The Taiwan Supreme Administrative Court recently issued two landmark decisions confirming taxpayers’ entitlement to claim an income tax deduction on the amortization of goodwill resulting from a merger transaction. The decisions, issued on 13 and 23 May 2011, involve a telecommunications company and a bank, respectively, and are particularly relevant to private equity funds and multinationals that have M&A activities in Taiwan.
Under Taiwan’s Generally Accepted Accounting Principles (GAAP), the purchase price method of accounting should be used to record a merger between two unrelated parties. Under this method, the purchase price should be allocated to identifiable tangible and intangible assets of the target based on the fair market value (FMV) of the assets, with any amount not so allocated being recorded as goodwill. The Merger and Acquisition Law allows goodwill recognized from an M&A transaction to be amortized over a period not exceeding 15 years. The amount of such goodwill is usually significant, as is the tax benefit from amortization and, therefore, typically subject to a challenge from the Taiwan tax authorities.
The most common areas challenged are as follows:
- The taxpayer could not provide evidence, such as valuation reports, to support the reasonableness of the acquisition price;
- The valuation reports to support the FMV of the identifiable assets do not detail the FMV of each asset acquired;
- The reasonableness of the valuation model;
- Whether the goodwill is “acquired” through a “purchase transaction,” as required by the Assessment Rules of Profit-Seeking Enterprises’ Income Tax (Assessment Rules). The Assessment Rules allow the amortization of business rights, trademarks, copyrights, patents, other franchises and goodwill over a specified number of years if the assets are acquired through a purchase transaction. In practice, there typically is a time lag between the time an acquisition takes place and the time the merger is finally effectuated. Goodwill is recognized when the merger is effectuated, so the tax authorities often raise a challenge on the grounds that goodwill is merely an accounting entry when the merger takes place, rather than a direct result of the acquisition, which takes place long before the merger; and
- The lag between the time of an acquisition and the effectuation of the merger also has prompted the tax authorities to argue that, before the merger takes place, the acquirer holds the majority of the shares in the target, so the parties are already related and, therefore, the purchase method of accounting should not be used; in other words, goodwill should not be recognized in a related party merger.
In most cases involving the amortization of goodwill from a merger, the tax authorities have disallowed the amortization and issued an assessment notice to the taxpayer. In Taiwan, if a taxpayer disagrees with a tax assessment notice, the taxpayer can request a re-examination by the governing tax office, followed by an appeal to the Ministry of Finance (MOF). If the appeal still does not give satisfactory result, the taxpayer has the option to commence administrative litigation with the High Administrative Court, or further to the Supreme Administrative Court. A decision of the Supreme Administrative Court is final, unless further challenged and the Grand Jury is applied to for a constitutional interpretation, which is very rare.
According to publicly available information, there have been more than 30 disputed cases relating to the amortization of goodwill stemming from mergers dealt with at the High Administrative Court level alone. The two recent decisions involving a telecommunications company and a bank are the first taxpayer favorable decisions made by the Supreme Administrative Court (and the first where the taxpayer was represented by Deloitte).
Supreme Administrative Court ruling
In its decision, the Supreme Administrative Court upheld several arguments advanced by the taxpayers:
- In any M&A deal, the final purchase price usually depends on the value determined by the buyer based on its expectations and calculation of the value of the target, as well as negotiations between the parties. Since multiple sellers are not involved in an M&A deal, it is not possible to obtain a “reasonable comparable price.” Thus, unless the tax authorities can prove that the purchase price is not at arm’s length, it is not reasonable to ask the taxpayer to prove the reasonableness of the acquisition price. Further, if the purchase price of a merger already has been accepted by various competent authorities as required under Taiwan law, it is not reasonable to question the purchase price solely for tax revenue collection purposes.
- In both of the decided cases, the purchase price had been determined when the buyer and the target were still unrelated parties. The fact that a buyer becomes the majority shareholder and, hence, a related party of the target before the merger is effectuated, should not be used as a basis to challenge the reasonableness of the purchase price.
- Taiwan GAAP requires the buyer to objectively determine the FMV of the identifiable assets of the target. In practice, the buyer and target could not possibly negotiate the purchase price of each asset and then add up all of the prices to arrive at the total purchase price. The tax authorities should not simply read the language of the relevant GAAP without looking at the substance and reality of the situation and request a taxpayer to obtain the FMV for each identifiable asset acquired and liability assumed.
Goodwill is calculated as follows:
Goodwill = purchase price - FMV of identifiable net assets
If the tax authorities argue that the goodwill is overvalued and should be reduced because the purchase price is fixed, they should allow the taxpayer to recognize the corresponding increase in the FMV of the identifiable net assets and corresponding increase in the depreciation/amortization of identifiable assets or bad debt expense. (Because the application of the purchase method of accounting was confirmed by the Accounting Research and Development Foundation to be appropriate, this particular issue was not a point of debate during the administrative litigation process).
Although the outcome of these two cases has been welcomed by many tax practitioners, it is important to note that the decisions are not binding on other cases involving the amortization of goodwill from merger transactions. It also is notable that the decisions were issued by the same panel of judges; a different panel could reach a different conclusion, so it is far from clear whether a consensus on this matter has been reached among the judges in the Supreme Administrative Court. It will be interesting to see how other appeals pending before the MOF and local high administrative court level are resolved.
Nevertheless, the two decisions of the Supreme Administrative Court are significant and, as noted above, particularly relevant to many private equity funds and multinationals with M&A activities in Taiwan. Although the amortization of goodwill is allowed under the M&A Law, it is clear from the number of cases that the tax authorities will not simply accept an income tax deduction without mounting a challenge, particularly when the authorities are under tremendous revenue collection pressure. It is important for companies that have experienced similar issues to be represented in the administrative litigation process by a seasoned team and to continue to monitor developments.
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