Corporate groups and tax consolidation
Under tax consolidation, the head company of the consolidated tax group will be primarily liable for the group’s income tax liabilities.
However, each subsidiary may be jointly and severally liable to the Australian Taxation Office for the entire amount of a group income tax liability if the head company defaults in paying that liability. This joint and several liability may have adverse consequences for the group, particularly in relation to external funding arrangements, solvency requirements, rating agency reviews, the sale of subsidiaries and directors’ duties.
On entry into the tax consolidation regime, corporate groups will need to consider how best to minimise the application of joint and several liability in relation to the group’s income tax liabilities. They will also need to consider the manner in which the subsidiaries will fund the head company’s payment of those liabilities. Both of these issues may be managed by corporate groups through tax sharing agreements and tax funding agreements.
Tax sharing agreements
Broadly, tax sharing agreements:
- prevent joint and several liability arising by “reasonably” allocating the group’s income tax liability to group members.
- allow companies leaving the tax group (e.g. on a sale to a third party) to take advantage of the “clear exit rules” which limit the leaving company’s exposure to its former group’s tax liabilities in certain circumstances. A buyer of a subsidiary in a tax group will normally request that the seller group enter into a valid tax sharing agreement and comply with the “clear exit rules”.
To date, most consolidated tax groups have decided to allocate their income tax liabilities on the basis of the notional stand-alone taxable income of each group member or on the basis of each member’s accounting profit as a percentage of overall group accounting profit. Whether or not allocation on these bases will be accepted as being reasonable will ultimately depend on the facts and circumstances surrounding the tax position of each group as well as the legislation, regulations and ATO policies applicable to tax sharing agreements generally.
Tax funding agreements
Tax funding agreements complement tax sharing agreements and set out how the subsidiaries will fund the payment of tax by the head company and when the head company will be required to make payments to subsidiaries for certain tax attributes generated by those subsidiaries which benefit the group as a whole (e.g. tax losses and tax credits).
Tax funding agreements also determine the tax accounting entries in the financial statements of members of tax groups (i.e. deferred tax assets and deferred tax liabilities).
Under the new International Financial Reporting Standards, tax groups will need to ensure that they have a tax funding agreement that adopts an “acceptable allocation method” under Urgent Issues Group (UIG) Interpretation 1052 Tax Consolidation Accounting. If the tax funding agreement does not adopt an “acceptable allocation method”, group members may be required to recognise deemed dividends and capital distributions, or deemed capital contributions, in their accounts.
Our tax consolidation products
Corporate groups are encouraged to consider entering into tax sharing agreements and tax funding agreements as part of their entry into the tax consolidation regime.
We have developed an extensive range of precedents documenting tax sharing and tax funding arrangements. These precedents include:
- Tax Sharing Agreements
- Tax Funding Agreements
- Combined Tax Sharing & Funding Agreements (for ordinary and MEC groups)
- Clear exit release deeds and exit payment schedules
- Tax warranties and indemnities in sale documents
- Accession deeds and assumption deeds
- Guidance notes for directors
- Proforma directors’ minutes for meetings of directors of head companies, subsidiaries and eligible tier-1 companies (for MEC groups)