M&a Accounting & Taxation FIIB

Mergers & Acquisitions Accounting and Taxation

Dr. P.K. GuptaAssociate Professor

Centre for Management Studies, Jamia Millia Islamia, New Delhi-25

Basic Issues

Taxation Domestic International

Valuation Country specific listings Corporate Strategy

Financial Reporting Format of M&A Convergence or Divergence from IAS IFRS Implications Clearances

Accounting for M&A

Effects of M & A- Accounting Implications

Existence is lost for both acquiring company and acquired company

A new entity is formed that generally issues shares to both the existing companies

Existence is lost for the acquired companyAcquiring company issues shares to acquired company

Existence is not lost for the acquired companyAcquiring company issues shares/other assets to acquired

company

Methods of Giving Effect to M&A

Pooling of Interests Method Purchase Method

Pooling of Interests Method

In the pooling of interests method of accounting, the balance sheet items and the profit and loss items of the merged firms are combined without recording the effects of merger. This implies that asset, liabilities and other items of the acquiring and the acquired firms are simply added at the book values without making any adjustments.


Transaction is simply an exchange of equity securities- the capital stock account of the target firm is eliminated, and the acquirer issues new stock to replace it.

The two firms' assets and liabilities are combined at their historical book values as of the acquisition date. The end result of a pooling of interests transaction is that the total assets of the combined firm are equal to the sum of the assets of the individual firms.

No goodwill is generated, and there are no charges against earnings. A tax-free acquisition would normally be reported as a pooling of interests.


Assets A B CombinedNet fixed assets 20 50 70Current assets 10 20 30Total 30 70 100Liabilities 10 22 32Shareholders Funds 18 38 56Currrent Liabilities 2 10 12Total 30 70 100

Purchase Method

The assets & liabilities after merger are generally

revalued under the purchase method. If the acquires pays

a price greater than the fair value of assets & liabilities,

the excess amount is shown as goodwill in the acquiring

companys books. On the contrary, if the fair-value of

assets & liabilities is less than the purchase price paid,

then this difference is recorded as capital reserve.

Purchase Method

The assets and liabilities of the acquiring firm after

the acquisition of the target firm may be stated at

their exiting carrying amounts or at the amounts

adjusted for the purchase price paid to the target

company.


Assets A FV(A) B CombinedNet fixed assets 20 22 50 70Current assets 10 7 20 30Total 30 70 100LT-Liabilities 10 9 22 32Shareholders Funds 18 38 56Currrent Liabilities 2 2 10 12Total 30 70 100

Purchase Consideration in M&A

In a business combination the former equity shareholders of the new subsidiary company will receive consideration from the new parent in exchange for their equity shares and that consideration could take the form of:

Cash; Equity Shares Non-equity shares/other securities Equity shares.

Purchase Consideration

Except Equity Shares, the income entitlement of the former equity shareholders of the subsidiary is not dependent on the level of profits of any company in the new group (since their income entitlement is either fixed or non-existent). Therefore in each of these first three cases the former (equity) shareholders have relinquished their risk capital in exchange for non-risk capital (or cash). Therefore there is a sense in which those equity shareholders have received a repayment of their risk capital as a result of the business combination.

Purchase Consideration

In such circumstances the Acquisition Method (the `normal'

method of consolidation which applies in the vast majority of

situations) is always appropriate. Thus it is only relevant to

compare the Acquisition Method of consolidation with the

Merger method of consolidation in the context of an exchange

of equity shares since in all other circumstances the

Acquisition Method would definitely be used.

Methods of Giving Effect to M&A

Merger Accounting

Acquisition Accounting

Features of Merger Accounting

All the profits of the newly merged subsidiary will be included

in consolidated reserves (subject to any minority interest).

No restatement is made of the net assets of the newly merged

subsidiary to fair value at the date of the merger.

Features of Merger Accounting

The consideration given by the parent company to facilitate the merger is recorded as the nominal value of the equity shares issued (plus any non-equity included in the consideration). Consequently no goodwill arises. The difference between the nominal value of the equity shares issued by the parent company plus the fair value of any other consideration given and the group share of the equity share capital (plus share premium if any) of the newly merged subsidiary is adjusted against consolidated reserves.

Features of Acquisition Accounting

Only the post-acquisition profits of a newly acquired

subsidiary are included in consolidated reserves.

The net assets of a newly acquired subsidiary should be

brought into the consolidated balance sheet at fair value to

the acquiring group at the date of acquisition.


The difference between the fair value of the consideration given and the fair value of the net assets acquired represents goodwill. Where the consideration given is wholly or partly shares the difference between the fair value of the shares issued and their nominal value must be shown in the consolidated balance sheet (although not necessarily in the individual balance sheet of the parent company) as a capital reserve.


If the ownership of the equity shares of the acquired subsidiary following the issue of shares by the parent company is less than 90% then this capital reserve must be called a share premium account. A share premium account must appear in the individual balance sheet of the parent company as well as in the consolidated balance sheet.

Acquisition of Vegetables Ltd. by Fruit Ltd.

On 1 July 1998 Fruit Ltd. acquired all of the issued equity share capital of Vegetables Ltd. in exchange for shares in Fruit Ltd.. Shares in both companies have a nominal value of 1 each and a market value at 1 July 1998 of 5 for a Fruit Ltd. share and 2.25 for a Vegetables Ltd. share. The agreed terms were 1 equity share in Fruit plc for every 2 equity shares in Vegetables plc. At 30 June 1999 the register of members of Fruit Ltd. was correct but no entries had been made in the books of account of the company to record the equity shares issued to obtain ownership of the equity shares of Vegetables.

Before Merger Balance Sheet

Equity shares of 1 each 765,000

Share premium account 100,000Retained earnings 347,525

Total Liabilities 1,212,525

Fixed assetsFreehold premises 573,750

Plant and machinery at cost 316,965Less provision for depreciation 127,500 189,465Quoted investments at cost 140,250

Net current assets 309,060

Total Assets 1212525

Balance Sheet of Vegetables Ltd. at 01-07-98

Additional Information

At 1 July 1998 the quoted investments had a market value of

318,750; the freehold premises a market value of 828,750;

The plant and machinery (which had an expected unexpired

useful life of four years) a market value of 300,000.

Vegetables Ltd. advised that it was their policy to invest

surplus cash on a short term basis in quoted investments.

Description Fruit Ltd. Vegetables Ltd.Profit & Loss A/cProfit before depreciation 568,310 437,070Depreciation for the year -91,290 -40,035Trading profit 477,020 397,035Profit on sale of investments 138,465Profit before tax 477,020 535,500Tax -119,255 -149,940Profit after tax 357,765 385,560Retained earnings: brought forward 651,015 347,525

carried forward 1,008,780 733,085Balance SheetFixed assetsFreehold premises 1,657,500 573,750Plant and machinery at cost 653,055 316,965Aggregate depreciation -276,165 -167,535Net current assets 249,390 874,905Total Assets 2,283,780 1,598,085Equity shares of 1 each 1,125,000 765,000Share premium account 150,000 100,000Retained earnings 1,008,780 733,085Total Liabilities 2,283,780 1,598,085

Effects on Vegetables Ltd. Balance Sheet

01-07-98 01-07-98 01-07-99Equity shares of 1 each 765,000 765,000

Share premium account 100,000 100,000Retained earnings 347,525 733,385

1,212,525 1,598,385

Fixed assetsFreehold premises 573,750 828,750 573,750

Plant and machinery at cost 316,965 316,965

Less provision for depreciation 127,500 189,465 300,000 167,535 149,430Quoted investments at cost 140,250 318,750

Net current assets 309,060 874,9051212525 1598085

Balance Sheet of Vegetables Ltd.at 01-07-98

Goodwill Computation

Fair value of Consideration

[765,000 x 1/2 x 5.00] 1,912,500

Fair value of net assets of Vegetables at the date of acquisition:

Quoted investments 318,750

Freehold premises 828,750

Plant and machinery 300,000

Net current assets 309,060-1,756,560

Goodwill 155,940

Description Acquisition Accounting Merger AccountingProfit & Loss A/cProfit before depreciation. 1,005,380 1,005,380Depreciation -166,290 -131,325Diff. on sale of investments -40,035 138,465Amortisation of Goodwill -15,594 -Profit before tax 783,461 1,012,520Tax -269,195 -269,195Profit after tax 514,266 743,325Retained profit b/fwd 651,015 998,540Retained profit c/fwd 1,165,281 1,741,865

Balance SheetUnamortised goodwill 140,346 -Freehold premises 2,486,250 2,231,250Plant and machinery 601,890 526,320Net current assets 1,124,295 1,124,295Total Assets 4,352,781 3,881,865Share capital 1,507,500 1,507,500Share premium account 150,000 150,000Capital reserve 1,530,000 Merger reserve 482,500Retained earnings 1,165,281 1,741,865Total Liabilities 4,352,781 3,881,865

Consolidated

Statements

of Fruit Ltd.

Under

respective

systems

Merger and Acquisitions Defined"A business combination that results in the creation of a new reporting entity formed from the combining parties in which the shareholders of the combining entities come together in a partnership for the mutual sharing of the risks and benefits of the combined entity, and in which no party to the combination in substance obtains control over any other, or is otherwise seen to be dominant, whether by virtue of the proportion of its shareholders' rights in the combined entity, the influence of its directors or otherwise. " A business combination that is not a merger is acquisition.

Fair Value Recording

All business combinations (whether full, partial or step acquisitions) will result in all assets and liabilities of an acquired business being recorded at their fair values, with limited exceptions.

Determining fair values of assets and liabilities based on market participant assumptions as opposed to company specific assumptions may present new valuation challenges.

Fair Value Recording

In partial acquisitions, recording all assets at their full fairvalues will likely affect companies future operating metrics due to increased amortization, depreciation, or future impairment chargeseven though net income will still be allocated between the parents interests and noncontrollinginterests.

In step acquisitions, previous investment interests held prior to obtaining control will also be recorded at fair value, with any gain or loss recognized in earnings.

Acquisition Accounting-Important things

All business combinations not accounted for as mergers should be accounted for as acquisitions.

The assets and liabilities should be included in the acquirer's consolidated Balance Sheet at fair value at the date of acquisition.

The results and cash flows of the acquired companies should be brought into the group accounts only from the date of acquisition. No adjustment of prior period results is required.

Merger Accounting-important things

The carrying values of assets and liabilities are not adjusted to fair value on consolidation. However appropriate adjustments should be made to achieve uniformity of accounting policies in the combining entities.

The results and cash-flows of all the combining entities should be brought into the financial statements of the combined entity from the beginning of the financial years in which the combination occurred. Corresponding prior-period figures should be restated.

Merger Accounting-important things Any existing balance on the share premium account or

capital redemption reserve should be brought in as part of this movement on other reserves. These movements should be shown as part of the reconciliation of movements on shareholders' funds.

Merger expenses should be charged to the profit and loss account of the combined entity at the effective date of merger.

Taxation of M&A

Amalgamation

Sec. 2(1B) of the Act defines Amalgamation as follows:-

Amalgamation means either merger or of one or more companies

with another company or the merger of two or more companies to

form one company.

For a merger to qualify as an amalgamation the following

conditions are to be satisfied:-

Amalgamation

all the property of the amalgamating company immediately before the amalgamation should become the property of the amalgamated company by virtue of amalgamation.

all the liabilities of the amalgamating company immediately before the amalgamation should become the liabilities of the amalgamated company by virtue of amalgamation; and

shareholders not less than 3/4th in the value of the shares in the amalgamated company (other than shares held by the amalgamated company or by its nominee) should become shareholders of the amalgamated company by virtue of amalgamation.

No Amalgamation if following conditions are satisfied

1. where the property of the company which merges is sold to the

other company and the merger is the result of a transaction of

sale;

2. where the company which merges is wound up in liquidation

and the liquidator distributes its property to the other company.

Demerger

Section 2(19AA) defines Demerger as follows:-

Demerger , in relation to companies, shall mean transfer,

pursuant to a scheme of arrangement under sections 391 to 394

of the Companies Act , 1956 by a Demerged company of its one

or more undertakings to the resulting company in the following

manner :

Conditions1. All the property of the undertaking , being transferred by the

demerged company , becomes the property of the resulting company.

2. All the liabilities relatable to the undertakings being transferred by the demerged company, become the liabilities of the resulting company.

3. The property and the liabilities of the undertaking being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger. (for this purpose , any change in the value of assets consequent to their revaluation shall be ignored).

Conditions4. The resulting company issues shares to the shareholders of the

demerged company on a proportionate basis as a consideration for the demerger.

5. shareholders not less than 3/4th in the value of the shares in thedemerged company (other than shares held by a by the nominee for, the resulting company or its subsidiary) should become shareholders of the amalgamated company by virtue of amalgamation.

6. The transfer is on a going concern basis.7. The demerger is in accordance with the conditions specified u/s

72A.

Tax Concessions Exemption from Capital gain Section 47(vi) Deduction in respect of (a) any asset of capital nature for

scientific research u/s 35(5) ; (b) Patent/copyright 35A(6); (c)know-how u/s 35AB(3); (d) telecom license fees 35AB(3) ; (e) preliminary expenses u/s 35D(3); (f) expenditure on amalgamation u/s 35DD; (g) minerals prospecting 35E(7); (h) family planning expenditure u/s 36(1)

WDV computations 80IA and 80IB deductions Carry forward of losses u/s 72A

Partnership/Sole to Company

All the business assets and liabilities before should be after

succession

Holdings

Partnership Ratio of Capital same proportion and total

capital 50%

Sole 50%

Five years lock in

Issues

Loss making to profit

or

Profit making to loss

Provisions for losses in amalgamation consideration

Unlisted should amalgamate with listed

Reverse Merger?

Cross Border M&A

Tax Issues

Sale of Shares Securities Transaction Tax Transfer Tax(Stamp Duty) Capital Gains taxSale of Assets Itemized sale Slump Sale (excess of net worth is CG) Stock-in-trade deficits and intangibles

Issues

Tax liabilities and cost should be minimized for the acquiring company.

Explore leveraging local-country operations for cash management and repatriation advantages.

Looking for availability of asset-basis set up structures for tax purposes and keeping a keen eye on valuable tax attributes in M&A targets, including net operating losses, foreign tax credits and tax holidays.

Thank You

Mergers & Acquisitions Accounting and TaxationBasic IssuesEffects of M & A- Accounting ImplicationsMethods of Giving Effect to M&APooling of Interests MethodPooling of Interests MethodPooling of Interests MethodPurchase MethodPurchase MethodPooling of Interests MethodPurchase Consideration in M&APurchase ConsiderationPurchase ConsiderationMethods of Giving Effect to M&AFeatures of Merger AccountingFeatures of Merger AccountingFeatures of Acquisition AccountingFeatures of Acquisition AccountingFeatures of Acquisition AccountingAcquisition of Vegetables Ltd. by Fruit Ltd.Before Merger Balance SheetAdditional InformationEffects on Vegetables Ltd. Balance SheetGoodwill ComputationMerger and Acquisitions DefinedFair Value RecordingFair Value RecordingAcquisition Accounting-Important thingsMerger Accounting-important thingsAmalgamationAmalgamationNo Amalgamation if following conditions are satisfiedDemergerConditionsConditionsTax ConcessionsPartnership/Sole to CompanyIssuesTax IssuesIssuesThank You

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M&a Accounting & Taxation FIIB