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March 1989

Mergers and acquisitions: new considerations.

by Rasmussen, Kurt D.

    Abstract- Recently issued Financial Accounting Standards Board standards are discussed in relation to their effect on post-acquisition financial statements, taxable and tax-free transactions, and stock versus asset acquisition. Alternative approaches that may now be used are also offered.

Prior to 1970, considerable flexibility existed in the accounting treatment accorded business combinations and related intangibles. In 1970, the APB issued Opinion No. 16, "Business Combinations" and Opinion No. 17, "Intangible Assets."

Opinion No. 16 recognized the acceptability of both the purchase method and the pooling-of-interests method but not as elective alternatives; it also established 12 criteria that must all be met to achieve a pooling-of-interests. Some of these criteria have proven to be difficult to implement and have created a need for numerous interpretations. Nevertheless, the APB Opinions have remained largely unchanged. During the past few years, however, the FASB has promulagated several standards that affect business combinations. Although Opinion Nos. 16 and 17 will likely not be superseded soon, they are being amended.

Recent Changes Affecting Financial Reporting

The FASB issued three standards that have significant ramifications for consolidated financial statements prepared after corporate acquisitions. The first was SFAS 87, "Employers' Accounting for Pensions," (1985); the second was SFAS 94, "Consolidation of All Majority-owned Subsidiaries," (1987); and the third was SFAS 96," Accounting for Income Taxes," (1987). In addition, the Emerging Issues Task Force, issued a "consensus" statement establishing de facto accounting rules pertaining to leveraged buyouts in 1987.

The New Pension Asset or Liability. Opinion No. 16 required certain acquiring companies to record a pension liability as a result of a business combination accounted for as a purchase, even though no such liability was recognized by the acquired company. The amount of this liability was the greater of 1) the unfunded accrued pension cost of the acquired company computed in conformity with the pension accounting policies of the acquiring company or 2) the excess, if any, of the actuarially-computed value of vested benefits of the acquired company over the amount of the pension fund.

This provision has been superseded. Under SFAS 87, when acompany that sponsors a single-employer defined-benefit pension plan is acquired in a business combination accounted for as a purchase, the assignment of the purchase price to individual assets acquired and liabilities assumed shall include either a liability for the amount of the projected benefit obligation in excess of plan assets or an asset for the amount of plan assets in excess of the projected benefit obligation. This provision substantially increases the likelihood that a liability will be recorded for an acquired company's pension obligation, because unlike the liability measures of Opinion No. 16, the projected benefit obligation includes the effect of expected future compensation levels and is generally a much larger amount than the pension obligation determined under Opinion No. 16. Also unlike Opinion No. 16, SFAS 87 permits the recognition of a pension asset whenever the plan assets exceed the projected benefit obligation.

It is important to understand the financial statement treatment of an acquired company's pension plan is considerably different from that pertaining to the acquiring company's plan. For the acquiring company's plan, a liability is recorded when the accumulated benefit obligation exceeds the plan assets, and no asset is recognized when the reverse is true. The accumulated benefit obligation includes no assumption about future compensation levels and is generally much lower than the projected benefit obligation. The pension asset or liability recorded at the date of the business combination will remain in the balance sheet until such time as future differences between the annual pension expense and the annual amounts funded cause the balance to be eliminated.

When companies that sponsor multi-employer plans are acquired, the estimated withdrawal liability (if any) must be recorded if the company is likely to withdraw from the plan after the business combination. If withdrawal is not probable, then no pension liability should be recognized.

The New Consolidation Rules. An argument put forth for the need to change pension accounting was that companies with significant defined- benefit plans were, in effect, operating a life insurance subsidiary whose operating results and financial position were not adequately presented in consolidation. Thus, there was a subtle similarity between the perceived need to revise pension accounting and the perception that improvement was also needed in the manner in which majority-owned subsidiaries were accounted for. The result was SFAS 94, which amended an accounting standard in effect for almost 30 years.

The underlying objective of consolidated financial statements has always been to present, primarily for the benefit of the shareholders and creditors of the parent company, the results of operations and the financial position of a parent company and its subsidiaries essentially as if the group were a single company with one or more divisions. The presumption that consolidated financial statements are more useful than separate statements and that they are necessary for a fair presentation when all of the companies in the group are directly or indirectly under the control of the same management continues to hold. The change is the elimination of several exceptions to this general rule that provided a basis for not consolidating certain majority-owned subsidiaries.

The two changes of particular importance to companies contemplating acquisitions pertain to the elimination of the exception for "nonhomogeneous" subsidiary operations and the narrowing of the exception for a majority-owned foreign subsidiary. Manufacturing and merchandising companies had increasingly used "nonhomogeneity" as a basis for not consolidating majority-owned finance, real estate, leasing, and insurance subsidiaries. Such practices drew increasing criticism for their exclusion from the financial statements of significant amounts of assets, liabilities, revenues, and expenses. Critics also charged that the omission of significant liabilities was tantamount to "off-balance-sheet financing." SFAS 94 requires the consolidation of all majority-owned subsidiaries except where control is likely to be temporary or control does not rest with the majority owner.

Accounting for Income Taxes. The complexities and potential impact of the new accounting standard for income taxes rival those of the new pension accounting standard. Prior to SFAS 96, annual increases in deferred-tax amounts were calculated using current tax rates and were not adjusted for subsequent changes in tax rates. This "deferred" method has now been replaced with the "liability" method, under which the amount shown in the balance sheet is adjusted when tax rates or other relevant provisions of the income tax laws change.

SFAS 96 changes the deferred-tax accounting associated with purchase- method business combinations; those accounted for as pooling-of-interest are unaffected. Under prior accounting standards, the assets acquired in business combinations accounted for as purchases were recorded at their fair values net of related income tax effects. If the acquiror chose to carry over the existing tax bases in the assets (i.e., did not elect to "step up" the assets' tax bases), then a difference resulted between the book bases and the tax bases of the acquired assets. This difference was considered to be "permanent," and no deferred taxes were recorded. The fair values of the assets were determined and recorded net of their related income tax effects. That is, the assets' fair values were reduced by the future taxes expected to be paid on the difference between their book bases and their lower tax bases. Albeit controversial, the expected future tax amounts were sometimes discounted.

SFAS 96 considers the differences between the book and tax bases of assets acquired in purchase business combinations to be "temporary" differences (an expanded but similar version of what used to be called "timing" differences) and subject to the provision of deferred taxes. The assets acquired are to be recorded at their gross fair values, and the related tax effects are to be recorded as deferred taxes. So purchase business combinations now carry a new and potentially large deferred tax liability whenever the tax bases in the assets acquired are not stepped-up to fair values. This approach does, however, eliminate the uncharacteristic gross profit percentages and the unusual relationships between pre-tax profit and tax expense that were frequently associated with purchase business combinations under previous accounting standards.

If allowed by tax law, SFAS 96 permits both the acquired and the acquiring companies' operating loss and tax credit carryforwards to be considered in measuring the deferred-tax liability or asset arising from the purchase business combination. Previously only the tax benefit of the acquired company's loss carryforward could be considered and only if its realization was assured beyond a reasonable doubt. This new treatment may reduce the amount of goodwill recognized in certain acquisitions. If not recognized at time of acquisition, subsequent realization of the operating loss and tax credit carryforwards of the acquired company are used to reduce goodwill and other non-current intangible assets to zero and are then subtracted from the current year's income tax expense. Previously, such realizations frequently required the restatement of prior-period financial statements.

New Rules for Leveraged Buyouts. The Emerging Issues Task Force (EITF) reached a consensus on accounting for leveraged buyouts (LBOs) in 1987. The task force had been asked to address LBO accounting because of perceived abuses and the seemingly inconsistent methods applied to leveraged transactions. The key controversy centered on whether a company that changes ownership in an LBO can adopt a new accounting (i.e., a stepped-up) basis for the corporate assets, and if so, to what extent. Stepping up asset values for accounting purposes means writing up their historic book values to current fair values, as is done with purchase business combinations. For LBO transactions, asset step-ups are often necessary to avoid showing a negative equity. Subsequent to asset revaluations, the balance sheet reflects the fair value of the assets, the substantial debt incurred to accomplish the buyout, and typically, a positive equity. Thus the financial position of the company appears much better than it would without the asset step-up, even though the underlying economics are the same.

The EITF consensus has two principal components. The first addresses the question of what factors must be present to warrant any asset step- up; the second addresses how the amount of an allowable step-up should be determined. The new LBO rules are more "form oriented" than most accounting standards. Therefore, careful consideration should be given to the form and structure of any proposed LBO.

The rationale supporting the Task Force's consensus parallels that of business combinations accounted for as purchases, and the new rules apply specifically to LBOs structured as such. They do not apply to LBOs consummated through the use of treasury stock or leveraged employee stock ownership plans (ESOPs). To insure that an LBO is of sufficient substance to warrant a step-up in asset valuation, the EITF concluded that a change in control must occur; a new controlling shareholder must be established. An investor that formerly did not have a controlling financial interest must obtain at least 51% of the company's voting securities. The new controlling interest must also be substantive, genuine, and not temporary.

Two tests pertain to determination of the amount of the asset step-up permitted: step acquisition and 80% monetary consideration. If the new controlling investor held any voting equity in the predecessor company, then the transaction must be accounted for as a step acquisition. The effect is to value the new entity as a combination of historic amounts and current fair values. This requirement is particularly relevant for LBOs in which management is part of the new controlling interest.

The other requirement states that at least 80% of the purchase price be paid in cash or other monetary consideration. Its purposes is to make sure that the price of the transaction can be objectively determined, and it restricts the issuance of new equity to 20% of the total fair value. Failure to meet the 80% test reduces the amount of the purchase price and, consequently, the amount of the permissible asset step-up. Thus, if an accounting step-up is an important consideration, the impact of the new EITF consensus must be considered.

Income Tax Considerations*

For federal income tax purposes, there are two principal types of corporate acquisitions: taxable and tax free. Recent tax legislation has significantly changed the tax treatment of "taxable" acquisitions as well as the tax treatment accorded certain transactions involving corporations and their shareholders. Surprisingly, little change has been made in the tax treatment of so-called tax-free acquisitions (also called corporate reorganizations). Because these acquisitions merely result in a deferral of tax, a better name for them would be "tax deferred." In determining the tax consequences of corporate acquisitions, it is important to realize that the Treasury Department is very form oriented.

Objectives of the Parties

Seller's Objectives. The seller consists of two parties: the corporation and its shareholders. The form in which the sale occurs (i.e., a sale of assets by the corporation versus a sale of the corporate stock by the shareholders) will significantly affect the tax results to the selling parties.

Historically, the sale of stock produced capital gains for the selling shareholders, whereas a sale of underlying assets by the corporation generally resulted in at least some ordinary income to the extent of recapture taxes. Since the elimination of favorable tax rates on capital gains, the distinction between capital gain and ordinary income has, at least for now, become much less important.

Buyer's Objectives. The buyer also consists of two parties: the corporation and its shareholders. From the perspective of a buyer the most significant tax objective is usually to maximize the availability of tax to be recovered through immediate deduction or through depreciation or amortization over the shortest period of time. The buyer may also wish to preserve net operating losses and other tax attributes existing within the target corporation.

If the target contains significant appreciated assets of a type that allows for depreciation or amortization, the buyer naturally would like to be able to deduct any premium paid (i.e., the excess of the price paid to acquire the business over the tax basis the selling corporation has in such assets). To do so, however, the buyer generally must purchase the assets directly. On the other hand, a buyer making a bargain purchase of a business might prefer to buy the stock of the corporation, thus preserving the higher tax basis the corporation might have in its underlying assets.

In determining whether the transaction should be structured as taxable or tax-free, there are two non-tax factors to be considered by the buyer. First, to effect a tax-free transaction, the buyer must be willing to allow the seller to assume an equity position in the reorganized operations. Many owners of closely held businesses are not willing to accept this requirement. Second, the buyer may wish to use the seller as a source of financing by allowing the seller to retain an equity and/or security interest. Such a position by the buyer creates an atmosphere conducive to a tax-free transaction in the form of a reorganization.

Tax-Free Acquisitions

To effect a tax-free acquisition, at least two corporations must be involved, one of which may be formed specifically for that purpose. Three other basis requirements must also be met to qualify as a tax-free reorganization. First, there must be a continuation of the acquired corporation's business activity--commonly referred to as continuity of business enterprise. However, this requirement does not mean that the entire historic business of the acquired company must be continued. Continuity of business enterprise has been deemed to be satisfied when one of three equal-sized business activities is continued and the other two terminated. Second, there must be a continuing equity ownership in the reorganized business by the selling shareholders--commonly termed continuity of interest. Nevertheless, acquisitions can be at least partially tax-deferred where a combination of equity and other property is used as consideration. The use of other property causes a portion of the realized gain to be taxable, but it permits the equity portion to be tax-deferred. Losses, however, are not recognized in partially tax- deferred acquisitions. The Supreme Court has ruled that continuity of interest was present where as little as 38% of the total consideration was in the form of equity. For advance-ruling purposes, the IRS requires that at least 50% equity be used to maintain continuity of interest. Finally, a transaction must have a valid business purpose to qualify as a reorganization.

Tax-free reorganizations can all be classified as either asset acquisitions or stock acquisitions.

Asset Acquisitions. The most popular form of tax-free asset acquisition is a statutory merger; this type of acquisition must be consummated under applicable state law. Typically, the acquiring corporation will survive the merger and possess the assets, as well as assume the liabilities, of the target corporation. By operation of law, shareholders of the acquired company become shareholders of the acquiring company. A variation of the typical merger allows a subsidiary, either existing or newly formed, to acquire the target in a statutory merger, but it must use its parent's equity as consideration and also acquire substantially all of the target's property. Treasury Department guidelines define "substantially all" as 90% of the fair market value of the net assets and 70% of the fair market value of the gross assets. The equity passing to the target's shareholders in either of these reorganizations may be voting or nonvoting, and may be either common, preferred, convertible preferred, or any combination thereof.

Tax deferral is usually not extended to other property used as consideration. Therefore, immediate income recognition will generally be imposed to the extent that other property is used in the transaction and the recipient has realized a gain. Prior to the elimination of favorable capital-gain rates, income arising from the use of other property as consideration was sometimes taxed as ordinary income (i.e., dividends) rather than as capital gain. While the distinction between dividend income and capital gain still exists, the equalization of the tax rates eliminates (at least for now) the negative impact of dividend- income treatment. Still a factor, however, is that if the non-equity consideration is treated as a dividend, the income generally recognized by shareholders is equal to the entire fair market value of the non- equity consideration and is not reduced by the bases shareholders have in the underlying stock.

Also, the acquiring corporation in a tax-free asset acquisition inherits the tax bases of the acquired assets and assumes the liabilities of the selling corporation. Consequently, the tax balance sheet will reflect the same dollar amounts for the property regardless of the amount paid.

Inherent in a tax-free asset acquisition is the ability of the acquiror to inherit the corporate attributes of the target, which generally include methods of accounting, net operating loss carryforwards, investment tax credit carryforwards, and foreign tax credit carryforwards.

If a tax-free reorganization causes a greater than 50% change in the ownership of the target (or if the ownership change resulting from the reorganization, when combined with other recent ownership changes of the target corporation, creates a greater than 50% change in ownership), a prescribed annual limitation will be imposed on the use of all tax attributes, including net operating losses. The statutes also prescribe limitations on the ability of an acquiror to shelter future taxable income by offsetting certain gains or losses against losses or gains of the target (or vice-versa) within five years of the acquisition.

The selling shareholders who receive only equity will recognize neither gain nor loss and will have a carryover basis in the stock received.

While not technically an asset acquisition, a type of statutory merger exists that allows the target to remain in existence through a merger with a subsidiary of the parent. It requires that 80% of the consideration be voting equity of the acquiring parent. This type of merger is actually more like a stock acquisition and is frequently used when the buyer doesn't want to tamper with contractual arrangements (e.g., lease agreements) already in place or when the target is subject to regulation and possesses desirable intangibles such as license or franchise agreements.

Still another type of asset acquisition requires that solely voting stock be exchanged for substantially all the property of the target. The target must be liquidate for the "voting stock for property reorganization" definition to be met. In the past, the old corporate shell could be retained. In all other respects, this "voting stock for property reorganization" is like a statutory merger.

Stock Acquisitions. The stock-for-stock tax-free transaction requires that solely voting stock be issued by an acquiror corporation for control of the target. Control for this purpose is generally 80% of the voting power of all classes of voting stock and 80% of each class of non-voting stock. Common, convertible preferred, or preferred stock may be used in the exchange providing it is voting stock. A subsidiary may use its parent's stock if it uses its parent's stock exclusively.

The acquisition of stock and the continuation of the legal corporate entity of the target normally cause the tax attributes to remain within the acquired corporation. The restrictions imposed on the use of attributes when there is a 50% change in ownership apply equally to stock acquisitions.

The tax basis to the acquiror in the stock of the newly acquired subsidiary is the same as the cumulative tax basis of all the former shareholders. The task of calculating this basis of a widely held target can be enormous, so statistical sampling is often used. The holding period of the stock of the target in the hands of the acquiror is also the same as that of the former target shareholders.

It is the voting stock-for-stock and the voting stock-for-property tax-free reorganizations that, if certain other criteria are met, qualify for the pooling-of-interests method of accounting. The financial reporting treatment of a transaction accounted for as pooling of interests ignores any continued existence of the target as a separate legal entity, whereas tax accounting recognizes that continued separate legal identity. For both financial reporting and tax purposes, the previous asset and liability values are carried forward.

Taxable Acquisitions

Taxable acquisitions generally require the recognition of gain or loss by the seller in the year of sale. As with tax-free transactions, taxable acquisitions may also take the form of asset purchases or stock purchases. Although the tax ramifications for a seller and its shareholders depend on the specific circumstances, recent legislation has altered the tax atmosphere for a corporation desiring to dispose of its business and place the proceeds with its shareholders. For example, 1987 tax legislation modified the manner in which intragroup (parent- subsidiary) stock basis is computed when the corporations file consolidated tax returns. The adjustment to the parent's basis in its subsidiary's stock for annual earnings was previously based on modified financial reporting (i.e., book) income of the subsidiary. Now the adjustment is based on a concept more akin to taxable income of the subsidiary. As a result, primarily because of the use of accelerated depreciation, the parent corporation now typically has a much lower basis in its subsidiary's stock than previously. This created a greater gain upon the disposal of the stock, a corresponding increase in taxes, and reduced net proceeds for stockholders.

Typically, the value of the target's business exceeds the tax basis of the corporation in its assets. Should the corporation sell the business assets, the net after-tax proceeds available for distribution to the shareholders typically exceed the basis the shareholders have in their stock. Thus, as a group, the selling corporation and its shareholders need to be concerned about the recognition of gain subject to tax at both the corporate and shareholder levels.

Previous tax rules allowed taxpayers to sell or distribute all the corporate assets, ultimately placing the proceeds with the shareholders, and yet not recognize any resulting gain (except to the extent of recapture taxes) at the corporate level. Full tax was typically paid only at the shareholder level. Recent legislation has practically eliminated the ability of taxpayers to avoid the corporate-level tax. Therefore, when a corporation sells assets and distributes the proceeds, or alternatively, distributes assets to shareholders who subsequently sell them, two levels of tax typically result.

Normally, a buyer paying a premium for a business will prefer to purchase assets because the premium will be allocable to the assets and a tax deduction will frequently result. Alternatively, a buyer may purchase the target's stock, and the target would not be taxed on any asset appreciation. However, the purchase of the stock of a target means that the tax basis in the acquired company's assets remains unaltered. Any premium that the buyer has paid for the business is not deductible other than upon the ultimate worthlessness or sale of the target's stock. The obvious trade-off is that, for the acquiror to receive a stepped-up tax basis, the appreciation must be taxed at the corporate level. Avoiding the corporate-level tax means a carryover tax basis in the underlying assets.

The corporate acquiror has the ability unilaterally to make an irrevocable election to treat the purchase of a controlling interest (i.e., 80% of the vote and value) in the stock of a target as a purchase of its underlying assets. The benefit is to allow the acquiror to allocate the purchase price to the assets acquired based on their relative fair market values. The penalty is that the purchaser must pay tax on any appreciation of the assets over the tax basis of the acquiree, thereby increasing the economic cost. Under prior law, the gain on the "deemed sale" was protected by the nonrecognition provisions available for corporate distributions and liquidations. The recent repeal of those provisions means that the viability of this election is limited to situations where net operating losses or other attributes exist within the target to offset the resulting gain. Where the target has losses or other attributes available, they can be used to offset gain generated on the deemed sale of the assets, but any remaining attributes will be lost. Acquiring control of a corporation and inadvertently triggering the application of this "deemed asset purchase" provision is also possible. Therefore, the acquiror must be careful to protect against the imposition of these provisions if not desired.

As an alternative, if the controlling shareholder of the target is another corporation, the buyer and seller have the option of making a joint election to treat the stock sale as an asset sale. For tax purposes, the selling shareholders are viewed as having caused the target to sell its assets and liquidate. In this case, the target would report the gain or loss on the asset sale in its final return. The buyer is treated as having formed a corporation to acquire all assets and assume all the liabilities of the target. This concept was originally applicable only in the context of a target being sold and that was in a consolidated tax return. Recent changes provide that regulations are to be written by the Secretary of the Treasury to apply similar rules where the corporate controlling shareholder sells, exchanges, or distributes all of a subsidiary's stock regardless of whether a consolidated return is filed. The advantage to the joint election is that the selling group recognizes a single level of tax (the corporate level) because the deemed liquidation of the target is accomplished without further tax consequences. An exception to such tax-free treatment on the liquidation is that any gain realized by minority shareholders is taxable and any appreciation on property distributed to them is taxed at the corporate level. If the selling corporation and the target are filing a consolidated return, attributes of other members of the group may generally be used to offset the gain on the deemed sale of target's assets. Now that the tax-rate benefit on capital gains is eliminated, the seller's primary concern is whether the basis it has in the stock of the target (used to determine gain or loss if the joint election is not made) is more or less than the basis the target has in its assets (used to determine gain or loss if the joint election is made).

If the joint election is made, the corporate buyer determines its basis in the assets by allocating the purchase price based on their relative fair market values. Assuming a premium is paid, the buyer will have accomplished the goal of achieving a stepped-up basis even though a stock acquisition has taken place. Through regulations, the Treasury has established a methodology for allocating the purchase price. This methodology prescribes that the purchase price be allocated first to cash; second to marketable securities and cash equivalents; third to accounts receivable, inventory, tangible assets, and known intangibles other than goodwill; and finally to goodwill. The purchase price is first allocated among these four categories in order, and then to specific assets within each category. The residual value placed on goodwill is not amortizable for tax purposes.

Obviously, the decision to make one of these elections is complex and involves the interaction of several key factors, but it can have a major economic impact on the transaction.

Leveraged Buyouts

Today's LBO usually involves the purchase of some shares of the target and a subsequent borrowing to fund the share purchases from shareholders not continuing in the shareholder group.

An LBO can take many of the forms of transactions previously discussed. Because the borrowing is done to reduce equity, shareholders receiving cash will generally have a taxable event--either as a sale or redemption of shares, or as a dividend. Shareholders receiving stock or securities may be afforded tax-free treatment if the transaction meets the criteria of a partially tax-free transaction.

To reduce the profitability of "greenmail" transactions, recent legislation included a 50% excise tax to be imposed on greenmail payments received by a person who makes or threatens to make a public tender offer if, within a two-year period, the corporation redeems the stock held by the person or a related party making or threatening the tender offer. The tax is not imposed if the redemption is pursuant to an offer made on the same terms and conditions to all shareholders. For financial reporting purposes, greenmail is expensed in the year of the transaction.

Corporate Alternative Minimum Tax (AMT)

Recent legislation greatly expanded the scope and impact of this tax imposed on corporations. Generally a method of accelerating tax payment, the AMT is a system of computing a level of tax that ignores a number of methods of deferring income or accelerating deductions used in computing regular tax, such as the installment method for sales or accelerated methods of depreciation.

The AMT is an alternative tax imposed whenever it exceeds the regular annual corporate tax. It is considered an acceleration of tax because the excess of AMT over regular tax attributable to deferral preferences results in a credit that can be used to reduce future regular tax when and to the extent regular tax exceeds AMT in the future.

The primary goal in expanding the AMT was to instill an improved level of fairness in the corporate taxing system by insuring that all corporations reporting profits pay at least some federal income tax. The principal means to accomplish this goal is an adjustment based on reported book (i.e., financial reporting) income, normally determined in accordance with GAAP. If a corporation's book income exceeds the AMT base, one-half of the excess is added to the AMT tax base. This particular adjustment is to be replaced by a different mechanism in 1990.

Net operating losses, ITC and foreign tax credits are available, subject to special limitations, to reduce the AMT liability. However, the AMT system has a limitation which prohibits the use of tax credits and net operating losses from reducing the AMT liability below 10% of AMT without these adjustments.

Remember also that liabilities not previously recognized for either book or tax purposes may now be recorded on the books for purchase business combinations. These liabilities (e.g., pensions) may result in future disbursements that create tax deductions, even though they will not affect book income. In this situation, the reduction of taxable income with no corresponding book expense will increase the AMT adjustment.

In an acquisition accounted for as a pooling-of-interests that also results in a carryover basis for tax purposes, the AMT consequences typically will be minimal. The primary exception is where one of the combining entities is paying AMT but the other party pays only regular tax. After combination, the net excess may be reduced and the tax of the combined entities may be lowered.

Where a premium is paid and the transaction is structured to provide for stepped-up tax bases as well as recording the assets at fair market values for financial reporting purposes, the effect on the book income adjustment to AMT is less predictable. Excess book over tax amortization will generally result from the allocation of the premium to non-deductible intangibles (i.e., goodwill). On the other hand, the different book and tax lives combined with accelerated depreciation rates for tax purposes may increase the AMT adjustment. The AMT impact on the timing of benefits may be significant enough to alter the structure of the transaction. Also, a transaction resulting in stepped- up tax bases in the assets will normally result in the adoption of new tax accounting methods by one of the entities involved. An analysis will be required to determine the most beneficial tax accounting methods.

Because of the significance of the AMT, its impact must be considered in any acquisition from both a tax and a financial reporting perspective.

Despite the breadth and complexity of the issues, this article is intended to provide only a basic understanding of the principal financial reporting and tax ramifications of corporate acquisitions. Both dimensions need to be understood and carefully considered.

It is important to realize that the tax and financial reporting aspects of business combinations have attracted attention from Congress and accounting standard setters. Much has changed in a short time, and more is likely to change, particularly in the tax area.

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