Merger Agreement Termination Fee Paid To Potential Acquiring Corporation Is Deductible

The Tax Court on April 27 held that a corporation was entitled to deduct $65 million paid to terminate a merger agreement with a would-be white knight when the corporation agreed to be bought by a competitor that increased its offer in a hostile takeover. (Santa Fe Pacific Gold Co. v. Commissioner, 132 T.C. No. 12 (Apr. 27, 2009).)

Santa Fe Pacific Gold was a publicly held mining company with large land positions, although it was considered “second-tier” in the mining industry, meaning that it was not one of the top mining companies in the country. In 1996, Santa Fe faced a hostile takeover by a first-tier competitor, Newmont. To avoid the takeover, Santa Fe entered into a merger agreement with a white knight, Homestake. That agreement provided for the payment of a termination fee should the agreement be terminated. Shortly thereafter, Newmont increased its offer, and Santa Fe’s board accepted the increased offer. Santa Fe paid a $65 million termination fee to Homestake and claimed a deduction for that amount on its 1997 tax return. The IRS disallowed the deduction.

The court distinguished the facts of this case from those of INDOPCO Inc. v. Commissioner, 503 U.S. 79 (1992), in which the Supreme Court held that no deduction was allowable for fees incurred during a friendly business combination. The High Court held that the fees had to be capitalized because the benefits that resulted for the taxpayer extended beyond the tax year at issue.

In this case, however, the Tax Court found that “Santa Fe did not reap the types of benefits present in INDOPCO.” In fact, “Newmont was primarily interested in obtaining Santa Fe’s land position [and] quickly terminated Santa Fe’s employees and discarded the business plans of Santa Fe’s management. Although Santa Fe the entity continued to exist on paper, it was nothing more than a shell owning valuable land.”

The court also found that Santa Fe agreed to the termination fee to protect its agreement with Homestake. That protective attempt failed when Newmont offered more money, causing Santa Fe’s board of directors to accept the higher offer in fulfillment of its fiduciary duties.

The court rejected the IRS’s assertion that Santa Fe was not facing a hostile takeover and that Santa Fe’s agreement with Homestake was merely a negotiating tactic to drive up Newmont’s offer.

It should be noted that the termination fee at issue was prior to Treasury reg. section 263(a)-5, under which a termination fee paid to a white knight is not deductible on the basis that the completed transaction and the failed transaction with the white knight are mutually exclusive.

For More Information Contact The Atlanta, Georgia Law Offices Of AttorneyBritt:

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Gary L. Britt, CPA, J.D.
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