Intercompany Profits

Transactions between the legal entities included in the consolidated financial statements are eliminated such that the consolidated results solely reflect the effects of 3rd party transactions. However, intercompany transactions may be taxable prior to the ultimate 3rd party transaction occurring.   

 

Most tax regimes impose an income tax when the entity or entities included in a particular return enter into a transaction with any entity not included in that same return, regardless of whether those entities are related parties or not. This creates a situation where there is an economic cost that must be accounted in the income taxes currently payable despite the fact that the transaction that gives rise to the tax is eliminated from the financial statements.

 

The elimination of the income tax expense on intercompany profits is recorded as a credit to current income tax expense offset by a deferred charge/prepaid tax rather than a DTA. ASC 740-10-25-3(e) prohibits the recognition of a DTA relating to intercompany profits.

 

There is diversity in practice regarding the types of transactions that should be eliminated and when to account for secondary effects such as Subpart F and FTC implications that arise due to the intercompany transactions.

 

The FASB is currently deliberating changes to these rules.