Tax sharing agreements: Overview, definition, and example
What is a tax sharing agreement?
A tax sharing agreement is a contract between two or more parties, typically within a corporate group, that outlines how tax liabilities and benefits will be allocated among the entities involved. These agreements are often used by parent companies and subsidiaries or related companies that are part of the same corporate structure, especially when they file consolidated tax returns. The tax sharing agreement specifies how the entities will share the responsibility for taxes, including income taxes, sales taxes, and other types of taxes. It also details how refunds or tax credits, if any, will be distributed among the parties.
For example, a parent company and its subsidiaries may enter into a tax sharing agreement to determine how much each company will pay or receive based on their individual income or tax positions.
Why are tax sharing agreements important?
Tax sharing agreements are important because they provide clarity and fairness in managing tax liabilities within a corporate group. Without such agreements, it can be unclear how to allocate tax expenses or benefits, leading to potential disputes or inefficiencies. By having a formal agreement, the companies involved can ensure that tax responsibilities are distributed in a way that aligns with their financial interests and complies with applicable tax laws. Additionally, tax sharing agreements help prevent conflicts with tax authorities and facilitate smoother internal financial management by clearly defining each entity’s share of tax obligations or refunds.
Understanding tax sharing agreements through an example
Let’s say a parent company owns multiple subsidiaries, and they file a consolidated tax return for the entire group. The tax sharing agreement between the parent and its subsidiaries would specify how the total tax liability for the group is divided among the parent and each subsidiary, based on factors like their respective revenues or profits. If one subsidiary generates a tax refund due to overpayment, the agreement would determine how the refund is distributed among the subsidiaries.
In another example, a group of companies may have incurred tax credits from a previous year. The tax sharing agreement would outline how those credits are allocated among the companies in the group, ensuring that each entity receives its fair share of the benefits.
An example of a tax sharing agreement clause
Here’s how a tax sharing agreement clause might appear in a contract:
“The Parent and each Subsidiary agree to share the tax liability arising from the consolidated tax return in proportion to their respective income as reported in the consolidated financial statements. In the event of a tax refund or credit, the Parent will distribute the refund to the Subsidiaries based on their contribution to the consolidated tax liability, subject to any other provisions in this Agreement.”
Conclusion
Tax sharing agreements are crucial for managing the allocation of tax liabilities and benefits within a group of related entities. These agreements provide clear guidelines for how taxes will be divided and ensure that each party's responsibilities are fairly and legally defined. By setting out the terms for handling taxes, refunds, and credits, tax sharing agreements help streamline corporate tax management and reduce the potential for disputes among affiliated companies, ensuring compliance with tax regulations and promoting financial transparency.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.