Mergers & Acquisitions

Accounting and Taxation

Dr. P.K. Gupta
Associate 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 company
Acquiring company issues shares to acquired company
Existence is not lost for the acquired company
Acquiring 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.

Pooling of Interests Method
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.

Pooling of Interests Method
Assets A B Combined
Net fixed assets 20 50 70
Current assets 10 20 30
Total 30 70 100
Liabilities 10 22 32
Shareholders Funds 18 38 56
Currrent Liabilities 2 10 12
Total 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.

Pooling of Interests Method
Assets A FV(A) B Combined
Net fixed assets 20 22 50 70
Current assets 10 7 20 30
Total 30 70 100
LT-Liabilities 10 9 22 32
Shareholders Funds 18 38 56
Currrent Liabilities 2 2 10 12
Total 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.

Features of Acquisition Accounting
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.

Features of Acquisition Accounting
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 100,000
Retained earnings 347,525
Total Liabilities 1,212,525
Fixed assets
Freehold premises 573,750
Plant and machinery at cost 316,965
Less provision for depreciation 127,500 189,465
Quoted 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/c
Profit before depreciation 568,310 437,070
Depreciation for the year -91,290 -40,035
Trading profit 477,020 397,035
Profit on sale of investments 138,465
Profit before tax 477,020 535,500
Tax -119,255 -149,940
Profit after tax 357,765 385,560
Retained earnings:
brought forward 651,015 347,525
carried forward 1,008,780 733,085
Balance Sheet
Fixed assets
Freehold premises 1,657,500 573,750
Plant and machinery at cost 653,055 316,965
Aggregate depreciation -276,165 -167,535
Net current assets 249,390 874,905
Total Assets 2,283,780 1,598,085
Equity shares of 1 each 1,125,000 765,000
Share premium account 150,000 100,000
Retained earnings 1,008,780 733,085
Total Liabilities 2,283,780 1,598,085

Effects on Vegetables Ltd. Balance Sheet
01-07-98 01-07-98 01-07-99
Equity shares of 1 each 765,000 765,000
Share premium account 100,000 100,000
Retained earnings 347,525 733,385
1,212,525 1,598,385
Fixed assets
Freehold 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
149,430
Quoted investments at cost 140,250 318,750
Net current assets 309,060 874,905
1212525 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 Accounting
Profit & Loss A/c
Profit before depreciation. 1,005,380 1,005,380
Depreciation -166,290 -131,325
Diff. on sale of investments -40,035 138,465
Amortisation of Goodwill -15,594 -
Profit before tax 783,461 1,012,520
Tax -269,195 -269,195
Profit after tax 514,266 743,325
Retained profit b/fwd 651,015 998,540
Retained profit c/fwd 1,165,281 1,741,865
Balance Sheet
Unamortised goodwill 140,346 -
Freehold premises 2,486,250 2,231,250
Plant and machinery 601,890 526,320
Net current assets 1,124,295 1,124,295
Total Assets 4,352,781 3,881,865
Share capital 1,507,500 1,507,500
Share premium account 150,000 150,000
Capital reserve 1,530,000
Merger reserve 482,500
Retained earnings 1,165,281 1,741,865
Total Liabilities 4,352,781 3,881,865
Consolidated
Statements
of Fruit Ltd.
Under
respective
systems

IRS 6

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 fair
values 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 noncontrolling
interests.
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 3/4
th
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 :

Conditions
1. 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).

Conditions
4. 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 the
demerged 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 tax
Sale 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