Tax Court allows ordinary deduction of termination fees

The Tax Court applied a narrow definition to Sec. 1234A(1)’s “with respect to property” requirement when considering the character of a corporation’s $1.6 billion deduction of a fee it paid to terminate a proposed merger, holding that it was an ordinary deduction to which Sec. 1234A did not apply.

Facts: AbbVie Inc., a Delaware public corporation operating in pharmaceuticals, announced in July 2014 its intention to pursue a merger with Shire PLC, a foreign public limited company also in the pharmaceutical sector. The merger was arranged so that shareholders of Shire and AbbVie would exchange their shares for shares of New AbbVie, a Jersey company (i.e., formed in the island of Jersey), which was created to facilitate the merger. The exchange was to take place in two phases. First, Shire shareholders would enter a court-sanctioned “scheme of arrangement” with Shire under the Jersey Companies Law of 1991 and exchange their Shire shares for cash and New AbbVie shares accordingly. Second, AbbVie shareholders would approve an Agreement and Plan of Merger (Delaware Merger Agreement) in which AbbVie would merge into a subsidiary of New AbbVie, and its shareholders would swap their shares for New AbbVie shares.

This intention was formalized in a series of joint documents, most notably a cooperation agreement that set out the rights and obligations of both parties, including a termination clause providing that AbbVie would pay Shire a “break fee” of approximately $1.6 billion if the merger did not occur as a result of AbbVie’s failure to carry out its agreed responsibilities under the agreement. Crucial among these responsibilities was AbbVie’s commitment to recommend the Delaware Merger Agreement to its shareholders. In October 2014, AbbVie’s board withdrew its recommendation to its shareholders after determining that failure to do so would be a breach of its fiduciary responsibility under Delaware law. This determination was made in response to Notice 2014-52, issued by the IRS in the preceding month, stating that it intended to issue new regulations concerning inversion transactions, which would be made retroactive to the date of the notice (Sept. 22, 2014), thereby making it prior to the date the proposed merger would have occurred.

AbbVie and Shire subsequently terminated the cooperation agreement, including all its rights and obligations, and entered a termination agreement that included the break fee. AbbVie paid the $1.6 billion break fee on Oct. 21, 2014. In its 2014 tax filings, AbbVie deducted the break fee as an ordinary deduction.

Eight years later, the IRS determined that the break fee did not qualify as an ordinary deduction but was a capital loss pursuant to Sec. 1234A. Accordingly, it issued AbbVie a notice of deficiency determining a deficiency of approximately $572 million. AbbVie filed a petition in Tax Court challenging the IRS’s determination. The company and the IRS filed cross-motions for summary judgment.

Issues: Sec. 1234A provides that any “[g]ain or loss attributable to the … termination of — (1) a right or obligation … with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer” be treated as a capital gain or loss. The IRS maintained that the termination of AbbVie’s rights and obligations under the cooperation agreement characterized the break fee as a capital loss. AbbVie, on the other hand, argued that Sec. 1234A(1) did not apply to the break fee since it was not “with respect to property,” thereby making it correct to characterize the fee as an ordinary deduction.

The Tax Court found that four requirements must be met in determining the applicability of Sec. 1234A(1):

1. There must be a gain or loss;
2. That gain or loss must be attributable to the cancellation, lapse, expiration, or other termination of a right or obligation (with certain exceptions);
3. The terminated right or obligation must be “with respect to property”; and
4. The property underpinning the terminated right or obligation must currently be (or on acquisition would be) a capital asset in the hands of the taxpayer.

The Tax Court identified the key issue as being the third, whether these rights and obligations were “with respect to property,” and how that phrase should be defined. Reviewing the case law, the Tax Court concluded that “in the context of [Sec.] 1234A(1), a ‘right or obligation … with respect to property’ is a right or obligation to transfer (for example, to buy, sell, or otherwise transfer) property or a property interest. By contrast, a right or obligation to perform services related to property or to otherwise act without such a transfer is not a ‘right or obligation … with respect to property’ within the meaning of [Sec.] 1234A(1).”

The Tax Court therefore rejected the IRS’s view of the cooperation agreement as having given AbbVie rights and obligations to transfer the shares, on two bases. First, the Tax Court held that AbbVie at no point had any rights or obligations to transfer the shares of AbbVie or Shire, nor did it have the power to enter a transaction that would have given the companies such rights and obligations. That power rested with the respective shareholders. AbbVie’s role was to facilitate the transfer, not to execute it. As such, the Tax Court determined that Sec. 1234A(1) did not apply.

Second, in response to the IRS’s assertion that the legislative history supported capital loss treatment under Sec. 1234A(1), the Tax Court noted that legislative history cannot override a statute’s unambiguous text. Even if the legislative history were considered, it would only serve to further weaken the IRS’s argument. The Tax Court examined congressional reports from 1981 and determined that the legislative intent of Sec. 1234A was to ensure that transactions economically equivalent to the sale of a capital asset were treated as such. The cooperation agreement was best characterized as a contract for services, and the termination of a contract for services is in no way equivalent to the sale of a capital asset. Thus, the break fee could not be considered a capital loss under Sec. 1234A(1).

Holding: The Tax Court granted AbbVie’s motion for summary judgment and denied the IRS’s motion. The court held that AbbVie’s rights and obligations under the cooperation agreement were fundamentally in the nature of services rather than a right to transfer property or a property interest and thus were not “with respect to property” pursuant to Sec. 1234A(1). Therefore, AbbVie was entitled to claim the $1.6 billion break fee as an ordinary deduction.

• AbbVie Inc., 164 T.C. No. 10 (2025)

— Jack Horner is a student in the Charles H. Dyson School of Applied Economics and Management, and Thomas Godwin, CPA, CGMA, Ph.D., and John McKinley, CPA, CGMA, J.D., LL.M., are both professors of the practice in accounting and taxation in the SC Johnson College of Business, all at Cornell University in Ithaca, N.Y. To comment on this column, contact Paul Bonner, the JofA‘s tax editor.