Was the federal tax savings retained by a parent under a consolidated-return tax-sharing agreement dividend income eligible for the historical dividend deduction?

Plain-English summary

California Legal Ruling 13 treated the federal tax savings retained by a parent corporation under a consolidated-return arrangement as dividend income from its subsidiaries.

Each subsidiary paid the parent the federal tax it would have owed on a separate return. The parent paid the group's lower consolidated federal liability and retained the difference.

The ruling also allowed the parent to use the historical section 24402 dividend deduction where the distribution came from subsidiary income already included in California's franchise-tax measure, even though no formal dividend was declared.

How the tax-sharing arrangement worked

The parent filed federal consolidated returns and achieved a substantial federal tax saving.

The subsidiaries did not share in that saving. Under written agreements, each subsidiary:

• computed federal tax as if it filed separately; and
• remitted that separately computed amount to the parent.

The parent calculated the subsidiary's allocable portion of the actual consolidated federal liability. The difference between the subsidiary's remittance and that allocable liability stayed with the parent.

The subsidiaries treated their excess payments as nondeductible.

Why the retained difference was a dividend

The ruling said distributions from earnings and profits could constitute dividends even when:

• they appeared to rest on consideration and were not labeled dividends;
• they were not proportional to stock ownership; or
• no formal dividend declaration occurred.

The net tax-sharing difference therefore was dividend income to the parent on the stated facts.

Why the deduction did not require formal declaration

Former section 24402 referred to dividends declared from income included in the declaring corporation's tax measure.

A literal reading could have denied the deduction because these payments were not formally declared dividends.

FTB rejected that narrow reading. The provision's purpose was to avoid double taxation of dividend income already subjected to franchise tax, and its wording focused on the income source rather than requiring corporate declaration formalities.

Income included in the tax measure

Several subsidiaries conducted all business in California, so all their earnings and profits were included in their franchise-tax measure.

The separately computed tax remittances arose only when a subsidiary had income. The ruling therefore considered it reasonable to treat the payments as coming from that income.

On those facts, the parent could claim the section 24402 deduction for the constructive dividend.

What this means for you

Affiliated corporate groups

Under the historical ruling, the economics of a tax-sharing agreement could create dividend treatment even without a board-declared cash dividend.

Parent companies

Retaining subsidiary remittances above the subsidiaries' shares of the consolidated liability was treated as a distribution from their earnings and profits.

Accountants and tax professionals

Reconcile separate-return calculations, actual consolidated liability, allocation methods, intercompany remittances, earnings and profits, California tax-measure inclusion, and formal tax-sharing terms.

Common questions

Q: Was the retained tax saving dividend income to the parent?

A: Yes.

Q: Did the subsidiaries formally declare dividends?

A: No, but the ruling said formal declaration was not required for the historical deduction.

Q: Why did section 24402 allow a deduction?

A: Its purpose was to avoid double taxation when the distributed income had already been included in the subsidiary's California tax measure.

Q: Did the subsidiaries receive the consolidated-return savings?

A: No. They paid separately computed amounts, and the parent kept the difference from the lower consolidated liability.

Q: Was every possible tax-sharing payment covered?

A: No. The ruling expressly based its conclusion on the facts presented.

Citations and references

• Former Cal. Rev. & Tax. Code § 24402
• Corporation of America v. Johnson, 7 Cal. 2d 295 (1936)
• 21 California Law Review 548

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 13

Original ruling text

Home

Legal Ruling 1958-13

California Franchise Tax Board
Legal Ruling No. 013

June 26, 1958

Dividend Income: Parent Subsidiary

From the facts presented, the net difference between the amount of tax computed by the parent corporation on consolidated returns and that amount computed separately by the subsidiaries and remitted to the parent corporation is to be treated as dividend income under section 24402 of the Bank and Corporation Tax Law.

The parent files consolidated returns for Federal purposes only, and thereby affects a considerable Federal tax saving.  However, none of this tax saving is passed along to the subsidiaries as each subsidiary computes its Federal tax liability separately (nonconsolidated) and remits this sum to the parent company pursuant to a written agreement to that effect.  The parent then computes the proportionate part of the consolidated Federal tax liability allocable to the subsidiary and the net difference is treated as dividend income. The subsidiaries treated the item as an unallowable deduction.

A number of the subsidiaries do their entire business in California and all of the earnings and profits would be included in the measure of the franchise tax of the subsidiary which has enabled the parent annually to claim a large deduction under the provisions of section 24402.

Advice is requested as to whether the net difference is to be treated as dividend income to the parent and as dividends for the purposes of the provisions of section 24402.

There are numerous cases which hold that a distribution out of earnings and profits may be taxable to the shareholders as dividends even though (1) they purport to be based upon a consideration and are not designated as dividends, (2) they are not in proportion to the stockholdings, or (3) there is no formal declaration of a dividend.

A more difficult question arises as to whether the amounts may be treated as dividends for the purposes of the deduction provisions of section 24402. That section provides for a deduction to the recipient of dividends declared from income which has been included in the measure of the tax upon the declaring corporation. Here the dividends were not declared as such, and if the above section is literally construed, the deduction would be denied.

The intent and purpose of the deduction is to avoid double taxation of dividend income which has already been included in the measure of the franchise tax (Corp. of America v Johnson (1936) 7 C2d 295). If this purpose is to be fulfilled in the instant case the deduction should be allowed.

The section should not be literally and technically construed as limited to formally declared dividends. The cases reveal many legitimate dividend payments which were not formally declared as such. The particular wording of the statute was apparently intended to emphasize and limit the income out of which the dividend may arise rather than to specifically require a "declared" dividend (see 21 Cal. Law Review 548).

There may be some question as to whether the amounts are out of income "included in the measure of the tax." The estimated tax computed on a separate basis by the various subsidiaries and remitted to the parent is applicable only where the subsidiary has income and we should reasonably assume that the payment of the amounts to the parent are out of that income.

Last updated: 09/24/2025