Date: November, 1998

Primary Author: D. Scott Beane, CPA

Topic:FAS 109 ACCOUNTING FOR INCOME TAXES IN CONSOLIDATION

 

Applicable FASB Literature:

Pronouncement: FAS 109 AC I27 Paragraph(s): .108 d and e
 

Question:

Primary:

What are the consolidated deferred income tax assets and liabilities given the below theoretical balance sheet?

Secondary:

a. Are below items (investment in subsidiary, depreciable assets and goodwill) really "temporary differences" that will be recovered or settled (when sold)?

b. AC I27.108d states that goodwill is not a deferred tax liability if for tax purposes it is not deductible. IRC Sec 197 permits deductions of goodwill, however, tax basis is zero. Is goodwill a deferred tax asset in the above fact pattern?

c. Should all items be netted to compute a non-reportable deferred tax asset (AC I27.108e) of 1.7 million (inside basis of subsidiary) or should each be taken individually?
 

Background Fact Pattern:

U.S. Parent purchases 100% of outstanding stock of domestic Subsidiary for 3.5 million in cash. Transaction is accounted for as "purchase" rather than as a " pooling of interests". Balance sheets are as follows:

Balance Sheet

Parent

Subsidiary

Consolidated

Deferred?

Tax Basis Tax Basis GAAP Basis
Cash, receivable and prepaids 100,000 10,000 110,000 n/a
Investment in subsidiary 3,500,000 0 0 Deferred Asset?
Depreciable assets 0 1,790,000 3,000,000 Deferred Liab?
Goodwill (before adjustment for deferred income tax) 0 0 590,000 Deferred Liab?
Accounts Payable 0 (100,000) (100,000) n/a
Equity (3,600,000) (1,700,000) (3,600,000)
Total 0 0 0

Tax Assumptions:

1. If Parent subsequently sells Subsidiary's stock for 3.5 million, then no gain or loss is recognized, however,

2. If Subsidiary subsequently sells its assets (outside the consolidated group) for 4 million, it will sustain a $2,220,000 taxable gain and in consolidation incur a tax of $755,000 on such. In liquidation, Parent will sustain a nondeductible [subsidiary stock loss disallowance rules (Reg 1.1502-20)] loss of $1,820,000 due to the fact that its basis is in excess of liquidation proceeds. [Computed as beginning tax basis of 3,500,000 plus gain of 2,220,000 less tax of 755,000 less liquidation proceeds 3,145,000.] Thus, loss is not netted against Subsidiary's gain.
 

Conclusion - Primary Issue:

1. Overall: Inside basis results in a deferred tax liability. Outside basis is a deferred tax asset which must be valued using "more likely than not" criterion. Accordingly, this will be a judgmental decision.

2. AC I27.110h anticipates that business combinations will result in deferred income tax assets and liabilities.

3. However, AC I27.108d indicates an item such as Goodwill that will not amortize over time or only at the end of the entity should not result in a deferred tax asset or liability. Evidently, differences that do not reverse until the "end" (sale of entire business) are not recognized. The "investment in subsidiary" account is exactly the opposite of Goodwill, an "end game" asset. Nonetheless, KPMG's publication makes it clear that all such assets and liabilities, except for life insurance type items, result in deferred taxes.

4. ACI27.116 states that deferred assets (net of allowances) and liabilities are separately aggregated before netting of long and short term portions, making AICPA Technical's opinion below questionable.

5. Looking at the actual tax implications of an asset sale one would conclude that a deferred tax liability exist, even if it is an end game liability, and should be booked.
 

Views of Others Involved

(accountants, clients, etc., as applicable) aside, deferred tax liability would amortized against goodwill.

AICPA Technical support said that there is no deferred income tax asset or liability due to the fact that the 3.5 million cost basis of stock is being allocated amongst 3.5 million of assets, thus tax basis equals book basis. However, technician was unable to offer any further explanation and abruptly ended the call.

Client believes that end game deferred assets and liabilities, goodwill or otherwise should not be booked.

KPMG's "Accounting for Income Taxes, An Analysis of FASB Statement 109, copyright September 1992" answers by question:
 

Secondary:


a. Yes (Page 32)

b. Yes (Page 37)

c. Each individually (Page 155)

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