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SCOTUS to rule on wrangling over corporate tax refunds

In a case that aims to resolve whether a parent corporation or its subsidiary owns a tax refund during bankruptcy proceedings, the U.S. Supreme Court will soon decide Rodriguez v. Federal Deposit Insurance Corp. The outcome has the potential to impact hundreds of millions of dollars in corporate tax refunds.

At issue in the case is the Bob Richards rule, in which the presumption is that a tax refund belongs to a subsidiary unless the parties agree otherwise. The current case involves a dispute between United Western Bancorp Inc. and its subsidiary United Western Bank, or “Bank,” both of which claimed a $4 million tax refund when the two entered bankruptcy.

UWBI received a tax refund check from the IRS while it was in Chapter 7 bankruptcy proceedings. The refund was the result of net operating losses incurred by one of its subsidiaries, Bank. UWBI and its subsidiaries had entered into an allocation agreement.

The FDIC, as receiver for the subsidiary Bank, argued that it was entitled to the refund. Simon Rodriguez, as the Chapter 7 trustee for the bankruptcy estate of UWBI, argued that UWBI owned the refund, and therefore it was part of the bankruptcy estate. The courts of appeals are split on the issue -- four circuits hold that ownership of a tax refund paid to an affiliated group should be based on the law of the relevant state, while three circuits have ruled that federal common law should apply (the Bob Richards rule).

The bankruptcy court agreed with Rodriguez, the FDIC appealed, and the district court reversed. The Tenth Circuit affirmed the district court, finding that under federal common law, “a tax refund due from a joint return generally belongs to the company responsible for the losses that form the basis of the refund.”

The American College of Tax Counsel, in an amicus brief supporting the hearing of the case by the Supreme Court, said that it does not recommend any particular approach regarding the issue: “It does believe that the differing positions of the circuits should be resolved in order to provide taxpayers with greater certainty in structuring their relationships in the consolidated group context. The lack of uniformity on this question of law with significant and recurring tax and bankruptcy implications warrants this court’s attention.”

A decision to hear the case was granted June 28, 2019, and the case was argued Dec. 3, 2019.

Although the statute was changed in 2017 so that NOL carrybacks are no longer permitted, the case could still help settle situations regarding consolidated returns where one member of the group has a profit and the other member has loss, according to Lee Zimet, senior director with Alvarez & Marsal Taxand.

“It will be interesting to see what the Supreme Court says about Bob Richards, specifically, and the concept of federal common law, more generally,” he said. “The court could agree that federal common law has a role to play or they could eliminate the concept entirely.”

“The key driver in the various court of appeals decisions has been determining whether the bank and the holding company had a debtor-creditor or agency-principal relationship,” he said. “The distinction is important because under bankruptcy law the bank would receive the full refund if the holding company is its agent but not if the bank is a mere creditor. It will be interesting to see if the Supreme Court makes this distinction based on a careful analysis of the language of the tax-sharing agreement, as the lower courts have done, or decides that the parties in such a situation will have one or the other relationship. Many of the court cases were decided based upon subtle differences in language or context. That could drive the Supreme Court to come up with a set rule for deciding the relationship issue.”

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