Tax and Book Impacts of a Bargain Purchase
By: Steven J. Siefert, CFA, AM, AccuVal Associates, Inc.
This article was originally published in the ACG Wisconsin's Corporate Growth Mergers & Acquisitions supplement to The Business Journal in September 2011.
During the stock market rally and housing and credit bubble, the issue of a "Bargain Purchase" was a relatively foreign concept in purchase price accounting. With soaring prices and strong valuations for many privately held companies, consideration paid for the stock or assets of a company would generally exceed the fair value of identifiable tangible and intangible assets of the company and become part of goodwill.
Given the recent economic downturn and tight, albeit steadily improving credit markets, there have been a number of distressed transactions in the marketplace. The goodwill from many of the transactions completed during stronger market times has been written off. According to industry studies, more than two-thirds of public companies in the United States recognized goodwill impairment under ASC 350, writing down an aggregate of $260 billion.
Since competition for transactions has been down in recent years, private equity buyers have been selective with their investment funds as the lack of large amounts of leverage increases the need for quality companies to keep returns strong. Public companies are sitting on record amounts of cash and are generally being more judicious with their acquisitions. This has hurt the efficiency in the private company marketplace and caused more one-sided transactions that would lead to Bargain Purchases.
What is a "Bargain Purchase"?
The term Bargain Purchase is defined in ASC 805, Business Combinations (formerly FASB Statement 141R), where the sum of the fair values of all of the identifiable assets and liabilities exceeds the aggregate of:
(1) the total purchase consideration,
(2) if applicable, the fair value of any non-controlling interest in the acquire, and
(3) the acquisition date fair value of the acquirer's previously held equity interest in the acquire.
In other words, a Bargain Purchase occurs when the fair value of all of the assets purchased of a company exceeds the purchase price for the company. When a Bargain Purchase occurs, the buyer records a gain on purchase for the fair value of assets above the purchase price.
What is the impact of a Bargain Purchase?
There are significant impacts of a Bargain Purchase from both a book and tax perspective.
From a tax perspective, the gain on the Bargain Purchase creates a basis difference between book and tax. This difference is recognized overtime on an asset by asset basis. If the acquired company's assets are disposed of in the same year they are acquired, this will create a large, negative cash flow to the acquirer. The depreciable tangible assets of the target company would be depreciated based on Modified Accelerated Cost Recovery System (MACRS), and the intangible assets will be amortized over the statutory 15-year life. In general, a transaction classified as a Bargain Purchase could be more tax efficient than a transaction not classified as a Bargain Purchase; however, total taxes paid overtime should be similar. Discussions with a tax professional should be held to determine the exact impact of the transaction on the parties' taxes, as the tax situation will differ from transaction to transaction.
From a tax perspective, the gain on the Bargain Purchase will be treated as regular income and will be taxed at the acquiring company's effective tax rates. Depending on the size of the Bargain Purchase, there could be a large immediate negative cash flow impact to the acquirer. The tangible assets of the target company would be depreciated based on Modified Accelerated Cost Recovery System (MACRS), and the intangible assets will be amortized over the statutory 15-year life. While the purchaser should effectively pay the same dollar amount in taxes over the life of the assets, we all know that a dollar today is worth more than a dollar tomorrow. A transaction classified as a Bargain Purchase will be more tax inefficient than a transaction not classified as a Bargain Purchase.
Valuations and Bargain Purchases
While there have been a number of Bargain Purchases in recent years, they are still exceedingly rare, and valuation practitioners are expected to make sure they have correctly valued the tangible and intangible assets of the target company. Guidance in ASC 805-30, "Goodwill or Gain from Bargain Purchase, Including Consideration Transferred", 25-4, states:
Before recognizing a gain on a bargain purchase, the acquirer shall reassess whether it has correctly identified all of the assets acquired and all of the liabilities assume and shall recognize any additional assets or liabilities that are identified in that review.
Many transactions that first appear as a Bargain Purchase are errors in the valuation of the assets of the target company. If there is a sufficient marketing period for the target company, and a sufficient pool of buyers, the transaction price should be the best indication of the fair value for the tangible and intangible assets of a company. Our experience shows that auditors will typically not accept an analysis by valuation professionals that indicates a Bargain Purchase for a company that was marketed for sale over a sufficient period of time. The predominant thinking is that the assets were competitively offered for sale and therefore achieved their fair value as of the transaction date. Auditors therefore often suggest to further adjust the individual asset values downward, in some cases lower than individual market evidence might support for individual fair values. This suggests an auditor view that could be interpreted as there being no Bargain Purchases for a company that has had sufficient market exposure.
As the economy improves, the number of Bargain Purchases will continue to decline as the overall economy improves, market multiples expand and strategic and financial buyers return to the marketplace. However, some troubled industries, such as the banking and homebuilding industries, will likely continue to see an elevated number of Bargain Purchases.
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