Accounting for Common Control Transactions

A common control transaction is a business combination or transfer of assets between entities that are controlled by the same party, both before and after the event. From the perspective of the ultimate owner, no substantive change in control has occurred, so the event is viewed as a reorganization of assets within a single economic enterprise. These transactions are often used in corporate restructuring to simplify group structures, for tax planning, or to align business operations more effectively.

For instance, a parent company might move a subsidiary from one of its divisions to another. While the immediate entities involved change, the ultimate controlling party does not, which distinguishes it from an arm’s-length transaction where a new party gains control.

Identifying a Common Control Transaction

Determining if a transaction falls under common control hinges on the concept of “control,” which is a controlling financial interest held by an individual, family, or another entity. This is not limited to majority voting interests; control can also be established through contractual arrangements that give one party the power to direct the activities of another. The requirement is that the same party or group of parties holds this power over the combining entities both before and after the transaction, and this control is not transitory.

A classic example is a parent company transferring a wholly-owned subsidiary to another of its wholly-owned subsidiaries. In this “parent-sub” scenario, the ultimate parent’s control over the transferred business is unchanged. Another common structure is the “brother-sister” transaction, where an individual who owns and controls two separate companies decides to merge them. A downstream merger, where a subsidiary acquires its parent company, is also considered a common control transaction because the ultimate control remains with the same source.

Accounting for the Transaction

Common control transactions are excluded from standard business combination accounting under U.S. GAAP (ASC 805), which requires the acquisition method. Instead, these transactions use a method similar to the historical “pooling of interests” concept, requiring the receiving entity to record the transferred assets and liabilities at their existing carrying amounts, or historical book values. This is known as the “carryover basis.”

Because the transaction is an internal transfer rather than an economic exchange with an outside party, no new basis of accounting is established, and no goodwill is recognized. The receiving entity continues the accounting that was in place for the transferred entity.

For example, Subsidiary A is transferred from Parent Corp. to another subsidiary, Subsidiary B. Subsidiary A has assets with a book value of $500,000 and liabilities of $200,000, for a net book value of $300,000. If Subsidiary B pays $350,000 for Subsidiary A, it still records the assets at $500,000 and liabilities at $200,000. The $50,000 difference between the cash paid and the net book value is not recorded as goodwill or a loss. Instead, it is treated as an adjustment directly to equity, recorded in an account like “Additional Paid-In Capital” or as a deemed distribution, reflecting the transaction’s substance as a capital contribution from the parent.

Financial Statement Presentation and Disclosures

When a common control transaction results in a change in the reporting entity, the financial statements must be retrospectively adjusted for all prior periods presented. The statements are restated as if the two entities had been combined since the date they first came under common control. This provides a continuous and comparable view of the combined entity’s performance.

For example, if a transaction occurs in 2024, the receiving entity’s 2024 financial statements will present the combined results for the full year. The comparative financial statements for 2023 and any other prior periods shown will also be restated to include the financial results of the transferred entity.

Accounting standards also mandate specific disclosures to provide transparency. The notes to the financial statements must include the name and a brief description of the entity being transferred. Companies must also disclose the accounting treatment, confirming that assets and liabilities were recorded at their historical carrying amounts. Additionally, the financial results of the transferred entity, including its revenues and earnings for the period, should be disclosed to give readers a clear picture of the components of the newly combined entity.

Tax Considerations

The tax treatment of a common control transaction is a separate analysis from its financial accounting under GAAP and depends on how the transaction is structured. Many reorganizations can be structured to be tax-free, but this requires careful planning to meet requirements in the Internal Revenue Code.

For a transaction to qualify as a tax-free reorganization, it must satisfy doctrines such as “continuity of interest” and “continuity of business enterprise.” Continuity of interest requires that the original owners retain a significant equity stake in the reorganized enterprise. Continuity of business enterprise requires the acquiring corporation to continue the acquired business’s historic operations or use a significant portion of its historic business assets.

If a transaction does not qualify as tax-free, it is treated as a taxable sale. This can result in taxable gains or losses and may lead to a “step-up” in the tax basis of the assets to their fair market value. This creates a difference between the book and tax basis of the assets, which requires tracking deferred tax assets and liabilities. Due to the complexity, obtaining guidance from a qualified tax professional is a necessary step.