8.2 Determining Whether an Allocation of Income Taxes Is Required in Separate or Carve-Out Financial Statements
ASC 740-10
Allocation of Consolidated Tax Expense to Separate Financial
Statements of Members
30-27 The consolidated amount of
current and deferred tax expense for a group that files a
consolidated tax return shall be allocated among the members of
the group when those members issue separate financial
statements. This Subtopic does not require a single allocation
method. The method adopted, however, shall be systematic,
rational, and consistent with the broad principles established
by this Subtopic. A method that allocates current and deferred
taxes to members of the group by applying this Topic to each
member as if it were a separate taxpayer meets those criteria.
In that situation, the sum of the amounts allocated to
individual members of the group may not equal the consolidated
amount. That may also be the result when there are intra-entity
transactions between members of the group. The criteria are
satisfied, nevertheless, after giving effect to the type of
adjustments (including eliminations) normally present in
preparing consolidated financial statements.
30-27A An entity is not required to
allocate the consolidated amount of current and deferred tax
expense to legal entities that are not subject to tax. However,
an entity may elect to allocate the consolidated amount of
current and deferred tax expense to legal entities that are both
not subject to tax and disregarded by the taxing authority (for
example, disregarded entities such as single-member limited
liability companies). The election is not required for all
members of a group that files a consolidated tax return; that
is, the election may be made for individual members of the group
that files a consolidated tax return. An entity shall not make
the election to allocate the consolidated amount of current and
deferred tax expense for legal entities that are partnerships or
are other pass-through entities that are not wholly owned.
30-28 Examples of
methods that are not consistent with the broad principles
established by this Subtopic include the following:
- 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 the asset and liability method described in this Subtopic (for example, the deferred method that was used before 1989)
- 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.
Question 3 of SAB Topic 1.B.1 (codified in ASC 220-10-S99-3) states:
ASC 220-10 — SEC Materials
SAB Topic 1.B, Allocation of Expenses and Related Disclosure
in Financial Statements of Subsidiaries, Divisions or Lesser
Business Components of Another Entity
S99-3 The following is the text of SAB Topic 1.B.1, Costs
Reflected in Historical Income Statements . . .
Question 3: What are the staff’s views with respect to the
accounting for and disclosure of the subsidiary’s income tax
expense?
Interpretive Response: Recently, a number of parent
companies have sold interests in subsidiaries, but have retained
sufficient ownership interests to permit continued inclusion of
the subsidiaries in their consolidated tax returns. The staff
believes that it is material to investors to know what the
effect on income would have been if the registrant had not been
eligible to be included in a consolidated income tax return with
its parent.
Some of these subsidiaries have calculated their tax provision on
the separate return basis, which the staff believes is the
preferable method. Others, however, have used different
allocation methods.
When the historical income statements in the filing do not
reflect the tax provision on the separate return basis, the
staff has required a pro forma income statement for the most
recent year and interim period reflecting a tax provision
calculated on the separate return basis.1
____________________
1 Paragraph 40 of Statement 109 [paragraph
740-10-30-27] states: “The consolidated amount of current and
deferred tax expense for a group that files a consolidated tax
return shall be allocated among the members of the group when
those members issue separate financial statements. . . . The
method adopted . . . shall be systematic, rational, and
consistent with the broad principles established by [Statement
109] [Subtopic 740-10]. A method that allocates current and
deferred taxes to members of the group by applying [Statement
109] [Subtopic 740-10] to each member as if it were a separate
taxpayer meets those criteria.”
To understand the accounting for income taxes in separate or carve-out
financial statements, management and practitioners must understand the legal structure
of the operations to be included in such statements. The remainder of this section
discusses some of the considerations related to whether an allocation of income taxes
would be required in separate or carve-out financial statements and, if so, which
allocation methods may be used, including considerations related to the application of
each method.
8.2.1 Separate Financial Statements Composed of One or More Taxable Legal Entities
The primary source of guidance applicable to the accounting for income taxes in
separate financial statements is ASC 740-10-30-27, which requires a group of
entities that files a consolidated tax return to allocate the “consolidated amount
of current and deferred tax expense . . . among the members of the group when those
members issue separate financial statements.” For income tax accounting purposes, a
“member” is generally a taxable legal entity (i.e., a corporation or an LLC that has
elected to be taxed as a corporation) that is included in the parent’s consolidated
tax return. Thus, if separate financial statements are being prepared that are
composed of one or more taxable legal entities that are included in the parent’s
consolidated tax return (as might be the case if the separate financial statements
are being prepared in connection with a spin-off of a subsidiary), an allocation of
current and deferred income tax expense is explicitly required under ASC
740-10-30-27.
8.2.2 Separate Financial Statements of Nontaxable Legal Entities or “Pass-Through” Entities
Separate financial statements may be composed of one or more
nontaxable entities (e.g., “pass-through” entities such as partnerships and multiple
member LLCs that have elected to be taxed as pass- throughs). Such nontaxable or
pass-through entities are not members of their parent’s consolidated income tax
return. Therefore, allocation of income tax expense is not appropriate in the
separate financial statements of a pass-through entity for jurisdictions in which
the entity is considered a nontaxable pass-through entity. This is true irrespective
of whether the separate financial statements will be included in a filing with the
SEC. See Section 14.5 for the disclosure
requirements that apply in this circumstance.
8.2.3 Separate Financial Statements of Legal Entities That Are Both Not Subject to Tax and Disregarded by the Taxing Authority
An LLC with only one member (a “single member LLC”) is a unique
legal entity structure that can, under certain circumstances, be classified for U.S.
federal income tax purposes as a regarded entity (i.e., similar to a corporation) or
can be disregarded (i.e., not respected as an entity separate from its owner but
rather treated like a division of a corporation). However, unlike a division of a
corporation, a disregarded single-member LLC generally is not severally liable for
the current and deferred income taxes of its taxable owner provided that it
maintains its separate and distinct legal existence. An entity’s determination of
whether an allocation of current and deferred income taxes is required in the
separate financial statements of a single-member LLC therefore depends, in part, on
how the single-member LLC elects to treat itself for U.S. federal income tax
purposes.
A regarded single-member LLC that is subject to federal, foreign,
state, or local taxes based on income should account for such taxes in its separate
financial statements in accordance with ASC 740 (see Section 8.2.1).
In the separate financial statements of legal entities that are not subject to tax
and are disregarded by the taxing authority, there is no requirement to
allocate current and deferred taxes. However, a disregarded single-member LLC may
elect to apply the guidance discussed in Section
8.2 and allocate current and deferred taxes in its financial
statements. If an entity that is not subject to tax and is disregarded by the taxing
authority has elected to allocate amounts of consolidated current and deferred taxes
in its separate financial statements ASC 740-10-50-17A requires to disclose that
election.
The policy election to allocate taxes to legal entities that are not
subject to tax and are disregarded by the taxing authority is made on an
entity-by-entity basis and allows the inclusion of a tax provision in the separate
financial statements of a single-member LLC (a disregarded entity for tax purposes)
but not in the financial statements of a partnership (a regarded entity for tax
purposes).
The policy election applies to the separate financial statements of
a single-member LLC being filed with the SEC (regardless of whether a tax-sharing
agreement exists between the single-member LLC and its taxable parent).
If an entity maintains a tax-sharing agreement and chooses to allocate income taxes,
the allocation method used must be appropriate for financial reporting purposes
regardless of the manner in which the contractual tax-sharing agreement allocates
taxes to the single-member LLC. See Section 8.3.1 for further discussion of
acceptable allocation methods and Section 8.3.4 for further discussion of tax-sharing arrangements
that are inconsistent with the broad principles established by ASC 740.
8.2.4 Carve-Out Financial Statements (i.e., Statements Composed of One or More Unincorporated Divisions, Branches, or Lesser Components of the Parent Reporting Entity)
Because ASC 740-10-30-27 discusses only the allocation of current
and deferred income taxes to the separate financial statements of a member (i.e., a
taxable legal entity subsidiary that is included in a parent’s consolidated income
tax return), it does not explicitly address the allocation of income taxes in
carve-out financial statements. Whether an allocation of the consolidated amounts of
current and deferred income taxes is required in carve-out financial statements
depends on the ultimate use of the financial statements.
If the carve-out financial statements will be included in a filing
with the SEC, an allocation of taxes is generally required under the guidance in SAB
Topic 1.B.1 (reproduced in ASC 220-10-S99-3). Question 3 of SAB Topic 1.B.1
specifically addresses income taxes and states, in part:
The
staff believes that it is material to investors to know what the effect on
income would have been if the registrant had not been eligible to be included in
a consolidated income tax return with its parent.
In this context, “the registrant” has been interpreted in practice
to include a carve-out “entity” either because the carve-out entity will ultimately
become a registrant or because the carve-out entity represents the predecessor of
the registrant.
The allocation of income taxes in carve-out financial statements
that will be included in a filing with the SEC is required regardless of whether the
carved-out operations will be subsumed into a taxable or nontaxable entity upon
consummation of the transaction for which the carve-out financial statements are
being prepared. Only in limited circumstances has the SEC allowed the omission of a
tax provision (e.g., if the carve-out entity prepares abbreviated financial
statements — see Section
8.2.5).
If the carve-out financial statements will not be included in a
filing with the SEC, the parent entity is generally not required to allocate income
taxes to such statements, although doing so is usually preferable because it yields
more useful information.
8.2.5 Abbreviated Financial Statements
SEC Regulation S-X, Rule 3-05, requires registrants to file separate preacquisition
historical financial statements for an acquired or to be acquired business that is
significant (acquiree). Similarly, under Regulation S-X, Rule 3-14, registrants may
be required to provide preacquisition financial statements for a significant
acquired or to be acquired real estate operation (real estate acquiree).
In certain circumstances, it may not be practicable for management to prepare full
carve-out financial statements of an acquiree, such as when the acquiree is a small
portion or product line of a much larger business and separate financial records
were not maintained. In such circumstances and as long as certain qualifying
conditions and presentation and disclosure requirements in Rule 3-05(e) are met,
abbreviated financial statements of an acquiree may be acceptable and would consist
only of (1) a statement of revenues and direct expenses (in lieu of a full statement
of operations), (2) a statement of assets acquired and liabilities assumed (in lieu
of a full balance sheet), and (3) certain footnote disclosures required by Rules
3-05(e)(2)(iii) and 3-14(c)(2). In a manner consistent with the presentation and
disclosure requirements in Rule 3-05(e), a registrant may omit an allocation of
income taxes in the acquiree’s abbreviated financial statements.
See Sections 2.6.4 and 3.5 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions
for further discussions of requirements related to abbreviated financial statements
under Rules 3-05 and 3-14, respectively. Also see Section 8.7.3 of this Roadmap for a discussion
of disclosures required when income taxes are not allocated in abbreviated financial
statements.