Temporary differences in business combinations: deferred tax treatment of fair value adjustments and goodwill
- Graziano Stefanelli
- Jul 29
- 2 min read
Acquisitions create temporary differences when fair value adjustments diverge from tax bases.
In a business combination, the acquirer must remeasure the identifiable assets and liabilities of the acquiree to fair value at the acquisition date. However, these revaluations often do not affect the tax base, leading to temporary differences under IAS 12 and ASC 740. These differences require the recognition of deferred tax assets or liabilities as part of the acquisition accounting process.
Understanding which adjustments create deferred taxes—and how they affect goodwill—is essential for accurate financial reporting and group consolidation.
Fair value increases create deferred tax liabilities.
When asset values increase for accounting but not for tax, the group must recognize a deferred tax liability.
Example:
A machine has a book value of €100,000 and a tax base of €100,000
Upon acquisition, the fair value is reassessed to €140,000
The tax base remains unchanged
This creates a taxable temporary difference of €40,000. A deferred tax liability must be recorded at the applicable tax rate:
€40,000 × 25% = €10,000 deferred tax liability
This liability is recognized as part of the purchase accounting and reduces the amount of goodwill recorded.
Deferred tax impacts the calculation of goodwill.
Deferred tax liabilities increase the net identifiable assets, thereby reducing goodwill.
Continuing the previous example:
Consideration transferred = €1,000,000
Fair value of net assets (excluding deferred tax) = €920,000
Deferred tax liability = €10,000
Net identifiable assets after deferred tax = €910,000
Goodwill = €1,000,000 – €910,000 = €90,000
If deferred tax had not been recognized, goodwill would have been understated. Accounting standards require that all identifiable temporary differences be included in the net asset calculation.
Some goodwill-related differences are not recognized for deferred tax.
The initial recognition exception limits the recognition of deferred tax on goodwill itself.
Under IAS 12, no deferred tax is recognized on:
The initial recognition of goodwill, and
Certain temporary differences arising on acquisition that do not affect taxable profit
This prevents circular recognition: deferred tax would affect goodwill, which in turn would change deferred tax, creating an endless loop.
In US GAAP (ASC 740), similar principles apply, but there are more exceptions allowing deferred tax on some forms of goodwill amortization (especially where tax-deductible).
Other fair value adjustments may create deferred tax assets.
Acquired liabilities or impairments may lead to deductible temporary differences.
For example:
The acquirer recognizes a legal provision of €200,000
The provision is not yet deductible for tax purposes
This creates a deductible temporary difference
Deferred tax asset = €200,000 × tax rate
These deferred tax assets must be assessed for recoverability and included in the net asset calculation if probable.
Disclosure is required for all acquisition-related deferred tax balances.
The group must clearly present the source and nature of temporary differences.
The following must be disclosed:
Types of temporary differences arising from the business combination
Amounts of deferred tax assets and liabilities recognized
How these amounts impacted the goodwill calculation
Any unrecognized deferred tax items and the reasons
This disclosure allows stakeholders to understand the long-term tax consequences of the acquisition and how it affects the financial position of the group.
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