Why Deferred Tax Liabilities Get Created in an M&A Deal

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Why Do Deferred Tax Liabilities Matter? They're part of any M&A deal.
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You'll find you always see them in the purchase price allocation schedule, and they impact the combined company's taxes after the deal takes place.

You see them all the time, especially for highly acquisitive companies like Oracle.

They reflect the fact that there are TIMING differences between when a company records taxes on its publicly filed Income Statement and when it actually pays those taxes.

Specifically, when a buyer writes up the seller's PP&E or Other Intangible Assets in a deal, the buyer depreciates or amortizes them over time... but only on the BOOK version of its statements!

It can't do that on the TAX version of its statements it files when paying taxes to the government, which means that the actual amount of cash taxes it pays will be different from what's on its Income Statement.

Here's the Easiest Way to Think About DTLs:

Instead of thinking about the company's historical situation or its taxable income, think about its FUTURE TAXES.

If future cash taxes exceed future book taxes, a DTL will be created.

We need to pay ADDITIONAL taxes for items that are not truly tax-deductible.

If future cash taxes are less than future book taxes, a DTA will be created.

We will pay LESS in taxes than the company's book Income Statement implies.

As the book and cash tax payments equalize over time, the DTL or DTA goes away.

Two Most Common Questions on DTLs:

"Wait a minute - why does a DTL get created immediately? Isn't it caused by the book and cash taxes being different many times historically?"

Nope, not necessarily - that CAN be a cause, but DTLs/DTAs can also be created by events that change the company's FUTURE tax situation.

So you need to think about how taxes will change in the future, not how they've changed in the past, to determine this.

"Wait a minute, the taxable income for book purposes is LOWER than it is for tax purposes - doesn't that create a Deferred Tax ASSET (DTA) instead?"

Nope. The relevant question is not how the taxable income differs, but how the FUTURE TAXES will differ.

If the company will pay more in cash taxes than book taxes in the FUTURE, as a result of these write-ups, or any other changes, then a DTL gets created.