Tax Sharing Agreements

Transcription

1 Tax Sharing Agreements Are you using your NOLs yet? AGA Tax Committee Meeting June 2016 Presented by: Chuck Lenns Vice President, Tax Consolidated Edison Company of NY

2 Agenda Federal Income Tax Consolidated Group Income Tax Allocations Basic Rules for filing Consolidated Tax Returns Why Consolidated Groups Allocate Taxes Tax Reasons for Allocations Regulatory Issues regarding Tax Attribute Carryovers State Income Tax Consolidated Group Tax Allocations The Sum of the Parts does not equal the Whole 2

3 Basic rules for filing consolidated tax returns A Consolidated group consists of a common parent corporation and its 80% or greater owned direct and indirect eligible corporate subsidiaries All eligible group members must join in filing the consolidated return The Consolidated group files a single federal income tax return and makes a single income tax payment 3

4 Basic rules for filing consolidated tax returns (cont d) Ineligible corporate subsidiaries include REITS, RICs, foreign corporations The common parent corporation is the agent of all the members in signing the tax return, paying tax, receiving refunds, and dealing with the Internal Revenue Service (Reg. Sec ) All members of the consolidated group are severally liable to the IRS for the group s entire tax liability (Reg. Sec ) 4

5 Why do consolidated groups allocate income taxes among members? Minority Shareholders Subsidiary group members can have up to 20% minority common stock ownership, and even more minority ownership through certain types of preferred stock (Section 1504(a)(4)), with the minority shareholder having an economic interest solely in the issuer rather than the entire group Creditor Concerns Consolidated group members often have their own debt obligations with separate company financial covenants that include separate company income tax matters 5

6 Why do consolidated groups allocate income taxes among members? (cont d) Bankruptcy Issues Do intercompany income tax allocations create creditor rights in bankruptcy? Do allocations control ownership of IRS refunds in the event of competing claims? Regulatory Reasons Income taxes are a significant component of the revenue requirement in rate cases Income taxes in rate cases are determined on a separate company, or even separate commodity, basis General Business Reasons Consolidated groups are not static Composition of Group s change through acquisitions, divestitures, and reorganizations What if a loss member leaves the group? 6

7 Income tax issues regarding consolidated group tax allocations Income tax issues regarding consolidated group tax allocations Earnings and Profits (Code Sec. 1552; Reg. Sec ) Earnings and Profits Extension of tax allocations to account for a member absorbing tax attributes of another member (Reg. Sec ) Stock basis adjustments (Reg. Sec ) 7

8 Does the tax law require consolidated groups to settle income taxes through inter-company tax sharing agreements? Code and Regs tell us how to allocate consolidated income tax liability for E&P purposes and for stock basis adjustment purposes Consolidated groups not required to actually settle income taxes on a cash basis (Reg. Sec (b)(2); Reg. Sec (d)(1)(ii)) Why is there no requirement to settle cash taxes? Members are severally liable for income taxes (Reg. Sec ) 8

9 Consolidated tax sharing agreements Regulatory issues Consolidated groups often consist of both regulated and nonregulated members Utility commissions deal with regulated companies on a stand alone basis Bonus depreciation, large repairs deductions, casualty losses have resulted in net operating losses for many consolidated groups, while being generated by only some of the group s members Renewable energy credits, R&D tax credit projects, have created income tax credit carryforwards for many consolidated groups, while being generated by only some of the group s members 9

10 Tax sharing issue How should consolidated tax attributes be shared among consolidated group members, when tax attribute carryovers of both regulated members and non-regulated members are used to reduce income taxes in any year? This issue should be addressed in Company s consolidated tax sharing agreement Does State law require utility commission approval of tax sharing agreement? 10

11 Consolidated tax sharing example P 100% 100% Regulated Subs Non- Regulated Subs Assume P has no income or loss 11

12 Year 1 Regulated Subs Non-Regulated Subs Consolidated Taxable Income $1,000 $0 $1,000 Tax Rate 40% 40% 40% Income Tax $400 $0 $400 Regulated Subs pay $400 to Parent Parent pays $400 to IRS and States 12

13 Year 2 Regulated Subs Non-Regulated Subs Consolidated Taxable Income $1,000 ($1000) $0 Tax Rate 40% 40% 40% Income Tax $400 ($400) $0 Regulated Subs pay $400 to Parent Does Parent pay $400 to Non-Regulated Subs? Does Parent keep $400 until such time as Non-Regulated Subs have taxable income (wait and see)? 13

14 Year 3 Regulated Subs Non-Regulated Subs Consolidated Taxable Income $1,000 ($2,000) ($1,000) Tax Rate 40% 40% 40% Income Tax $400 ($400) $0 NOL Carryback to Year 1 $0 ($1,000) ($1,000) Total Tax $400 ($800) ($400) Regulated Subs pay $400 to Parent Does Parent pay $400 to Non-Regulated Subs for current use of $1,000 loss in Year 3? Does Parent pay another $400 to Non-Regulated Subs on Carryback of Year 3 Consolidated $400 loss to Year 1? Does Parent wait and see how the second $1,000 loss is absorbed? 14

15 Year 4 Regulated Subs pay $400 to CEI Regulated Subs Non-Regulated Subs Consolidated Taxable Income ($1,000) ($2,000) ($3,000) Tax Rate 40% 40% 40% Income Tax $0 $0 $0 No intercompany payment to Parent, and Year 4 losses are carried forward Does Parent pay Regulated Subs $400 under hypothetical, stand-alone loss carryback calculation? 15

16 Year 5 Regulated Subs Non-Regulated Subs Consolidated Taxable Income ($1,000) ($2,000) ($3,000) Tax Rate 40% 40% 40% Income Tax $0 $0 $0 No intercompany payment to Parent, and Year 5 losses are carried forward Does Parent pay Regulated Subs $400 under hypothetical, stand-alone loss carryback calculation? 16

17 Year 6 Regulated Subs Non-Regulated Subs Consolidated Taxable Income $2,000 $0 $2,000 Loss Carryforward from Year 4 ($2,000) Taxable Income $0 Whose loss is used in Year 6? Choice 1 Choice 2 Choice 3 Regulated $ 667 Regulated $1,000 Regulated $2,000 Non-Regulated 1,333 Non-Regulated 1,000 Non-Regulated 0 $2,000 $2,000 $2,000 17

18 State tax issue The sum of the parts does not equal the whole Issue is with respect to consolidated or unitary State income tax filings Is your policy to record State income taxes on a stand-alone basis? In consolidated or unitary filing jurisdictions, State apportionment factors of group members can result in a consolidated group State tax that is different than the sum of the State taxes of its members computed on a stand-alone basis 18

19 State tax issue The sum of the parts does not equal the whole (cont d) Unlike federal income tax where the options are issues of timing, the State tax issues produce permanent differences Which group member(s) absorb the delta tax? How do you handle tax sharing for State NOL carryforwards? What if the apportionment factor changes the impact the value of loss carryforwards? Does a member get reimbursed at the rate at which the NOL originated, or at the rate when used? There are no right or wrong answers but make sure your tax sharing agreement addresses the issues 19

20 State tax example P 100% 100% Regulated Subs Non- Regulated Subs Group files consolidated State tax return Regulated business is in one State Non-Regulated Subs have large out-of-state apportionment factors 20

21 State tax issue The sum of the parts does not equal the whole (cont d) Regulated Subs Non-Regulated Subs Consolidated State Income $100,000 $10,000 $110,000 Apportionment factor 100% 10% 80% State taxable income $100,000 $1,000 $88,000 State tax rate 10% 10% $10% State income tax $10,000 $100 $8,800 Regulated Subs pay Parent $10,000 Non-Regulated Subs pay Parent $100 Parent pays State $8,800 Who gets the remaining $1,300 ($10,000 + $100 - $8,800)? 21

22 State tax issue The sum of the parts does not equal the whole (cont d) Regulated Subs Non-Regulated Subs Consolidated State Income $100,000 ($10,000) $90,000 Apportionment factor 100% 10% 80% State taxable income $100,000 ($1,000) $72,000 State tax rate 10% 10% 10% State income tax $10,000 ($100) $7,200 Regulated Subs pay Parent $10,000 Does Parent pay Non-Regulated Subs $100? Parent pays State $7,200 Who gets the remaining $2,700 ($10,000 - $100 - $7,200)? 22

23 State tax issue The sum of the parts does not equal the whole (cont d) Regulated Subs Non-Regulated Subs Consolidated State Income $100,000 $10,000 $110,000 NOL carryforward (50,000) (5,000) (55,000) State taxable income Before apportionment $50,000 $5,000 $55,000 Apportionment 100% 10% 80% State taxable income $50,000 $5,000 $44,000 State tax rate 10% 10% 10% State tax $5,000 $500 $4,400 Regulated Subs pay Parent $5,000 Non-Regulated Subs pay Parent $500 Parent pays State $4,400 What happens to the remaining $1,100 ($5,000 + $500 - $4,400)? 23

24 State tax issues If Regulated Subs pay tax on pure stand-alone basis, assuming consolidated apportionment factors always drive down consolidated taxable income, the Regulated Subs will NEVER pay the amount of tax that has been charged to its customers in cost of service. Is this fair? If not, what if consolidation drags the Regulated Subs into a non-resident State? Will rate payers reimburse the Regulated Subs? Do group members with NOL carryforwards get reimbursed by Parent at the State tax rate applicable to when loss originated, or when loss is absorbed? What if State law allows for NOL carryforward post-apportionment rather than pre-apportionment? Consider impact on State deferred income taxes Consolidated Tax Sharing Agreement should address these issues 24