Bank Holding Companies, It Is Time To Update Your Tax Sharing Agreements

It is time to update tax allocation agreements between bank holding companies and affiliated entities, say the federal regulators.  According to guidance issued this summer, examiners will be looking for updated tax allocation agreements beginning this fall. 

photo by Phillip via on flickr/Foter

Bank holding companies usually own all of the outstanding stock of their depository institutions, which means that the holding companies and their banks are deemed to be "affiliated groups" within the meaning of Section 1504 of the Internal Revenue Code. Accordingly, they often choose to file consolidated federal income tax returns, and in some states, they are required to file consolidated state income tax returns. To address the allocation of the tax liability and the timing of contributions, bank holding companies and their banks are required* to enter into tax allocation agreements.

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.

The agencies' addendum states that the agencies expect tax sharing agreements to be updated by October 31, 2014 (although it is not a true deadline).  Therefore, bank holding companies should update their tax sharing agreements and obtain board approvals promptly, if they have not already done so.

New Tax Changes in North Carolina

July means the start of a new fiscal year for the State of North Carolina, which means some new changes to the tax code become effective.  Below are brief descriptions of some of the key changes:

Elimination of Back to School (August) Sales Tax Holiday.

N.C. General Statutes Section 105-164.13C provided an exemption for certain items of tangible personal property sold between the first Friday in August and the following Sunday.  It included clothing, footwear, and school supplies of $100 or less per item; school instructional materials of $300 or less per item; sports and recreation equipment of $50 or less per item, computers of $3,500 or less per item; and computer supplies of $250 or less per item will be exempt.  Clothing accessories, jewelry, cosmetics, protective equipment, wallets, furniture, items used in a trade or business, and rentals were never covered by the exemption to begin with.  The elimination of this exemption is expected to yield $14.7 million during  fiscal year 2014-2015.  

 

Elimination of Energy Star Products Tax Holiday

 

N.C.G.S. 105-164.13D provided an exemption from sales and use tax from the first Friday in November through the following Sunday for Energy Star products.  An "Energy Star qualified product" is "a product that meets the energy efficient guidelines set by the [EPA] and the United States Department of Energy and is authorized to carry the Energy Star label."  Items purchased for use in a trade or business and rentals were not covered by the exemption.  This sales tax holiday was enacted in 2008, and eliminating it is expected to bring $1.6 million in FY14-15 . 

 

Elimination of Sales Tax Exemption for Bakery Thrift Stores

A bakery thrift store is a retail outlet of a bakery that sells at wholesale over 90% of the items it makes and sells at the retail outlet day-old bread returned to it by retailers.  The exemption from sales tax was enacted in 2007, and its repeal is expected to result in $3.9 million in revenue in FY14-15.

 

Cap on Sales Tax Refund for Nonprofit Entities

Nonprofits will begin paying sales tax on purchases that exceed $666 million in a fiscal year.   In other words, the exemption is now capped at $45 million annually.   

 

Income Requirement for Farm Equipment Emption 

Farm equipment will continue to be exempt from sales tax, but only if the farm has a certificate showing annual gross income from farming operations of $10,000.   More than 40,000 farm exemption certificates are currently outstanding.  North Carolina has more than 52,000 farms, according to the 2007 USDA Census of Agriculture.  There are a number of issues that remain to be addressed in connection with this change.  The change in this exemption is expected to result in $16.5 million in revenue for FY14-15. 

 

Sales Tax on Energy

State sales tax will now be due on electricity and piped natural gas at the combined general rate.  The combined general rate is the State's general rate of tax plus the sum of the rates of the local sales taxes authorized for all counties. The current combined general rate is 7%.  A number of other taxes on electricy and natural gas are repealed in connection with this change, including the following:

• Franchise taxes on electric power, water, and public sewerage companies (G.S. 105-116). 
• Distribution of electric power company franchise tax to cities (G.S. 105-116.1). 
• The 3% sales tax discount for municipalities that sell electricity (G.S. 105-164.21A). 
• Payments in lieu of franchise taxes required of electric cities and joint power agencies (G.S. 159B-27(b) through (e)).