Fort Howard Corp. & Subsidiaries v. Comm'r of Internal Revenue
| Decision Date | 24 August 1994 |
| Docket Number | No. 6362–92.,6362–92. |
| Citation | 103 T.C. 345,103 T.C. No. 18 |
| Parties | FORT HOWARD CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
James L. Malone III, Kristen E. Hazel, and Lonn W. Myers, Chicago, IL, for petitioner.
Lawrence C. Letkewicz, William E. Bogner, and Dana E.P. Hundrieser, Chicago, IL, for respondent.
In 1988, P was the subject of a leveraged buyout (LBO) that was treated as a redemption for Federal tax purposes. P incurred numerous costs in obtaining the debt financing used to complete the LBO. P capitalized these costs and amortized them over the life of the debt, deducting in full the costs attributable to debt retired in 1988. In addition, P now contends that a portion of an organizer fee constituted “additional interest” fully deductible in 1988.
Held: Sec. 162(k), I.R.C., prohibits corporate deductions for amounts “paid or incurred by a corporation in connection with the redemption of its stock”. Sec. 162(k)(2), I.R.C., provides an exception for interest. P's costs of obtaining debt financing were incurred “in connection with the redemption of its stock” and therefore, except for interest, are not deductible.
Held, further: Amortization deductions constitute an “amount paid or incurred” for purposes of sec. 162(k), I.R.C. Commissioner v. Idaho Power Co., 418 U.S. 1 (1974), applied.
Held, further: No portion of the organizer fee constituted additional interest.
Respondent determined deficiencies in petitioner's 1985 and 1988 Federal income taxes in the respective amounts of $2,445,098 and $32,557,015.
After severance of certain issues for trial and concessions by the parties, the issues for decision are: (1) Whether certain deductions taken by petitioner in 1988 are prohibited by section 162(k); 1 and (2) whether certain expenses incurred by petitioner in 1988 constitute a fee for services as opposed to interest deductible under section 163.
Some of the facts have been stipulated and are so found. The stipulation of facts, first and second supplemental stipulations of fact, and attached exhibits are incorporated herein by this reference. During 1988, petitioner was a corporation engaged in manufacturing, converting, and marketing a diversified line of single-use paper and plastic products including table napkins, paper towels, bath tissue, wipers, and boxed facial tissues. Petitioner is incorporated in Delaware and has its principal office in Green Bay, Wisconsin.
The facts in this case surround the 1988 leveraged buyout (LBO) of petitioner. In early 1988, petitioner's management was concerned about the market price of petitioner's common stock, which had declined considerably in prior months. After consultation with Morgan Stanley Group, Inc. (Morgan Stanley), petitioner's management concluded that an LBO would be the best way to increase stockholder value. On April 6, 1988, during consultations with management, Morgan Stanley proposed an LBO timetable that included: (1) A tender offer for petitioner's stock commencing during weeks 11 to 14; (2) expiration of the tender offer and purchase of tendered shares in week 15; (3) merger of the acquisition vehicle into petitioner; (4) filing the SEC Form S1 registration statement for the sale of permanent debt in week 16; and (5) closing the sale of permanent refinancing debt in weeks 20 to 24. All the significant planning documents 2 contemplated a similar, if not identical structure, including a prompt refinancing via long-term debt after the merger. On June 7, 1988, petitioner's outside directors granted petitioner's management permission to explore the possibility of an LBO.
Petitioner's management and Morgan Stanley made two formal proposals to petitioner's board of directors. On June 25, 1988, the Board voted to accept the second, which proposed—at a price of $53 per share—an LBO of petitioner by its senior management, its largest individual shareholder, and outside investors consisting principally of Morgan Stanley, certain institutional investors,3 and Bankers Trust Co. (Bankers Trust) (hereinafter collectively referred to as “the investors”). Bankers Trust and a syndicate of 27 banks would provide bank financing for the transaction. Morgan Stanley played a substantial role in getting the commitment from the five lead banks and in selling the LBO as a credit risk to the remaining banks in the bank syndicate. It also acted as financial advisor and dealer manager for all stages of the LBO.
Pursuant to the Agreement and Plan of Merger (Merger Plan), Morgan Stanley organized FH Holdings Corp. (FH Holdings) and its wholly owned subsidiary, FH Acquisition Corp. (FH Acquisition), on June 22 and 23, 1988, respectively. Under the Merger Plan, the investors would initially become shareholders of FH Holdings. FH Acquisition would receive debt capital for the purpose of making a tender offer for all petitioner's outstanding shares. After the tender of shares, FH Holdings would merge into FH Acquisition, and the combined entity would then merge into petitioner.
In order to procure adequate capital for the tender offer, FH Acquisition obtained commitments from several of the investors to purchase subordinated floating-rate bridge notes (bridge notes) to be issued by it. The proceeds from the bridge note issuance would cover the difference between the bank financing and the cost of the shares to be tendered. As part of the Merger Plan, the bridge notes were to be replaced with long-term, fixed-rate subordinated notes and debentures (hereinafter referred to as permanent financing or permanent debt) as soon as the LBO was completed.4 For numerous reasons, Morgan Stanley was “highly confident” of its ability to underwrite the permanent financing. These reasons included the quality of petitioner's management, the quality of petitioner's production technology and its advancement over the technology of petitioner's competitors, the consistency of petitioner's business, the timing of the LBO in the business cycle of petitioner's industry, and the economic environment.
As of June 30, 1988, FH Acquisition had obtained commitments from the investors to purchase bridge notes worth $1.040 billion. Of this amount, $793 million was committed by Morgan Stanley on June 30, 1988. In the commitment letter, FH Acquisition agreed to pay Morgan Stanley a contingent amount—described as additional interest—on the bridge notes.5 On August 1, 1988, FH Holdings, FH Acquisition, and the investors executed a Securities Purchase Agreement, in which the investors made commitments to purchase bridge and permanent financing. In this agreement, Morgan Stanley International (MSI), a wholly owned subsidiary of Morgan Stanley, agreed to purchase the bridge notes to which Morgan Stanley had previously committed. In consideration for this agreement, FH Acquisition agreed to pay MSI $10,660,000, described as additional interest.
On July 1, 1988, pursuant to the Merger Plan, FH Acquisition commenced a cash tender offer for all petitioner's outstanding shares. The tender offer terminated on August 8, 1988, and resulted in the tender of approximately 80 percent of petitioner's stock.
On August 9, 1988, in order to purchase the tendered shares, FH Acquisition incurred approximately $1.206 billion in term loans, $400 million in bridge loans, and a $400 million revolving credit facility from Bankers Trust and the bank syndicate.6 On the same day, FH Acquisition also sold $1.04 billion in subordinated floating-rate bridge notes to MSI and the institutional investors. Of this amount, $533 million of bridge notes were purchased by MSI. By August 11, 1988, MSI had entered into Secondary Note Purchase Agreements with respect to $545 million 7 of bridge notes and Participation Agreements with respect to $60 million of bridge notes.8 By August 11, 1988, MSI closed on Secondary Note Purchase Agreements or Participation Agreements with respect to all but $75 million of the bridge notes it purchased. Also, on August 9, 1988, Morgan Stanley, Bankers Trust, and the institutional investors purchased common stock for $414 million from FH Holdings, which promptly contributed the $414 million to FH Acquisition.
FH Acquisition used $2,835,527,083 of the above financing to purchase the tendered shares on August 9, 1988. On August 17, 1988, FH Acquisition filed a Preliminary Prospectus with the Securities and Exchange Commission (SEC) for the issuance of the permanent debt. The drafting of the Preliminary Prospectus had begun in early July 1988. According to an internal Morgan Stanley selling memorandum for the permanent debt, dated September 1988: “The proceeds of the Permanent Financing being offered will be used to refinance the $400 million senior bridge loan and $800 million of subordinated bridge notes”, as well as other elements of the bridge financing following the merger of FH Acquisition into petitioner.
On October 24, 1988, FH Holdings was merged into FH Acquisition, with FH Acquisition surviving the merger. Immediately prior to this merger, 32 members of petitioner's management and its largest shareholder purchased shares in FH Holdings. FH Acquisition then immediately merged with and into petitioner, with petitioner as the surviving corporation in the merger. This resulted, after operation of State law, in 100–percent ownership of petitioner by the investors. On November 1, 1988, the permanent financing was issued and used to pay in full the bank bridge loan and all the subordinated floating-rate bridge notes.
Petitioner (through its predecessor, FH Acquisition) incurred and paid numerous expenses in order to complete the LBO. These included fees for the services of Morgan Stanley and the various banks and legal expenses. They also included costs of obtaining the various loans and issuing debt and equity. As to the issuance of debt and loan financing, these costs included commitment fees, transaction...
To continue reading
Request your trial
-
Mueller v. Comm'r of Internal Revenue (In re Estate of Mueller)
...equitable recoupment. 21. The excursus in the text further sharpens the point of my observation in Fort Howard Corp. v. Commissioner, 103 T.C. 345, 377 n. 2 (1994) (Beghe, J., dissenting), that for tax purposes the connections that are important are not so much the logical connections arriv......
-
Redlark v. Comm'r of Internal Revenue
...because the interest is connected to the Federal income taxes that they must pay on their business income. Fort Howard Corp. and Subs. v. Commissioner, 103 T.C. 345, 352 (1994) (an expense is incurred “in connection with” the conduct of a trade or business if it is associated with or logica......
-
Tigers Eye Trading, LLC v. Comm'r of Internal Revenue
...Generally, words in revenue legislation should be interpreted according to their ordinary, everyday meaning. Fort Howard Corp. & Subs. v. Commissioner, 103 T.C. 345, 351 (1994) (citing Commissioner v. Soliman, 506 U.S. 168, 174 (1993)). "Relate" means, inter alia, "to show or establish logi......
-
Berry Petroleum Co. v. Comm'r of Internal Revenue, 28578-91.
...might be deemed to have interpreted “in connection with” more narrowly than we interpreted it in Fort Howard Corp. v. Commissioner, 103 T.C. 345, 352 (1994). However, the Court of Appeals for the Ninth Circuit has not taken a position on the interpretation of “in connection with” in the con......
-
Practical advice on current issues.
...payment constitutes interest is whether the payment bears some relationship to the amount borrowed (Fort Howard Corp. & Subs., 103 T.C. 345 (1994)). A fee paid to a lender, then, is more likely to be regarded as interest if it is determined by reference to the amount loaned by that lend......
-
Deductibility of loan fees in light of conflicting judicial opinions.
...arrangement and the stock redemption. In contrast, just weeks later, the Tax Court ruled, under similar facts, in Fort Howard Corp., 103 TC 345 (1994), that such expenses were not deductible under Sec. 162(k). The Tax Court concluded that the financing arrangements were an integral and inex......
-
Congress clarifies denial of redemption expenses under sec. 162(k).
...However, the courts have reached conflicting conclusions on the issue. The Tax Court found in favor of the Service in Fort Howard Corp., 103 TC 345 (1994), but the Ninth Circuit reached a contrary decision in Kroy (Europe) Limited, 27 F3d 367 (1994). The issue has been addressed by a techni......