The following article is adapted from reprinted from the M&A Tax Report, Vol. 7, No. 9, April 1999, Panel Publishers, New York, NY.


By Robert W. Wood, San Francisco

Although The M&A Tax Report covers tax issues and planning techniques, we've come to view accounting issues as an integral part of our mix. Pooling transactions, for example, are creatures of the FASB accounting pronouncements. They are not tax rules, but virtually every tax advisor needs to understand the rudiments.

The FASB is now poised to announce the decisions that will, this summer, populate its eagerly awaited Exposure Draft regarding the new reality for accounting for business combinations. Members of the M&A community have good reason to feel uneasy. Each decision, thus far confined to the area of purchase accounting, indicates a degree of hostility toward the current order of things. The current climate suggests that the FASB will almost certainly propose a substantial curtailment of the ability to account for a transaction as a pooling of interests.

Size Matters...

This curtailment will probably take the form of an addition of a relative size test to the already complex pooling guidelines. Under the new relative size test, a transaction would not qualify for pooling treatment unless it is essentially a merger of equals. A kind of unisex spin on the merger community, the idea is that it would not be possible to identify who the acquirer vs. the target truly is.

It is now well-known that the FASB has voted to repeal FIN 4, the pronouncement that established the opportunity to "expense" the portion of the purchase consideration allocable to in-process R&D. In-process R&D represented the amount allocable to assets of the target to be used in R&D activities, as well as its research projects in process. In order to level the playing field between those who would acquire another entity's R&D and those who would perform their own R&D activities, FIN 4 required immediate expensing of the values ascribed to purchased R&D.

The FASB has now decided to abandon this reasoning and, instead, require the capitalization and amortization of this asset in a manner equivalent to the treatment accorded other purchased intangible assets. The problem with this approach, seems to be that the playing field which FIN 4 painstakingly leveled will now be tilted. Indeed, perhaps FASB should also consider a rule that would enable entities that perform their own R&D to capitalize some, or all, of the attendant costs.

If such an approach is not considered, we would expect that companies, at least at the margin, will turn inward for their R&D. They should presumably eschew the acquisition of R&D projects of outside targets. Instead, they may well devote more resources to internal R&D efforts. At this point, the accounting treatment of these comparable endeavors would favor the latter approach.

Goodwill and Bad Timing

The FASB has also determined to shorten the amortization period generally available with respect to acquired intangible assets. Apparently, the ability to amortize goodwill over periods as long as 40 years will no longer be available. The FASB has rejected an approach, known as discernible elements, under which certain intangibles not possessing a determinable useful life could have been permanently capitalized (subject only to periodic impairment reviews). Instead, the FASB has decided that most intangibles should be amortized over periods not exceeding 10 years. Despite this 10-year cap, in certain cases, useful lives of up to 20 years would apparently be permissible.

In addition, the FASB seems to have accepted the notion that even longer amortization lives are possible in the limited instance in which the particular intangible produces identifiable cash flows that extend for periods exceeding 20 years. This test that would seem to exclude goodwill from its ambit. Oddly, however, in light of this preference for capitalization and amortization, the FASB has also decided that negative goodwill (the amount by which the fair value of the target's assets exceeds the purchase consideration) will not be recorded as a "deferred credit" and amortized into income. Instead, it will be recognized as an extraordinary item as soon as its existence is confirmed.

Consolidation Policy

Some four years after the publication (and eventual withdrawal) of a prior Exposure Draft, the FASB appears to be undaunted about consolidation. Indeed, it apparently has decided to try again. The new document only tackles the sort of makeshift philosophy of consolidation. The thorny questions attending consolidation procedures have not yet been fleshed out. The basic notion, though, has as its objective the expansion of the circumstances in which an entity would be viewed as a subsidiary of another entity. Currently, consolidation is generally required only in cases where an entity possesses a majority voting interest with respect to an investee.

This simple standard would now be replaced with a more flexible (manipulative?) approach that eschews reliance on mere legal control. It would opt for a facts and circumstances inquiry that seeks to discern the presence of a more elusive concept: effective control. As a practical matter, because the bare definition of effective control is not particularly useful as an implementation guide, much attention will be focused on the rebuttable presumptions of effective control that may be implemented.

The existence of control will be presumed if an entity:

Has a majority voting interest in the election of the investee's governing body; Has a "large minority voting interest" (one that exceeds 50% of the votes typically cast in the election of such governing body) and no other person, or organized group, has a "significant" voting interest; or, Has a unilateral ability to obtain a majority voting interest, through the ownership of convertible securities or other rights, that are currently exercisable, in cases where the expected benefit from exercise of these rights exceeds its expected cost.

There is also a standard for partnerships. Control of a limited partnership will be presumed if an entity is the only general partner and no other person, or organized group, has the current ability to dissolve the partnership or otherwise remove the general partner.

These standards are supplemented by comprehensive examples that seem to encompass, among others, the popular R&D spinoffs established by some of the pharmaceutical companies. These standards might even bring within the sphere of what will now be a consolidated group Coca-Cola's investment in Coca-Cola Enterprises. The proposal, should it be adopted, would be effective for years beginning after December 15, 1999. As is typical, if this becomes effective it would be accompanied by the need to restate comparative financial statements included in any post-effective date filing.

Will FASB Actions Derail the M&A Train?, Vol. 7, No. 9, M&A Tax Report (April 1999), p. 3.