Ownership Patterns and Income Taxes

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					                                           CHAPTER 7
                         PATTERNS AND INCOME TAXES
Chapter Outline
I.   Indirect subsidiary control
     A. Control of subsidiary companies within a business combination is often of an indirect
         nature; one subsidiary possesses the stock of another rather than the parent having
         direct ownership.
         1. These ownership patterns may be developed specifically to enhance control or for
             organizational purposes.
         2. Such ownership patterns may also result from the parent company's acquisition of a
             company that already possesses subsidiaries.
     B. One of the most common corporate structures is the father-son-grandson configuration
         where each subsidiary in turn owns one or more subsidiaries.
     C. The consolidation process is altered somewhat when indirect control is present.
         1. The worksheet entries are effectively doubled by each corporate ownership layer but
             the concepts underlying the consolidation process are not changed.
         2. Calculation of the accrual-based income of a subsidiary recognizing the consolidated
             relationships is an important step in an indirect ownership structure.
             a. The determination of accrual-based income figures is needed for equity income
                 accruals as well as for the computation of noncontrolling interest balances.
             b. Any company within the business combination that is in both a parent and a
                 subsidiary position must recognize the equity income accruing from its subsidiary
                 before computing its own income.

II. Indirect subsidiary control-connecting affiliation
    A. A connecting affiliation exists whenever two or more companies within a business
        combination hold an equity interest in another member of that organization.
    B. Despite this variation in the standard ownership pattern, the consolidation process is
        essentially the same for a connecting affiliation as for a father-son-grandson
    C. Once again, any company in both a parent and a subsidiary position must recognize an
        appropriate equity accrual in computing its own income.

III. Mutual ownership
     A. A mutual affiliation exists whenever a subsidiary owns shares of its parent company.
     B. Parent shares being held by a subsidiary are accounted for by the treasury stock
        1. The cost paid to acquire the parent's stock is reclassified within the consolidation
            process to a treasury stock account and no income is accrued.
       2. The treasury stock approach is popular in practice because of its simplicity and is now
          required by the FASB Codification.

IV. Income tax accounting for a business combination—consolidated tax returns
    A. A consolidated tax return can be prepared for all companies comprising an affiliated group.
        Any other companies within the business combination file separate tax returns.
    B. A domestic corporation may be included in an affiliated group if the parent company (either
        directly or indirectly) owns at least 80 percent of the voting stock of the subsidiary as well
        as 80 percent of each class of its nonvoting stock.
    C. The filing of a consolidated tax return provides several potential advantages to the
        members of an affiliated group.
        1. Intra-entity profits are not taxed until realized.
        2. Intra-entity dividends are not taxed (although these distributions are nontaxable for all
            members of an affiliated group whether a consolidated return or a separate return is
        3. Losses of one affiliate can be used to reduce the taxable income earned by other
            members of the group.
    D. Income tax expense—effect on noncontrolling interest valuation
        1. If a consolidated tax return is filed, an allocation of the total expense must be made to
            each of the component companies to arrive at the realized income figures that serve
            as a basis for noncontrolling interest computations.
        2. Income tax expense is frequently assigned to each subsidiary based on the amounts
            that would have been paid on separate returns.

V. Income tax accounting for a business combination—separate tax returns
   A. Members of a business combination that are foreign companies or that do not meet the 80
       percent ownership rule (as described above) must file separate income tax returns.
   B. Companies in an affiliated group can elect to file separate tax returns. Deferred income
       taxes are often recognized when separate returns are filed due to temporary differences
       stemming from unrealized gains and losses as well as intra-entity dividends.

VI. Temporary tax differences can stem from the creation of a business combination
    A. The tax basis of a subsidiary's assets and liabilities may differ from their consolidated
       values (which is based on the fair market value on the date the combination is created).
    B. If additional taxes will result in future years (for example, it the tax basis of an asset is
       lower than its consolidated value so that future depreciation expense for tax purposes will
       be less), a deferred tax liability is created by a combination.
    C. The deferred tax liability is then written off (creating a reduction in tax expense) in future
       years so that the net expense recognized (a lower number) matches the combination's
       book income (a lower number due to the extra depreciation of the consolidated value).

Vll. Operating loss carryforwards
     A. Net operating losses recognized by a company can be used to reduce taxable income
        from the previous two years (a carryback) or for the future 20 years (a carryforward).
   B. If one company in a newly created combination has a tax carryforward, the future tax
      benefits are recognized as a deferred income tax asset.

However, a valuation allowance must also be recorded to reduce the deferred tax asset to the
amount that is more likely than not to be realized

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