Deloitte & Touche Suggests Changes to Proposed Regs on Intangible Asset Capitalization

Deloitte & Touche LLP appreciates the opportunity to provide comments on the proposed regulations relating to the tax treatment of amounts incurred in acquiring, creating, or enhancing certain intangible assets or benefits ("Proposed Regulations").¹

Deloitte & Touche is one of the nation's leading professional services firms. We provide assurance and advisory, tax, and consulting services through over 30,000 people in more than 100 U.S. cities. We have not been retained by any client to prepare and submit comments and our comments are not being made on behalf of any particular client. These comments are made by the firm based on our experience in advising clients on the tax matters that are the subject of the Proposed Regulations.

These Proposed Regulations significantly affect the tax treatment of many different types of expenditures affecting all taxpayers and industries. Further, the Proposed Regulations address issues that have often been controversial and sometimes treated in an unclear or inconsistent manner. We commend the Treasury and the IRS for using the Proposed Regulations to promote consistent interpretation and application in an extremely difficult area of the law. In preparing these comments, in order to provide the most comprehensive comments possible, several different practitioners within this firm have addressed specific issues raised by these Proposed Regulations. All of these practitioners bring detailed industry specific expertise and years of experience to their comments. The principal author of each section is identified at the end of this document, in the event that you would like to discuss any of the subjects we address in further detail.

I. EXECUTIVE SUMMARY

A. General. We appreciate the enormity of the task of trying to set forth, in a single set of comprehensive regulations, rules that advance the efficient administration of the capitalization requirements applicable to intangible assets, while adhering to the principles established by decades of case law and administrative pronouncements. Rather than relying exclusively on a facts and circumstances analysis, in an effort to achieve the stated goal of ease of administration, the Proposed Regulations have adopted a variety of "bright-line tests" and "simplifying conventions" to determine the appropriate treatment of an expenditure.

The Proposed Regulations would require taxpayers to use the constant yield method for accruing debt issuance costs, replacing the straight-line method that has been a longstanding method of accounting for these costs. We believe the method of accounting currently used by taxpayers clearly reflects income. Because the administrative burden that would be imposed on taxpayers would outweigh any benefit to the government in requiring the constant yield method, we believe it would be inappropriate for the government to mandate a new method of accounting for these costs.

D. Enterprise Resource Planning Implementation Costs and the Definition of Software Development. Although the Proposed Regulations do not specifically address the treatment of enterprise resource planning ("ERP") software costs, the Preamble provides that the IRS and Treasury expect that the treatment of such costs will be consistent with the treatment prescribed in Private Letter Ruling 200236028 (June 4, 2002).⁴ We agree, in general, with this proposed approach, but suggest that detailed rules in this area be issued first as proposed regulations before being included in the Final Regulations. In the event that the IRS and Treasury determine to include the treatment of ERP software costs in the Final Regulations, we recommend that the IRS and Treasury consider several points.

The question of whether any particular expenditure incurred by a business taxpayer should be treated as a currently deductible expense or as a capital expenditure is as old as our tax system. There are literally hundreds of cases, rulings, opinions, and articles addressing some aspect of this issue. One of the main reasons that this area is so contentious is that these hundreds of sources often disagree. An examination of these sources does not easily lead to any common theme or set of rules that can be consistently applied to any given issue. In fact, only one thing is clear from the sources: The determination of whether any particular expenditure should be currently deducted or capitalized can only be determined by consideration of the "facts and circumstances."

To try to resolve this "facts and circumstances" consideration, the Proposed Regulations provide bright-line tests and "simplifying conventions." Although we agree that bright-line tests and simplifying conventions do provide certainty and reduce controversy, this approach is not, in every case, in accordance with the law that has developed in this area over many years because it eliminates consideration of the facts and circumstances surrounding each expenditure. A consideration of the facts and circumstances is what all the authorities consider as crucial to the proper treatment of an expenditure as deductible or capital. Perhaps this problem could be eliminated if the bright-line rules or simplifying conventions were stated as safe harbors or as rebuttable presumptions, thereby allowing facts and circumstances to be considered in appropriate situations. In fact, the Preamble states that the simplifying conventions are intended to be rules of administrative convenience and not substantive rules of law.⁷ However, we are very concerned that, in practice, the simplifying conventions will be treated as rules of law because we expect that examination agents will use the simplifying conventions as substantive bright-line rules of law. In fact, we have already experienced such treatment in connection with the examination of client tax returns -- even though the Proposed Regulations are not yet final.

If the Proposed Regulations are to be finalized with the proposed bright-line rules and simplifying conventions that may be treated (at least on audit) as substantive law, it becomes especially crucial that those rules are consistent with established case law as well as with economic reality. In some cases we are very concerned that the tests and conventions provided in the Proposed Regulations either do not comport with current law or disregard economic reality. In the comments below we will point out a number of instances where we believe the Proposed Regulations are inconsistent with existing law or economic reality, and we will propose some alternatives.⁸

We are also concerned about the uneven and difficult application of some of the rules and conventions. For example, the simplifying convention for employee compensation provides that compensation paid to employees is not required to be capitalized as a transaction cost, even if such costs would otherwise meet the requirements of Prop. Treas. Reg. § 1.263(a)-4(e).⁹ We believe that this convention should apply equally to all of the intangible assets acquired, created, or enhanced by the efforts of taxpayers' employees.

In conclusion, we commend the Treasury and IRS for attempting, with these Proposed Regulations, to bring more uniformity and certainty to an extremely difficult area of taxation. However, we do believe that conceptual flaws exist in the approach taken by the Proposed Regulations. Specifically, we believe that the bright-line rules and simplifying conventions will be treated in practice as substantive rules of law, and we do not believe that result is supported by the case law in some instances. We also believe that practical application of the proposed rules and conventions sometimes leads to results that are difficult to understand. However, if the Final Regulations will indeed include the proposed simplifying conventions and bright-line rules, we strongly believe that some of those rules and conventions should be changed. The remainder of this letter discusses changes we believe to be appropriate.

III. TRANSACTION COSTS

With respect to the proposed treatment of transaction costs, we are submitting the following comments in an effort to achieve what we believe is the principal goal of the Proposed Regulations, i.e., the correct matching of income and expenses. It is our understanding that the Proposed Regulations' treatment of transaction costs attempts to further this goal by establishing bright-line rules with the hope of eliminating uncertainty for the treatment of these costs, as well as promoting efficient administration of the capitalization rules. We agree that the treatment of transaction costs should correctly match income and expenses in any given period, and we welcome rules that will eliminate uncertainty in the treatment, as well as promote efficient administration, of these costs. However, we believe that the Proposed Regulations do not fully achieve these goals. Below are our comments with regard to: (A) deducting transaction costs under section 162; (B) application of the Proposed Regulations to section 195; (C) the treatment of stock issuance costs; and (D) the proper treatment of capitalized transaction costs.

A. Deducting Transaction Costs under Section 162

Our comments regarding deducting transaction costs under section 162 address five bright-line rules set forth in the Proposed Regulations: (i) the "facilitate" rule; (ii) the "inherently facilitative" rule; (iii) the termination fee rule; (iv) the success- based fee rule; and (v) the hostile takeover defense fee rule.

(i) The Facilitate Rule

Section 1.263(a)-4(e)(4)(i)(A) of the Proposed Regulations rejects the "whether and which" facts and circumstances rule set forth in Rev. Rul. 99-23¹⁰ and instead requires capitalization of transaction costs under a bright-line rule which provides that:

We have two concerns regarding the proposed bright-line rule. First, the "earlier of the date" rule that focuses on the acquirer submitting to a target a letter of intent, offer letter, or similar written communication ordinarily will not result in the correct matching of income with expenses for either the acquirer or the target. We commend the Treasury and the IRS for the employment of simplifying conventions to ease the administration of otherwise inherently factual determinations; however, we believe the rationale for each convention must be reasonable and grounded on experience. It has been our experience that the measuring points selected by the Proposed Regulations raise substantial problems in practice. The terms "letter of intent" and "offer letter" are not self-defining, and these types of documents often are sketchy non-binding proposals designed only to enable the acquirer to be able to conduct due diligence with respect to the target(s) before any decision has been made with respect to such target(s). This problem is compounded by the use of the phrase "or similar written communication," which in our view is open-ended and overly broad, and is not likely to achieve the desired goal of reducing uncertainty. For example, would a presentation made to a potential target(s) by an acquirer's investment banker rise to the level of a "similar written communication"?

Second, the "earlier of the date" rule that focuses on the acquirer submitting to a target a letter of intent, offer letter, or similar written communication also has no bearing on any decision made by the target(s). Both the acquirer and target have their own set of facts and circumstances that affect when they may ultimately decide whether to pursue a capital transaction with one another. Stated differently, the decision of the acquirer should not dictate when a target reaches a decision whether to engage in a capital transaction with the acquirer.

In light of these concerns, and to ensure that income is not distorted by capitalizing expenditures that are properly deductible and to promote efficient administration of these rules, we propose that the Final Regulations retain the "whether and which" analysis as described in Rev. Rul. 99-23. As with any factual determination, controversies will arise. However, we believe that there is sufficient guidance regarding the application of the "whether and which" test to provide the necessary parameters. Additionally, we believe that introduction of a new rule is likely to increase the amount of controversies until there is sufficient judicial guidance interpreting these new rules.

Alternatively, if the Final Regulations reject the "whether and which" facts and circumstances rule set forth in Rev. Rul. 99-23 and instead adopt a bright-line rule, we do not understand how the Proposed Regulations are applying the "facts and circumstances" rule set forth in the "Scope of facilitate" section under Prop. Treas. Reg. § 1.263(a)-4(e)(1)(i), which provides that "[w]hether an amount is paid in the process of pursuing a transaction is determined based on all facts and circumstances." If there are any circumstances in which the "facts and circumstances" rule overrides the bright-line rule, examples would be helpful.

We also propose that if a bright-line rule is adopted, only the second prong of the "facilitate" rule be adopted: the date on which an acquisition proposal is approved by the acquirer's or target's Board of Directors (or committee of the Board of Directors), as the case may be.¹² It would be helpful if the Final Regulations also included examples of such a rule. One such example could describe "conditions subsequent" to board approval, which would relieve one party from closing the transaction, as set forth in most acquisition agreements. Typical conditions to closing may include further due diligence, shareholder and regulatory approvals, etc., and should not further defer the decision cut-off date.

(ii) The Inherently Facilitative Rule

The Proposed Regulations also provide that even though transaction costs are not "facilitative" because, for example, such amounts were incurred before a letter of intent was entered into, such amounts, to the extent they are "inherently facilitative," must be capitalized. Prop. Treas. Reg. § 1.263(a)-4(e)(4)(i)(B) defines an amount as "inherently facilitative" if:

Second, based on case law, taxpayers capitalize expenditures that are incurred prior to the date on which the "whether and which" decisions have been made when those expenditures are "inherently facilitative." The determination under the case law of what is "inherently facilitative" is based upon all of the relevant facts and circumstances. We believe that the list set forth in the Proposed Regulations as to what is "inherently facilitative," absent facts and circumstances supporting such a list, is overly inclusive. For example, expenditures incurred in determining the value of a target and options for structuring the transaction may be important in facilitating the consummation of the transaction, but they also play a critical role in the pre-decisional investigation of a particular transaction. Because these expenditures may, in some transactions, be primarily related to the pre-decisional analysis, while in other transactions be facilitative of the consummation of the transaction, a continuation of a facts and circumstances analysis is proper.

Additionally, costs incurred by an acquirer in obtaining a fairness opinion often represent costs associated with gathering information about a prospective target(s). Similarly, costs incurred by a target in obtaining a fairness opinion often represent costs associated with gathering information about a prospective acquirer(s). Such costs associated with gathering information do not necessarily rise to the level of being "inherently facilitative" until the investment banker actually writes a fairness opinion. Costs incurred to gather information should not be considered "inherently facilitative" to the extent such information is used to reach a decision whether or not to engage in a transaction. Similarly, costs associated with reviewing transactional documents, reviewing regulatory filings made by the other party to the transaction, and securing advice on the tax consequences of a potential transaction, depending upon the facts and circumstances, can have an impact on the decision whether to enter into a transaction. In order to achieve the correct matching of income with expenses, we recommend retention of the historic facts and circumstances test, despite the temptation to classify certain costs as "inherently facilitative" in order to eliminate uncertainty in the treatment of such costs and to promote efficient administration of the capitalization rules. Deviating from the facts and circumstances test, by creating an expansive list of costs that are to be capitalized, does not account for the numerous costs that should not be capitalized because they are costs incurred to help a taxpayer decide whether to engage in a capital transaction.

(iii) Termination Fee Rule

The Proposed Regulations appear to provide that an amount paid to terminate or facilitate the termination of an existing agreement is deductible. However, the Proposed Regulations also provide a bright-line rule that provides that if a transaction is "expressly conditioned" on the termination of an existing agreement, then the amount paid to terminate or facilitate such a termination of the existing agreement must be capitalized. Specifically, Prop. Treas. Reg. § 1.263(a)-4(e)(1)(ii) provides:

If the regulations do maintain the "expressly conditioned" rule, the operation of that rule should be clarified. In other words, as appears to be the case in Prop. Treas. Reg. § 1.263(a)-4(e)(7), Example 16, is it correct to interpret the rule as providing that termination fees must be capitalized only in those cases where the transaction is "expressly conditioned" on the termination of the existing agreement? A statement in the Final Regulations to that effect would be helpful.

(iv) The Success-Based Fee Rule

The Proposed Regulations require capitalization of success-based fees unless the evidence clearly demonstrates that such fees do not facilitate the acquisition. Specifically, Prop. Treas. Reg. § 1.263(a)-4(e)(4)(i)(C) provides:

Historically, the IRS has ruled and the courts have held that the investment banker fees may be allocated among the actual services provided and are not solely costs incurred to facilitate the transaction. In Rev. Rul. 99-23, investment banker fees are to be allocated based upon the types of services provided. In A.E. Staley Manufacturing Co. v. Commissioner,¹⁶ the Seventh Circuit Court of Appeals directly addressed the issue of an investment banker fee that was success-based and stated:

(v) The Hostile Takeover Defense Fee Rule

Section 1.263(a)-4(e)(4)(iii)(A) of the Proposed Regulations sets forth the general rule that:

However, Prop. Treas. Reg. § 1.263(a)-4(e)(4)(iii)(B) sets forth an exception to the general rule, as follows:

B. Application of the Proposed Regulations to Section 195

The Preamble states that the Proposed Regulations do not affect the treatment of "start-up expenditures" under section 195.¹⁹ However, there is no affirmative statement as to whether the Proposed Regulations affect the treatment of transaction costs, other than "start-up expenditures," that would otherwise be amortizable under section 195. Amortization of transaction costs, other than "start-up expenditures," under section 195 is predicated on the hypothetical construct that such costs would have been deductible under section 162 if the acquirer and target were engaged in the same line of businesses.²⁰ The Proposed Regulations address the treatment of transaction costs in the context of an acquisition and provide that those costs that do not facilitate the acquisition are not required to be capitalized pursuant to Prop. Treas. Reg. § 1.263(a)-4(b)(1)(iii).²¹

We believe that transaction costs incurred by either an acquirer or target that would otherwise be amortizable under section 195 are affected by the Proposed Regulations. For example, an acquirer (or a target) may incur costs to investigate potential targets (or acquirers, as the case may be) in order to determine whether to enter into an acquisition. If the ultimate acquirer and target are in different lines of business, then those costs that do not "facilitate" or are not "inherently facilitative" within the meaning of the Proposed Regulations should be amortized under section 195. If the Proposed Regulations are intended to affect the treatment of transaction costs other than "start-up expenditures" that would otherwise be amortizable under section 195, examples of how they do so would be helpful.

C. Treatment of Stock Issuance Costs

The Proposed Regulations provide rules for determining the extent to which taxpayers must capitalize transaction costs that facilitate the acquisition, creation, or enhancement of intangible assets or that facilitate certain restructurings, reorganizations, and transactions involving the acquisition of capital.²² According to the Preamble, transaction costs that effect a change in a taxpayer's capital structure create betterments of a permanent or indefinite nature, thus requiring capitalization.²³ However, with respect to transaction costs that facilitate an issuance of stock, Prop. Treas. Reg. § 1.263-4(g)(2)(i) states:

(i) Case Law -- Historical Treatment

In determining whether a taxpayer was entitled to a deduction for stock issuance costs in the year that the stock was issued, the early case law focused on what is referred to as the "lack of a balancing account" in determining that no asset is created when amounts are expended for stock issuance costs.²⁷ The courts concluded that the costs "simply diminish the net return from the stock issue," and that, "[f]inancially, they are equivalent to an issue of stock at a discount from par."²⁸

(a) Lack of a Balancing Account

The lack of a "balancing account" was relied upon in Pacific Coast Biscuit Co. v. Commissioner,²⁹ which stated that "money paid out to acquire capital does not result in the acquisition of any asset other than the capital."³⁰ Similarly, in Barbour Coal Co. v. Commissioner,³¹ the Tenth Circuit Court of Appeals concluded that stock issuance costs produce no asset. Likewise, in Motion Picture Capital Corp. v. Commissioner,³² where a corporation incurred expenses to increase its capital, the Second Circuit Court of Appeals conceded that the amounts were capital items, but refused to find that in incurring the costs the taxpayer had acquired a capital asset. Although the Second Circuit acknowledged that the "benefits . . . may well have been worth as much or more than what was paid to secure them," it concluded that the benefits "were but part of the capital cost to the petitioner of rights essential to its existence but having no value as an asset apart from the petitioner itself."³³

INDOPCO effectively overruled the rationale that stock issuance costs may not be capitalized because they create no asset. The United States Supreme Court flatly rejected the argument that "creation or enhancement of an asset is a prerequisite to capitalization." Rather the Court stated, "the creation of a separate and distinct asset well may be a sufficient, but not a necessary, condition to classification as a capital expenditure." The Court further clarified its view that the mere realization of benefits beyond the year in which the expenditure is incurred is "undeniably" important in determining whether the appropriate tax treatment to be afforded to a payment is immediate deduction or capitalization. The Court concluded that reorganization costs, like organization costs, create an intangible asset with an indefinite life that are recovered in a liquidation of the enterprise.

The underlying rationale applied by the courts in the cases discussed above is essentially the same as the reason the courts have required capitalization under section 263(a) in other contexts, i.e., the fact that benefits will be enjoyed substantially beyond the current taxable year, and the concern about matching expenses against the income that the expenditures help to produce. In fact, the above-cited cases all directly or indirectly ultimately refer to Emerson Electric Manufacturing Co. v. Commissioner.³⁴ In Emerson Electric, the court initially stated that stock issuance costs represent a "capital expenditure, which should be charged against the proceeds of the stock and not recouped out of operating earnings."³⁵ This sentence could be read to state that stock issuance costs should never enter into the calculation of the taxable income of a corporation. In the very next sentence, however, the court continues by stating that "the revenue of a day or a year should not be burdened with the cost of acquiring additional capital, the benefits from which will inure to the corporation over a long period of years."³⁶ This follow-up sentence indicates that the court was not necessarily advocating the position that the costs should never enter into the calculation of taxable income, but rather that the period to which they relate is extensive and cannot be ascertained at the time the costs are incurred.³⁷ Thus, the costs should neither be deducted when incurred nor amortized over a fixed period of time. These principles are echoed in INDOPCO, as well as in the Preamble by reference to Rev. Rul. 69-330, 1969-1 C.B. 51. Rev. Rul. 69-330 supports the position that stock issuance costs create an intangible asset. Rev. Rul. 69-330 states that "[s]tock registration costs . . . are nondeductible because they pertain to the corporate structure or existence and as such are something intangible with an indefinite life." (Emphasis added.)

(b) No Offset to Proceeds

The "offset" notion is flawed and inappropriate for at least two reasons: (1) the analogous treatment of debt issuance costs; and (2) the treatment of disposition costs generally.

1. Analogy to Debt Issuance Costs. The benefits derived from obtaining equity capital economically are very similar to the benefits derived from obtaining debt capital. Under both scenarios, a corporation obtains property to be used in its business, either to fund its current operations or to undertake strategic initiatives.³⁸ Although the term over which the corporation has the use of these funds ordinarily differs significantly between debt and equity capital, that distinction only concerns the relevant recovery period; the benefits in both cases are the same; i.e., the corporation realizes significant benefits when it obtains needed capital to be employed in its business. Yet, the treatment of the costs incurred to obtain debt capital has historically been quite different than the treatment of the costs incurred to obtain equity capital.

The Tax Court has held that expenses incurred in obtaining a mortgage must be capitalized because the expenditures are made for the purpose of securing the use of money, throughout the loan period, as the basis for deriving income for the borrower.³⁹ According to the court, "[i]t is not the purpose for which the loan is made that is important. It is the purpose of the expenditures . . . . That purpose is to obtain financing or the use of money over a fixed period extending beyond the year of borrowing."⁴⁰

In Lovejoy v. Commissioner, ⁴¹ the Tax Court held that expenses for securing a mortgage loan to finance the building of a warehouse that was expected to produce rental income had to be apportioned over the length of the loan based on the rationale that such costs "result in property of a sort and its cost is being exhausted proportionately over a period of years . . . . "⁴² According to the court, "[t]he result of this disbursement was that petitioner had for ten or fifteen years the use of another's money as the basis of deriving income."⁴³ The court continued by stating that "[i]f, notwithstanding petitioner's so-called cash basis, she had prepared a balance sheet and had included in her assets this item by whatsoever designation so long as it disclosed the facts, such a schedule would have been beyond reproach."⁴⁴

These court decisions leave little doubt that debt issuance costs result in the creation of an asset. The mention of a balance sheet in Lovejoy should leave no doubt about this point. In fact, the Proposed Regulations support the position that debt issuance costs result in the creation of an asset. The Proposed Regulations provide that the costs associated with the issuance of debt are capitalized under section 263 and are deductible over the term of the debt. The debt issuance costs are treated as an "offset" (i.e., treated as increasing or creating original issue discount ("OID")) solely for purposes of determining the timing of the deduction.⁴⁵ However, the debt issuance costs are actually deducted under section 162 or 212, not section 163. This treatment is supported by the case cited in the Preamble,⁴⁶ which specifically holds that debt issuance costs are not interest (interest is paid by the borrower to the lender) and is consistent with the conclusion that these costs create a separate asset. The same logic should apply to stock issuance costs. Such costs should be viewed as creating a separate asset.

The reasons the Tax Court gives for reaching its conclusions regarding debt issuance costs, as well as the general principles taken in the Proposed Regulations, apply equally to stock issuance costs; therefore, the same treatment should be afforded to such costs. With respect to both debt and equity capital, costs are incurred for the purpose of securing the use of money or other property for the purpose of generating income for the taxpayer. Equity capital is used to generate income in just the same manner as debt capital. Both debt and equity capital oftentimes take the form of cash, a fungible asset, that is generally the source of the funding of a corporation's operations. Accordingly, we do not think that offset treatment is appropriate for stock issuance costs. Instead, we believe that the stock issuance costs, like debt issuance costs, create an intangible asset.

2. Treatment of Disposition Costs. "Offset" treatment has been specifically rejected in connection with selling costs in the case of an asset disposition. Historically, courts have described selling costs as an "offset to the selling price."⁴⁷ However, where treatment as an offset was relevant to applying the tax law, courts have rejected offset-to-proceeds treatment.⁴⁸ As the Ninth Circuit discussed in Kirschenmann, the word "offset" does not fully explain how costs are to be treated. With respect to the costs incurred to dispose of an asset, "offset" could potentially mean that the costs should be directly netted against the proceeds from the sale of the asset, or, alternatively, it could mean that the costs should be added to the basis of the asset, which basis will then be compared to proceeds to determine gain. In the context of the sale of an asset, the choice between these two alternatives generally does not make any difference, as the same gain or loss will result from either calculation. However, as the Ninth Circuit noted, there are certain instances where the distinction is important. According to the Ninth Circuit, the latter scenario, i.e., the addition of the costs to asset basis, is the correct way to analyze the treatment of transaction costs.

Applying the principles set forth in Kirschenmann, stock issuance costs should not be netted directly against the proceeds of a stock offering. Nor should they be capitalized to the stock that is issued, because the stock that is issued is not an asset of the issuing corporation. Rather, the costs should be capitalized to the basis of the intangible asset that is created by the realization of the direct, long-term benefits enjoyed in a stock issuance -- the raising of capital to be used by a corporation to generate income in its operations.

(ii) Principles of the Proposed Regulations

The general principles of the Proposed Regulations provide that costs associated with the acquisition, creation, or enhancement of intangible assets must be capitalized in order to prevent the distortion of taxable income through current deduction of expenditures relating to the production of income in future years (the "significant future benefit" standard).⁴⁹ The proposed treatment of stock issuance costs, i.e., a direct offset against issuance proceeds, necessarily implies that stock issuance costs do not create a separate intangible asset. As previously discussed, Rev. Rul. 69-330 and the current case law do not support the proposition that stock issuance costs do not create a separate intangible asset, and clearly such costs provide a significant future benefit.⁵⁰

(iii) Other Issues

(a) Sections 265 and 1032

We considered whether sections 265 or 1032 could somehow apply to disallow a deduction for stock issuance costs, and we believe they would not. Section 265 applies to disallow deductions associated with tax-exempt income. Section 1032 provides that no gain or loss is recognized to the issuer on the issuance of stock for property. Although section 1032 provides that no gain or loss is recognized, we believe that no gain or loss is recognized because no income is even realized. Our conclusion is consistent with the notion that stock proceeds do not create earnings and profits, which would be created if the proceeds were tax-exempt income. Moreover, the IRS acknowledges that some stock issuance costs are deductible,⁵¹ a conclusion that would be plainly wrong if stock proceeds were tax-exempt income. Thus, we do not believe that section 265 could apply.

We realize that section 1032 would protect an issuer from gain recognition, whereas with respect to debt that the issuer fails to repay, the issuer in general must recognize cancellation of indebtedness income. While the Proposed Regulations do not state that such a distinction supports different treatment for stock issuance costs and debt issuance costs, it could be argued that such a difference warrants different treatment. We do not understand why a difference on the future repayment should result in a different treatment for issuance costs. Certainly, the possibility of cancellation of indebtedness income does not mean that the debt issuance costs are treated differently. The initial treatment of issuance costs does not take into account the possible recognition of cancellation of indebtedness income. Whether the taxpayer has stock issuance costs or debt issuance costs, the benefit in both cases is the same, namely the use of capital. An issuer of debt or stock intends to repay the proceeds, if at all possible.

(b) Section 162(k)

When Congress wishes to change an existing tax law, such change is made through an addition or change to the statute. For example, in 1986, Congress enacted section 162(k), which disallows otherwise allowable deductions for "any amount paid or incurred by a corporation in connection with the reacquisition of its stock." As previously discussed, the case law supports deduction of stock issuance costs when the future benefit of such costs no longer remains, but unlike stock redemption costs, a statutory change has not been made with regard to the tax treatment of stock issuance costs. Regulations are not the appropriate avenue to make such a change, even if such a change were supported by some tax ruling, which we do not believe to be the case.

(c) Appropriate Recovery Period

Generally, the period to which stock issuance costs relate is indefinite in nature and cannot be ascertained at the time such costs are incurred. Thus, the appropriate time to recover stock issuance costs is when the corporation no longer maintains the benefit of such costs; e.g., when the capital is returned to the shareholders in the form of a liquidation, partial liquidating distribution, or redemption. In the case of stock issuance costs associated with stock having a fixed term, amortization over that term, similar to debt issuance costs, would provide for better matching of income and expenses, or in the case of preferred stock having a fixed term, amortized over that term.⁵²

For all of the above reasons, we believe that the proposed treatment of stock issuance costs, i.e., as a direct offset against issuance proceeds, is not supported by current case law, nor is it in agreement with the general principles set forth in the Proposed Regulations. We believe that stock issuance costs are costs that are incurred to effect a change in a taxpayer's capital structure, and thus create betterments of a permanent or indefinite nature requiring capitalization under section 263(a). The appropriate time to recover such costs would be when the corporation no longer maintains the benefit; i.e., when the capital is returned to the shareholders. For stock with a fixed term, amortization over that fixed term may be appropriate.

D. Proper Treatment of Capitalized Transaction Costs

The Preamble requests that comments be submitted regarding the proper treatment of capitalized transaction costs.⁵³ More specifically, five issues are raised in the Preamble regarding an acquirer's and target's transaction costs in a tax-free acquisition. Below is a reiteration of the five issues and our general comments.

These very questions were addressed by the Second Circuit Court of Appeals in McCrory Corp. v. United States.⁵⁴ In McCrory, the court was faced with the question of whether capitalized expenditures incurred in connection with the acquisition of ongoing lines of business by statutory merger should be treated as (i) reorganization costs that are intangible assets of the acquiring corporation, or (ii) incident to the purchase of assets. According to McCrory, if the costs are reorganization costs, such costs should not be deducted until the acquiring corporation is dissolved.⁵⁵ If the costs are incident to the purchase of assets, the costs should be capitalized as part of the cost of the assets and either amortized or depreciated over the life of the assets, or, in the case of nonamortizable or nondepreciable assets, deducted only when the assets are disposed of.⁵⁶ With regard to the costs incurred in the mergers that took place in McCrory, it was the court's view that:

IV. FINANCIAL ASSETS

A capitalization regime for options and forward contracts would represent something of a departure from current law. Under general rules of law, an option premium or forward payment is not capitalized into the basis of the option or forward contract. Instead, the amount is held in suspense under the open transaction doctrine until the contract is settled or some other realization event occurs.⁶⁴ For instance, a taxpayer that paid a $10 premium for a call option on a share of stock would hold the premium in suspense. If the taxpayer exercised the option and took delivery of the stock, the $10 premium would become part of the taxpayer's cost basis in the stock. If the option expired or was otherwise terminated, the taxpayer would treat the $10 premium as a loss at that time. The premium would not be capitalized into a separate asset, but merely held in suspense until a later time. No separate accounting would be made for the option upon exercise. Instead, the exercise of the option would be treated as the completion of an executory contract.

Holding a payment in suspense is qualitatively different from requiring capitalization of the payment into the basis of a separate asset. The proposed capitalization rule might be read to suggest that a separate accounting would need to be made for the settlement of the option at the time it was exercised (with gain or loss recognized on the option itself), instead of merely treating the option as an open transaction. Although we doubt that the IRS and Treasury intended to displace the normal rules of law applying to options and forward contracts, a capitalization regime for options and forward contracts could create a great deal of uncertainty by raising a question as to whether the established rules for the tax treatment of options and forward contracts continue to apply.

Moreover, even assuming the IRS and Treasury did not intend to create a new capitalization regime for option premiums and prepayments under a forward contract, we request clarification of the special rule in Prop. Treas. Reg. § 1.263(a)-4(d)(2)(ii). This rule provides that option premiums and payments for the direct costs of creating a forward contract need not be capitalized if the amount is allocable to property required to be provided or acquired by the taxpayer before the end of the taxable year in which the amount is paid. This rule could be interpreted as allowing a deduction for an option premium or payment under a forward contract, if the option or forward settles within the same taxable year it is entered into. If so, the rule represents a departure from current law, which requires a taxpayer to capitalize an option premium or forward payment into the basis of property acquired under the contract.

We assume that the IRS and Treasury did not intend to change the general rules of law applying to options and forward contracts. There is no indication in the Preamble of any such intent, and we question whether the IRS and Treasury would have the authority to provide new rules of law affecting the established tax treatment of these financial instruments in regulations under section 263. If, however, the Proposed Regulations were intended to create new substantive rules of law for the tax treatment of options and forward contracts, we ask that the IRS and Treasury clarify this intent so that taxpayers have an opportunity to comment on the new rules. A change in this area of law would be of great significance to a number of taxpayers.

B. Treatment of Debt Issuance Costs

Section 1.446-5 of the Proposed Regulations would require taxpayers to amortize debt issuance costs on a constant yield basis in the same manner as original issue discount. This new rule is being proposed pursuant to section 446(b), which provides the IRS with the authority to require taxpayers to use a method of accounting that clearly reflects income. We believe, however, that the method currently used by taxpayers already clearly reflects income. Because the administrative burden that would be imposed on taxpayers would outweigh any benefit to the government, we believe it would be inappropriate for the government to mandate a new method of accounting for these costs.

Currently, most taxpayers deduct the costs of issuing a debt instrument ratably over its term (the "straight-line method"). This method of accounting for debt issuance costs is long-standing and has been specifically authorized by a number of court cases. For instance, the Tax Court has held that the costs of obtaining a loan should be recovered ratably over the life of a loan because the costs "result in property of a sort" (i.e., the loan) and are "exhausted proportionately over a period of years."⁶⁵ In the same vein, the Supreme Court has held that when new bonds were issued in exchange for old bonds, the unamortized costs of issuing the old bonds should be amortized annually over the life of the new bonds: "The remaining unamortized expenses of issue of the original bonds and the expense of the exchange are both expenses attributable to the issuance of the new bonds and should be treated as a part of the cost of obtaining the loan. They should, accordingly, be amortized annually throughout the term of the bonds delivered in exchange for those retired."⁶⁶ Longstanding IRS guidance also has specifically provided for a straight-line amortization of debt issuance costs. In Rev. Rul. 70-360, 1970-2 C.B. 103, the IRS held that the costs of obtaining a loan must be pro-rated over the life of the loan. All of these authorities indicate that a straight-line amortization of debt issuance costs is an appropriate method of accounting that clearly reflects a taxpayer's income.

Taxpayers with bonds that mature serially also use a variation of the straight-line method by allocating debt issuance costs proportionately among different series of bonds as provided in Rev. Rul. 70-359, 1970-2 C.B. 103. The debt issuance costs allocated to each series are then amortized over the life of each series on a straight-line basis. We believe this method also clearly reflects income. Although Rev. Rul. 70-359 was issued at a time when the OID rules differed from the rules in place today, the ruling provides a method that allocates the costs of issuing a debt instrument in a manner that matches them with the amount that is borrowed. Debt issuance costs should be distinguished from interest equivalents, i.e., charges that are properly characterized as interest for federal income tax purposes. For instance, "points" and other loan fees paid to the lender have long been characterized as interest for federal income tax purposes, assuming they do not represent payments for any separate property or services provided to the borrower.⁶⁷ Likewise, a premium payment a borrower makes to a lender in repurchasing a debt instrument is treated as interest under Treas. Reg. § 1.163-7(c).

Debt issuance costs, in contrast, include any costs incidental to issuing the debt, including amounts paid to third parties, such as legal fees, underwriting fees, and commissions. Unlike points or repurchase premium, debt issuance costs are not interest for federal income tax purposes. Constant yield accrual is mandated by the Code and the regulations only for interest and OID. Because the straight- line method clearly reflects income, we believe there is no compelling reason to require the use of the constant yield method.

Furthermore, the clear reflection of income principle does not require that taxpayers use the method of accounting that most clearly reflects income. As long as a taxpayer's current method already clearly reflects income, the government is not justified in requiring a method of accounting that reflects income more clearly.⁶⁸ The straight-line method is a relatively simple, straightforward method of accounting for these costs. Requiring the use of the constant yield method would increase the complexity of accounting for these costs and impose a real administrative burden on taxpayers who may need to change their computer systems and internal accounting for these costs. We believe any benefit that the government might gain from requiring the constant yield method would far outweigh the burden that would be imposed on taxpayers. The Proposed Regulations were intended to promote greater simplicity and reduce the administrative burden for taxpayers. We believe that requiring a constant yield accrual for debt issuance costs would not further these goals.

(i) Configuration

Configuration of ERP software involves the utilization of templates or tables in the ERP software to select various options and set parameters which determine how the software will perform various business processes. We agree that this activity is not software development in and of itself. However, depending on the specific facts, configuration can be inextricably involved with the development of software or can be an activity that can qualify as a research and experimentation expense under section 174. We strongly believe, based on actual experience with these projects that it is not sufficient to simply classify all activities associated with configuration in a single category without any reference to the actual activities performed. Complicated configuration issues often lead to software development in order to solve specialized problems. Other complicated configuration issues require extensive experimentation and substantial iterative processes that can qualify for treatment under section 174. To classify all configuration activities as an "installation cost" is simply not correct in all fact situations.

(ii) Technology Architecture Development

Another activity common to ERP implementations is technology architecture development. This term encompasses those activities necessary to design, develop, and implement the systems environment in which the ERP software will be implemented. These activities utilize principles of computer science and engineering and are sometimes the most technically challenging aspects of implementing an ERP system. More often than not, the technical uncertainties that arise in technology architecture development require research and experimentation to resolve them. We believe many of these activities can qualify for treatment under section 174.

(iii) Data Design and Management

Data design and management are often significant components in implementing an ERP system. ERP systems are frequently designed to extract the company's data from a database in order to perform the necessary operations. The data must be formatted in such a manner that they can be properly interpreted by the ERP software. The ERP system must be able to access the data efficiently so as not to slow down processing time. This is accomplished through various database management techniques which require research and experimentation in order to overcome issues such as table locking, concurrency (two users or programs trying to access the same data simultaneously), and errors caused by corrupted or unclean data. We believe many of these activities can qualify for treatment under section 174.

Rev. Proc. 2000-50 addresses "all costs properly attributable to the development of software" and defines computer software as "any program or routine . . . that is designed to cause a computer to perform a desired function or set of functions and the documentation required to describe and maintain that program or routine." The term "program" is further defined, in part, as "any sequence of machine readable code." The ambiguity results from two areas. First, Rev. Proc. 2000-50 defines "computer software," but does not define "software development." Second, there is no guidance on what the phrase "properly attributable to" means. For example, software developers generally agree that the software development process involves the following activities in the software development life cycle: requirements definition, conceptual design, detail design, coding, development of test scripts and scenarios, execution of testing (unit testing, systems testing and integration testing), evaluation of test results, recoding and documentation and not simply the writing of computer code. We believe this definitional issue should be addressed. Accordingly, for the reasons described above, we strongly recommend that the treatment of ERP software be addressed in a separate proposed regulation subject to public comment.

VI. OTHER SPECIFIC COMMENTS

For these reasons, we recommend that the IRS and Treasury not adopt a financial statement conformity requirement as a condition of using the simplifying convention.

B. Effective Dates and Section 481(a) Adjustments

With respect to the proposed effective dates and the required accounting method change procedures, we have one comment relating to the steps that would be necessary to bring taxpayers not already treating costs covered by the Proposed Regulations into compliance with the Proposed Regulations. Section 1.263(a)-4(o)(1) of the Proposed Regulations provides that the capitalization rules would apply to amounts paid or incurred on or after the date the Final Regulations are published in the Federal Register. Section 1.263(a)- 4(o)(2) of the Proposed Regulations provides, in part, as follows:

Another issue regarding the effective date relates to prepaid expense method change requests. Many taxpayers that historically used a capitalization method for prepaid expenses satisfying the twelve- month rule filed method change requests after the U.S. Freightways decision to deduct the expenses in the year of prepayment. Because the IRS has advised its field examination agents in an internal memorandum not to pursue proposed adjustments requiring capitalization of these types of expenditures, taxpayers that have historically deducted prepayments essentially have audit protection. This audit protection affords taxpayers currently deducting prepaid expenses more favorable treatment than taxpayers that are not deducting their prepaid expenses. This inconsistent treatment of similarly situated taxpayers has been overruled by the courts. See International Business Machines Corp. v. United States, 343 F.2d 914, 920-21 (Ct. Cl. 1965), cert. denied, 382 U.S. 1028 (1966) (the IRS abused its discretion in revoking the taxpayer's ruling exempting it from certain excise taxes retroactively when it had previously revoked the ruling of a competitor prospectively). The inconsistent treatment of similarly situated taxpayers is also contrary to sound tax policy insofar as it treats taxpayers that followed the IRS position regarding prepaid expenses less favorably than taxpayers that were more aggressive in applying the provisions of Treas. Reg. § 1.263(a)-2. Thus, taxpayers that do not currently deduct their prepaid expenses satisfying the twelve-month rule should be able to file a change in accounting method request (under the non-automatic procedures of Rev. Proc. 97-27⁷⁷) prior to the effective date of the Final Regulations. If the IRS denies such a request, taxpayers may argue abuse of discretion. Therefore, taxpayers who have filed prepaid expense accounting method changes for a taxable year preceding the effective date of the Final Regulations should not be required to delay their taxable year of change.

C. The Twelve-Month Rule

The conflict between adherence to principle and the use of bright-line tests is graphically illustrated by the formulation of the twelve-month rule in the Proposed Regulations applicable to prepaid expenses. Under current law, whether prepaid expenses may be deducted or must be capitalized in the year of the prepayment is governed by Treas. Reg. §§ 1.263(a)-2(a) and 1.461-1(a), which provides that capitalization is required when an expenditure creates an asset with a useful life extending substantially beyond the close of the taxable year. However, the Proposed Regulations provide that prepaid expenses are not required to be capitalized if the period of the future benefit does not extend beyond the earlier of twelve months after the first date on which the taxpayer realizes the benefit, or the end of the taxable year following the taxable year in which the payment is made.⁷⁸ Under these rules, capitalization is not required when a one-year insurance policy premium is paid on December 15 by a calendar-year taxpayer, even though benefit of the prepayment extends 11 1/2 months beyond the close of the taxable year.⁷⁹ In contrast, if a fifteen-month insurance policy premium is paid on January 1 by the same taxpayer, capitalization of the payment is required because the duration of the benefit exceeds twelve months, even though the benefit extends only three months beyond the close of the taxable year.⁸⁰ Consistent with the earlier comments regarding the possible use of the Proposed Regulations as safe harbors rather than bright-line rules, the taxpayer in the second example described above might be confident of the non-capitalization result by resorting to the general principles of capitalization, but would not be entitled to an immediate deduction for the expense if the twelve-month rule is promulgated as a bright-line rule.

VII. CONCLUSION

We commend the Treasury and IRS for attempting to bring more uniformity and certainty to this extremely difficult area of taxation and we appreciate the opportunity to share our views on these issues with you. We do believe, however, that more has to be done in the process of finalizing the Proposed Regulations in order to achieve the desired objectives implicit in the Proposed Regulations. We believe that there is a reason why after all these years and all of the cases, the courts have not been able to state a simple rule distinguishing between capital expenditures and currently deductible expenses. We believe there is also a good reason why the courts have insisted on a careful examination of the facts and circumstances of each case before making a determination. The truth is that these issues and the vast universe of business transactions and motivations are just too complex to be handled solely with bright-line rules without reference to the facts and circumstances surrounding specific expenditures. However, to the extent that the Final Regulations will continue to employ the proposed bright-line rules and simplifying conventions, it is important that they be practical and reflect the law in the applicable cases. We believe that the suggestions for changes made above would make the regulations more consistent with current law in this area. If you have any questions regarding our comments please contact the appropriate principal authors of the sections of this letter as identified below.

General Overview and Other

²88 T.C. 1157 (1987).

³503 U.S. 79 (1992).

⁴Explanation of Provisions Section VIII.

⁵2000-2 C.B. 601.

⁶U.S. Freightways Corp. v. Commissioner, 270 F.3d 1137 (7^th Cir. 2001), rev'g and rem'g 113 T.C. 329 (1999).

⁷Explanation of Provisions Section V.D.1.

⁸We believe that these concerns are particularly prevalent in the context of the proposed effective date rules, the limitations on available section 481(a) adjustments for taxpayers seeking to comply with the regulations when they are finalized, and the proposed formulation of a twelve-month rule. See Part VI., Other Specific Comments, for further analysis of these provisions.

⁹Prop. Treas. Reg. § 1.263(a)-4(e)(3)(i).

¹⁰1999-1 C.B. 998.

¹¹Prop. Treas. Reg. § 1.263(a)- 4(e)(4)(i)(A)(2) also contains an alternative standard for taxpayers that are not corporations. Our recommendation contemplates that the entire rule be retained in the form set forth in the Proposed Regulations, so that the appropriate date can be determined with certainty for all types of taxpayers.

¹²As indicated above, we recommend the retention of the balance of the proposed rule for non-corporate taxpayers so that such taxpayers can determine the appropriate date with certainty.

¹³United States v. Gilmore, 372 U.S. 39 (1962) ("the origin and character of the claim with respect to which an expense was incurred, rather than its potential consequences upon the fortunes of the taxpayer, is the controlling basic test of whether the expense was 'business' or 'personal'"); and Anchor Coupling Co. v. United States, 427 F.2d 429 (7^th Cir. 1970), cert. denied, 401 U.S. 908 (1971) (applying Gilmore).

¹⁴It is our understanding that the Proposed Regulations adopt the origin-of-the-claim rule and provide that such severance payments would not be required to be capitalized. Prop. Treas. Reg. § 1.263(a)-4(e)(3)(i).

¹⁵Explanation of Provisions Section V.B.

¹⁶119 F.3d 482 (7^th Cir. 1997).

¹⁷Id. at 491.

¹⁸Explanation of Provisions Section V.C.

¹⁹Explanation of Provisions Section V.B.

²⁰Section 195(c)(1)(B).

²¹Of course, the mere fact that such expenditures are not required to be capitalized pursuant to the Proposed Regulations does not necessarily ensure that they are deductible under section 162. If such expenditures are start-up expenditures, as defined in section 195(c)(1), then section 195(a) requires that they be capitalized.

²²Prop. Treas. Reg. § 1.263(a)-4(b).

²³Explanation of Provisions Section V.A.

²⁴Explanation of Provisions Section V.A. See also Explanation of Provisions Section VII.B.

²⁵See Affiliated Capital Corp. v. Commissioner, 88 T.C. 1157 (1987), as cited in the Preamble.

²⁶503 U.S. 79 (1992).

²⁷See, e.g., Van Keuren v. Commissioner, 28 B.T.A. 480, 486 (1933).

²⁸See Simmons Co. v. Commissioner, 33 F.2d 75, 76 (1^st Cir. 1929). See also, the legislative history to section 248 (providing for the capitalization and elective amortization of organizational expenditures by a corporation), in which the Senate Committee on Finance states that stock issuance costs are not organizational expenditures, and describes such costs as "a reduction of the proceeds derived from the issue, . . . properly chargeable against the paid-in capital." Report of the Senate Committee on Finance, 83d Cong., 2d Sess., S. Rep. No. 1622, at 224 (1954).

²⁹32 B.T.A. 39 (1935).

³⁰Id.

³¹74 F.2d 163 (10^th Cir. 1934).

³²80 F.2d 872 (2^nd Cir. 1936).

³³Id. at 873.

³⁴Emerson Electric, 3 B.T.A. 932 (1926).

³⁵Id. at 935.

³⁶Id.

³⁷In McCrory Corp. v. United States, 651 F.2d 828 (2^nd Cir. 1981) the court in dicta states that stock issuance costs may not be deducted when incurred or upon liquidation and dissolution. McCrory was decided prior to INDOPCO and cites cases that relied upon the same rationale set forth in Simmons Co. v. Commissioner, 33 F.2d 75 (1^st Cir. 1929), which in turn relied on the rationale of Emerson Electric.

³⁸See Emerson Electric Manufacturing Co. v. Commissioner, 3 B.T.A. 932 (1926) (the business of the taxpayer had increased to such a volume that it was necessary to acquire additional capital), and Corning Glass Works v. Commissioner, 37 F.2d 798 (D.C. Cir. 1929) (the taxpayer was in need of money on account of a large increase in business and decided to obtain additional funds through the issuance of its stock because it was unable to borrow from banks).

³⁹Anover Realty Corp. v. Commissioner, 33 T.C. 671 (1960).

⁴⁰Id. at 675.

⁴¹Lovejoy, 18 B.T.A. 1179 (1930).

⁴²Id. at 1182.

⁴³Id.

⁴⁴Id.

⁴⁵Prop. Treas. Reg. § 1.446-5(b)(1).

⁴⁶Enoch v. Commissioner, 57 T.C. 781 (1972).

⁴⁷Dwight v. Ward, 20 T.C. 332 (1953); Godfrey v. Commissioner, 335 F.2d 82 (6^th Cir. 1964); Spreckels v. Commissioner, 315 U.S. 626 (1942).

⁴⁸Kirschenmann v. Commissioner, 488 F.2d 270 (9^th Cir. 1973).

⁴⁹Explanation of Provisions Section II.C.

⁵⁰If the Proposed Regulations are to be adopted, Rev. Rul. 69-330 will need to be modified or revoked.

⁵¹Rev. Rul. 73-463, 1973-2 C.B. 34 (open-end investment companies may deduct under section 162 all stock issuance costs, except for those incurred in connection with the corporation's initial stock offering); Rev. Rul. 94-70, 1994-2 C.B. 17 (open-end investment companies may deduct under section 162 stock distribution costs). These distinctions are retained in the Proposed Regulations. See Prop. Treas. Reg. § 1.263(a)-4(e)(6).

⁵²But see Commercial Investment Trust Corp. v. Commissioner, 28 B.T.A. 143 (1933) (preferred stock issuance costs may not be amortized over the term of the stock). We do not understand why debt costs produce a wasting asset but preferred stock costs do not.

⁵³Explanation of Provisions Section VII. ¶ B.3.

⁵⁴651 F.2d 828 (2^nd Cir. 1981).

⁵⁵Id. at 833.

⁵⁶Id. at 834.

⁵⁷Id. at 832. The court in McCrory did not address the fact that McCrory probably should have depreciated or amortized a portion of the costs allocated to certain of the Olen and National assets acquired and directly held by McCrory. The court only spoke to whether McCrory could deduct a portion of the costs upon the liquidation of the acquired companies and the subsequent asset dispositions. The court also did not indicate whether any deduction for the amounts allocable to the assets of Olen and National should have been reduced for any depreciation or amortization that would have been allowable during the period beginning on the day following each respective acquisition and ending on the date of each respective liquidation or disposition.

⁵⁸503 U.S. 79 (1992).

⁵⁹110 T.C. 402 (1998).

⁶⁰INDOPCO also did not address the applicability of section 195 to the expenses at issue.

⁶¹INDOPCO, 503 U.S. at 84. The Court noted that a deduction in effect would arise as part of a section 336 liquidation. When a corporation completely liquidates, realized gains and losses are recognized under section 336(a). At that time, the loss associated with the liquidation of the corporate structure may be set off against gain recognized for other corporate assets. In its brief to the Supreme Court, the government conceded this position. See Brief for the Respondent at 73, INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992) (No. 90-1278).

⁶²110 T.C. 402 (1998).

⁶³488 F.2d 270 (9^th Cir. 1973).

⁶⁴Rev. Rul. 71-521, 1971-2 C.B. 313. Under general tax principles, an option is treated as an open transaction, and the option premium is not taken into account until the option is settled, terminated, sold, or otherwise disposed of. See Rev. Rul. 78- 182, 1978-1 C.B. 265. Likewise, a forward contract is treated as an open transaction until the underlying property is delivered, or the contract is otherwise closed out. Generally, neither the purchaser nor the seller under a forward contract takes any prepayment of the purchase price into account until the transaction is closed. See, e.g., Lucas v. North Texas Lumber Co., 281 U.S. 11 (1930). A forward contract would be treated as a completed sale or exchange, however, if the incidents of ownership had been transferred to the purchaser prior to settlement. See Rev. Rul. 2003-7, 2003-5 I.R.B. 363.

⁶⁵Lovejoy v. Commissioner, 18 B.T.A. 1179 (1930).

⁶⁶Great Western Power Co. v. Commissioner, 297 U.S. 543, 546-47 (1936). See also Helvering v. Union Pacific Railroad Co., 293 U.S. 282 (1934); Enoch v. Commissioner, 57 T.C. 781 (1972); Anover Realty Corp. v. Commissioner, 33 T.C. 671 (1960).

⁶⁷Rev. Rul. 69-188, 1969-1 C.B. 54. The OID regulations also recognize that payments made from a borrower to a lender (assuming they are not made for any separate property or services rendered) are properly treated as an adjustment to the issue price of a loan, resulting in OID. Treas. Reg. § 1.1273-2(g)(2).

⁶⁸See Capitol Federal Savings & Loan Ass'n v. Commissioner, 96 T.C. 204 (1991); Molsen v. Commissioner, 85 T.C. 485 (1985); Auburn Packing Co. v. Commissioner, 60 T.C. 794 (1973); Garth v. Commissioner, 56 T.C. 210 (1971), acq. 1978-1 C.B. 1.

⁶⁹Explanation of Provisions Section VIII (sixth paragraph).

⁷⁰2000-2 C.B. 601.

⁷¹Explanation of Provisions Section V.D.1.

⁷²See Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979).

⁷³Wells Fargo & Co. v. Commissioner, 224 F.3d 874, (8^th Cir. 2000).

⁷⁴PNC Bancorp v. Commissioner, 212 F.3d 822 (3^rd Cir. 2000).

⁷⁵However, if the taxpayer's financial statement treatment were to be viewed as one of the taxpayer's underlying facts, then a change in such treatment would not be a change in method of accounting. See Treas. Reg. § 1.446- 1(e)(2)(ii)(b).

⁷⁶U.S. Freightways Corp. v. Commissioner, 270 F.3d 1137 (7^th Cir. 2001), rev'g and rem'g 113 T.C. 329 (1999).

⁷⁷1997-1 C.B. 660.

⁷⁸Prop. Treas. Reg. § 1,263(a)-4(f)(1)(i).

⁷⁹Prop. Treas. Reg. § 1.263(a)-4(f)(8), Example 2.

⁸⁰Prop. Treas. Reg. § 1.263(a)-4(f)(1)(i)(A).