How deferred tax on business combinations is recognized and measured under IFRS 3, IAS 12, and ASC 740

Graziano Stefanelli
Nov 17, 2025
5 min read

Whenever an acquisition occurs, the fair value adjustments made to the acquiree’s assets and liabilities typically create temporary differences between their carrying amounts and their tax bases. These differences give rise to deferred tax assets (DTAs) or deferred tax liabilities (DTLs) that must be recognized at the acquisition date. Both IFRS (IFRS 3 and IAS 12) and US GAAP (ASC 740) require recognition of deferred tax in business combinations, but they differ in measurement rules, goodwill interaction, and treatment of uncertain tax positions.

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Why deferred tax arises in business combinations

When an acquirer measures identifiable assets and liabilities at fair value, the tax base in the target’s jurisdiction usually remains unchanged. This misalignment creates temporary differences. For example:

A building fair-valued upward creates a DTL because future depreciation for accounting purposes will exceed tax depreciation.
An acquired loss carryforward creates a DTA because it will reduce future taxable income.

The deferred tax impact is recognized as part of the purchase price allocation (PPA), ensuring that post-acquisition tax effects are attributed to the correct period.

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IFRS framework — IAS 12 and IFRS 3 interaction

Under IFRS 3 (Business Combinations) and IAS 12 (Income Taxes):

Recognize deferred taxes for all temporary differences between the fair value of assets/liabilities recognized in the acquisition and their tax bases.
Initial recognition exception: Do not recognize deferred tax on goodwill itself (IAS 12.15(b)). However, recognize deferred tax on identifiable intangible assets even if arising from the same transaction.
DTAs and DTLs are measured at tax rates expected to apply when the differences reverse, based on laws enacted or substantively enacted at the acquisition date.
The deferred tax effect is included in determining goodwill (not P&L).
After the acquisition, any changes in tax rates or reassessment of recoverability of DTAs/DTLs are recognized in profit or loss, not in goodwill.

Formula:Goodwill = Consideration + NCI + FV(PHI) − FV(Net identifiable assets) +/− Deferred tax effects recognized in the PPA.

Illustrative example (IFRS):

FV PPE: €10,000,000; tax base €7,000,000 → temporary difference €3,000,000.
Tax rate: 30%.

→ DTL = €900,000 recognized in PPA.

Entry:

Dr PPE 10,000,000
Cr DTL 900,000
Cr Cash / Equity / NCI 9,100,000 (balancing through goodwill).

Goodwill increases because the DTL effectively raises the net identifiable liabilities acquired.

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ASC 740 and ASC 805 interaction under US GAAP

US GAAP follows parallel logic but with nuanced differences:

Recognize deferred taxes for temporary differences created in the PPA.
No deferred tax on non-deductible goodwill; if goodwill is deductible, a DTL is recognized for the temporary difference between book and tax goodwill.
Measurement: based on enacted (not substantively enacted) tax rates at acquisition date.
Subsequent changes in DTAs/DTLs due to rate changes or reassessment flow through earnings, not goodwill.
Uncertain tax positions of the acquiree are recognized according to ASC 740-10 (FIN 48), not in goodwill; adjustments within the measurement period affect goodwill.

Example (US GAAP):

FV Customer Relationship: $5,000,000; tax basis $0; tax rate 25%.

→ DTL = $1,250,000.

Entry:

Dr Intangible Asset 5,000,000
Cr DTL 1,250,000
Cr Cash / APIC 3,750,000 (balancing through goodwill).

Goodwill includes the deferred tax impact indirectly via net asset measurement.

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Comparative framework — IFRS vs US GAAP

Topic	IFRS (IAS 12 & IFRS 3)	US GAAP (ASC 740 & ASC 805)
Recognition principle	Deferred tax for all temporary differences in PPA	Same principle
Goodwill	No deferred tax on goodwill	No deferred tax on non-deductible goodwill; DTL if deductible goodwill
Tax rate used	Enacted or substantively enacted at acquisition	Enacted only
Measurement period	Adjustments within 1 year affect goodwill	Adjustments within 1 year affect goodwill
Uncertain tax positions	IAS 12 / IAS 37; initial recognition part of goodwill	ASC 740-10; within measurement period affects goodwill
Subsequent changes	Through P&L, not goodwill	Through earnings, not goodwill

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Worked example — deferred tax effects in purchase price allocation

Facts:

Purchase consideration: €50 million.
FV of identifiable net assets before tax = €40 million.
Included: brand FV €5 million (tax base €0) → DTL €1.25m (25%).
Included: PPE FV step-up €3 million (tax base €3m less) → DTL €0.75m.
Total DTL = €2.0m.

Computation:Goodwill = 50 − (40 − 2) = €12 million.

Entries (simplified):

Dr Identifiable Assets (gross) 48,000,000
Cr Deferred Tax Liabilities 2,000,000
Cr Cash 50,000,000
Dr Goodwill 12,000,000

Deferred tax effects thus increase goodwill because they reduce the net identifiable asset base.

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Special areas — deferred tax on acquisitions with NOLs and deductible goodwill

Acquired NOLs (loss carryforwards): Recognize DTA if probable (IFRS) or more likely than not (GAAP) that future taxable income will allow utilization.
Example: FV NOL = €10m, expected utilization 60%, tax rate 30% → DTA €1.8m.
- Dr DTA 1.8m
- Cr Goodwill 1.8m (reducing goodwill).
Deductible goodwill (GAAP): If tax law permits amortization of goodwill (e.g., US Internal Revenue Code 15-year rule), a DTL arises equal to book goodwill × tax rate × proportion of deductible amount.
Uncertain tax positions: Initial measurement follows normal rules; changes within measurement period affect goodwill, afterward through earnings.

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Disclosure requirements

Both frameworks require disclosing tax effects of acquisitions, including:

Aggregate DTLs and DTAs recognized in the PPA.
Nature of temporary differences that gave rise to them.
Tax rate(s) applied and jurisdictions involved.
Changes to deferred taxes within the measurement period and their goodwill impact.
For NOLs, amounts of unrecognized DTAs and expiration profiles.

Example note (IFRS):

As part of the ABC acquisition, deferred tax liabilities of €2.0 million were recognized on fair value adjustments to intangible assets and property, plant, and equipment. These liabilities increased goodwill by the same amount. Deferred tax assets of €1.8 million were recognized on acquired loss carryforwards considered probable of realization.

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Journal entries summary

At acquisition (IFRS or GAAP):

Dr Identifiable Assets (FV) xx
Dr Goodwill xx
Cr Deferred Tax Liabilities xx
Cr Deferred Tax Assets xx
Cr Cash / Consideration xx

Subsequent changes (after measurement period):

Dr / Cr Deferred Tax Expense xx
Cr / Dr Deferred Tax Liabilities / Assets xx

If recognition of additional DTA within measurement period (IFRS/GAAP):

Dr Deferred Tax Asset xx
Cr Goodwill xx

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Impact on financial performance and ratios

Goodwill magnitude: Deferred tax liabilities inflate goodwill, while deferred tax assets reduce it.
Effective tax rate (ETR): Temporary differences from the acquisition affect deferred tax expense but not current tax immediately.
ROE and tangible equity: Higher deferred tax liabilities and goodwill both reduce tangible net worth.
Future profitability: Amortization of fair value step-ups creates future deductible differences, reversing DTLs over time.

Analysts reviewing acquisitions should reconcile goodwill changes to deferred tax effects and adjust ETR projections accordingly.

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Operational considerations

Ensure tax specialists participate in the PPA from day one to capture all temporary differences.
Align legal entity structures so tax bases are correctly determined by jurisdiction.
Reassess NOL realizability within the measurement period to avoid overstatement of goodwill.
Maintain documentation of enacted rates and valuation allowances.
Reconcile deferred tax schedules with consolidation systems and audit working papers for transparency.

Deferred tax recognition in acquisitions ensures that tax consequences of fair value adjustments are neither overstated nor delayed—producing a faithful representation of both the purchase price and the future tax impacts.

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DATA STUDIOS

.....[datastudios.org]