Fiduciary Duties, Consolidated Returns, and Fairness
Bruce A. McGovern
South Texas College of Law
Nebraska Law Review, Vol. 81, p. 170, Fall 2002
Conflicts of interest between parent and subsidiary corporations often present particularly difficult issues to which state corporate law attempts to respond. This Article addresses one of these issues: the appropriate allocation between a parent and its subsidiary of federal tax savings that arise when the two corporations file a consolidated tax return. Tax savings in this context arise because filing a consolidated return permits the corporations that join in the return to combine their income, deductions, credits and other tax attributes and determine their federal tax liability largely as if they were divisions of a single corporation. For example, if a parent and subsidiary file a consolidated return, the subsidiary's deductions might completely offset the parent's income and eliminate the federal tax liability that the parent would have if it filed its own, separate return. The federal tax rules do not require a specific allocation of tax savings that a parent or subsidiary achieves; that issue is primarily the province of any agreement that the corporations enter into and of areas of law other than the federal tax laws, including state corporate law.
The allocation issue is not a new one, but it is one that has proved especially difficult for the courts to resolve and that has arisen with increasing frequency in recent years, particularly in the bankruptcy context. Minority shareholders or creditors of a subsidiary have sought unsuccessfully in several cases to compel the parent either to share its tax savings or to restore to the subsidiary tax savings that the subsidiary was required to share with the parent. This lack of success exists because, despite the well-established rule that a parent corporation serves as a fiduciary of its subsidiary's minority shareholders and, in some circumstances, the subsidiary's creditors, the courts have developed what is tantamount to a per se rule that a parent has virtually unlimited discretion in allocating tax savings. In this Article, the author demonstrates that the early judicial decisions primarily responsible for the development of this rule do not constitute an appropriate foundation for the construction of a normative rule. The author also discusses how the federal tax rules, despite their lack of a required allocation, reflect a policy directly contrary to the result of most recent judicial decisions. The author argues that allocations of tax savings between parent and subsidiary constitute self-dealing transactions that courts should review under an entire fairness standard and proposes an analytical framework under that standard designed to encourage the negotiation between parent and subsidiary of express tax sharing agreements.
Keywords: Fiduciary duty, consolidated return, consolidated tax returns, parent and subsidiary
JEL Classification: G30, K22, K34Accepted Paper Series
Date posted: January 24, 2003
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