Source: https://appellatetax.com/category/interest/
Timestamp: 2019-04-19 05:00:08+00:00

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On Wednesday, the Federal Circuit issued its decision in the Wells Fargo interest netting case, affirming in part the trial court’s decision in favor of the taxpayer but also reversing in part. We previously covered the trial court decision and the oral argument here. As our prior coverage explained, the case presented three different fact patterns (termed “situations” in the decision) in which the taxpayer’s entitlement to interest netting hinged on the extent to which corporate mergers resulted in distinct corporations becoming the “same taxpayer” under the relevant Code section governing interest netting (§ 6621(d)). And as the questioning at oral argument had indicated, the Federal Circuit’s decision did not categorically adopt either party’s position, finding for the taxpayer in one situation and for the government in another.
The Federal Circuit did not have to address all three situations because in one of them—Situation Two—the government conceded that the taxpayer was entitled to interest netting. In Situation Two, the corporation that made the overpayment had the same Taxpayer Identification Number (TIN) as the corporation that had the later underpayment, even though the corporation had been through several intervening mergers between the time of the overpayment and the underpayment.
The government effectively had to make this concession—that interest netting is available when the underpaying corporation and overpaying corporation have the same TIN—in order to be consistent with its argument regarding Situation Three. In Situation Three, the corporation that had an overpayment (CoreStates) later merged into First Union, and after the merger the resulting First Union entity (which kept First Union’s TIN) had an underpayment. Relying on the decision in Magma Power (see our prior coverage of Magma Power here), the government argued that the taxpayer was not entitled to interest netting because CoreStates had a different TIN when it made its overpayment than First Union had at the time of the underpayment.
As the Federal Circuit observed, however, the only difference between Situation Two and Situation Three was “the choice of who is the named surviving corporation.” The choice of the name (and TIN) of the surviving corporation in a merger is hardly the sort of thing that ought to determine whether a taxpayer is entitled to interest netting. As the Federal Circuit astutely observed, every merger results in the surviving corporation becoming “automatically liable for the underpayments and entitled to the overpayments of its predecessors,” regardless of which TIN the surviving corporation adopts. Hewing to Congress’s intent for the statute to serve a remedial purpose, the Federal Circuit concluded that the CoreStates-First Union merger made the surviving corporation the “same taxpayer” as either of the pre-merger entities under section 6621(d).
With respect to Situation One, however, the Federal Circuit drew a limit on how broadly it was willing to interpret the “same taxpayer” requirement. In Situation One, the 2001 merger of Old Wachovia and First Union came after both Old Wachovia’s overpayment (1993) and First Union’s underpayment (1999). The Federal Circuit agreed with the government that under the decision in Energy East, the “same taxpayer” requirement is applied by asking whether “the entity that made the underpayment at the time of the underpayment is the ‘same taxpayer’ as the entity who made the overpayment at the time of the overpayment.” And since the merger postdated both the underpayment and the overpayment in Situation One, the Federal Circuit denied the taxpayer’s netting claim.
But is the Energy East test correct that entitlement to netting should be measured at the time of the underpayment or overpayment? One might reasonably argue that in applying the “same taxpayer” requirement, it makes more sense to look the period of overlap. Consider Situation One: After the 2001 merger, the surviving corporation would have been entitled to Old Wachovia’s overpayment and liable for First Union’s underpayment. And since the period of overlap extended beyond the September 2001 merger into later periods, there was good reason to conclude that the surviving corporation was entitled to interest netting from the date of the merger until the overlap periods ended. While the taxpayer did not pursue such a partial resolution on appeal, perhaps a future case will present that issue for decision.
The Federal Circuit heard argument on November 5 in the government’s appeal in Wells Fargo. The Court of Federal Claims had upheld the taxpayer’s claim for interest netting based on overlapping periods of interest for companies that later became part of Wells Fargo following statutory mergers. See our prior report here.
The panel consisted of Judge Lourie and the two most recent appointments to the Federal Circuit, Judges Hughes and Stoll. Although Judge Lourie was silent during the argument, the latter two judges posed questions of both sides. Both of those judges expressed skepticism of the government’s position that it is entitled to prevail on the authority of the Federal Circuit’s earlier decision in Energy East Corp. v. United States, 645 F.3d 1358 (Fed. Cir. 2011), and of its position that identity of the taxpayer identification number (TIN) should be the litmus test of “same taxpayer.” At the same time, the judges expressed concern that the logic of the taxpayer’s position could lead to expanding the scope of interest netting beyond the scope of what Congress intended, and even create an improper incentive for companies to merge in order to obtain interest netting benefits. Overall, the questioning was evenhanded, and the outcome of the appeal will remain in doubt until a decision is rendered, although Judge Hughes did appear to lean towards the view that Wells Fargo has a strong case for interest netting on its particular facts.
Shortly after government counsel began the argument, Judge Hughes began to question her about whether Energy East is distinguishable because it involved two companies who filed a consolidated return (and hence were still distinct companies), rather than companies that had merged into one new company. Although she eventually acknowledged that this factual difference could be significant in some cases, government counsel pointed out that the Energy East court did not rely on the fact that the companies were consolidated rather than merged. Instead, that court relied on the non-consolidated status of the companies at the time of the overpayment and underpayment interest payments. That approach of focusing on the time of payment, she argued, was fatal to Wells Fargo’s case because the TINs were not the same at the time of the respective interest payments (pre-merger and post-merger respectively). The court returned to Energy East on the government’s rebuttal, with Judge Stoll observing that the portion of the opinion on which the government sought to rely did not truly address the “same taxpayer” requirement. Judge Hughes concurred, observing that there never was a “same taxpayer” in Energy East and thus the court there simply did not consider how this requirement applies in the case of a merger. He suggested that the discussion relied upon by the government was best viewed as dicta and hence could not be viewed as controlling in this case. On the other hand, when the taxpayer’s counsel embraced the distinction between consolidated and merged taxpayers in his presentation, Judge Hughes echoed the government’s argument and pointed out that the Energy East court had not relied upon this distinction, but in fact had relied on a timing-of-payment rationale that would apply equally to Wells Fargo.
The government argued that a relatively narrower reading of “same taxpayer” is necessary because Congress wanted to ensure that obtaining interest netting benefits would not be an incentive for mergers. It proffered Code section 381 as an example of this concern in the context of net operating losses. Judge Hughes remarked that the government’s position made more sense in the case of “retroactive” interest netting for past years (where a merger might make preexisting interest netting claims available to a new company that had no connection to the payments), but made less sense on a going-forward basis. Government counsel responded that there would still be an incentive for a company to “shop” for a merger partner whose overpayment interest characteristics could be used to net against an underpayment interest liability.
Judge Stoll then questioned why the government argued for different outcomes in Situations 2 and 3, where the only difference is which company is the acquirer. She characterized the distinction as “arbitrary.” Government counsel responded that the different outcomes flowed from its position that identity of the TIN should be the dispositive factor. (In this connection, government counsel stated that it embraced the Court of Federal Claims’ holding in Magma Power Co. v. United States, 101 Fed. Cl. 562 (2011), but did not argue for the stricter rule set forth in the CFC’s Energy East decision that the taxpayers must be “identical.” See our report on Magma Power here.) The TIN rule is “administrable,” counsel argued, and taxpayers can plan with the rule in mind if interest netting benefits are going to be affected by which company is the acquirer. Judge Hughes then jumped in to second Judge Stoll’s view that there is no significant difference between Situations 2 and 3. He also remarked that the government’s proffered policy justification for its position—namely, to prevent interest netting benefits from becoming an incentive for corporate acquisitions—is inapplicable in the Wells Fargo case because the relevant underpayment did not occur until after the particular merger that caused the change in the TIN.
In his argument, taxpayer’s counsel stated that it relies on three points: (1) the legal effect of a merger under state law; (2) the principles previously applied by the IRS under Code section 6402 to interest offsetting when both the overpayment and underpayment were still outstanding; and 3) the IRS’s administrative practice of looking to the successor corporation in contexts other than interest netting. He particularly emphasized the legal effect of the merger in explaining why Energy East is distinguishable, stating that once a merger occurs the surviving corporation succeeds to the attributes of the predecessor corporations.
The other topic raised by the judges during the argument was the extent to which existing law requires that a merger be treated as making two corporations into the same taxpayer. Judge Stoll asked taxpayer’s counsel whether Libson Stores, Inc. v. Koehler, 353 U.S. 382 (1957), belied this notion, but he replied that nothing in that case disturbed Helvering v. Metropolitan Edison Co., 306 U.S. 522 (1939), which indicated that state merger law would govern this question. He added that the IRS itself in Rev. Rul. 58-603 recognized that Libson had limited effect in stating that it would not apply Libson in situations covered by section 381. The government for its part stated that merged corporations do not actually become the same taxpayer in all respects under section 381 and that principle supersedes anything to the contrary in Metropolitan Edison or other cases.
In sum, the questioning of the two judges who participated in the Wells Fargo argument focused on three key points and suggested some predisposition by the panel on those points: (1) although statements in the Federal Circuit’s Energy East precedent support the government, the case is distinguishable on its facts and does not require a ruling for the government; (2) the court is skeptical of the government’s proposed rule that identity of the TIN should be the dispositive factor; and (3) conversely, the panel is concerned that the taxpayer’s approach of applying traditional merger law to hold that the merged corporation inherits all the interest netting attributes of the predecessor corporations is a bridge too far and would allow more generous interest netting than intended by Congress—at least when applied to completed pre-merger periods of interest overlap. How the Federal Circuit reconciles all of these predispositions remains to be seen, but there is a good chance that the court’s opinion ultimately will stake out a path somewhat different from that argued by either of the parties. Keeping in mind Judge Hughes’s comment that the taxpayer is “asking for more than you need to win your case,” the outcome could still leave some uncertainty for other taxpayers with post-merger interest netting claims, even if Wells Fargo prevails, depending on their particular facts.
A decision is likely in early 2016, but there is no firm deadline for the court to issue its opinion.
In Wells Fargo v. United States, however, the government again invoked this statutory language to oppose interest netting—this time in the context of a large taxpayer that had emerged from a series of mergers. The government contended that the “same taxpayer” requirement barred interest netting because the mergers altered the corporate identity of the taxpayers who incurred the overpayments and underpayments. The facts are complex, but the trial court distilled them into three possible scenarios – whether it is permitted to net interest from underpayments and overpayments between: 1) a pre-merger acquiring corporation and a pre-merger acquired corporation; or 2) a pre-merger acquiring corporation and the post-merger surviving corporation; or 3) a pre-merger acquired corporation and the post-merger surviving corporation.
Seizing on the rationale of Magma Power, the government argued that interest netting was unavailable in situations 1 and 3 because the two taxpayers involved do not have the same TIN. The government also relied upon Energy East Corp. v. United States, 645 F.3d 1358 (Fed. Cir. 2011), where the court of appeals held that a parent corporation and subsidiary that were not affiliated at the time each made tax payments could not later net interest in their consolidated return. By contrast, the taxpayer argued that, under established principles, the legal identities of the pre-merger companies are absorbed into the new, post-merger corporation. The new entity, of course, has a different TIN because the acquired corporation no longer exists, but that should not change the availability of interest netting.
The Court of Federal Claims first found that Energy East and Magma Power were distinguishable because “they involved separate but affiliated corporations,” not merged corporations. The court then examined merger law, noting that the surviving corporation is “liable retroactively for the tax payments of its predecessors.” The court concluded that “following a merger, the law treats the acquired corporation as though it had always been part of the surviving entity,” and therefore “the corporations in the present case became the ‘same taxpayer’ by virtue of the statutory merger.” As a result, the court ruled that Wells Fargo was entitled to interest netting in all three of the described scenarios.
The trial court agreed to certify the issue for interlocutory appeal, and the Federal Circuit accepted the appeal. In its briefs, the government relies primarily on the same arguments it made below. It argues that both Energy East and the TIN rule require that interest netting be denied in scenarios 1 and 3. The brief distinguishes between the two scenarios, however, arguing that even if the court were to adopt “a broader inquiry into corporate identity” that would allow netting for scenario 1, it should still deny netting for scenario 3 because the “relevant essentials” of the two entities involved are too different.
The taxpayer’s brief largely defends the rationale of the Court of Federal Claims, relying on “longstanding principles of state merger law.” The taxpayer also emphasizes, as did the trial court, that prior to Energy East the IRS had generally applied the “corporate continuity principle” in its administrative rulings in areas of federal tax law other than interest netting.
Oral argument is scheduled for November 5.
Last spring, the Tax Court held in Sophy v. Commissioner, that the limitations on indebtedness for the mortgage interest deduction are applied on a per residence rather than per taxpayer basis. The taxpayers appealed to the Ninth Circuit (Nos. 12-73257 and 12-73261), and filed their opening brief on January 30. The government’s response is due in March.
Under I.R.C. § 163(h)(3), taxpayers are allowed to deduct “qualified residence interest,” which includes interest paid or accrued on acquisition indebtedness with respect to any qualified residence of the taxpayer, or home equity indebtedness with respect to any qualified residence of the taxpayer. For purposes of the deduction, acquisition indebtedness is capped at $1 million and home equity indebtedness is capped at $100,000, for a total indebtedness limit of $1.1 million on up to two residences. The taxpayers, an unmarried couple registered as domestic partners with the State of California, had approximately $2.7 million of indebtedness associated with their primary residence in Beverly Hills and secondary residence in Rancho Mirage, California. They argued that, together, they should be able to deduct interest paid on up to $2.2 million of indebtedness, or $1.1 million each. The Tax Court rejected this position. Parsing the language of the statute, the Tax Court noted repeated references to “residence” in the provisions on the indebtedness limitations and concluded that the limitations are “residence focused rather than taxpayer focused.” The Tax Court also found support for treating the $1.1 million limitation as a per residence rather than per taxpayer limitation in the subsection of § 163(h) that provides that married taxpayers who file separate returns are limited to half of the otherwise allowable amount of indebtedness, and in the general rule that married couples filing jointly are subject to the $1.1 million limitation.
In Magma Power v. United States, Case No. 09-419T, the Court of Federal Claims tackled the arcane topic of interest netting. The issue in Magma Power was a narrow question of statutory interpretation, but the broader topic of interest netting warrants a word of explanation.
The narrow statutory-interpretation issue in Magma Power is the meaning of the term “same taxpayer” under section 6621(d). The IRS had denied section 6621(d) relief to Magma Power on the theory that Magma Power was no longer the “same taxpayer” after becoming a member of a consolidated group.
Magma Power filed a return for its 1993 tax year sometime in 1994. In February 1995, CalEnergy Company acquired Magma Power and subsequently included Magma Power on its consolidated tax returns. The IRS later determined a deficiency for Magma Power’s 1993 tax year, and Magma Power paid that deficiency and over $9 million in associated underpayment interest in 2000 and 2002. The CalEnergy consolidated group overpaid its taxes in four consecutive tax years from 1995 through 1998. Despite some disagreement between the parties, the court found that some portion of these overpayments were attributable to Magma Power’s activities. In 2004 and 2005, the IRS refunded those overpayments plus the associated overpayment interest to the consolidated group agent (which by then was MidAmerican Energy Holdings Company). There were overlapping underpayments and overpayments for the period that began with the filing of the 1995-98 returns and ended with the satisfaction of Magma Power’s 1993 underpayment. Magma Power claimed interest-netting refunds for that period. The IRS denied the refund on the theory that the consolidated group could not net its overpayments with Magma Power’s underpayments because of the “same taxpayer” requirement of section 6621(d).
The court’s plain-language analysis of section 6621(d) is straightforward and decisively rebuts what appears to be a flimsy position taken by the IRS. The essence of the court’s conclusion is that becoming a member of a consolidated group does not fundamentally alter a taxpayer’s identity. The court rests this decision on the uncontroversial premise that the taxpayer identification number (or EIN, for corporations like Magma Power) is the sine qua non of taxpayer identity. And because Magma Power retained the same EIN (and therefore same identity) after its inclusion in the consolidated group, the court held that Magma Power was the same taxpayer for section 6621(d) purposes for the 1993 underpayment and its allocable portion of the 1995-98 overpayments.
The court in Magma Power had little difficulty distinguishing Energy East: Energy East was trying to net the overpayment years of acquired companies against its own underpayment years. The hitch was that both the underpayment years and overpayment years came before Energy East acquired those companies. In Magma Power, the court held that the Energy East situation was “radically different” than Magma Power’s attempt to net its own 1993 underpayment against its own later overpayments (albeit encompassed within the Cal Energy consolidated group).
The government may well appeal Magma Power based on the broad language in the lower court’s decision in Energy East. If they do, we’ll keep you posted.
In our report on the oral argument in Sunoco, which took place back in January, we remarked that the Third Circuit panel seemed skeptical of the Tax Court’s decision, even if the panel had not yet mastered the complexities of the case. It took more than eight months, but the Third Circuit has now issued a comprehensive opinion reversing the Tax Court and holding that it lacked jurisdiction to consider Sunoco’s claims for additional overpayment interest. The court’s opinion tracks the government’s position fairly closely, and it accepts the government’s view that Estate of Baumgardner v. Commissioner, 85 T.C. 445 (1995), is correctly decided but applies only to claims for deficiency (i.e., underpayment) interest. That case cannot help Sunoco with its efforts to receive additional overpayment interest, which it could have obtained only by bringing suit in the Court of Federal Claims.
If Sunoco decides to seek further review, a petition for rehearing would be due on November 21, and a petition for certiorari would be due on January 5, 2012.
As we have previously reported, the Third Circuit is considering a tricky issue relating to the Tax Court’s jurisdiction to resolve disputes concerning overpayment interest. At the oral argument, the court explored different facets of the issue, even while joking about its complexity. At one point, one of the judges appeared to question whether the Tax Court’s Estate of Baumgardner case was correctly decided, even though the IRS had acqueisced in it. Government counsel declined that offer, instead adhering to the view that Baumgardner is different because it involved deficiency interest rather than overpayment interest. Taxpayer’s counsel invoked Code section 7481(c) as a possible alternative jurisdictional basis for the Tax Court, but the government responded that section 7481(c) could not apply to Sunoco’s situation. In response to a question, government counsel acknowledged that the dispute in Sunoco would not affect many taxpayers, as they usually bring overpayment interest claims to the Court of Federal Claims.
Although no precise consensus emerged from the court’s questions and answers, the panel seemed to exhibit sufficient skepticism about the Tax Court’s reasoning that practitioners should be cautious in placing much weight on the Tax Court’s decision. There is certainly a substantial risk that it will be reversed.
The Third Circuit has revised its January oral argument calendar and rescheduled the oral argument in Sunoco for the morning of Tuesday, January 25. The case had been scheduled for argument on the previous day. The panel that will hear the case is Chief Judge Theodore McKee, Judge D. Brooks Smith, and Judge Richard Stearns, a district judge from the District of Massachusetts who is sitting by designation.
The Third Circuit has scheduled the oral argument in Sunoco for January 24, 2011. The briefing was completed back in March, and the briefs can be found at the bottom of our previous post.
On March 5, 2010, the government filed its reply brief in its appeal from the Tax Court’s decision in Sunoco Inc. v. Commissioner, 122 T.C. 88 (2004), thus completing the appellate briefing. The case raises a novel issue concerning the Tax Court’s jurisdiction to determine overpayment interest. Sunoco filed a petition seeking redetermination of deficiencies for its 1979, 1981, and 1983 tax years. In an amended petition, Sunoco reported that certain issues had settled but argued that the IRS had committed errors in calculating the interest on underpayments and overpayments arising out of those issues because it used incorrect starting and ending dates. The IRS moved to dismiss Sunoco’s claims for additional overpayment interest on the ground that Code section 6512 does not give the Tax Court jurisdiction to make a determination of overpayment interest with respect to overpayments not at issue in the case. The Tax Court denied the motion, holding that it had jurisdiction over Sunoco’s claims because the court would be resolving the same issues regarding starting and ending dates in connection with disputes over underpayment interest that were unquestionably before the court.
The Tax Court’s decision is a narrow one, finding that the settled principles of Estate of Baumgardner v. Commissioner, 85 T.C. 445 (1995), apply in Sunoco’s unusual circumstances because the date issues necessarily affect both underpayment interest and overpayment interest. The government, however, objects that Baumgardner is limited to underpayment interest and that Sunoco opens a Pandora’s box with broad implications by holding that section 6512 can give the Tax Court jurisdiction to resolve a dispute over overpayment interest. In the government’s view, there are no circumstances in which the overpayment jurisdiction of section 6512 can cover a claim for overpayment interest.
Because the appeal of Sunoco was delayed for years while a motion for reconsideration was pending, actual events cast some doubt on the government’s claim of broad implications. The case was decided in 2004 and in the past six years, the Tax Court has had little occasion even to cite it, much less to use it to open the gates to all sorts of taxpayer claims for overpayment interest. Nonetheless, the case has finally reached the Third Circuit, and that court will now decide whether the Tax Court overstepped its bounds in applying the principles of Baumgardner to overpayment interest in this context.

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