A consolidated net operating loss (CNOL) is created whenever the losses of the consolidated group members exceed the taxable income of the profitable group members. According to the TCJA, corporate NOLs generated in taxation years ending after December 31, 2017 cannot be carried forward, but can be carried forward indefinitely. (Under previous rules, corporation NOLs were generally entitled to a two-year carry-forward and a twenty-year deferral.) In addition, many other unused consolidated tax attributes (e.g. B excess capital losses, tax credits) can be carried forward and used to reduce the Group`s future tax liability. If a tax allocation treaty pays members for the use of their tax attributes, it is important that it also include rules to determine the order in which members` attributes are used. Tax incentive treaties also determine the tax accounting entries in the financial statements of members of tax groups (i.e., deferred tax assets and deferred tax liabilities). If the TSA does not address or is inaccurate about NOL deferrals, what general principles did the authors assume they would apply to fill in the gaps? Prior to February 25, courts in some circles applied federal common law.15 But in Rodriguez v. FDIC, a unanimous Supreme Court urged them to do so, insisting that they should instead apply state contract law and principles of fairness. While state law may, in some cases, lead to the same answer,16 the political considerations that govern state rules bear little resemblance to federal tax policy, with potentially surprising results – at least from a tax perspective. In addition to federal income tax issues, there are several state tax issues that consolidated groups should address in their tax distribution agreements. While a full discussion of state taxes would be beyond the scope of this article, it can have important implications, and changes in the statutory rates of the state of the corporation or allocation factors from the year a loss is generated and the year the loss is absorbed by the group may raise tax allocation issues. In addition, the state taxes of the individual members of the group, calculated on an autonomous basis, are often different from the state taxes of the group, and tax distribution agreements must take into account how these differences are to be allocated. Therefore, groups should work closely with their lawyers and tax advisors to ensure that their tax allocation agreement adequately addresses federal and state issues.
Tax financing agreements complement tax-sharing agreements and specify how subsidiaries finance the payment of tax by the main company and when the main company will be required to make payments to subsidiaries for certain tax attributes generated by subsidiaries that benefit the group as a whole (for example. B, tax losses and tax credits). Figure 1 summarizes the consolidated group`s taxable income for year 1, which is $1,000. The tax payable is $210. Under the tax allocation agreement, Subsidiary 1 would be required to make a payment of $210 to the parent company, which would transfer that money to the IRS on behalf of the group. If a tax credit or NOL is returned before 2018, the IRS will refund a tax refund to the parent company, regardless of which member generated the credit. In order to ensure that members receive compensation for the use of their attributes, a tax allocation agreement should specify how tax refunds are distributed and distributed among group members. In year 2, the consolidated group has no taxable income because Subsidiary 1`s taxable income of $1,000 for the current fiscal year is fully offset by The Loss of Subsidiary 2 of $1,000 (Figure 2). As in year 1, Subsidiary 1 is required to pay the parent corporation an amount equal to the tax it would have owed if it had filed a separate income tax return for the year ($210). However, in year 2, the question arises as to whether Subsidiary 2 should be compensated for the Group`s use of the $1,000 loss. The answer depends on the terms of the tax allocation agreement.
In the absence of a tax allocation agreement, it will be difficult for Subsidiary 2 to force the parent company to complete the loss of a potentially valuable tax attribute. Business groups are encouraged to consider entering into tax sharing agreements and tax financing agreements as part of their entry into the tax consolidation system. If a tax allocation agreement exists, it could require the parent company to compensate subsidiary 2 if the loss of subsidiary 2 is absorbed by the group. Under this approach, a subsidiary is compensated for the loss of its tax attributes, whether or not those attributes would have been beneficial to it. Alternatively, some tax allocation agreements take a wait-and-see approach. Under this approach, Subsidiary 2 would not be compensated for the use of its loss in year 2. Instead, the group would wait to see whether Subsidiary 2 would later generate sufficient income to benefit from its loss, provided that the loss had not previously been absorbed by the consolidated group. If Subsidiary 2 continues to suffer losses, they can never be compensated for the profit that the Group derived from its loss in year 2. Given the potentially significant difference in the payment schedule, care must be taken to ensure that all parties understand when members will be compensated for the use of their attributes. When multiple companies are combined into a large group, the parent company deals directly with the IRS, pays the group`s tax obligations, and receives refunds.
Members of a consolidated group often use tax-sharing agreements to determine how these funds should be allocated and distributed. The authors outline the issues that businesses need to consider when drafting such agreements, including how the carry-forward and presentation of net operating losses has been affected by the Tax Cuts and Employment Act, 2017. Because consolidated groups are not static, additional problems can arise when a member leaves a group that has an agreement that takes a wait-and-see approach. For example, if the tax allocation agreement adopts a wait-and-see attitude to compensate members for the use of their losses, and subsidiary 2 is deconsolidated from the group at the end of year 2, it is unlikely that subsidiary 2 will be compensated for the group`s use of its loss without a specific provision in the agreement. To address this issue, many tax allocation agreements include deconsolidation provisions. For example, an agreement could require the parent company to compensate subsidiary 2 immediately after deconsolidation for the tax benefit of its losses previously absorbed by the group or absorbed by the group in the year of deconsolidation of the parent company. Alternatively, the agreement could require parent company 2 to repay any tax liability it incurs within one year of consolidation if liability had not arisen if subsidiary 2 had retained its separate corporate attributes previously assumed by the group. Tax allocation treaties should also take into account what happens when a member joins a consolidated group and has distinct corporate tax attributes (p.B. credit losses and carry-forwards) that may benefit the group.
To date, most consolidated tax groups have decided to allocate their tax obligations according to the notional autonomous taxable income of each group member or according to the accounting profit of each member as a percentage of total net profit. Whether or not the allocation is accepted as appropriate on these bases ultimately depends on the facts and circumstances that affect the tax situation of each group, as well as the ATO`s legislation, regulations and guidelines that apply to tax sharing agreements in general. In addition, complexity can multiply in practice. First, a subsidiary leaving one group often joins another, which can result in layers of ASD to be interpreted and resolved for each issue. Second, when a subsidiary leaves a group, tax attribute provisions are often not limited to TSA and may be included in a number of agreements related to an acquisition. Therefore, a review of ASD may require a statement of facts about other related agreements. We have developed a wide range of precedents documenting tax sharing and tax financing agreements. These precedents include: To address these issues, companies often adhere to ASDs that specify which entities are eligible for certain benefits and which entities are responsible for certain costs. In general, these agreements can take many forms. For example, there are ASDs that are adopted by many consolidated groups to govern the economic allocation of tax attributes and other tax-related elements during the group`s existence. There are also tax allocation provisions for share purchase or merger agreements.