Tax News
PLR 201152010: Damages Arising from the Acquisition of Target Treated as Return of Capital
January 16, 2012
Administrative Actions
When representing investment funds, and particularly private equity funds which often engage in large buy or sell side M&A deals with significant sums of money at stake, it is not uncommon that a deal gets contentious. A fund could find itself in a number of interesting predicaments when it is participating as a purchaser in an auction process where the target happens to be a very lucrative asset sought after many bidders. Sometimes there could be company internal or external interests, such as disgruntled minority shareholders, that are pushing for an increase of the final purchase price above and beyond what the private equity fund as a final bidder has agreed on.  PLR 201152010 illustrates such a contentious fact pattern where the acquisition of target lead to litigation against a party who interfered with the transaction, and as a result the target shareholders did not approve the auction purchase price. To complete the transaction, most likely in the face of significant acquisition costs, the buyer re-executed the purchase agreement, albeit at a higher purchase price.  Thereafter, the buyer proceeded to successfully sue the party that interfered with the transaction for the difference between the original and increased purchase price. The central issue in this PLR was whether the litigation damages should be treated as a return of capital or taxable income. Based on Arrowsmith and “origin of the claim” theory, and because the litigation was directly related to the cost of the acquisition, the IRS decided that the proceeds should be treated as a return of capital and should not be taxable to the plaintiff.  While this ruling does not present any new tax law, it is the most current illustration of the legal principles and issues that could come up in an acquisition that goes sour.  It has been often emphasized on this blog that litigation and settlements raise numerous tax issues in their own right and to be able to quickly respond to these issues, investment funds should keep track of the newest developments and fact patterns that arise in this area of the law. This ruling could be set aside for future reference if a fund finds itself in a similar fact pattern.
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Tags: Damages, PLR 201152010. Arrowsmith, Return of Capital, settlements