11.1 Introduction

ASC 805-740

05-1 This Subtopic provides incremental guidance on accounting for income taxes related to business combinations and to acquisitions by not-for-profit entities. This Subtopic requires recognition of deferred tax liabilities and deferred tax assets (and related valuation allowances, if necessary) for the deferred tax consequences of differences between the tax bases and the recognized values of assets acquired and liabilities assumed in a business combination or in an acquisition by a not-for-profit entity.

05-2 The recognition and measurement requirements related to accounting for income taxes in this Subtopic are exceptions to the recognition and measurement principles that are otherwise required for business combinations and acquisitions by not-for-profit entities, as established in Sections 805-20-25 and 805-20-30.

Overall Guidance

15-1 This Subtopic follows the same Scope and Scope Exceptions as outlined in the Overall Subtopic, see Section 805-10-15.

25-1 This Section provides general guidance on the recognition of deferred tax assets and liabilities in connection with a business combination. It also addresses certain business-combination-specific matters relating to goodwill, replacement awards, and the allocation of consolidated tax expense after an acquisition.

25-2 An acquirer shall recognize a deferred tax asset or deferred tax liability arising from the assets acquired and liabilities assumed in a business combination and shall account for the potential tax effects of temporary differences, carryforwards, and any income tax uncertainties of an acquiree that exist at the acquisition date, or that arise as a result of the acquisition, in accordance with the guidance in Subtopic 740-10 together with the incremental guidance provided in this Subtopic.

25-3 As of the acquisition date, a deferred tax liability or asset shall be recognized for an acquired entity’s taxable or deductible temporary differences or operating loss or tax credit carryforwards except for differences relating to the portion of goodwill for which amortization is not deductible for tax purposes, leveraged leases, and the specific acquired temporary differences identified in paragraph 740-10-25-3(a). Taxable or deductible temporary differences arise from differences between the tax bases and the recognized values of assets acquired and liabilities assumed in a business combination. Example 1 (see paragraph 805-740-55-2) illustrates this guidance. An acquirer shall assess the need for a valuation allowance as of the acquisition date for an acquired entity’s deferred tax asset in accordance with Subtopic 740-10.

25-4 Guidance on tax-related matters related to the portion of goodwill for which amortization is not deductible for tax purposes is in paragraphs 805-740-25-8 through 25-9; guidance on accounting for the acquisition of leveraged leases in a business combination is in Subtopic 842-50; and guidance on the specific acquired temporary differences identified in paragraph 740-10-25-3(a) is referred to in that paragraph.

25-5 The tax bases used in the calculation of deferred tax assets and liabilities as well as amounts due to or receivable from taxing authorities related to prior tax positions at the date of a business combination shall be calculated in accordance with Subtopic 740-10.

25-6 In a taxable business combination, the consideration paid is assigned to the assets acquired and liabilities assumed for financial reporting and tax purposes. However, the amounts recognized for particular assets and liabilities may differ for financial reporting and tax purposes. As required by paragraph 805-740-25-3, deferred tax liabilities and assets are recognized for the deferred tax consequences of those temporary differences. For example, a portion of the amount of goodwill for financial reporting may be allocated to some other asset for tax purposes, and amortization of that other asset may be deductible for tax purposes. If a valuation allowance is recognized for that deferred tax asset at the acquisition date, recognized benefits for those tax deductions after the acquisition date shall be applied in accordance with paragraph 805-740-45-2.

25-7 See Examples 1 through 3 (paragraphs 805-740-55-2 through 55-8) for illustrations of the recognition of deferred tax assets and related valuation allowances at the date of a nontaxable business combination.

A business combination occurs when one substantive legal entity obtains control of a group of assets that meets the ASC master glossary’s definition of a business. A business combination can be legally structured in a variety of ways and as discussed further below, the determination of whether a legal entity (or group of assets) being acquired meets the definition of a business is often a conclusion that requires significant judgment as well as a good understanding of the components of the transaction.

The main difference between the accounting for an acquisition of a business (i.e., a business combination) and that for an acquisition of a group of assets that is not a business (i.e., an asset acquisition) is the existence of goodwill. As discussed further in Section 11.8, the accounting for income tax consequences differs between an asset acquisition and a business combination as well.

The underlying premise of accounting for a business combination (which is addressed by ASC 805) is that when an entity obtains a controlling financial interest in a business, it becomes accountable for all of the acquiree’s assets and liabilities. This results in an accounting recognition event for which the entity should recognize the assets acquired and liabilities assumed at their fair values on the acquisition date. This is true regardless of whether the acquirer obtains 100 percent or lesser controlling financial interest in a business. That is, the acquisition method of accounting, whereby acquired assets and liabilities are recorded at fair value by the acquirer, is applied whenever an entity obtains control of a business.

ASC 805 has two key principles, known as the “recognition principle” and the “measurement principle.” According to the recognition principle, for financial reporting purposes, an acquirer must “recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.” Under the measurement principle, for financial reporting purposes, the acquirer must then measure “the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values.”1 The application of these principles will have an impact on the accounting for income taxes since, depending on how the transaction is structured for tax purposes, deductible and taxable temporary differences might need to be recorded in connection with the accounting for the business combination or asset acquisition.

Before an entity can apply the acquisition method, it must determine whether a transaction meets the definition of a business combination. The ASC master glossary defines a business combination as “[a] transaction or other event in which an acquirer obtains control of one or more businesses.” Typically, a business combination occurs when an entity purchases the equity interests or the net assets of one or more businesses in exchange for cash, equity interests of the acquirer, or other consideration. However, the definition of a business combination applies to more than just purchase transactions; it incorporates all transactions or events in which an entity or individual obtains control of a business.

Control has the same meaning as “controlling financial interest,” and an entity applies the guidance in ASC 810-10 to determine whether it has obtained a controlling financial interest in a business. Under ASC 810-10, an entity determines whether it has obtained a controlling financial interest by applying the VIE model or the voting interest entity model.

In January 2017, the FASB issued ASU 2017-01 to clarify the definition of a business because the previous definition in ASC 805 was often applied so broadly that transactions that were more akin to asset acquisitions were being accounted for as business combinations. The ASU introduced a screen for determining when a set of activities and assets is not a business. An entity uses the screen to assess whether substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets. If so, the set is not a business. The screen is intended to reduce the number of transactions that an entity must further evaluate to determine whether they are business combinations or asset acquisitions.

To be considered a business, an acquired group of assets must (1) pass the screen and (2) include an input and a substantive process that together significantly contribute to the ability to create outputs. Under the previous definition of a business, it was not always clear whether an element was an input or a process or whether a process had to be substantive to affect the determination. Therefore, the ASU provided a framework to help entities evaluate whether both an input and a substantive process are present.

See Chapter 1 of Deloitte’s Roadmap Business Combinations for additional guidance on the determination of whether an acquired group of assets meets the definition of a business.

Once it has been concluded that a business combination has occurred and the amount of consideration to acquire the business has been determined, the next step in applying the acquisition method is recognizing and measuring the identifiable assets, liabilities, and any noncontrolling interest in the acquiree. Acquired assets and liabilities are generally initially measured at their acquisition-date fair value. However, certain assets or liabilities are exceptions to the recognition principle, the measurement principle, or both, and are measured in accordance with other U.S. GAAP. These would include income taxes that are recognized and measured in accordance with ASC 740, which is discussed throughout this chapter.

11.1.1 Measurement Period

Because it may take time for an entity to obtain the information necessary to recognize and measure all the items exchanged in a business combination, the acquirer is allowed a period in which to complete its accounting for the acquisition. That period — referred to as the measurement period — ends as soon as the acquirer (1) receives the information it had been seeking about facts and circumstances that existed as of the acquisition date or (2) learns that it cannot obtain further information. However, the measurement period cannot be more than one year after the acquisition date. During the measurement period, the acquirer recognizes provisional amounts for the items for which the accounting is incomplete, including income taxes. Adjustments to any of these items will affect the amount of goodwill recognized or bargain purchase gain.

ASC 805 originally required that if a measurement-period adjustment was identified, the acquirer retrospectively revised comparative information for prior periods, including making any change in depreciation, amortization, or other income effects as if the accounting for the business combination had been completed as of the acquisition date. However, revising prior periods to reflect measurement-period adjustments added cost and complexity to financial reporting, and many believed that it did not significantly improve the usefulness of the information provided to users. To address those concerns, the FASB issued ASU 2015-16 in September 2015. Under the ASU, an acquirer is now required to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined rather than retrospectively, including the effect on earnings of changes in depreciation or amortization, or other income effects (if any) as a result of the change to the provisional amounts, calculated as if the accounting had been completed as of the acquisition date.

The measurement period is not intended to allow for subsequent adjustments of the amounts recognized as part of the business combination that result from the uncertainties and related risks the acquirer assumed in the combination. For example, adjustments that are due to decisions made by the combined company or changes in facts and circumstances or economic conditions that occurred after the acquisition date are not measurement-period adjustments; rather, they are included in the determination of net income in the period in which they are made. See Section 11.4 for additional information.

11.1.2 Asset Acquisitions

An asset acquisition is an acquisition of an asset, or a group of assets, that does not meet the definition of a business; such an acquisition therefore does not meet the definition of a business combination. The accounting for these transactions is addressed in the “Acquisition of Assets Rather Than a Business” subsections of ASC 805-50, but many of the same considerations apply to the accounting for income taxes as a business combination.

For financial reporting purposes, asset acquisitions are accounted for by using a cost accumulation model (i.e., the cost of the acquisition, including certain transaction costs, is allocated to the assets acquired on the basis of relative fair values, with some exceptions). By contrast, a business combination is accounted for by using a fair value model (i.e., the assets and liabilities are generally recognized at their fair values, and the difference between the consideration paid, excluding transaction costs, and the fair values of the assets and liabilities is recognized as goodwill). As a result, there are differences between the accounting for an asset acquisition and the accounting for a business combination.

A significant difference in an asset acquisition is that there is no goodwill recorded. That is, the cost paid to acquire the assets and liabilities is allocated entirely to the assets and liabilities acquired. This includes acquired DTLs and DTAs that result from an asset acquisition. This adds complexities to the calculation of acquired DTAs and DTLs in asset acquisitions since there is no goodwill to record as an offset to acquired DTAs and DTLs (resulting in the need to use the simultaneous equations method to determine the DTAs or DTLs). For a discussion and illustration of the simultaneous equations method, see ASC 740-10-25-51 and ASC 740-10-55-171 through 55-182. In addition, see Section 11.8 for a discussion of the accounting for income tax consequences of asset acquisitions.

11.1.3 Taxable Versus Nontaxable Business Combination

Once recognition and measurement of the identifiable assets, liabilities, and any noncontrolling interest in the acquiree has occurred (for financial reporting purposes under the principles of U.S. GAAP), ASC 805-740 requires recognition of a DTL or DTA as of the acquisition date for the taxable and deductible temporary differences between (1) the financial reporting values of assets acquired and liabilities assumed and (2) the tax bases of those assets and liabilities. Determining the appropriate tax bases of those assets and liabilities depends in part on whether the transaction is treated as taxable or nontaxable.

Generally, the difference between a taxable business combination and a nontaxable business combination is that the assets acquired and liabilities assumed in a taxable business combination are typically recorded at fair value for both income tax and financial reporting purposes; however, in a nontaxable business combination, the predecessor’s tax bases are carried forward for assets acquired and liabilities assumed.

A taxable business combination will usually occur when the purchase transaction is structured as an asset purchase wherein the acquirer purchases the specific assets and liabilities of the acquiree but does not assume ownership of the target’s stock. This type of transaction allows the acquirer to step up the tax basis of the assets and liabilities to their fair value. By contrast, a nontaxable business combination will typically be the result in a stock purchase wherein the acquirer will assume the acquiree’s tax basis of the assets and liabilities. However, certain elections under the tax code related to the establishment of the tax bases of assets and liabilities acquired may be available that will allow an acquirer to treat a stock purchase in a manner similar to an asset purchase (e.g., IRC Section 338(h)(10)).

Connecting the Dots

Asset acquisitions or business combinations under U.S. GAAP could be asset purchases or stock purchases for tax purposes. It is critical that an entity understand the structure and accounting for a given transaction under ASC 805 and the tax code, including what tax elections may apply, when determining the deferred tax consequences of the transaction.

In both taxable and nontaxable business combinations, the amounts assigned to the individual assets acquired and liabilities assumed for financial statement purposes may differ from the amounts assigned or carried forward for tax purposes. A DTL or DTA is recognized for each of these temporary differences with certain exceptions (e.g., recognition of deferred taxes on goodwill), as described throughout this Roadmap.

An entity would apply the recognition and measurement criteria of ASC 740 (or other authoritative literature) to record acquired DTAs and DTLs instead of the general measurement principles of ASC 805 (i.e., they are not recorded at fair value).

Specific guidance on certain temporary differences that may occur in both taxable and nontaxable business combinations is addressed in other sections of this chapter as follows:

Reacquired rights (Section 11.3.4.2).
Contingent liabilities (Section 11.3.5.1.1).
Contingent consideration (Section 11.3.6.2.1.1).

Footnotes

As discussed further in this chapter, there are certain exceptions to the measurement principle.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.