Merger Termination Fee Is Deductible as Ordinary Loss

(Parker Tax Publishing June 2025)

The Tax Court held that a corporation's rights and obligations under a cooperation agreement it entered in connection with a proposed merger with another corporation were fundamentally in the nature of services and thus, when the merger could not be completed, the taxpayer's payment under the agreement to the other corporation was deductible as an ordinary loss and not as a capital loss under Code Sec. 1234A(1) as the IRS had argued. The court concluded that Code Sec. 1234A(1) did not require the taxpayer to treat the payment as a capital loss because, under the agreement, the taxpayer did not have a "right or obligation . . . with respect to property" within the meaning of Code Sec. 1234A(1). AbbVie Inc. and Subs. v. Comm'r, 164 T.C. No. 10 (2025).

Background

In 2014, AbbVie, Inc. (AbbVie), a domestic public corporation, and Shire plc (Shire), a foreign public limited company, announced that they were combining the two companies. AbbVie and Shire then entered into contracts to facilitate the proposed combination. Among those contracts was a Co-operation Agreement that defined the steps each party would take to work towards the proposed combination. Within the Co-operation Agreement, AbbVie agreed to pay Shire approximately $1.6 billion as a termination fee if it failed in carrying out its agreed responsibilities and, as a result of that failure, the combination did not occur.

On September 22, 2014, before either AbbVie's or Shire's shareholders had voted on the proposed combination, the IRS issued Notice 2014-52, which stated its intention to issue new regulations concerning inversion transactions. Those regulations would be retroactive to the date of the Notice - that is, before the proposed combination was completed. On October 15, 2014, having reviewed Notice 2014-52, AbbVie's board of directors withdrew its recommendation that shareholders approve the proposed combination. Instead, the two companies entered into a Termination Agreement, which ended the Co-operation Agreement and required AbbVie to pay Shire approximately $1.6 billion (the Break Fee).

On its 2014 tax return, AbbVie reported the $1.6 billion fee as an ordinary loss deduction. The IRS rejected that characterization and concluded that the payment and termination of the agreement resulted in a capital loss under Code Sec. 1234A(1) and a deficiency of approximately $572 million. AbbVie took its case to the Tax Court.

Code Sec. 1234A characterizes gains or losses from certain terminations as capital gains or losses. Code Sec. 1234A(1) applies when four requirements are met. First, there must be a gain or loss. Second, that gain or loss must be attributable to the cancellation, lapse, expiration, or other termination of a right or obligation. Third, the terminated right or obligation must be "with respect to" property. Fourth, the property underpinning the terminated right or obligation must currently be (or would on acquisition be) a capital asset in the hands of the taxpayer.

Both AbbVie and the IRS filed motions for summary judgment. AbbVie argued that Code Sec. 1234A(a) did not apply to the Break Fee and thus it correctly claimed an ordinary deduction for the Break Fee. The IRS argued that Code Sec. 1234A(1) applied and required AbbVie to treat the Break Fee as a capital loss.

Analysis

The Tax Court held that, because AbbVie's rights and obligations under the merger agreement were fundamentally in the nature of services, the third requirement of Code Sec. 1234A(1) was not met and the Break Fee was thus deductible as an ordinary loss rather than a capital loss.

In examining whether the terminated right or obligation at issue was "with respect to" property, the court began with the statute's ordinary meaning. In this contractual context, the court said, the term "right" generally means something to which a party has a claim as a legal matter. Considering the Co-operation Agreement and the related arrangements between the parties, the court said there was no doubt that AbbVie had rights and obligations related to its proposed combination with Shire. However, the key question for the court was whether any of AbbVie's myriad rights and obligations under the Co-operation Agreement were "with respect to property." Considering the essence of the agreement as a whole, the court found the required connection lacking.

At its core, the court said, the Co-operation Agreement was not an agreement to buy, sell, or otherwise transfer property. In fact, the court observed, it could not be such an agreement because the parties to the agreement (AbbVie and Shire) did not own the valuable property (their own shares) that would have been exchanged in the proposed combination. In other words, none of the Co-operation Agreement's terms could have conferred rights or obligations with respect to AbbVie or Shire shares because the power to confer such rights rested with the companies' public shareholders.

While noting that no other court has considered this precise issue, the Tax Court said that its interpretation was consistent with how various courts have characterized Code Sec. 1234A(1). For example, the Tax Court cited the Eleventh Circuit's decision in CRI-Leslie, LLC v. Comm'r, 2018 PTC 42 (11th Cir. 2018), in which the Eleventh Circuit said that "stated simply, Section 1234A says that any gain or loss that results from the termination of an agreement to buy or sell property that is properly classified as a "capital asset" will, notwithstanding the termination, be treated as a gain or loss from a consummated sale. Section 1234A thereby ensures capital-gains treatment of income resulting from canceled property sales by relaxing the "sale or exchange" element of the Code's general definition of "[l]ong-term capital gain"i.e., "gain from the sale or exchange of a capital asset held for more than 1 year . . . ." The Tax Court noted that other courts, including itself, have used similar wording and, in reading Code Sec. 1234A(1), these courts focused on rights to buy and sell capital assets.

For a discussion of the tax treatment of the gains or losses on terminations of contracts, see Parker Tax ¶116,130. For a general discussion of the tax treatment of gains or losses from sales, exchanges, and dispositions of property, see Parker Tax ¶110,100.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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