Discussion (INT1052_06-05_COMPmar20_07-21)

All mandatory requirements included in enacted or substantively enacted tax consolidation legislation are relevant to an entity, and are taken into account in measuring and recognising income tax amounts. Where an entity is applying the tax consolidation system, the elective tax consolidation requirements are also relevant to the entity. This Interpretation addresses the accounting for income tax amounts where the entity is applying the tax consolidation system during the reporting period (whether for the whole of or a part of the period).

Under the tax consolidation system, the head entity in the tax-consolidated group is liable for income taxes arising in relation to the transactions and other events of the wholly-owned subsidiaries in the tax-consolidated group subsequent to the adoption of tax consolidation, with the exception that transactions between entities in the group are ignored for tax purposes. This means that the subsidiaries’ transactions, events and balances continue to be subject to income tax.

The implementation date of tax consolidation for an entity is the date from which the tax consolidation system will be applied to the taxation obligations of the entities in the tax-consolidatable group, that is, the date from which a consolidated tax return will be prepared. If the entity (or its head entity) has chosen an implementation date that is prior to or the same as the end of the reporting period, then the accounting for income tax amounts is required to reflect the full effects of the tax consolidation system from the implementation date. The implementation date would normally be expected to be specified by the entity or its head entity in a formal resolution of the board of directors or other governing body or of management delegated to determine the implementation date for the entity or group.

The implementation date for an entity can be different from the date on which the entity (or its head entity) makes the decision to adopt the tax consolidation system, and from the date on which the decision is formally notified to the Australian Taxation Office. Formal notification can occur up to the date of lodgement of the first consolidated income tax return, which may be after the completion of the financial statements for the reporting period. However, if the implementation date is determined prior to the completion of the financial statements, the appropriate accounting depends on the implementation date, as explained in the preceding paragraph, rather than on the decision date or the date of formal notification to the taxation authority. Where the implementation date is not determined prior to the completion of the financial statements, the financial statements are not prepared in accordance with the requirements set out in this Interpretation. Those financial statements are not amended and reissued where the implementation date, as subsequently determined, retrospectively falls in that previous reporting period. This Interpretation does not address the accounting prior to the implementation of tax consolidation by a group.

When a tax-consolidated group is first formed, it comprises the head entity and all the wholly-owned subsidiaries that satisfy the requirements of the tax consolidation legislation at that time. A subsidiary joins an existing tax-consolidated group when it becomes wholly owned by the head entity and satisfies those requirements. The subsidiary may previously have been a partly-owned subsidiary of the head entity, or may be a newly acquired subsidiary. When a subsidiary becomes part of a tax-consolidated group, the subsidiary’s transactions, events and balances continue to be subject to income tax, even though it is the head entity in the tax-consolidated group that is then liable for the income taxes.

The view adopted in this Interpretation is that a subsidiary in a tax-consolidated group has taxable profits (or tax losses) as defined in AASB 112, since income taxes are payable or recoverable on the subsidiary’s profits or losses as determined in accordance with the rules of the taxation authority – even though the income taxes are payable (recoverable) by the head entity and not the subsidiary itself. Therefore, this Interpretation requires subsidiaries in the tax-consolidated group to recognise current and deferred tax amounts: each entity in the tax-consolidated group in substance remains taxable, and the legal form of the tax-consolidation arrangement should not determine the accounting. Consequently, the head entity does not recognise any initial tax balances relating to the assets and liabilities of subsidiaries when they join the tax-consolidated group (with the possible exception of tax-loss/tax-credit deferred tax assets). The consolidated financial statements covering the tax-consolidated group continue to include income taxes in accordance with AASB 112.

Under AASB 112, deferred tax liabilities and assets arise from temporary differences and from unused tax losses and tax credits. Temporary differences are differences between the carrying amount of an asset or a liability in the statement of financial position and its tax base. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

The head entity continues to recognise current and deferred taxes in relation to its own transactions, events and balances. The head entity also recognises, as tax consolidation adjustments, current tax liabilities (or assets) and deferred tax assets relating to tax losses and relevant tax credits that are assumed from the subsidiaries. These deferred tax assets are recognised in accordance with the recognition criteria in paragraph 34 of AASB 112. Relevant tax credits are those assumed by the head entity from the subsidiaries under the tax consolidation system. Subsequent references in this Interpretation to tax credits are only to such tax credits.

The subsidiaries in the group are also required to recognise deferred taxes, since amounts are attributed to their assets and liabilities for tax purposes – even though the tax transactions occur (from a legal perspective) in the head entity instead. When a subsidiary joins a tax-consolidated group, the tax bases of its assets and liabilities are determined by reference to the tax values applying under tax consolidation. The tax effects of any change in the tax base are recognised in accordance with paragraph 65 of AASB 112.

This Interpretation permits the use of different methods for measuring the current and deferred tax amounts to be recognised initially for each reporting period by the entities in the tax-consolidated group (including the head entity), provided that the method is systematic, rational and consistent with the broad principles in AASB 112. Paragraph 9 indicates that “stand-alone taxpayer”, “separate taxpayer within group” and “group allocation” approaches can be acceptable methods. The specific tax consolidation adjustments required by paragraphs 11 to 15 are recognised only after the application of the chosen method.

Under this approach, each entity in the tax-consolidated group measures its current and deferred taxes as if it continued to be a separate taxable entity in its own right. This approach means, for example, that an entity recognises tax in relation to its intragroup transactions. The entity also assesses the recovery of its unused tax losses and tax credits only in the period in which they arise, and before assumption by the head entity, in accordance with AASB 112 applied in its own circumstances, without regard to the circumstances of the tax-consolidated group.

When recognising deferred taxes in the separate financial statements of each entity in the tax-consolidated group under this approach, temporary differences are measured by reference to the carrying amounts of assets and liabilities in the entity’s statement of financial position and their tax bases applying under tax consolidation, as those are the only available tax bases. Therefore, consolidation adjustments to reflect business combinations or other transactions within the group are ignored. As a result, deferred taxes associated with these adjustments are recognised only on consolidation and not in the separate financial statements of an entity in the group under the stand-alone taxpayer approach.

The “separate taxpayer within group” approach involves the calculation of current and deferred taxes for each entity in the tax-consolidated group on the basis that the entity is subject to tax as part of the tax-consolidated group. Therefore, adjustments are made in each entity in relation to its transactions that do not give rise to a tax consequence for the group or that have a different tax consequence at the level of the group. For example, adjustments are required in relation to:

(a) unrealised profits and losses on the intragroup sale or transfer of inventory or other assets;

(b) management fees and other charges between entities in the group; and

(c) tax losses/credits that are not expected to be recoverable by the entity on a stand-alone basis but which are expected to be recoverable in the context of the group.

When recognising deferred taxes in the separate financial statements of each entity in the tax-consolidated group under this approach, temporary differences are measured by reference to the carrying amounts of assets and liabilities either in the entity’s statement of financial position or at the level of the tax-consolidated group and their tax bases applying under tax consolidation. These alternative approaches illustrate that there are a range of acceptable methods for allocating group current and deferred taxes in accordance with the criteria in paragraph 8.

Each entity in the tax-consolidated group assesses the recovery of its unused tax losses and tax credits only in the period in which they arise, and before assumption by the head entity, in accordance with AASB 112 applied in the context of the group. Thus, each entity initially recognises such deferred tax assets arising during a period to the extent that they are recoverable by the group, whether as a reduction of the current tax of other entities in the group or as a deferred tax asset of the head entity. When several entities in a tax-consolidated group derive tax losses/credits in the same period but not all of the aggregate amount of the tax losses/credits is expected to be utilised as a reduction of a current tax liability or recognised as a deferred tax asset by the head entity, the aggregate amount expected to be utilised or recognised is apportioned on a systematic and reasonable basis between those entities for their initial tax-loss/tax-credit deferred tax asset recognition.

A “group allocation” approach may be most appropriate where the tax return for the tax-consolidated group is prepared directly on a consolidated basis. Under this approach, current and deferred taxes are allocated to the entities in the group in a systematic manner that is consistent with the broad principles in AASB 112. Paragraph 10 identifies a number of potential group allocation methods that do not satisfy this criterion. Other unacceptable allocation methods include:

(a) a method that allocates current taxes only to entities in the group that have accounting profits, with no allocation to entities that have accounting losses; and

(b) a method that allocates current taxes to entities in the group on an arbitrary basis, for example on the basis of sales revenue, total assets, net assets or operating profits, without adjustment for material items that are not assessable or deductible for tax purposes.

A group allocation approach based on the terms of any tax funding arrangement between the entities in the group would be acceptable only where it satisfies the criteria in paragraph 8.

Following the implementation of tax consolidation for the tax-consolidated group, both the head entity and the subsidiaries in the group continue to recognise in each reporting period current tax amounts. However, it is the head entity that normally will settle or recover with the taxation authority current tax liabilities or assets that arise in relation to the subsidiaries. That is, the current tax liability is effectively assumed by the head entity or the current tax asset benefits the head entity. Therefore, a subsidiary’s current tax liability or asset needs to be derecognised immediately after its initial recognition in each reporting period.

The derecognition of a subsidiary’s current tax liability (or asset) is treated under this Interpretation as a contribution by (or distribution to) the head entity, in conjunction with any tax funding arrangement amounts, on the basis that the transaction is with the parent in its capacity as the parent. The definition of “income” (or “expenses”) in the Framework for the Preparation and Presentation of Financial Statements^[1] cannot be satisfied, as the decrease in the subsidiary’s current tax liability (or asset) results from a contribution by or distribution to equity participants. This Interpretation does not prescribe which equity accounts are to be adjusted by subsidiaries for tax-consolidation contributions or distributions.

The assumption by the head entity of the current tax liability (or asset) arising in a subsidiary in the tax-consolidated group is recognised by the head entity as a contribution to (or distribution from) the subsidiary (not as a component of tax expense or tax income), unless a tax funding arrangement between the entities results in the head entity recognising an inter-entity receivable (payable) equal in amount to the tax liability (asset) assumed. There will be no net contribution (or distribution) where the amounts arising for the period under a tax funding arrangement equate to the amounts initially recognised by the subsidiary for its current taxes and any tax losses/credits assumed by the head entity under the tax consolidation system. Nevertheless, the head entity recognises the assumed current tax amounts as current tax liabilities (assets), adding to its own current tax amounts, since they are also due to or from the same taxation authority.

Similarly, the subsidiary recognises the assumption of its current tax liability or asset as a contribution by or distribution to the head entity, in conjunction with any tax funding arrangement amounts. Thus, the subsidiary continues to recognise tax expense (income) even though it derecognises its current tax liability or asset. The subsidiary may choose to classify a tax-consolidation equity contribution from the head entity as contributed equity other than paid-in capital. A transaction that would result in an equity reduction for the subsidiary may be subject to legal restrictions concerning capital distributions.

When the tax consolidation adjustments required by this Interpretation result in the recognition of a distribution to an entity, that entity accounts for the distribution in accordance with the requirements of AASB 127 Separate Financial Statements and AASB 139 Financial Instruments: Recognition and Measurement concerning dividends and other distributions. Distributions arising from tax consolidation adjustments may take the form of either a return of capital or a return on capital. The particular circumstances of a distribution need to be considered in determining the appropriate accounting.

The head entity’s equity investment in subsidiaries relates to the ownership interests it holds directly in subsidiaries. This means that the head entity’s assumption of current tax liabilities or assets in relation to indirect subsidiaries needs to be accounted for, in conjunction with any tax funding arrangement amounts, as equity contributions or distributions (if any) via the interposed parents, as each parent in turn holds the investment in the next layer of subsidiaries.

In the case of multiple entry consolidated (MEC) groups, some or all of the subsidiaries in the tax-consolidated group may not be direct or indirect subsidiaries of the head entity in the group. However, in that case, the assumption by the head entity of the other entities’ current tax liabilities or assets is treated, in conjunction with any tax funding arrangement between the entities, as equity contributions or distributions via the foreign parent of the head entity, again on the basis that the transactions in substance are transfers via each interposed parent.

The entries for interposed parents would not be recognised in the consolidated financial statements for the group, as they concern transactions within the group. However, they would be recognised in each parent’s separate financial statements or consolidated financial statements of sub-groups, if prepared. For example, a contribution from an interposed entity’s parent would give rise to a contribution by the interposed entity to its subsidiary. Similarly, a distribution from a subsidiary of the interposed entity would give rise to a distribution by the interposed entity to its parent.

Following the implementation of tax consolidation for the tax-consolidated group, both the head entity and the subsidiaries in the group continue to recognise deferred tax amounts. The tax consolidation system results in subsidiaries’ tax losses/credits being assumed by the head entity, but does not address deferred tax assets and liabilities arising from temporary differences. Therefore, such deferred taxes continue to be recognised by each entity in the tax-consolidated group and are not transferred to the head entity.

A subsidiary derecognises any tax-loss/tax-credit deferred tax asset that it has initially recognised in a reporting period where the tax losses/credits are transferred to the head entity under tax consolidation. The amount (if any) paid or payable by the head entity for the transferred tax losses/credits is determined in accordance with any tax funding arrangement between the entities. Where the arrangement does not provide for a funding contribution from the head entity to the subsidiary equal to the asset derecognised by the subsidiary (or recognised by the head entity), the assumption of the tax losses/credits results in a contribution to or distribution by the subsidiary in the same manner as with current tax liabilities or assets.

Where unutilised and unrecognised tax losses/credits are subsequently recognised by the head entity, the deferred tax income arising is recognised only by the head entity and not treated as an adjustment of the previous accounting by the originating subsidiaries for the tax losses/credits assumed by the head entity. However, if a tax funding arrangement between the entities provides compensation to the subsidiaries in the period in which the tax losses/credits are utilised by the head entity, the compensation is accounted for as contributions by an equity participant.

The entities in a tax-consolidated group may choose to enter into a tax funding (or contribution) arrangement in order to fund tax amounts. This Interpretation does not establish any specific requirements for the nature and terms of tax funding arrangements. However, the Interpretation requires an entity subject to any form of tax funding arrangement to account for the inter-entity assets and liabilities (if any) that arise for it under the arrangement. These amounts are treated as arising through equity contributions or distributions, in the same way as the head entity’s assumption of subsidiaries’ current tax amounts and tax losses/credits, and therefore alter the net amount recognised as tax-consolidation contributions by or distributions to equity participants. As noted in paragraph 43, there will be no net contribution (or distribution) where the amounts arising for the period under a tax funding arrangement equate to the amounts initially recognised by a subsidiary for its current taxes and any tax losses/credits assumed by the head entity.

The entities may also establish a tax sharing agreement to determine the allocation of income tax liabilities between the entities should the head entity default on its tax payment obligations or the treatment of entities leaving the tax-consolidated group. A tax sharing agreement that satisfies the specific tax law requirements has the effect in default circumstances that the liability of subject entities is limited to their contribution as determined in accordance with the agreement. Tax sharing agreements that operate only in the event of default by the head entity normally would not give rise to accounting entries where the possibility of default was remote. A tax sharing agreement may also be used to determine the consequences of a subsidiary leaving the group. Any payments under a tax sharing agreement are accounted for in the same way as tax funding arrangement amounts.

The head entity may be required to recognise a deferred tax asset or liability in its separate financial statements in relation to temporary differences arising on its investments in subsidiaries in the tax-consolidated group. Differences between the carrying amounts of the investments and the associated tax bases may arise due to the head entity’s accounting for tax-consolidation contributions by or distributions to equity participants, whereas the tax bases of the investments may indirectly reflect the aggregate tax values of the subsidiaries’ assets and liabilities. Paragraphs 39 and 44 of AASB 112 specify the circumstances in which such deferred taxes are not required to be recognised.

A wholly-owned subsidiary leaves the tax-consolidated group when it no longer is wholly owned as required by the tax consolidation legislation. This can occur, for example, when the head entity (or another entity in the group) sells the subsidiary or when the subsidiary issues shares to parties outside the group. A subsidiary may leave the tax-consolidated group but remain part of the group of entities where the parent entity continues to control the subsidiary. It may become part of another tax-consolidated group, under a different head entity, or it may become the head entity of its own tax-consolidated group, including its own wholly-owned subsidiaries.

Where a subsidiary leaves the tax-consolidated group, the head entity continues to recognise current taxes that arose in relation to the subsidiary as a member of the tax-consolidated group, since the head entity continues to be liable under the tax consolidation system for those taxes. It is only after the subsidiary leaves the group and does not become a subsidiary in another tax-consolidated group that it starts to recognise its own new current tax liabilities or assets without having to derecognise them for their assumption by a head entity.

Any tax losses/credits assumed by the head entity from the subsidiary when it joined the group or whilst a member of the group remain with the head entity when the subsidiary leaves the group, and so the head entity continues to recognise deferred tax assets based on those tax losses/credits to the extent that it is probable that they will be recovered by the head entity. However, the subsidiary continues to recognise deferred tax liabilities and assets based on temporary differences. The temporary differences are likely to change where, under the particular allocation method previously adopted, they were not determined by reference to the carrying amounts of the subsidiary’s assets and liabilities in its statement of financial position. Furthermore, the tax bases are those applicable to the subsidiary’s assets and liabilities under tax law, and may be reset if the subsidiary joins another tax-consolidated group.

As noted in paragraph 55, a subsidiary may leave the tax-consolidated group but remain part of the group of entities where the parent continues to control the subsidiary. The change in the structure of the group results from an intragroup transaction which is eliminated in preparing the consolidated financial statements. Therefore, the carrying amounts of the subsidiary’s assets and liabilities in those statements would not change. However, the temporary differences at the group level may be different where the subsidiary is now under another head entity in the group, due to its asset tax values being reset upon joining the second tax-consolidated group. In this case, the group’s deferred tax balances would change despite the subsidiary remaining within the group.

A number of specific disclosures are required by this Interpretation in addition to those required by AASB 112, to assist users of the financial statements of the head entity or of a wholly-owned subsidiary to understand the impact of tax consolidation upon the entity. Disclosures concerning the relevance of tax consolidation to an entity would normally include, where applicable, a statement that the adoption of the tax consolidation system had not yet been formally notified to the Australian Taxation Office. Other accounting standards may also require disclosures that are relevant to tax consolidation. For example, AASB 124 Related Party Disclosures requires disclosure of the identity of certain controlling entities, which may or may not include the head entity in the tax-consolidated group, as well as disclosures concerning transactions and balances with related parties, which includes other entities in the tax-consolidated group.

AASB 137 Provisions, Contingent Liabilities and Contingent Assets requires the disclosure of contingent liabilities. Wholly-owned subsidiaries in a tax-consolidated group have contingent liabilities as a result of their joint and several liability in default circumstances, which is in effect a guarantee by the subsidiaries. If the probability of default by the head entity or leaving the tax-consolidated group is remote, disclosure of the contingent liability is not required.

Where Abstract 52 was previously applied by an entity in accounting for tax consolidation, the accounting policies adopted under that Abstract can no longer continue to be applied by the entity. When application of this Interpretation begins in the context of adopting all Australian equivalents to International Financial Reporting Standards (IFRSs), AASB 1 First-time Adoption of Australian Accounting Standards requires an entity to use the same accounting policies in its opening Australian-equivalents-to-IFRSs statement of financial position as for all periods presented in its first Australian-equivalents-to-IFRSs financial statements. AASB 1 notes that this may require an entity to apply accounting policies that differ from those used previously. Any adjustments at the date of transition to Australian equivalents to International Financial Reporting Standards are recognised directly in retained earnings or, if appropriate, another category of equity.

Initial application of this Interpretation in the context of AASB 1 requires the head entity in the tax-consolidated group to derecognise at the date of transition to Australian equivalents to IFRSs any temporary-difference (or timing-difference) deferred tax balances recognised in relation to subsidiaries in the group. However, the head entity continues to recognise any current tax liability or asset and any tax-loss/tax-credit deferred tax asset (if appropriate) relating to the subsidiaries. Any adjustment is recognised via retained earnings.

The head entity (and any interposed parents) also needs to determine whether the application of this Interpretation from the date tax consolidation was implemented to the date of transition would have resulted in carrying amounts for investments in subsidiaries that are materially different from those previously determined at the date of transition. This is particularly likely to be the case where there was no tax funding arrangement and there were no dividends or other distributions from subsidiaries to fund the head entity. Dividends or other distributions used to fund the head entity are likely to offset any equity contributions that would otherwise arise on the retrospective application of this Interpretation. Any adjustment of investment carrying amounts at the date of transition is recognised via retained earnings.

At the date of transition, subsidiaries in the tax-consolidated group recognise deferred tax balances measured in accordance with an allocation method that meets the requirements of this Interpretation. Similarly to the head entity, subsidiaries (including interposed parents) may have to account for contributions by or distributions to equity participants in relation to the head entity’s assumption of current taxes and tax losses/credits in conjunction with any tax funding arrangement amounts.

However, it may be appropriate for subsidiaries to reclassify as deferred tax balances at the date of transition the non-current inter-entity balances that arose under tax funding arrangements, without having to recognise contributions or distributions to the head entity. This would be the case where the pre-date-of-transition tax funding arrangement covered both current and deferred taxes, with the intention of reflecting in a subsidiary the tax amounts relating to its transactions and balances, which it could not recognise directly. Under Abstract 52, the subsidiary would have recognised the amounts as current and deferred tax expense (income) and as current and non-current inter-entity balances, with no contributions by or distributions to equity participants. In substance, this is the same outcome required by this Interpretation, based on the principle that there is no such contribution or distribution where the tax funding arrangement amounts equate to the amounts initially recognised by the subsidiary. For this approach to be justified, it would be expected that the tax funding arrangement would be revised during the reporting period in which Australian equivalents to IFRSs are adopted to address only current tax amounts and tax losses/credits, so that under this Interpretation no contributions or distributions to equity participants would normally arise in the future. The head entity would also need to reverse existing inter-entity balances relating to deferred tax balances arising from subsidiaries’ temporary (or timing) differences that were previously recognised by the head entity under Abstract 52, supporting the view that in substance no contribution by or distribution to equity participants had occurred. When this approach is appropriate, the head entity is not required to adjust the carrying amounts of its investments in the relevant subsidiaries at the date of transition.

If the tax funding arrangement is not amended as indicated in paragraph 65, this would indicate that the original substance of the arrangement was not to effectively reflect tax balances in the subsidiary, and could result in the recognition of contributions or distributions by affected entities both on transition and on an on-going basis under this Interpretation. Furthermore, in this case the adjustment or writing-off of inter-entity balances arising from the pre-date-of-transition tax funding arrangement is a contribution by or distribution to equity participants in the period in which this occurs, rather than a date-of-transition adjustment, since the application of this Interpretation does not alter the terms of any previous tax funding arrangement.

Entities may decide in any case to revise the terms of a tax funding arrangement in response to the requirements of this Interpretation. For example, tax funding arrangements previously may have covered both current and deferred tax amounts since Abstract 52 required the head entity to recognise both current and deferred taxes in relation to subsidiaries. As the head entity no longer recognises subsidiaries’ deferred taxes (other than in respect of tax losses/credits) under this Interpretation, entities may prefer tax funding arrangements to address only current tax amounts and deferred tax assets relating to tax losses/credits.