It is not every day that a company gets to tout that its acquisition offers savings of $1 billion.
Yet, Procter & Gamble gets to do just that with its purchase of Clairol on Monday. It is taking advantage of a tax code benefit for buying subsidiaries and benefits from the anticipated new accounting rules for goodwill.
Bristol-Myers Squibb Co. is selling the hair-care subsidiary to P&G for $4.95 billion. But P&G is really paying about $1 billion less on the basis of its tax benefits alone. How?
The companies are executing a joint Sec. 338(h)(10) election with respect to the sale of the Clairol subsidiary. You’ve seen this structure before in Cadbury Schweppes’ purchase of Snapple Beverage from Triarc last year.
The tax benefit effectively reduces the cash payment for this acquisition to about $4 billion. This is equivalent to a multiple of 2.5 times sales and 12 times EBITDA.
For most subsidiary purchases, the election of the tax code is a no- brainer. “This election converts the transaction, for tax purposes, from a sale of Clairol’s stock, by Bristol-Myers Squibb to P&G, into a sale by Clairol of its assets to P&G,” says Robert Willens, Lehman Brothers’ tax and accounting analyst. “It allows the buyer to record the target’s assets on its tax books at an amount equal to the price paid for the target’s stock plus the target’s liabilities assumed by the buyer.”
Simply put, Willens says, the election provides the buyer with a “cost” basis in the target’s assets (as opposed to the historic basis at which the target held its assets). “This benefits the buyer because it allows the buyer to amortize and depreciate this higher cost basis which, in turn, reduces the buyer’s taxable income and its tax liabilities,” he adds.
Moreover, in light of Sec. 197 of the tax code, which was enacted in 1993, the buyer gets to amortize for tax purposes the amounts allocated to goodwill and other intangible assets over 15 years.
This is where P&G’s deal for Clairol can get confusing as some people may assume that the end of goodwill amortization proposed by the Financial Accounting Standards Board’s (FASB) new guidelines for purchase accounting affects the tax treatment of goodwill. In fact, they are unrelated actions. P&G would continue to benefit from the amortization on a tax basis. For more on this, read “Ask the Expert.”
Willens breaks down P&G’s savings on a tax basis: Assume that the Clairol purchase created some $4 billion of goodwill. To calculate the “tax benefit,” multiply this figure by the corporate tax rate of roughly 40 percent. The resulting tax savings: $1.6 billion, Willens notes. “If you then ‘present value’ that result (to reflect the fact that it will be realized over 15 years) you arrive at about the $1 billion ‘savings’ they (P&G) are touting,” he adds.
However, P&G will enjoy another benefit. This time it’s for financial accounting purposes. Remember, FASB is prepping the final statements on business combinations that will require companies with fiscal years starting after December 15 to cease the amortization of existing goodwill and with it the earnings dilution; instead, goodwill will be tested for impairment.
Again, FASB’s new rules have no effect on the tax benefit from amortizing goodwill over 15 years.
“Arguably, P&G gets the best of both worlds,” Willens says. “Amortization of goodwill for tax purposes, a consequent reduction of its taxable income, and a lack of amortization for financial accounting purposes and, hence, no earnings penalty.”