Chapter 14 - Separate Financial Statements of A Subsidiary

Separate Financial Statements of
a Subsidiary
Intercorporate
or intra-entity tax allocation (i.e., allocating
income taxes to entities within a consolidated
tax group) involves related parties and
typically results from an expressed or implied
agreement among the parties concerning the
allocation of taxes currently payable.
Intercorporate
It is not uncommon for intercorporate taxallocation agreements to be inconsistent with
arrangements that might have been derived on
an arms-length basis.
Intercorporate
ASC 850, Related Party Disclosures, and SAS
45/AU 334 recognize that a subsidiary does
not independently control its own actions and
that most related party transactions
including intercorporate tax allocations, might
have been structured differently if the
subsidiary had not been a controlled entity.
ASC 740-10-30-27
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
ASC 740-10-30-27
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
ASC 740-10-30-27
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 intraentity transactions between members of the
group
ASC 740-10-30-27
The criteria are satisfied, nevertheless, after
giving effect to the type of adjustments
(including eliminations) normally present in
preparing consolidated financial statements.
ASC 740-10-30-28
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
ASC 740-10-30-28
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)
ASC 740-10-30-28
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.
ASC 740-10-50-17
An entity that is a member of a group that files a
consolidated tax return shall disclose in its separately
issued financial statements:
The aggregate amount of current and deferred tax
expense for each statement of earnings presented

and the amount of any tax-related balances due to
or from affiliates as of the date of each statement of
financial position presented
ASC 740-10-50-17
The principal provisions of the method by which
the consolidated amount of current and deferred
tax expense is allocated to members of the group
and the nature and effect of any changes in that
method (and in determining related balances to
or from affiliates) during the years for which the
above disclosures are presented.
Acceptable methods
ASC 740-10-30-27 through 30-28 require 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
Acceptable methods
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
Acceptable methods
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.
Acceptable methods
While ASC 740-10-30-27 through 30-28 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:
Acceptable methods
A method that allocates only current taxes
payable to a member of the group that has
taxable temporary differences
Acceptable methods
A method that allocates deferred taxes to a
member of the group using a method
fundamentally different from its asset and
liability method (the deferred method that was
used before 1989 is cited as an example)
Acceptable methods
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
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 SAB Topic 1B, 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. The SEC
staff further states: 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

Under this 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

The rules followed by the subsidiary in
computing its tax or refund, including the
effects of AMT, should be exactly the same as
those followed by the subsidiary in filing a
separate return with the IRS.

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, the subsidiary could reflect a
current-year loss as being carried back against
its taxable income in the carryback period,
even though the consolidated group was in a
loss carryforward position.

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 subsidiarys current provision
would be the amount of tax payable or
refundable based on the subsidiarys
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 (i.e.,
within the control of the subsidiary).

ASC 740-10-30-27 acknowledges that, if the
separate return method is used, the sum of the
amounts allocated to 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.
Benefits-for-loss
Another type of tax allocation, known as
benefits-for-loss, may be considered to comply
with the criteria of ASC 740-10-30-27 through
30-28.
Benefits-for-loss
This approach modifies the separate return method
so that net operating losses (or other current or

deferred tax attributes) are characterized as
realized (or realizable) by the subsidiary when
those tax attributes are realized (or realizable) by
the consolidated group even if the subsidiary
would not otherwise have realized the attributes on
a stand-alone basis.
Benefits-for-loss
Thus, when the benefit of the net operating
loss (or other tax attribute) is recognized in the
consolidated financial statements, the
subsidiary would generally reflect a benefit in
its financial statements.
Benefits-for-loss
However, application of this policy may be
complicated when the consolidated group is in
an AMT position or requires a valuation
allowance on its deferred tax assets.
Benefits-for-loss
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.
Benefits-for-loss
While not a pre-requisite, oftentimes the
benefits-for-loss policy mirrors the taxsharing
agreement between the parent and the
subsidiary
Benefits-for-loss
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 14.2 below).
Other methods
If another method or a modified method
(described above) is used, it must be
determined whether that method falls within
the parameters of ASC 740-10-30-27 through
30-28
Other methods
The tax allocation requirements of ASC 740
pertain to the allocation of expense; yet the
basic methodology of ASC 740 pertains to the
determination of deferred tax liabilities or
assets based on temporary differences.
Other methods
Although the allocation method must be
consistent with the broad principles of ASC
740, it is not clear whether any correlation is
intended between an individual members
temporary differences and the portion of the
consolidated deferred tax liabilities and assets
that are reflected in its separate statements.
Other methods
In most cases, the same allocation method
should be applied to all members of the group.
However, there may be facts and
circumstances that prompt the use of different
methods for certain members of a consolidated
group.
Tax allocation versus tax sharing

arrangements
If a tax-sharing agreement differs from the method
of allocation under ASC 740-10- 30-27 through
30-28, the difference between the amount paid or
received under the tax-sharing agreement and the
expected settlement amount based on the method
of allocation is treated as a dividend, cont.

arrangements
cont. (i.e., when less cash was received or more
cash was paid by the subsidiary than would have
been expected under the method of tax allocation)
or a capital contribution (i.e., when more cash was
received or less cash was paid by the subsidiary
than would have been expected under the method
of tax allocation).

arrangements
For example, a single-member limited liability
company (LLC) that presents a tax provision on the
separate return basis, but is not required to remit cash
to the parent for any amounts payable or is not
entitled to receive cash for amounts receivable should
recharacterize these amounts payable or receivable as
a capital contribution or dividend.

arrangements
A single-member LLC should also
recharacterize these amounts payable or
receivable as a capital contribution or dividend
if the parent decides not to collect or reimburse
a subsidiary under a tax-sharing arrangement
that would otherwise require settlement.
Change in method
A change in tax-allocation policy is considered
a change in accounting principle, as ASC 740
prescribes criteria that an intra-entity taxallocation policy must meet to be considered
acceptable under U.S. GAAP.
Change in method
Therefore, the change in policy must be justified as
preferable given the circumstances, and an SEC
registrant must obtain a preferability letter from its
auditors. Companies need to follow the guidance in
ASC 250, Accounting Changes and Error
Corrections, which requires a retrospective
application.
Single-member and multiple-member limited

liability companies revised June 2015
Questions often arise regarding how singlemember and multiple-member LLCs should
account for income taxes in their separate
financial statements. ASC 740 does not
specifically mention either type of entity.

ASC 272, Limited Liability Entities, however,
provides some guidance for accounting for
LLCs. ASC 272-10-05-4 indicates that LLCs are
similar to partnerships in that members of an
LLC (rather than the entity itself) are taxed on
their respective shares of the LLCs earnings.

Therefore, multiple-member LLCs generally do
not reflect income taxes if they are taxed as

partnerships (a partnership tax return is filed and
the investors each receive K-1s) and are not
otherwise subject to state or local income taxes.

(However, if a multiplemember LLC is subject
to state or local income taxes (i.e., because
certain states impose income taxes on LLCs) the
entity would be required to provide for such
taxes in accordance with ASC 740.) This is also
true if the multiple members are part of the same
consolidated group

Single-member LLCs, however, are accounted
for differently. The U.S. federal tax law
provides an election for single-member LLCs
to be taxed as either associations (i.e.,
corporations) or disregarded entities.

If the election is made to be taxed as an
association, there is no difference between
classification as a single-member LLC and a
wholly owned C corporation for federal
income taxes.

If a single-member LLC does not specifically
check the box and elect to be taxed as an
association, it is automatically treated as a
disregarded entity. This means that, for federal
income tax purposes, single-member LLCs are
accounted for as divisions of the member and
do not file separate tax returns.

How single-member LLCs account for income
taxes in their separate financials statements
depends in part on the character of the singlemember.

For example, if the member was a C corporation, the
earnings and losses of the LLC would automatically
roll up into the members corporate tax return, where
they would be subject to tax at the corporate rate.

From a federal income tax perspective, there is no
substantive difference between a single-member LLC
that is treated as a disregarded entity and a division
that is included in the consolidated tax return.

In these situations, we believe that presenting a
tax provision in the separate financial
statements of single-member LLC is the
preferred accounting policy election. For those
entities that do not present an income tax
provision, we would expect disclosures stating
why income taxes have not been provided.

Conversely, if the single member was a
partnership, the earnings and losses of the LLC

would automatically roll up into the members
partnership return and be passed through to the
individual partners. In these cases, we believe
that the single-member LLC should not provide
income taxes in its separate financial statements.

In instances where the LLC is owned by a
second single-member LLC, the character of
the member of the second LLC (for example, a
C corporation or a partnership) should
determine the presentation of income taxes in
the separate financial statements of the lowertier LLC.

The separate financials of all single-member
LLCs should disclose the entitys accounting
policy with regard to income taxes (i.e.,
whether a tax provision is recorded). The
accounting policy should be applied
consistently from period to period.

In addition, single-members that present a tax
provision should also include disclosures
consistent with those required by ASC 740-1050-17 (discussed in FSP 16.8.3). Single
members that do not present a tax provision
should strongly consider including the following
disclosures in their financial statements:

The reason(s) why they chose an accounting
policy not to record a tax provision (e.g., the
single-member LLC is a disregarded entity for
federal and state tax purposes)

Affirmation that no formal tax-sharing
arrangement exists with the member
If applicable, a description of any
commitments the single-member LLC has to
fund any tax liability of the member with
earnings of the LLC
Disclosures revised June 2015

Guidance can now be found in FSP 16.8.3.
Impact of a change in tax basis on separate

historical financial statements
ASC 740-20-45-11 addresses the way an entity
should account for the income tax effects of
transactions among or with its shareholders.
ASC 740-20-45-11 provides that the tax effects
of all changes in tax bases of assets and
liabilities caused by transactions among or with
shareholders should be included in equity.

In addition, if a valuation allowance was initially
required for deferred tax assets, as a result of a
transaction among or with shareholders, the effect
of recording such a valuation allowance should also
be recognized in equity. However, changes in the
valuation allowance that occur in subsequent
periods should be included in the income statement.

For example, ASC 740-20-45-11 would apply in
the separate financial statements of an acquired
entity that does not apply push-down accounting
to a transaction in which an investor entity
acquires 100 percent of the stock (i.e., a nontaxable transaction) of the acquired entity.

If, for tax purposes, this transaction is accounted
for as a purchase of assets (e.g., under IRC
Section 338(h)(10)), there would be a change in
the tax bases of the assets and liabilities.

However, because the purchase accounting
impacts are not pushed-down to the separate
financial statements of the acquired entity for
book purposes, there would be no change in the
carrying value of the acquired entitys assets and
liabilities.

In this situation, both the impacts of the
change in tax basis and any changes in the
valuation allowance that result from the
transaction with shareholders would be
recognized in equity.

However, changes in the valuation allowance
that occur in subsequent periods should be
included in the income statement.
Uncertain tax positions and separate

financial statements of a subsidiary
The recognition and measurement provisions
of ASC 740 are applicable to the uncertain tax
positions in the separate financial statements
of a member of a consolidated tax group to the
same extent that they are applicable to the
consolidated group.

Accordingly, the assumptions used for
determining the unrecognized tax benefits in
the separate financial statements of the group
member should be consistent with those used
in the consolidated financial statements.

Questions have arisen regarding the
appropriate disclosures related to
unrecognized tax benefits for separate
statements of a member of a group that files as
part of a consolidated tax return.

The following example illustrates the
correlation between the intercorporate
allocation accounting policy under ASC 74010-30-27 through 30-28 and its related impact
on the disclosure requirements for
unrecognized tax benefits.
Carve-out financial statements

Carve-out financial statements refer to
financial statements prepared by an entity for a
division or other part of its business that is not
necessarily a separate legal entity, but is part
of the larger consolidated financial reporting
group.

The preparation of carve-out financial
statements can be complex and is often highly
judgmental. Preparing the tax provision for
carve-out financial statements can likewise be
challenging, particularly if separate financial
statements (including a tax provision) have not
historically been prepared.

However, for taxable entities, the exclusion of a tax
provision in such financial statements is not an option
because a tax provision is required for the carve-out
financial statements to be in compliance with ASC
740.

The methods for intercorporate tax allocation for a
carve-out are the same as the methods described

previously for the separate financial statements of a
subsidiary that is part of a consolidated tax group.
However, preparing a tax provision for carveout
financial statements can present a unique set of
financial reporting issues. These include the
following:

Understanding the purpose of the carve-out
financial statements and the corresponding pretax accounting:
Carve-out financial statements are often guided by
the legal or strategic form of a business transaction
that involves capital formation, or the acquisition
or disposal of a portion of a larger entity.

financial statements and the corresponding pre-tax
accounting:
Alternatively, the statements may be guided by
regulatory requirements for certain industry-specific
filings.
financial statements and the corresponding pre-tax

accounting:
Understanding the overall context and intended use
of the statements is important in deciding which tax
provision allocation method to apply and in
aligning the application of the chosen allocation
method to the pre-tax accounts.

Persons responsible for preparing a tax
provision should coordinate closely with those
responsible for the pre-tax aspects of the
carve-out financial statements. The tax
provision should be based on the financial
statement accounts that are included in the
carve-out entity

Accordingly, one must fully understand the
pretax accounts that will be included in the
carve-out statements, as well as the impacts of
any adjustments to such accounts, in order to
reflect the appropriate income tax effects.

The tax provision can be affected by methodologies
being used for revenue or cost allocations that differ
from historical practices. Carve-out financial statements
should reflect all the costs of doing business. That
typically requires an allocation of corporate overhead
expenses (and the related tax effects) to the carve-out
entityeven if allocations were not previously made.

Similarly, it may be necessary to allocate other
expenses, such as stock-based compensation,
to the carve-out entity. An appropriate
methodology for determining the pool of
windfall benefits applicable to the carve-out
entity will then also need to be adopted (see
Section TX 18.12.1).

Stand-alone financials may also reflect pushdown accounting adjustments, which can
often relate to debt obligations of the parent or
other members of the reporting group. The tax
provision would be prepared based upon such
pre-tax accounts.

Accordingly, the stand-alone entity would be
assumed to have tax basis in such debt for
purposes of applying ASC 740 and, as a
consequence, no temporary difference or
deferred tax consequence would arise from the
pushdown

Intercompany transactions: Intercompany
transactions that were formerly eliminated in the

consolidated financial statements (e.g.,
transactions between the carve-out entity and
other entities in the consolidated financial
statements) generally would not be eliminated
in the carve-out financial statements.

For example, sales of inventory to a sister
company that are eliminated in the
consolidated financial statements generally
would remain in the carve-out statements.
Accordingly, the income tax accounting for
those transactions would also change.

Specifically, ASC 740-10-25-3(e) (which
prescribes the accounting for the income tax
effects of intercompany transactions) would
not apply to such transactions in the carveout financial statements.

Similarly, it may be appropriate to reflect in
carve-out statements intercompany transaction
gains (or losses) that were previously deferred in
a consolidated tax return. It would be necessary to
assess whether the respective income tax
accounting effects are recognized in equity, in
accordance with ASC 740-20-45-11(c) or (g).

Intercompany cash settlement
arrangements: When a company is preparing
carve-out financial statements, the underlying
cash flows related to taxes during the historical
period may have no relationship to the actual
tax liabilities of the carved-out entity.

As such, there could be a series of equity
transactions (capital contributions and
dividends) that account for the differences
between actual cash flow and the taxes that are
allocated under the accounting policy chosen
for intercorporate tax allocation.

Hindsight: ASC 740-10-30-17 states that all
available evidence . . . shall be considered . . . and
that historical information is supplemented by all
currently available information about future years.
Notwithstanding ASC 740-10-30-17, we generally
believe that hindsight should not be used to apply
ASC 740 when preparing carve-out financial
statements for prior years.

Accordingly, if an assumption that existed in one year
changed in the succeeding year as a result of
economic events, hindsight should not be used to
apply the new assumption to the prior year.

For example, consider this scenario: A deferred tax
asset was supportable in Year 1 based on the fact that
the entity had been profitable and had no negative
evidence, but, as a result of significant subsequent
losses, a valuation allowance was required in Year 2.

Without using hindsight, we believe that it would be
appropriate to set up a deferred tax asset without a
valuation allowance in Year 1 and then to record a
valuation allowance in Year 2 based on the
subsequent developments.

Historical assertions made by management
of the consolidated group: At times,
management may indicate in a carve-out
situation that it would havemade different
assertions or tax elections if the entity had
been a stand-alone entity.

The preparation of carve-out financial
statements, in and of itself, should not be
considered to constitute new information that
would justify recording a change with respect
to uncertain tax positions.

However, it is generally not appropriate to
revisit historical assertions or elections made
by management of the consolidated group
because the tax provision for the carve-out
entity is an allocation of the group tax
provision.

Similarly, it would generally be inappropriate to reassess
the historical recognition and measurement of uncertain
tax positions when preparing carveout financial
statements. The preparation of carve-out financial
statements, in and of itself, should not be considered to
constitute new information that would justify recording
a change with respect to uncertain tax positions.

For example, some carved-out entities have
questioned whether it would be appropriate to
revisit the indefinite reinvestment assertion
(ASC 740-30-25-17) that the parent reflected
in its consolidated financial statements.

We do not believe that this would be
appropriate. However, if the carve-out entity
expects its assertions may change in the near
future (e.g., after it has been separated from
the consolidated group), it may be appropriate
to disclose such expectations and the estimated
financial reporting impact of such a change.

In certain limited situations, it may be
appropriate for a stand-alone entitys carve-out
financial statements to deviate from the
assertion or election made by management of
the consolidated group as illustrated below in
Example 14-7

In this narrow fact pattern, the federal tax
regulations provide for a choice in the
treatment of foreign taxes paid. Companies are
allowed to deduct foreign taxes paid or may
find it more beneficial to claim a credit for
those payments.

Chapter 14 - Separate Financial Statements of A Subsidiary

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Chapter 14 - Separate Financial Statements of A Subsidiary

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Separate Financial Statements of

expense for each statement of earnings presented

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

Separate return method

so that net operating losses (or other current or

Tax allocation versus tax sharing

Tax allocation versus tax sharing

Tax allocation versus tax sharing

Tax allocation versus tax sharing

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

not reflect income taxes if they are taxed as

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

partnership, the earnings and losses of the LLC

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Single-member and multiple-member limited

Disclosures revised June 2015

Impact of a change in tax basis on separate

Impact of a change in tax basis on separate

Impact of a change in tax basis on separate

Impact of a change in tax basis on separate

Impact of a change in tax basis on separate

Impact of a change in tax basis on separate

Impact of a change in tax basis on separate

Uncertain tax positions and separate

Uncertain tax positions and separate

Uncertain tax positions and separate

Uncertain tax positions and separate

Carve-out financial statements

Carve-out financial statements

Carve-out financial statements

Carve-out financial statements

carve-out are the same as the methods described

Carve-out financial statements

Carve-out financial statements

Carve-out financial statements

Understanding the purpose of the carve-out

financial statements and the corresponding pre-tax

Carve-out financial statements