d 687 (E.D. Va. 2002) (court held that a taxpayer’s termination of contracts were abandonments for U.S. federal income tax purposes, despite the fact that the taxpayer attempted to reestablish contractual relationships with the cancelled or terminated parties afterward).