Chapter 5 — Initial Recognition and Measurement

5.4 Other Considerations Related to the Initial Recognition of a Noncontrolling Interest

5.4.1 Accounting for the Issuance of a Noncontrolling Interest With Ownership Tax Benefits

Some consolidated entities are pass-through entities (e.g., partnerships). Often, the equity interests issued by pass-through entities entitle their holder to receive tax credits and other tax benefits (e.g., accelerated pass-through tax losses) that arise from the pass-through entities’ activities. Since only ownership interests that are “classified as equity” should be classified as noncontrolling interests, the first step is to consider whether the instrument should be classified outside of equity in accordance with ASC 480, which may be the case if the instrument is mandatorily redeemable.

In most instances, this form of equity interest will be appropriately classified in equity as a noncontrolling interest. Because of the complexity of attributing earnings to the noncontrolling interest, the parent will generally apply the HLBV method to subsequently attribute (comprehensive) income and loss to the noncontrolling interest (see Section 6.2.1).

This type of interest may have certain provisions that could result in the redemption of the equity interest outside the control of the parent. In such a case, the SEC requires classification of the instrument in temporary equity and a subsequent potential adjustment to the redemption amount (see Chapter 9 for additional information on accounting for redeemable noncontrolling interests).

5.4.1.1 Separating the Benefits of Tax Credits From the Substantive Noncontrolling Interest

The U.S. federal government encourages private capital investment in various projects (e.g., affordable housing or rehabilitation of historic buildings) by allowing investors in those projects to claim tax credits on their federal income tax returns. Projects that qualify for tax credits are usually undertaken by limited liability entities (typically, either limited partnerships or limited liability companies) to limit an investor’s financial risk exposure while still allowing the tax credits generated from the project to pass through to the investor.

In many limited partnership structures that generate tax credits, the general partner has an insignificant equity interest in the partnership but receives a fee for its decision-making responsibilities in the limited partnership. This fee is embedded in the general partnership interest and is a capital allocation of the general partner in the limited partnership. The limited partners typically hold essentially all of the equity interests; and in a tax equity structure, the price paid by the limited partners to acquire their equity interests is generally a function of the estimated tax benefits to be earned as well as any other rights to income and cash.

Sometimes, a limited partnership that generates tax credits is considered a VIE and, despite not having made a substantial equity investment in the partnership, the general partner will meet both of the characteristics of a controlling financial interest and thus will consolidate the limited partnership.2

If the general partner consolidates the legal entity that generates tax credits (i.e., the limited partnership), the parent (i.e., the general partner) recognizes the limited partner’s capital contributions on its balance sheet in accordance with the noncontrolling interest guidance. In general, such amounts are not mandatorily redeemable, in which case the general partner would not classify the noncontrolling interest entirely as a liability in its financial statements. However, questions have arisen about whether it would be appropriate for the parent to bifurcate the limited partner’s capital contribution (i.e., the noncontrolling interest) into separate liability (e.g., deferred revenue) and equity components. Some have asserted that as general partner of the limited partnership, the reporting entity has effectively “sold” the tax credits to the limited partner(s) in a manner akin to the transfer of goods or services in a revenue transaction.

However, in at least one instance, the SEC staff indicated that ownership interests in a low-income housing tax credit (LIHTC) partnership structure that provide limited partners with substantive and contractually specified rights to receive allocations of the partnership’s economic benefits should be classified as noncontrolling interests in the parent’s consolidated financial statements. In conjunction with this observation, the SEC staff objected to the bifurcation of limited partners’ noncontrolling interests into separate liability and equity components in the general partner’s consolidated balance sheet. While the SEC staff’s views were specific to tax credits for LIHTC partnership structures, this accounting framework should be applied to other forms of partnerships that generate tax credits.

Footnotes

For additional information about the analysis of a limited partnership structure as a VIE and the subsequent determination of its primary beneficiary, see Chapters 5 and 7 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.