A recent unanimous Supreme Court decision, Rodriguez v. FDIC,1 reinforces the need for every U.S. consolidated tax group — especially if the consolidated tax group has issued debt that is supported by some, but not all, of the entities in the group — to evaluate carefully whether the group should have a formalized written tax sharing agreement (a “TSA”). In addition, if the group already has a written TSA, the group should carefully review the existing agreement to verify that the agreement is properly drafted in a manner consistent with the group’s intentions, and is being properly and consistently applied.
From the Internal Revenue Service’s and the Treasury’s (collectively, the “Service”) perspective, under the U.S. federal consolidated income tax return rules, the parent of the tax group generally serves as the group’s only point of contact with the government. Under these rules, each consolidated group calculates a single tax liability taking into account the activities and operations of every entity in the group. The parent of the group pays any tax liability to the Service, and if and when the government owes the group a refund, the parent of the group receives the refund. From the Service’s perspective, particularly with respect to refunds, such payment (to the parent of the group) ends its interaction with the group for the relevant tax year. However, from the group’s perspective, there is a further question, particularly in situations involving regulated businesses or where some, but not all, of the entities in the tax group are obligors on particular debt instruments issued by entities in the group. In these circumstances, it can be critically important to have a mechanism to determine which entity in the group is responsible for a tax liability, entitled to a refund with respect to previous taxes paid, or otherwise entitled to some sort of benefit or payment in respect of tax attributes generated by that entity and that are used to reduce the overall tax liability of the group as a whole.
Some, but not all, tax groups enter into written TSAs to address these intra-group issues. Unfortunately, these documents often have drafting ambiguities or uncertainties and do not adequately address all relevant considerations regarding the allocation and sharing of tax liabilities, refunds and tax attributes. No matter what a TSA provides (or does not provide), the course of conduct of the group does not always align with the text of the agreement. Both in cases where groups have and have not entered in TSAs, significant intercompany disputes can arise among the entities in the group regarding liability for taxes, entitlement to refunds, and for usage of tax attributes in situations where entities in the group file for bankruptcy or otherwise have financial distress. In fact, intercompany disputes regarding the application of written TSAs, and potential tax-based claims in situations with no written TSA, have been a prominent factor in numerous large Chapter 11 cases.
Rodriguez addressed, and ultimately struck down, a federal common law principle established in Bob Richards.2 Bob Richards addressed a situation in which (a) the tax group had no written TSA; (b) the group received a cash tax refund; and (c) the refund could be traced to income and losses of a specific subsidiary. The Ninth Circuit ruled that, as a matter of federal common law, in this set of facts, the subsidiary (and, therefore, the subsidiary’s creditors) was entitled to receive the tax refund. Many courts followed Bob Richards, though the Sixth Circuit had previously declined to follow it.3
Rodriguez involved an example of Bob Richards arguably being expanded to a situation involving a written TSA. Where there is a written TSA, a critical question is whether the TSA creates a trust or agency relationship, or merely a contractual claim, between the subsidiary that is entitled to payment with respect to a refund and its parent. If the TSA creates a trust or agency relationship, then the tax refund itself belongs to the subsidiary; if it merely creates a contractual claim, then the claim is an unsecured claim and potentially worth little or nothing. Most courts addressing written TSAs have not applied Bob Richards at all, and have concluded that the resolution of the dispute is simply a matter of state trust, agency and contract law. These cases come to widely divergent conclusions on facts that are often somewhat difficult to distinguish. However, in Rodriguez, the Tenth Circuit arguably applied Bob Richards as a “tie-breaker,” with the TSA creating a trust or agency relationship because it did not unambiguously create a mere contractual relationship.4 Although this “thumb on the scale” may not have been vital to the Tenth Circuit’s decision, the Tenth Circuit ultimately concluded that the subsidiary (and, therefore, the subsidiary’s creditors), rather than the parent company, was entitled to receive the tax refund at issue in that case.
The Supreme Court took the opportunity to unanimously strike down the Bob Richards rule in its entirety. The most obvious effect is to render ownership of tax refunds a state law issue in all situations, regardless of whether there is a written TSA. But Rodriguez arguably has broader lessons.
For tax groups with written TSAs, Rodriguez makes it clear that tax groups should conduct a “wellness check” to ensure that, if they want the TSA to create an agency or trust relationship, the TSA does so under relevant state law. This could mean, for instance, causing tax refunds to be deposited into escrow or other, concrete steps, beyond “magic words” in the TSA. Groups desiring a particular outcome with respect to group tax matters under a TSA should also ensure that their TSAs are actually being implemented according to their terms. Though courts applying written TSAs have come to divergent conclusions on somewhat similar facts, it is still possible to examine the cases with a critical eye in an effort to draft and implement a TSA in the way that will best support the tax group’s intended outcome.
Moreover, if a bankruptcy court cannot apply federal common law principles in determining the allocation of tax refunds, it also probably cannot apply similar equitable principles in determining whether a loss-generating entity in a tax group should be entitled to compensation when these attributes are utilized by other entities in the tax group to reduce the group’s overall tax burden. That is consistent with recent case law developments (with support from an older Supreme Court decision) that have generally supported the position that, in the absence of a written TSA, no such compensation is owed. Therefore, it is critical that tax groups evaluate whether they want, or need, entities that generate losses to receive reimbursement from other entities in the tax group upon usage of tax attributes. If so, these groups should implement well-crafted TSAs establishing this principle. This type of detailed analysis is particularly imperative in fact patterns where not every member of the group is equally liable for all of the debt obligations of the group.
1. No. 18-1269 (Feb. 25, 2020).↩
2. In re Bob Richards Chrysler-Plymouth Corp., 473 F.2d 262 (9th Cir. 1973).↩
3. FDIC v. AmFin Financial Corp., 757 F.3d 530, 535 (2014).↩
4. In re United Western Bancorp, Inc., 914 F.3d 1262, 1269-1270 (10th Cir. 2019).↩