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IAS 12, the international accounting standard on income taxes, requires a parent company to recognize a deferred tax liability on the undistributed earnings of its subsidiaries—except when the parent can control the timing of dividend distribution and it is probable that dividends will not be distributed in the foreseeable future. This rule applies when the subsidiary operates in a jurisdiction where dividends are taxable when distributed.
This is great news for a growing parent company focused on net income. Provided that the aforementioned accounting requirements are met—for example, if the subsidiary reinvests its earnings back into the business and does not distribute any dividends in the near future—the parent recognizes less tax expense at the consolidated level under this rule in the current year.
However, while the parent may appear to benefit from lower taxes, if the plan changes and the subsidiary repatriates earnings back to the parent, the immediate P&L impact could come as a heavy blow to the parent's bottom line.
There is no definitive answer as to the best approach for dealing with dividend distributions by subsidiaries—it all boils down to management's plan and execution. The parent could ask the subsidiary to reinvest its earnings and declare dividends later. Alternatively, the parent could instruct the subsidiary to declare dividends progressively and avoid a large one-time recognition of deferred tax expense and liability.
The point is that scenario analysis could help the parent understand how the bottom line would vary based on changes in the timing of dividend declarations, ahead of finalizing business plans. What does this tell us? Accounting treatments can be favorable or unfavorable for a certain period, so taking a long-term view on how things can unfold is important to avoid surprises.
Navigating growth and need guidance? Contact VMC.
VMC's views are general insights—not one-size-fits-all advice. Every company's situation is unique.
