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.
At that point, both Judge Stoll and Judge Hughes pressed taxpayer’s counsel on why interest netting should be allowed in Situation 1, where the companies had no connection at the time of both the underpayment and overpayment. Judge Hughes sought to illustrate his concern by presenting taxpayer’s counsel with the hypothetical situation where interest had stopped running on both the overpayment and the underpayment before the merger, yet the statute of limitations for seeking interest netting remained open after the merger. Taxpayer’s counsel maintained that the merged corporation would be able to obtain retroactive interest netting in this situation, stating that merger law establishes that the “history [of the predecessor corporations] passes” to the successor corporation and that this conclusion accords with IRS rulings involving mergers (albeit not in the interest netting context)—specifically, Rev. Rul. 62-60, which involves employment taxes. Both judges suggested that this result appeared to be a windfall for the taxpayer, but taxpayer’s counsel emphasized that this result accorded with the way that the IRS has consistently treated mergers. Judge Hughes remarked that there was no unfairness to the taxpayer that needed to be remedied in this situation because at the time of the overlapping interest payments the two companies were completely unrelated. He also criticized that outcome as running afoul of the policy not to encourage the purchase of tax benefits. Judge Hughes went on to suggest in this connection that the taxpayer is “asking for more than you need to win your case.”
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.
Federal Circuit Set to Address Post-Merger Application of “Same Taxpayer” Requirement for Interest Netting
The Federal Circuit is now considering an appeal by the government that seeks to restrict the availability of interest netting following mergers. Section 6621(d) provides for a “net interest rate of zero” on “equivalent underpayments and overpayments by the same taxpayer.” As we previously reported here and here, the government declined to pursue an appeal in Magma Power Co. v. United States, 101 Fed. Cl. 562 (2011), in which the Court of Federal Claims held that the “same taxpayer” requirement did not prevent interest netting where the taxpayer was a member of a consolidated group with respect to the period of overpayment interest but was outside the group in the tax year that triggered the underpayment interest. The court concluded there that since the taxpayer had the same taxpayer identification number (TIN) both before and after it became of member of the consolidated group it was the “same taxpayer.”
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.