The October 31st deadline to review and revise your tax allocation agreement is rapidly approaching. Banks and their holding companies need to ensure their agreements are in compliance with new regulatory guidance that, amongst other things, expressly acknowledges an agency relationship exists between the entities. This past June, regulators published an Addendum to their 1998 Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure. A copy of the Addendum can be found here.
The Addendum is the federal banking regulators’ response to recent court cases regarding the ownership of tax refunds between bankrupt bank holding companies and failed banks. While the earlier Policy Statement provided that a holding company receiving a tax refund from a taxing authority obtains such funds as agent for its subsidiaries, several courts have found that a tax refund for the consolidated group is an asset of the holding company, and the subsidiary bank was simply a creditor of the holding company. In those decisions, the courts determined that the applicable tax allocation agreements created a “debtor-creditor” relationship rather than an agency relationship. Accordingly, the Addendum seeks to ensure that tax allocation agreements are drafted in a manner that properly establishes an agency relationship, in an effort to avoid such outcomes going forward.
Companies are expected to revise their tax allocation agreements to reflect the new guidance no later than October 31, 2014. Immediately following this deadline, the federal banking regulators expect to see tax allocation agreements that: (i) clearly acknowledge that an agency relationship exists between the holding company and its subsidiary bank with respect to tax refunds; and (ii) contain no conflicting language regarding such relationship.
Holding companies can satisfy the above by incorporating in their tax allocation agreements the model language included in the Addendum, or substantially similar language. The model language reads:
The [holding company] is an agent for the [IDI and its subsidiaries] (the “Institution”) with respect to all matters related to consolidated tax returns and refund claims, and nothing in this agreement shall be construed to alter or modify this agency relationship. If the [holding company] receives a tax refund from a taxing authority, these funds are obtained as agent for the Institution. Any tax refund attributable to income earned, taxes paid, and losses incurred by the Institution is the property of and owned by the Institution, and shall be held in trust by the [holding company] for the benefit of the Institution. The [holding company] shall forward promptly the amounts held in trust to the Institution. Nothing in this agreement is intended to be or should be construed to provide the [holding company] with an ownership interest in a tax refund that is attributable to income earned, taxes paid, and losses incurred by the Institution. The [holding company] hereby agrees that this tax sharing agreement does not give it an ownership interest in a tax refund generated by the tax attributes of the Institution.
All holding companies should ensure that the above model language, or similar language, is reflected in their tax allocation agreements to make certain that they comply with the Addendum.
Further, the federal banking regulators made it clear in the Addendum that failure to include such language may result in violation of Sections 23A and 23B of the Federal Reserve Act. The Addendum notes that tax allocation agreements that do not clearly acknowledge that an agency relationship exists may cause the tax refund to be deemed an extension of credit from the bank to the holding company and, as such, may be subject to the collateralization and other requirements of Section 23A. The Addendum also notes that a tax allocation agreement would likely violate the “arms length” requirements of Section 23B if it did not establish an agency relationship and require the holding company to promptly transmit tax refunds attributable to the holding company’s subsidiary.
With only two weeks remaining until the deadline, holding companies should immediately review and revise their tax allocation agreements to avoid regulatory scrutiny and violations on their next exam.