In Year 2, the consolidated group has no taxable income, since the taxable income of Subsidiary 1 is fully offset by the loss of Subsidiary 2 of $1,000 this year (Figure 2). As in Year 1, Subsidiary 1 is required to pay the parent company an amount equal to the tax it would have owed if it had filed a separate tax return for the year (USD 210). In year 2, however, the question arises as to whether Subsidiary 2 should be compensated for the group`s use of the $1,000 loss. The answer depends on the terms of the tax allocation agreement. In the absence of a tax sharing agreement, Subsidiary 2 will find it difficult to force the parent company to make it a whole for the loss of a potentially valuable tax feature. 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. One of the advantages of filing a consolidated tax return is that the losses incurred by members can be used to host the income of other members. However, if a member`s loss is absorbed by the consolidated group, the member cannot use that loss to protect the income it will generate in the future. Therefore, tax allocation agreements should determine whether and how class members will be compensated for the use of their tax attributes (for example.
B operating losses, excess capital losses, tax credits). If a tax-sharing agreement exists, it could require the parent company to compensate subsidiary 2 if the loss of subsidiary 2 is absorbed by the group. In this approach, a subsidiary is compensated for the loss of its tax attributes, whether or not those attributes have benefited the subsidiary at present. Alternatively, some tax distribution agreements take a “waiting-and-see” approach. Under this approach, Subsidiary 2 would not be compensated for the use of its loss in year 2. Instead, the group would wait to see if Subsidiary 2 would later produce sufficient revenue to benefit from its loss, provided that the loss had not previously been absorbed by the consolidation circle. If subsidiary 2 continues to generate losses, it can never be compensated for the utility that the group has derived from its loss in year 2. Given the potentially significant difference at the time of payment, care should be taken to ensure that all parties understand when members are compensated for the use of their attributes. .