What is an ASC 805 business combination?
ASC 805 defines a business combination as “a transaction or other event in which an acquiring entity obtains control of one or more businesses.”
Business combinations can give rise to a variety of complicated tax implications when calculating the provision for income tax under ASC 740, which governs how companies recognize the effects of income taxes on their financial statements under U.S. GAAP. When a company acquires the assets of another entity, it must account for the potential tax effects of tax credit carryforwards and income tax uncertainties.
Taxable vs. nontaxable business combinations
ASC 805 distinguishes between “taxable” and “nontaxable” business combinations. These terms refer to whether a tax is imposed on the acquired entity because of a business combination. This should not be confused with the terminology regarding tax-free reorganizations under U.S. tax law.
Taxable income from asset acquisitions
Taxable business combinations typically involve acquiring the net assets of the acquired entity rather than its stock. The tax attributes of the acquiree, such as net operating losses (NOLs) and tax credit carryovers, do not transfer to the acquirer in an asset acquisition.
A taxable asset acquisition may create tax-deductible goodwill equal to the excess of the purchase price over the fair value of the net assets. Goodwill is generally the total value of the acquisition over and above the fair value of identifiable net assets, including deferred tax accounts and intangible assets.
Though the acquired net assets are recorded at fair value for both GAAP and tax purposes, there are often differences in determining the fair value or allocating value between the acquired assets and liabilities under the two systems. Deferred taxes are recorded for the differences between the book basis and tax basis of the acquired assets and liabilities.
A business combination may have other deferred tax consequences due to the expected impact of the acquired business on federal, state, and foreign tax filings. These income tax impacts are recorded to continuing operations rather than through purchase accounting.
Nontaxable stock acquisitions
Generally, in a nontaxable business combination, the acquirer purchases the acquiree’s stock. Under U.S. tax law, the acquirer has carryover tax basis in the acquired company’s assets after a stock acquisition of a corporate entity. Unlike an asset purchase, a stock acquisition does not create tax-deductible goodwill.
Tax attributes such as NOLs and tax credit carryovers are typically retained after a change in ownership in a stock acquisition. The company should record the appropriate deferred taxes for those attributes. However, §382 and §383 may limit an acquirer’s ability to utilize pre-acquisition date tax attributes to offset postacquisition taxable income. In that case, it may be appropriate to record a valuation allowance based on the facts and circumstances.
The financial reporting basis in the net assets is reported at fair value, whereas the tax basis is carryover basis. Therefore, deferred taxes should be recorded on differences between the book and tax basis of the net assets in the acquired company.
A taxpayer may elect to treat a stock acquisition as an asset acquisition for U.S. tax purposes. If a company makes such an election, its purchase accounting and related deferred taxes should reflect the fair value tax basis based on that election and be accounted for as a taxable business combination.