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Income tax accounting refresh: Business combinations · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC.
• 0:07
  SPEAKER_02: Welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_02: I'm Heather Horn.
• 0:12
  SPEAKER_02: Thanks for joining me as we continue our Tuesday series in which one of our all-star podcast guests takes over the podcast, picking the topics for the month and joining me on all the episodes.
• 0:25
  SPEAKER_02: For the month of May, our takeover guest is Jennifer Spang, the income tax accounting leader in PWC's national office.
• 0:33
  SPEAKER_01: ASC 805, while it provides the U.S.
• 0:36
  SPEAKER_01: GAAP guidance for accounting for acquisition accounting, it also sends you back to ASC 740, the income tax accounting standard for all of your income tax accounting.
• 0:46
  SPEAKER_01: So, you know, point being there are going to be unique issues that come up in acquisition accounting, but they're still all within the ASC 740.
• 0:53
  SPEAKER_03: This distinction of whether the transaction itself is taxable or non-taxable isn't the same as like the tax status of the entity that's getting acquired.
• 1:01
  SPEAKER_03: So what you really want to be looking for here is to understand that the tax laws in most jurisdictions generally differentiate between taxable and non-taxable business combinations, and that distinction is relevant because the type of transaction determines the tax basis of the acquired assets and assumed liabilities.
• 1:23
  SPEAKER_02: That was Jen, joined again by Cassie Baumann, a managing director in PwC's national office.
• 1:29
  SPEAKER_02: Jen and Cassie are back to share insights on the numerous income tax accounting assessments and judgments in a business combination.
• 1:37
  SPEAKER_02: There's certainly no shortage of complexities you'll want to get in front of when determining the tax basis of assets acquired, measuring temporary differences, or performing evaluation assessment, just to name a few of the topics.
• 1:52
  SPEAKER_02: There's a lot to unpack, so let's get started.
• 1:59
  SPEAKER_02: Jen, welcome back to the podcast for your month of income taxes.
• 2:03
  SPEAKER_02: And Cassie, nice to have you back for a second week in a row.
• 2:06
  SPEAKER_02: And this week's uh discussion, I think in a way builds on last week's discussion because we're going to be talking about business acquisitions and in particular what companies should be thinking about in terms of taxes as of the acquisition date.
• 2:20
  SPEAKER_02: So, again, sort of similar to some of the other ones in this series, I thought it'd be helpful to start off by just talking about the applicable guidance when we're accounting for it in for a business combination and in particular level setting on the big picture steps that are part of the process when you're analyzing income tax implications.
• 2:40
  SPEAKER_02: So maybe John, starting with you.
• 2:42
  SPEAKER_01: So I think a really important point right out of the gate is to get some lingo taken care of.
• 2:50
  SPEAKER_01: So we are talking about in this time together transactions that are accounted for under ASC 805, so acquisition accounting.
• 3:00
  SPEAKER_01: We are going to mention more than once language like asset acquisition or you know, asset deals.
• 3:08
  SPEAKER_01: When we use those words, we're using them through a tax lens because it's very important that you understand whether you're acquiring assets or stock, because all of the other questions can be impacted in your tax accounting.
• 3:23
  SPEAKER_01: But what we're not talking about is asset purchases from a gap perspective that are excluded from ASC 805.
• 3:32
  SPEAKER_01: So probably just important that we level set on that.
• 3:35
  SPEAKER_01: Everything we're hitting on is in ASC 805.
• 3:38
  SPEAKER_01: Maybe one other level setting point, ASC 805, while it provides the US GAAP guidance for accounting for acquisition accounting, it also sends you back to ASC 740, the income tax accounting standard for all of your income tax accounting.
• 3:53
  SPEAKER_01: So, you know, point being there are going to be unique issues that come up in acquisition accounting, but they're still all within the ASC 740.
• 4:00
  SPEAKER_01: Um at a high level, the acquirer is going to account for the tax effects of any temporary differences essentially that it acquires.
• 4:08
  SPEAKER_01: So, you know, um, you get a step up maybe in some fact patterns for book basis, but not for tax.
• 4:15
  SPEAKER_01: So there's temporary differences.
• 4:17
  SPEAKER_01: Um, you know, you're also buying, you know, a group of assets and liabilities that also already have historical basis differences.
• 4:25
  SPEAKER_01: So essentially you're accounting for any book tax basis differences in the acquisition.
• 4:29
  SPEAKER_01: You're also accounting for any tax attributes or carry-forwards because those might be coming with target.
• 4:36
  SPEAKER_01: Um, and then you're gonna record any uncertainties.
• 4:39
  SPEAKER_01: So you're gonna have to address any UTPs, and UTPs can come from either the historical target business or new UTPs could be created as part of the acquisition.
• 4:52
  SPEAKER_01: So all of those are going to come into the mix.
• 4:54
  SPEAKER_01: Now, you know, nothing is linear, I don't think, in any transaction or probably in any accounting, but there are some basic steps you could think through just to like organize how you're thinking through tax accounting when it comes to an acquisition.
• 5:11
  SPEAKER_01: Start with what is the tax structure?
• 5:13
  SPEAKER_01: So am I buying assets?
• 5:15
  SPEAKER_01: Am I is it a taxable transaction, or am I buying the stock of an entity?
• 5:19
  SPEAKER_01: So typically a non-taxable transaction.
• 5:22
  SPEAKER_01: What am I buying?
• 5:23
  SPEAKER_01: Um, what is the tax status of any of the entities I'm buying?
• 5:26
  SPEAKER_01: Am I buying corporations, partnerships, both, um, other flow-through kind of entities?
• 5:32
  SPEAKER_01: All of those decisions can impact both recognition and measurement of temporary differences.
• 5:39
  SPEAKER_01: Then you move into, in fact, determining what basis differences you have in the assets acquired or the liabilities assumed.
• 5:46
  SPEAKER_01: Um, and then, of course, once you figure out you have those basis differences, you move into measurement of those temporary differences or recording the measurement of your acquired tax benefits.
• 5:59
  SPEAKER_01: So once you have your temporary differences, you need to, of course, go through a valuation allowance assessment on your deferred tax assets.
• 6:07
  SPEAKER_01: So figuring out what's realizable and whether or not you need to change or record some value, I should say, record some valuation allowance.
• 6:14
  SPEAKER_01: Again, I mentioned uncertainties, so you'll go there next, thinking about your tax uncertainties and importantly indemnifications, which we'll probably do a whole podcast on indemnifications.
• 6:25
  SPEAKER_01: Um, and then last but surely not least, um, you move to deferred taxes related to goodwill, because like any other asset or liability that you're recording, um, once you get your tax provision or you get your taxes calculated, then that obviously impacts goodwill.
• 6:41
  SPEAKER_01: And so you got to go through that whole process.
• 6:43
  SPEAKER_01: So I'd say that's like a level setting, if you will.
• 6:48
  SPEAKER_02: Although it's practically like just a little checklist, Jen, that I could just sit down and and do my business combination tax accounting.
• 6:55
  SPEAKER_02: However, I know it is definitely not that easy.
• 6:58
  SPEAKER_02: And one of the things I think you briefly touched on, but I I think is worth getting into is I know a complication here.
• 7:07
  SPEAKER_02: You mentioned the sort of the tax status of the entities involved.
• 7:11
  SPEAKER_02: So how do we need to think about that before we even get into some of the other aspects of tax accounting?
• 7:17
  SPEAKER_01: Yeah, and and we've talked about some of these concepts before, but a lot of this comes down to discussions about, you know, whether you have inside basis differences or outside basis differences.
• 7:28
  SPEAKER_01: But when you buy a corporation, your deferred taxes are recognized on inside basis differences for the assets and liabilities.
• 7:36
  SPEAKER_01: Now, I will also say that when you're buying a corporation, you also may have to think about that second layer of tax on your investment in.
• 7:44
  SPEAKER_01: Contrast that to when you acquire a partnership or you have a partnership in the structure.
• 7:49
  SPEAKER_01: Here, you're just a single layer of tax, so you're just looking at your outside basis difference.
• 7:54
  SPEAKER_01: So form is really important.
• 7:57
  SPEAKER_01: You have to understand what you purchased because you could have, for example, um purchased a partnership, and let's say it's consolidated for financial statement purposes.
• 8:08
  SPEAKER_01: But imagine for it to be a partnership, it has to have at least two owners.
• 8:12
  SPEAKER_01: And so you could still be consolidated in the financial statements, but two separate entities, maybe the parent owns 90% and a subsidiary of the parent owns 10%.
• 8:23
  SPEAKER_01: Um, it's important to know that because how you account for a partnership temporary difference is going to be different than if you're looking at the inside basis differences.
• 8:32
  SPEAKER_01: So those are just some of the examples that you need to keep in mind.
• 8:35
  SPEAKER_01: But again, uh that what you're buying, this, you know, if you will, the the structure and tax status is important.
• 8:42
  SPEAKER_03: And that form when you acquire an entire partnership but through a couple different entities in your structure is really important to acknowledge because you're you're probably doing it that way for a reason.
• 8:54
  SPEAKER_03: So you have to respect the form that you've chosen.
• 8:56
  SPEAKER_02: And do we, is there any sort of typical examples of why someone would be taking that approach instead of just like collapsing it and saying, well, I now own 100% of this entity?
• 9:07
  SPEAKER_03: Yeah, there can be a number of reasons.
• 9:09
  SPEAKER_03: I think one of the most common is that sometimes you'll acquire a partnership that has certain attributes already in it, like maybe it has had an interest expense limitation.
• 9:20
  SPEAKER_03: So it has like an interest carry-forward deduction in it.
• 9:24
  SPEAKER_03: And um sometimes under the tax law, these attributes that sit in the partnership can only be used to offset income from that partnership.
• 9:32
  SPEAKER_03: So if the partnership evaporates, the benefit from that tax uh carry forward just kind of goes away.
• 9:38
  SPEAKER_03: So you might keep the partnership in existence for a few years in order to generate enough income to use that tax benefit, and then you might collapse it later.
• 9:46
  SPEAKER_02: So then, Cassie, let me ask you a follow-up question because you just mentioned partnerships, which are business structures that are not subject to tax.
• 9:54
  SPEAKER_02: And I know one of the things we talk about with business combinations and tax accounting is whether they're taxable or non-taxable.
• 10:03
  SPEAKER_02: So is that being driven by the fact you're acquiring a partnership or what factors go into that determination?
• 10:10
  SPEAKER_02: Because obviously that's fairly material.
• 10:12
  SPEAKER_03: Right.
• 10:12
  SPEAKER_03: So it's not.
• 10:13
  SPEAKER_03: So just because the partnership is not a taxable entity doesn't mean the acquisition itself is non-taxable.
• 10:20
  SPEAKER_03: Um, this distinction of whether the transaction itself is taxable or non-taxable isn't the same as like the tax status of the entity that's getting acquired.
• 10:28
  SPEAKER_03: So what you really want to be looking for here is to understand that the tax laws in most jurisdictions generally differentiate between taxable and non-taxable business combinations, and that distinction is relevant because the type of transaction determines the tax basis of the acquired assets and assumed liabilities.
• 10:50
  SPEAKER_03: So, as Jen had mentioned at the outset, when we talk about an asset deal, that's typically a considered under the tax law a direct purchase of assets and assumption of liabilities.
• 11:02
  SPEAKER_03: And so that's a taxable transaction.
• 11:05
  SPEAKER_03: In those situations, there's new tax basis, it gets established at the transaction date.
• 11:12
  SPEAKER_03: If you instead were acquiring the stock of an entity, that's generally a non-taxable transaction.
• 11:19
  SPEAKER_03: And in those situations, the tax basis typically carries over from whatever the previous owner had.
• 11:25
  SPEAKER_03: There are situations in some jurisdictions where stock acquisitions, which are the non-taxable type, can be treated.
• 11:32
  SPEAKER_03: You can make an election to treat it as an asset acquisition.
• 11:36
  SPEAKER_03: And um that's an election that can be filed.
• 11:41
  SPEAKER_03: Sometimes, depending on the jurisdiction, it might have to be approved by the tax authorities.
• 11:45
  SPEAKER_03: Um you do have to, you know, sometimes dig a little deeper than just like, was it an acquisition of stock or was it an acquisition of assets and kind of go the extra mile and ask the question, like, well, you know, if it was a stock acquisition, are you treating it like a stock acquisition from tax purposes, or did you make an election to treat it like an asset acquisition?
• 12:03
  SPEAKER_03: Um, but that tax basis, obviously, when Jen was talking about measuring temporary differences, the tax basis is part of that calculation.
• 12:12
  SPEAKER_03: And so knowing whether you're gonna get a step up in basis or you're not will help you just have a broad initial understanding of am I gonna have deferreds to record?
• 12:21
  SPEAKER_03: Or could could it be possible, like in an asset deal, that often you might have tax basis and book basis at the same.
• 12:28
  SPEAKER_03: So you might not have a lot of deferred tax liabilities and assets to record in in purchase accounting.
• 12:33
  SPEAKER_03: All right.
• 12:34
  SPEAKER_02: Definitely very complicated for a non-taxed person listening to that.
• 12:38
  SPEAKER_02: And I guess one of the key things so that kind of caught my ear there was this election.
• 12:43
  SPEAKER_02: And clearly the election, uh, one way or another, will impact the accounting, like depending on what it is or the policy or otherwise.
• 12:51
  SPEAKER_02: And so, Jen, how does this really fit in in this context?
• 12:55
  SPEAKER_02: That can you elaborate on that?
• 12:57
  SPEAKER_01: Yeah, I I think what comes up very often.
• 13:00
  SPEAKER_01: So if you step back for a minute, whether the transaction is taxable or non-taxable, is something that the buyer and seller, it's part of the purchase and sale agreement, right?
• 13:09
  SPEAKER_01: So it's something that the buyer and seller have agreed to.
• 13:12
  SPEAKER_01: But the buyer, as part of its plan to acquire this business, might have um plans that it intends to put in place.
• 13:23
  SPEAKER_01: Um, and the question that comes up from a tax prof tax provision perspective is whether those buyer only, I'm gonna call it broadly post-transaction restructuring, but it could be an election, it could be an action, it could be a lot of different things, whether or not those should be considered in acquisition accounting.
• 13:41
  SPEAKER_01: So whether or not it should generally be considered within, for example, the measurement of your deferred tax assets and liabilities.
• 13:47
  SPEAKER_01: And so maybe I can um give a few things we think about and then give a couple of examples just to maybe bring that home.
• 13:55
  SPEAKER_01: So um 805 tells you that uh you are measuring uh based on a market participant lens, the fair value of assets acquired and then you know um liabilities assumed.
• 14:10
  SPEAKER_01: But I mentioned, and it would require in 805, you wouldn't be taking into account post-transaction restructuring.
• 14:17
  SPEAKER_01: But I mentioned earlier that 805 sends you to 740, which is clearly not modeled through a market participant lens, and it doesn't consider intent.
• 14:26
  SPEAKER_01: And I think this is where there's like an inherent, not conflict, but you know, inherent question that comes up as to then how do I think about something?
• 14:35
  SPEAKER_01: It's pretty clear if, you know, six months later I decide to restructure the entire business, that that's not something that's in acquisition accounting, right?
• 14:43
  SPEAKER_01: But what about those decisions that have a direct impact on, let's say, the measurement of a deferred tax item and there's nothing that needed to happen to make that happen?
• 14:53
  SPEAKER_01: So how do you think about those things?
• 14:55
  SPEAKER_01: So we would generally think of it through a few lens, you know, or a few questions.
• 14:59
  SPEAKER_01: You know, one, was the transaction contemplated at the time of the acquisition?
• 15:03
  SPEAKER_01: Is it in essentially the control of management?
• 15:07
  SPEAKER_01: Meaning, is there some approval that's necessary?
• 15:10
  SPEAKER_01: Does some government need to get involved?
• 15:12
  SPEAKER_01: Similarly, is there a second economic transaction?
• 15:15
  SPEAKER_01: Or is there, you know, this election is simply a piece of paper you file and it is so?
• 15:20
  SPEAKER_01: How do you think about almost like what's baked in and perfunctory versus what actually is, you know, clearly a second transaction that needs to happen?
• 15:30
  SPEAKER_01: So let's talk about a couple of examples.
• 15:33
  SPEAKER_01: You know, one that comes up is a voluntary change in tax status.
• 15:38
  SPEAKER_01: So imagine they purchase an LLC and they want to convert it to a corporation.
• 15:42
  SPEAKER_01: And so GAP, the income tax accounting standard provides guidance, specific guidance on a change in tax status.
• 15:50
  SPEAKER_01: Um and so generally speaking, when you have a voluntary change in tax status, we would say that, you know, that's likely outside of the acquisition accounting.
• 16:01
  SPEAKER_01: But we do think that in some circumstances, it could be considered.
• 16:06
  SPEAKER_01: So going back to those criteria I shared, when at the the it was contemplated at the acquisition date, when the election to make this conversion is either effective on the acquisition or retroactively effective at the date of acquisition.
• 16:20
  SPEAKER_01: So really what you're saying is on the date of acquisition, I had the acquisition and I had this election.
• 16:25
  SPEAKER_01: Why should I separate those two things?
• 16:28
  SPEAKER_01: Um when the um, you know, and then whether there's any consideration that needs to be, you know, paid.
• 16:34
  SPEAKER_01: And in this case, very often that wouldn't be the case.
• 16:37
  SPEAKER_01: So if you can meet those criteria, we we think that you could argue that those are in acquisition accounting.
• 16:43
  SPEAKER_01: Another example, and this one goes to recognition of assets, and I think this one, you know, is pretty judgmental.
• 16:51
  SPEAKER_01: But imagine you are buying um a company and it is in a jurisdiction, you know, a foreign jurisdiction or a state, wherever.
• 17:00
  SPEAKER_01: And let's imagine that there are they have NOL carry forwards from a past loss, but they're actually a profitable company and left to their own devices, they're going to make money and they'll realize those assets, and they don't have a valuation allowance when you when you first find them and you you intend to inquire them, acquire them.
• 17:18
  SPEAKER_01: Let's say you as the buyer intend to leave that jurisdiction.
• 17:24
  SPEAKER_01: So again, what I've said is that entity on its own, left to its own devices, is a profitable, doesn't need a valuation allowance.
• 17:30
  SPEAKER_01: You consciously are making a decision.
• 17:32
  SPEAKER_01: And remember what I said, 805 would say post-transaction restructurings are not included.
• 17:37
  SPEAKER_01: But in this case, you run into, I think, an interesting cross-section because the valuation allowance guidance in GAP in 740, which is where 805 sends you, says you look at all available evidence.
• 17:50
  SPEAKER_01: So when we've answered this question, we actually think there's two reasonable alternative um conclusions.
• 17:56
  SPEAKER_01: You know, one is to say, under all available evidence, I'm acquiring, I'm leaving this jurisdiction, that is what I'm doing.
• 18:04
  SPEAKER_01: And so I should record that valuation allowance on my deferred tax asset in acquisition accounting.
• 18:10
  SPEAKER_01: Another alternative would say, I'm going to look at the boundaries around 805, and I'm not going to consider it in acquisition accounting.
• 18:18
  SPEAKER_01: Now, if you went down that path because 740 is intent-based, you will not wait until you leave the jurisdiction to write that asset off.
• 18:26
  SPEAKER_01: You'll essentially have acquisition accounting, and then next day two, you'll write off the asset because you don't have objectively verifiable information.
• 18:33
  SPEAKER_01: So these are just a couple of examples of where I think you know what's in acquisition accounting can get a little more complicated in tax provisions.
• 18:43
  SPEAKER_03: Well, and Heather, as I listen to Jen talk about elections and decisions that you might make related to the acquisition, the other thing that pops to mind for me is accounting policies.
• 18:54
  SPEAKER_03: So there can be situations, for example, if you say acquire a partnership and it's still a partnership after you acquire it.
• 19:05
  SPEAKER_03: You're not like liquidating the partnership once you acquire it.
• 19:09
  SPEAKER_03: And sometimes a portion of a basis difference that might exist within the partnership could be related to things that if it was a corp, you wouldn't have a deferred tax liability related to it.
• 19:23
  SPEAKER_03: That could be things we've talked about in other podcasts, like um an indefinite reinvestment assertion or the APB23 assertion.
• 19:30
  SPEAKER_03: Or it could be because that partnership had somewhere in its its structure had done an acquisition and there's non-deductible goodwill in that partnership and you wouldn't have a DTL related to that.
• 19:41
  SPEAKER_03: And so now that you have bought the partnership and there's a basis difference being driven by one of those things that that qualifies for an exception under 740, um, you have to, uh you can, there's a policy election, you can like look through basically your outside basis difference and say, Oh, I see you non-deductible goodwill in there, and I shouldn't record a DTL for you.
• 20:05
  SPEAKER_03: Or you can just say, I'm not, I'm not going to look through and I'm just going to record the outside basis difference.
• 20:11
  SPEAKER_03: Now, the thing is, as the acquirer, you may have a precedent already.
• 20:15
  SPEAKER_03: You may have already picked a policy regarding whether you apply look through or you don't apply look through.
• 20:21
  SPEAKER_03: And just because you have maybe haven't done an acquisition recently, it may not be top of mind for you.
• 20:26
  SPEAKER_03: So you have to make sure that you're thinking about any existing policies that could impact how you think about deferred taxes in the acquisition accounting.
• 20:34
  SPEAKER_02: All right.
• 20:34
  SPEAKER_02: Definitely a lot of moving parts that a company needs to think about if it's contemplating one of these acquisitions.
• 20:41
  SPEAKER_02: But we haven't even gotten into what you kind of consider one of the biggest things that comes to mind when you talk about income taxes, which would be identifying and measuring temporary differences, because I am guessing there's also some impact on that.
• 20:57
  SPEAKER_02: So then, Cassie, can you kind of walk us through how we think about that in the context of a business combination?
• 21:03
  SPEAKER_03: Yep, sure.
• 21:04
  SPEAKER_03: So this is where the whole taxable versus non-taxable transaction comes into play.
• 21:09
  SPEAKER_03: So in a taxable transaction, also known as an asset acquisition or asset deal, or in a situation where you acquired stock but you made an election to account for it or treat it like an asset acquisition, the acquirer records the tax basis of the assets acquired and liabilities assumed at their the fair value under the tax law.
• 21:32
  SPEAKER_03: So a lot of times the fair value under the tax law and the fair value from a business combination 805 perspective may equal one another and you have no deferred to record.
• 21:41
  SPEAKER_03: But I just caution people to not default to that because the tax law doesn't say, oh, recorded at the fair value, the 805 says.
• 21:49
  SPEAKER_03: It has specific rules.
• 21:50
  SPEAKER_03: And so sometimes there can be differences there.
• 21:53
  SPEAKER_03: So I think it's, you know, sometimes people get used to not seeing deferred in that situation, but there can actually be some that arise.
• 22:00
  SPEAKER_03: And then once any differences that might exist have been measured, then you have to think about valuation allowance related to them.
• 22:09
  SPEAKER_03: Now, in a non-taxable transaction, this is where deferreds typically come up a lot.
• 22:13
  SPEAKER_03: So when you're doing just a straight stock acquisition, the historical tax basis of the acquired assets and liabilities assumed come over at the carryover basis from the predecessor owner.
• 22:26
  SPEAKER_03: And so the other thing that you have to think about when you're doing the acquisition of stock is that attached to that stock are all the tax attributes related to that corporation.
• 22:37
  SPEAKER_03: So, or or um if you're acquiring a you know a partnership, there could be some attributes that come through too.
• 22:44
  SPEAKER_03: So, for example, if the entity you're acquiring through a stock acquisition has net operating losses, they'll come over.
• 22:50
  SPEAKER_03: If it has any other carry-forwards or credits that it's carrying forward, those would come over with it too.
• 22:55
  SPEAKER_03: And you have to account for them.
• 22:57
  SPEAKER_03: Those do not come over in a taxable asset deal.
• 23:01
  SPEAKER_03: Attributes don't come with an asset deal.
• 23:03
  SPEAKER_03: So those are really kind of the things that you have to think about when you're measuring temporary differences and why that type of transaction becomes so important.
• 23:11
  SPEAKER_02: So wait, let me ask you a question because you mentioned that the um all the tax items carry over from the acquired company, but then obviously the assets and liabilities are being stepped up.
• 23:24
  SPEAKER_02: So then that's creating big differences.
• 23:28
  SPEAKER_03: Yeah, usually big deferred tax liabilities, most often, because if you think about what tends to pop in a business combination, a lot of the value gets attributed to intangibles or goodwill.
• 23:40
  SPEAKER_03: Now, goodwill, there's an exception related to that.
• 23:42
  SPEAKER_03: But intangibles, like you could have, you know, huge intangible for book purposes, but they could have zero value for tax purposes.
• 23:49
  SPEAKER_03: And so a big DTL will be generated.
• 23:52
  SPEAKER_03: All right.
• 23:52
  SPEAKER_02: And then not to overly complicate this, but if you are carrying over the predecessor company's amounts, I'll use the word carry over, but there could be differences in tax rates, right?
• 24:04
  SPEAKER_02: Or am I overthinking that?
• 24:06
  SPEAKER_03: Well, the jurisdiction would normally stay the same for where wherever they're located.
• 24:10
  SPEAKER_02: Because wherever they're located.
• 24:11
  SPEAKER_02: That's right.
• 24:11
  SPEAKER_02: Okay.
• 24:12
  SPEAKER_02: That's right.
• 24:12
  SPEAKER_02: That makes sense.
• 24:13
  SPEAKER_02: So didn't think that all the way through.
• 24:14
  SPEAKER_02: But anything else though, on that?
• 24:16
  SPEAKER_02: Like, are there any exceptions or other things then that we should be thinking about as you're um doing that carryover or talking about the temporary differences?
• 24:25
  SPEAKER_03: Yep.
• 24:25
  SPEAKER_03: So the two that I had just mentioned in relation to that look through come up here just in normal purchase accounting.
• 24:31
  SPEAKER_03: So the first is indefinite reinvestment assertion.
• 24:34
  SPEAKER_03: So it's possible you may you may acquire a foreign subsidiary and you have to make your own determination at the acquisition date whether you can assert indefinite reinvestment or not.
• 24:44
  SPEAKER_03: And if you can, then you don't have anything to record from an outside basis difference perspective in purchase accounting.
• 24:52
  SPEAKER_01: And then I, Heather, I think the other big exception is around goodwill.
• 24:56
  SPEAKER_01: So maybe first some background before we get into it, um, because you know it gets a little complicated as you might imagine.
• 25:04
  SPEAKER_01: Um ASC 740 describes a process of separating goodwill into two components, creatively called component one and component two component.
• 25:13
  SPEAKER_02: Uh taxes, pillar one, pillar two, component one, component two.
• 25:17
  SPEAKER_02: Anyway.
• 25:18
  SPEAKER_01: Listen, this is gap, though.
• 25:19
  SPEAKER_01: This is gap.
• 25:19
  SPEAKER_01: Oh, fair.
• 25:20
  SPEAKER_01: This is fair.
• 25:21
  SPEAKER_02: Okay.
• 25:22
  SPEAKER_01: Um so the first component, component one, equals the lesser of goodwill for financial reporting purposes or tax deductible goodwill.
• 25:31
  SPEAKER_01: And then the second component, again, creatively, is everything else.
• 25:35
  SPEAKER_01: So if you think of it as an example, um, assume I've got$100 of book goodwill and zero tax goodwill.
• 25:42
  SPEAKER_01: My component one goodwill is zero because it's the lesser of tax-deductible goodwill, which is zero or book goodwill.
• 25:50
  SPEAKER_01: So then I will have component two goodwill of a hundred.
• 25:54
  SPEAKER_01: But in order to get your accounting correct, you need to understand what kind of component to goodwill I have.
• 26:01
  SPEAKER_01: So do I have book in excess of tax or taxes, tax in excess of book?
• 26:06
  SPEAKER_01: When I have book goodwill higher than tax-deductible goodwill, which was my example in the$100, um, you will not record a deferred tax liability.
• 26:16
  SPEAKER_01: So that is a specific exception in gap that you will not record that.
• 26:22
  SPEAKER_01: If you have tax deductible goodwill in excess of book goodwill, then you will record a deferred tax asset.
• 26:30
  SPEAKER_01: Now, recording that deferred tax asset is where you bring in this lovely algebraic equation that challenges all of our brains at this age.
• 26:41
  SPEAKER_01: But if you break out your algebra book, you're going to figure out your deferred tax asset by using something called the simultaneous equation.
• 26:47
  SPEAKER_01: I'm not going to go through the math on this podcast, but it's in the standard.
• 26:51
  SPEAKER_01: You can also find it in our book, of course.
• 26:54
  SPEAKER_01: But essentially, the reason you need a simultaneous equation is because when you identify that you have tax in excess of books, a goodwill, and you need to record that deferred tax asset, you record that deferred tax asset.
• 27:07
  SPEAKER_01: I said before I gave the list of things you do, and the last thing you do is you figure out your goodwill.
• 27:12
  SPEAKER_01: So when you record that deferred tax asset, it's going to impact goodwill, which is going to cause you to have a deferred, which is going to impact your goodwill, and around and around you'll go.
• 27:20
  SPEAKER_01: So that iterative it needs to get solved for, and the way it gets solved is by using this simultaneous equation.
• 27:26
  SPEAKER_01: Um that will determine the amount of your deferred tax asset that gets recorded to goodwill.
• 27:31
  SPEAKER_01: If if by chance um all of your goodwill is gone, then that actually would go to the PL.
• 27:38
  SPEAKER_01: Um, one important note here though, this is an exception for goodwill.
• 27:42
  SPEAKER_01: It does not apply to indefinite lived assets or intangibles or anything else.
• 27:47
  SPEAKER_01: This is a goodwill-related um requirement.
• 27:51
  SPEAKER_02: All right, so that's very helpful.
• 27:53
  SPEAKER_02: And then one of the other things that I uh is always an important topic that we talk about when we talk about taxes and that I would like to understand how it plays in here would be the valuation allowance assessment.
• 28:06
  SPEAKER_02: It's another important thing.
• 28:07
  SPEAKER_02: So, Cassie, how do are you thinking about that?
• 28:10
  SPEAKER_03: Yeah, so the first thing I think you need to do when you're acquiring a corporation, especially in the same jurisdiction, is you're thinking about is this entity going to join my consolidated tax return?
• 28:23
  SPEAKER_03: And um, that becomes important because uh ASC 740 says you assess valuation allowance and you do all tax counting based on the tax paying component level.
• 28:34
  SPEAKER_03: And so if you have a consolidated return in a jurisdiction, that is your taxpaying component level.
• 28:40
  SPEAKER_03: It's not just the one entity, it's all the entities that are part of that consolidated return.
• 28:44
  SPEAKER_03: And so um, so in this situation, what that helps you do is then understand okay, if if there's some impact on valuation allowance from this acquisition, who's first of all, will there be an impact from this consolidated return um grouping?
• 29:03
  SPEAKER_03: And second, whose DTAs are being impacted?
• 29:06
  SPEAKER_03: Is it the buyers or the acquired entities?
• 29:09
  SPEAKER_03: And so I think maybe the easiest thing to do is a quick simple example.
• 29:14
  SPEAKER_03: So if I had, say I was a US parent and I bought a US subsidiary and uh I as the parent have been profitable, I had no valuation allowance, I buy an entity that has historically lost money.
• 29:29
  SPEAKER_03: But um they're going to join my consolidated return.
• 29:32
  SPEAKER_03: So what I'm looking at is in consolidation in total, do I now have enough income between the parent and this and the subsidiary to use like basically the subsidiary's losses will just offset the income from the parent, but I'm still gonna be in in income generally, in which cases, like any NOLs that I brought over with that acquisition of the subsidiary, I can use them up as the parent because I'm gonna still in total generate profit.
• 30:00
  SPEAKER_03: Now, um, in that situation, that acquired entity may have had a valuation allowance before because it was losing money on its own.
• 30:07
  SPEAKER_03: But now, if if in total I can still, I can now say um that it I can use the NOLs, for example, then I wouldn't need a valuation allowance.
• 30:17
  SPEAKER_03: So I wouldn't record one in purchase accounting.
• 30:20
  SPEAKER_03: Now, on the flip side, there could be a situation where I'm say a loss-making parent and I buy an entity that's profitable.
• 30:30
  SPEAKER_03: If still now as part of this consolidated group, the subsidiary is making more money than the parent is losing, it's possible that the parent may have had a valuation allowance in the past, but now it's going to have enough consolidated income to use any attributes it may have or not be a lossmaker anymore.
• 30:47
  SPEAKER_03: But in that situation, the VA release that's happening that could happen at the parent goes to the PL, it does not go through purchase accounting.
• 30:56
  SPEAKER_03: So just important to clarify that.
• 31:26
  SPEAKER_03: Well, if if the acquired entity is part of the consolidated return with the parent, those DTLs by themselves may be enough to realize the parent's DTAs, in which case, again, that VA release of the parent would go through the PL.
• 31:38
  SPEAKER_03: But it's helpful to understand whose DTAs are being realized.
• 31:41
  SPEAKER_02: That makes sense.
• 31:42
  SPEAKER_02: And then just one question, because when you talked about it, it almost seemed like it's like an all or nothing.
• 31:46
  SPEAKER_02: You either release all of the VA or none of it is there in between ground or not really.
• 31:53
  SPEAKER_03: Definitely.
• 31:53
  SPEAKER_03: Definitely.
• 31:54
  SPEAKER_03: Yeah.
• 31:54
  SPEAKER_03: Sometimes it's just a mathematical how it works.
• 31:57
  SPEAKER_03: And sometimes it could be you acquired um an entity that has foreign tax credits, but still you have no foreign source income to use them, whether it's in consolidation or not.
• 32:08
  SPEAKER_03: So you might need a VA on those, but not potentially not anything else.
• 32:11
  SPEAKER_02: Got it.
• 32:11
  SPEAKER_02: That's very helpful.
• 32:12
  SPEAKER_02: Okay, thank you.
• 32:13
  SPEAKER_02: And then obviously, I think we've hit, at least in my mind, the big areas of tax because we talked about valuation allowances, deferreds, you talked about your elections early on, I guess, UTPs.
• 32:25
  SPEAKER_02: And then is there anything else, Jen, that we should be talking about?
• 32:27
  SPEAKER_02: But maybe start with UTPs.
• 32:29
  SPEAKER_01: I think just a UTP is goes back to something I think we already said.
• 32:33
  SPEAKER_01: Just you can have UTPs that are both embedded in what you're acquiring, essentially.
• 32:39
  SPEAKER_01: So, you know, Target might have had UTPs prior to your acquisition.
• 32:43
  SPEAKER_01: Um, but importantly, the transaction itself might impact or add new UTPs to the mix.
• 32:50
  SPEAKER_01: So I think it's just important to say, you know, look at both of those are um in the acquired liabilities essentially.
• 32:57
  SPEAKER_01: I I think closely aligned with UTPs is indemnifications.
• 33:01
  SPEAKER_01: Um, you know, the reality is that, again, that's a pretty in-depth topic, but in any acquisition, you're going to likely have some kind of a tax-sharing arrangement, um, or I should say, in this case, unrelated parties, so some kind of an agreement.
• 33:18
  SPEAKER_01: Um, and so you'll need to think about how you're recording that.
• 33:22
  SPEAKER_01: 805 actually provides guidance for the recognition and measurement of that.
• 33:27
  SPEAKER_01: And so you will record an indemnification asset.
• 33:30
  SPEAKER_01: Um, it requires though mirror image.
• 33:32
  SPEAKER_01: And so very typically, you've got your UTP and then you're gonna have a mirror image receivable to the extent you're being indemnified for pre-acquisition liabilities.
• 33:44
  SPEAKER_01: Um, but two important notes one, that indemnification receivable is um above the line, if you will, it's not on the tax line, and then your UTP is on the tax line.
• 33:54
  SPEAKER_01: So while in some cases you may end up being still in net income zero, um you it will be in two different places in geography.
• 34:03
  SPEAKER_01: But also important um is you may not always be equal as time goes on because that receivable is subject to collectability, contractual limitations on the indemnified amount.
• 34:15
  SPEAKER_01: So um maybe tapping back to something Cassie said it's important not to just make an assumption that you just have mirror accounting.
• 34:21
  SPEAKER_01: You actually need to look at the contract and make sure that that you have full coverage.
• 34:26
  SPEAKER_01: If you don't, then even on day one, you'll have a difference.
• 34:29
  SPEAKER_01: And then I think the final thing we'd be remiss not to mention is measurement period.
• 34:34
  SPEAKER_01: Uh income tax accounting is not at all different from a measurement period perspective than any other area of ASC 805.
• 34:43
  SPEAKER_01: So there is a measurement period.
• 34:44
  SPEAKER_01: It's not to extend beyond a year.
• 34:47
  SPEAKER_01: From an income tax accounting perspective, just like every other area, this should be focused on changes or adjustments that are related to items that in the initial accounting were incomplete, or maybe the information wasn't readily available.
• 35:01
  SPEAKER_01: It should not be based upon new information.
• 35:03
  SPEAKER_01: And if I just give you an example that comes up in not infrequently in the tax world, let's imagine that you've made your estimate for a UTP and you're six months into the measurement period, and there's development.
• 35:16
  SPEAKER_01: It could be a development with an agent, or it could be even a case law development or something like that, which was clearly not part of your original estimate.
• 35:24
  SPEAKER_01: That just because you're still in the measurement period, that doesn't, that's not a measurement period adjustment.
• 35:29
  SPEAKER_01: That's based upon information that would be recorded in the period in continuing ops.
• 35:34
  SPEAKER_01: So really important not to turn measurement period into sort of something bigger than it is.
• 35:39
  SPEAKER_01: Um I think that's probably important to keep in mind as well.
• 35:42
  SPEAKER_02: All right, very helpful.
• 35:44
  SPEAKER_02: So definitely another very complicated area.
• 35:47
  SPEAKER_02: I guess any final thoughts for our listeners if they're dealing with a business combination and maybe Cassie starting with you.
• 35:54
  SPEAKER_03: Yeah, so the one that I like to emphasize is what Jen was speaking of with component one and component two goodwill.
• 36:02
  SPEAKER_03: It seems like it's a tax-techie thing, and it seems like it's something that always only comes up in business combinations, but it's actually it persists through the life of that goodwill.
• 36:12
  SPEAKER_03: And so it comes up when if you have a goodwill impairment down the road, you need to know what portion of that reporting unit's goodwill was component one versus component two if you end up selling a portion of a reporting unit.
• 36:26
  SPEAKER_03: And you have to be able to know again what portion was component one versus component two in order to continue to get your deferred tax accounting correct.
• 36:34
  SPEAKER_03: And so we have a little graphic in our guide that for the first couple of years I was working on tax accounting, I printed that little graphic in order to constantly just be a quick visual reminder of you know what the difference between the two is.
• 36:47
  SPEAKER_03: So all right, very helpful.
• 36:49
  SPEAKER_02: And Jen, anything to add?
• 36:51
  SPEAKER_01: I'd just say that uh the details matter.
• 36:54
  SPEAKER_01: Um, you know, coming in, making any kind of broad uh simplification, you know, simplifying assumptions or anything like that is probably gonna send you down a harder path than an easier path.
• 37:05
  SPEAKER_01: So it's important you understand the form of the transaction and the entities that you acquired.
• 37:09
  SPEAKER_01: And it's important to recognize you have temporary differences because there are differences in the tax law and in financial accounting.
• 37:16
  SPEAKER_01: So that is still true in acquisition accounting.
• 37:19
  SPEAKER_01: So it's important that you're really understanding both your financial reporting basis as well as the tax law.
• 37:25
  SPEAKER_02: All right.
• 37:26
  SPEAKER_02: I actually have a question you made me think of that I should have asked you before.
• 37:30
  SPEAKER_02: We talked about taxable versus non-taxable business combinations.
• 37:34
  SPEAKER_02: And I know this is probably a whole other topic, but we talked about how you figure out which one it is.
• 37:40
  SPEAKER_02: But from a deal economics, do do you care?
• 37:43
  SPEAKER_02: It seems like inherently you would if you're going to have to pay taxes or you're gonna have the carryover.
• 37:49
  SPEAKER_02: Is is there a simple answer?
• 37:51
  SPEAKER_01: Was it so you're asking, like, is there a reason why you do a taxable asset versus a stock?
• 37:56
  SPEAKER_02: Yeah.
• 37:56
  SPEAKER_02: Yeah.
• 37:56
  SPEAKER_01: Yeah, I there are reasons, but they will depend upon your facts.
• 38:00
  SPEAKER_01: In other words, sometimes you might be indifferent between between them.
• 38:03
  SPEAKER_01: But for example, you know, you're getting a step up in one, um, you're not getting a step up in the other, your purchase price might be impacted by whether you're getting those step-ups or not.
• 38:13
  SPEAKER_01: Your overall profile might be impacted.
• 38:15
  SPEAKER_01: And of course, it's not as simple.
• 38:17
  SPEAKER_01: Um, you know, in certain cases, keep in mind there's legal liabilities and things like that, even outside of tax.
• 38:23
  SPEAKER_01: So there can be other non-tax reasons for buying something in a certain form, but there's no question that tax people are at the table when you're deciding what is the most tax, this is the way I think about it, the most tax efficient way to execute on an acquisition of something that you want, a group of assets.
• 38:40
  SPEAKER_01: So um there can be a lot of different reasons why you choose one over the other.
• 38:43
  SPEAKER_02: All right, so even before you get into everything we talked about today, there's a lot of tax items to consider if you're doing one of these deals.
• 38:51
  SPEAKER_02: And that's what made me think of the question from that comment you made.
• 38:55
  SPEAKER_02: So, Jen and Cassie, as always, such a pleasure to talk to you.
• 38:58
  SPEAKER_02: Thanks so much for joining me today.
• 39:01
  SPEAKER_02: That's our show for today.
• 39:03
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• 39:06
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• 39:09
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• 39:14
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• 39:23
  SPEAKER_02: From Thought Leadership at PwC, I'm Heather Horn.
• 39:28
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