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ASC 740-10-30-27 requires that the consolidated amount of current and deferred tax expense for a group that files a consolidated tax return be allocated among the group members when those members issue separate financial statements. See TX 14.5 for a discussion of additional considerations for allocating income tax expense to single-member and multiple-member LLCs. Further, the method adopted must be systematic, rational, and consistent with the broad principles of ASC 740. Typically, the same method should be used to allocate tax expense to each member of the consolidated tax group. However, depending on the individual facts and circumstances, it may be acceptable to use more than one allocation method for different subsidiaries in a consolidated group.
While ASC 740-10-30-27 does not require the use of any single allocation method, it does indicate that the following methods are inconsistent with the broad principles of ASC 740:
  • A method that allocates only current taxes payable to a member of the group that has taxable temporary differences
  • A method that allocates deferred taxes to a member of the group using a method fundamentally different from its asset and liability method
  • A method that allocates no current or deferred tax expense to a member of the group that has taxable income because the consolidated group has no current or deferred tax expense

14.2.1 Separate return method

Under ASC 740-10-30-27, it is acceptable to use a method that allocates current and deferred taxes to members of the group by applying ASC 740 to each member as if it were a separate taxpayer. In SEC Staff Accounting Bulletin (SAB) Topic 1 question 3, which discusses financial statements included in registrations of initial public offerings, the SEC staff states its belief that the separate return basis is the preferred method for computing the income tax expense of a subsidiary, division, or lesser business component of another entity included in consolidated tax returns. According to SAB Topic 1B, when the historical income statements do not reflect the separate return basis, pro forma income statements reflecting a tax provision calculated on the separate return basis is required.
Under the separate return method, the subsidiary is assumed to file a separate return with the taxing authority, thereby reporting its taxable income or loss and paying the applicable tax to or receiving the appropriate refund from the parent. Thus, it is possible that the subsidiary could recognize a loss or credit carryforward, even though there is no carryforward on a consolidated basis (i.e., they were used by the parent). Additionally, when the tax law in the jurisdiction provides for the carryback of losses, the subsidiary could reflect the carry back of a current-year loss against prior taxable income even though the consolidated group had losses.
When the separate return method is used to allocate the current and deferred tax expense or benefit for a group that files a consolidated return, the subsidiary’s current provision would be the amount of tax payable or refundable based on the subsidiary’s hypothetical, current-year separate return. After computing its current tax payable or refund, the subsidiary should provide deferred taxes on its temporary differences and on any carryforwards that it could claim on its hypothetical return. The subsidiary should also assess the need for a valuation allowance on the basis of its projected separate return results. The assessment should include tax-planning strategies that are prudent and feasible.
ASC 740-10-30-27 acknowledges that if the separate return method is used, the sum of the amounts reported by individual members of the group may not equal the consolidated amount. For example, one member might generate deferred tax assets for which a valuation allowance would be required if that member were a separate taxpayer. However, a valuation allowance may not be needed when the assessment is made from the standpoint of the consolidated group. Similarly, the sum of amounts determined for individual members may not equal the consolidated amount as a result of intercompany transactions.

14.2.2 Benefits-for-loss

Entities may modify the separate return approach for the assessment of deferred tax asset realizability. A “benefits-for-loss” approach modifies the separate return method so that current or deferred tax assets are characterized as realized (or realizable) by the subsidiary when those tax assets are realized (or realizable) by the consolidated group, even if the subsidiary would not otherwise have realized them on a stand-alone basis. Thus, when the benefit of the current or deferred tax asset is recognized in the consolidated financial statements, the subsidiary would generally reflect a benefit in its financial statements. We believe the benefits-for-loss approach complies with the criteria in ASC 740-10-30-27.
Application of this policy may be complicated when the consolidated group requires a valuation allowance on its deferred tax assets. To comply with the criteria in ASC 740, the policy should not be applied in a manner that results in either current or deferred tax benefits being reported in the separate subsidiary financial statements that would not be considered realizable on a consolidated basis unless such benefits are realizable on a stand-alone basis.
While not a pre-requisite, oftentimes the benefits-for-loss policy mirrors the tax-sharing agreement between the parent and the subsidiary. To the extent that the consolidated return group settles cash differently than the amount reported as realized under the benefits-for-loss accounting policy, the difference should be accounted for as either a capital contribution or as a distribution (see TX 14.3). Example TX 14-1 addresses considerations when the current or deferred taxes utilized by the parent differs from those at the separate company level.
EXAMPLE TX 14-1
Determining the separate company tax provision when the benefits-for-loss approach is used
Company A has two subsidiaries, Company X and Z, that comprise all the operations of the consolidated company. Company X and Company Z are part of Company A’s consolidated tax return.
Both subsidiaries have previously generated NOL carryforwards of $1,000 each that have not yet been used by the parent. Company Z issues its own financial statements and uses the separate return method modified for the “benefits-for-loss” approach. In the current year, Company X generated losses of $100 and Company Z generated income of $250. On a consolidated basis, the company will have net taxable income of $150 and will utilize NOL carryforwards to offset the taxable income. The parent will pay each subsidiary for the NOLs utilized at the consolidated level by applying a formula outlined in the tax sharing agreement. In accordance with that agreement, Company X received $100 and Company Z received $50 for their NOLs, respectively.
In determining the current and deferred tax provision for Company Z in its separate company financial statements, how much of the NOL should be recognized by Company Z?
Analysis
Company Z should recognize current taxes of zero and a decrease to its NOL DTA of $250. Even though on a consolidated basis the carryforward being utilized related to Company Z is only $50 based on the tax sharing agreement, Company Z on a stand-alone basis has sufficient taxable income to realize $250 of NOLs. Although the tax sharing agreement provides a lower cash settlement, it would not be consistent with ASC 740 to reflect an income tax expense at the subsidiary level when sufficient NOL carryforwards exist to offset the subsidiary’s taxable income. Therefore, any difference between the NOL realized by the subsidiary and the NOL utilized in consolidation and settled by the parent is accounted for in equity.
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