Often, a parent corporation and its subsidiaries will file a consolidated tax return because it comes with many benefits, such as being able to offset gains and losses and deferring tax consequences for sales between consolidated groups. The parent corporation and the subsidiaries will often enter into a tax sharing agreement, which will determine each entity’s respective tax liability. In the event that a refund is issued, the tax sharing agreement will usually dictate how to allocate the refund amongst the parent and the subsidiaries.
A tax sharing agreement is “an agreement among members of an affiliated group of entities that file consolidated or combined tax returns that allow for the allocation or apportionment of certain tax attributes among affiliates.” State law determines the “validity and interpretation” of the tax sharing agreement. In particular, the plain language of the tax sharing agreement will determine its “validity and interpretation.” The parties to the tax sharing agreement are free to allocate the rights of the tax benefits amongst themselves. A tax sharing agreement may allocate the tax benefits by explicitly stating which entity is entitled to the tax benefits under the tax sharing agreement or by implicitly relying on the past relationship of the parties. Most tax sharing agreements explicitly provide how to allocate the tax benefits amongst the affiliated group. However, “these agreements often differ in their precise language, and these differences can be critical” to determining the rights of each party. Although the IRS will return the tax refund to one entity initially, the tax sharing agreement will determine how the tax refund will be distributed amongst the parent corporation and its subsidiaries.
The language of the tax sharing agreement will create relationships that will determine which entity owns the tax refund. The types of relationships formed are generally a debtor-creditor, agency, or trust relationship. On one hand, if a debtor-creditor relationship was created under the tax sharing agreement, a tax refund is “considered to be ‘owned’ by the entity receiving it.” Some courts have found that words such as “payments” and “reimbursements” will create a debtor-creditor relationship. However, on the other hand, at least two circuit courts have recently rejected such an analysis. Those circuit courts stated that those words do not indicate a debtor-creditor relationship was formed between the parent corporation and the subsidiary. If a debtor creditor relationship was not created in the tax sharing agreement, courts will generally determine that an agency or trust relationship was formed. If the court determines that an agency or trust relationship exists, the entity that receives the tax benefit will be considered to be holding the benefit in trust of the other entity.
This Article is separated into two parts. Part I discusses the different results when the tax sharing agreement is either explicit, silent, or ambiguous as to who owns a tax refund between a parent corporation and its subsidiary. Part II summarizes the implications of the conflicting court decisions regarding tax sharing agreements.