Appeal from the United States Tax Court.
Before HARLINGTON WOOD, JR., RIPPLE and KANNE, Circuit Judges.
The predecessor of A.E. Staley Manufacturing Company and Subsidiaries ("Staley") paid investment bankers in connection with an unsuccessful effort to defeat a hostile tender offer. On its federal income tax return, the company claimed a deduction for the fees paid to the bankers. The Commissioner of Internal Revenue disallowed the claimed deduction and issued a notice of deficiency. Staley's predecessor then filed a petition in the United States Tax Court challenging the disallowance. The Tax Court agreed with the Commissioner and held that the expenses were capital expenditures which cannot be deducted. Staley now appeals the Tax Court's judgment, and we reverse and remand for further proceedings consistent with this opinion.
Staley, the petitioner in this case, was an affiliated group of corporations, formerly named Staley Continental, Inc. and Subsidiaries ("SCI"). The predecessor of both petitioner and SCI was A.E. Staley Manufacturing Co. ("AES"). From its organization in 1906 until November 1984, AES' primary business consisted of storing, marketing, milling, processing and refining corn and soybeans. AES employed a process called corn wet milling to produce sweeteners, starches, oils and other ingredients for the food and beverage industry. AES' principal product was high fructose corn syrup. By the mid-1980s, high fructose corn syrup had become the leading sweetener in the country's food and beverage market, especially in the soft drink industry.
Because AES believed that the market had matured for its product, in 1984 its board of directors made the long-term strategic decision to enter into the food service business. AES diversified into this area by acquiring other companies, including CFS Continental, Inc., one of the country's leading suppliers in the food service industry. SCI was formed and became the parent company of AES and CFS Continental, Inc. Using the revenues it earned from corn wet milling, SCI began to pursue growth in the food service business.
When an investment banker threatened to acquire SCI in 1986, SCI began to fear the possibility of a hostile takeover. SCI hired a law firm in response, which advised SCI to adopt antitakeover devices. SCI followed this advice and adopted some antitakeover measures. SCI also hired the First Boston Corporation and Merrill Lynch Capital Markets (collectively, "investment bankers") to prepare SCI for, and to advise and assist SCI in the event that another company were to attempt, a hostile takeover. SCI also agreed to hire the investment bankers to represent SCI in the event an offer was made.
In March 1987 Merrill Lynch made presentations to SCI's management and board of directors, in which it recommended that SCI take certain actions to prepare for any unsolicited takeover attempts. SCI implemented many of these proposals and, at the suggestion of Merrill Lynch, set up a defense team of attorneys, investment bankers and SCI executives.
Because Merrill Lynch also suggested that SCI identify friendly "white knight" investors to acquire enough stock in SCI to block any future takeover attempt, SCI sought out Tate & Lyle and discussed the possibility of Tate & Lyle's acquiring a 20% interest in SCI. Some casual conversation occurred about the possibility of merging the two companies. Tate & Lyle began purchasing SCI stock on the open market in April 1987; it soon acquired about 4% of the company. SCI soon feared Tate & Lyle, though, because Tate & Lyle would not sign a "standstill agreement," which would limit the amount of stock that Tate & Lyle would purchase. When Tate & Lyle filed a Hart-Scott-Rodino notification to acquire up to 25% of SCI's stock, SCI feared that this action would put SCI up for sale and decided to resist additional purchases of its stock.
On April 8, 1988, Tate & Lyle made a public tender offer directly to SCI's stockholders to purchase shares for $32 per share. On that same day, Tate & Lyle also sued SCI to enjoin the use of SCI's antitakeover devices and the application of various states' antitakeover statutes. Tate & Lyle's chairman of the board of directors and chief executive officer, Neil M. Shaw, wrote Donald E. Nordlund, who held the same positions at SCI, stating that if Tate & Lyle were successful in its bid to acquire SCI, it would cancel SCI's diversification policy by selling CFS Continental, Inc. and would return SCI back to its core business, corn syrup. The management, board of directors and investment bankers of SCI considered Tate & Lyle's tender offer to be hostile because it was made without their consent or knowledge. On April 9 the defense team of SCI held an emergency meeting at which it decided that the tender offer was not in the best interests of the company or its shareholders because Tate & Lyle had no capital, marketing or research and development to offer. However, because the board recognized that it had a duty to evaluate the merits of the tender offer, it hired First Boston and Merrill Lynch on April 12 to advise and assist it with respect to the offer. The agreements provided that the investment bankers' fees for their services would be (1) $500,000 in cash; (2) an additional fee of 0.40% of the value of the transaction if Tate & Lyle or another company acquired at least 50% ...