Merger Termination Fee Deductible

By David A. Thornton, CPA, and James D. Slivanya, CPA, Columbus, OH

Editor: Frank J. O’Connell Jr., CPA, Esq.

The Tax Court recently held in Santa Fe Pacific Gold Co., 132 T.C. No. 12 (2009), that a termination fee paid by the taxpayer to cancel a merger agreement in order to consummate a more lucrative merger was deductible. In reaching this conclusion, the court determined that the termination fee did not produce any significant long-term benefits for the taxpayer and that the terminated merger represented an abandoned transaction. While the IRS has historically sought to disallow deductions for merger termination fees paid under these circumstances, the decision reinforces the importance of the underlying facts and circumstances in making this determination.


Santa Fe (the taxpayer) was a small mining company spun off as a separate and independent corporation by its former parent, a railroad company. Santa Fe owned significant land holdings containing valuable mineral rights, which it mined. Santa Fe sought to expand its business into a larger, more fully integrated mining operation. However, Santa Fe was aware that it would likely be the target of hostile takeover attempts by larger mining companies due to its attractive mineral deposit holdings.

In April 1996, Newmont USA Limited (Newmont), a prominent mining company, approached Santa Fe about a possible business combination and was rebuffed by Santa Fe. However, when it became evident that Newmont might launch a hostile takeover attempt, Santa Fe was forced to consider its strategic alternatives. Among these alternatives was to explore a potential combination with Newmont or seek a “white knight” merger candidate that might be more compatible with Santa Fe’s business aspirations.

While in the process of exploring the consequences of a merger with Newmont, Santa Fe began secretly negotiating a possible merger with Homestake Mining Co. (Homestake), a smaller mining company that Santa Fe viewed as friendly to its overall business objectives. On November 21, 1996, Newmont submitted an offer to acquire Santa Fe. Homestake also submitted an offer one day later. Santa Fe’s management and board determined that it was in the company’s best interest to pursue the combination with Homestake. Upon being notified of its rejected offer, Newmont immediately began taking actions to thwart the Homestake merger and launch a hostile takeover of Santa Fe.

On December 8, 1996, the boards of both Santa Fe and Homestake unanimously approved and executed a merger agreement. The agreement included a fiduciary-out clause, allowing Santa Fe to consider superior offers if not doing so would violate its fiduciary duty to shareholders, and a termination fee clause that required Santa Fe to pay Homestake a fee of $65 million if Santa Fe terminated the merger agreement.

Notwithstanding the Santa Fe–Homestake merger agreement and the termination fee clause, Newmont proceeded with an increased offer to acquire Santa Fe. Santa Fe’s board determined that rejecting the more lucrative Newmont offer would be a breach of its fiduciary duties under Delaware state law. Homestake was given the opportunity to match the increased Newmont offer but declined to do so. Consequently, Santa Fe ultimately consummated the Newmont merger and paid Homestake the $65 million termination fee required under their agreement.

Subsequent to the merger of the two companies, Newmont was free to mine Santa Fe’s land at will. Furthermore, Newmont reduced the combined companies’ operating expenses primarily by terminating a significant portion of Santa Fe’s employees and management, terminating Santa Fe board members, and closing the Santa Fe offices.

On its 1997 federal income tax return, Santa Fe deducted the full $65 million termination fee as an ordinary and necessary business expense under Sec. 162. Upon examination, the IRS disallowed the entire deduction on the grounds that the termination fee constituted a capital expenditure under Sec. 263(a).

Applicable Code Sections and Treasury Regs.

Sec. 162 generally allows a deduction for business expenses that are ordinary and necessary in the operation of a taxpayer’s trade or business. An expenditure can be considered ordinary and necessary even if the expenditure rarely occurs or occurs only once within the taxpayer’s lifetime, provided the expenditure is customary within the overall business environment in which the taxpayer operates.

Sec. 165 allows a deduction for any loss sustained during the tax year not compensated for by insurance or otherwise. Abandonment losses fall under Regs. Sec. 1.165-2, which states that a loss incurred in a transaction entered into for profit and arising from the sudden termination of that transaction shall be allowed as a deduction under Sec. 165(a) for the tax year in which the loss is actually sustained. Regs. Sec. 1.165-1(b) requires loss to be evidenced by closed and completed transactions and fixed by identifiable events in order to secure a deduction under Sec. 165.

Regs. Sec. 1.263(a)-5 generally requires a taxpayer to capitalize amounts paid to facilitate a transaction that provides the taxpayer with significant longterm benefits. Regs. Sec. 1.263(a)-5(c)(8) requires capitalization of amounts paid to terminate an agreement to enter into a merger transaction if the payment enables the taxpayer to consummate a second merger transaction and the transactions are mutually exclusive (i.e., consummating the first transaction would preclude the taxpayer from consummating the second transaction).

Lack of Significant Long-Term Benefit

INDOPCO, Inc., 503 U.S. 79 (1992), established that expenses that produce significant long-term benefits must be capitalized. It is also well established under Federated Dept. Stores, Inc., 171 B.R. 603 (S.D. Ohio 1994), that expenses paid to ward off a hostile takeover attempt are deductible as ordinary and necessary expenses of defending a business. In seeking to disallow the taxpayer’s deduction for the termination fee paid to Homestake, the IRS argued that the Newmont takeover was not hostile and that the taxpayer had sought access to Newmont’s capital resources from the outset. The Service viewed Santa Fe’s initial discussions with Newmont as an indication that Santa Fe sought as an overall goal to engage in a merger transaction.

The foundation of the IRS argument is that Santa Fe sought to engage in a merger transaction as part of its overall plan of expanding its mining operations and skillfully negotiated two mutually exclusive alternatives to achieve this goal. Consequently, the Service argued that the payment of the termination fee to Homestake facilitated the closing of the merger with Newmont and enabled Santa Fe to secure a higher offer from Newmont. The IRS pointed to the synergies of the business combination touted by Newmont’s management as support for the significant long-term benefits secured by Santa Fe in the merger.

However, the Tax Court ruled in favor of Santa Fe’s deduction of the Homestake merger termination fee. In rendering its decision, the court disagreed with two fundamental IRS positions:

  • Santa Fe desired to engage in a merger transaction from the outset; and
  • Newmont’s acquisition of Santa Fe did not constitute a hostile takeover.

The court placed significant emphasis on the facts and circumstances surrounding Santa Fe’s decision to enter into the merger agreements and to pay the termination fee. Of particular importance was whether the merger ultimately consummated with Newmont produced significant long-term benefits to Santa Fe.

The court determined that the Newmont merger was a hostile takeover of Santa Fe. Although Santa Fe had originally initiated discussions with Newmont before entering into the merger agreement with Homestake, its intentions throughout these discussions were to preserve its long-term business plans. Furthermore, it was clear from the outset that Newmont planned to initiate a hostile takeover of Santa Fe if amicable negotiations failed. It was for this reason—i.e., protecting its current and future business plans—that Santa Fe sought a white knight merger with Homestake.

The court determined that Santa Fe ultimately consummated the merger with Newmont in order to fulfill its fiduciary obligation to its shareholders under Delaware state law and not because of any perceived long-term benefits that would result from such a transaction. In this regard, Santa Fe had no choice but to accept the higher Newmont offer.

As to whether any significant longterm benefits resulted to Santa Fe from the merger with Newmont, the court pointed to the fact that, subsequent to its acquisition of Santa Fe, Newmont discarded Santa Fe’s independent business plans, removed its board of directors, terminated over half of Santa Fe’s employees, and closed a disproportionate number of Santa Fe’s facilities. The court found that the primary benefit to Newmont resulting from its acquisition of Santa Fe was the ability to mine Santa Fe’s land unfettered while at the same time cutting out Santa Fe’s now duplicate operating costs. While this opportunity offered a significant long-term benefit to Newmont, it did not offer any significant long-term benefits to Santa Fe—i.e., the taxpayer that incurred the termination fee.

On the basis of this conclusion, the court found the entire agreement between Santa Fe and Homestake to be an attempt to ward off a hostile takeover attempt by Newmont. Thus, absent the existence of any significant long-term benefits to the taxpayer, the court permitted Santa Fe a current deduction for the termination fee under Sec. 162 as a cost of attempting to protect its business.

Abandonment Loss

Santa Fe also raised an alternative argument that it should be allowed an abandonment loss for the termination fee under Sec. 165 because it abandoned its merger with Homestake. In making this argument, Santa Fe again pointed to the fact that its merger agreement with Homestake was an attempt to ward off a hostile takeover by Newmont and to preserve its business. Santa Fe claimed that it was ultimately obligated to accept the increased offer from Newmont only because of its fiduciary obligations to its shareholders under Delaware state law, and not because of any perceived longterm benefits resulting from a merger with Newmont.

The IRS argued against the abandonment loss deduction on the grounds that the merger with Newmont and the potential merger with Homestake were mutually exclusive alternatives to achieving the taxpayer’s overall goal—i.e., engaging in a corporate merger transaction. The Service has historically taken the position that if a taxpayer seeks to engage in a merger or acquisition, contracts to do so with another taxpayer, and then subsequently receives a more attractive offer from a different taxpayer, any termination fees paid to cancel the original agreement in favor of pursuing the more attractive offer are deemed to facilitate the consummation of the more attractive offer. As a result, the taxpayer must generally capitalize these fees if it ultimately consummates the second agreement and significant long-term benefits result to the taxpayer from terminating the original agreement. Although the IRS’s position was not included in the regulations at the time of Santa Fe’s merger with Newmont, it has since been added in Regs. Sec. 1.263(a)-5(c)(8).

In support of its argument that the Homestake and Newmont mergers were mutually exclusive, the IRS claimed that Santa Fe had as its overall goal from the outset the pursuit of a corporate restructuring transaction. The Service pointed to the fact that the taxpayer had initial discussions with Newmont before ever negotiating the merger agreement with Homestake. Consequently, the IRS argued that the taxpayer used the merger agreement with Homestake to secure a better offer from Newmont and as a result was merely in a position of choosing between two viable merger candidates to satisfy its overall goal of engaging in a corporate restructuring transaction.

However, the court did not agree that Santa Fe sought initially to engage in a corporate restructuring transaction. Instead, the court found that the taxpayer’s overall goal from the outset was to preserve its business plans. The taxpayer conducted its initial discussions with Newmont as a protective measure aimed at negotiating the preservation of its longterm business objectives. However, once the taxpayer concluded that Newmont’s intentions did not include such preservation, it sought to preserve its interests by entering into the merger agreement with Homestake.

The court viewed the potential Homestake merger as a failed attempt by Santa Fe to ward off a hostile takeover by Newmont rather than an integrated step in the transaction ultimately consummated with Newmont. When Santa Fe terminated the Homestake merger agreement, it abandoned its alternative plans with Homestake.

For these reasons, the court alternatively permitted the taxpayer to deduct the Homestake termination fee as an abandonment loss under Sec. 165.


The Tax Court’s decision in Santa Fe underscores the importance of examining the facts and circumstances behind the payment of fees to terminate mergers and other transactions, as this information often determines the deductibility of these fees. In supporting the taxpayer’s deduction of the termination fee, the court reasoned that no significant long-term benefits resulted to the taxpayer from a merger transaction in which the acquiror’s key motivation for the merger was merely to exploit the taxpayer’s resources at a low cost. It appears that the court might have ruled differently if the taxpayer’s motivations for entering the terminated merger agreement had been different or if there had been significant benefits to the taxpayer resulting from the consummated merger.


Frank O’Connell Jr. is a partner in Crowe Horwath LLP in Oak Brook, IL.

Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.

For additional information about these items, contact Mr. O’Connell at (630) 574-1619 or

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