Deferred tax is the difference between the time a tax liability or asset arises and the time the associated tax is actually paid or offset. This is relevant in the context of a business acquisition because deferred tax liabilities reduce the value of the company, while deferred tax assets—such as tax-loss carryforwards or R&D credits—can actually increase its value.
Deferred tax refers to the time period between when a tax liability arises and when it is actually paid. This can affect a company's tax position and is important in the context of business acquisitions.
In a business acquisition, the buyer takes over a business from the seller. This can be through the purchase of shares(stock transaction) or through the purchase of assets(asset/liability transaction). Both types of acquisitions have different tax consequences and can affect deferred taxes.
Why is deferred tax important in a business acquisition?
During a business acquisition, it is crucial to have a clear picture of the tax position of the target company. This includes understanding existing deferred taxes, which can arise from various factors such as deferred tax liabilities, tax credits, or unclaimed losses.
- Deferred tax liabilities: These are taxes owed on income or profits that have already been earned but have not yet been paid. For example: a company may have made profits, but the taxes on those profits have not yet been paid due to deferral arrangements or because the company is taking advantage of tax benefits.
- Deferred tax assets: These are future tax benefits arising from temporary differences between accounting and tax profit calculations. For example: a company may be operating at a loss, and these losses can be carried forward to future tax years, resulting in lower tax liabilities in the future.
- Tax benefits and credits: This includes unclaimed tax benefits or credits that the company can use in the future to reduce tax payments.
What is the impact of deferred taxes on a business acquisition?
When evaluating an acquisition, the buyer must consider deferred taxes because they can affect the value and risks of the business to be acquired. Some important considerations are:
- Company Valuation: The value of the target company can be affected by deferred taxes. For example, deferred tax liabilities may represent a future cash flow obligation that reduces the value of the company. On the other hand, deferred tax assets can reduce future tax expenses and increase the value of the company.
- Due diligence: During the due diligence process, the buyer analyzes the financial and tax position of the business to be acquired. Here it is essential to get a complete picture of the deferred taxes in order to correctly assess future tax liabilities and benefits.
- Structuring the Acquisition: The presence of deferred taxes can influence how the acquisition is structured. For example: if the target company has significant deferred tax liabilities, the buyer may choose to renegotiate these liabilities or structure the acquisition in a way that minimizes the impact of these liabilities.
What are some real-world examples of deferred taxes?
- Deferred tax liabilities: Suppose a company has a deferred tax liability of €1 million due to temporary differences in the depreciation of assets. In an acquisition, the buyer must observe this liability because it may affect future cash flow.
- Deferred tax assets: A business may have tax losses that can be carried forward to future years. These losses represent a deferred tax asset that can reduce future tax expenses. The buyer must assess how realistic it is that these losses can be used in the future.
- Tax credits: A company may be entitled to future tax credits because of investments in research and development. These credits represent a deferred tax asset that can reduce tax payments. The buyer must assess whether these credits can be fully utilized.
Calculation example deferred tax on acquisition
Let's give a hypothetical example of tax deferral in a business acquisition to illustrate how this concept works and the impact it can have.
Business A wants to acquire Business B. Business B has the following tax position:
- Deferred tax liabilities: €500,000
- Deferred tax assets due to tax losses: €300,000
- Tax credits due to investments in R&D: €200,000
Analysis
- Deferred tax liabilities (€500,000): This amount represents a future tax liability arising from temporary differences between accounting profit and taxable income. For example: Business B has assets that are depreciated more slowly under tax rules than under accounting rules. This deferred liability must be paid at some point, which affects future cash flow.
- Deferred tax assets due to tax losses (€300,000): Business B has suffered losses in the past that can be carried forward to future years to reduce taxable profits. This means that Business B will have to pay less tax in the future.
- Tax credits due to investments in R&D (€200,000): Business B is entitled to tax credits for investments in research and development. These credits can be used to reduce future tax liabilities.
Valuation of Business B
To determine the value of Business B, Business A must consider deferred taxes. Suppose the value of Business B without deferred taxes is estimated at €10,000,000. We adjust this value based on the deferred taxes.
Adjustment for deferred tax liabilities:
- This liability represents a future cash outflow of €500,000.
- It is deducted from the estimated value of €10,000,000.
- Adjusted value: €10,000,000 - €500,000 = €9,500,000.
Adjustment for deferred tax assets due to tax losses:
- This receivable represents a future tax savings of €300,000.
- It is added to the adjusted value of €9,500,000.
- Adjusted value: €9,500,000 + €300,000 = €9,800,000.
Adjustment for tax credits by R&D:
- These credits represent future tax savings of €200,000.
- It is added to the adjusted value of €9,800,000.
- Adjusted value: €9,800,000 + €200,000 = €10,000,000.
Conclusion
The final value of Business B, taking into account deferred taxes, remains €10,000,000. Although the deferred taxes cancel each other out in this particular example, in practice this can vary greatly depending on the size and nature of the deferrals.
This example shows how deferred taxes can be a crucial factor in determining the value of a business. Understanding and correctly analyzing these deferrals helps in making informed decisions and optimizing the acquisition strategy.
Frequently Asked Questions About Deferred Taxes
What is deferred taxation?
Deferred taxation is the difference between the time when a tax liability or benefit arises and the time when the corresponding tax is actually paid or offset. This can include deferred tax liabilities, deferred tax assets, or tax credits that have not yet been claimed.
Why is deferred tax important in a business acquisition?
Deferred taxes affect the value and risks of the target company: deferred tax liabilities reduce the value because they represent a future cash flow obligation, while deferred tax assets and credits can actually increase the value.
What is the difference between a deferred tax liability and a deferred tax asset?
A deferred tax liability is tax that is already due on earned profits but has not yet been paid. A deferred tax asset is a future tax benefit—such as from tax-deductible losses or unused tax credits—that can reduce future tax expenses.
How do you factor deferred taxes into a business’s value?
You subtract deferred tax liabilities from de ondernemingswaarde and add deferred tax assets and credits. In the calculation example in this article, this results in a value of €10,000.000 excluding deferred taxes, adjusted for a €500,000 liability and €300,000 plus €200,000 in assets, results in €10,000,000.
Does the method of acquisition (share transaction or asset/liability transaction) affect deferred taxes?
Yes. A stock transaction and an asset/liability transaction have different tax implications, and this affects how deferred taxes are accounted for in the acquisition.
