June 18, 2013
[Note: Miller and Chevalier represented the taxpayer Exxon Mobil Corp. in this case.]
We previously reported on the Second Circuit’s consideration of the interest netting issue that had been resolved against the taxpayer by the Federal Circuit in FNMA v. United States, 379 F.3d 1303 (2004). Although we did not follow up with a timely report on the Second Circuit’s decision in that case in favor of the taxpayer, the decision is now final, with the government having allowed the time to seek certiorari to expire. To close the loop, we provide here a summary of the decision and a link to the opinion.
As explained in our prior post, the issue concerned a “special rule” enacted when Congress passed the interest netting rule of section 6621(d) in 1998. The statute operates prospectively, but Congress also allowed taxpayers to file interest netting claims for pre-1998 periods subject to a statute of limitations constraint. The dispute was over the scope of that constraint, with the taxpayer arguing that interest netting is available so long as the statute of limitations was still open on the 1998 effective date for either of the years used in the interest netting calculation. The government, by contrast, argued that the statute of limitations must have been open on the relevant date for both the underpayment and overpayment years that are used in the interest netting calculation. The Federal Circuit in Fannie Mae had ruled for the government, reasoning that the statutory text is ambiguous and should be construed narrowly in favor of the government because the “special rule,” the court concluded, is a waiver of sovereign immunity. The Tax Court, however, declined to follow Fannie Mae in this case and ruled for the taxpayer.
The Second Circuit affirmed the Tax Court in a comprehensive decision that closely tracked the taxpayer’s brief. The court rejected the sovereign immunity argument and then concluded “that the structure, context, and evident purpose of section 6621(d) and the special rule indicate that the special rule is to be read broadly, such that global interest netting may be applied when at least one leg of the overpayment/underpayment overlapping period is not barred by the applicable statute of limitations.”
The court did not dwell on the statutory text, finding that “the provision is susceptible to both proffered interpretations and that the intended meaning of the special rule cannot be derived from the text alone.” Therefore, the court stated that it was necessary “to consult the provision’s structure, historical context, and purpose–as well as applicable canons of statutory construction–in order to determine its meaning.” The court added that it would be “particularly mindful” of one pro-taxpayer canon of construction that is sometimes mentioned by courts but also often ignored in favor of competing pro-government canons – namely, “where ‘the words [of a tax statute] are doubtful, the doubt must be resolved against the government and in favor of the taxpayer,’ United States v. Merriam, 263 U.S. 179, 188 (1923).”
The court then stated that it agreed with the portion of the Fannie Mae opinion that rejected the government’s requests for deference to the relevant Revenue Procedure or to the “Blue Book” summary of the special rule. It is a bit surprising that the court addressed these arguments since the government had not made them in its brief in ExxonMobil; the court noted that “it appears . . . that the Commissioner has abandoned these arguments in this appeal.” Apparently, the court wanted to make sure that its opinion left no room for further litigation of the interest netting issue.
The court then turned to the main bone of contention, the holding in Fannie Mae that the special rule was a waiver of sovereign immunity that must be narrowly construed in favor of the government. The court’s analysis was succinct, observing that a “waiver of sovereign immunity is a consent on the part of the government to be sued,” and “[t]he special rule at issue here does no such thing.” Specifically, the special rule “does not create jurisdiction or authorize claims against the United States. Other provisions of the tax code perform that function.”
If the case was not to be resolved on the basis of sovereign immunity, the court explained, it should be resolved using the basic rules of statutory interpretation, which pointed towards a ruling for the taxpayer. First, “[t]he structure of § 6621(d) as a whole–and particularly its use of interest equalization–strongly suggests that the special rule is meant to apply whenever the period of limitations for at least one leg of the overlapping period of reciprocal indebtedness remains open.” Under that approach, it is “not necessary to adjust the computation of interest” for both legs “to achieve the zero net rate,” and therefore “it is not necessary for the limitations period to be open for both legs.” The court also noted that the government conceded that only one leg needed to be open when the statute was being applied prospectively, and it saw no reason for different treatment for retrospective interest netting claims. Finally, the court found support for the taxpayer’s position by examining “the historical context from which section 6621(d) emerged.” Given Congress’s repeated efforts to urge the IRS “to ameliorate the inequitable effects of the interest rate differential,” the court found that section 6621(d) and the special rule are “best understood as remedial provisions, and should therefore be interpreted broadly to effectuate Congress’s remedial goals.”
The Second Circuit’s holding in ExxonMobil is of limited significance to other taxpayers going forward. This is likely why the government chose not to seek certiorari despite the clearest circuit conflict imaginable. The holding applies only to the availability of interest netting for periods ending before July 22, 1998, so the number of remaining interest netting claims governed by the special rule at all is not large. And even within that universe, for many taxpayers the only available jurisdictional route will be through a refund suit in the Court of Federal Claims, where Fannie Mae remains binding precedent.
The court’s reasoning, however, could come into play in other settings, particularly where the government seeks to invoke sovereign immunity principles to support its position in a tax case. See, e.g., Ford Motor Co. v. United States, 2013-1 U.S. Tax Cas. (CCH) ¶ 50,102 (6th Cir. Dec. 17, 2012). The Second Circuit’s thoughtful approach to the definition of waivers of sovereign immunity will stand as a strong counterweight to the exceedingly expansive approach taken by the Fannie Mae court.
Briefing Underway in Ninth Circuit on Question of Mortgage Interest Deduction for Non-married Couples
February 6, 2013
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.
On appeal, the taxpayers argue that § 163(h) should be construed consistently with I.R.C. § 121, which limits the exclusion of gain from the sale of a taxpayer’s “principal residence” to $250,000. Under the regulations, the limitation is applied on a per taxpayer, not per residence basis. Section 163(h) defines “principal residence” with reference to § 121. The taxpayers also argue there is no reason to treat non-married couples the same as married couples for purposes of § 163(h) because differential treatment “is consistent with various provisions of the Code where there is a different result for similarly situated taxpayers based on filing status.”
January 3, 2013
We previously reported on the Court of Federal Claims’ decision in Magma Power that allowed an interest netting claim when the taxpayer was a member of a consolidated group for one leg of the overlap period but not during the other leg. The government had argued that such a claim did not fall within the statutory language requiring that the overlapping interest payments involve the “same taxpayer.” The government filed a protective notice of appeal from the decision, but it has now voluntarily dismissed the appeal in the Federal Circuit. The Court of Federal Claims’ decision therefore will stand, and it is likely that the government will not contest future interest netting claims on this ground.
Second Circuit to Resolve Disagreement Between Tax Court and Federal Circuit Over Availability of Interest Netting for Pre-1998 Tax Periods
April 24, 2012
[Note: Miller & Chevalier represents the taxpayer Exxon Mobil Corp. in this case.]
The government has appealed the Tax Court’s decision on interest netting in Exxon Mobil Corp. v. Commissioner, 136 T.C. No. 5 (Feb. 3, 2011). The briefing is now complete, and the Second Circuit (Judges Cabranes, Walker, and Winter) is scheduled to hear oral argument on April 25.
Congress expressly required global interest netting by enacting Code section 6621(d) in 1998. Before then, the IRS had sometimes taken advantage of the differential interest rates established in 1986 to collect net interest when no net tax was due. Specifically, for periods of overlapping indebtedness where the taxpayer owed money to the government for one tax year but the government owed money to the taxpayer for a different tax year, the government would not net the overlapping amounts, but rather would collect interest at the higher underpayment rate while paying interest to the taxpayer at the lower overpayment rate on the same amount. Section 6621(d) ended this practice by providing that “the net rate of interest . . . on such amounts” of overlapping indebtedness “shall be zero.” That net rate of zero can be implemented either by increasing the overpayment rate or decreasing the underpayment rate from what they would otherwise be in the absence of interest netting. Section 6621(d) applies prospectively without restriction, but Congress also enacted a “special rule” that makes the interest netting rule also apply to pre-1998 periods of overlapping indebtedness in certain circumstances. The Exxon Mobil case involves the construction of that special rule.
The special rule provides that section 6621(d) applies to past periods “[s]ubject to any applicable statute of limitation not having expired with respect to either a tax underpayment or a tax overpayment” on the July 22, 1998, effective date of section 6621(d). Taxpayers interpret this provision to mean that interest netting is available for past periods so long as the statute of limitations for either of the overlapping periods of indebtedness was open on the effective date. The IRS, however, has interpreted the special rule to mean that interest netting is available for past periods only if the statute of limitations for both of the overlapping periods of indebtedness was open on the effective date.
The issue was first litigated by Fannie Mae in the Court of Federal Claims, which held that the special rule was best read in accordance with the taxpayer’s position. The Federal Circuit, however, reversed. Federal National Mortgage Ass’n v. United States, 379 F.3d 1303 (Fed. Cir. 2004), rev’g, 56 Fed. Cl. 228 (2003). The Federal Circuit did not take issue with the statutory analysis of the Court of Federal Claims, but instead relied on an argument that was not presented below. The Federal Circuit reasoned that the special rule was a waiver of sovereign immunity that must be strictly construed in favor of the government; since the statutory language was capable of being read to support either position, the court concluded, that strict construction principle required a ruling in the government’s favor.
The Exxon Mobil case raises the same issue, but it arises in a different procedural posture and hence in a different jurisdiction. Exxon petitioned the Tax Court for a redetermination of deficiencies for its 1979-1982 tax years, and the Tax Court’s determination eventually resulted in an overpayment. The IRS paid interest on that overpayment at the regular overpayment rate, unadjusted for the fact that interest netting principles would have called for a higher rate because there was a period of overlapping indebtedness with underpayments that Exxon owed for the 1975-78 tax years. Exxon Mobil then filed a motion for redetermination of interest under Code section 7481 seeking additional overpayment interest through application of the interest netting rule of section 6621(d).
The IRS argued that interest netting did not apply because the statutes of limitations for the 1975-78 tax years were no longer open on July 22, 1998, although it acknowledged that the statutes of limitations for the overpayment leg of the overlap period were open on that date. The Tax Court declined to follow the Federal Circuit’s view and rejected the IRS’s argument. The Tax Court stated that “the special rule is not a waiver of sovereign immunity but an interest rate provision.” It added that, even if it were a waiver of sovereign immunity, that would not require the court to adopt a reading that contravened Congress’s intent to achieve the remedial purpose of relieving taxpayers from paying interest when no net tax was due.
The government’s brief on appeal relies heavily on the Federal Circuit’s decision in Fannie Mae. It argues that the Tax Court erred in rejecting the basic principle of that decision, asserting that “the special rule is a waiver of sovereign immunity because it authorizes recovery of certain retroactive refund claims for overpaid interest and thus ‘discriminates between those claims for overpaid interest Congress has authorized and those it has not’” (quoting Fannie Mae, 379 F.3d at 1310). Exxon Mobil’s brief first addresses the special rule independently, asserting that the natural reading of the text and the evident purpose of the special rule both indicate that Congress intended to allow interest netting for pre-1998 periods so long as one leg of the overpayment period was open. The brief then addresses the government’s sovereign immunity argument, arguing that the special rule is not a waiver of sovereign immunity and, even if it were, the canon of construction would not justify adopting an interpretation that would thwart the evident intent of Congress.
December 9, 2011
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 government charges interest on tax underpayments at a higher rate (under section 6601) than it pays on tax overpayments. Because it often takes several years or more to determine whether a taxpayer has an overpayment or underpayment for a particular tax year and the amount of that overpayment or underpayment, there are sometimes post-return periods during which a taxpayer has overlapping overpayments and underpayments. When this occurs, the taxpayer should owe no interest on the overlapping amount. If the overlapping amounts are not netted, however, the rate disparity results in net interest in the government’s favor. To correct this inequity, Congress enacted section 6621(d), which provides that “to the extent that, for any period, interest is payable . . . and allowable . . . on equivalent underpayments and overpayments for the same taxpayer, . . . the net rate of interest on such amounts shall be zero.”
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.
Although the court addresses several arguments made by the government, the only notable bump in the court’s road to its conclusion was some language in another Court of Federal Claims decision, Energy East v. United States, 92 Fed. Cl. 29 (2010), aff’d 645 F.3d 1358 (Fed. Cir. 2011). Interpreting the meaning of “same taxpayer” for interest-netting purposes in Energy East, the lower court cited the dictionary definition of “same” and decided that section 6621(d) requires that the taxpayer must be “identical” and “without addition, change, or discontinuance.” (The issue on appeal was narrower and the Federal Circuit did not reject or adopt this aspect of the lower court’s opinion.)
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.
October 10, 2011
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.
The Third Circuit explains that the Code gives the Tax Court jurisdiction over claims for overpayment interest only “in two very narrow circumstances,” under sections 6512(b)(2) and 7481(c), and neither of those sections come into play in Sunoco’s situation. The court summarized its view of the critical defect in Sunoco’s position as follows: “The overpayment interest at issue here is not attributable to any decision of the Tax Court . . . . Rather, the interest at issue here arises from overpayments that were refunded or credited before this case began. We can find no statutory authorization for the Tax Court to determine this kind of claim.”
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.
March 18, 2011
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.
January 12, 2011
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.
November 3, 2010
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.
June 30, 2010
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.
The key documents in the case are here: