MERGERS & ACQUISITIONS

There are a number of transactions related to mergers and acquisitions that require valuations:

• Asset transactions.
• Stock transactions.
• Section 338 transactions.
• Statutory merger transactions.
• Other tax-free transactions.

Valuations in acquisition situations assist in both the tax and financial reporting determinations and the practical economic determinations.

Section 1060 requires the allocation of the purchase price to the fair market values of the tangible assets with the intangible value, with limited exceptions, determined as the residual. This applies to all taxable asset purchases. This methodology used in §1060 is borrowed from the methodology used in IRC §338 transactions.

Section 1060 Allocations

The buyer should be aware that the accounting treatment of an acquisition will not necessarily match the tax treatment. In an asset purchase, the allocation of the purchase price for tax purposes is governed by §1060. Under §1060, the purchase price must generally be allocated among the assets, other than goodwill and going-concern value, in accordance with their fair market values. The remainder is allocated to goodwill and going concern. This is known as the "residual method." Under this method, individual assets are assigned to an "asset class."

The purchase price is to be allocated among the following asset classes in priority order:

• Asset acquisitions before February 14, 1997
  1. Cash and demand deposits.
  2. Highly liquid assets such as readily marketable securities and certificates of deposit.
  3. All transferred assets other than those in Classes I, II, and IV, both tangible and intangible, including furniture, equipment, buildings, accounts receivable, and covenants not to compete.
  4. Goodwill and going concern.
• Asset acquisitions after February 13, 1997, and before January 6,2000
  1. Cash and demand deposits.
  2. Highly liquid assets such as certificates of deposit, U.S. government securities, readily marketable stock or securities, and foreign currency.
  3. All assets other than Class I, II, IV, or V assets, both tangibles and non-section 197 intangibles.
  4. Section 197 intangibles, except those in the nature of goodwill and going concern value.
  5. Section 197 intangibles in the nature of goodwill and going concern value.
• For assets acquired after January 5, 2000, consideration is allocated among the following seven asset classes:
  1. Cash and cash equivalents.
  2. Actively traded securities.
  3. Accounts receivable, mortgages, property, plant, and equipment.
  4. Stock in trade of the taxpayer or other property of the kind that would properly be included in the inventory of the taxpayer if on hand at the close of the tax year, or property held by the taxpayer primarily for sale to customers in the ordinary course of trade or business.
  5. All assets not in Classes I, II, ill, or IV.
  6. All section 197 intangibles, except goodwill and going concern value.
  7. Goodwill and going concern value.

Both the buyer and the seller, in an asset acquisition, must complete Form 8594, Asset Acquisition Statement, and report the transaction's details, including the allocation of purchase price to §197 intangibles and any modifications thereof [§1060(b)].

Note

An individual who owns 10% or more of the transferred entity, as determined under §318 immediately before the transfer, must also report to the IRS the existence of any covenants not-to-compete, employment contracts, lease agreements, royalties, or similar arrangements entered into between the individual [or person who is "related" to that individual within the meaning of §267(b) or §70(b)(1)] and the transferee. This reporting requirement applies unless the covenant, contract, lease, royalty or similar arrangement was not entered into in connection with the transfer of the interest in the entity to the transferee [§1060(e)].

Caution

Since, under §197, goodwill and other intangibles such as customer lists and covenants not-to -compete may be amortized over a IS-year period for tax purposes, the IRS will carefully scrutinize asset allocations and may attempt to allocate as much purchase price as possible to such assets.