Chapter 11 — Business Combinations
Chapter 11 — Business Combinations
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.
Measurement-period adjustments (i.e., those that result in an
adjustment to goodwill or bargain gain) do not result from new information that
was not available as of the acquisition date (e.g., new information that might
affect the realization assessment of uncertain tax benefits). Adjustments to
acquired assets and liabilities related to events or occurrences after the
acquisition date would be recorded immediately to income even if the new
information was obtained within the measurement period. 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
1
As discussed further in this chapter, there are certain
exceptions to the measurement principle.
11.2 General Principles of Income Tax Accounting for a Business Combination
Understanding the details of a business combination transaction is important to
understanding the related impacts on income tax accounting. For example, depending
on the nature of the transaction, certain elements may be accounted for as part of
purchase accounting or as separate transactions in the postcombination financial
statements of the acquirer or in the precombination financial statements of the
acquiree.
11.2.1 Identifying Parts of the Business Combination
ASC 805-20-25-6 states:
At the acquisition date, the acquirer shall classify or
designate the identifiable assets acquired and liabilities assumed as
necessary to subsequently apply other GAAP. The acquirer shall make
those classifications or designations on the basis of the contractual
terms, economic conditions, its operating or accounting policies, and
other pertinent conditions as they exist at the acquisition date.
Under ASC 805-20-25-6, DTAs and DTLs recognized in a business combination should
reflect the tax attributes of the acquired entity as well as the structure of
the combined entity as it exists on the acquisition date. Accordingly, the tax
effects of income tax elections, changes in tax status, tax planning, and
subsequent business integration steps that occur post-closing are generally
accounted for separately and apart from the business combination (i.e., on “day
2”). However, some income tax elections, changes in tax status, tax planning,
and subsequent business integration steps may be so integral to the business
combination transaction that they should be included in the application of the
acquisition method of accounting to the business combination.
While ASC 805-10-25-20 through 25-22 provide general guidance an
entity should consider when determining whether a transaction is part of the
business combination (see Section 1.1.9 of Deloitte’s Roadmap Business Combinations), there is no
direct guidance addressing whether the tax effects of income tax elections, tax
planning, and subsequent business integration steps that occur post-closing are
so integral to the business combination transaction that they should be included
in the acquisition accounting.
Accordingly, an entity must apply significant judgment on the basis of its facts
and circumstances and should consider the following questions, which are neither
mutually exclusive nor individually conclusive, when determining whether to
include income tax elections, changes in tax status, tax planning, or other
subsequent business integration steps that occur post-closing in its application
of the acquisition method of accounting to the business combination.
-
Was the income tax election, change in tax status, tax planning, or subsequent business integration step a factor in the negotiations of the business combination (e.g., were any adjustments to the purchase price considered during negotiations with the previous owners in contemplation of, or as consideration for, any of the income tax elections, tax planning, or subsequent business integration steps), or was the income tax election, tax planning, or subsequent business integration step identified post-closing?
-
Was the effective date of the income tax election, tax planning, or subsequent business integration step concurrent with or retroactive to the acquisition date, or will it only become effective post-closing?
-
Was the income tax election, tax planning, or subsequent business integration step primarily within the control of the acquirer or seller, or were there uncertainties or regulatory hurdles related to the income tax election, tax planning, or business integration step as of the closing?
-
Would the income tax election, tax planning, or subsequent business integration step be expected of every market participant, or would it be based on the acquirer’s specific facts and circumstances?
-
Were the tax benefits of the income tax election, tax planning, or subsequent business integration step obtained without interaction with the government, or was the acquirer required to (1) make a separate payment directly to the governmental taxing authority or (2) forego tax attributes to obtain the tax benefits?
11.2.2 Change in Tax Status as a Result of Acquisition
An entity’s taxable status may change as a result of a business combination. For
example, an S corporation could lose its nontaxable status when acquired by a C
corporation. When an entity’s status changes from nontaxable to taxable, DTAs
and DTLs should be recognized for any temporary differences in existence on the
recognition date (unless one of the recognition exceptions in ASC 740-10-25-3 is
applicable). Entities should initially measure such recognizable temporary
differences in accordance with ASC 740-10-30. See Section 3.5.2 for further discussion of recognizing and
measuring changes in tax status.
If the loss of the acquiree’s nontaxable status directly results
from an acquisition, temporary differences in existence on the acquisition date
should be recognized as part of the business combination acquisition accounting
(i.e., through goodwill during the measurement period) under ASC 805-740-25-3
and 25-4. If, because of the acquisition, the acquired entity no longer meets
the requirements to be considered a nontaxable entity, all the basis differences
in the entity that would be considered taxable or deductible temporary
differences would be recognized on the acquisition date. If a valuation
allowance is established as part of the acquisition accounting (including
amounts recorded as part of the measurement period), all subsequent changes to
the valuation allowance are recorded in accordance with ASC 740, typically in
income from continuing operations. See Section 11.5.1 for more information. Also
see Section 3.5.2
for additional financial reporting considerations related to a change in tax
status.
11.2.3 The Applicable Tax Rate
Because the combined entity and predecessor may have different
tax characteristics, an entity must determine which tax rate to use to establish
initial DTAs and DTLs when accounting for the tax impacts of a business
combination.
ASC 740-10-30-5 states, in part, that “[d]eferred taxes shall be
determined separately for each tax-paying component (an individual entity or
group of entities that is consolidated for tax purposes) in each tax
jurisdiction.” In addition, under ASC 740-10-30-8, an acquired entity’s deferred
taxes should be measured by “using the enacted tax rate(s) expected to apply to
taxable income in the periods in which the deferred tax liability or asset is
expected to be settled or realized.”
If, in periods after the business combination, the combined entity expects to
file a consolidated tax return, the enacted tax rates for the combined entity
should be used in measuring the deferred taxes of the acquirer and the acquiree.
The effect of tax law or rate changes that occur after the acquisition date
should be reflected in income from continuing operations in the period in which
the change in tax law or rate occurs (e.g., not as part of the business
combination).
In some cases, the process of establishing the enacted rate(s) expected to apply
is not straightforward. Among other situations, complexities arise during tax
holidays and when an entity adds state jurisdictions to the acquirer’s state tax
profile as a result of the acquisition.
11.2.3.1 Tax Holidays
Deferred taxes are not recognized for the expected taxable or deductible amounts of temporary differences that are related to assets or liabilities that are expected to be recovered or settled during a tax holiday. Paragraph 183 in the Basis for Conclusions of FASB Statement 109 states:
The Board considered whether a deferred tax asset ever should be
recognized for the expected future reduction in taxes payable during
a tax holiday. In most jurisdictions that have tax holidays, the tax
holiday is “generally available” to any enterprise (within a class
of enterprises) that chooses to avail itself of the holiday. The
Board views that sort of exemption from taxation for a class of
enterprises as creating a nontaxable status (somewhat analogous to
S-corporation status under U.S. federal tax law) for which a
deferred tax asset should not be recognized.
Therefore, deferred taxes are recognized for the expected taxable or
deductible amounts of temporary differences that are expected to reverse
outside of the tax holiday. In some situations, a temporary difference
associated with a particular asset or liability may reverse during both the
tax holiday and periods in which the entity is taxed at the enacted rates.
Accordingly, it may be necessary to use scheduling to determine the
appropriate deferred taxes to record in connection with the business
combination.
For additional information on the effect of tax holidays on the applicable
tax rate, see Section 3.3.4.5.
11.2.3.2 State Tax Footprint
The acquirer’s state tax footprint for an entity can change because of a
business combination. For example, an acquirer that is operating in Nevada
with no deferred state taxes but substantial temporary differences acquires
a target company in California. As a result of this acquisition, the
acquirer is now required to file a combined California tax return with the
target company. Therefore, the acquirer must record deferred taxes for
California state tax when no state taxes were previously recognized. When
calculating the impact of this change on the state tax footprint, an entity
must account for the income tax effects of its assets and liabilities before
the combination separately from those that were acquired as part of the
business combination.
Any change in the measurement of existing deferred tax items
of the acquirer as a result of this acquisition are recorded “outside” of
the acquisition accounting as a component of income tax expense. The initial
recognition of deferred tax items of the target company by the acquirer is
accounted for as part of the business combination.
11.3 Recognition and Measurement of Temporary Differences Related to Identifiable Assets Acquired and Liabilities Assumed
As noted in Section 11.1, the recognition principle and the measurement
principle of ASC 805 require an entity to “recognize, separately from goodwill, the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree” and to measure “the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree at their
acquisition-date fair values.” These recognition and measurement principles may
differ for financial reporting and tax purposes (i.e., an asset may be recorded at
fair value for book purposes versus at carryover basis for tax purposes). In both
taxable and nontaxable business combinations, DTAs and DTLs might need to be
recorded for any deductible and taxable temporary differences (i.e., basis
differences) that arise in connection with the accounting for the business
combination or asset acquisition. The sections below discuss how to account for
basis differences resulting from a business combination and provide examples of
common scenarios in which additional considerations are necessary.
11.3.1 Basis Differences
A basis difference arises when there is a difference between the financial
reporting amount of an asset or liability and its tax basis, as determined by
reference to the relevant tax laws in each tax jurisdiction. There are two
categories of basis differences: “inside” basis differences and “outside” basis
differences. (For more information about inside and outside basis differences,
see Section 3.3.1.)
The sections below describe the accounting for inside and
outside basis differences that arise in a business combination.
11.3.1.1 Inside Basis Difference
An inside basis difference is a temporary difference between the carrying
amount, for financial reporting purposes, of individual assets and
liabilities and their tax bases that will give rise to a tax deduction or
taxable income when the related asset is recovered or liability is settled.
Deferred taxes are always recorded on taxable and deductible temporary
differences unless one of the exceptions in ASC 740-10-25-3 applies.
11.3.1.2 Outside Basis Difference
An outside basis difference is the difference between the carrying amount of
an entity’s investment (e.g., an investment in a consolidated subsidiary)
for financial reporting purposes and the underlying tax basis in that
investment (e.g., the tax basis in the subsidiary’s stock).
Deferred taxes are always recorded for taxable and
deductible temporary differences unless a specific exception applies. The
exception that may apply under ASC 740 depends on whether the outside basis
difference results in a DTL or a DTA. DTLs are recorded on all outside basis
differences that are taxable temporary differences unless one of the
exceptions described in Section 3.3.2
is applicable. ASC 740-30-25-9 states that no DTAs should be recorded on the
excess of tax over financial reporting basis in subsidiaries and corporate
joint ventures unless it is “apparent that the temporary difference will
reverse in the foreseeable future” (e.g., generally within the next 12
months).
Example 11-1
Inside Basis Difference
Assume the following:
-
Acquiring Company (AC) purchases Target Company’s (TC’s) stock for $1,000 in cash in a nontaxable business combination. TC meets the definition of a business under ASC 805.
-
TC has two subsidiaries (S1 and S2), each of which was acquired in a previous taxable stock acquisition.
-
S1’s and S2’s assets consist of buildings and equipment, which have fair values of $750 and $250, respectively.
-
All of the entities are domestic corporations with respect to AC.
-
The tax rate is 21 percent.
TC’s only assets are its shares of S1 and S2, as
illustrated in the following table:
The journal entries recording the accounting for the
initial acquisition are as follows:
To record AC’s investment in TC:
Note that while pushdown accounting
is not required by ASC 805, journal entries have
been recorded (i.e., pushed down) to the
subsidiaries’ books because, in accordance with ASC
740-10-30-5, “[d]eferred taxes shall be determined
separately for each tax-paying component . . . in
each tax jurisdiction.” See Section 11.7.3 for
further discussion.
Example 11-2
Outside Basis Difference
Assume the same facts as in the
example above. Acquiring Company (AC) must determine
whether there is a basis difference in its
investment in Target Company (TC) and TC’s
subsidiaries and whether that difference (if any) is
a taxable temporary difference. The initial outside
basis differences are as follows:
As illustrated in the table above, there is no
difference between AC’s book and tax basis in its
investment in TC for AC to assess as of the
acquisition date. AC does, however, have differences
to assess with respect to TC’s investment in S1 and
S2. The following are two potential conclusions that
AC could reach in assessing the outside basis difference:
-
Because S1 and S2 are domestic subsidiaries of AC, AC could determine that it would liquidate S1 and S2 into TC to eliminate the outside basis differences in a tax-free manner. Accordingly, in applying the provisions of ASC 740-30-25-7, AC could conclude that the outside basis differences in S1’s and S2’s stock are not temporary differences. See Section 3.4.3 for further discussion of a tax-free liquidation or merger of a subsidiary.
-
AC could determine that to dispose of S1 and S2, AC would choose to have TC sell their stock rather than sell their assets to maximize after-tax proceeds. Accordingly, the outside basis differences in S1’s and S2’s stock would both be taxable temporary differences and the DTLs would be recorded in the business combination accounting.
11.3.2 Goodwill
As previously noted, the acquisition method of accounting
requires the acquirer to recognize and measure all separately identifiable
assets and liabilities acquired or assumed in connection with a business
combination. Even in a taxable business combination, there may be instances in
which the financial statement carrying amount of goodwill differs from its tax
basis. For example, certain intangibles are subsumed into goodwill for book
purposes but are bifurcated into separate intangible assets for tax purposes,
resulting in a basis difference in the goodwill and intangible assets.
Conversely, book basis is allocated to some assets and liabilities in the
acquisition that do not have tax basis (e.g., payment liabilities or lease
assets and liabilities). In other instances, assets or liabilities may be valued
differently for book and tax purposes (e.g., reacquired rights). Any of these
scenarios could result in differences between the book basis and tax basis of
goodwill.
As discussed further in Section
11.3.4, deferred taxes may need to be recorded as part of
purchase accounting for these acquired assets and liabilities. For financial
reporting purposes, the difference between the acquisition price and the fair
value of the acquired assets and liabilities will be recorded as goodwill (or on
rare occasions as a bargain purchase gain). A business combination may also
result in an entity’s acquiring goodwill for tax purposes. Special accounting
consideration (discussed further below) is required when an entity is
determining how to account for the tax effects of acquired goodwill.
ASC 805-740
Goodwill
25-8 Guidance
on the financial accounting for goodwill is provided in
Subtopic 350-20. For tax purposes, amortization of
goodwill is deductible in some tax jurisdictions. In
those tax jurisdictions, the reported amount of goodwill
and the tax basis of goodwill are each separated into
two components as of the acquisition date for purposes
of deferred tax calculations. The first component of
each equals the lesser of goodwill for financial
reporting or tax-deductible goodwill. The second
component of each equals the remainder of each, that is,
the remainder, if any, of goodwill for financial
reporting or the remainder, if any, of tax-deductible
goodwill.
25-9 Any
difference that arises between the book and tax basis of
that first component of goodwill in future years is a
temporary difference for which a deferred tax liability
or asset is recognized based on the requirements of
Subtopic 740-10. If that second component is an excess
of tax-deductible goodwill over the reported amount of
goodwill, the tax benefit for that excess is a temporary
difference for which a deferred tax asset is recognized
based on the requirements of that Subtopic (see Example
4 [paragraph 805-740-55-9]). However, if that second
component is an excess of goodwill for financial
reporting over the tax-deductible amount of goodwill, no
deferred taxes are recognized either at the acquisition
date or in future years.
Related Implementation Guidance and Illustrations
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Example 1: Nontaxable Business Combination [ASC 805-740-55-2].
-
Example 4: Tax Deductible Goodwill Exceeds Financial Reporting Goodwill [ASC 805-740-55-9].
ASC 805-740-25-3 indicates that recognition of deferred taxes on
differences between the financial reporting and the tax basis of goodwill
depends on whether goodwill amortization is deductible for tax purposes and on
which approach an entity applies to determine whether amortization of goodwill
is deductible for tax purposes. We are aware of two acceptable approaches in
practice:
- Approach 1 — Under this approach, for financial reporting purposes, deferred taxes generally should not be recognized for book and tax basis differences related to the portion of goodwill for which deductions are not allowed for the amortization or impairment of goodwill (e.g., goodwill subject to antichurning rules in the United States).
- Approach 2 — Under this approach, deferred taxes could be recognized even if the goodwill amortization is not deductible for tax purposes as long as the tax basis in the goodwill would be deductible upon cessation or sale of a business with which it is associated. This view is based on ASC 740-10-25-50, which addresses the tax basis of an asset used in the determination of temporary differences.
In tax jurisdictions where goodwill is deductible, goodwill for financial
reporting purposes and tax-deductible goodwill must be separated as of the
acquisition date into two components, in accordance with ASC 805-740-25-8 and
25-9 (see illustration below).
The first component of goodwill (“component 1 goodwill”) equals the lesser of (1)
goodwill for financial reporting purposes or (2) tax-deductible goodwill. Any
difference that arises between the book and tax basis of component 1 goodwill in
future periods is a temporary difference for which a DTA or DTL is
recognized.
The second component of goodwill (“component 2 goodwill”) equals (1) total
goodwill (the greater of financial reporting goodwill or tax-deductible
goodwill) less (2) the calculated amount of component 1 goodwill.
If component 2 goodwill is an excess of tax-deductible goodwill
over financial reporting goodwill, an entity must recognize a DTA related to the
excess as of the acquisition date in accordance with ASC 740. The entity should
use an iterative calculation to determine this DTA because goodwill and the DTA
are established simultaneously as of the acquisition date. ASC 805-740-55-9
through 55-13 provide the “simultaneous equations method” for this purpose.
Using this method, an entity simultaneously determines the amount of goodwill to
record for financial reporting purposes and the amount of the DTA. The example
below illustrates the application of the simultaneous equations method.
However, in accordance with ASC 805-740-25-9, if component 2 goodwill is an
excess of financial reporting goodwill over tax-deductible goodwill, no DTL
should be recorded.
Further, in certain business combinations, the acquired entity may have
tax-deductible goodwill from a prior acquisition for which it received
carry-over tax basis. The acquired tax-deductible goodwill should be included in
the acquisition date allocation between component 1 goodwill and component 2
goodwill.
Example 11-3
Assume the following:
-
Acquisition date of January 1, 20X9.
-
Financial reporting goodwill of $800, before initial tax adjustments.
-
Tax goodwill of $1,000.
-
Annual tax amortization of $500 per year.
-
No other temporary differences.
-
Tax rate of 25 percent.
-
Income before taxes in year 1 is $10,000, in year 2 is $11,000, and in year 3 is $12,000.
On Acquisition
Date:
-
Preliminary calculation of goodwill components:
-
Calculation of the DTA:
-
DTA = [0.25 ÷ (1 – 0.25)] × $200.
-
DTA = $67.
-
-
Journal entry to record the DTA:
Accounting in Years
1–3:
-
Calculation of taxes payable:
-
Calculation of deferred taxes:2Goodwill is not amortized for financial reporting purposes. Each year, a DTL must be calculated and recognized for the difference between component 1 financial reporting goodwill and component 1 tax goodwill. This DTL will reverse when the company impairs, sells, or disposes of the related assets.
-
Realization of the tax benefit:A tax benefit will be realized for the tax deduction associated with goodwill.Journal Entries for Years 1 and 2:
-
P&L snapshot:
11.3.2.1 Pre-FASB Statement 141(R) Transactions
Given the long-term nature of goodwill balances, some goodwill may have been generated in connection with business combinations that were accounted for under FASB Statement 141 before the issuance of FASB Statement 141(R) (codified in ASC 805), which amended paragraph 262 of FASB Statement 109 to require that the tax benefit associated with component 2 tax-deductible goodwill (an excess of tax-deductible goodwill over financial reporting goodwill) be recognized as of the acquisition date. Before the amendments made by Statement 141(R), the tax benefit associated with component 2
tax-deductible goodwill was recognized only when realized on the tax return.
This tax benefit was applied first to reduce goodwill related to the
acquisition to zero, then to reduce other noncurrent intangible assets
related to the acquisition to zero, and lastly to reduce income tax
expense.
After the effective date of Statement 141(R) (codified in ASC 805), the tax benefit associated with component 2 tax-deductible goodwill should continue to be recognized when realized on the tax return for business combinations previously accounted for in accordance with FASB Statement 141 (i.e., business combinations consummated in periods before the effective date of Statement 141(R)).
Paragraph 77 of Statement 141(R) states, in part, “For business combinations in which the acquisition date was before the effective date of this Statement, the acquirer shall apply the requirements of Statement 109, as amended by this Statement, prospectively” (emphasis added). Therefore, an entity would still need to apply the guidance in paragraphs 262 and 263 of Statement 109 (before the Statement 141(R) amendments) to any component 2 tax-deductible goodwill from business combinations accounted for under Statement 141. That is, for business combinations consummated before the effective date of ASC 805 (Statement 141(R)), goodwill would continue to be adjusted as the tax benefit associated with component 2 goodwill is realized on the tax return. Paragraph 262 of Statement 109, before being amended by Statement 141(R),
stated:
Amortization of goodwill is deductible for tax
purposes in some tax jurisdictions. In those tax jurisdictions, the
reported amount of goodwill and the tax basis of goodwill are each
separated into two components as of the combination date for
purposes of deferred tax calculations. The first component of each
equals the lesser of (a) goodwill for financial reporting or (b)
tax-deductible goodwill. The second component of each equals the
remainder of each, that is, (1) the remainder, if any, of goodwill
for financial reporting or (2) the remainder, if any, of
tax-deductible goodwill. Any difference that arises between the book
and tax basis of that first component of goodwill in future years is
a temporary difference for which a deferred tax liability or asset
is recognized based on the requirements of this Statement. No
deferred taxes are recognized for the second component of goodwill.
If that second component is an excess of tax-deductible goodwill
over the reported amount of goodwill, the tax benefit for that
excess is recognized when realized on the tax return, and that tax
benefit is applied first to reduce to zero the goodwill related to
that acquisition, second to reduce to zero other noncurrent
intangible assets related to that acquisition, and third to reduce
income tax expense.
Paragraph 263 of Statement 109, before being amended by Statement 141(R), included an example that illustrated the accounting for the tax consequences of goodwill when amortization of goodwill is deductible for tax purposes. The example below has been adapted from paragraph 263 of Statement 109 (as published before the amendments of Statement 141(R)) and illustrates the accounting that a reporting entity should apply to tax benefits associated with component 2 tax-deductible goodwill from business combinations originally accounted for under Statement 141. As described above, this accounting method applies even after the effective date of Statement 141(R).
Example 11-4
Assume the following:
-
As of the acquisition date (i.e., January 1, 20X8), the financial reporting amount and tax basis amount of goodwill are $600 and $800, respectively.
-
For tax purposes, amortization of goodwill will result in tax deductions of $400 in each of years 1 and 2. Those deductions result in current tax benefits in years 20X8 and 20X9.
-
For simplicity, the consequences of other temporary differences are ignored for years 20X8–2X11.
-
The entity has a calendar year-end and will adopt FASB Statement 141(R) on January 1, 20X9.
-
Income before income taxes is $1,000 in each of years 20X8–2X11.
-
The tax rate is 25 percent for all years.
Income taxes payable for years 20X8–2X11 are:
As of the combination date, goodwill is separated
into two components as follows:
A DTL is recognized for the tax amortization of
goodwill for years 20X8 and 20X9 for the excess of
the financial reporting amount over the tax basis of
the first component of goodwill. Although there is
no difference between the book and tax basis of
component 1 goodwill as of the business combination
date (both $600), a difference does arise as of the
reporting date. This difference results from (1) the
reduction of book goodwill by the realized benefits
on component 2 goodwill (the calculation is
explained below) and (2) the tax amortization of the
component 1 tax-deductible goodwill. When the second
component of goodwill is realized on the tax return
for years 20X8 and 20X9, the tax benefit is
allocated to reduce financial reporting
goodwill.
The second component of goodwill is
deductible at $100 per year in years 20X8 and 20X9.
Those tax deductions provide $25 ($100 at 25
percent) of tax benefits that are realized in years
20X8 and 20X9. The realized benefits reduce the
first component of goodwill and produce a deferred
tax benefit by reducing the taxable temporary
difference related to that component of goodwill.
Thus, the total tax benefit (TTB) allocated to
reduce the first component of goodwill in years 20X8
and 20X9 is the sum of (1) the $25 realized tax
benefit allocated to reduce goodwill and (2) the
deferred tax benefit from reducing the DTL related
to goodwill. The TTB is determined as follows:
TTB = realized tax benefit plus (tax rate times
TTB)
TTB = $25 + (0.25 × TTB)
TTB = $33
Goodwill for financial reporting purposes for years
20X8–2X11 is:
The DTL for the first component of goodwill and the
related amount of deferred tax expense (benefit) for
years 20X8–2X11 are:
Income for financial reporting for years 20X8–2X11
is:
11.3.2.2 Amortization of Goodwill
As discussed in Section 11.3.2, in jurisdictions in which goodwill is
deductible under the tax law, goodwill for financial reporting purposes and
tax-deductible goodwill should be separated as of the acquisition date into
two components in accordance with ASC 805-740-25-8 and 25-9. The first
component of goodwill (“component 1 goodwill”) equals the lesser of (1)
goodwill for financial reporting purposes or (2) tax-deductible goodwill.
The second component of goodwill (“component 2 goodwill”) equals (1) total
goodwill (the greater of financial reporting goodwill or tax-deductible
goodwill) less (2) the calculated amount of component 1 goodwill.
When tax-deductible goodwill exceeds goodwill for financial reporting
purposes, entities have alternatives for allocating tax amortization between
component 1 goodwill and component 2 goodwill. However, these alternatives
will have the same net effect on the consolidated financial statements.
The following two approaches are acceptable for allocating tax amortization
between component 1 goodwill and component 2 goodwill:
-
Approach 1 — Allocate the tax amortization first to any amount of tax-deductible goodwill greater than goodwill for financial reporting purposes (i.e., allocate first to component 2 goodwill). Under this approach, the entity will first reduce any DTA recognized in the acquisition accounting before recognizing a DTL.
-
Approach 2 — Allocate the tax amortization on a pro rata basis between component 1 goodwill and component 2 goodwill. Under this approach, the entity will reduce the DTA recognized in the acquisition accounting for the tax amortization allocated to component 2 goodwill and at the same time recognize a DTL for the tax amortization allocated to component 1 goodwill.
The example below demonstrates the two approaches and their
similar effects on the financial statements.
Example 11-5
Assume that Entity X acquires Entity
Y in a taxable business combination. The acquisition
results in goodwill for financial reporting purposes
of $1 million and tax-deductible goodwill of $1.3
million. Entity X’s tax rate is 25 percent. Because
tax-deductible goodwill exceeds goodwill for
financial reporting purposes, X recognizes a DTA of
$100,000 as part of the business combination
accounting (see Section
11.3.2 for guidance on calculating this
amount), with an offset to goodwill for financial
reporting purposes (i.e., final goodwill for
financial reporting purposes is $900,000 on the
acquisition date). Assume for tax purposes that the
tax-deductible goodwill is amortized over 10 years
and that X has not recognized any goodwill
impairments. In this example, component 1 goodwill
would be $900,000 (i.e., the lesser of goodwill for
financial reporting purposes and tax-deductible
goodwill) and component 2 goodwill would be $400,000
(i.e., the difference between total tax-deductible
goodwill of $1.3 million and component 1 goodwill of
$900,000).
The following journal entries would be recorded to
recognize the first year of tax amortization:
-
Approach 1 — The tax amortization of $130,000 ($1,300,000 ÷ 10 years) would be allocated to the component 2 goodwill. Therefore, component 2 goodwill would be reduced to $270,000 ($400,000 – $130,000) and the DTA recognized as of the acquisition date would be reduced by $32,500 ($130,000 × 25%).
-
Approach 2 — The tax amortization of $130,000 ($1,300,000 ÷ 10 years) would be allocated on a pro rata basis between the component 1 goodwill and the component 2 goodwill. Component 2 goodwill would be reduced to $360,000, which is calculated as $400,000 – ($400,000 ÷ $1,300,000 × $130,000), and the DTA associated with component 2 goodwill would be reduced by $10,000, or ($400,000 ÷ $1,300,000 × $130,000) × 25%. Component 1 goodwill would be reduced to $810,000, which is calculated as $900,000 – ($900,000 ÷ $1,300,000 × $130,000), which would create a DTL of $22,500, or ($900,000 ÷ $1,300,000 × $130,000) × 25%, for the taxable temporary difference between goodwill for financial reporting purposes and tax-deductible goodwill.
While amortization of the goodwill is reflected in
both approaches, Approach 2 seemingly creates a DTL
with the allocation. However, the goodwill remains
one asset for financial reporting purposes and,
correspondingly, the related deferred taxes should
be considered on a net basis in the assessment of
the need for a valuation allowance (i.e., the ending
DTA in year 1 would be $67,500).
11.3.2.3 Private Company Alternative
The accounting for goodwill by a private company may differ from the
accounting for goodwill by a public company. Under ASC 350-20-15-4, a
private company may elect a simplified, alternative approach to subsequently
account for goodwill (the “goodwill accounting alternative”). Under this
approach, the company can amortize financial reporting goodwill related to
each business combination on a straight-line basis, generally over a period
of 10 years.
A private company that elects the goodwill accounting alternative should
consider several things when preparing its provision for income taxes. Those
considerations vary, in part, depending on whether the goodwill is
deductible for tax purposes:
-
Non-tax-deductible goodwill — The accounting alternative does not change the prohibition on the recognition of a DTL for goodwill that is not deductible for tax purposes. The amortization of goodwill for financial reporting purposes will typically create a reconciling item related to the ETR (i.e., an unfavorable permanent difference).
-
Tax-deductible goodwill — The amortization of financial reporting goodwill will result in either an increase or a decrease to deferred taxes depending on how it compares with the related tax amortization in the period.
When both tax-deductible and non-tax-deductible goodwill are
present, an entity must determine the amount of financial reporting goodwill
amortization attributable to the components of goodwill that were originally
determined in acquisition accounting. (See Section 11.3.2 for more information
about the recognition of deferred taxes on the basis of the components of
goodwill.) When an entity is determining the amount of financial reporting
goodwill amortization attributable to the components of goodwill, it should
consider whether it has already established a policy for such attribution in
connection with a past impairment and, if so, should apply that policy
consistently. One method that is commonly used in such circumstances is a
pro rata allocation. (See the next section for an example illustrating a pro
rata allocation.) Under a pro rata allocation approach for goodwill
amortization, an entity would proportionally allocate the amortization to
tax-deductible and nondeductible goodwill on the basis of the proportion of
each. Other approaches may also be acceptable. Further complexities arise
when the goodwill in a reporting unit is associated with multiple
acquisitions or spans multiple taxing jurisdictions.
11.3.2.4 Impairment Testing
ASC 350-20 requires that goodwill be tested for impairment at least annually
or between annual tests if certain events or circumstances occur. It further
states that the “annual impairment test may be performed any time during the
fiscal year provided the test is performed at the same time every year.
Different reporting units may be tested for impairment at different times.”
Entities should evaluate their own facts and circumstances in assessing
whether to establish different reporting dates for different reporting
units.
When tested, goodwill is tested for impairment at the
reporting unit level. The ASC master glossary defines a reporting unit as
“[t]he level of reporting at which goodwill is tested for impairment. A
reporting unit is an operating segment or one level below an operating
segment (also known as a component).”
Entities have the option to perform the qualitative assessment for a
reporting unit to determine whether the quantitative impairment test is
necessary. In evaluating whether it is more likely than not that the fair
value of a reporting unit is less than its carrying amount, an entity should
consider (1) the expected impact of the event or change in circumstances on
the fair value of the reporting unit and (2) the amount by which fair value
exceeds carrying value as of the date of the last impairment test. When the
fair value of a reporting unit is only marginally higher than its carrying
value, any expected decrease in the fair value of the reporting unit as a
result of a subsequent event or change in circumstances should generally
result in the conclusion that the entity needs to perform an impairment
test.
Accordingly, an entity should perform its annual or interim goodwill
impairment test by comparing the fair value of a reporting unit with its
carrying amount. The entity should recognize an impairment charge for the
amount by which the carrying amount exceeds the reporting unit’s fair value;
however, the loss recognized would not exceed the total amount of goodwill
allocated to that reporting unit. In addition, an entity should consider
income tax effects from any tax deductible goodwill on the carrying amount
of the reporting unit when measuring the goodwill impairment loss, if
applicable (see ASC 350-20-35-8B and the discussion in Section
11.3.2.4.3 and illustration in Example
11-6).
11.3.2.4.1 Assumptions Related to a Reporting Unit Bought or Sold in a Taxable or Nontaxable Business Combination
Determining the fair value of a reporting unit requires
some assumptions about the sale of the reporting unit to a market
participant. ASC 350-20-35-25 states that an entity’s assumption about
whether a reporting unit would be bought or sold in a taxable or
nontaxable business combination in its quantitative goodwill impairment
test is a matter of judgment and will depend on facts and
circumstances.
ASC 350-20-35-26 provides the following considerations to help entities
make this determination:
-
Whether the assumption is consistent with those that marketplace participants would incorporate into their estimates of fair value
-
The feasibility of the assumed structure
-
Whether the assumed structure results in the highest and best use and would provide maximum value to the seller for the reporting unit, including consideration of related tax implications.
In addition, under ASC 350-20-35-27, an entity must also consider the
following factors (not all-inclusive) when assessing whether it is
appropriate to assume a nontaxable transaction:
-
Whether the reporting unit could be sold in a nontaxable transaction
-
Whether there are any income tax laws and regulations or other corporate governance requirements that could limit an entity’s ability to treat a sale of the unit as a nontaxable transaction.
11.3.2.4.2 Assigning Deferred Taxes to a Reporting Unit
When performing the quantitative goodwill impairment
test, an entity should assign deferred taxes to its reporting units in
determining their carrying value.
ASC 350-20-35-7 states that the deferred taxes related
to the assets and liabilities of the reporting unit should be included
in the carrying value of the reporting unit. This is true regardless of
whether the entity assumes, in its determination of the fair value of
the reporting unit, that the reporting unit would be bought or sold in a
taxable or nontaxable business combination. In determining whether to
assign DTAs associated with NOL and tax credit carryforwards to a
reporting unit, an entity should consider the following guidance from
ASC 350-20-35-39 and 35-40:
35-39 For the purpose of
testing goodwill for impairment, acquired assets and assumed
liabilities shall be assigned to a reporting unit as of the
acquisition date if both of the following criteria are met:
-
The asset will be employed in or the liability relates to the operations of a reporting unit.
-
The asset or liability will be considered in determining the fair value of the reporting unit.
Assets or liabilities that an entity considers
part of its corporate assets or liabilities shall also be
assigned to a reporting unit if both of the preceding criteria
are met. Examples of corporate items that may meet those
criteria and therefore would be assigned to a reporting unit are
environmental liabilities that relate to an existing operating
facility of the reporting unit and a pension obligation that
would be included in the determination of the fair value of the
reporting unit. This provision applies to assets acquired and
liabilities assumed in a business combination and to those
acquired or assumed individually or with a group of other
assets.
35-40 Some assets or
liabilities may be employed in or relate to the operations of
multiple reporting units. The methodology used to determine the
amount of those assets or liabilities to assign to a reporting
unit shall be reasonable and supportable and shall be applied in
a consistent manner. For example, assets and liabilities not
directly related to a specific reporting unit, but from which
the reporting unit benefits, could be assigned according to the
benefit received by the different reporting units (or based on
the relative fair values of the different reporting units). In
the case of pension items, for example, a pro rata assignment
based on payroll expense might be used. A reasonable allocation
method may be very general. For use in making those assignments,
the basis for and method of determining the fair value of the
acquiree and other related factors (such as the underlying
reasons for the acquisition and management’s expectations
related to dilution, synergies, and other financial
measurements) shall be documented at the acquisition date.
If an entity has recorded a valuation allowance
pertaining to a DTA of a specific jurisdiction or character that has
been allocated to a reporting unit, the associated valuation allowance
would also be allocated to that reporting unit. If an entity has
recorded a valuation allowance at the consolidated level and files a
consolidated return, it should allocate the valuation allowance on the
basis of the DTAs and DTLs assigned to each reporting unit.
11.3.2.4.3 Determining the Deferred Tax Effects of a Goodwill Impairment
The initial accounting for an acquisition of a business
is affected by whether the transaction is structured as a taxable or
nontaxable transaction and whether the acquisition results in
tax-deductible and nondeductible goodwill. (See Sections 11.1.3
and 11.3.2
for further discussion of the initial accounting in a business
combination.) ASC 350-20-35-41 states, in part, that, for financial
reporting purposes, “goodwill acquired in a business combination shall
be assigned to one or more reporting units as of the acquisition
date.”
ASC 350-20-35-1 states, in part, that “goodwill shall be
tested at least annually for impairment at a level of reporting referred
to as a reporting unit” (emphasis added). Under
U.S. GAAP, a reporting unit is defined as “an operating segment or one
level below an operating segment.”
However, ASC 740-10-30-5 states, in part, that
“[d]eferred taxes shall be determined separately for each tax-paying
component . . . in each tax jurisdiction.”
A reporting unit’s goodwill balance subject to impairment testing may
comprise both tax-deductible and nondeductible goodwill. One common
method used to allocate the goodwill impairment among the legal entities
that constitute the reporting unit is pro rata allocation. Under this
approach, an entity proportionately allocates the impairment to
tax-deductible and nondeductible goodwill on the basis of the proportion
of each in the reporting unit. Other approaches may also be acceptable;
however, the approach an entity selects is an accounting policy election
that, like all such elections, should be applied consistently.
The example below illustrates the application of the pro
rata allocation approach, although we are aware of other approaches in
practice. Note that this approach involves consolidated financial
statements. When one or more of the legal entities within a reporting
unit prepare separate-company financial statements, the allocations may
differ between the separate and consolidated financial statements.
Entities are encouraged to consult with their income tax accounting
advisers when determining an appropriate approach.
Example 11-6
Tax Deductible Goodwill
Background
Assume the following:
- Company A has $1,500 of goodwill from an acquisition that is allocated to Reporting Unit RU.
- All of the goodwill is tax deductible over 15 years.
- The tax rate is 25 percent.
- As of the date of the goodwill impairment test
for RU:
- The tax basis of goodwill is $1,000, and RU has a DTL of $125.
- RU has a carrying value of $1,775, a fair value of $1,500, and a preliminary goodwill impairment of $275.
As a result of the change in
deferred taxes related to the goodwill, RU has a
carrying value of $1,569, which exceeds the fair
value.
Assume that there is no book/tax difference on
the other assets.
Analysis Under ASC
350-20-35-8B
The impairment loss is increased
by $92, which is calculated by using the
simultaneous equations method: 25% ÷ (1 – 25%) ×
275 = 92. The additional impairment loss is offset
by the deferred tax benefit.
Note that
the total goodwill impairment of $367 can also be
calculated as 275 ÷ (1 – 25%).
Tax Deductible and Nondeductible
Goodwill
Background
Assume the same facts as those
above, except that Company A has $5,000 of
goodwill from an acquisition that is allocated to
Reporting Unit RU. Of this amount, $1,500 of the
goodwill is tax deductible over 15 years.
In addition, assume the
following:
- On the date of the goodwill impairment test, RU has a carrying value of $5,300, a fair value of $4,300, and a preliminary goodwill impairment of $1,000.
- RU has both tax deductible and nondeductible goodwill, and the pro rata approach is used to allocated goodwill impairment for deferred tax purposes (component 1 is 30% and component 2 is 70%).
- Assume that there is no book/tax difference on the other assets.
Analysis Under ASC 350-20-35-8B
The impairment loss is increased
by $81, which is calculated by using the
simultaneous equations method: $1,000÷1 – (25% ×
30%) = $1,081. The additional impairment loss is
offset by the deferred tax benefit. Allocation of
the total goodwill impairment between component 1
and 2 goodwill is as follows:
-
Component 1 impairment: $1,081 × 30% = $324.
-
Component 2 impairment: $1,081 × 70% = $757.
11.3.2.5 Disposal of Goodwill
In accordance with ASC 350-20, when all or a portion of a reporting unit that
constitutes a business is disposed of, all or a portion of the goodwill
allocated to that reporting unit needs to be included in the carrying amount
of the reporting unit (or disposal group) when an entity is determining the
gain or loss on disposal. Given the intricacies involved with determining
the deferred tax accounting for goodwill (e.g., calculating component 1 and
component 2 goodwill), additional complexities may arise when a reporting
unit (or portion thereof) that has goodwill is disposed of.
An acquired business that generates goodwill will often be integrated into an
existing reporting unit (or reporting units) of the acquirer. The reporting
unit to which the assets and liabilities of the acquiree are assigned may be
composed of multiple legal entities that were either acquired in previous
business combinations or formed by the acquirer. Although the goodwill
generated in the business combination will continue to be associated with
the reporting unit to which it is allocated, the goodwill may not be
specifically associated with the assets and liabilities from the business
combination that generated the goodwill. For example, if an acquired
business is significantly integrated with other subsidiaries of a reporting
unit and a subsidiary within the reporting unit is subsequently disposed of,
the acquirer may need to allocate a portion of the total goodwill of the
reporting unit to the disposal group regardless of how the goodwill was
generated.
Under ASC 350-20-40-3, an entity determines the amount of goodwill that must
be deconsolidated by allocating goodwill from the larger reporting unit to
the part of the reporting unit being sold on the basis of relative fair
value. However, for a reporting unit that contains goodwill that is tax
deductible, ASC 350-20-40 does not provide guidance on how to determine what
portion of the goodwill being disposed of represents component 1 goodwill
and what portion represents component 2 goodwill. Further, because the
allocation is made at the reporting unit level, the character of the
goodwill to be deconsolidated (i.e., component 1 or component 2) will not
always be determinable from the character of the goodwill recognized in the
financial statements of the specific entity to be deconsolidated.
Accordingly, several methods have developed in practice for determining the
deferred tax consequences in these types of situations.
One such approach is the pro rata method, under which the character of the
deconsolidated goodwill is determined on a pro rata basis by reference to
the character of goodwill within the larger reporting unit.
A second approach is to determine the character of the
goodwill to be retained by reference to the character of the goodwill of the
component being deconsolidated, even though ASC 350-20-40-1 through 40-73 suggest that acquired goodwill loses its entity-specific character
when an entity is performing an impairment test or determining the amount of
goodwill to be deconsolidated when part of a reporting unit is sold.
A third approach is to interpret ASC 350-20-40-1 through
40-74 as simply requiring the reporting entity to retain a portion of its
investment in the disposed-of subsidiary within the reporting unit and then
classify that portion as goodwill in its consolidated financial statements
until the goodwill is recovered in accordance with ASC 350. Under this
alternative, a DTL would be recorded because the residual outside basis
difference would represent a taxable temporary difference for which no
exception exists. The recognition of a DTL for the residual outside basis is
also consistent with the fact that the corresponding tax basis in the
“investment” is deducted upon the sale of the disposed-of entity’s stock for
income tax purposes.
A fourth approach is to treat any goodwill retained by the reporting unit as
a permanent difference (i.e., not a temporary difference). Under this
approach, any goodwill remaining in the reporting unit is effectively
characterized as internally generated goodwill that must be capitalized.
Accordingly, ASC 740-10-25-3(d) would preclude the reporting entity from
recognizing a DTL on goodwill retained for financial reporting purposes but
not deductible for tax purposes. ASC 740-10-25-3(d) prohibits “recognition
of a deferred tax liability [or asset] related to goodwill (or the portion
thereof) for which amortization is not deductible for tax purposes.”
All of the approaches described above may be considered acceptable when a
portion of the goodwill originally related to the component to be
deconsolidated is retained. Regardless of the method selected, an entity
should consistently apply its chosen approach to all dispositions of
businesses within a reporting unit and provide adequate footnote disclosures
that describe the accounting method used and the effects of applying that
method.
While complexities are likely to be encountered when any of the approaches
described above are applied, the second approach, in particular, will need
to be supplemented by additional policies when the amount being
deconsolidated exceeds the amount recognized on the books of that specific
component. Entities are encouraged to consult with their accounting advisers
in these situations.
Note that each approach described above assumes that a subsidiary has been
fully integrated into a reporting unit before deconsolidation. If a
subsidiary has not been previously integrated into a reporting unit,
entities should apply ASC 350-20-40-4, which requires that the current
carrying amount of the acquired goodwill (i.e., the actual
subsidiary-specific goodwill) be included in the carrying amount of the
subsidiary to be disposed of. In these types of situations, which are
expected to be infrequent, entities are encouraged to consult with their
accounting advisers.
The example below illustrates the methods described above
applied to the disposal of goodwill.
Example 11-7
USP acquires 100 percent of the
voting common stock of S1 for $1,000 in a nontaxable
acquisition accounted for as a business combination.
Accordingly, USP’s outside tax basis in the stock of
S1 is $1,000. USP recognizes $100 of goodwill in the
acquisition of S1. Since the transaction results in
carryover tax basis, there is no corresponding tax
basis in the goodwill (i.e., all goodwill is
component 2 goodwill). USP assigns all the assets
and liabilities of S1, including goodwill, to
Reporting Unit 1.
As of the acquisition date of S1,
Reporting Unit 1 consists of multiple legal
entities, some of which were acquired and others of
which were formed by USP. The goodwill recognized in
these acquisitions and assigned to Reporting Unit 1
consists of a combination of tax-deductible and
non-tax-deductible goodwill. When tax-deductible
goodwill has been acquired, it has been amortized in
accordance with tax law after the acquisition.
As of the acquisition date of S1, the GAAP and tax
values of the goodwill are as follows:
Before the acquisition of S1, there
is a $136.5 DTL associated with component 1 goodwill
((800 - 150) × 21%). After S1 is integrated into
Reporting Unit 1, USP decides to sell S1 for
consideration of $1,000. For simplicity, assume that
the book basis in the assets of S1, exclusive of
goodwill and related deferred taxes, if any, is $900
and there is no tax gain or loss on the sale. Assume
that no goodwill impairments have been recognized
under ASC 350 between the date of the acquisition of
S1 and its disposition and there has been no
amortization of the goodwill for financial or tax
reporting purposes. Further assume that, in
accordance with ASC 350-20-40-1 through 40-7,5 $70 of Reporting Unit 1 goodwill will be
deconsolidated upon the sale of S1 and will affect
the determination of the gain or loss on disposal
for financial reporting purposes. Accordingly, upon
the disposition of S1, only $70 of the goodwill
recognized in connection with the acquisition of S1
will be deconsolidated, while $30 of the total
goodwill recognized in connection with the
acquisition of S1 will be retained as continuing
goodwill of Reporting Unit 1.
Application of the Four Approaches
Deconsolidated Goodwill
Goodwill Remaining After Disposal
As shown above, the total goodwill remaining in
Reporting Unit 1 is the same regardless of the
approach used. The allocation between component 1
and component 2 goodwill under the different
approaches is not constant.
Under approach 1, the reduction for the
deconsolidated goodwill was allocated pro rata to
Reporting Unit 1's component 1 and component 2
goodwill. As a result, there is a $4.7 reduction in
the goodwill DTL (136.5 – (777.6 – 150) × 21%). Such
reduction in DTL would be included as part of the
disposal group, increasing the gain on the sale.
Under approach 2, all of the goodwill on S1's books
is considered component 2, and the remaining $30
would still represent component 2 goodwill,
resulting in no change to the recorded DTL.
Under approach 3, USP retains a portion of its
investment in S1 within the reporting unit and
classifies that portion as goodwill until the
goodwill is recovered in accordance with ASC 350. A
DTL would be recorded because the residual outside
basis difference would represent a taxable temporary
difference for which no exception exists. As a
result, there is a $6.3 increase in the goodwill DTL
((830 – 150) × 21% – 136.5), resulting in a $6.3
increase to deferred tax expense.
Under approach 4, the $30 of goodwill remaining in
Reporting Unit 1 is effectively characterized as
internally generated goodwill that P must
capitalize. Accordingly, ASC 740-10-25-3(d)
precludes P from recognizing a DTL on goodwill
retained for financial reporting purposes that is
not deductible for tax purposes. As in approach 2
(in this fact pattern), there is no change to the
goodwill DTL.
11.3.3 Bargain Purchase
In some limited situations, the fair value of assets acquired (net of assumed
liabilities) exceeds the consideration paid to acquire the business. A bargain
purchase occurs when the net of the fair value of the identifiable assets
acquired and liabilities assumed exceeds the sum of:
-
The acquisition-date fair value of the consideration transferred, including the fair value of the acquirer’s previously held interest (if any) in the acquiree (i.e., a business combination achieved in stages).
-
The fair value of any noncontrolling interest in the acquiree.
These instances are expected to be infrequent and require an acquirer to
reconsider whether all acquired assets have been separately recognized and
properly measured. However, after the acquirer confirms that the fair value of
acquired net assets exceeds the consideration paid, the acquirer recognizes the
excess (i.e., the bargain purchase element) as a gain on the acquisition
date.
When an entity has been acquired, the acquirer calculates the
gain on the bargain purchase after the deferred taxes on the inside basis
differences are recorded on the acquired entity’s assets and liabilities (see
Section 11.3.1
for more information about inside and outside basis differences). The resulting
bargain purchase gain recognized by the acquiring entity is recognized in
earnings in accordance with ASC 805-30-25-2. Because the amount of the bargain
purchase gain does not result in a step-up in the tax basis of the investment in
the acquiree, a difference typically arises between the investment in the
acquiree for financial reporting purposes and the investment in the acquiree for
tax purposes. If deferred taxes are recorded on the outside basis difference
caused by the bargain purchase gain, we believe that the corresponding tax
effects would similarly be recorded in earnings as a component of income tax
expense.
Example 11-8
Taxable Business Combination — Bargain
Purchase
AC pays $800 to acquire TC, a domestic
corporation, in a taxable business combination. The fair
value of the identifiable assets is $1,000. AC
recognizes a $158 gain on the bargain purchase. Assume a
21 percent tax rate.
For the inside basis difference, a DTL of $42 is recorded
on the difference between the book basis ($1,000) and
tax basis ($800) of the acquired assets.
The journal entries for the acquisition, gain on the
bargain purchase, and resulting deferred taxes are as
follows:
TC’s Journal
Entry
AC’s Journal
Entry
Regarding the outside basis difference, the carrying
amount of AC’s investment in TC for financial reporting
purposes will increase by $158 and there will be a
corresponding increase in TC’s equity as a result of the
recognition of the $158 gain.
The following table illustrates AC’s investment in
TC:
In accordance with ASC 740-30-25-7, AC could determine
that the outside basis difference in TC’s stock is not a
taxable temporary difference because (1) the tax law
provides a means by which the reported amount of that
investment can be recovered tax free and (2) AC expects
it will ultimately use that means. See Section 3.4.3 for
further discussion of tax-free liquidation or merger of
a subsidiary.
Example 11-9
Nontaxable Business Combination — No Bargain Purchase
Gain Recognized as a Result of the DTL
AC pays $900 to acquire the stock of TC,
a domestic corporation, in a nontaxable business
combination. The fair value of the identifiable assets
is $1,000. Assume that the tax bases of the identifiable
assets are $400 and that the tax rate is 21 percent.
The following are TC’s and AC’s journal entries recording
the acquisition and resulting deferred taxes:
TC’s Journal
Entry
AC’s Journal
Entry
The gain on the bargain purchase is calculated after
deferred taxes are recorded. AC does not recognize a
gain on the bargain purchase because the fair value of
the identifiable assets acquired and liabilities assumed
(net amount of $874) does not exceed the consideration
transferred. There is no bargain purchase after the DTL
is recorded for the difference between the book basis of
$1,000 and tax basis of $400 for the assets
acquired.
Example 11-10
Nontaxable Business Combination — Bargain
Purchase
Assume the same facts as in the previous
example except that the tax bases of the identifiable
assets are $700 rather than $400.
A DTL of $63 is recorded for the difference between the
book basis of $1,000 and tax basis of $700 for the
assets acquired. The journal entries recording the
acquisition gain on the bargain purchase and resulting
deferred taxes are as follows:
TC’s Journal
Entry
AC’s Journal
Entry
These journal entries show that AC recognizes a $37 gain
on the bargain purchase. As a result of AC’s recognition
of a $37 gain, AC’s investment in TC will increase by
$37, with a corresponding increase in TC’s equity. Thus,
an outside basis difference will arise between the book
basis of $937 and tax basis of $900 for TC’s stock. AC
determines that the outside basis difference in TC’s
stock is a taxable temporary difference and records a
DTL.
AC’s Journal
Entry
The DTL represents a $37 basis difference at a tax rate
of 21 percent. Goodwill is not affected because the
outside basis difference is related to the bargain
purchase gain recognized and therefore is unrelated to
the business combination accounting.
11.3.4 Other Assets Acquired
Although recognition and measurement of income taxes related to goodwill acquired
in a business combination are considered among the most significant exceptions
to the basic principles of acquisition accounting, special consideration must
also be made for other types of assets acquired.
11.3.4.1 Other Intangibles
Deferred taxes are not recognized for differences between goodwill for
financial statement purposes and nondeductible goodwill for tax purposes.
However, deferred income taxes are always recognized for differences between
the carrying amounts and tax bases of all acquired identifiable intangible
assets (e.g., customer lists, trademarks, and core deposit intangibles of
financial institutions), regardless of whether they are indefinite-lived or
finite-lived. The FASB concluded that goodwill is a residual asset that is
uniquely different from other types of long-term intangible assets that may
not be deductible in certain tax jurisdictions. Therefore, the exception to
recording deferred taxes on nondeductible goodwill is not carried over to
indefinite-lived intangible assets.
11.3.4.2 Reacquired Rights
In a business combination, the acquirer may reacquire a right that it
previously granted to the acquiree (e.g., a license or franchise). ASC
805-20-30-20 stipulates that reacquired rights are intangible assets that
the acquirer must recognize apart from goodwill.
An acquirer measures the value of the reacquired right in a business
combination in accordance with the fair value measurement guidance in ASC
820, with one exception: The value of the intangible asset is limited to its
remaining contractual term (i.e., the contractual term that remains until
the next renewal date), regardless of whether market participants would
assume renewal or extension of the existing terms of the arrangement.
Because renewals are not taken into consideration in the determination of
the fair value, the reacquired right’s tax basis and its financial reporting
basis as of the acquisition date will generally differ and a DTA should be
recognized for the difference between the assigned value for financial
reporting and tax purposes.
Subsequently, for financial reporting purposes, an entity
must amortize the intangible assets related to reacquired rights on the
basis of their remaining contractual terms. See the example below.
An acquiring entity must also determine whether the terms of the contract
give rise to a reacquired right that is favorable or unfavorable in relation
to similar market transactions for similar rights. If the terms of the
contract do give rise to such a reacquired right, the acquirer recognizes a
settlement gain or loss. ASC 805-10-55-21(b) provides guidance on
calculating the settlement gain or loss, stating that it should be recorded
as the lesser of:
-
The amount by which the contract is favorable or unfavorable from the perspective of the acquirer when compared with pricing for current market transactions for the same or similar items. . . .
-
The amount of any stated settlement provisions in the contract available to the counterparty to whom the contract is unfavorable. . . . [See Example 11-12.]
An acquirer may subsequently sell a reacquired right to a third party. The
carrying amount of the recognized intangible asset (i.e., reacquired right)
would then be included in the gain or loss on sale.
Example 11-11
Company B sells products in Europe under a license
agreement with Company A. Company A acquires B for
$100 million in a taxable business combination. As
of the acquisition date, the license agreement has a
remaining contractual term of three years and can be
renewed at the end of the current term and
indefinitely every five years thereafter. Assume
that the pricing of the license agreement is
at-market and that the agreement does not have
explicit settlement provisions. The tax rate is 21
percent. Company A has calculated the following
values for the license agreement:
-
$7.5 million — Value of the license for the remaining three-year contractual term.
-
$20 million — Fair value of the license agreement, calculated in accordance with the principles of ASC 820, which takes into account future renewals by market participants.
-
$60 million — Other tangible assets.
The following illustrates the book and tax bases of
the assets:
In this example, A would recognize
an intangible asset for $7.5 million and would
amortize this amount over the remaining three-year
contractual term for financial reporting purposes.
Company A recognizes a DTA related to the license
agreement’s tax-over-book basis of $2.625 million,
or ($20 million – $7.5 million) × 21%. In accordance
with ASC 805-740-25-3 and ASC 805-740-25-9, no DTL
is recorded for the book-over-tax-basis goodwill of
$9.875 million ($29.875 million – $20 million).
Example 11-12
Assume the same facts as in the
example above, except that under the terms of the
license agreement, Company B pays a license fee that
is below-market in relation to that of its
competitors with similar licensing agreements. In
addition, Company A now calculates the value of the
license, for the remaining three-year contractual
term, to be $10 million. (Note that this amount is
greater than the $7.5 million value calculated in
the example above for an at-market contract, because
the expense related to the license is less than the
market rate.)
Company A would record an intangible asset of $7.5
million for the reacquired license (the at-market
value for similar agreements) and would recognize a
$2.5 million settlement loss in the income
statement. In effect, the settlement loss represents
additional consideration A would be required to give
B to terminate the existing agreement, which was
unfavorable to A.
The following illustrates the book and tax bases of
the assets:
Company A recognizes a DTA related
to the license agreement’s tax-over-book basis of
$2.625 million, which is calculated as ($20 million
– $7.5 million) × 21%, of which $2.1 million is a
DTA recorded in the acquisition accounting (as a
reduction to goodwill). The remaining component of
the DTA of $525,000 is associated with the $2.5
million financial reporting loss ($2.5 million ×
21%) that was recognized in the statement of
operations by the acquirer (i.e., separately and
apart from acquisition accounting). Therefore, in
evaluating the DTA for realizability after the
acquisition date, an entity should remember that the
character of the DTA originated in part from a
finite-lived intangible asset and in part from an
expense recorded in the statement of operations.
In addition, ASC 805-740-25-3 and ASC 805-740-25-9
prohibit the recognition of a DTL for the
book-over-tax-basis goodwill.
11.3.4.3 R&D Assets
Under ASC 350-30-35-17A, acquired R&D assets will be separately
recognized and measured at their acquisition-date fair values. ASC
350-30-35-17A states that an R&D asset acquired in a business
combination must be considered an indefinite-lived intangible asset until
completion or abandonment of the associated R&D efforts. Once the
R&D efforts are complete or abandoned, an entity should apply the
guidance in ASC 350 to determine the useful life of the R&D assets and
should amortize these assets accordingly in the financial statements. If the
project is abandoned, the asset would be written off if it has no
alternative use.
In accordance with ASC 740, deferred taxes should be recorded for temporary
differences related to acquired R&D assets as of the business
combination’s acquisition date. As with all acquired assets and assumed
liabilities, an entity must compare the amount recorded for an R&D
intangible asset with its tax basis to determine whether a temporary
difference exists. If the tax basis of the R&D intangible asset is zero,
as it will be in a typical nontaxable business combination, a DTL will be
recorded for that basis difference. (See Section 5.3.1.3 for guidance on using these DTLs to evaluate
DTAs for realization.)
11.3.4.4 Leveraged Leases Acquired
For accounting guidance on acquiring a leveraged lease in a business
combination, see Section 4.3.11.1.14 of Deloitte’s Roadmap Business
Combinations.
Under ASC 842-50-30-2, the initial recognition of a leveraged lease acquired
in a business combination is unchanged from the guidance in ASC 840. That
is, the acquiring entity should record an acquired leveraged lease on the
basis of the remaining future cash flows while giving appropriate
recognition to the estimated future tax effects of those cash flows.
Example 4 in ASC 842-50-55-27 through 55-33 illustrates the accounting for a
leveraged lease acquired in a business combination.
For additional information about ASC 842, see Deloitte’s
Roadmap Leases.
11.3.4.5 Obtaining Tax Basis Step-Up of Acquired Assets Through Direct Transaction With Governmental Taxing Authority
In some tax jurisdictions, an acquirer may pay the taxing authority to obtain
a step-up in the tax basis of the net assets of the acquired business. Such
a transaction is not with the acquiree and is not in exchange for the
business acquired. Accordingly, the resulting step-up in tax basis should
not be accounted for as part of the recording of deferred taxes under the
acquisition method of accounting.
Rather, the acquisition of tax basis from the tax authority should be
accounted for as a transaction that is separate and apart from the business
combination in accordance with ASC 740-10-25-53. That guidance indicates
that the deferred tax effects of a payment to a taxing authority to obtain a
step-up in tax basis are generally accounted for directly in income (net of
the amount of the payment). See ASC 740-10-55-202 through 55-204 for an
example of such a transaction.
ASC 740-10-25-54 lists factors that may help an entity
determine whether the step-up in tax basis is related to the business
combination that caused the initial recognition of goodwill or to a separate
transaction. If the step-up is related to the business combination in which
the book goodwill was originally recognized, the entity would not record a
DTA for the step-up in basis except to the extent that the newly deductible
goodwill amount exceeds the remaining balance of book goodwill. If the
step-up is related to a subsequent transaction, however, the entity would
record a DTA. The factors in ASC 740-10-25-54 are not all-inclusive,
however, and an entity must apply judgment when making this
determination.
11.3.5 Liabilities Assumed
Recognition and measurement principles of certain liabilities assumed in a
business combination may differ for financial reporting and tax purposes,
resulting in deferred taxes. In addition, certain liabilities may be accounted
for under exceptions to the general principles of ASC 805, requiring additional
consideration when an entity is determining the appropriate tax accounting
consequences.
11.3.5.1 Contingencies
Under ASC 805-20-25-19, a contingency should be recognized at its
acquisition-date fair value if the acquisition-date fair value can be
determined during the measurement period.
ASC 805-20-35-3 does not prescribe a specific method for measuring and
accounting for contingencies after the acquisition date for financial
reporting purposes; rather, it states that the acquirer should “develop a
systematic and rational basis for subsequently measuring and accounting for
. . . contingencies depending on their nature.” A contingency could result
in a temporary difference on the acquisition date.
For tax purposes, the acquirer is generally precluded from
recognizing a contingency until the contingency has become fixed and
determinable with reasonable accuracy or, in some jurisdictions, until it
has been settled. This could result in a basis difference between the assets
and liabilities recognized for financial reporting and tax purposes on the
acquisition date.
When assessing whether a DTA or DTL should be recognized on the acquisition
date, the acquirer should determine the expected tax consequences that would
result if the contingency was settled at its initial reported amount in the
financial statements. In other words, the acquirer should determine the tax
consequences as if the contingency was settled at the amount reported in the
financial statements as of the acquisition date. The tax consequences will,
in part, depend on how the business combination is structured for tax
purposes (i.e., taxable or nontaxable business combination).
After the acquisition, the acquirer should account for the tax consequences
resulting from a change in the fair value of an acquired contingency and
recognize the deferred tax consequences of such change as a component of
income tax expense (i.e., outside of the business combination), unless the
change qualifies as a measurement-period adjustment under ASC
805-10-25-13.
11.3.5.1.1 Taxable Business Combination
11.3.5.1.1.1 Recognition and Initial Measurement
In a taxable business combination, the settlement of a contingency
will generally affect the tax basis of goodwill. Therefore, the
acquirer should assume that the contingency will be settled at its
acquisition-date fair value and should include this amount in the
calculation of tax-deductible goodwill when performing the
acquisition-date comparison of tax-deductible goodwill with
financial reporting goodwill. If the amount of the hypothetical
tax-deductible goodwill (i.e., tax-deductible goodwill that includes
the amount associated with the contingency) exceeds the amount of
financial reporting goodwill, a DTA should be recorded. However, if
the financial reporting goodwill continues to exceed the
hypothetical tax-deductible goodwill, no DTL is recorded for the
excess (because of the exception in ASC 805-740-25-9). See Section 11.3.2 for further discussion of the
acquisition-date comparison of financial reporting goodwill with
tax-deductible goodwill.
11.3.5.1.1.2 Subsequent Measurement
In a taxable business combination, a subsequent increase or decrease
in the value of the contingency will result in an adjustment to the
tax bases of the acquired assets. A DTA or DTL would be recorded
through the tax provision for the expected tax consequences.
If the revised fair value exceeds the amount recorded as a liability,
a DTA will be recorded in connection with expected additional
tax-deductible goodwill. For financial reporting purposes, the
additional tax-deductible goodwill is treated as unrelated to the
acquisition (i.e., it is attributed to the expense recognized);
therefore, a DTA results in the recording of a benefit to the
continuing operation’s income tax provision rather than a reduction
in financial reporting goodwill.
If the contingency is settled for an amount less
than the liability recorded on the books, there is a favorable
adjustment to pretax book income. This pretax book income is
eliminated from taxable income (e.g., by a Schedule M adjustment for
U.S. federal tax). This adjustment to pretax book income is treated,
in substance, as an accelerated deduction of component 1 amortizable
goodwill (see Section 11.3.2 for a discussion of goodwill
components). In this case, a DTL is recognized and the related
income tax expense is recorded (see Example 11-13).
11.3.5.1.2 Nontaxable Business Combination
11.3.5.1.2.1 Recognition and Initial Measurement
In a nontaxable business combination, the settlement of a contingency
may result in a tax deduction or taxable income (e.g., a legal
dispute between an acquired entity and a third party is settled,
resulting in a payment from the third party to the acquired entity).
If the settlement of the contingency will result in either a tax
deduction or taxable income, deferred taxes should be recorded as
part of the acquisition accounting.
11.3.5.1.2.2 Subsequent Measurement
In a nontaxable business combination, if it was
determined that the settlement of the contingency would result in
either a tax deduction or taxable income, a subsequent change in the
value of the contingency would result in a corresponding change to
the previously recorded DTA or DTL. Any change recorded to either
the DTA or DTL would be recognized as a component of income tax
expense (i.e., outside of the business combination). See the example
below.
Example 11-13
Taxable Business Combination
AC acquires the stock of TC for $45 million in
a taxable business combination on June 30,
20X9 (e.g., a stock acquisition with a taxable
election under IRC Section 338). In connection
with the acquisition, AC recognizes a contingent
liability at a fair value of $650,000. AC’s
applicable tax rate is 25 percent.
The goodwill for financial reporting purposes
is $4 million (including the fair value of the
contingent liability). Tax-deductible goodwill is
$3.5 million, excluding the fair value of the
contingent liability.
For tax purposes, AC has determined that once
the contingency is settled, it will be added to
tax-deductible goodwill. Therefore, AC includes
the acquisition-date fair value of the contingent
liability in tax-deductible goodwill when
comparing acquisition-date tax-deductible goodwill
with financial reporting goodwill.
Tax-deductible goodwill is compared with
financial reporting goodwill as follows:
Because hypothetical
tax-deductible goodwill exceeds financial
reporting goodwill, AC records a DTA by using the
following iterative calculation, as described in
Section
11.3.2:
DTA = [0.25 ÷ (1 – 0.25)] ×
$150,000
DTA = $50,000
June 30, 20X9
The following journal entries are recorded on
June 30, 20X9:
AC
TC (to reflect “push-down” of the journal
entries to TC’s books)
September 30, 20X9
On September 30, 20X9, AC remeasures the
contingent liability and determines its fair value
to be $300,000, a decrease of $350,000 ($650,000 –
$300,000). AC has determined that the adjustment
to the contingent liability will decrease
tax-deductible goodwill if settled at its adjusted
financial reporting basis. Therefore, AC reduces
the DTA recorded on the acquisition date and
records a DTL. The acquisition-date comparison of
financial reporting goodwill with tax-deductible
goodwill should not be reperformed after the
acquisition date.
The following journal entry is recorded on
September 30, 20X9 (for simplicity, the effects of
tax-deductible goodwill amortization are excluded
from this example):
TC (to reflect “push-down” of the journal
entries to TC’s books)
December 31, 20X9
On December 31, 20X9, AC
settles the contingent liability for $1 million.
The $700,000 increase in the obligation gives rise
to an operating expense for financial reporting
purposes and a deferred tax benefit of $175,000
($700,000 × 25% tax rate). At settlement, AC
adjusts its tax-deductible goodwill for the $1
million amount. Deferred taxes are adjusted
accordingly.
The following journal entry is recorded on
December 31, 20X9 (for simplicity, the effects of
tax-deductible goodwill amortization are excluded
from this example):
TC (to reflect “push-down” of the journal
entries to TC’s books)
Example 11-14
Nontaxable Business Combinations
AC acquires the stock of TC for $45 million in
a nontaxable business combination on June
30, 20X9. In connection with the acquisition, AC
recognizes a contingent liability at a fair value
of $650,000. The tax basis of the contingent
liability is zero. For this example, assume that
there are no differences between the carryover tax
basis and book basis of the identifiable assets
acquired. AC has determined that it will receive a
tax deduction when the contingency is settled.
AC’s applicable tax rate is 25 percent.
Because AC has determined that the contingent
liability has a tax basis of zero and will result
in a tax deduction when settled, a temporary
difference exists.
June 30, 20X9
The following journal entries are recorded on
June 30, 20X9:
AC
TC (to reflect “push-down” of the journal
entries to TC’s books)
September 30, 20X9
On September 30, 20X9, AC remeasures the
contingent liability and determines its fair value
to be $300,000, a decrease of $350,000 ($650,000 –
$300,000). AC has determined that the adjustment
to the contingent liability will decrease the tax
deduction allowed at settlement.
The following journal entry is recorded on
September 30, 20X9:
TC (to reflect “push-down” of the journal
entries to TC’s books)
December 31, 20X9
On December 31, 20X9, AC settles the contingent
liability for $1 million. The $700,000 increase in
the obligation gives rise to an operating expense
for financial reporting purposes. AC is entitled
to a tax deduction at settlement.
The following journal entry is recorded on
December 31, 20X9:
TC (to reflect “push-down” of the journal
entries to TC’s books)
11.3.5.2 Environmental Liabilities
A specific type of contingency that can be encountered as
part of a business combination is an environmental remediation liability.
There are unique tax considerations related to situations in which an
acquirer purchases the assets of an entity that has preexisting contingent
environmental liabilities. Presumably, the acquirer has factored the costs
of any known remediation requirements into the amount that it would pay for
the property when determining the property’s fair value in a business
combination.
For financial reporting purposes, the asset requiring
environmental remediation is recorded at fair value, full remediation is
assumed, and a liability is recorded to recognize the estimated costs of
remediation. However, for tax purposes, the asset is recorded at its
unremediated value (the fair value less the estimated costs of remediation).
Therefore, the acquirer will record a DTL for the taxable temporary
difference between the amount recorded for financial reporting purposes and
the tax basis of the asset.
Further, U.S. Treasury Regulation Section 1.338–5(b)(2)(iii)
gives the following example illustrating when to adjust the tax basis for
the contingent environmental liability:
T, an accrual basis taxpayer, is a chemical
manufacturer. In Year 1, T is obligated to remediate environmental
contamination at the site of one of its plants. Assume that all the
events have occurred that establish the fact of the liability and
the amount of the liability can be determined with reasonable
accuracy but economic performance has not occurred with respect to
the liability within the meaning of section 461(h). P acquires all
of the stock of T in Year 1 and makes a section 338 election for T.
Assume that, if a corporation unrelated to T had actually purchased
T’s assets and assumed T’s obligation to remediate the
contamination, the corporation would not satisfy the economic
performance requirements until Year 5. . . . The incurrence of the
liability in Year 5 under the economic performance rules is an
increase in the amount of liabilities properly taken into account in
the basis and results in the redetermination of AGUB [adjusted
grossed-up basis].
Therefore, in a taxable business combination, the settlement
of a contingent environmental liability will generally increase
tax-deductible goodwill. Therefore, as described in Section 11.3.5.1, the
acquirer should assume that the contingent environmental liability will be
settled at its acquisition-date fair value and should include this amount in
the calculation of tax-deductible goodwill when performing the
acquisition-date comparison with financial reporting goodwill. If the amount
of the hypothetical tax-deductible goodwill (i.e., tax-deductible goodwill
that includes the amount associated with the contingency) exceeds the amount
of financial reporting goodwill, a DTA should be recorded. However, if the
financial reporting goodwill exceeds the hypothetical tax-deductible
goodwill, no DTL is recorded for the excess (because of the exception in ASC
805-740-25-9). See Section
11.3.2 for further discussion of the acquisition-date
comparison of financial reporting goodwill with tax-deductible goodwill.
Example 11-15
AC acquires the stock of TC for $45
million in a taxable business combination on June
30, 20X9 (e.g., a stock acquisition with a taxable
election under IRC Section 338). As part of the
acquisition, AC recognizes a contingent
environmental liability with a fair value of $1
million in connection with contaminated land. For
financial reporting purposes, the land is recognized
at its fair value (full remediation is assumed) of
$5 million; however, for tax purposes, the land is
recognized at only $4 million (i.e., the tax basis
is based on unremediated fair value). The remaining
assets of TC have a fair value of $37 million with
an equal tax basis. AC’s applicable tax rate is 25
percent.
Goodwill for both financial
reporting and tax purposes is calculated below:
AC will recognize a DTL of $250,000
for the taxable temporary difference between the tax
basis of the land and the amount recorded for
financial reporting purposes, or ($5,000,000 –
$4,000,000) × 25%.
For tax purposes, AC has determined
that once the contingent environmental liability is
settled, it will be added to tax-deductible
goodwill. Therefore, AC includes the
acquisition-date fair value of the contingent
environmental liability in tax-deductible goodwill
when comparing acquisition-date tax-deductible
goodwill with financial reporting goodwill.
Tax-deductible goodwill is compared
with financial reporting goodwill as follows:
Because hypothetical tax-deductible
goodwill exceeds financial reporting goodwill, AC
records a DTA by using the following iterative
calculation, as further described in Section
11.3.2:
DTA = [0.25 ÷ (1 – 0.25)] ×
$750,000
DTA = $250,000
June 30,
20X9
The following journal entries are
recorded on June 30, 20X9:
AC
TC (to reflect “push-down” of the
journal entries to TC’s books)
11.3.6 Other Considerations
Other special considerations in connection with the recognition, measurement, and
subsequent measurement of income taxes related to a business combination include
those regarding transaction costs incurred, the settlement of preexisting
relationships, assets that were previously subject to intra-entity sale
guidance, and indemnification assets. As previously noted, it is important to
fully understand the components of a business combination to appropriately apply
the guidance.
11.3.6.1 Transaction Costs
Significant acquisition-related costs are often incurred in connection with a
business combination, and the accounting for such costs may differ for
financial and tax reporting purposes. To determine the appropriate
accounting for acquisition-related costs, entities may need to also consider
(among other factors) the timing of the expenditures (i.e., before or after
the business combination is consummated) and which entity incurs the costs
(i.e., the acquiree or the acquirer).
11.3.6.1.1 Transaction Costs Incurred by the Acquirer
In accordance with ASC 805-10, acquisition-related costs incurred by the
acquirer in connection with a business combination (e.g., deal fees for
attorneys, accountants, investment bankers, and valuation experts) must
be expensed as incurred for financial reporting purposes unless they are
subject to other U.S. GAAP (e.g., costs related to the issuance of debt
or equity securities).
When acquisition-related costs are incurred, it may not
be clear whether they will ultimately be deductible for income tax
reporting purposes. For example, certain acquisition-related costs may
have to be capitalized for income tax reporting purposes when incurred
and become immediately deductible if the business combination is not
consummated. If the business combination is consummated, the capitalized
costs may be added (1) to the basis of the assets acquired in a taxable
asset acquisition or (2) to the basis in the stock of the acquired
entity in a nontaxable stock acquisition. Because acquisition-related
costs are not considered part of the acquisition and are expensed as
incurred for financial reporting purposes, the related deferred taxes
(if any) will be recorded as a component of income tax expense (i.e.,
outside of the business combination). In addition, the portion of tax
deductible goodwill related to acquisition costs should not be included
in the determination of component 1 and component 2 goodwill.
When acquisition-related costs are incurred in a period
before a business combination is consummated and those costs are
capitalized for tax purposes, a book/tax basis difference results. The
acquirer will need to assess whether that basis difference represents a
deductible temporary difference for which a DTA should be recorded. In
making this determination, the acquirer may use either of the following
two approaches.6
-
Approach 1 — If the costs that were capitalized for tax purposes will become deductible in the event the business combination does not occur, a deductible temporary difference exists, and a DTA should be recorded when the expense is recognized for financial reporting purposes. If the business combination is ultimately consummated, the acquirer would need to reassess the DTA to determine whether recognition continues to be appropriate. For example, if the business combination occurs and is a taxable asset acquisition, the capitalized costs would be added to the basis of the net assets acquired, and a DTA would generally result. Alternatively, if the business combination is consummated and is a nontaxable stock acquisition, the capitalized costs would be added to the basis of the stock acquired, and an outside basis deductible temporary difference would typically be created. However, the entity would need to evaluate whether an exception to recognition of the outside basis DTA is applicable (i.e., the entity would need to evaluate ASC 740-30-25-9). If recognition is no longer appropriate, the DTA should be reversed to the income statement.
-
Approach 2 — The acquirer can record a DTA if, on the basis of (1) the probability that the business combination will be consummated and (2) the expected tax structure of the business combination, the acquisition-related expenses would result in a future tax deduction. Approach 2 requires the acquirer, in determining whether to record all or a portion of the DTA for the acquisition expenses, to make assumptions about how the transaction would be structured from a tax perspective and about the probability that the business combination would be consummated. As a result of this approach, the entity would conform its financial reporting to its “expectation” as of each reporting date (i.e., the DTA may be recognized and subsequently derecognized if expectations change from one reporting period to the next).
11.3.6.1.2 Transaction Costs Incurred by the Target
Like acquisition-related costs incurred by the acquirer, precombination
transaction costs incurred by the target are generally expensed as
incurred for financial reporting purposes. It may not be clear at the
time the costs are incurred whether they will ultimately be deductible
for income tax reporting purposes. In some jurisdictions, capitalized
transaction costs incurred by the target may result in a tax deduction
(1) if the business combination is not consummated or (2) if the
business combination is consummated and is treated as a taxable asset
sale. However, if the business combination is consummated in the form of
a nontaxable stock sale, the target’s capitalized transaction costs may
not be deductible or amortizable.
When the target incurs precombination transaction costs
and those costs are capitalized for tax purposes, the target will also
need to assess whether that temporary difference is a deductible
temporary difference for which a DTA should be recorded. We believe that
the target may use either of the aforementioned approaches available to
the acquirer to account for the expected tax consequences of the
precombination transaction costs.7
Example 11-16
Taxable Business Combination
AC acquires TC in a taxable business
combination for $1,000 and incurs $200 of costs
related to the acquisition. The identifiable
assets have a fair value of $700. For financial
reporting purposes, AC expenses the $200
acquisition-related costs. For income tax
reporting purposes, AC adds the $200
acquisition-related costs to the total amount that
is allocated to assets, resulting in
tax-deductible goodwill of $500. Assume that the
tax rate is 21 percent.
AC would record the following journal entries on
the acquisition date:
The tax impact of the
acquisition costs is reflected in the income
statement because the excess amount of
tax-deductible goodwill over financial reporting
goodwill relates solely to the acquisition costs
that are expensed for financial reporting
purposes. As a result, neither (1) the
acquisition-date comparison of tax-deductible
goodwill with financial reporting goodwill nor (2)
the iterative calculation described in ASC
805-740-25-8 and 25-9 and Section 11.3.2 is
required.
Example 11-17
Nontaxable
Business Combination
AC acquires TC in a
nontaxable business combination for $1,000
and incurs $200 of costs related to the
acquisition. The identifiable assets have a fair
value of $700 and a tax basis of $250. For
financial reporting purposes, AC expenses the $200
of acquisition-related costs. For tax purposes, AC
adds the $200 of acquisition-related costs to the
basis of TC’s stock. Assume a 21 percent tax
rate.
AC would record the following
journal entries on the acquisition date:
Unlike the acquisition expenses
in the taxable business combination in Example
11-7, the acquisition expenses may not
be tax-affected in a nontaxable business
combination. The acquisition-related costs are
included in the outside tax basis of AC’s
investment in TC. Therefore, the DTA would have to
be assessed in accordance with ASC 740-30-25-9. As
long as it is not apparent that the temporary
difference will reverse in the foreseeable future,
no DTA is recorded.
11.3.6.2 Contingent Consideration
Many business combinations include contingent consideration features whereby
the amount of consideration the buyer ultimately pays for the business will
depend on the outcome of future events (for example, the earnings generated
by the business for a period after the acquisition). ASC 805 requires the
buyer to initially measure the contingent consideration at fair value and
include the incurred liability as part of the purchase price for the
acquired business. However, as discussed further below, there can be
complexities regarding the initial and subsequent accounting for the tax
impacts of contingent consideration.
11.3.6.2.1 The Income Tax Measurement Consequences of Contingent Consideration in a Business Combination
Differences exist between the accounting for contingent
consideration in a business combination under U.S. GAAP and the tax
treatment under the tax code. For financial reporting purposes, the
acquirer is required to recognize contingent consideration as part of
the consideration transferred in the business combination. The
obligation is recorded at its acquisition-date fair value and classified
as a liability or as equity depending on the nature of the
consideration. The accounting consequences of the classification of
contingent consideration are as follows:
-
Contingent consideration classified as equity is not remeasured.
-
Contingent consideration classified as a liability is remeasured at fair value on each reporting date. All post-measurement-period adjustments are recorded through earnings unless the arrangement is a hedging instrument under ASC 815, in which case the changes in fair value must be initially recognized in OCI (see ASC 805-30-35-1).
For tax purposes, however, the acquirer is generally
precluded from recognizing contingent consideration as part of the
consideration transferred until the contingency has become fixed and
determinable with reasonable accuracy or, in some jurisdictions, until
it has been settled. This could result in a difference in the total
consideration recognized for financial reporting and tax purposes on the
acquisition date.
To determine whether a DTA or DTL should be recognized on the acquisition
date, the acquirer should determine the expected tax consequences that
would result if the contingent consideration was settled at its initial
reported amount in the financial statements as of the acquisition date.
The tax consequences will, in part, depend on how the business
combination is structured for tax purposes (i.e., as a taxable or
nontaxable business combination).
11.3.6.2.1.1 Taxable Business Combination — Initial Measurement
In a taxable business combination, the settlement of
contingent consideration will generally increase the tax basis of
goodwill. The acquirer should assume that the contingency will be
settled at its acquisition-date fair value and should include this
amount in the calculation of tax-deductible goodwill when performing
the acquisition-date comparison of tax-deductible goodwill with
financial reporting goodwill. If the amount of the hypothetical
tax-deductible goodwill (i.e., tax-deductible goodwill that includes
the amount associated with the contingent consideration) exceeds the
amount of financial reporting goodwill, a DTA should be recorded.
However, if the financial reporting goodwill exceeds the
hypothetical tax-deductible goodwill, no DTL is recorded for the
excess (because of the exception in ASC 805-740-25-9). See Section
11.3.2 for further discussion of the acquisition-date
comparison of financial reporting goodwill with tax-deductible
goodwill.
11.3.6.2.1.2 Taxable Business Combination — Subsequent Measurement
A subsequent increase or decrease in the fair value
of the contingent consideration liability will result in an
adjustment to the hypothetical tax bases of the acquired assets. As
a result, a book-to-tax basis difference may arise. A DTA or DTL
would be recorded through the tax provision for the expected tax
consequences of the change in the liability-classified contingent
consideration.
If the revised fair value exceeds the amount originally recorded as a liability, a
DTA will be recorded in connection with expected additional
tax-deductible goodwill. For financial reporting purposes, this
additional tax-deductible goodwill is treated as unrelated to the
acquisition (i.e., it is considered to be newly arising after the
business combination as a result of the expense recognized);
therefore, the DTA results in recognition of a tax provision benefit
to continuing operations rather than a reduction in financial
reporting goodwill.
If the revised fair value is adjusted to an amount
that is less than the liability originally
recorded on the books, a DTL will be recorded to the extent that the
adjustment results in a reduction to the hypothetical tax basis of
component 1 goodwill. Component 1 goodwill is established on the
acquisition date and not adjusted for subsequent changes to the fair
value of the liability. Therefore, a DTL would be recognized for the
difference between component 1 book goodwill and the revised
hypothetical tax basis of component 1 goodwill (i.e., ASC
740-10-25-3(d) would not apply). See Section 11.3.2 for a
discussion of goodwill components. For financial reporting purposes,
this reduction to tax-deductible goodwill is also treated as
unrelated to the acquisition; therefore, the DTL results in
recognition of a tax provision expense to continuing operations
rather than an adjustment to financial reporting goodwill (see
Example 11-18).
Generally, any deferred tax consequences resulting from the
resolution of equity-classified contingent consideration (i.e.,
changes in deferred taxes related to differences between the initial
reported amount of equity-classified contingent consideration and
the amount at settlement) are charged or credited directly to equity
in accordance with ASC 740-20-45-11(g).
11.3.6.2.1.3 Nontaxable Business Combination — Initial Measurement
In a nontaxable business combination, the settlement of contingent
consideration will generally increase the tax basis in the stock of
the acquired company (i.e., it increases the outside tax basis; for
more information about “inside” and “outside” basis differences, see
Section 3.3.1). If the hypothetical tax
basis in the shares (i.e., tax basis that includes the amount
associated with the contingent consideration) exceeds the financial
reporting basis of the shares acquired, the acquirer should consider
the provisions of ASC 740-30-25-9 regarding the possible limitations
on recognizing a DTA. However, if the financial reporting basis of
the shares acquired exceeds the hypothetical tax basis, the acquirer
should consider the provisions of ASC 740-10-25-3(a) and ASC
740-30-25-7 regarding the possible exceptions to recognizing a DTL.
See Section 11.3.1.2 for further discussion of
recognizing DTAs and DTLs related to outside basis differences.
11.3.6.2.1.4 Nontaxable Business Combination — Subsequent Measurement
In a nontaxable business combination, an increase or a decrease in
the fair value of the contingent consideration for financial
reporting purposes would result in an adjustment to the original
hypothetical tax basis of the acquired company’s stock. In many
cases, an exception to recording deferred taxes on outside basis
differences will apply (e.g., see ASC 740-10-25-3(a) and ASC
740-30-25-7 and 25-8 for DTLs and ASC 740-30-25-9 for DTAs). See
Example 11-19.
Example 11-18
Taxable Business Combination
AC acquires the stock of TC for $45 million and
a contingent payment (classified as a liability)
with a fair value of $5 million in a
taxable business combination on June 30,
20X9 (e.g., a stock acquisition with a taxable
election under IRC Section 338). The identifiable
assets have a fair value of $45 million and an
initial tax basis of $45 million. AC’s applicable
tax rate is 21 percent.
June 30, 20X9
The following journal entries are recorded on
June 30, 20X9:
AC
TC (to reflect “push-down”
of the journal entries to TC’s books)
AC determines that the expected tax
consequences of settling the $5 million contingent
consideration liability would be to increase the
tax basis of its identifiable assets and goodwill
to equal the book amounts. Therefore, no deferred
taxes are recorded on the acquisition date because
AC identifies no difference when performing the
acquisition-date comparison of hypothetical
tax-deductible goodwill with financial reporting
goodwill.
September 30, 20X9
On September 30, 20X9, subsequent facts and
circumstances indicate that the contingent
consideration has a fair value of $3 million.
AC
The $2 million decrease would reduce the
hypothetical tax-deductible component 1 goodwill
by $2 million. Accordingly, a $420,000 DTL is
recognized ($2 million × 21%), with an offsetting
journal entry to deferred tax expense.
December 31, 20X9
On December 31, 20X9, AC settles the contingent
consideration for $11 million (fair value).
AC
The $8 million increase gives rise to an equal
amount of tax-deductible goodwill that corresponds
to the $8 million pretax book expense.
Accordingly, a $1.26 million DTA is recognized
along with a decrease of the $420,000 DTL that was
recognized on September 30, 20X9. The offsetting
journal entry is to recognize deferred tax expense
of $1.68 million.
Example 11-19
Nontaxable Business Combination
AC acquires the stock of TC for $45 million and
a contingent payment (classified as a liability)
with a fair value of $5 million in a
nontaxable business combination on June 30,
20X9. The identifiable assets have a fair value of
$45 million and a carryover tax basis of $45
million. AC’s applicable tax rate is 21
percent.
June 30, 20X9
The following journal entries are recorded on
June 30, 20X9:
AC
TC (to reflect “push-down”
of the journal entries to TC’s books)
AC determines that the expected tax
consequences of settling the $5 million contingent
liability would be to increase the tax basis of
its investment in TC. As demonstrated below, after
considering the future tax consequences of
settling the contingent consideration liability,
there is no difference between the book basis and
the hypothetical tax basis of its investment in
TC, so no deferred taxes are recorded on the
acquisition date.
However, if, after the contingent liability is
considered, the hypothetical tax basis had
exceeded the book basis, AC would have needed to
consider ASC 740-30-25-9 before recognizing a DTA
on the outside basis difference. If, after the
contingent consideration liability is considered,
the hypothetical tax basis had still been less
than the book basis, AC would have needed to
consider ASC 740-10-25-3(a) and ASC 740-30-25-7
before recognizing a DTL on the outside basis
difference.
September 30, 20X9
On September 30, 20X9, subsequent facts and
circumstances indicate that the contingent
consideration has a fair value of $3 million.
AC
Because the future settlement of the contingent
consideration will affect the outside tax basis of
the shares, AC considers ASC 740-10-25-3(a) and
ASC 740-30-25-7 and concludes that no associated
DTL should be recorded. Therefore, there is book
income without a corresponding tax expense,
resulting in an impact to the ETR.
December 31, 20X9
On December 31, 20X9, AC settles the contingent
consideration for $11 million (fair value).
AC
Because the settlement of the contingent
consideration affects the outside tax basis of the
shares, AC considers ASC 740-30-25-9 and concludes
that no associated DTA should be recorded.
Therefore, there is book expense without a
corresponding tax benefit, resulting in an impact
to the ETR.
11.3.6.3 Business Combinations Achieved in Stages
A business combination is achieved in stages when an acquirer holds a
noncontrolling interest in an investment (e.g., an equity method investment)
in the acquired entity (the “original investment”) before obtaining control
of the acquired entity. When the acquirer obtains control of the acquired
entity, it remeasures the original investment at fair value. The acquirer
adds the fair value of the original investment to the total amount of
consideration transferred in the business combination (along with the fair
value of any noncontrolling interest still held by third parties) to
determine the target’s opening equity (which in turn affects the measurement
of goodwill). The gain or loss resulting from the fair value remeasurement
is reported in the statement of operations (separately and apart from the
acquisition accounting). Any gains or losses previously recognized in OCI
that are associated with the original investment are reclassified and
included in the calculation of the gain or loss.
For the acquirer, the remeasurement of the original investment in a business
combination achieved in stages at fair value will result in an increase or a
decrease in the financial reporting basis of the investment. Generally, the
tax basis of the investment will not be affected, and an outside basis
difference will therefore be created. (For further guidance on outside basis
differences, see Section 3.3.1.)
11.3.6.3.1 DTLs for Domestic Subsidiaries Acquired in Stages
If the acquiree is a domestic subsidiary, the acquirer may not be
required to recognize a DTL for an outside basis difference once the
acquirer obtains control of the acquiree. ASC 740-30-25-7 states that
the acquirer should assess whether the outside basis difference of an
investment in a domestic subsidiary is a taxable temporary difference.
If the tax law provides a means by which the tax basis of the investment
can be recovered in a tax-free transaction and the acquirer expects that
it will ultimately use that means to recover its investment, a DTL
should not be recognized for the outside basis difference. Therefore,
under these circumstances, the acquiring entity should reverse any DTL
previously recognized for the outside basis difference, including any
DTL associated with the remeasurement of the original investment. This
reversal of the DTL should be recognized in the acquirer’s statement of
operations in the same period that includes the business
combination.
The gain or loss resulting from the remeasurement of the
original investment at fair value is reported in the statement of
operations (separately and apart from the acquisition accounting). The
corresponding tax effect of the remeasurement should also be recorded as
a component of the income tax provision unless an exception applies
(e.g., ASC 740-30-25-9, ASC 740-10-25-3, or ASC 740-30-25-7). See the
example below.
Example 11-20
In year 1, AC purchased 20 percent of TC, a
domestic investee, for $100. In year 2, AC records
$100 of equity method earnings. Accordingly, at
the end of year 2, AC has a $200 book basis and
$100 tax basis in its equity method investment and
records a DTL of $21 on the outside basis
difference. Assume that the tax rate is 21
percent.
AC’s journal entries are as follows:
Year 1
Year 2
In a nontaxable business combination, AC
purchases the remaining 80 percent of TC for
$2,000. The fair value of all the identifiable
assets is $2,000, and their tax basis is $500.
AC remeasures its 20 percent investment in TC as
$500 (for simplicity, any control premium is
ignored) and recognizes $300 of gain.
AC records the following journal entries for the
remeasurement of its original investment in
TC:
AC records a DTL on the remeasurement gain
because it determines that the outside basis
difference is a taxable temporary difference
(i.e., the exception in ASC 740-30-25-7 does not
apply).
AC records the following journal entries for the
acquisition and resulting deferred taxes:
AC
TC (to reflect “push-down” of the journal
entries to TC’s books)
A DTL of $315 is recorded on the inside basis
difference attributable to the asset acquired,
since the book basis of the assets acquired is
greater than the tax basis ($2,000 – $500). No DTL
is recorded on the book-greater-than-tax basis
($815 – $0) in goodwill, in accordance with ASC
805-740-25-9.
If, at any time after the acquisition, AC (1)
reassesses the outside basis difference in its
investment in TC and concludes that the tax law
provides a means by which the reported amount of
its investment can be recovered tax free, and (2)
expects that it will ultimately use that means,
the DTL on the outside basis difference would be
reversed as an adjustment to income tax
expense.
Example 11-21
Assume the same facts as in the
example above, except that in applying ASC
740-30-25-7, AC determines that its outside basis
difference in TC is not a taxable temporary
difference and therefore records no deferred
taxes.
AC records the following journal entries for the
remeasurement of its original investment in
TC:
Because AC determines that its
outside basis difference in TC (a domestic
investee) is not a taxable temporary difference
under ASC 740-30-25-7, AC reverses the previously
recorded DTL for the outside basis difference,
which is calculated as ($200 book basis – $100 tax
basis) × 21% tax rate, and records no DTL for the
outside basis difference created from the
remeasurement gain.
AC records the following journal entries for the
acquisition and resulting deferred taxes:
AC
TC (to Reflect “Pushdown” of
the Journal Entries to TC’s Books)
A DTL of $315, or ($2,000 –
$500) × 21%, is still recorded on the inside basis
difference of the assets acquired, since the
exception in ASC 740-30-25-7 is related only to
the outside basis differences.
If TC were a partnership for U.S. tax
purposes and AC purchased its interest via a
separate subsidiary so that TC’s partnership
status postacquisition was preserved, the
exception in ASC 740-30-25-7 would generally not
apply because an investor in a flow-through entity
typically cannot recover its investment in a
tax-free manner. Rather, the outside basis
difference would reverse through normal operations
and would therefore be a taxable temporary
difference. In addition, deferred taxes would not
be recorded on the underlying assets inside TC
since TC is a nontaxable entity.
11.3.6.4 Accounting for the Settlement of a Preexisting Relationship
If a business combination effectively results in the settlement of a
preexisting relationship between an acquirer and an acquiree, the acquirer
would recognize a gain or loss. ASC 805-10-55-21 indicates how such a gain
or loss should be measured:
-
For a preexisting noncontractual relationship, such as a lawsuit, fair value
-
For a preexisting contractual relationship, the lesser of the following:
-
The amount by which the contract is favorable or unfavorable from the perspective of the acquirer when compared with pricing for current market transactions for the same or similar items. An unfavorable contract is a contract that is unfavorable in terms of current market terms. It is not necessarily a loss contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.
-
The amount of any stated settlement provisions in the contract available to the counterparty to whom the contract is unfavorable. If this amount is less than the amount in (b)(1), the difference is included as part of the business combination accounting.
-
Note that if a preexisting contract is otherwise cancelable
without penalty, no settlement gain or loss would be recognized. The
acquirer’s recognition of an asset or liability related to the relationship
before the business combination will affect the calculation of the
settlement (see the example below).
When a business combination results in the settlement of a noncontractual
relationship, such as a lawsuit or threatened litigation, the gain or loss
should be recognized and measured at fair value. This settlement gain or
loss may differ from any amount previously recorded under the contingency
guidance in ASC 450.
The examples below have been adapted from ASC 805-10-55-30
through 55-32 to illustrate the tax effects of a preexisting relationship
between parties to a business combination.
Example 11-22
AC acquires TC in a taxable business
combination. The acquisition includes a supply
contract under which AC purchases electronic
components from TC at fixed rates over a five-year
period. Currently, the fixed rates are higher than
the rates at which AC could purchase similar
electronic components from another supplier. The
supply contract allows AC to terminate the contract
before the end of the initial five-year term only by
paying a $6 million penalty. With three years
remaining under the supply contract, AC pays $50
million to acquire TC.
This amount is the fair value of TC and is based on
what other market participants would be willing to
pay for the entity (inclusive of the above-market
contract). The total fair value of TC includes $8
million related to the fair value of the supply
contract with AC. The $8 million represents a $3
million component that is “at-market” because the
pricing is comparable to pricing for current market
transactions for the same or similar items (e.g.,
selling effort, customer relationships) and a $5
million component for pricing that is unfavorable to
AC because it exceeds the price of current market
transactions for similar items. TC has no other
identifiable assets or liabilities that are related
to the supply contract, and AC has not recognized
any assets or liabilities in connection with the
supply contract before the business combination. The
remaining fair value of $42 million relates to
machine equipment. The tax rate is 21 percent.
Assume a taxable transaction in a
jurisdiction that allows for tax-deductible
goodwill.
AC will record the following journal entries on the
acquisition date:
In applying ASC 805-10-55-21(b), AC recognizes a loss
of $5 million (the lesser of the $6 million stated
settlement amount in the supply contract or the
amount by which the contract is unfavorable to the
acquirer) separately from the business combination.
The $3 million at-market component of the contract
is part of goodwill.
The $5 million loss on the supply contract is
recognized as an expense in the statement of
operations for financial reporting purposes (e.g.,
separately and apart from the acquisition
accounting). Typically, the supply contract will not
be viewed as a separate transaction for tax purposes
and will be included in tax-deductible goodwill,
resulting in a temporary difference. This will give
rise to a DTA and a tax provision credit as a result
of tax affecting the $5 million loss recognized in
the statement of operations. The resulting DTA would
be reversed when the goodwill is deducted on the tax
return (as long as there are no realization
concerns).
Note that if this transaction was structured as a
nontaxable business combination (i.e., AC
acquires the stock of TC), the basis difference that
arises related to the $5 million loss would not give
rise to a DTA as discussed in the preceding
paragraph (i.e., because it would now be related to
an excess tax over financial reporting basis in a
subsidiary and be subject to the exception in ASC
740-30-25-9).
Example 11-23
Assume the same facts as in the
example above (e.g., a taxable business combination and
tax-deductible goodwill), except that AC had
recorded a $6 million liability and a $1.26 million
DTA related to the supply contract with TC before
the business combination.
AC will record the following journal
entries on the acquisition date:
In applying ASC 805-10-55-21(b), AC
recognizes a $1 million settlement gain on the
contract (the $5 million measured loss on the
contract less the $6 million loss previously
recognized), along with the corresponding tax
effects, separately from the business combination.
The $3 million at-market component of the contract
is part of goodwill.
Because the transaction is
structured as a taxable business combination, the
tax impact on the total $5 million loss related to
the supply contract is treated the same as in the
example above (i.e., the supply contract will not be
viewed as a separate transaction for tax purposes
and will be included in tax-deductible goodwill,
resulting in a temporary difference and
corresponding DTA and tax provision credit).
11.3.6.5 Recognition of Changes in Indemnification Assets Under a Tax Indemnification Arrangement
Business combinations commonly involve tax indemnification arrangements
between the former parent and the acquirer of a subsidiary in which the
parent partly or fully indemnifies the acquirer for tax uncertainties
related to uncertain tax positions taken by the subsidiary in periods before
the sale of the subsidiary.
ASC 805 addresses the accounting for indemnifications in a
business combination. Specifically, ASC 805-20-25-27 states, in part, that
the “acquirer shall recognize an indemnification asset at the same time that
it recognizes the indemnified item, measured on the same basis as the
indemnified item, subject to the need for a valuation allowance for
uncollectible amounts.” ASC 805-20-30-19 further elaborates on
indemnifications provided for uncertain tax positions:
[A]n indemnification may relate to an asset or a
liability, for example, one that results from an uncertain tax
position that is measured on a basis other than acquisition-date
fair value. [I]n those circumstances, the indemnification asset
shall be recognized and measured using assumptions consistent with
those used to measure the indemnified item, subject to management’s
assessment of the collectibility of the indemnification asset and
any contractual limitations on the indemnified amount.
Therefore, if the subsidiary (after the acquisition) has
UTBs determined in accordance with ASC 740 and if the related tax positions
are indemnified by the former parent, the acquirer (or potentially the
subsidiary itself if it is the legal counterparty to the indemnification
agreement) could recognize an indemnification asset on the basis of the
indemnification agreement and the guidance in ASC 805-20-25-27 and ASC
805-20-30-19. The guidance in ASC 805-20-35-4 also addresses the subsequent
measurement of indemnification assets.
Example 11-248
Company P sells its subsidiary (Company S) to an
unrelated party in January 20X9. Before the sale, P
and S were separate companies and filed separate
income tax returns. In connection with the sale, P
and S enter into an indemnification agreement in
which P will partially indemnify S for the
settlement of S’s uncertain tax positions related to
periods before the sale (i.e., P and S will share 40
percent and 60 percent of the settlement,
respectively). Specifically, if S settles an
uncertain tax position with the tax authority for
$100, S would be reimbursed $40 by P. However, S
remains the primary obligor for its tax positions
since it filed separate returns before the sale.
Assume that, upon the sale, S has recorded a
liability of $100 for UTBs. On the basis of its
specific facts and circumstances, S determines that
recording a receivable (i.e., an indemnification
asset) for the indemnification agreement is
appropriate in accordance with ASC 805. At the time
of the acquisition and subsequently, S concluded
that, in the absence of collectibility concerns, the
indemnification receivable should be accounted for
under the same accounting model as that used for the
related liability and subsequently adjusted for any
changes in the liability. Company S also concluded
that the indemnification receivable should not be
recorded net of the related UTBs because it does not
meet the criteria for offsetting in ASC 210-20. (See
Section 2.8 for an example
illustrating the accounting for the guarantor side
of the indemnification agreement.) Therefore, at the
time of the acquisition, S recorded an
indemnification receivable (an “indemnification
asset”) of $40, which equals the amount that it
expects to recover from P as a result of the
indemnification agreement.
The potential payments to be received under the
indemnification agreement are not income-tax-related
items because the amounts are not due to or from a
tax jurisdiction. Rather, they constitute a
contractual agreement between the two parties
regarding each party’s ultimate tax obligations. If
S settled its uncertain tax positions with the tax
authority, and P was unable to pay S the amount due
under the indemnification agreement, S’s liability
to the tax authority would not be altered or
removed.
SEC Regulation S-X, Rule
5-03(b)(11),9 notes that a company should include “only
taxes based on income” in the income statement line
item under the caption “income tax expense.”
Accordingly, any adjustment to the indemnification
asset should be included in an “above the line”
income statement line item. If S determined that P
was unable to pay its $40 obligation, S would impair
the indemnification asset and record the associated
expense outside of “income tax expense.”
Similar issues may arise when a subsidiary is spun
off from its parent. See Section
4.6.6 for considerations involving UTBs
in a spin-off transaction.
For additional considerations related to income tax indemnifications upon the
sale of a subsidiary that previously filed a separate tax return, meaning
that the acquiring entity may not be directly liable for the acquiree’s tax
obligations upon acquisition, see Section 2.8.
11.3.6.6 Acquired Current Taxes Payable
In general, acquired liabilities are recorded at fair value on the
acquisition date as prescribed under ASC 805-20-25-1. However, this
requirement only applies to liabilities that exist as of the acquisition
date.
In some business combinations, income taxes are due as a result of a
requirement to prepare a stub-period tax return for the acquired entity.
Those income taxes payable would be included as a liability acquired by the
acquirer and recorded in purchase accounting. After the acquisition, any tax
on income generated would not be included as a liability assumed by the
acquirer and would be recorded as a component of postacquisition income tax
expense.
Footnotes
2
In the calculation of deferred
taxes in this example, it is assumed that
allocation is consistent with Approach 2 described
in Section
11.3.2.2.
3
Once effective, ASU 2017-04 amends ASC 350-20-40-7
to refer to ASC 350-20-35-3A through 35-13 rather than ASC
350-20-35-3A through 35-19. ASU 2017-04, which eliminates step 2
from the goodwill impairment test, supersedes ASC 350-20-35-14
through 35-19. Entities that have early adopted the amendments in
ASU 2017-04 should refer to the updated guidance.
4
Once effective, ASU 2017-04 amends ASC 350-20-35-1
to state that “goodwill shall be tested at least annually for
impairment at a level of reporting referred to as a reporting unit”
(emphasis added). While ASC 350-20-35-1 is amended, as described
above, the requirement under ASC 350-20-35-28 to test goodwill at
least annually did not change.
5
See footnote
4.
6
The approach an entity selects is an accounting
policy election that, like all such elections, should be applied
consistently.
7
See footnote
3.
8
Entities should not use this
example as a basis for recording an
indemnification receivable since they would need
additional facts to reach such a conclusion.
Rather, entities must evaluate their own facts and
circumstances and use significant judgment when
determining the appropriateness of such a
receivable. Any receivable recorded should be
adjusted to reflect collection risk as
appropriate.
9
Rule 5-03 applies to commercial and industrial
companies only; however, Regulation S-X, Rules
6-07 and 7-04, provide similar guidance and apply
to registered investment companies and insurance
companies, respectively.
11.4 Accounting for Uncertainty in Income Taxes in Business Combinations
Uncertain tax positions related to a business combination and subsequent changes to
those positions require special consideration under ASC 805 during the initial
measurement period and after a business combination.
ASC 805-740
Other Presentation Matters
45-1
This Section addresses how an acquirer recognizes changes in
valuation allowances and tax positions related to an
acquisition and the accounting for tax deductions for
replacement awards.
Changes in Tax Positions
45-4
The effect of a change to an acquired tax position, or those
that arise as a result of the acquisition, shall be
recognized as follows:
-
Changes within the measurement period that result from new information about facts and circumstances that existed as of the acquisition date shall be recognized through a corresponding adjustment to goodwill. However, once goodwill is reduced to zero, the remaining portion of that adjustment shall be recognized as a gain on a bargain purchase in accordance with paragraphs 805-30-25-2 through 25-4.
-
All other changes in acquired income tax positions shall be accounted for in accordance with the accounting requirements for tax positions established in Subtopic 740-10.
The recognition and measurement guidance in ASC 740 is applicable to a business
combination accounted for in accordance with ASC 805. ASC 805-740-25-5 states, “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.” In addition, the effect of subsequent changes to acquired
uncertain tax positions established in the business combination should be recorded
in accordance with the presentation and classification guidance in ASC 740 unless
that change relates to new information about facts and circumstances that existed as
of the acquisition date and occurs within the measurement period (as described in
ASC 805-10-25-13 through 25-19).
The measurement period applies to the potential tax effects of (1) uncertainties
associated with temporary differences and carryforwards of an acquired entity that
exist as of the acquisition date in a business combination or (2) income tax
uncertainties related to a business combination (e.g., an uncertainty related to the
tax basis of an acquired asset that will ultimately be agreed to by the tax
authority) acquired or arising in a business combination.
ASC 805-740-45-4(a) states that if the change occurs in the measurement period and
relates to “new information about facts and circumstances that existed as of the
acquisition date,” it is reflected with a “corresponding adjustment to goodwill.”
However, if goodwill is reduced to zero, the remaining portion will be reflected as
a bargain purchase gain.
If the adjustment to the acquired tax position balance directly results from an event
that occurred after the business combination’s acquisition date, regardless of
whether the adjustment is identified during or after the measurement period, the
entire adjustment is recognized as an adjustment to income tax expense in accordance
with ASC 740 and is not an adjustment to goodwill.
After the measurement period, changes in the acquired tax position balances because
of additional information about facts and circumstances that existed as of the
acquisition date would need to be assessed to determine whether the adjustment is a
correction of an error.
11.4.1 Changes in Uncertain Income Tax Positions Acquired in a Business Combination
Before ASC 805 (formerly FASB Statement 141(R)), the acquirer generally recorded subsequent adjustments to uncertain tax positions arising from a business combination through goodwill, in accordance with EITF Issue 93-7, regardless of
whether such adjustments occurred during the allocation period or thereafter. If
goodwill attributable to the acquisition was reduced to zero, the acquirer then
reduced other noncurrent intangible assets related to that acquisition to zero
and recorded any remaining credit as a reduction of income tax expense.
An acquirer must record all changes to acquired uncertain tax positions arising from a business combination consummated before the adoption of Statement 141(R)
in accordance with ASC 805-740-45-4, which requires that changes to an acquired
tax position, or those that arise as a result of the acquisition (other than
changes occurring during the measurement period that are related to facts and
circumstances as of the acquisition date), be accounted for in accordance with
ASC 740-10 (generally as an adjustment to income tax expense).
11.5 Valuation Allowances
In accordance with the guidance in ASC 740-10 and ASC 805-740, an acquirer recognizes
DTAs and DTLs associated with the assets acquired and the liabilities assumed in a
business combination. The acquirer also assesses whether a valuation allowance is
required against some or all of the acquired DTAs when it is not more likely than
not that such DTAs will be realized. This is generally done as part of purchase
accounting. The business combination may also cause a change in judgment about the
realizability of the acquirer’s DTAs.
Special consideration is required of a reporting entity when it is accounting for
changes in a valuation allowance as of or after a business combination under ASC
805-740. The reporting entity should carefully consider the reason for the change in
the valuation allowance, the DTAs to which the change in valuation allowance relates
(i.e., whether they are the acquiree’s or the acquirer’s), and whether the
information that caused the change in judgment existed before the acquisition
date.
ASC 805-740
30-1 An acquirer shall measure a
deferred tax asset or deferred tax liability arising from
the assets acquired and liabilities assumed in a business
combination in accordance with Subtopic 740-10. Discounting
deferred tax assets or liabilities is prohibited for
temporary differences (except for leveraged leases, see
Subtopic 842-50) related to business combinations as it is
for other temporary differences.
30-2 See Example 1
(paragraph 805-740-55-2) for an illustration of the
measurement of deferred tax assets and a related valuation
allowance at the date of a nontaxable business
combination.
30-3 The tax law in some tax
jurisdictions may permit the future use of either of the
combining entities’ deductible temporary differences or
carryforwards to reduce taxable income or taxes payable
attributable to the other entity after the business
combination. If the combined entity expects to file a
consolidated tax return, an acquirer may determine that as a
result of the business combination its valuation for its
deferred tax assets should be changed. For example, the
acquirer may be able to utilize the benefit of its tax
operating loss carryforwards against the future taxable
profit of the acquiree. In such cases, the acquirer reduces
its valuation allowance based on the weight of available
evidence. However, that reduction does not enter into the
accounting for the business combination but is recognized as
an income tax benefit (or credited directly to contributed
capital [see paragraph 740-10-45-20]).
35-1 An acquirer may have a
valuation allowance for its own deferred tax assets at the
time of a business combination. The guidance in this Section
addresses measurement of that valuation allowance and the
potential need to distinguish the separate pasts of the
acquirer and the acquired entity in the measurement of
valuation allowances together with expected future results
of operations. Guidance on the subsequent measurement of
deferred tax assets or liabilities arising from the assets
acquired and liabilities assumed in a business combination,
and any income tax uncertainties of an acquiree that exist
at the acquisition date, or that arise as a result of the
acquisition, is provided in Subtopic 740-10.
35-2 Changes in the
acquirer’s valuation allowance, if any, that result from the
business combination shall reflect any provisions in the tax
law that restrict the future use of either of the combining
entities’ deductible temporary differences or carryforwards
to reduce taxable income or taxes payable attributable to
the other entity after the business combination.
35-3 Any changes in the
acquirer’s valuation allowance shall be accounted for in
accordance with paragraph 805-740-30-3. For example, the tax
law may limit the use of the acquired entity’s deductible
temporary differences and carryforwards to subsequent
taxable income of the acquired entity included in a
consolidated tax return for the combined entity. In that
circumstance, or if the acquired entity will file a separate
tax return, the need for a valuation allowance for some
portion or all of the acquired entity’s deferred tax assets
for deductible temporary differences and carryforwards is
assessed based on the acquired entity’s separate past and
expected future results of operations.
Other Presentation Matters
45-1 This Section addresses
how an acquirer recognizes changes in valuation allowances
and tax positions related to an acquisition and the
accounting for tax deductions for replacement awards.
Changes in Valuation Allowances
45-2 The effect of a change
in a valuation allowance for an acquired entity’s deferred
tax asset shall be recognized as follows:
-
Changes within the measurement period that result from new information about facts and circumstances that existed at the acquisition date shall be recognized through a corresponding adjustment to goodwill. However, once goodwill is reduced to zero, an acquirer shall recognize any additional decrease in the valuation allowance as a bargain purchase in accordance with paragraphs 805-30-25-2 through 25-4. See paragraphs 805-10-25-13 through 25-19 and 805-10-30-2 through 30-3 for a discussion of the measurement period in the context of a business combination.
-
All other changes shall be reported as a reduction or increase to income tax expense (or a direct adjustment to contributed capital as required by paragraphs 740-10-45-20 through 45-21).
45-3 Example 2 (see
paragraph 805-740-55-4) illustrates this guidance relating
to accounting for a change in an acquired entity’s valuation
allowance.
Change in Acquirer’s Valuation Allowance as a Result of a
Business Combination
50-1 Paragraph 805-740-30-3
describes a situation where an acquirer reduces its
valuation allowance for deferred tax assets as a result of a
business combination. Paragraph 740-10-50-9(h) requires
disclosure of adjustments of the beginning-of-the-year
balance of a valuation allowance because of a change in
circumstances that causes a change in judgment about the
realizability of the related deferred tax asset in future
years. That would include, for example, any acquisition-date
income tax benefits or expenses recognized from changes in
the acquirer’s valuation allowance for its previously
existing deferred tax assets as a result of a business
combination.
Related Implementation Guidance and Illustrations
-
Example 2: Valuation Allowance at Acquisition Date Subsequently Reduced [ASC 805-740-55-4].
11.5.1 Accounting for Changes in the Acquirer’s and Acquiree’s Valuation Allowances as of and After the Acquisition Date
The table below summarizes the differences between accounting
for changes in the acquiring entity’s valuation allowance and accounting for the
acquired entity’s valuation allowances as of and after the acquisition date.
Changes in Valuation Allowance as a Result of Facts and
Circumstances That:
| ||
---|---|---|
Existed as of the Acquisition Date
|
Occurred After the Acquisition Date
| |
Valuation allowance on the acquiring entity’s DTAs that
existed as of the acquisition date
|
Generally, ASC 805-740-35-3 requires that changes in
assumptions about the realizability of an
acquirer’s valuation allowance as a result of
a business combination be recorded separately from
business combination accounting. Accordingly, all
changes to an acquirer’s valuation allowance as the
result of a business combination, whether as of the
acquisition date or subsequently, should be recognized
in income tax expense (or credited directly to
contributed capital [see ASC 740-10-45-20]).
| |
Valuation allowance on the acquired entity’s DTAs that
existed as of the acquisition date
|
Record as part of the business combination (adjustment to
goodwill) only if the change occurred in the measurement
period and resulted from new information about facts and
circumstances that existed as of the acquisition date.
If, as a result of the adjustment, goodwill is reduced
to zero, any additional amounts should be recognized as
a bargain purchase in accordance with ASC 805-30-25-2
through 25-4. All other changes should generally be
recorded as an adjustment to income tax expense (see ASC
805-740-45-2).
|
Generally, record as an adjustment to income tax expense
(see ASC 805-740-45-2).
|
Under ASC 805, a valuation allowance established against acquired DTAs is
recorded as part of acquisition accounting (i.e., establishing the valuation
allowance would generally result in an increase to goodwill). By contrast, under
ASC 805-740-30-3, a change in the acquirer’s valuation allowance as a result of
the business combination is recognized as a component of income tax expense
(i.e., it is accounted for separately from the business combination). In
addition, the impact of a change in a valuation allowance related to acquired
DTAs as a result of facts and circumstances that occurred after the acquisition
date is recognized as a component of income tax expense separately from the
business combination.
Although a change in judgment related to an acquiring entity’s
valuation allowance may appear to be linked to the business combination (e.g.,
the addition of an extra source of income to support realizability of DTAs), the
impact should generally be recorded to income tax expense or benefit in the
period of the change in judgment. For example, in some tax jurisdictions, tax
law permits the use of deductible temporary differences or carryforwards of an
acquiring entity to reduce future taxable income if consolidated tax returns are
filed after the acquisition. Assume that as a result of a business combination,
it becomes more likely than not that an acquiring entity’s preacquisition tax
benefits will be realized. ASC 805-740-30-3 requires that changes in assumptions
about the realizability of an acquirer’s valuation
allowance, as a result of the business combination, be recorded separately from
the business combination accounting. If, as of the acquisition date, realization
of the acquiring entity’s tax benefits becomes more likely than not, reductions
in the acquiring entity’s valuation allowance should be recognized as an income
tax benefit (or credited directly to contributed capital — see ASC 740-10-45-20
and related guidance in Sections 6.2.2 and 6.2.3). Similarly, any subsequent changes to
the acquiring entity’s valuation allowance will not be recorded as part of
acquisition accounting (i.e., no adjustments to goodwill).
11.5.2 Assessing the Need for a Valuation Allowance as of and After the Acquisition Date
It may be complex for a reporting entity to determine whether DTAs — whether
those of the acquiree or those of the acquirer — are more likely than not to be
realized when the entity undertakes an acquisition. ASC 740-10-30-18 indicates
that the future reversal of existing taxable temporary differences is one of
four possible sources of taxable income that may be available to an entity for
realizing a tax benefit for deductible temporary differences and carryforwards
under the tax law. In some cases, acquired DTLs may represent a source of
taxable income that supports the realizability of some or all of the benefit of
either (1) the acquired DTAs or (2) the acquirer’s DTAs but is not sufficient to
support both. In this circumstance, the guidance in ASC 805 and ASC 740 is not
clear about whether the acquired DTLs should be first considered a source of
taxable income in the evaluation of realizability of the acquired DTAs or the
acquirer’s existing DTAs.
There are two acceptable methods that entities can use to determine how the
source of taxable income from the future reversal of acquired DTLs should be
allocated in the evaluation of the realizability of the acquired DTAs and the
acquirer’s existing DTAs. The method an acquirer selects is an accounting policy
decision that should be applied consistently. The acquirer should also provide
appropriate disclosures, including information about benefits or expenses
recognized for changes in its valuation allowance made in accordance with ASC 805-740-50-1.
-
Method 1: Assess acquired DTAs first — The acquirer first considers the acquired DTLs to be a source of taxable income for realization of the acquired DTAs. ASC 805-20-30-1 states that the “acquirer shall measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values.” Allocating the source of taxable income from the acquiree’s DTLs first to the realization of the acquiree’s DTAs is consistent with this principle. Any net residual source of taxable income from the acquiree’s DTLs remaining after the acquiree’s DTAs are taken into account would be considered a potential source of taxable income for the realization of the benefit of the acquirer’s existing DTAs. Any change in the acquirer’s valuation allowance is recognized in income tax expense.
-
Method 2: Assess on the basis of tax law ordering — Allocation of the source of taxable income from the acquiree’s DTLs is based on the tax law in the given jurisdiction. To determine whether the acquiree’s DTAs or the acquirer’s DTAs will be used to reduce taxable income that results from the reversal of the DTLs, the acquirer schedules the reversal of all temporary differences of both the acquirer and the acquiree on the basis of the applicable tax law. If such scheduling does not result in a determination, the acquirer should develop a systematic, rational, and consistent method for scheduling the reversal of the temporary differences. Under this method, a net DTL could be recorded through purchase accounting, and the entity could simultaneously recognize an income tax benefit for the release of the acquirer’s valuation allowance. The net DTL that is reflected in the acquisition accounting will commonly result in an increase of an asset (generally goodwill).Under this method, it is assumed that the fair value measurement principle is not applied to DTAs and DTLs and that scheduling of the combined group’s DTLs and DTAs is a normal part of that valuation analysis by an acquirer. It is also assumed that immediately after the business combination, the valuation allowance determination is performed by using the combined group’s postacquisition positive and negative evidence (i.e., not solely the acquiree’s positive and negative evidence).
Example 11-25
This example illustrates the application of each method
in a valuation allowance assessment.
Assume the following:
-
AC purchased TC in a nontaxable transaction.
-
AC will file a consolidated tax return that will include TC.
-
Before the acquisition, AC has a $1,000 NOL DTA with a $1,000 valuation allowance.
-
After the application of acquisition accounting, TC has a $600 NOL DTA and a $600 DTL.
-
Other than the $600 DTL, there are no other sources of taxable income for realizing the benefit of the consolidated group’s DTAs.
-
In accordance with tax law, the oldest available NOLs must be used first. There are no other limitations on the use of attributes.
The following table shows the years when the NOL
carryforwards will expire:
The following table shows the years when the DTL will
reverse:
Application of Method 1
TC records a DTA of $600 and a DTL of $600 as part of the
acquisition accounting. There is no impact on AC’s
deferred tax balances. AC’s final consolidated financial
statements will reflect a $1,600 DTA, a $600 DTL, and a
$1,000 valuation allowance.
Application of Method 2
Per tax law, AC’s older NOL DTAs must be used first;
however, a portion of AC’s NOL DTAs will expire in 20X1
and 20X2 before the full reversal of the DTL. The $300
of taxable income that will result from reversal of the
acquired DTL in 20X1 and 20X2 will be allocated as a
source of income to support the realizability of AC’s
NOL DTA. The $300 of taxable income that will result
from reversal of the acquired DTL in 20X3 and 20X4 will
be allocated as a source of income to support the
realizability of TC’s NOL DTA.
The purchase price allocation for TC will therefore
include a $600 DTA, a $600 DTL, and a $300 valuation
allowance as part of the acquisition accounting. AC will
reverse $300 of valuation allowance and record a
corresponding income tax benefit of $300. AC’s final
consolidated financial statements will reflect a $1,600
DTA, a $600 DTL, and a $1,000 valuation allowance.
11.6 Share-Based Payments
In a business combination, share-based payment awards held by
employees of the acquiree are often exchanged for share-based payment awards of the
acquirer. ASC 805 refers to the new awards as “replacement awards.” This exchange
may or not be required as part of the acquisition or as part of the acquiree’s stock
compensation plan. When the exchange is required as part of the acquisition, the
acquirer must analyze the terms of both the preexisting and the replacement awards
to determine what portion of the replacement awards is related to past service and
therefore part of the consideration transferred in the business combination. The
portion of replacement awards that is related to future services should be
recognized as compensation cost in the postcombination period. Additional
complexities arise when the terms of the replacement awards are different from those
of the original rewards. See Deloitte’s Roadmap Share-Based Payment Awards for
additional discussion about the accounting for equity awards issued in connection
with a business combination.
Similarly, ASC 805-740 includes specific income tax accounting guidance related to
these types of awards. Because a portion of the fair value of the replacement award
may be considered part of the consideration transferred in the business combination,
initial and subsequent accounting for the income tax effects of the awards may be
complex.
ASC 805-740
Replacement Awards Classified as Equity
25-10 Paragraph 805-30-30-9
identifies the types of awards that are referred to as
replacement awards in the Business Combinations Topic. For a
replacement award classified as equity that ordinarily would
result in postcombination tax deductions under current tax
law, an acquirer shall recognize a deferred tax asset for
the deductible temporary difference that relates to the
portion of the fair-value-based measure attributed to a
precombination exchange of goods or services and therefore
included in consideration transferred in the business
combination.
25-11 For a replacement award
classified as equity that ordinarily would not result in tax
deductions under current tax law, an acquirer shall
recognize no deferred tax asset for the portion of the
fair-value-based measure attributed to precombination
vesting and thus included in consideration transferred in
the business combination. A future event, such as an
employee’s disqualifying disposition of shares under a tax
law, may give rise to a tax deduction for instruments that
ordinarily do not result in a tax deduction. The tax effects
of such an event shall be recognized only when it
occurs.
Tax Deductions for Replacement Awards
45-5 Paragraph
805-30-30-9 identifies the types of awards that are referred
to as replacement awards in this Topic. After the
acquisition date, the deduction reported on a tax return for
a replacement award classified as equity may be different
from the fair-value-based measure of the award. The tax
effect of that difference shall be recognized as income tax
expense or benefit in the income statement of the
acquirer.
11.6.1 Tax Benefits of Tax-Deductible Share-Based Payment Awards Exchanged in a Business Combination
The appropriate income tax accounting for tax-deductible share-based payment
awards exchanged in a business combination depends on the timing of the exchange
relative to the acquisition date.
11.6.1.1 Income Tax Accounting as of the Acquisition Date
For share-based payment awards that (1) are exchanged in a
business combination and (2) ordinarily result in a tax deduction under
current tax law (e.g., NQSOs), an acquirer should record a DTA as of the
acquisition date for the tax benefit of the fair-value-based measure10 of the acquirer’s replacement award included in the consideration
transferred, generally with a corresponding reduction of goodwill. For
guidance on calculating the amount of the fair-value-based measure to
include in the consideration transferred, see Section 10.2 of Deloitte’s Roadmap Share-Based Payment Awards.
11.6.1.2 Income Tax Accounting After the Acquisition Date
For the portion of the fair-value-based measure of the acquirer’s replacement
award that is attributed to postcombination service and therefore included
in postcombination compensation cost, a DTA is recorded over the remaining
service period (i.e., as the postcombination compensation cost is recorded)
for the tax benefit of the postcombination compensation cost.
In accordance with ASC 718, the DTA for awards classified as equity is not
subsequently adjusted to reflect changes in the entity’s share price. In
contrast, for awards classified as a liability, the DTA is remeasured, along
with the compensation cost, in every reporting period until settlement.
11.6.1.3 Income Tax Accounting Upon Exercise of the Share-Based Payment Awards
ASC 805-740-45-5 states, in part, that “the deduction reported on a tax
return for a replacement award classified as equity may be different from
the fair-value-based measure of the award. The tax effect of that difference
shall be recognized as income tax expense or benefit in the income statement
of the acquirer.”
The examples below, adapted from ASC 805-30-55, illustrate the income tax accounting for tax benefits received from tax-deductible share-based payment awards that are exchanged in a business combination after the effective date of FASB Statement 141(R).
Example 11-26
The par value of the common stock issued and cash
received for the option’s exercise price are not
considered in this example.
Assume the following:
-
Company A has a calendar year-end and therefore adopted FASB Statement 141(R) on January 1, 20X1.
-
The acquisition date of the business combination is June 30, 20X1.
-
Company A was obligated to issue the replacement awards under the terms of the acquisition agreement.
-
The replacement awards in this example are awards that would typically result in a tax deduction (e.g., NQSOs).
-
Company A’s applicable tax rate is 25 percent.
Company A issues replacement awards of $110
(fair-value-based measure) on the acquisition date
in exchange for Company B’s awards of $100
(fair-value-based measure) on the acquisition date.
The exercise price of the replacement awards issued
by A is $15. No postcombination services are
required for the replacement awards, and B’s
employees had rendered all of the required service
for the acquiree awards as of the acquisition
date.
The amount attributable to precombination service is
the fair-value-based measure of B’s awards ($100) on
the acquisition date; that amount is included in the
consideration transferred in the business
combination. The amount attributable to
postcombination service is $10, which is the
difference between the total value of the
replacement awards ($110) and the portion
attributable to precombination service ($100).
Because no postcombination service is required for
the replacement awards, A immediately recognizes $10
as compensation cost in its postcombination
financial statements. See the following journal
entries.
Journal Entry: June 30, 20X1
Journal Entry: June 30, 20X1
On September 30, 20X1, all
replacement awards issued by A are exercised when
the market price of A’s shares is $150. Given the
exercise of the replacement awards, A will realize a
tax deduction of $135 ($150 market price of A’s
shares less the $15 exercise price). The tax benefit
of the tax deduction is $33.75 ($135 × 25% tax
rate). Therefore, an excess tax benefit of $6.25
(tax benefit of the tax deduction of $33.75 less the
previously recorded DTA of $27.50) is recorded to
current income tax expense. See the following
journal entry.
Journal Entry: September 30, 20X1
Example 11-27
The par value of the common stock issued and cash
received for the option’s exercise price are not
considered in this example.
Assume the following:
-
Company A has a calendar year-end and therefore adopted FASB Statement 141(R) on January 1, 20X1.
-
The acquisition date of the business combination is June 30, 20X1.
-
Company A was obligated to issue the replacement awards under the terms of the acquisition agreement.
-
The replacement awards in this example are awards that would typically result in a tax deduction (e.g., NQSOs).
-
Company A’s applicable tax rate is 25 percent.
Company A exchanges replacement awards that require
one year of postcombination service for share-based
payment awards of Company B for which employees had
completed the requisite service period before the
business combination. The fair-value-based measure
of both awards is $100 on the acquisition date. The
exercise price of the replacement awards is $15.
When originally granted, B’s awards had a requisite
service period of four years. As of the acquisition
date, B’s employees holding unexercised awards had
rendered a total of seven years of service since the
grant date. Even though B’s employees had already
rendered the requisite service for the original
awards, A attributes a portion of the replacement
award to postcombination compensation cost in
accordance with ASC 805-30-30-12 because the
replacement awards require one year of
postcombination service. The total service period is
five years — the requisite service period for the
original acquiree award completed before the
acquisition date (four years) plus the requisite
service period for the replacement award (one
year).
The portion attributable to precombination service
equals the fair-value-based measure of the acquiree
award ($100) multiplied by the ratio of the
precombination service period (four years) to the
total service period (five years). Thus, $80 ($100 ×
[4 years/5 years]) is attributed to the
precombination service period and therefore is
included in the consideration transferred in the
business combination. The remaining $20 is
attributed to the postcombination service period and
therefore is recognized as compensation cost in A’s
postcombination financial statements, in accordance
with ASC 718. See the following journal entries.
Journal Entries: December 31, 20X1
Journal Entries: June 30, 20X1
On June 30, 20X2, all replacement
awards issued by A vest and are exercised when the
market price of A’s shares is $150. Given the
exercise of the replacement awards, A will realize a
tax deduction of $135 ($150 market price of A’s
shares less the $15 exercise price). The tax benefit
of the tax deduction is $33.75 ($135 × 25% tax
rate). Therefore, an excess tax benefit of $8.75
(tax benefit of the tax deduction of $33.75 less the
previously recorded DTA of $25 [$20 + $2.5 + $2.5])
is recorded to current income tax expense. See the
following journal entries.
Journal Entries: June 30, 20X2
Journal Entry: June 30, 20X2
11.6.2 Settlement of Share-Based Payment Awards Held by the Acquiree’s Employees
As described above, in a business combination, the acquiring company often issues
replacement share-based payment awards to the acquiree’s employees. In other
situations, however, the acquiring company may choose to cash-settle the awards
instead. If the awards are unvested at the time of the business combination, the
acquiring company’s discretionary decision to cash-settle the awards will
typically result in its recognition of an accounting cost for the unvested
portion in the postacquisition period (see ASC 805-30-55-23 and 55-24). However,
since the tax deduction may be included in the acquiree’s final tax return, an
entity may have questions about when and how to account for the corresponding
tax benefit in the acquirer’s financial statements. Consider the following
example:
Example 11-28
On December 1, 20X1, Company A enters into an agreement
to acquire Company B, in which A offers to purchase all
issued and outstanding shares of B. Under the terms of
the purchase agreement, A is required to cash-settle all
outstanding employee awards held by B’s employees.
Company A agrees to pay each holder of the awards,
through B’s payroll system, a cash payment due on
settlement no later than five business days after the
closing of the purchase agreement. As a result, vesting
will be accelerated for all of B’s unvested employee
awards that A will cash-settle.
During negotiations of the purchase agreement, A agrees
to the cash-settlement provision because it wants to (1)
compensate B’s employees and (2) establish
postacquisition compensation arrangements that would be
consistent with A’s existing compensation arrangements.
Because no postcombination services are required by
holders of B’s awards that will be cash-settled, and
because the decision to accelerate the awards is made at
A’s discretion, the accelerated unrecognized
compensation cost of B’s awards will be accounted for as
if A had decided to accelerate the vesting of B’s awards
immediately after the purchase-agreement closing.
Therefore, A will allocate the fair value of these
awards to postcombination compensation cost because all
the awards that were outstanding and cash-settled were
unvested before the close of the acquisition.
Company B will file a short-period income tax return for
the period of January 1, 20X1, through December 1, 20X1,
because it was purchased by A. Under the agreement, on
December 6, 20X1, B cash-settles all awards outstanding.
The settlement of B’s awards is tax deductible in B’s
short-period tax return for the period ended December 1,
20X1, because B cash-settles the awards within
two-and-a-half months of the end of B’s taxable period
ending December 1, 20X1. The income tax deduction for
the cash-settled awards reduces taxable income and
creates an NOL carryforward in B’s income tax return for
the short period ended December 1, 20X1. This NOL
carryforward is available to reduce A’s postcombination
taxable income.
Because the cash settlement of B’s awards is deductible
for tax purposes in B’s precombination consolidated tax
return and payment does not occur until December 6,
20X1, A’s tax-basis acquisition accounting balance sheet
will reflect not only the NOL but also an employee
compensation liability as of the close of the
acquisition on December 1, 20X1. Company A is accounting
for the compensation cost associated with the
cash-settled awards attributable to postcombination
services as a transaction that is separate from the
business combination. As a result, A will have
postcombination compensation cost for which the related
tax deduction will be claimed on B’s precombination tax
return.
Each of the following alternatives is acceptable in
accounting for the tax consequences (deduction claimed
by B) of the postcombination compensation expense that
is recognized separately and apart from the business combination:
-
Alternative 1 — Recognize all tax consequences in purchase accounting — Recognizing the tax consequences of the postcombination compensation cost in purchase accounting is consistent with B’s deduction of the compensation cost on its income tax return for the precombination short period. Company A’s acquisition tax-basis balance sheet reflects the tax consequences related to the deduction claimed by B. As a result, the acquisition balance sheet includes a DTA related to the NOL carryforward created by the deduction claimed on B’s tax return. In addition, the acquisition balance sheet will also include a DTL representing the taxable temporary difference related to A’s assumed obligation to settle B’s awards, which is included in A’s tax return but is not recognized for book purposes until after the combination.
-
Alternative 2 — Recognize tax consequences separately from purchase accounting — Under this alternative, because ASC 805 requires entities to recognize the compensation cost in the postcombination financial statements, it is assumed that the tax effects of the postcombination compensation cost also arise separately from the business combination in A’s postcombination financial statements. Accordingly, there is no DTA or DTL established in B’s acquisition balance sheet. Rather, it is assumed that A receives a tax deduction that creates a DTA (to the extent that such deduction increased an NOL carryforward) or reduction in taxes payable (to the extent that such deduction reduced taxes payable) separately from the business combination, which results in a tax benefit for A in the postcombination financial statements.
Although the balance sheet presentation of each
alternative would differ, the same amount of goodwill
and tax effects would be reflected in the
postcombination income statement.
11.6.3 Tax Effects of Replacement Awards Issued in a Business Combination That Would Not Ordinarily Result in Tax Deductions
Under ASC 805-740-25-11, an acquirer should not record a DTA as of the
acquisition date for the tax benefits of the fair-value-based measure of its
replacement share-based payment awards included in the consideration transferred
that do not ordinarily result in a tax deduction (e.g., ISOs).
11.6.4 Tax Effects of a Disqualifying Disposition in a Business Combination
Because of events that occur after the acquisition date (e.g., a disqualifying
disposition), the acquirer may receive a tax deduction associated with
replacement awards that would not ordinarily result in tax deductions. The tax
effects of such events are recognized only when they occur and would be recorded
in the income tax provision.
Footnotes
10
This guidance uses the term “fair-value-based
measure”; however, ASC 718 also permits the use of “calculated
value” or “intrinsic value” in specified circumstances. This
guidance would also apply in situations in which calculated value or
intrinsic value is permitted.
11.7 Other Considerations
Entities should be mindful of other tax considerations that are not directly related
to or within the scope of the accounting literature on business combinations,
including those that address deconsolidation, a planned sale or disposal of a
business (either of which would trigger discontinued operations presentation in the
financial statements), the election of an acquiree to apply pushdown accounting, and
other reorganizations or mergers in contemplation of an IPO or related
transaction.
11.7.1 Deconsolidation
Although this chapter focuses on business combinations, entities must also
evaluate special considerations when accounting for transactions that cause
deconsolidation of subsidiaries. The deconsolidation of a subsidiary may result
from a variety of circumstances, including a sale of 100 percent of an entity’s
interest in the subsidiary. The sale may be structured as either a “stock sale”
or an “asset sale.” A stock sale occurs when a parent sells all of its shares in
a subsidiary to a third party and the subsidiary’s assets and liabilities are
transferred to the buyer.
An asset sale occurs when a parent sells individual assets (and liabilities) to
the buyer and retains ownership of the original legal entity. In addition, by
election, certain stock sales can be treated for tax purposes as if the
subsidiary sold its assets and was subsequently liquidated.
Upon a sale of a subsidiary, the parent entity should consider the income tax
accounting implications for its income statement and balance sheet.
11.7.1.1 Income Statement Considerations
ASC 810-10-40-5 provides a formula for calculating a parent entity’s gain or
loss on deconsolidation of a subsidiary, which is measured as the difference between:
-
The aggregate of all of the following:
-
The fair value of any consideration received
-
The fair value of any retained noncontrolling investment in the former subsidiary or group of assets at the date the subsidiary is deconsolidated or the group of assets is derecognized
-
The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated.
-
-
The carrying amount of the former subsidiary’s assets and liabilities or the carrying amount of the group of assets.
11.7.1.1.1 Asset Sale
When the net assets of a subsidiary are sold, the parent
will present the gain or loss on the net assets (excluding deferred
taxes) in pretax income and will present the reversal of any DTAs or
DTLs associated with the assets sold (the inside basis differences11) and any tax associated with the gain or loss on sale in income
tax expense (or benefit).
11.7.1.1.2 Stock Sale
As with an asset sale, when the shares of a subsidiary
are sold, the parent will present the gain or loss on the net assets in
pretax income. One acceptable approach to accounting for the reversal of
deferred taxes (the inside basis differences12) is to include the reversal in the computation of the pretax gain
or loss on the sale of the subsidiary; under this approach, the only
amount that would be included in income tax expense (or benefit) would
be the tax associated with the gain or loss on the sale of the shares
(the outside basis difference13). The rationale for this view is that any future tax benefits (or
obligations) of the subsidiary are part of the assets acquired and
liabilities assumed by the acquirer with the transfer of shares in the
subsidiary and the carryover tax basis in the assets and liabilities.
Other approaches may be acceptable depending on the facts and
circumstances.
If the subsidiary being deconsolidated meets the
requirements in ASC 205-20 for classification as a discontinued
operation, the entity would need to consider the intraperiod guidance on
discontinued operations in addition to this guidance. In addition, see
Section
3.4.17.2 for a discussion of outside basis differences in
situations in which the subsidiary is presented as a discontinued
operation.
11.7.1.2 Balance Sheet Considerations
Entities with a subsidiary (or component) that meets the held-for-sale
criteria in ASC 360 should classify the assets and liabilities associated
with that component separately on the balance sheet as “held for sale.” The
presentation of deferred tax balances associated with the assets and
liabilities of the subsidiary or component classified as held for sale is
determined on the basis of the method of the expected sale (i.e., asset sale
or stock sale) and whether the entity presenting the assets as held for sale
is transferring the basis difference to the buyer.
Deferred taxes associated with the stock of the component
being sold (the outside basis differences14) should not be presented as held for sale in either an asset sale or a
stock sale since the acquirer will not assume the outside basis
difference.
11.7.1.2.1 Asset Sale
In an asset sale, the tax bases of the assets and
liabilities being sold will not be transferred to the buyer. Therefore,
the deferred taxes related to the assets and liabilities (the inside
basis differences15) being sold should not be presented as held for sale; rather, they
should be presented along with the consolidated entity’s other deferred
taxes.
11.7.1.2.2 Stock Sale
In a stock sale, the tax bases of the assets and
liabilities being sold generally are carried over to the buyer.
Therefore, the deferred taxes related to the assets and liabilities (the
inside basis differences16) being sold should be presented as held for sale and not with the
consolidated entity’s other deferred taxes.
11.7.2 Discontinued Operations
When an entity contemplates sale or disposition of a portion of its business,
this might cause the portion of the business to be presented as discontinued
operations. In this scenario, specific accounting considerations apply. Guidance
on discontinued operations is presented in other sections of this Roadmap:
-
See Section 3.4.17.2 for a discussion of recognition of a DTA related to a subsidiary presented as a discontinued operation.
-
See Section 7.2 for interim reporting implications of intraperiod tax allocation for discontinued operations.
11.7.3 Pushdown Accounting Considerations
As previously noted, when an entity obtains control of a business, a new basis of
accounting is established in the acquirer’s financial statements for the assets
acquired and liabilities assumed. Sometimes the acquiree will prepare separate
financial statements after its acquisition. Use of the acquirer’s basis of
accounting in the preparation of an acquiree’s separate financial statements is
called pushdown accounting.
In November 2014, the FASB issued ASU 2014-17, which
became effective upon issuance. This ASU gives an acquiree the option to apply
pushdown accounting in its separate financial statements when it has undergone a
change in control. See Appendix A of Deloitte’s Roadmap Business Combinations for
additional discussion regarding pushdown accounting.
11.7.3.1 Applicability of Pushdown Accounting to Income Taxes and Foreign Currency Translation Adjustments
ASC 740-10-30-5 indicates that deferred taxes must be “determined separately
for each tax-paying component . . . in each tax jurisdiction.” ASC 805-50
does not require an entity to apply pushdown accounting for separate
financial statement reporting purposes. However, to properly determine the
temporary differences and to apply ASC 740 accurately, an entity must push
down, to each tax-paying component, the amounts assigned to the individual
assets and liabilities for financial reporting purposes. That is, because
the cash inflows from assets acquired or cash outflows from liabilities
assumed will be reflected on the tax return of the respective tax-paying
component, the acquirer has a taxable or deductible temporary difference
related to the entire amount recorded under the acquisition method (compared
with its tax basis), regardless of whether such fair value adjustments are
actually pushed down and reflected in the acquiree’s statutory or separate
financial statements.
An entity can either record the amounts in its subsidiary’s books (i.e.,
actual pushdown accounting) or maintain the records necessary to adjust the
consolidated amounts to what they would have been had the amounts been
recorded on the subsidiary’s books (i.e., notional pushdown accounting). The
latter method can often make recordkeeping more complex.
Further, to the extent the reporting entity’s functional currency differs
from the currency in which an acquiree files its tax return, an entity must
convert the entire amount recorded under the acquisition method for a
particular asset or liability to the currency in which the tax-paying
component files its tax return (the “tax currency”) to properly determine
the (1) temporary difference associated with the particular asset or
liability and (2) the corresponding DTA or DTL (i.e., deferred taxes are
calculated in the tax currency and then translated or remeasured in
accordance with ASC 830).
Example 11-29
Assume the following:
-
A U.S. parent acquires the stock of U.S. Target (UST), which owns Entity A, a foreign corporation operating in Jurisdiction X, in which the income tax rate is 25 percent.
-
Entity A must file statutory financial statements with X that are prepared in accordance with A’s local GAAP; the acquisition does not affect these financial statements or A’s tax basis in its assets and liabilities in X.
-
As a result of the acquisition, A will record a fair value adjustment of $10 million related to its intangible assets, which will be amortized for U.S. GAAP purposes over 10 years, the estimated useful life of the intangible assets, which was not recognized for statutory purposes.
-
Entity A’s functional currency and local currency is the euro. As of the date of acquisition, the conversion rate from USD to the euro was 1 USD = 1 euro. At the end of year 1, the conversion rate was 1.20 USD = 1 euro.
Entity A will record its intangible assets as part of
its statutory-to-U.S.-GAAP adjustments
(“stat-to-GAAP adjustments”) and will not be
entitled to any amortization deduction for local
income tax reporting purposes. However, the cash
flows related to such intangible assets will be
reported on A’s local income tax return
prospectively, and such cash flows will be taxable
in X. Thus, A must recognize a $2.5 million DTL as
part of its stat-to-GAAP adjustments related to the
excess of the intangible assets’ U.S. GAAP reporting
basis over its income tax basis. This DTL will
reverse as the intangible assets are amortized for
U.S. GAAP financial statement reporting purposes.
The year-end stat-to-GAAP adjustments and related
currency conversions (in thousands) are as
follows:
Example 11-30
Assume the same facts as in the
example above, except that Entity A has NOL
carryforwards and, on the reporting date, has
significant objectively verifiable negative
evidence. Entity A has determined that the only
available source of future taxable income is the
reversal of existing DTLs.
Entity A’s statutory books at the end of year 1 (in
thousands) are as follows:
Parent’s books, for A’s original business combination
journal entries, at the end of year 1 (in thousands)
are as follows:
Entity A’s DTL that is recorded on the parent’s books
represents an available future source of income in
the assessment of the realization of A’s DTAs.
Accordingly, A’s net DTA (before valuation
allowance) at the end of year 2 is €250 ([a] + [b]
in the tables above) or $300 (€250 × 1.2);
therefore, on the basis of the evidence, a full
valuation allowance will be needed. Regardless of
whether the journal entries are actually or
notionally pushed down, A’s net DTA to be assessed
for realizability should be the same.
11.7.4 Other Forms of Mergers
11.7.4.1 Successor Entity’s Accounting for the Recognition of Income Taxes When the Predecessor Entity Is Nontaxable
In connection with a transaction such as an IPO, the
historical partners in a partnership (the “legacy partners”) may establish a
C corporation that will invest in the partnership at the time of the
transaction. In the case of an IPO, the C corporation is typically
established to serve as the IPO vehicle (i.e., it is the entity that will
ultimately issue its shares to the public) and therefore ultimately becomes
an SEC registrant. These transactions have informally been referred to in
the marketplace as “Up-C” transactions.
The legacy partners typically control the C corporation even
after the IPO (i.e., the legacy partners sell an economic interest to the
public while retaining shares with voting control but no economic interest).
The C corporation uses the IPO proceeds to purchase an economic interest in
the partnership along with a controlling voting interest. Accordingly, the C
corporation consolidates the partnership for book purposes. Because the C
corporation is taxable, it will need to recognize deferred taxes related to
its investment in the partnership. This outside basis difference is created
because the C corporation (1) receives a tax basis in the partnership units
that is equal to the amount paid for the units (i.e., fair value) but (2)
has carryover basis in the assets of the partnership for U.S. GAAP reporting
(because the transaction is a transaction among entities under common
control). See Appendix
B of Deloitte’s Roadmap Business Combinations for
further discussion of the accounting for common-control transactions.
Typically, the original partnership is the C corporation’s predecessor entity
and the C corporation is the successor entity (and the registrant). After
the transaction becomes effective, the registrant’s initial financial
statements reflect the predecessor entity’s operations through the effective
date and the successor entity’s post-effective operations in a single set of
financial statements (i.e., the predecessor and successor financial
statements are presented on a contiguous basis). Since no step-up in basis
occurs for financial statement purposes because of the common-control nature
of the transaction, the income statement and balance sheet are presented
without use of a “black line.” The equity statement, however, reflects the
recognition of a noncontrolling interest as of the effective date and
prospectively in the registrant’s post-effective financial statements. In
addition, the C corporation must recognize deferred taxes upon investing in
the partnership, which occurs on the effective date.
In such situations, questions often arise about whether (1) the predecessor
entity’s tax status has changed in such a way that the deferred tax benefit
or expense related to the recognition of the deferred tax accounts would be
accounted for in the income statement or (2) there has been a contribution
of assets among entities under common control, in which case the recognition
of the corresponding deferred tax accounts would be accounted for in
equity.
While the formation of the new C corporation has resulted in
a change in the reporting entity, we do not believe that the predecessor
entity’s tax status has changed. In fact, in the situation described above,
the predecessor entity was formerly structured as a partnership and
continues to exist as a partnership after the effective date (i.e., the
legacy partners continue to own an interest in the same entity, which
remains a “flow-through” entity to them both before and after the effective
date) even though the successor entity’s financial statements are presented
on a contiguous basis with the predecessor entity’s financial statements,
albeit with the introduction of a noncontrolling interest.
Accordingly, we believe that the recognition of taxes on the
C corporation’s investment in the partnership should be recorded as a direct
adjustment to equity, as if the former partners in that partnership
contributed their investments (along with the corresponding tax basis) to
the C corporation (see Section 12.4.1
for a discussion of why these adjustments are recorded as equity
transactions). The additional step-up in tax basis received by the C
corporation upon its investment in the partnership (and in the flow-through
tax basis of the underlying assets and liabilities of the partnership) after
the effective date would similarly be reflected in equity in accordance with
ASC 740-20-45-11(g), which states:
All changes in the tax bases of assets and
liabilities caused by transactions among or with
shareholders shall be included in equity including the
effect of valuation allowances initially required upon recognition
of any related deferred tax assets. Changes in valuation allowances
occurring in subsequent periods shall be included in the income
statement. [Emphasis added]
Example 11-31
F1 and F2 own LP, a partnership with net assets whose
book basis is $2,000 and fair value is $20,000. F1
and F2 have a collective tax basis of $1,000 in
their units of the partnership and a collective DTL
of $210. (Assume that the tax rate is 21 percent and
that the outside basis temporary difference will
reverse through LP’s normal operating
activities.)
F1 and F2 form Newco, a C corporation, which sells
nonvoting shares to the public in exchange for IPO
proceeds of $12,000. Newco records the following
journal entry:
Newco then uses the IPO proceeds to purchase 60
percent of the units of LP from F1 and F2. Because
Newco and LP are entities under common control,
Newco records a $2,000 investment in LP’s assets (at
F1’s and F2’s historical book basis as if the net
assets were contributed) along with a noncontrolling
interest of $800 (representing the units of LP still
held by F1 and F2) and a corresponding reduction in
equity of $10,800 for the deemed distribution to F1
and F2. This leaves $1,200 that is attributable to
the controlling interest (which also reflects the
book basis of Newco’s investment in the assets of
LP). Newco records the following journal entry:
If it is assumed that Newco is
subject to a 21 percent tax rate and that Newco’s
tax basis in the units has remained consistent with
F1’s and F2’s historical tax basis in LP, Newco will
also record a DTL of $126, which is calculated as
($1,200 book basis – $600 tax basis) × 21%, with an
offset to equity, as follows:
In other words, F1 and F2 have effectively
contributed their 60 percent investment in LP (along
with 60 percent of their corresponding DTL related
to LP) to Newco.
Because the sale of units of LP to
Newco is a taxable transaction, F1 and F2 would have
taxable income of $11,400 ($12,000 proceeds less tax
basis of the interest sold [60% of $1,000]),
resulting in taxes payable of $2,280 ($11,400 × 20%
capital gains rate). F1 and F2 would also eliminate
the portion of their collective DTL that was
effectively contributed to Newco, which is
calculated as ($2,000 book basis – $1,000 tax basis)
× 60% × 20%. Newco would receive a tax basis in the
units of LP that is equal to its purchase price of
$12,000 and would record a DTA of $2,268, which is
calculated as ($12,000 tax basis – $1,200 book
basis) × 21%, ignoring realizability
considerations.
In accordance with ASC 740-20-45-11(g), Newco’s
change in deferred taxes as a result of a change in
its tax basis in its investment in LP would be
recorded directly in equity as follows:
11.7.4.2 Accounting for the Elimination of Income Taxes Allocated to a Predecessor Entity When the Successor Entity Is Nontaxable
In connection with certain transactions such as an IPO, a
parent may plan to contribute the “unincorporated” assets, liabilities, and
operations of a division or disregarded entity to a new company (i.e., a
“newco”) at or around the time of the transaction. The newco is typically
established to serve as the IPO vehicle (i.e., it is the entity that will
ultimately issue its shares to the public) and therefore ultimately becomes
an SEC registrant. In some instances, income taxes will be allocated in the
financial statements of the predecessor division or disregarded entity in
periods before the IPO, but the successor newco will be a nontaxable entity
after the IPO. See Deloitte’s Roadmap Initial
Public Offerings for additional guidance around the
identification of and reporting by predecessor and successor entities.
Typically, the division or disregarded entity is determined to be the newco’s
predecessor entity and the newco is determined to be the successor entity.
After the transaction is effective, the successor’s initial financial
statements reflect the predecessor entity’s operations through the effective
date and the successor entity’s operations after the effective date in a
single set of financial statements (i.e., the predecessor and successor
financial statements are presented on a contiguous basis). Since no step-up
in basis occurs for financial statement purposes because of the
common-control nature of the transaction, the income statement and balance
sheet are typically presented without the use of a “black line.”
If the predecessor entity’s financial statements have been
filed publicly, those financial statements would generally include an income
tax provision because SAB Topic
1.B.1 requires that both members (i.e., corporate
subsidiaries) and nonmembers (i.e., divisions or disregarded entities) of a
group that are part of a consolidated tax return include an allocation of
taxes when those members or nonmembers issue separate financial
statements.17 When the successor entity is nontaxable (e.g., a master limited
partnership), however, the successor entity will need to eliminate (upon
effectiveness) any deferred taxes that were previously allocated to the
predecessor entity.18
In situations in which deferred income taxes that were allocated to the
predecessor entity are eliminated in the successor entity’s financial
statements when the successor entity is nontaxable, questions often arise
about whether (1) the predecessor entity’s tax status has changed in the
manner discussed in ASC 740-10-25-32 such that the deferred tax
benefit/expense from the elimination of the deferred tax accounts would be
accounted for in the income statement, as prescribed by ASC 740-10-45-19, or
(2) the deferred taxes were effectively retained by the contributing entity,
suggesting that the deferred taxes should be eliminated through equity.
As noted above, while the predecessor entity has received an allocation of
the parent’s consolidated income tax expense, the predecessor entity
typically comprises unincorporated or disregarded entities that are not
individually considered to be taxpayers under U.S. tax law (i.e., the
historical owner was, and continues to be, the taxpayer). Accordingly, we do
not believe that the predecessor entity’s tax status has changed in the
manner discussed in ASC 740-10-25-32. Rather, we believe that the parent has
retained the previously allocated deferred taxes (which is consistent with
removing the deferred taxes through equity). Alternatively, the removal of
the net deferred tax accounts, particularly in the case of a net DTL, might
be analogous to the extinguishment (by forgiveness) of intra-entity debt.
ASC 470-50-40-2 provides guidance on such situations, noting that
“extinguishment transactions between related entities may be in essence
capital transactions.” Accordingly, we believe that it is appropriate to
reflect the elimination of deferred income taxes that were allocated to the
predecessor entity as a direct adjustment to the successor entity’s equity
on the effective date of the transaction.
The elimination of deferred taxes via an adjustment to equity is also
consistent with an SEC staff speech by Leslie Overton, associate chief
accountant in the SEC’s Division of Corporation Finance, at the 2001 AICPA
Conference on Current SEC Developments. Ms. Overton discussed a fact pattern
in which the staff believed that certain operations that would be left
behind upon a spin-off (i.e., retained by the parent) still needed to be
included in the historical carve-out financial statements of the predecessor
entity to best illustrate management’s track record with respect to the
business operations being spun. However, Ms. Overton concluded her speech by
noting that “[a]ssets and operations that are included in the carve-out
financial statements, but not transferred to Newco should be reflected as a
distribution to the Parent at the date Newco is formed.”
11.7.4.3 Change in Tax Status as a Result of a Common-Control Merger
A common-control merger occurs when two legal entities that
are controlled by the same parent company are merged into a single entity.
Such a transaction is not a business combination because there was not a
change in control of the entities involved (i.e., they are controlled by the
same entity before and after the merger). The accounting for a change in an
entity’s taxable status through a common-control merger may differ from the
method described in the previous section. For example, an S corporation
could lose its nontaxable status when acquired by a C corporation in a
transaction accounted for as a merger of entities under common control. When
an entity’s status changes from nontaxable to taxable, the entity should
recognize DTAs and DTLs for any temporary differences that exist as of the
recognition date (unless these temporary differences are subject to one of
the recognition exceptions in ASC 740-10-25-3). The entity should initially
measure those recognizable temporary differences in accordance with ASC
740-10-30 and record the effects in income from continuing operations under
the guidance in ASC 740-10-45-19.
Although the transaction was between parties under common control, the
combined financial statements should not be adjusted to include income taxes
of the S corporation before the date of the common-control merger. ASC
740-10-25-32 states that DTAs and DTLs should be recognized “at the date
that a nontaxable entity becomes a taxable entity.” Therefore, any periods
presented in the combined financial statements before the common-control
merger should not be adjusted for income taxes of the S corporation.
However, it may be appropriate for an entity to present pro forma financial
information, including the income tax effects of the S corporation (as if it
had been a C corporation), in the historical combined financial statements
for all periods presented. For more information on financial reporting
considerations, see Section 14.7.1.
Footnotes
11
See Section 11.3.1 for the
meaning of “inside” and “outside” basis differences.
12
See footnote 11.
13
See footnote 11.
14
See footnote 11.
15
See footnote 11.
16
See footnote 11.
17
See Section 8.3 for guidance on
acceptable methods of allocating income taxes to members of a group
and Section
8.2.3 for a discussion of the allocation of income
taxes to single member LLCs.
18
If the parent actually contributes a member
(corporate subsidiary) to a nontaxable successor entity and the
successor entity will continue to own that C corporation, previously
allocated deferred taxes would not be eliminated and this guidance
would not be applicable. However, such situations are rare.
11.8 Asset Acquisitions
As described in Section 11.1, an entity may
acquire a group of assets that do not meet the definition of a business under ASC
805. Acquisitions of this nature are considered “asset acquisitions” and do not
follow the measurement principles of a business combination under ASC 805. For
financial reporting purposes, such transactions are generally recognized under a
cost accumulation model. However, the tax bases of assets acquired could be
different from the cost bases for a variety of reasons. As a result, temporary
differences arise. The accounting for these differences differs from the accounting
for a business combination described throughout this chapter. The primary difference
is that no goodwill is recorded in an asset acquisition. Instead, the cost basis of
an asset may be adjusted to account for recognition of deferred taxes.
ASC 740-10-25-51 prohibits immediate income statement recognition
when the amount paid for an asset accounted for as an asset acquisition differs from
the tax basis in that asset. Instead, a simultaneous equations method is used to
determine the measurement of the asset and a related DTL or DTA in such a manner
that there is no income statement impact (i.e., the financial reporting measurement
of the asset and the DTA or DTL taken together equal the consideration transferred
for the asset in such a way that there is no effect on earnings).
ASC 740-10-55-171 through 55-182 provide illustrative examples of how an entity can
apply the simultaneous equations method when accounting for asset acquisitions that
are not accounted for as business combinations.
See Example 25 in ASC 740-10-55-170 through
55-182 in Appendix A.
ASC 740-10
25-49 The
following guidance addresses the accounting when an asset is
acquired outside of a business combination and the tax basis
of the asset differs from the amount paid.
25-50
The tax basis of an asset is the amount used for tax
purposes and is a question of fact under the tax law. An
asset’s tax basis is not determined simply by the amount
that is depreciable for tax purposes. For example, in
certain circumstances, an asset’s tax basis may not be fully
depreciable for tax purposes but would nevertheless be
deductible upon sale or liquidation of the asset. In other
cases, an asset may be depreciated at amounts in excess of
tax basis; however, such excess deductions are subject to
recapture in the event of sale.
25-51
The tax effect of asset purchases that are not business
combinations in which the amount paid differs from the tax
basis of the asset shall not result in immediate income
statement recognition. The simultaneous equations method
shall be used to record the assigned value of the asset and
the related deferred tax asset or liability. (See Example
25, Cases A and B [paragraphs 740-10-55-171 through 55-182]
for illustrations of the simultaneous equations method.) For
purposes of applying this requirement, the following
applies:
-
An acquired financial asset shall be recorded at fair value, an acquired asset held for disposal shall be recorded at fair value less cost to sell, and deferred tax assets shall be recorded at the amount required by this Topic.
-
An excess of the amounts assigned to the acquired assets over the consideration paid shall be allocated pro rata to reduce the values assigned to noncurrent assets acquired (except financial assets, assets held for disposal, and deferred tax assets). If the allocation reduces the noncurrent assets to zero, the remainder shall be classified as a deferred credit. (See Example 25, Cases C and D [paragraphs 740-10-55-183 through 55-191] for illustrations of transactions that result in a deferred credit.) The deferred credit is not a temporary difference under this Subtopic.
-
A reduction in the valuation allowance of the acquiring entity that is directly attributable to the asset acquisition shall be accounted for in accordance with paragraph 805-740-30-3. Subsequent accounting for an acquired valuation allowance (for example, the subsequent recognition of an acquired deferred tax asset by elimination of a valuation allowance established at the date of acquisition of the asset) would be in accordance with paragraphs 805-740-25-3 and 805-740-45-2.
25-52
The net tax benefit (that is, the difference between the
amount paid and the deferred tax asset recognized) resulting
from the purchase of future tax benefits from a third party
which is not a government acting in its capacity as a taxing
authority shall be recorded using the same model described
in the preceding paragraph. (See Example 25, Case F
[paragraph 740-10-55-199] for an illustration of a purchase
of future tax benefits.)
25-53
Transactions directly between a taxpayer and a government
(in its capacity as a taxing authority) shall be recorded
directly in income (in a manner similar to the way in which
an entity accounts for changes in tax laws, rates, or other
tax elections under this Subtopic). (See Example 26
[paragraph 740-10-55-202] for an illustration of a
transaction directly with a governmental taxing
authority.)
25-54 An entity shall determine
whether a step up in the tax basis of goodwill relates to
the business combination in which the book goodwill was
originally recognized or whether it relates to a separate
transaction. In situations in which the tax basis step up
relates to the business combination in which the book
goodwill was originally recognized, no deferred tax asset
would be recorded for the increase in basis except to the
extent that the newly deductible goodwill amount exceeds the
remaining balance of book goodwill. In situations in which
the tax basis step up relates to a separate transaction, a
deferred tax asset would be recorded for the entire amount
of the newly created tax goodwill in accordance with this
Subtopic. Factors that may indicate that the step up in tax
basis relates to a separate transaction include, but are not
limited to, the following:
-
A significant lapse in time between the transactions has occurred.
-
The tax basis in the newly created goodwill is not the direct result of settlement of liabilities recorded in connection with the acquisition.
-
The step up in tax basis is based on a valuation of the goodwill or the business that was performed as of a date after the business combination.
-
The transaction resulting in the step up in tax basis requires more than a simple tax election.
-
The entity incurs a cash tax cost or sacrifices existing tax attributes to achieve the step up in tax basis.
-
The transaction resulting in the step up in tax basis was not contemplated at the time of the business combination.
25-55 Paragraph superseded by
Accounting Standards Update No. 2018-09.
Related Implementation Guidance and
Illustrations
- Example 26: Direct Transaction With Governmental Taxing Authority [ASC 740-10-55-202].
ASC 740-10 — SEC Materials — SEC Staff Guidance
S25-1
See paragraph 740-10-S99-3, SEC Observer Comment: Accounting
for Acquired Temporary Difference in Certain Purchase
Transactions that Are Not Accounted for as Business
Combinations, for SEC Staff views on accounting for such
transactions.
S99-3 The following is the text of
SEC Observer Comment: Accounting for Acquired Temporary
Differences in Certain Purchase Transactions that Are Not
Accounted for as Business Combinations.
Paragraph 740-10-25-50 provides guidance
on the accounting for acquired temporary differences in
purchase transactions that are not business combinations.
The SEC staff would object to broadly extending this
guidance to adjust the basis in an asset acquisition to
situations different from those illustrated in Examples 25
through 26 (see paragraphs 740-10-55-170 through 55-204)
without first having a clear and complete understanding of
those specific fact patterns.
ASC 740-10
35-5 A
deferred credit may arise under the accounting required by
paragraph 740-10-25-51 when an asset is acquired outside of
a business combination. Any deferred credit arising from the
application of such accounting requirements shall be
amortized to income tax expense in proportion to the
realization of the tax benefits that gave rise to the
deferred credit.