concurring: I join the majority opinion in this case because I agree with its interpretation and application— even if it arguably amounts to an extension — of the Supreme Court’s reasoning in INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992). Given the way that the line of battle was drawn and disputed by the parties, I’ve joined the majority in indulging the inference that long-term benefits to SCI resulted from the services of the investment bankers, justifying the disallowance as deductions through capitalization of their fees, particularly those fees that were generated by the done deal. However, I write separately to respond to some of the dissenters’ specific points as well as to highlight the prior question — one that we saw fit to avoid in National Starch & Chem. Corp. v. Commissioner, 93 T.C. 67, 78-79 (1989), affd. 918 F.2d 426 (3d Cir. 1990), affd. sub nom. INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992), but which the majority opinion adverts to — whose correct answer would also lead to disallowance of some substantial part if not all of the claimed deductions.1
As a preliminary matter, I disagree with Judge Cohen’s conclusion that the majority has adopted a “more stringent rule” than the rule applied in INDOPCO, Inc. or Victory Mkts., Inc. v. Commissioner, 99 T.C. 648 (1992). Cohen, J., dissenting op. p. 210. I don’t read the majority opinion as laying down a per se rule that “any expenses relating to a change in corporate ownership are not deductible.” Id.
The keys to the majority’s opinion requiring capitalization are its findings that neither the investment bankers’ fees nor the printing costs related to current income production or needs: “Those fees were incurred in connection with a change in ownership with indefinite and extended future consequences to SCI. They are properly matched against revenues of a taxable period (perhaps an indefinite taxable period) longer than the taxable year during which such fees were incurred.” Majority op. pp. 197-198. Although it would be a rare change in corporate ownership that does not have indefinite and extended future consequences, the majority’s inquiry is consistent with the Supreme Court’s observation in INDOPCO, Inc. v. Commissioner, supra at 89 (internal quotation marks omitted), that “Courts long have recognized that expenses * * * incurred for the purpose of changing the corporate structure for the benefit of future operations are not ordinary and necessary business expenses.” The emphasis should not be on the word “benefit” if that is to suggest that we must determine whether the corporation will be advantaged by the change. The contrast is between expenditures that have current effects as opposed to definite or indefinite future consequences. That, of course, is the contrast that the majority points out was emphasized by the Court of Appeals for the Eighth Circuit in General Bancshares Corp. v. Commissioner, 326 F.2d 712, 715 (8th Cir. 1964), affg. 39 T.C. 423 (1962), the case that the Supreme Court cited with approval in INDOPCO, Inc. in support of its comment about “benefit”. Majority op. p. 196.
Even if I agreed with the dissenters’ conclusion that the investment bankers’ fees produced no long-term benefit to SCI, the facts of this case2 as well as the inherent facts of corporate life in corporate takeover bids3 would require the conclusion that some part of the advice of the investment bankers produced a benefit to the shareholders of SCI by helping them obtain a higher price for their shares than Tate & Lyle’s initial offering price. As a result, this case could have been decided by dealing with the prior issue encompassed by the language of the statutory notice, “It has not been established that any of those amounts * * * are deductible as ordinary and necessary business expenses for tax purposes”, and adverted to by the Supreme Court in INDOPCO, Inc. v. Commissioner, supra at 90. This concerns the corporate payor’s need to establish deductibility of the expenditures under section 162(a) as “ordinary and necessary” and “incurred in carrying on any trade or business”.
The parties did not try or argue this case on the theory of shareholder benefit, although that theory was put in play by the statutory notice. In appropriate future cases, that theory might justify an allocation between nondeductible fees for services that benefit the shareholders of the target by helping them obtain a higher price for their shares and some portion allocable to services in aid of an unsuccessful defense that arguably turn out to be of no benefit to anyone other than the service providers who received the fees.
Judge Cohen argues that the majority’s conclusion — and I agree with that conclusion — that the investment bankers’ services for which the fees were paid necessarily benefited the SCI shareholders by helping them obtain a higher price for their shares confuses the simple sequence of events with a cause and effect relationship. Cohen, J., dissenting op. p. 217. I believe that the cause and effect relationship is clear. On April 7, 1995, the day before Tate & Lyle’s initial bid, SCI shares closed at $31.50,4 50 cents less than Tate & Lyle’s initial bid of $32 on April 8, on which, no doubt due to the buying activity of arbitrageurs, SCI shares closed at $37,375. On April 20, 1995, the SCI board rejected Tate & Lyle’s initial bid of $32 and so advised the SCI shareholders. This is because, in the meantime, after the April 12 retainer agreements were in place, the investment bankers had advised the SCI board that the per-share value of SCI was in the range of $35.83 to $43.57, and that the $32 initial offer was clearly inadequate. In response to the rejection of its initial offer, Tate & Lyle raised its offer two more times. Once the Tate & Lyle offer had been raised to $36.50, an amount within the range of fair market values previously determined by the investment bankers, they advised the SCI directors that there was no way out other than to accept the last offer.
The causal relationship is clear. The advice of the investment bankers justified the SCI board’s rejection of the initial Tate & Lyle offer and made it necessary for Tate & Lyle to raise its offer to an amount that was within the range of values determined by the investment bankers. The investment bankers’ advice benefited the SCI shareholders by helping them obtain a higher price for their shares.
The question of shareholder benefit was also kept in play by the parties’ disagreement — expressed in their briefs and addressed by the dissent — over when the directors’ fiduciary duty under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), matured into a duty to obtain the best price for the shareholders. The SCI board’s initial fidüciary duty to resist the takeover attempt does not require that the investment bankers’ fees be given or retain the character of ordinary and necessary trade or business expenses over the entire course of the takeover attempt. Characterization of the expenses should be postponed until the takeover attempt and defense are completed, and the effects of the expenditures can be determined.
The investment bankers earned their fees by providing advice that served interrelated functions that permitted the SCI directors to satisfy their fiduciary duties to the corporation and its shareholders. See Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985) (“they satisfy that burden ‘by showing good faith and reasonable investigation’ ” (quoting Cheff v. Mathes, 199 A.2d 545, 554-555. (Del. 1964))). If the SCI directors had immediately approved the initial offer and supported Tate & Lyle, or had found a “white knight” whose offer was accepted by the SCI shareholders, the bulk of the investment bankers’ fees would clearly have been properly capitalizable as expenditures providing long-term benefits. INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992); Victory Mkts., Inc. v. Commissioner, 99 T.C. 648 (1992). If petitioner had redeemed or issued stock in successfully defending against Tate & Lyle’s offers, the expenditures would have been capitalized as costs of acquiring or issuing stock. Sec. 162(k); Woodward v. Commissioner, 397 U.S. 572, 576 (1970); United Carbon Co. v. Commissioner, 32 B.T.A. 1000, 1010 (1935), revd. 90 F.2d 43 (4th Cir. 1937). However, in the case at hand, even if petitioner had not received any long-term benefits from the takeover, and did not redeem or issue any stock, it did incur costs that helped to provide its shareholders with an addition of $167 million to the price received for their shares (although at the time the expenditures were authorized the amount and existence of the benefit were unclear) at the total cost of $23 million, including the amounts in issue paid to the investment bankers.
As disclosed by the majority’s recital of the facts and the observations of the commentators cited above,5 the shareholder benefit theory is an appropriate rationale for disallowing the target’s expenditures incurred in defending itself against an initially hostile takeover attempt. The opinion of the Delaware Supreme Court in Revlon, as well as the actual facts in the case at hand, makes clear that the unsuccessful defensive measures contribute to the increased price ultimately obtained by the target shareholders. Even if the initial hostility between SCI and Tate & Lyle reflects a difference from the friendly takeovers in INDOPCO, Inc., and Victory Markets, which were decided on the capitalization theory, the shareholder benefit was clearly present in this case.
The dissenters have uncritically accepted petitioner’s argument that the corporate propriety of engaging the investment bankers and attorneys to defend against a takeover bid requires that all their fees and disbursements be deductible as ordinary and necessary business expenses. This argument equates the propriety of incurring the costs with their deductibility as ordinary and necessary expenses. Apparently, this is on the theory that the costs are an integral part of sci’s appropriate initial response to the hostile offer, which includes the defense of the target’s current business and business plan. In my view, the bulk of the fees incurred by the target is nondeductible because their unavoidable effect is to benefit the shareholders. This is so even though they were initially incurred as part of an appropriate' corporate response to a hostile offer, and without regard to the corporate propriety of the purpose that actuated the directors in incurring them.
This case can be analyzed in terms of the traditional distinctions about primary versus incidental purposes and effects of the expenditures in dispute. A subordinate or incidental corporate business purpose will not control where the primary purpose of the expenditure is to benefit the shareholders, resulting in a dividend taxable to them. Jack’s Maintenance Contractors, Inc. v. Commissioner, 703 F.2d 154, 156 (5th Cir. 1983), revg. T.C. Memo. 1981-349; Sammons v. Commissioner, 472 F.2d 449, 452 (5th Cir. 1972), affg. on this issue and revg. and remanding on another issue T.C. Memo 1971-145; Cummins Diesel Sales of Oregon, Inc. v. United States, 207 F. Supp. 746, 748-749 (D. Or. 1962), affd. 321 F.2d 503 (9th Cir. 1963). Conversely, where corporate expenditures are primarily associated with the profit-motivated purposes of the corporation, and shareholder use and benefit are distinctly secondary, the corporate deduction will be allowed. See International Artists, Ltd. v. Commissioner, 55 T.C. 94, 104-105 (1970). However, where there are both substantial business purposes and substantial shareholder benefits, allocation becomes appropriate. Hal E. Roach Studios v. Commissioner, 20 B.T.A. 917 (1930), cited with approval and applied in International Artists, Ltd. v. Commissioner, supra at 105, is instructive on this point.
The taxpayer in Hal E. Roach Studios v. Commissioner, supra, was a corporate movie studio that had built a yacht for use in making a marine movie series. The Commissioner did not question the taxpayer’s corporate business judgment in so doing. However, after the demand for such movies drastically diminished, members of the family of the corporation’s sole shareholder used the yacht for personal pleasure trips. The Commissioner disallowed the deductions claimed by the corporation for maintenance expenses and depreciation during this period, although the yacht was used a dozen times during the year for movie production, was at all times kept available for business, and would have deteriorated unless maintained. In these circumstances the Board applied the equivalent of the Cohan 6 rule, and concluded:
Though the evidence was not precise on the relative costs incurred for business and pleasure use, we are satisfied that at least one-half of the expense was an ordinary and necessary expense of petitioner’s business, and accordingly we allow the sum of $8,776.67 as a deduction [$17,543.35 having been disallowed by the Commissioner]. [Id. at 919.]
The case stands for the proposition that, even though corporate business judgment is properly exercised in incurring the expense, there is still a basis for making an allocation between deductible business purpose and nondeductible shareholder personal purpose on the basis of the actual benefits given and received.7
Under this approach, we would have no occasion, much less any need, to decide whether the nondeductible fees of SCI would have properly been includable in the income of the SCI shareholders as a dividend. Putting aside the administrative and other difficulties of pursuing the income inclusion of any such fees against the shareholders of a public company, the questions of corporate disallowance/shareholder inclusion can properly be decoupled where the corporate expenditures had substantial corporate business purposes as well as directly benefited the shareholders in their capacities as potential and actual sellers of their stock.8 In any event, the former SCI shareholders are not before us, and in all likelihood respondent did not determine any dividend tax deficiencies against them.9
Finally, United States v. Federated Dept. Stores, Inc., 171 Bankr. 603 (S.D. Ohio 1994),10 is the first post -INDOPCO, Inc. case holding that expenses attributable to unsuccessful defenses against hostile takeovers are deductible, on the alternative grounds of section 162 and section 165. Although we are not bound to follow a District Court opinion, its reasoning and approach merit some further discussion.
At issue were the contractually committed break-up fees paid in two separate transactions by Allied Stores and Federated Department Stores, respectively, to “white knights” in the aftermath of their highly leveraged acquisitions by Robert Campeau. Soon after Allied and Federated were acquired, they went into bankruptcy because they could not sustain the debt burdens imposed on them to finance the acquisitions. The evident sympathies of the bankruptcy judge and the District Court judge for these hapless debtors, and the obvious lack of “synergy” between the acquiror and his targets, are clear.
In the Allied/Federated situations, the expenses were held deductible under section 162 on essentially the same grounds used by the dissenters in the case at hand, that the breakup fees provided no benefit to the corporate debtors lasting beyond the years in which they were paid.11 However, not present in the case at hand are explicit findings in the Allied/ Federated cases that the provisions for the payment of the break-up fees did not enhance the amounts that the debtors’ shareholders actually received in the acquisition transactions. The final and most important basis for distinguishing the Allied/Federated cases from the case at hand is that the break-up fees in Allied/Federated were more directly related to the “white knight” transactions that were never consummated than to the acquisitions that actually did occur.
Swift, Wells, and Vasquez, JJ., agree with this concurring opinion.APPENDIX
The following chart shows the closing price of Staley Continental, Inc. common stock on the New York Stock Exchange between March 1, 1988, and June 7, 1988:
jDate Closing price Date Closing price
Mar. 1 23.875 Apr. 20 36.375
Mar. 2 23.750 Apr. 21 37.250
Mar. 3 24.125 Apr. 22 37.000
Mar. 4 24.250 Apr. 25 36.500
Mar. 7 23.750 Apr. 26 36.500
Mar. 8 24.125 Apr. 27 37.000
Mar. 9 25.000 Apr. 28 37.875
Mar. 10 24.875 Apr. 29 38.375
Mar. 11 25.125 May 2 37.875
Mar. 14 24.875 May 3 38.375
Mar. 15 24.625 May 4 38.375
Mar. 16 24.750 May 5 38.000
Mar. 17 25.375 May 6 38.250
Mar. 18 25.750 May 9 38.750
Mar. 21 25.675 May 10 38.125
Mar. 22 25.375 May 11 37.125
Mar. 23 25.500 May 12 37.000
Mar. 24 28.000 May 13 36.875
Mar. 25 29.500 May 16 36.500
Mar. 28 29.750 May 17 36.250
Mar. 29 30.375 May 18 36.250
Mar. 30 28.500 May 19 36.250
Mar. 31 28.500 May 20 36.250
Apr. 1 28.500 May 23 36.250
Apr. 4 28.125 May 24 36.250
Apr. 5 29.375 May 25 36.250
Apr. 6 30.125 May 26 36.250
Apr. 7 31.500 May 27 36.375
Apr. 8 37.375 May 30 Holiday
Apr. 11 36.750 May 31 36.375
Apr. 12 36.750 June 1 36.250
Apr. 13 36.500 June 2 36.250
Date Closing price Date Closing price
Apr. 14 35.750 June 3 36.250
Apr. 15 34.875 June 6 36.500
Apr. 18 36.125 June 7 36.500
Apr. 19 35.750
The most important ancillary tax consequence of adopting the alternative theory of disallowance suggested in this concurring opinion is that the disallowed amount would not appear on the tax balance sheet as capital expenditures that might be deductible at some later time, such as the payor’s liquidation. Hollywood Baseball Association v. Commissioner, 42 T.C. 234, 255-256, 270-271 (1964), affd. on another issue 352 F.2d 350 (9th Cir. 1965); Shellabarger Grain Prods. Co. v. Commissioner, 2 T.C. 75, 89 (1943), affd. 146 F.2d 177, 185 (7th Cir. 1944). See generally Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 5.06 (6th ed. 1994). However, the payor’s shareholders may not necessarily be taxable on the value of the benefit or the amount of the payment. See infra note 8 and text.
See majority op. note 3 and pp. 182-183; pp. 191-193.
See, e.g., Johnson, “The Expenditures Incurred by the Target Corporation in an Acquisitive Reorganization Are Dividends to the Shareholders (Psst, Don’t Tell the Supreme Court)”, 53 Tax Notes 463 (1991); Sheppard, “The Indopco Case and Hostile Defense Expenses”, 54 Tax Notes 1458, 1460 (1992); Paber, “Indopco: The Still Unresolved Riddle”, 47 Tax Law. 607, 640 (1994).
See appendix, infra p. 209-210, setting forth closing prices of SCI shares for the period Mar. 1 to June 7, 1988, as stipulated by the parties.
See supra note 3.
Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), affg. in part and revg. in part 11 B.T.A. 743 (1928).
Compare Sibley, Lindsay & Curr Co. v. Commissioner, 15 T.C. 106 (1951) and Mills Estate Inc. v. Commissioner, 17 T.C. 910 (1952), revd. and remanded 206 F.2d 244 (2d Cir. 1953) with Galt v. Commissioner, 19 T.C. 892 (1953), affd. in part and revd. in part 216 F.2d 41 (7th Cir. 1954).
The approach suggested here would be consistent with the observation in Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 7.05, at 7-33 (4th ed. 1979), that the Service was often content to disallow deduction of constructive dividends at the corporate level without coupling the disallowance with a deficiency determination based upon a dividend income inclusion to the shareholders. But see Rev. Rul. 75-421, 1975-2 C.B. 108.
Martin v. Machiz, 251 F. Supp. 381 (D. Md. 1966), is arguably in point on this issue. The District Court’s introductory remarks indicated that the nondeductibility of the payments in issue to the corporate payor did not require that they must have been taxable or should have been taxed to its shareholders as dividends:
The fact that an expense was not an ordinary and necessary business expense of a corporation does not unerringly point to the conclusion that the expense was a personal expense of the corporation’s stockholders. An expense might be a capital expense to a corporation, or a non-allowable expense of a corporation, and still not be a personal expense of the corporation’s stockholders. [Id., at 384.]
The taxpayer before the District Court in Martin v. Machiz, supra, was not the corporation, but its dominant shareholder. One question before the court was whether a proportionate part of the fee paid by the corporation in 1959 for the preparation of a valuation of the corporation “as a basis for merger or valuation for other purposes * * * [and to] locate merger and/or sale and/or refinancing to market personal ownership of Mr. Martin [the individual shareholder/taxpayer]” should be includable in the shareholder’s income. Id. at 383. The court concluded that the fee served a valid business purpose and was not taxable as a dividend to the shareholder. Consistent with its introductory remarks, however, the District Court indicated that the payment might not have been deductible by the corporation, not a question before the court:
Thus, the Court concludes that the payment was not payment of a personal expense of taxpayers or taxpayer-husband, but was a payment for the benefit of Cloverdale and serving its legitimate corporate business purpose, whether or not it was an item chargeable against the corporation’s ordinary income as an ordinary and necessary business expense. 4 * * [Id. at 385; emphasis supplied.]
For an accurate and useful summary of the facts of these cases and of the opinions of the bankruptcy judge and the District Court, see Lipton & Brenneman, “Expenses Related to Failed Merger Defense Held to Be Deductible Despite INDOPCO”, 82 J. Taxn. 26 (1995).
The alternative holding in United States v. Federated Dept. Stores, Inc., 171 Bankr. 603 (S.D. Ohio 1994), is that the break-up fees should be treated as losses under section 165 on the ground that the acquisitions by the white knights, which never occurred, made it appropriate to treat the fees as abandonment losses with respect to transactions that had been initiated but never consummated.