Under Australia’s tax regime, entities under 100% common ownership can be grouped for tax purposes (referred to as a “tax consolidated group”).
The head company of a tax consolidated group is principally liable for the income tax liabilities of the group and lodges a single tax return for the group.
However, under the tax legislation, each subsidiary in the group is jointly and severally liable for the entire group tax liability in the event that the head company defaults in paying that liability (unless the group has entered into a valid tax sharing agreement).
In addition, tax funding agreements outline how the head company will fund the payment of tax liabilities, make and receive payments for certain tax attributes and account for tax consolidation.
Indirect tax sharing agreements apply similar principles to a direct tax sharing agreement to allocate the GST liability on a reasonable basis among the members of a GST Group.
Joint and several liability can create difficulties, particularly in the event of a disposal of a subsidiary(s), but also in obtaining external funding, managing directors’ duties, adjustments to financial statements, solvency and rating reviews. To manage joint and several liability most tax consolidated groups tend implement a tax sharing agreement.
The head company and each subsidiary member of the group which was a member of the group for at least part of a period to which the group liability relates, will be jointly and severally liable for the group liability. A subsidiary entity can thus remain jointly and severally liable in respect of a group liability even although it left the group before the time at which the group liability became due and payable.
Joint and several liability does not arise in respect of a group liability unless the head company fails to pay or otherwise discharge the relevant group liability in full by the time it becomes due and payable.
Tax funding agreements typically work in tandem with tax sharing agreements by setting out: • how the members of the tax consolidated group will fund the payment of the tax liability by the head company; • when the head company will make payments to subsidiaries to recognise the tax attributes generated by those members; and • the accounting entries required to correctly reflect the deferred tax assets and tax liabilities of group members. It is a requirement of the tax effect accounting standards (AASB 112 and UIG Interpretation 1052 Accounting for Income Taxes) that tax consolidated groups use an ‘acceptable allocated method’ for group tax liabilities. This enables the head company and group members to record tax accounting entries in the financial statements of each group member – otherwise groups may have to recognise deemed intra-group dividends, capital distributions or capital contributions in their accounts.
It is prudent to have these in place from the formation of a tax consolidated group, and not to wait for an external sale, funding or other needs before acting. However, the agreements can be entered into at any time following formation of a tax consolidated group, and new members can ‘sign up’ to the agreements under a Deed of Accession.
Joint and several liability also arises under GST groups, so an Indirect Tax Sharing Agreement is also commonly used.
An indirect tax sharing agreement applies similar principles to a direct tax sharing agreement to allocate the GST liability on a reasonable basis among the members of a GST Group. A different methodology is used to do this because the nature of the tax liabilities is quite different. Similar to a direct tax sharing agreement, a valid Indirect tax sharing agreement also enables a member to exit the GST group on sale to a third party with a ‘clear exit’ without exposure to the joint and several GST liabilities of the whole group.
GST grouping is different from income tax consolidation. In particular, there is a choice whether to include members within a GST group. It is not compulsory to group all members who qualify to group and individual qualified members can be excluded from a GST group. In addition the membership criteria are very different. For example the threshold ownership level for GST grouping is 90% compared to 100% for consolidation. Further, individuals, partnerships and non-fixed trusts can all qualify for GST grouping, unlike consolidation.
Tax Sharing Agreements overcome joint and several liability by contractually allocating a tax consolidated group’s income tax liabilities among group liabilities on a ‘reasonable’ basis. Thus, if the head company defaults on its income tax obligations, and the group has entered into a valid tax sharing agreement, each subsidiary which is part to the tax sharing agreement only becomes liable to pay an amount determined in accordance with the tax sharing agreement.
Portoria Legal Service’s agreements ensure a reasonable allocation by using the common method of notionally treating each entity in the group as a stand-alone entity and by applying clear rules to reasonably allocate the group’s tax adjustments (consistent with the approach outlined in PS LA 2013/5).
In practice, a buyer of an entity from a tax consolidated group would normally want the seller group to have entered into valid tax sharing and to comply with the other requirements of the clear exit rules.
A tax sharing agreement is only used to manage joint and several liability on default by the head company and to provide a clean exit for a leaving member (ie it has nothing to do with funding of the head company’s regular payments (eg PAYG Instalments) to the ATO). Where as a tax funding agreement is used to assist the head company in allocating and funding its ongoing tax liability.