Tax Amortization Benefit

Last Updated :

21 Aug, 2024

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Table Of Contents

What Is Tax Amortization Benefit (TAB)?

Tax Amortization Benefit (TAB) in accounting refers to the tax savings a company enjoys by eliminating amortization expenses associated with intangible assets. The sole purpose of TAB is to deduct amortization expenses incurred on intangible assets.

Like a tax amortization benefit factor, it can also occur on tangible assets, but the depreciation benefit would be evident in that case. Besides, it acts as a major advantage to the acquirer during the creation or development of patents and goodwill. However, unlike depreciation, they cannot be deducted at the time of purchase.

What Is Tax Amortization Benefit (TAB)?

Tax Amortization benefit refers to the savings made by the firm when acquiring an intangible asset like patents, goodwill, or intellectual property rights.
It is a present value of the income tax savings on these assets. It originated in 1954 when Congress added this concept in the IFS Section 197.
The two calculation methods include the fair market value and income valuation approach. In the latter, the TAB factor is necessary but no need for the FMV method.
However, the application of TAB may differ from country to country as not all nations allow its practice.

Tax Amortization Benefit Explained

Tax Amortization Benefit is a type of accounting treatment where firms can save taxes by deducting amortization expenses while developing intangible assets. It includes patents, goodwill, intellectual rights, and similar others. Like depreciation is allocated to land and buildings throughout their estimated life, amortization expenses apply here as the cost of acquiring or developing. This cost is further distributed evenly until the duration of that patent. Later, it can be deducted by the firms to save taxes during sales.

Through the application of the tax amortization benefit factor, the assets are mentioned at the fair market value. So, if there are high resulting taxes, the seller will list the intangibles at a value that is less or equal to the FMV. It means the cost of acquiring the patent will be distributed over 15 years. However, when the sale occurs, the seller enjoys the TAB to offset the tax burden. At the same time, the acquirer avails the tax step-up on the intangibles.

Since intangible assets are more paramount in the healthcare and technology sector, their approaches to purchase prices also differ. The popular two methods are FMV and the income valuation approach. Here, the latter tries to consider the present value of the cash flows after tax. However, the tax amortization benefit factor is only possible in income valuation instead of FMV. Since this method involves discounted cash flow (DCF) or Relief from the Royalty model, including factors is crucial.

History

According to the International Financial Standards (IFS), Section 197 deals with the amortization of intangible assets. Congress passed the Tax Code in 1954. During the initial stages, the IFS allowed goodwill to be first amortized. Later, other intangible assets were also engaged in the process. In addition, they enabled a 15-year uniform amortization period. So, it becomes easy for them during the tax amortization benefit calculation. However, it is only applicable to intangible assets that are tax deductible.

How To Calculate?

After understanding the working, let us look at the formula and tax amortization benefit calculation for better understanding:

Formula

where,

t refers to the tax rate applicable in that period.
n is the useful estimated lifetime for the asset. In this case, it is as long as 15 years.
k is the discounting factor to derive the purchase price of the intangibles.

Calculation

The user can calculate the TAB factor using the formula or iteration method. However, the method of calculation differs. In the latter case, they can prepare a tabular format in a spreadsheet or Excel. Likewise, the former will have a rough calculation of the factor. But the n differs in the tax amortization benefit by country. While the uniform rule as per IFS is 15 years, it may differ for other regulatory bodies.

However, various issues are attached to applying for tax amortization benefits. The allowance of tax amortization benefits by country may not be possible in others. Therefore, it is necessary to look at the legislation and practice TAB. The same applies to the tax rate. Likewise, the firm is assumed to enjoy tax benefits under the market approach valuation. As a result, the calculation becomes easy.

Examples

Let us look at the examples that explain the application of tax amortization benefit in the real-world scenario:

Example #1

Suppose XYZ Ltd is a firm with most patents as intangibles. Therefore, they used the income valuation method to calculate the tax amortization benefit by country. The tax rate in that year was 20%, and the discounting factor was 10%. The estimated life of the patent was five years. Besides, the present value of the cash flows after tax is $6000. Here, the annual cash flows are asset value divided by the PV factor (3.79078). It is later multiplied by the tax rate (30%). So, let us look at the calculation:

After applying the formula, the TAB factor is:

$1582.78 * 0.20 = $316

Example #2

Consider the same example with a net asset value of $10,000, a tax rate of 25%, k as 10%, and a lifetime of 5 years. After using the formula, the value of the TAB factor is as follows. In short, it predicts the tax savings on the intangible asset.

= $8.3548 per year

The firm can deduct $8.3548 annually from the asset value as a benefit.

Frequently Asked Questions (FAQs)

When to use tax amortization benefit?

The application of the TAB depends on the duration of the intangible asset. If the seller has sold it, they can claim the benefit, and the acquirer can also set off taxes with it. However, the major use is visible when the asset is acquired by the company or developed. It is feasible to use when the asset’s life has just begun.

What is the tax amortization benefit in the Netherlands?

Every country has different TAB benefits hidden. But, in the Netherlands, the tax amortization benefit for intangible assets like goodwill is 10 percent of the acquisition cost. It also includes the development costs. In contrast, in Australia, the estimated life of a patent for calculation is 20 years.

Is tax amortization benefit applicable in all nations?

Not all nations allow the practice of TAB. However, twenty-five countries have approved the use of tax amortization benefits. But, in other countries, the TAB factor will equal 1.0.