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Common control transactions occur frequently, particularly in the context of group reorganizations, spin-offs, and initial public offerings. Combinations between entities that are under common control are excluded from the scope of business combinations. However, the guidance on accounting for common control transactions did not change and is carried forward in ASC 805-50.
Common control transactions are generally accounted for based on the nature of the transaction. For example, transactions involving the transfer of an asset (such as a building) are accounted for at historical carrying values. Transactions involving the transfer of a business will result in a change in reporting entity for the entity receiving the assets and require the application of the procedural guidance in ASC 805-50. Transfers of net assets, depending upon whether its nature is considered to be similar to assets or a business, will be accounted for either at historical carrying values or based on the procedural guidance. Companies will need to use judgment to determine the nature of the transaction. The accounting for common control transactions is discussed in BCG 7.
When accounting for a transfer of assets or exchange of shares between entities under common control, the entity that receives the net assets or the equity interests should initially recognize the assets and liabilities transferred at their carrying amounts in the accounts of the transferring entity at the date of the transfer. If the carrying amounts of the assets and liabilities transferred differ from the historical cost of the parent of the entities under common control, for example, because push-down accounting had not been applied, then the financial statements of the receiving entity should reflect the transferred assets and liabilities at the historical cost of the parent of the entities under common control.

10.10.1 Presentation for a change in reporting entity

If a transaction combines two or more commonly controlled entities that historically have not been presented together, the resulting financial statements are, in effect, considered those of a different reporting entity. This results in a change in reporting entity, which requires retrospectively combining the entities for all periods presented as if the combination had been in effect since inception of common control (see ASC 250-10-45-21). Certain adjustments to the financial statements of the new reporting entity may be required. The types of adjustments that may be necessary are discussed in ASC 805-50.
US GAAP does not specifically address the accounting for the deferred tax consequences that may result from a transfer of net assets or the exchange of equity interests between entities under common control. The retrospective combination of the entities for all periods must be considered when determining whether any adjustment to the new reporting entity’s historical valuation allowance conclusion is necessary.
In the periods prior to the combination date, a combining entity’s deferred tax assets (e.g., operating loss carryforward) cannot offset the other entity’s taxable income unless allowed under the tax law. However, future taxable income of the combined operations subsequent to the combination date should be considered in assessing the need for a valuation allowance in the restated periods prior to the combination date. Similarly, any tax law limitations on the use of combined attributes subsequent to the transfer or exchange date should also be considered. Accordingly, in restating periods prior to the transfer or exchange, a valuation allowance against deferred tax assets that is necessary for the combined entity may be more or less than the sum of the valuation allowance in the entities’ separate financial statements before the transfer or exchange. If the transfer or exchange causes any change in the combined entities’ valuation allowance, the reduction or increase should be recognized as part of the adjustment to restate the entities’ prior-period financial statements on a combined basis subject to the intraperiod allocation rules.
For purposes of restating periods prior to the transfer or exchange, hindsight is required to take into account (1) that the transfer or exchange has occurred and (2) the amount of any resulting tax law limitations on the use of carry-over tax benefits after the transfer or exchange. However, hindsight is precluded for purposes of assessing pre-transfer or exchange estimates of future taxable income. In other words, any reduction in the valuation allowance for either entity’s deferred tax assets would be reflected in the years that the deductible differences or carryforwards arose, provided that one of the following conditions exists:
  • The other entity’s taxable differences existing at that time will generate sufficient future post-transfer or exchange taxable income to ensure realization of the deferred tax assets.
  • Estimates that would have been made at the time of future combined taxable income (i.e., after the transfer or exchange, other than reversing differences and carryforwards of the other entity) would have been sufficient for realization of the deferred tax assets.
  • A valid tax-planning strategy ensures realization of the deferred tax assets.
If none of these conditions were met in the year that the deductible differences and carryforwards arose, the reduction in the valuation allowance will be reflected in the first subsequent year in which one or more of these conditions are met.
In addition to adjustments that may be required to restate prior periods, new tax bases of assets and liabilities may be established in a taxable transfer or exchange. Because a new basis is not established for book purposes, taxable temporary differences may be reduced or eliminated, and deductible temporary differences may be increased or created. As of the transfer or exchange date, the tax effects attributable to any change in tax basis (net of valuation allowance, if necessary) should be charged or credited to contributed capital, as per ASC 740-20-45-11(g). If a valuation allowance is provided against the deferred tax assets at the combination date, any subsequent release of the valuation allowance should be reported as a reduction of income tax expense and reflected in continuing operations, unless the release is based on income recognized during the same year and classified in a category other than continuing operations, consistent with the guidance at TX 12.3.2.3.
Example TX 10-25 illustrates the assessment of a valuation allowance for a transfer of entities under common control.
EXAMPLE TX 10-25
Assessing a valuation allowance when there is a transfer of entities under common control
Parent controls both Entity Y and Entity Z. Entity Y acquires Entity Z in a nontaxable acquisition. The acquisition is accounted for in Entity Y’s financial statements in a manner similar to how the entity would have accounted for a pooling of interests. Entity Y’s prior-period financial statements will be restated retroactively for the effects of the “acquisition” (i.e., transfer of entities under common control).
Historically, Entity Y has been profitable. Entity Z has not had a history of profitability, and before the acquisition it had a full valuation allowance on its deferred tax assets. Following the acquisition/combination, Entity Y will file a consolidated tax return that includes the results of Entity Z.
In Entity Y’s restatement of its prior-period financial statements to include Entity Z, how should the need for a valuation allowance relative to Entity Y and Entity Z’s deferred tax assets be assessed?
Analysis
The deferred tax assets should be evaluated for realizability in accordance with ASC 740 at the time of the combination and for prior periods. The fact that the companies will file a consolidated tax return for periods after the legal combination should be taken into consideration.
By analogy to the historical guidance on recording the tax effects of pooling-of-interest transactions, in determining the need for a valuation allowance for prior periods, the estimated combined future taxable income of Entity Y and Entity Z after their legal combination should be considered. If the valuation allowance is reduced as a result of the common control transaction, the reduction should be recorded as a decrease in income tax expense in the period that it became apparent that future taxable income could be a source of recovery, which could potentially be a period prior to the period of the actual legal combination/transfer. In determining the appropriate period for reversal, hindsight is precluded for purposes of assessing estimates of future taxable income.
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