The tax implications of FAS 141 & 142.

• Author: Ross, Sharon
• Position: Brief Article

Pooling--dead. Goodwill amortization--gone. Goodwill impairment tests--mandatory.

It's been more than a year since FASB released its unprecedented Financial Accounting statements 141 and 142 on business combinations that sent the merger and acquisition sector reeling from the implications.

While the statements left the tax treatment of business combinations and goodwill untouched, they are having a ripple effect on M&A deals, bringing up some significant tax issues. In some cases, the issues affect only a small number of business combinations. But because of the complexity of tax accounting combined with the new financial accounting standards, it's important to use caution when charting the course for a company's tax statements, says Dan Giannini, a mergers and acquisitions tax partner at PricewaterhouseCoopers in San Jose.

"Failure to pay close attention to the tax effects of adoption and implementation of the new pronouncements can quickly result in a misstatement of an acquiring company's financial statements," writes Giannini in PricewaterhouseCoopers' newsletter Nextwave.

THE RIPPLE EFFECT

The combination of new accounting rules and the existing tax law have the potential to yield some short-term benefits and long-term risks for acquiring companies. Adoption of FASB's new statements has the potential to boost earnings per share by increasing the bottom-line book income, now that acquired goodwill and indefinite-lived intangible assets (in a tax-free deal) are back on the books without amortization. And since the tax law (IRC Sec. 197) remains the same, goodwill is still amortized for 15 years for tax purposes, which decreases the effective tax rate for asset acquisitions.

But this benefit comes with consequences. While amortizing goodwill for tax purposes does create an even and certain tax deduction during the length of amortization, it creates a deferred tax liability once those 15 years are up. Goodwill also has the potential to hurt earnings if it ever becomes impaired, since FAS 142, which eliminated amortization of goodwill and intangible assets, also requires annual and periodic impairment tests.

Once considered a hindrance to a company's financial statements, goodwill absent impairment now becomes an asset, remaining on a company's books indefinitely and fattening earnings per share. This is in addition to the potential benefit of getting a tax deduction, specifically for asset acquisitions or stock purchases treated as asset acquisitions.

"For the first time, it is possible, in an asset acquisition for example, that goodwill is deductible for tax purposes but not amortizable for financial accounting purposes," writes Giannini. "Upon adoption of FAS 142, a company should expect its effective tax rate to decline." So, the effective rate won't rise for a new acquisition.

While goodwill may be an asset in the short term by lowering the tax expense, it may not necessarily lower the tax burden, because it transforms into a tax liability in the future, says Tom Snell, associate professor...