Dual Company Structures, Tax Consolidation And Tax Sharing Agreements: What You Need To Know

In Short

• Tax Consolidation Benefits: Combining wholly owned subsidiaries into a single taxpayer group streamlines tax reporting and offers potential tax advantages. ​

• Group Tax Responsibility: In a consolidated group, the head company manages tax payments, but subsidiaries may be liable if the head company defaults.

• Tax Sharing Agreements (TSAs): TSAs allow group members to allocate tax liabilities differently, limiting subsidiary exposure if the head company fails to pay.

Tips for Businesses

Establishing a tax-consolidated group can simplify tax compliance and potentially reduce liabilities. It’s crucial to understand the implications of such a structure, including the responsibilities of each entity within the group. Consulting with tax professionals can help tailor arrangements like Tax Sharing Agreements to suit your business’s specific needs.

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Table of Contents

• What Is Tax Consolidation? 
• How Is a Consolidated Group Generally Taxed?
• What is a Tax Sharing Agreement? 
• Is a Tax Sharing Agreement Always Needed?
• Key Takeaways
• Frequently Asked Questions

A dual company structure offers flexibility and asset protection. However, it also creates tax complexities, as each company is a separate taxpayer. To simplify tax affairs, a corporate group can elect to form an income tax consolidated group. This means the group is treated as a single taxpayer for income tax purposes. The group head is responsible for paying the tax liability. If the head company fails, subsidiaries may be liable for the amount. Group members can enter into a tax-sharing agreement to change this default position. This article explains tax consolidation, how consolidated groups are taxed, and how a tax-sharing agreement works.

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What Is Tax Consolidation? 

Tax consolidation allows wholly owned subsidiaries to join their head company through an election to the ATO. Once made, the election is irreversible. Subsidiaries with a trading history or assets may face tax implications. The subsidiary is deemed to dispose of certain assets to the head company upon election.

Forming an income tax consolidated group can have several benefits, such as:

• intercompany transactions between group members are ignored for tax purposes. For example, transferring an asset (which would ordinarily trigger a capital gains tax event) does not create any tax liability; 
• tax losses of one entity can be offset against the profits of another since the group as a whole is taxed;
• only one set of accounts needs to be prepared for each financial year, rather than one for each company; and
• If the group is planning on accessing the R&D tax incentive, having a consolidated group in place removes the issue of a different entity owning the R&D outputs (usually the head company) to the entity doing the R&D work (usually the subsidiary). This is because the R&D tax incentive is assessed at the group level.

How Is a Consolidated Group Generally Taxed?

In a consolidated group, the head company is generally responsible for paying income tax on behalf of the group. In doing so, the head company is discharging the income tax liability on behalf of the entire group, not any one particular entity. 

Suppose the head company fails to fully discharge the group’s income tax liability by the time the tax is due and payable. In that case, the starting position is that subsidiary members that were part of the group for any part of the period where the liability arose become jointly and severally liable for the group liability. This means that each group member is equally responsible for paying the income tax liability and that the ATO can pursue any number of the group members to pay the debt. 

What is a Tax Sharing Agreement? 

A group member is jointly and severally liable for the group income tax debt unless a valid tax sharing agreement (TSA) exists. The TSA must be signed before the head company’s due date. It allows the group liability to be split between members using a specified formula. The head company remains liable for the group debt initially. However, the TSA limits a subsidiary’s liability if the head company fails to pay.

There is no prescribed form for a TSA. However, a group liability will only be covered by a TSA if the document contains the following characteristics:

• it existed immediately before the head company’s due time;
• it determines how the group liability will be allocated to group members;
• the allocation of the liability is “reasonable” and accounts for the entire liability; 
• no other TSA exists concerning the same liability; and
• be in writing, show the date of execution and the names of all group members.

What is a Tax Funding Agreement?

A consolidated group will also have a tax funding agreement (TFA) and the TSA in certain circumstances. Sometimes, the two will be combined into one document, but usually, they sit separately. 

Broadly, a TFA is an agreement between the head company and its subsidiaries whereby the subsidiaries agree to contribute an amount to the head company for their agreed share of the group tax liability. The purpose of a TFA is to ensure the head company has sufficient funds to pay the group income tax liability. 

Is a Tax Sharing Agreement Always Needed?

TSAs and TFAs are not always necessary. For example, where the dual company structure consists only of one head company and one subsidiary, putting these documents in place may not be required as it is quite clear what the outcome would be if the head company fails to pay the income tax. 

TSAs become critical when the head company plans to sell any subsidiary. The buyer wants the subsidiary to have a “clear exit” from the consolidated group. Before leaving the group, the subsidiary pays the head company its contribution amount or an estimate. If this happens before the due date, the subsidiary is generally no longer liable for group income tax. In M&A transactions, the buyer must know the contribution amount and ensure a clear exit.

Key Takeaways

Dual company structures often elect to form an income tax consolidated group to provide administrative ease for the group’s tax affairs and to streamline transactions between group members. However, consolidation means the head company is ultimately responsible for paying the group’s income tax liability. Without a valid TSA, the head company failing to pay this liability means the subsidiaries become jointly and severally liable for the group’s tax debts. However, a TSA is not required by law and is not always necessary to put in place. 

If you have any questions regarding company tax structures, our experienced taxation lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions

What is a tax sharing agreement (TSA)? 

A TSA is an agreement that allows the group income tax liability to be split among members using a specified formula, reducing a subsidiary’s liability if the head company fails to pay.

Is a TSA always necessary for tax consolidation? 

A TSA is not always required, especially for smaller structures with only one head company and one subsidiary. However, it becomes critical when a subsidiary is sold or exits the group.