In accordance with ASC 323-30-25-1, investors in partnerships, unincorporated joint ventures, and limited liability companies (LLCs) should generally account for their investment using the equity method of accounting by analogy if the investor has the ability to exercise significant influence over the investee. However, there may be situations when significant influence does not exist but the equity method of accounting applies.
A general partnership interest in assets, liabilities, earnings, and losses accrues directly to the individual partners. No “corporate veil” exists between the partners and the related investment. General partners in a general partnership usually have the inherent right, absent agreements in partnership articles to the contrary, to influence the operating and financial policies of a partnership.
An interest in a general partnership usually provides an investor with the ability to exercise significant influence over the operating and financial policies of the investee. As such, assuming an investor does not hold a controlling financial interest, a general partnership interest is generally accounted for under the equity method of accounting.
Generally, interests in a limited partnership or unincorporated joint venture when the investor does not have a controlling financial interest would be accounted for under the equity method of accounting by analogy. ASC 323-30-S99-1 describes the SEC staff’s view on the application of the equity method to investments in limited partnerships.
This guidance requires a limited partner to apply the equity method of accounting to its investment unless the limited partner’s interest is so minor that the limited partner has virtually no influence over the operating and financial policies of the partnership.
An ownership interest greater than 3-5% in limited partnerships is presumed to provide an investor with the ability to influence the operating and financial policies of the investee. This differs from the threshold of 20% of outstanding voting securities presumed to create influence for an investment in common stock or in-substance common stock of a corporation. See EM 2.1 for further discussion.
See EM 1.3.3 for guidance on whether a limited liability company should be viewed as a limited partnership or a corporation for purposes of determining whether the equity method of accounting is appropriate.
Limited liability companies frequently have characteristics of both corporations and partnerships. Investors must determine whether a limited liability company should be viewed as similar to a corporation or a partnership for purposes of determining whether its investment should be accounted for under the equity method of accounting.
Per ASC 323-30-35-3, a noncontrolling investment in a limited liability company that maintains a specific ownership account (similar to a partnership capital account structure) for each investor should be viewed similarly to an investment in a limited partnership when determining whether the investment provides the investor with the ability to influence the operating and financial policies of the investee.
An investment in a limited liability company that does not maintain specific ownership accounts for each investor should be viewed similar to an investment in a corporation when determining whether to apply the equity method of accounting.
Joint venture: An entity owned and operated by a small group of businesses (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group. A government may also be a member of the group. The purpose of a joint venture frequently is to share risks and rewards in developing a new market, product, or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities. A joint venture also usually provides an arrangement under which each joint venturer may participate, directly or indirectly, in the overall management of the joint venture. Joint venturers thus have an interest or relationship other than as passive investors. An entity that is a subsidiary of one of the joint venturers is not a joint venture. The ownership of a joint venture seldom changes, and its equity interests usually are not traded publicly. A minority public ownership, however, does not preclude an entity from being a joint venture. As distinguished from a corporate joint venture, a joint venture is not limited to corporate entities.
Joint ventures are often used to create alliances to enter new markets or expand business operations while sharing risks and expertise with other investors. Joint ventures are not limited by the type or legal form of the entity and can be formed as corporations, partnerships, and limited liability companies. The most distinctive characteristic of a joint venture is the concept of joint control. Refer to EM 6 for discussion around identifying and accounting for a joint venture.
Other entities, such as trusts, can take a variety of forms, and may maintain specific ownership accounts. When evaluating investments in these entities, it is often appropriate to analogize to the guidance for limited liability companies (EM 1.3.3) to determine what level of ownership requires the use of the equity method of accounting. Investors should consider all relevant facts and circumstances.
In March 2023, the FASB issued ASU 2023-02, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for investments in tax credit structures using the proportional amortization method. The new guidance expands the use of the proportional amortization method of accounting (PAM) for investments in tax credit vehicles, which historically was only allowed for qualifying investments in affordable housing tax credit structures.
ASU 2023-02 is effective for public entities for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. For all other entities, the guidance is effective for fiscal years beginning after December 15, 2024. Early adoption is permitted.
Companies, particularly financial institutions, may invest in limited partnerships or limited liability companies that generate various tax credits, such as those for qualified affordable housing projects, new markets, or renewable energy such as solar or wind. These investors earn federal tax credits as the principal return for providing capital to facilitate the development, construction, and/or rehabilitation of qualified projects.
Under ASC 323-740, investors in these entities may be eligible, subject to meeting a number of criteria, to elect to apply the proportional amortization method rather than the equity method of accounting. Under the proportional amortization method, investors amortize the cost of their investment as a component of income taxes in the income statement. See TX 3.3.6 for further information on these criteria and the application of the proportional amortization method.
To be eligible for the election, one of the criteria is that the investor cannot have the ability to exercise significant influence over the operating and financial policies of the underlying project. This is evaluated using the indicators of significant influence for determining eligibility for the equity method of accounting (see EM 2.2). The guidance in EM 2.1 includes certain ownership levels at which it is presumed that the equity method should be applied to limited partnerships and similar entities. That guidance should not be considered when determining if significant influence exists for the purpose of this analysis. Companies should evaluate the existence of significant influence for these entities, as the organizational and operating documents for the entities may provide investors with various rights.
Investors that do not qualify for PAM (or do not elect to apply it for a particular type of tax credit program) would account for their equity investments in these entities under either ASC 323 or ASC 321 depending on the facts and circumstances (see EM 1.3.2 on limited partnerships and EM 1.3.3 on LLCs), or under ASC 310 if the investment represents a loan. When accounting for investments in tax credit entities under the equity method, the hypothetical liquidation at book value method would typically be used. See EM 4.1.4.
Companies, particularly financial institutions, may invest in limited partnerships or limited liability companies that operate qualified affordable housing projects or invest in entities that operate qualified affordable housing projects. These investors earn federal tax credits as the principal return for providing capital to facilitate the development, construction, and rehabilitation of low-income rental property. Per ASC 323-740, investors in these entities may be eligible, subject to meeting a number of criteria, to elect to apply the proportional amortization method rather than the equity method of accounting. Under the proportional amortization method, investors amortize the cost of their investment as a component of income taxes in the income statement. See TX 3.3.6 for additional information.
To be eligible for the election, one of the criteria is that the investor cannot have the ability to exercise significant influence over the operating and financial policies of the entity. This is evaluated using the indicators of significant influence for determining eligibility for the equity method of accounting (see EM 2.2). The guidance in EM 2.1 includes certain ownership levels at which it is presumed that the equity method should be applied to limited partnerships and similar entities. That guidance should not be considered when determining if significant influence exists for the purpose of this analysis. Therefore, care should be taken when evaluating the existence of significant influence for these entities.
Investors that do not qualify for the proportional amortization method (or do not elect to apply it) would account for their investments in these partnerships under the equity method if the investor has a more than minor interest in the investee. When accounting for investments in low-income housing tax credit partnerships under the equity method, the hypothetical liquidation at book value model would typically be used. See EM 4.1.4.
For guidance related to accounting for investments in tax credit entities after adoption of ASU 2023-02, refer to EM 1.3.6.