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The legal structure and tax status of the entities acquired and the tax structure of the transaction should be considered to determine the appropriate deferred tax balances to record in acquisition accounting.

10.2.1 Determining whether the business combination is taxable

The tax laws in most jurisdictions generally differentiate between taxable and nontaxable business combinations. The distinction is important because the type of transaction determines the tax bases of the acquired assets and assumed liabilities. The acquisition of a business through the direct purchase of its assets and assumption of its liabilities generally is treated as a taxable transaction (often referred to as an “asset acquisition” for tax purposes), while the acquisition of a business through the purchase of its corporate shares (often referred to as a “share” or “stock” acquisition for tax purposes) generally is treated as a nontaxable transaction. In some jurisdictions, a stock acquisition can be treated as an asset acquisition for tax purposes if the appropriate tax election is made and approved by the relevant taxing authorities.

10.2.2 Identifying the tax status of the entities involved

Business combinations may involve the acquisition of taxable entities (e.g., corporations), nontaxable entities (e.g., partnerships and multimember LLCs), or a combination of both. The acquired entity’s tax status will determine the deferred tax assets and liabilities to be recorded in acquisition accounting.
When the acquiree is a corporation, the acquirer generally recognizes deferred taxes on each of the acquiree’s identifiable assets and liabilities, including tax carryforwards and credits (referred to as “inside basis differences”). When the acquiree is a partnership, however, the acquirer generally recognizes deferred taxes only for differences between the financial statement carrying amount of the acquirer’s investment and its tax basis (referred to as “outside basis differences”). This is the case regardless of whether the partnership is accounted for as a consolidated entity or as an investment for financial reporting purposes.
Sometimes a portion of the outside basis difference in a partnership acquiree is attributable to assets for which deferred taxes generally would not be recognized if the acquiree was a corporation (e.g., nondeductible goodwill and the partnership’s investment in foreign subsidiaries). In these situations, an acquirer should apply a policy to either (1) look through the outside basis of the partnership and exclude from the computation of deferred taxes basis differences arising from items for which there is a recognition exception under ASC 740, or (2) not look through the outside basis of the partnership and record deferred taxes based on the entire difference between the financial reporting and tax bases of its investment. If the acquirer has already selected one of these policies with regards to existing partnership investments, it should apply that policy consistently when recording deferred tax accounting to acquired partnership interests as well. Refer to TX 11.7 for a more detailed discussion on outside basis differences related to partnerships and other flow-through entities.
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