Some jurisdictions permit or require combined reporting or combined or consolidated filing of income tax returns. Such returns include income, deductions, and other items of multiple related corporations, and may compute tax as if such multiple entities were a single taxpayer. Most rules require that the corporations combined be commonly owned with only small minority ownership. Rules for such reports differ widely among jurisdictions. Combined reporting can limit tax benefit of shifting income between such related corporations, but permits the combined filers to benefit from losses of some entities where others have profits. Combined tax reporting rules may be complex, and may differ materially from combined financial reporting rules. Some jurisdictions that do not permit combined reporting nonetheless permit intragroup benefit of losses.
United States consolidated returns
United States Federal income tax rules permit commonly controlled corporations to file a consolidated return. The income tax and credits of the consolidated group are computed as if the group were a single taxpayer. Intercorporate dividends are eliminated. Once a group has elected to file a consolidated return, all members joining the group must participate in the filing. The common parent corporation files returns, and is entitled to make all elections related to tax matters. The common parent acts as agent for the members, and it and the members remain jointly and severally liable for all Federal income taxes. Many U.S. states permit or require consolidated returns for corporations filing Federal consolidated returns.
Requirements for filing
Only entities organized in the United States and treated as corporations may file a consolidated Federal income tax return. The return if filed by a “common parent” and only those subsidiaries in which the common parent owns 80% or more of the vote AND value. The parent and all subsidiaries must file Form 1122 to elect to file a consolidated return in the first year of election. Every 80% subsidiary must make the election or it is not valid. Thereafter, all corporations that begin to meet the 80% vote and value test must join in the consolidated return. If a subsidiary ceases to meet the 80% vote and value test, it is removed from the group. Adjustments to basis and other tax attributes apply upon a subsidiary joining or leaving a group.
Consolidated taxable income
Taxable income of each member is computed as if no consolidated return were filed, with the exception of certain items computed on a consolidated basis. Then adjustments are made for certain transactions between group members. Dividends between group members are eliminated. Sales of property between members give rise to a deferred intercompany transaction. The effect on the selling member is deferred and recognized as the corresponding effects are recognized by the buying member. For example, Member A sells Member B some goods at a profit. This profit is not recognized until Member B sells the goods or recognizes depreciation expense on the goods. These complex rules require adjustments related to intra-group sales of property (including depreciable assets and inventory), transactions in stock or other obligations of members, performance of services, entry and exit of members, and certain back-to-back and avoidance transactions.
Certain deductions and most credits are computed on a consolidated rather than separate company basis. These include the deductions for net operating loss, charitable contributions, domestic production activities deduction, dividends received deduction and others.
Each member of a group must recognize gain or loss on disposition of its shares of other members. Such gain or loss is affected by the member's basis in such shares. Basis must be adjusted for several items, including taxable income or loss recognized by the other member, distributions, and certain other items. To the extent a member recognizes losses in excess of the owner's basis, such excess loss is treated as negative basis for all U.S. Federal income tax purposes. Additional adjustments apply in the case of intra-group reorganizations or acquisition of the common parent, and upon entry to or exit from the group by a member. The adjustments “tier up” to consolidated return members who own shares of the entity making the adjustment. Numerous other adjustments apply.
All members of the group must use the same tax year as the common parent. This may be adopted or changed by the common parent. If one group acquires another group, the acquiring common parent's tax year must be adopted by all acquired subsidiaries then meeting the 80% vote and value test. Short periods may be required upon joining or leaving a group. In addition, if a member enters or leaves the group, certain adjustments to earnings and profits, basis, and other tax attributes apply.
Several countries allow related groups of corporations to compute income tax on a consolidated basis, in a manner similar to consolidation for financial reporting purposes. This is referred to in the Netherlands and Luxembourg as a Fiscal Unity, and in France as Intégration Fiscale. A similar consolidated return regime applies in Spain. In such systems, consolidating eliminations of income and expense are taken into account.
The Netherlands system allows a group of Netherlands resident corporations and branches of foreign corporations to elect to be taxed as a Fiscal Unity. Such election is permitted only for a parent corporation and its 95% or greater owned subsidiaries. Upon election, the parent is taxed on the combined income of the members of the group. The parent and subsidiaries retain joint and several liability for the tax of the group.
Netherlands fiscal unity functions much like financial statement consolidation. Intra-group transactions, including property transfers, are generally eliminated. Most intra-group reorganizations do not trigger taxable events.
Some countries allow losses of one commonly controlled company to offset the profits of another commonly controlled company. The United Kingdom permits group relief, and Germany permits an Organschaft. Neither of these systems involve combined reporting or combined tax return filing, though certain additional reporting may be required.
Under the UK scheme, a company's losses may be surrendered to a related company if several conditions are met. The companies must be 75% owned companies. For this purpose, a parent company and its subsidiaries qualify if the parent company owns at least 75% of the ordinary share capital of the subsidiary(ies) and have a beneficial interest in at least 75% of any distributions of earnings or upon winding up. Alternative similar rules apply for certain corsortia and branches. Under European Court of Justice rulings incorporated into UK law, the parent company need not be resident in the UK.
The UK scheme allows losses of one group member to be relieved (deducted) by members using a different accounting period, with certain adjustments. Trading (business) losses, capital losses, certain excess (disallowed) management expenses from non-UK affiliates, and certain excess charges may be relieved, subject to limitations. The surrender of these items is done by one company for the benefit of one other company.
Some states in the United States require related corporations to file a consolidated return if such corporations constitute a unitary business or unitary group. Such consolidated returns tend to follow the pattern of United States Federal consolidated returns, though differences exist in the particular rules. Generally, a group of corporations in the same, similar, or integrated busineses that are under common management and operational control may be treated as a unitary group. California adopted a requirement that both United States and foreign corporations be included in a worldwide unitary group filing, absent a “water's edge” election and fee. This requirement was limited somewhat by the U.S. Supreme Court in Barclays Bank PLC v. Franchise Tax Board and California subsequently repealed the “water's edge” fee. Illinois requires unitary group filings for United States corporations only.
Under the unitary concept, all commonly controlled corporations within the unitary management and control group are required to join in a consolidated return filing for the state. The apportionment factors for state income tax are computed on a consolidated basis and applied to the income of members doing business in the state. Illinois taxes only United States corporations in this manner. California, following the Barclays case, modified its rules to include in the combined reporting only the taxable income of United States corporations. California's computation of apportionment factors is still based on worldwide group amounts unless a “water's edge” election is made.
- Crestol, Jack; Hennessey, Kevin M., and Yates, Richard F.: "Consolidated Tax Return : Principles, Practice, Planning, 1998 ISBN 978-0-7913-1629-0
- Hellerstein, Jerome & Walter, and Youngman, Joan: State and Local Taxation, ISBN 0-314-15376-4.
- ^ The very complex rules are contained in 26 CFR 1.1502-1 through -100, authorized by the one paragraph 26 USC 1502.
- ^ According to the CCH State Tax Handbook, 26 states either permitted or required consolidated or combined returns for 2009. See ISBN 978-0-8080-1921-3. Consolidated or combined returns are not the same as composite returns. Many states require or permit that flow through entities (partnerships, LLCs, or S corporations) file a composite return reflecting the income of nonresident members. Such composite returns are often filed in lieu of the relevant members filing separate (e.g., individual) returns.
- ^ Those states requiring or permitting consolidated returns generally allow only entities joining in the Federal consolidated return to file a consolidated state return. Rules vary widely by state.
- ^ For definitions, see 26 USC 1504.
- ^ 26 CFR 1.1502-75.
- ^ 26 CFR 1.1502-30 and 26 CFR 1.1502-31.
- ^ 26 CFR 1.1502-12.
- ^ 26 CFR 1.1502-11 through 26 CFR 1.1502-28.
- ^ 26 CFR 1.1502-13.
- ^ 26 CFR 1.1502-12.
- ^ 26 CFR 1.1502-32.
- ^ 26 CFR 1.1502-30 and 26 CFR 1.1502-31.
- ^ 26 CFR 1.1502-76.
- ^ Chorus, Jeroen M. J.; Gerverm P. H. M.; Hondius, E. H.: Introduction to Dutch Law, p. 463. ISBN 978-90-411-2507-1.
- ^ United Kingdom HMRC Corporation Tax Manual CTM 80100 Group Relief.
- ^ For a general discussion, with cases, see Hellerstein, Hellerstein, & Youngman, State and Local Taxation, chapter 8 section 3. ISBN 0-314-15376-4.
- ^ 114 S.Ct. 2268 (1994).
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