Just about two years ago, I wrote about the Court of Federal Claims holding in Wells Fargo v. United States, which can be found here. The government took the case on appeal to the Federal Circuit, which handed down a very important decision regarding interest netting in the context of corporate mergers. We discuss the ways the courts and IRS have wrestled with the netting rules in the updated Saltz/Book chapter 6, which I recently revised and updated to include the latest developments, including the lower court holding (and, imminently, this holding). A few other online outlets have covered this, but I think it is still worth adding our thoughts, even if a few weeks late.
The Federal Circuit’s holding was not as taxpayer friendly as the Court of Federal Claims holding, but it still is significantly better, and I believe more sound, than the IRS position on the matter. I’ve recreated a bit of my prior post as background, which will be followed with a discussion of the Federal Circuit’s holding, including some helpful stripped down examples from the holding as to how the netting works:
The Facts – Together we’ll go far…to get some tax benefits.
So, this case involves bank mergers (and lots of them) that Wells Fargo has been involved with over the last 15 years; all of which were statutory mergers. Following the actual mergers is a little confusing, and the specifics of those mergers are not that important to the holding [sjo updated note: this statement is less true with the Federal Circuit holding, as you will see below]. What does matter is the issue, as stated by the Court, which was:
It concerns whether plaintiff…Wells Fargo…is entitled to net the interest paid on certain tax underpayments owed by Wells Fargo or its predecessor…First Union…, with the interest owed by the United States to Wells Fargo on overpayments made by First Union or other companies acquired by Wells Fargo through various corporate mergers.
Positions and the law.
Section 6621(d) was enacted in 1998 to allow overpayment and underpayment interest rates to be netted against each other at a zero percent interest rate when the “same taxpayer” has overpayments and underpayments of tax. Corporate overpayments and underpayments, otherwise, would be at different rates. The key issue before the court was the definition of “same taxpayer”.
Wells Fargo argued that the “same taxpayer” was both the predecessors and the surviving corporation of statutory mergers, so that the surviving entity could benefit from the tax attributes of all prior corporations. The IRS argued for a more narrow view of “same taxpayer”, stating that a taxpayer is only the same if it has the same taxpayer identification number before and after the merger.
The Service had previously been successful with this position in Magma Power and Energy East, and had repeatedly taken this position in rulings and Counsel Advice.
And the Court of Federal Claims says…
The Court of Federal Claims took the taxpayer friendly, and I believe correct, approach to the issue, and held that a TIN is not fully determinative of legal status in the merger context. The Court stated that because Energy East and Magma involved fully separate but affiliated corporations, they did not control the Wells Fargo case. The Court further stated:
In a merger, the acquired and acquiring corporations have no post-merger existence beyond the surviving corporation; instead, they become one and the same by operation of law, and thereafter the surviving corporation is liable for the pre-merger tax payments of both the acquired and acquiring corporations.
As stated above, this went to the Federal Circuit, which affirmed the Court of Federal Claims in part and reversed in part. As a brief summary, the Federal Circuit held TINs were not determinative, and neither was the fact that the two entities became one eventually. The key to the Federal Circuit was the timing of when the underpayment and overpayment occurred, which it indicated was the actual holding of Energy East.
The parties to the case agreed to three specific fact patterns, which the Court included in its holding. I have taken out the specific names, but you can find those names and graphical reproductions of the same in the holding. I think these will be helpful in explaining the holding. The examples are:
- In 1993, Company A had an overpayment. In 1999, Company B had an underpayment. In 2001, Companies A and B merged pursuant to a statutory merger under Section 368(a)(1)(A).
- In 1993, Company A had an overpayment. Between 1993 and 1999, Company A merged with four other companies under Section 368(a)(1)(A) and (2)(D). Company A survived in each merger, and in 1999 had an underpayment.
- In 1992, Company A had an overpayment. In 1998, Company A merged with Company B under Section 368(a)(1)(A). In 1999, Company B, the surviving company, made an underpayment.
Each party largely advocated the same positions, although Wells Fargo incorporated much of the Federal Claims holding into its arguments. Based on the TIN argument advanced by the Service, the Service conceded interest netting in example two above, leaving only examples one and three.
The Federal Circuit held that interest netting would not apply in example one, but it would in example three. The Federal Circuit looked to its holding in Energy East for the analysis of the statute regarding the timing. It stated the fact that “different corporations” generated the overpayment and underpayment was of less importance…depending on the timing. Under Section 6621(d) the Court highlighted the language, “for any period…interest is payable…on equivalent underpayments and overpayments by the same taxpayer…” Meaning, the two entities could not have been separate in the period where the underpayment and overpayment were generated subsequently brought together, but could be different if the sequence was the merger occurring prior to the later underpayment or overpayment.
The Federal Circuit held in example 1 above, Company A and Company B had their overpayment and underpayment each separately prior to the merger, when each was a distinct taxpayer. In this instance, “the payments were both made before the merger, and thus the payments were made by two separate corporations…[and] do not meet the “same taxpayer” requirement under [Section] 6621(d).” The subsequent unity does not invalidate the required timing to the Federal Circuit.
The holding in example 3 provided the most interesting analysis. The question boiled down to whether pre-merger A was the “same taxpayer” as post-merger B, more akin to Wells Fargo’s general position. This analysis followed somewhat the Court of Federal Claims’ holding. The Federal Circuit found that the legislative history, tax treatment in similar situations, and general laws of mergers leaned in favor of treating the acquired corporation being “absorbed” by the continuing one and stepping into its shoes. This allowed the treatment as the same taxpayer for later underpayments/overpayments. Company A had an underpayment, was then absorbed by Company B, which then had an underpayment – same taxpayer due to merger.
This is a very technical argument, and it will be interesting to see if the Service continues the TIN argument in other courts, as it has not met with much success and the Federal Circuit is fairly influential. It is also interesting why, based on the holding in three, the eventual unity doesn’t cause the netting from the time of merger forward but not prior periods (perhaps it does, and I misunderstood the holding). In any event, all corporations that have engaged in mergers should be going through and making sure interest netting has occurred in a minimum under examples two and three above (and possibly one if you are in a different circuit and like litigating).