12.4 Noncontrolling Interests
The ASC master glossary defines a noncontrolling interest as the
“portion of equity (net assets) in a subsidiary not attributable, directly or
indirectly, to a parent.” Consequently, noncontrolling interests are presented only
in the consolidated financial statements of a parent whose holdings include a
controlling interest in one or more subsidiaries it partially owns. The objective of
accounting for noncontrolling interests is to present users of the consolidated
financial statements with a clear depiction of the portion of a subsidiary’s net
assets, net income, and net comprehensive income that is attributable to equity
holders other than the parent.
12.4.1 Accounting for the Tax Effects of Transactions With Noncontrolling Shareholders
A parent accounts for changes in its ownership interest in a subsidiary over
which it maintains control (“control-to-control” transactions) as equity
transactions. The parent cannot recognize a gain or loss in consolidated net
income or comprehensive income for such transactions and is not permitted to
step up a portion of the subsidiary’s net assets to fair value to the extent of
any additional interests acquired (i.e., no additional acquisition method
accounting). As part of the equity transaction accounting, the entity must also
reallocate the subsidiary’s AOCI between the parent and the noncontrolling
interest.
The tax accounting consequences related to stock transactions associated with a
subsidiary are addressed under ASC 740-20-45-11. The direct tax effect of a
change in ownership interest in a subsidiary when a parent maintains control is
generally recorded in shareholders’ equity. Some transactions with
noncontrolling shareholders may create both a direct and an indirect tax effect.
It is important to properly distinguish between the direct and indirect tax
effects of a transaction since the accounting for each may be different. For
example, the indirect tax effect of a parent’s change in its assumptions
associated with undistributed earnings of a foreign subsidiary resulting from a
sale of its ownership interest in that subsidiary is recorded as income tax
expense in continuing operations rather than in shareholders’ equity. Similarly,
a parent’s change in ownership in a domestic subsidiary that causes a change in
its ability and intent to recover the investment in a tax-free manner would be
an indirect tax effect and recorded in continuing operations (see ASC
740-30-25-3).
Example 12-5
Parent Entity A owns 80 percent of its foreign
subsidiary, which operates in a zero-rate tax
jurisdiction. The subsidiary has a net book value of
$100 million as of December 31, 20X9. Entity A’s tax
basis of its 80 percent investment is $70 million.
Assume that the carrying amounts of the interest of the
parent (A) and noncontrolling interest holder (Entity B)
in the subsidiary are $80 million and $20 million,
respectively. The $10 million difference between A’s
book basis and tax basis in the subsidiary is
attributable to undistributed earnings of the foreign
subsidiary. In accordance with ASC 740-30-25-17, A has
not historically recorded a DTL for the taxable
temporary difference associated with undistributed
earnings of the foreign subsidiary because A has
specific plans to reinvest such earnings in the
subsidiary indefinitely and the reversal of the
temporary difference is therefore indefinite.
On January 1, 20Y0, A sells 12.5 percent of its 80
percent interest in the foreign subsidiary to a
nonaffiliated entity, Entity C, for total proceeds of
$20 million. As summarized in the table below, this
transaction (1) dilutes A’s interest in the subsidiary
to 70 percent and decreases its carrying amount by $10
million (12.5% × $80 million) to $70 million, and (2)
increases the total carrying amount of the
noncontrolling interest holders (B and C) by $10 million
to $30 million.
Below is A’s journal
entry on January 1, 20Y0, before consideration of income
tax accounting:
Entity A’s current tax payable and tax expense from its
taxable gain on the sale of its investment in the
subsidiary is $2,812,500, which is computed as follows:
[$20 million selling price – ($70 million tax basis ×
12.5% portion sold)] × 25% tax rate. The amount consists
of the following direct and indirect tax effects:
- The direct tax effect of the sale is $2.5 million. This amount is associated with the difference between the selling price and book basis of the interest sold by A (i.e., the gain on the sale) and is computed as follows: [$20 million selling price – ($80 million book basis × 12.5% portion sold)] × 25% tax rate. The gain on the sale of A’s interest is recorded in shareholders’ equity; therefore, the direct tax effect is recognized in shareholders’ equity.
- The indirect tax effect of the sale is $312,500. This amount is associated with the preexisting taxable temporary difference (i.e., the undistributed earnings of the subsidiary) of the interest sold for which a DTL was not recognized because of A’s assertion regarding the undistributed earnings of the subsidiary and is computed as follows: [($80 million book basis – $70 million tax basis) × 12.5% portion sold] × 25% tax rate. The partial sale of the subsidiary results in a change in A’s assertion regarding the indefinite reinvestment of the subsidiary’s earnings associated with the interest sold by A. This is considered an indirect tax effect and recognized as income tax expense in continuing operations.
Below is A’s journal
entry on January 1, 20Y0, to account for the income tax
effects of the sale of its interest in the foreign
subsidiary:
In addition, as a result of the sale, A should reassess
its intent and ability to indefinitely reinvest the
earnings of the foreign subsidiary associated with its
remaining 70 percent ownership interest. A DTL should be
recognized if circumstances have changed and A concludes
that the temporary difference is now expected to reverse
in the foreseeable future. This reassessment and the
recording of any DTL may occur in a period preceding the
actual sale of its ownership interest, since a liability
should be recorded when A’s assertion regarding
indefinite reinvestment changes.
12.4.2 Noncontrolling Interests in Pass-Through Entities: Income Tax Financial Reporting Considerations
ASC 810-10-45-18 through 45-21 require consolidating entities to report earnings
attributed to noncontrolling interests as part of consolidated earnings and not
as a separate component of income or expense. Thus, the income tax expense
recognized by the consolidating entity will include the total income tax expense
of the consolidated entity. When there is a noncontrolling interest in a
consolidated entity, the amount of income tax expense that is consolidated will
depend on whether the noncontrolling interest is a pass-through (i.e., a U.S.
partnership) or taxable entity (e.g., a U.S. C corporation).
ASC 810 does not affect how entities determine income tax expense under ASC 740.
Typically, no income tax expense is attributable to a pass-through entity;
rather, such expense is attributable to its owners. Therefore, a consolidating
entity with an interest in a pass-through entity should recognize income taxes
only on its controlling interest in the pass-through entity’s pretax income. The
income taxes on the pass-through entity’s pretax income attributed to the
noncontrolling interest holders should not be included in the consolidated
income tax expense.
Example 12-6
Entity X has a 90 percent controlling interest in
Partnership Y (an LLC). Partnership Y is a pass-through
entity and is not subject to income taxes in any
jurisdiction in which it operates. Entity X’s pretax
income for 20X3 is $100,000. Partnership Y has pretax
income of $50,000 for the same period. Entity X has a
tax rate of 25 percent. For simplicity, this example
assumes that there are no temporary differences.
Given the facts above, X
would report the following in its consolidated income
statement for 20X3:
In this example, ASC 810 does not affect how X determines
income tax expense under ASC 740, since X recognizes
income tax expense only for its controlling interest in
the income of Y. However, ASC 810 does affect the ETR of
X. Given the impact of ASC 810, X’s ETR is 24.2 percent
($36,250/$150,000). Provided that X is a public entity
and that the reconciling item is significant, X should
disclose the tax effect of the amount of income from Y
attributed to the noncontrolling interest in its
numerical reconciliation from expected to actual income
tax expense.