Rodriguez v. Federal Deposit Insurance Corp. was filed by the Chapter 7 trustee for the bankruptcy estate of United Western Bancorp Inc., the parent company of United Western Bank. The trustee argues that the $4.1 million refund belongs to the parent holding company. The Federal Deposit Insurance Corp. (FDIC), acting as the receiver for the subsidiary bank that generated the loss, asserts it belongs to the subsidiary. The case should prompt bank holding companies to review their tax allocation, or tax sharing, agreements to avoid their own prolonged court battles.
The case before the CourtThe IRC allows a parent corporation and its subsidiaries to file a single consolidated tax return. One of the advantages of filing one consolidated return is that it permits members of the group to offset each other’s tax losses. It also simplifies interactions with the IRS, giving the common parent the authority to act as an agent on behalf of the consolidated group.
When a parent corporation and its subsidiaries file a consolidated return, the tax refunds are issued to the parent corporation, raising the question of who owns the refund – the parent or the subsidiary. Three federal courts of appeals previously have applied the so-called “Bob Richards rule,” in reference to a 1973 court case, In re Bob Richards Chrysler-Plymouth Corp. Under this rule, a tax refund paid to an affiliated group is presumed to belong to the corporate subsidiary whose losses gave rise to the refund unless the parties clearly agree otherwise. Four federal courts of appeals have rejected that rule, though, instead determining ownership of a tax refund based on applicable state law.
United Western Bancorp and its subsidiary United Western Bank entered bankruptcy and filed competing claims for the $4.1 million tax return issued to United Western Bancorp. The bankruptcy court applied Colorado state law and determined that the refund belonged to the holding company rather than the subsidiary. The 10th Circuit Court of Appeals disagreed, holding that the refund belonged to the subsidiary in the absence of “unambiguous” language in the written terms of the parties’ tax allocation agreement that assigns it to the holding company.
Tax allocation agreements typically cover common issues such as:
- The requirement that the parent and subsidiary compute their income taxes (both current and deferred) on a separate-entity basis
- The timing of the institution’s tax payments
- Reimbursements to an institution when it has a loss for tax purposes
- The prohibition of the payment or other transfer of deferred taxes by the institution to another member of the consolidated group
In 1998, the FDIC, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision issued guidance on income tax allocation in a holding company structure.
Among other things, the guidance states that a tax allocation agreement should be drafted to make clear that the holding company that receives a tax refund is acting as an agent for the group on behalf of its members. The agreement should not characterize refunds attributable to a subsidiary depository institution that the parent receives from a taxing authority as the property of the parent.
After the 1998 guidance was released, courts reached different conclusions regarding whether tax allocation agreements create a debtor-creditor relationship between a holding company and failed banks that are insured deposit institutions (IDIs). Some courts found that the tax refunds in question were the property of the holding company in bankruptcy (rather than property of the subsidiary IDI) and held by the holding company as the IDI's debtor – meaning a bank would have to get in line with other creditors to claim its tax refund. These findings generally were the result of tax sharing agreements that were unclear about the allocation of the refunds.
In 2014, regulators responded by releasing additional guidance advising consolidated groups to review their tax allocation agreements to confirm they clearly acknowledge that an agency relationship exists between the holding company and its subsidiary IDIs with respect to tax refunds. According to the additional guidance, agreements that fail to do so could be subject to additional requirements under Section 23A of the Federal Reserve Act of 1913, which restricts the ability of a member bank to fund its affiliates through a loan or similar transaction.
The regulators provided the following sample language for companies to use:
The [holding company] is an agent for the [IDI and its subsidiaries] (the "Institution") with respect to all matters related to consolidated tax returns and refund claims, and nothing in this agreement shall be construed to alter or modify this agency relationship. If the [holding company] receives a tax refund from a taxing authority, these funds are obtained as agent for the Institution. Any tax refund attributable to income earned, taxes paid, and losses incurred by the Institution is the property of and owned by the Institution, and shall be held in trust by the [holding company] for the benefit of the Institution. The [holding company] shall forward promptly the amounts held in trust to the Institution. Nothing in this agreement is intended to be or should be construed to provide the [holding company] with an ownership interest in a tax refund that is attributable to income earned, taxes paid, and losses incurred by the Institution. The [holding company] hereby agrees that this tax sharing agreement does not give it an ownership interest in a tax refund generated by the tax attributes of the Institution.1In reviewing their agreements, consolidated groups should see that their tax allocation agreements not only clearly acknowledge that an agency relationship exists between the holding company and its subsidiary IDIs with respect to tax refunds but also do not contain other language to suggest a contrary intent.
Do not wait for the Supreme Court
Holding companies that have not already amended their tax sharing agreements should consider revising them to incorporate the sample language. Until the Supreme Court weighs in, though, lower courts might reach different conclusions regarding whether an agreement creates a debtor-creditor relationship. A Supreme Court decision potentially could lead to additional regulatory guidance down the road.
1 "Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure," Federal Deposit Insurance Corp., June 30, 2014, https://www.fdic.gov/regulations/laws/rules/5000-5000.html