Because consolidated groups are not static, additional problems can arise when a member leaves a group that has an agreement that takes a “wait-and-see” approach. For example, if the tax allocation agreement takes a “wait-and-see” approach to compensating members for the use of their losses and Subsidiary 2 leaves the group at the end of Year 2, then Subsidiary 2 will likely never be compensated for the group`s use of its loss. To address this problem, many tax allocation agreements contain deconsolidation provisions. For example, an agreement could require the parent company to repay subsidiary 2 immediately after the deconsolidation of the tax benefit of its losses previously absorbed by the group or absorbed by the group in the year of the deconsolidation of the parent company. The agreement could also oblige the parent company to repay subsidiary 2 any tax debt it would have incurred within one year of consolidation if the liabilities had not been incurred, if subsidiary 2 had retained its distinct characteristics as an undertaking previously absorbed by the group. Tax allocation agreements should also take into account what happens when a member joins a consolidated group and has a separate set of corporate taxes (e.g. B carry-overs of losses and credit) which may benefit the group. Alternatively, a tax-sharing agreement could allocate the refund based on the member who generates the taxable income that allows the group to use the statement. Under this method, the group would be treated as if it were absorbing the total loss of Subsidiary 1 of Year 3, with the subsidiary generating 1,100% of the revenues that allowed the Group to use the statement. Since Subsidiary 1`s share is fully absorbed in the loss carry-forward, the group would then turn to Subsidiary 2 and use US$600 of its $2,000 share in CNOL. A third alternative, which may be necessary if Subsidiary 1 is a regulated entity, would require the parent company to pay the full refund to Subsidiary 1, since it would have been able to use its full loss carry-forward to offset its taxable income in year 4. There are many ways to approach this problem through tax distribution agreements. For example, the agreement could stipulate that loss carry-forwards will be absorbed on a pro rata basis to the first, first and pro rata.
The consolidated tax return rules provide that losses that may be absorbed in a consolidated return year are generally absorbed in the order of the taxation years in which they were incurred and on a pro rata basis (Treasury Regulations Section 1.1502-21 (b) (1)). In the example below, this means that the group is treated in this way, as if it were creating $533 ($1,000 of separate business loss ÷ $3,000 of consolidated loss × $1,600 CNOL) of the loss of subsidiary 1 and $1.06 7 ($2,000 annual loss 3 ÷ $3,000 of consolidated loss of year 3 × 1,600 CNOL) of the loss of subsidiary 2. If there is a tax allocation agreement, it could require that subsidiary 2 of the parent company be compensated if the loss of subsidiary 2 is absorbed by the group. . . .