Thursday, 1 March 2012

More on Tax Amortization Benefit (TAB)

Let's take another look at the relatively simple topic of TAB (Tax Amortization Benefit).

Acquisition accounting requires us to put a fair value on the acquired assets. In case of a share deal which involves internally generated (thus not recognized to this point) intangible assets we need to come up with the valuation.

In the absence of reliable external indicators of value (a market for similar assets) one is required to look at the future cash flows generated from using the assets (for instance sales revenues from products made using the technology behind the asset, net of any COGS, M&D etc, and also net of tax which would be applicable to such income. One should also adopt an "independent valuer" perspective and thus exclude any synergies to be realized from the deal - assumption being an "independent valuer" wouldn't be able to realize similar synergies.)

So far so good - but there is one more thing - namely the TAB.

Conceptually it represents an additional saving realized from deducting the amortization of the asset itself
in arriving at taxable income.

Now - here's where it gets tricky - these additional tax savings are also a part of the ultimate asset value - and thus drive the amortization charge up - which in turn leads to higher tax benefits - which get added to the asset value - which drives the amortization charge up - which in turn... you get the picture. It's a classical circular reference in the making. But it doesn't have to be.

The formula to use is:

TAB =( NPV * (n / ( n - TR * PV of 1$) -1))

NPV = Net present value of the future cash flows (net of tax and at a specified Discount rate)
TR = applicable tax rate
PV of 1$ at a specified Discount rate and over a nr of tax amortisation periods of the asset (assumed linear)
n = nr of tax amortisation periods of the asset

assuming NVP is already calculated and entered in cell A1 the Excel formula for TAB at 30% tax rate, 10% discount rate and 10 year amortization would be:

= A1 * ( 10 / ( 10 - 30% * PV (10%, 10, 1)) - 1)

In an extreme case of discount rate of 0% and the tax rate of 50% the TAB = NPV - or in other words one would need to double the NVP amount to arrive at the Fair Value.  (seems counterintuitive - but actually is correct - if the original "pre-TAB" NPV was 50 then the ultimate FV is 100 - amortized at 50% tax rate gives us a tax saving of 50 - which added to the original NPV of 50 gives the Fair Value of exactly 100... QED)

And here is a  link to a simple excel spreadsheet

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