||It has been suggested that this article be merged into Tax consolidation. (Discuss) Proposed since December 2010.|
Some jurisdictions permit or require combined reporting or combined or consolidated filing of income tax returns. Such returns include income, deductions, and other items of multiple related corporations, and may compute tax as if such multiple entities were a single taxpayer. Most rules require that the corporations combined be commonly owned with only small minority ownership. Rules for such reports differ widely among jurisdictions. Combined reporting can limit tax benefit of shifting income between such related corporations, but permits the combined filers to benefit from losses of some entities where others have profits. Combined tax reporting rules may be complex, and may differ materially from combined financial reporting rules. Some jurisdictions that do not permit combined reporting nonetheless permit intragroup benefit of losses.
United States consolidated returns
United States Federal income tax rules permit commonly controlled corporations to file a consolidated return. The income tax and credits of the consolidated group are computed as if the group were a single taxpayer. Intercorporate dividends are eliminated. Once a group has elected to file a consolidated return, all members joining the group must participate in the filing. The common parent corporation files returns, and is entitled to make all elections related to tax matters. The common parent acts as agent for the members, and it and the members remain jointly and severally liable for all Federal income taxes. Many U.S. states permit or require consolidated returns for corporations filing Federal consolidated returns.
Requirements for filing
Only entities organized in the United States and treated as corporations may file a consolidated Federal income tax return. The return is filed by a “common parent” and only those subsidiaries in which the common parent owns 80% or more of the vote AND value. The parent and all subsidiaries must file Form 1122 to elect to file a consolidated return in the first year of election. Every 80% subsidiary must make the election or it is not valid. Thereafter, all corporations that begin to meet the 80% vote and value test must join in the consolidated return. If a subsidiary ceases to meet the 80% vote and value test, it is removed from the group. Adjustments to basis and other tax attributes apply upon a subsidiary joining or leaving a group.
Consolidated taxable income
Taxable income of each member is computed as if no consolidated return were filed, with the exception of certain items computed on a consolidated basis. Then adjustments are made for certain transactions between group members. Dividends between group members are eliminated. Sales of property between members give rise to a deferred intercompany transaction. The effect on the selling member is deferred and recognized as the corresponding effects are recognized by the buying member. For example, Member A sells Member B some goods at a profit. This profit is not recognized until Member B sells the goods or recognizes depreciation expense on the goods. These complex rules require adjustments related to intra-group sales of property (including depreciable assets and inventory), transactions in stock or other obligations of members, performance of services, entry and exit of members, and certain back-to-back and avoidance transactions.
Certain deductions and most credits are computed on a consolidated rather than separate company basis. These include the deductions for net operating loss, charitable contributions, domestic production activities deduction, dividends received deduction and others.
Each member of a group must recognize gain or loss on disposition of its shares of other members. Such gain or loss is affected by the member's basis in such shares. Basis must be adjusted for several items, including taxable income or loss recognized by the other member, distributions, and certain other items. To the extent a member recognizes losses in excess of the owner's basis, such excess loss is treated as negative basis for all U.S. Federal income tax purposes. Additional adjustments apply in the case of intra-group reorganizations or acquisition of the common parent, and upon entry to or exit from the group by a member. The adjustments “tier up” to consolidated return members who own shares of the entity making the adjustment. Numerous other adjustments apply.
All members of the group must use the same tax year as the common parent. This may be adopted or changed by the common parent. If one group acquires another group, the acquiring common parent's tax year must be adopted by all acquired subsidiaries then meeting the 80% vote and value test. Short periods may be required upon joining or leaving a group. In addition, if a member enters or leaves the group, certain adjustments to earnings and profits, basis, and other tax attributes apply.
Several countries allow related groups of corporations to compute income tax on a consolidated basis, in a manner similar to consolidation for financial reporting purposes. This is referred to in the Netherlands and Luxembourg as a Fiscal Unity, and in France as Intégration Fiscale. A similar consolidated return regime applies in Spain. In such systems, consolidating eliminations of income and expense are taken into account.
The Netherlands system allows a group of Netherlands resident corporations and branches of foreign corporations to elect to be taxed as a Fiscal Unity. Such election is permitted only for a parent corporation and its 95% or greater owned subsidiaries. Upon election, the parent is taxed on the combined income of the members of the group. The parent and subsidiaries retain joint and several liability for the tax of the group.
Netherlands fiscal unity functions much like financial statement consolidation. Intra-group transactions, including property transfers, are generally eliminated. Most intra-group reorganizations do not trigger taxable events.
Some countries allow losses of one commonly controlled company to offset the profits of another commonly controlled company. The United Kingdom permits group relief, and Germany permits an Organschaft. Neither of these systems involve combined reporting or combined tax return filing, though certain additional reporting may be required.
Under the UK scheme, a company's losses may be surrendered to a related company if several conditions are met. The companies must be 75% owned companies. For this purpose, a parent company and its subsidiaries qualify if the parent company owns at least 75% of the ordinary share capital of the subsidiary(ies) and have a beneficial interest in at least 75% of any distributions of earnings or upon winding up. Alternative similar rules apply for certain corsortia and branches. Under European Court of Justice rulings incorporated into UK law, the parent company need not be resident in the UK.
The UK scheme allows losses of one group member to be relieved (deducted) by members using a different accounting period, with certain adjustments. Trading (business) losses, capital losses, certain excess (disallowed) management expenses from non-UK affiliates, and certain excess charges may be relieved, subject to limitations. The surrender of these items is done by one company for the benefit of one other company.
Some states in the United States require related corporations to file a consolidated return if such corporations constitute a unitary business or unitary group. Such consolidated returns tend to follow the pattern of United States Federal consolidated returns, though differences exist in the particular rules. Generally, a group of corporations in the same, similar, or integrated businesses that are under common management and operational control may be treated as a unitary group.
In a late June, 1983 decision, the US Supreme Court first sanctioned worldwide combined reporting in Container Corp. v. Franchise Tax Board (CA). The years in question were 1963-1965 and the California corporate income tax rate was 5.5%. The additional amount of tax due applying the worldwide combined reporting method was less than $72,000. The vote was 5-3, Justice John Paul Stevens did not participate.
The court's majority decision was written by Justice Brennan, joined by White, Marshall, Blackmun, and Rehnquist. Justice Powell wrote the dissenting opinion, joined by Burger and O'Connor. Friend-of-the-court amicus curiae briefs were filed in support of California by the Attorneys General of Idaho, Utah, Illinois, Montana, New Mexico, New York, North Dakota, Oregon, Alaska, Colorado, Connecticut, Delaware, Indiana, Kansas, Massachusetts, Michigan, Nebraska, Minnesota, Missouri, New Hampshire, North Carolina, Hawaii, and Vermont. Also, in support of California, briefs were filed by the National Governors' Association, the National Farmers Union, and the Citizens for Tax Justice.
In support of the Container Corporation, amicus briefs were filed by Allied Lyons, Coca-Cola, Colgate-Palmolive, EMI Limited, Firestone Tire & Rubber, Canadian Imperial Bank of Commerce, Caterpillar Tractor, Gulf Oil, Phillips Petroleum, Shell Oil, and Sony. Also, in support of Container, were briefs filed by the U.S. Chamber of Commerce's Committee on State Taxation, the Financial Executives Institute, the Government of the Kingdom of the Netherlands, the Confederation of British Industry, the International Bankers Association in California, and the Union of Industries of the European Union.
Within days of that decision, UK Prime Minister Margaret Thatcher contacted the Reagan Administration to petition the court for a re-hearing and to introduce federal legislation to prevent any state from utilizing worldwide combined reporting. For example, in a letter dated 8/30/83, Thatcher wrote the following:
I am writing to you personally to stress our concern over the use by States of unitary taxation and to urge you to support legislation to ban it.
You will know that Nigel Lawson wrote to Donald Regan on 12 July, following the Supreme Court decision in the Container Corporation case. In that letter he drew attention to the very strong pressure that is building up here, both in the business community and in Parliament which approved the ratification of the 1980 Double Taxation Convention on the understanding that action to eliminate unitary taxation would soon be undertaken.
The spread of unitary taxation would hinder international trade and investment and the growing interdependence of Western economies. Briefly, our objections to it, which are shared, as you will know, by the other members of the European Community, are that it runs totally contrary to the international accepted arm's length method of attributing profits to members of a group for tax purposes; that it involves very heavy compliance costs; and that it undermines internationally accepted methods of relieving double taxation. Its spread would act as a severe disincentive to UK investment in those States which apply it, thus harming both our countries; and, since we abolished Exchange Control, there is now more UK investment available. Less developed countries would, we believe be tempted to follow suit and to adopt it as a method of taxing overseas investment. I am sure you will agree that this would not be in the interests of either of our countries.
The strength of feeling in our Parliament was shown last month, when a Member sought to introduce legislation which would have had the effect of denying to US parent companies relief from UK tax which is given under the Double Taxation Convention. Pressure for retaliatory action of this kind is bound to grow if unitary taxation remains unchecked.
I understand that there may be a re-hearing of the Container Corporation case, which would afford another opportunity for your Administration to file an amicus curiae brief. I would welcome this and would also urge you to lend the Administration's support to the application for a re-hearing and to file a brief for this purpose. I believe, however, that legislation against unitary taxation is also needed; and I am therefore urging you to support legislation which would ban it.
I fully recognise the serious constitutional issues which this matter raises for you. But I believe that the international implications are of very great importance. If the practice of unitary taxation is not curbed, it could do harm to the economic relations between our two countries and between the USA and the European Community and other industrialised countries.
Although unsuccessful, Thatcher was able to get the Reagan Administration to pressure the dozen states utilizing worldwide combined reporting to restrict its scope to the water's edge to US domestic corporate entities. In a letter dated 5/14/84, Reagan wrote the following letter to Thatcher:
Thank you for your timely letter on unitary taxation. As we discussed last year, I fully appreciate your concern on this issue and the problems it has posed for your government.
I am pleased to say that I have been informed by Secretary Regan that at its May 1 meeting the Worldwide Unitary Tax Working Group reached agreement in principle to recommend that the states adopt a "water's edge" limitation to the application of unitary taxation. This would apply to both U.S. and foreign-based companies. I believe such a limitation would meet your concerns about taxation of British multinationals in the United States, and I will urge that the states implement this recommendation as quickly as possible.
As you noted, the states are very concerned about the effect a "water's edge" approach would have on their revenues. Largely for this reason, the Working Group did not reach agreement on how states should tax dividends American firms receive from their foreign subsidiaries; of course, this issue does not directly affect British firms.
The recommendations agreed upon by the Working Group include a number of measures for increased federal efforts to assist in the administration of separate accounting and arm's-length pricing and greater sharing with the states of federal tax information. These measures will greatly aid the states in administering their tax systems, but they are contingent on state acceptance of the Working Group's recommendation on "water's edge."
While implementation of the Working Group recommendations is the responsibility of each state, I am confident that competition between states for new investment will spur them to act quickly on this issue. A number of state officials, as you have probably heard, have recently expressed reservations over continued use of the unitary method.
Thank you for writing. I look forward to seeing you in less than a month.
The Working Group agreed on three principals that should guide state taxation of the income of multinational corporations:
Principal One: Water's edge unitary combination for both U.S. and foreign based companies.
Principal Two: Increased federal administrative assistance and cooperation with the states to promote full taxpayer disclosure and accountability.
Principal Three: Competitive balance for U.S. multinationals, foreign multinationals, and purely domestic businesses.
 In 1985 the United Kingdom passed retaliatory legislation which would have overridden the UK-US tax treaty and denied significant UK tax benefits to corporations headquartered in US states which applied worldwide unitary taxation.
California adopted a requirement that both United States and foreign corporations be included in a worldwide unitary group filing, absent a “water's edge” election and fee. This requirement was limited somewhat by the U.S. Supreme Court in Barclays Bank PLC v. Franchise Tax Board. The vote in that case was 7-2 in favor of California and 9-0 in the companion Colgate-Palmolive case.  California subsequently repealed the “water's edge” fee. Illinois requires unitary group filings for United States corporations only.
Under the unitary concept, all commonly controlled corporations within the unitary management and control group are required to join in a consolidated return filing for the state. An example of why a state would adopt unitary combined reporting is in Vermont's 2004 Act #152 STATEMENT OF INTENT:
In recognition of the fact that corporate business is increasingly conducted on a national and international basis, it is the intent of the general assembly to adopt a unitary combined system of income tax reporting for corporations, and as an integral part of this proposal, to lower the corporate income tax rates. Vermont's separate accounting system is inadequate to measure accurately the income of a corporation with non-Vermont affiliates and creates tax disadvantages for Vermont corporations which compete with multistate and multinational corporations doing business in Vermont. It is the intent of the general assembly, in adopting a unitary combined reporting system, to put all corporations doing business in Vermont on an equal income tax footing, and with the revenue from the expanded and more accurate tax base, to lower Vermont's corporate income tax rates.
The enabling statute, however, excludes "overseas business organizations" from the taxable combined group so water's edge instead of worldwide combined reporting is adopted. Therefore, purely domestic businesses (i.e. national multi-state corporations) are subject to tax on 100% of their taxable profits, U.S. based multinational corporations are subject to tax on 100% of their reported U.S. profits plus foreign profits via repatriated dividends from foreign subsidiaries (if and when repatriated), and foreign based multinational corporations are subject to tax on 100% of their U.S. subsidiaries' reported U.S.profits. As a result, under water's edge combined reporting, separate accounting is only ignored for purely domestic businesses but retained for multinational corporations. Per the 2003-2004 Biennial Report of the Vermont Commissioner of Taxes, the adoption of unitary combined reporting "will diminish opportunities for certain aggressive tax management strategies that were available to multi-state corporations and will help create a level playing field with respect to Vermont-based corporations."  Therefore, under water's edge, U.S. based and foreign-based multinationals have the ability to shift U.S. profits to foreign subsidiaries and avoid federal and state income taxes. Profits shifted out of the U.S. would be taxed only if and when they are repatriated as foreign dividends to a U.S. based multinational. Most foreign countries do not tax foreign dividends received by multinationals based in their countries so profits shifted out of the U.S. by U.S. subsidiaries owned by foreign based multinationals and later repatriated to the foreign parent are usually not taxed.
The State of New Hampshire adopted worldwide combined reporting in 1981 but restricted it to water's edge five years later in 1986. In 1999, in Caterpillar Inc. v. New Hampshire Department of Revenue, the court stated "We point out that the water's edge method was adopted for the benefit of foreign businesses." 
Approaching 30 years since the 1984 principals of the Worldwide Unitary Tax Working Group, it is questionable whether or not a competitive balance for U.S. multinationals, foreign multinationals, and purely domestic businesses has been attained. Bloomberg reporter Jesse Drucker demonstrates that separate accounting/arm's length pricing favors the multinationals in an October 2010 article titled "Google 2.4% Rate Shows How $60 Billion Lost to Loopholes" with tax strategies known as the "Double Irish" and the "Dutch Sandwich."  In a New York Times October 2012 Dealbook column, Victor Fleischer wrote about "Overseas Cash And The Tax Games Multinationals Play." Although billions in corporate profits are reported to be on the books of foreign subsidiaries located in tax havens, a New York Times article by David Kocieniewski titled "For U.S. Companies, Money Offshore Mean Manhattan" dated May 2013, indicates that those corporate profits are being utilized in the U.S.  This is supported by a more recent report by Kitty Richards and John Craig at the Center for American Progress titled "Offshore Corporate Profits - The Only Thing 'Trapped' is Tax Revenue"  An article by Floyd Norris in the May 23, 2013 New York Times, "The Corrosive Effect of Apple's Tax Avoidance", points out how these tax avoidance strategies will most likely be followed by many other multinational corporations.  And, an article by David Gelles titled "New Corporate Shelter: A Merger Abroad" dated October 8, 2013 makes a case that the best tax strategy for a U.S. based corporation is to become a foreign based corporation. 
The apportionment factors for state income tax are computed on a consolidated basis and applied to the income of members doing business in the state. Illinois taxes only United States corporations in this manner. California, following the Barclays case, modified its rules to include in the combined reporting only the taxable income of United States corporations. California's computation of apportionment factors is still based on worldwide group amounts unless a “water's edge” election is made.
- Crestol, Jack; Hennessey, Kevin M., and Yates, Richard F.: "Consolidated Tax Return : Principles, Practice, Planning, 1998 ISBN 978-0-7913-1629-0
- Hellerstein, Jerome & Walter, and Youngman, Joan: State and Local Taxation, ISBN 0-314-15376-4.
- The very complex rules are contained in 26 CFR 1.1502-1 through -100, authorized by the one paragraph 26 USC 1502.
- According to the CCH State Tax Handbook, 26 states either permitted or required consolidated or combined returns for 2009. See ISBN 978-0-8080-1921-3. Consolidated or combined returns are not the same as composite returns. Many states require or permit that flow through entities (partnerships, LLCs, or S corporations) file a composite return reflecting the income of nonresident members. Such composite returns are often filed in lieu of the relevant members filing separate (e.g., individual) returns.
- Those states requiring or permitting consolidated returns generally allow only entities joining in the Federal consolidated return to file a consolidated state return. Rules vary widely by state.
- For definitions, see 26 USC 1504.
- 26 CFR 1.1502-75.
- 26 CFR 1.1502-30 and 26 CFR 1.1502-31.
- 26 CFR 1.1502-12.
- 26 CFR 1.1502-11 through 26 CFR 1.1502-28.
- 26 CFR 1.1502-13.
- 26 CFR 1.1502-12.
- 26 CFR 1.1502-32.
- 26 CFR 1.1502-30 and 26 CFR 1.1502-31.
- 26 CFR 1.1502-76.
- Chorus, Jeroen M. J.; Gerverm P. H. M.; Hondius, E. H.: Introduction to Dutch Law, p. 463. ISBN 978-90-411-2507-1.
- United Kingdom HMRC Corporation Tax Manual CTM 80100 Group Relief.
- For a general discussion, with cases, see Hellerstein, Hellerstein, & Youngman, State and Local Taxation, chapter 8 section 3. ISBN 0-314-15376-4.
-  (under a search for "unitary taxation")
-  [Office of the Secretary Department of the Treasury: The Final Report of the Worldwide Unitary Taxation Working Group, Chairman's Report and Supplemental Views] (August 1984)
- Income and Corporation Taxes Act 1988 Section 812
-  114 S.Ct. 2268 (1994).