Company’s $1.6 billion ‘break fee’ payment treated as ordinary deduction

The Tax Court held that a company properly treated as an ordinary deduction (and not a capital loss under Sec. 1234A) a $1.6 billion termination fee payment it made to another company pursuant to a cooperation agreement regarding a proposed merger.

Background

In July 2014, AbbVie, a domestic public corporation, and Shire PLC, a foreign public limited company, announced that their boards had agreed on the terms of a proposed combination of the companies, under which Shire was valued at nearly $55 billion. Pursuant to those terms, both AbbVie and Shire would come under the umbrella of New AbbVie, a Jersey company (i.e., registered in the island of Jersey) formed by AbbVie, and shareholders of AbbVie and Shire would receive shares of New AbbVie in exchange for their existing shares.

The proposed combination was planned to proceed in two phases. In the first phase, Shire’s shareholders would exchange their shares for shares of New AbbVie and cash pursuant to a court–sanctioned “scheme of arrangement” between Shire and the Shire shareholders under the Jersey Companies Law of 1991. In the second phase, AbbVie would merge into a subsidiary of New AbbVie pursuant to an Agreement and Plan of Merger (Delaware Merger Agreement) that had to be approved by AbbVie’s shareholders.

AbbVie and Shire executed a cooperation agreement that “set out certain mutual commitments to regulate the basis on which they are willing to implement the [m]erger.” The cooperation agreement included a provision for a termination payment (break fee payment) under which AbbVie would pay approximately $1.6 billion if it eventually failed to recommend to its shareholders to approve the proposed combination or invoked a regulatory condition to avoid proceeding with the combination. AbbVie entered into the Delaware Merger Agreement with two affiliated entities that, subject to shareholder approval, would cause AbbVie to become a subsidiary of New AbbVie.

On Sept. 22, 2014, before either AbbVie’s or Shire’s shareholders had voted on the proposed combination, the IRS issued Notice 2014–52. The notice stated the IRS’s intention to issue new regulations concerning inversion transactions. Those regulations would be retroactive to the date of Notice 2014–52 (i.e., before the proposed combination was completed).

On Oct. 15, 2014, after reviewing Notice 2014–52, AbbVie’s board of directors withdrew its recommendation that shareholders approve the proposed combination because the proposed regulations “introduced an unacceptable level of uncertainty to the transaction.” AbbVie acknowledged that the withdrawal, if accompanied by shareholder disapproval of the combination, could cause AbbVie to have to make the approximately $1.6 billion break fee payment to Shire.

Following the withdrawal of the recommendation, AbbVie and Shire recognized that there was little prospect of AbbVie’s shareholders approving the proposed combination. Thus, on Oct. 20, 2014, the companies entered into an agreement that terminated the cooperation agreement. As a condition of that termination agreement, AbbVie was required to make a break fee payment in the same amount that would have been due under the cooperation agreement. AbbVie made the payment on Oct. 21, 2014.

AbbVie timely filed Form 1120, U.S. Corporation Income Tax Return, for its 2014 calendar tax year. On the return, AbbVie claimed the break fee payment as an ordinary deduction.

The IRS examined AbbVie’s return and as a result issued a notice of deficiency with a deficiency of approximately $572 million. The IRS determined that the break fee payment was not deductible as a Sec. 162 expense or as a Sec. 165 ordinary loss because it and the termination of the cooperation agreement resulted in a loss that should be treated as a Sec. 1234A loss from the sale of a capital asset. Accordingly, the IRS determined that the break fee payment should be treated as a capital loss.

Upon receiving the notice of deficiency, AbbVie timely filed a petition in Tax Court challenging the IRS’s determination. The parties filed cross–motions for summary judgment on whether Sec. 1234A(1) applied to AbbVie’s break fee payment. AbbVie argued that the provision did not apply to the break fee payment and that, as a result, it correctly claimed an ordinary deduction for the payment. The IRS argued that Sec. 1234A(1) applied and required AbbVie to treat the break fee payment as a capital loss.

Cooperation agreement

Under the cooperation agreement, AbbVie agreed, among other things, before the combination of the companies, to (1) take the lead in securing regulatory approval of the proposed combination and communicating with Shire about regulatory approvals; (2) “co–operate with Shire and its advisers to take all such steps as are reasonably necessary to implement the [proposed combination]”; (3) recommend the Delaware Merger Agreement to its own shareholders, call a shareholder meeting for purposes of voting on the Delaware Merger Agreement, and use best efforts to secure shareholder approval of the agreement; and (4) provide information and documentation as required ahead of Shire’s shareholder vote. Shire promised to (1) assist AbbVie in communicating with regulators, (2) provide information to AbbVie as needed, and (3) notify AbbVie of any matters that could influence regulatory compliance.

If the proposed combination were approved, AbbVie agreed in the cooperation agreement to (1) be bound by the scheme of arrangement and to procure New AbbVie’s adherence to it; (2) ensure that the New AbbVie shares that were to be issued to Shire shareholders pursuant to the scheme of arrangement ranked equally with the New AbbVie shares that were to be issued to AbbVie shareholders pursuant to the Delaware Merger Agreement; (3) ensure that, as part of AbbVie’s merger into New AbbVie’s subsidiary, AbbVie shareholders would exchange one AbbVie share for one New AbbVie share; and (4) implement the merger of AbbVie and New AbbVie’s subsidiary pursuant to the Delaware Merger Agreement immediately following the completion of the scheme.

Sec. 1234A

Sec. 1234A reads:

§1234A. Gains or losses from certain terminations

Gain or loss attributable to the cancellation, lapse, expiration, or other termination of —

(1) a right or obligation (other than a securities futures contract, as defined in section 1234B) with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer, or

(2) a section 1256 contract (as defined in section 1256) not described in paragraph (1) which is a capital asset in the hands of the taxpayer,

shall be treated as gain or loss from the sale of a capital asset. The preceding sentence shall not apply to the retirement of any debt instrument (whether or not through a trust or other participation arrangement).

The Tax Court’s decision

The Tax Court granted AbbVie’s motion for summary judgment. It held that the company’s rights and obligations under the cooperation agreement were fundamentally in the nature of services. Thus, it also held that AbbVie was not required to treat the break fee payment as a capital loss, because under the agreement, the company did not have a “right or obligation … with respect to property” within the meaning of Sec. 1234A(1).

Requirements for Sec. 1234A to apply

Sec. 1234A(1) applies when four requirements are met: (1) There is a gain or loss; (2) the gain or loss is attributable to the cancellation, lapse, expiration, or other termination of a right or obligation; (3) the terminated right or obligation is “with respect to” property; and (4) the property underpinning the terminated right or obligation is currently (or would on acquisition be) a capital asset in the hands of the taxpayer.

Meaning of ‘rights and obligations’ and ‘with respect to property’

With respect to whether AbbVie had rights or other obligations under the agreement, the court looked to the ordinary meaning of the statute. In this contractual context, the court found that the term “right” generally means something to which a party has a claim as a legal matter. Based on the terms of the cooperation agreement, including the break fee payment obligation, the court determined that AbbVie had rights and obligations under the cooperation agreement.

With respect to whether these rights and obligations were “with respect to property,” the Tax Court took a much deeper dive in its analysis, looking at both the phrase’s ordinary meaning and the context in which it was used. In reviewing the context of the phrase, the court considered the role played by Sec. 1234A in the Code, the text of related provisions, and interpretations of Sec. 1234A(1) in prior case law. According to the court, close consideration of the context revealed that a right or obligation “with respect to property” within the meaning of Sec. 1234A is a “right or obligation to exchange (i.e., to buy, sell, or otherwise transfer or receive) an interest in property.”

Application of Sec. 1234A(1) to the break fee payment

As the Tax Court observed, determining whether the cooperation agreement was “with respect to property” was not straightforward because AbbVie’s rights and obligations under the agreement were “many and multifaceted.”

The Tax Court found that, at its core, the cooperation agreement was not an agreement to buy, sell, or otherwise transfer property, as AbbVie and Shire could not sell the property (the shares in the companies) in the proposed combination. At best, the Tax Court stated, the agreement was an aspirational arrangement under which each side agreed to do everything it could to facilitate the potential combination.

Consistent with this reality, the Tax Court found that AbbVie’s core obligations under the cooperation agreement were services provided to increase the likelihood that a combination would occur and that these facilitative services were the crux of the cooperation agreement. As the court stated, “[I]t was not AbbVie’s failure to complete the combination that triggered the liability; instead, it was the failure of the AbbVie board to recommend the combination to AbbVie’s shareholders.” Considering this point in the broader context of the cooperation agreement, the court concluded that the break fee was not paid to terminate rights and obligations with respect to property within the meaning of Sec. 1234A(1).

In sum, the Tax Court concluded that because the break fee payment was not attributable to the “termination of … a right or obligation … with respect to property” but was instead attributable to the termination of an agreement that set out certain mutual commitments to regulate the basis on which AbbVie and Shire were willing to implement the proposed combination of the two companies, Sec. 1234A(1) did not apply to it. Therefore, AbbVie was not required, on account of Sec. 1234A(1), to treat the break fee payment as a capital loss.

Reflections

While AbbVie takes the first round of this tax dispute, given the huge amount of tax at issue, the IRS undoubtedly will seek to appeal the Tax Court’s decision. The court in a footnote stated that AbbVie and the IRS made several other arguments regarding the requirements of Sec. 1234A(1), including whether the break fee payment was an ordinary and necessary business expense deductible under Sec. 162(a) or a loss under Sec. 165(a) and whether Shire stock would have been a capital asset in AbbVie’s hands. However, because of its conclusion that the terminated right was not with respect to property and thus Sec. 1234A(1) did not apply, the court did not address those arguments.

AbbVie Inc. & Subsidiaries, 164 T.C. No. 10 (2025)

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.