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  • Explanation - Lecture 8

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    Phan Chi
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    When target shareholders receive equity consideration in an M&A stock sale, their capital gains tax is deferred. If they receive cash consideration, a capital gains tax is triggered. A deferred tax liability is created when a target's assets are written up during an acquisition but can only be depreciated for accounting purposes and not tax purposes. The deferred tax liability is reduced each year by the amount of taxes associated with depreciation of the written-up assets. In an example, goodwill is calculated as the total purchase premium minus asset write-ups plus the deferred tax liability.

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    When target shareholders receive equity consideration in an M&A stock sale, their capital gains tax is deferred. If they receive cash consideration, a capital gains tax is triggered. A deferred tax liability is created when a target's assets are written up during an acquisition but can only be depreciated for accounting purposes and not tax purposes. The deferred tax liability is reduced each year by the amount of taxes associated with depreciation of the written-up assets. In an example, goodwill is calculated as the total purchase premium minus asset write-ups plus the deferred tax liability.

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    Explanation - Lecture 8

    Uploaded by

    Phan Chi
    When target shareholders receive equity consideration in an M&A stock sale, their capital gains tax is deferred. If they receive cash consideration, a capital gains tax is triggered. A deferred tax liability is created when a target's assets are written up during an acquisition but can only be depreciated for accounting purposes and not tax purposes. The deferred tax liability is reduced each year by the amount of taxes associated with depreciation of the written-up assets. In an example, goodwill is calculated as the total purchase premium minus asset write-ups plus the deferred tax liability.

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    Slide 9: Tax treatment in Stock sale M&A deal:

    - If target shareholders receive significant equity consideration in the


    acquirer, their capital gain tax is generally deferred.
    - If target shareholders receive cash as a method of consideration, a capital
    gain tax is triggered. In this case, if shareholders are taxable (such as
    individual investors or taxable institutional investors), they pay tax on
    capital gain; if shareholders are non-taxable (such as pension funds) they
    don’t pay tax on capital gain (tax-free).

    Slide 10: Deferred tax liability (DTL) or Deferred income tax is created because
    target’s asset write-ups are depreciated (amortized) on a GAAP book basis but not
    for tax purposes.
    GAAP book basis vs. Tax basis. DTL remedies this difference.
    DTL = Amount of Asset write-ups x Tax rate
    Each year, this DTL account is reduced by the amount of taxes associated with the
    transaction-related D&A of that year (i.e., each year, DTL account is reduced by
    this amount: annual transaction-related D&A x Tax rate).

    Example of calculating goodwill: Exhibit 7.17 p.383


    Total purchase premium = Purchase price – Target’s net identifiable assets =
    $2,200

    We allocate x% of the total purchase premium to the target’s Tangible assets


    (depending on the fair market value of the target’s Tangible assets):
    Tangible asset write-up = Total purchase premium * x%
    = $2,200 * 15% = $330
    We allocate y% of the total purchase premium to the target’s Intangible assets
    (depending on the fair market value of the target’s Intangible assets):
    Intangible asset write-up = Total purchase premium * y%
    = $2,200 * 10% = $220

    Amount of asset write-ups = Tangible asset write-up + Intangible asset write-up


    = $330 + $220 = $550
    DTL = Amount of asset write-ups * Tax rate
    = $550 * 38% = $209
    Goodwill = Total purchase premium - Amount of asset write-ups + DTL
    = $2,200 - $550 + $209 = $1,859

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