Appeals Court Rejects Retroactive Adjustments in Purchase Price Allocations
Peco Foods, Inc. & Subsidiaries v. Comm., (CA 11, 7/2/2013)
The Court of Appeals for the 11th Circuit, affirming the Tax Court, has concluded that for depreciation purposes, a taxpayer couldn't unilaterally change its original purchase price allocations in two asset purchase agreements entered into in connection with acquiring certain assets. The taxpayer had attempted to make the modifications to expedite depreciation deductions following a cost segregation analysis.
Peco Foods (“Peco”) acquired two poultry processing plants in the '90s (Sebastopol and Canton plants). Each agreement stated that Peco and the transferor agreed to allocate the purchase price among the assets "for all purposes (including financial accounting and tax purposes)" in accordance with the allocation schedule included in the sale transaction documents.
Subsequent to the purchases, Peco hired a company to perform a cost segregation study of the Sebastopol and Canton plants. The study determined that subdividing the acquired assets into various subcomponents entitled Peco to an additional depreciation deduction of $5,258,754 from 1998 through 2002.
Under Internal Revenue Code (“IRC”) 1060, an applicable asset acquisition is any transfer of assets constituting a trade or business in which the transferee's basis is determined wholly by reference to the consideration paid for the assets. Generally, in connection with an applicable asset acquisition, the parties agree to a written agreement concerning purchase price allocation which they are bound to, absent satisfaction of the Danielson rule. Under the Danielson rule, a party may for tax purposes repudiate an unambiguous contractual term only via evidence that would be admissible in an action between the parties to alter that construction or to show its unenforceability because of a mistake, undue influence, fraud, or duress. (Danielson, (CA 3 1967) 19 AFTR 2d 1356 , cert den)
IRC 1060 was amended after Danielson to provide that if the buyer and seller agree in writing as to the allocation of any consideration, or as to the fair market value (“FMV”) of the assets, the agreement is binding on both the buyer and seller unless IRS determines that the allocation (or FMV) not appropriate. But where the parties do not allocate the consideration entirely, the residual method of purchase price allocation under IRC 338(b)(5) may apply to determine both the purchaser's basis in, and the seller's gain or loss from, the transferred assets.
More on The Case
The IRS asserted that IRC 1060 and the Danielson rule each barred Peco from modifying the purchase price allocations of the Sebastopol and Canton plants in a manner inconsistent with the original allocation schedules. Peco contended that Danielson and IRC 1060 did not prohibit it from classifying property as IRC 1250 property (structural components of a building) or IRC 1245 property (tangible personal property), and that IRC 1060 required only that the purchase price be allocated under the residual method.Peco argued it could re-determine the useful lives of assets received in the acquisitions.
The Tax Court Decision
The Tax Court concluded that Peco couldn't modify the purchase price allocations it agreed to for the two asset acquisitions. The Court rejected Peco's argument that neither IRC 1060 nor the Danielson rule prohibited it from making an initial determination of the useful lives of assets acquired in the acquisition inconsistent with the original allocation schedule.
The Tax Court found that the written agreement superseded the residual method of purchase price allocation since the Sebastopol and Canton agreement were both enforceable.
The Appellate Decision
The Eleventh Circuit agreed with the Tax Court, disallowing the retroactive adjustments in the allocation schedules. Although the benefits to Peco from using shorter and faster depreciation methods were obvious and immediate, Peco was bound by, and could not modify, the original purchase price allocations set out in the asset agreements.
The Tax Warriors’ Perspective
- The Tax Court and Appellate decisions strengthens the notion that purchase agreements should have ambiguity where possible avoiding highly-specific purchase price allocations that may limit the planning available to the purchasing party in the future.
- Taxpayers contemplating the purchase of the assets of a business may want to arrange for a cost segregation analysis before the purchase agreement is executed and incorporate that analysis into the purchase agreement.
The Peco decision reinforces that before purchasing a business and its assets, communication with your tax advisor is imperative to creating a transaction and related documents that are tax efficient.
The Tax Warriors® at Drucker & Scaccetti have a deep level of experience advising on the purchase or sale of business assets. Let us put our highly skilled business consultants to work for you. Contact us via the “Ask A Tax Warrior” button below or call us directly at (215) 665-3960. We are always prepared to help you with this or any other tax or business-related matter.