|photo by Phillip via on flickr/Foter|
In 1998, the federal financial institution regulatory agencies jointly issued an Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure ("Interagency Statement") to provide guidance to insured depository institutions and their holding companies and other affiliates regarding the payment of taxes on a consolidated basis.
In 2014, an addendum to the Interagency Statement became effective. The addendum was intended to clarify the agencies' existing positions and to add new requirements in light of the FDIC's recent disputes with holding companies of failed banks for which it acted as receiver. According to the amended guidance, a tax allocation agreement should explicitly address the following issues:
- Calculation of Tax Allocation. A subsidiary depository institution must compute its income taxes (both current and deferred) on a separate entity basis, regardless of whether the actual returns will be consolidated. This is done both for purposes of preparing regulatory reports and to ensure the insured depository institution does not pay more than its own share of the tax liability. Certain adjustments that arise in a consolidated return, such as the application of graduated tax rates, may be made to the separate entity calculation as long as they are done consistently and fairly.
- Current Taxes Only. A bank should not pay its deferred tax liabilities or to its holding company, because the deferred tax account is not a tax liability required to be paid in the current reporting period. The regulators frown on this.
- Timing of Payments to the Holding Company. Tax payments from a bank to a holding company should never exceed the amount the bank's current tax expense calculated on a separate entity basis, nor should they be made before the bank would have been obligated to pay as a separate entity. The regulators consider any advance payments to be extensions of credit from the bank to the holding company (which are restricted by the Federal Reserve Act and regulations).
- Tax Refunds from the Holding Company. A bank incurring a loss for tax purposes should record a current income tax benefit and receive a refund--within a reasonable timeframe--from its holding company in an amount no less than the amount the bank would have been entitled to receive as a separate entity. If the refund is not passed along to the bank within a reasonable period, regulators may consider it either an extension of credit or a dividend. If, however, on a separate entity basis, the bank would not be entitled to a current refund because it has no carryback benefits available, its holding company can still use the bank's tax loss to reduce the consolidated group's current tax liability. In this situation, the holding company may reimburse the bank for the use of the tax loss.
- Agency Relationship. Because of recent litigation by the FDIC-R over tax assets, regulators emphasize that one of the most important provisions in a tax allocation agreement is the clear statement of an agency relationship between the bank and holding company. The agreement should clearly state that a holding company that receives a tax refund from a taxing authority holds the funds as an agent for the subsidiary(ies).
- Board Approval. All tax sharing agreements should be approved by the boards of directors of each holding company and insured depository institution in the consolidated group.