Recently, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency (collectively, the “Agencies”) issued a notice requesting comment on supplemental rules regarding income tax allocation agreements between bank holding companies and their subsidiary banks. The proposal is intended to resolve the growing number of disputes between holding companies in bankruptcy and failed banks regarding the ownership of tax refunds generated by the banks. The proposed rules would require banks and their holding companies to review their existing tax allocation agreements to ensure that the agreements comply with the current guidance as amended by the proposed rules.
In 1998, the Agencies issued the “Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure” (63 FR 64757, Nov. 23, 1998) (“Interagency Policy Statement”), effectively allowing members of a consolidated group, comprised of one or more insured depository institutions (“IDIs”) and their holding company and affiliates (the “Consolidated Group”), to prepare and file their federal and state income tax returns as a group subject to certain conditions (most notably, the act of filing as a group may not prejudice the interests of any one of the IDIs). The Interagency Policy Statement also included language addressing the nature of the agency relationship between an IDI and its parent company.
However, subsequent interpretation of tax allocation agreements by the judiciary has led to conflicting determinations of the nature of the relationship between an IDI and its holding company. In certain circumstances, courts have determined that a debtor-creditor relationship, rather than an agency relationship, existed within the Consolidated Group. In an effort to further clarify the nature of this relationship, the Agencies are proposing to issue an Addendum to the Interagency Policy Statement to achieve the following objectives:
- ensure that tax allocation agreements between an IDI and its parent holding company expressly acknowledge the existence of an agency relationship, which is necessary to protect the IDI’s ownership rights in tax refunds;
- encourage the use of express language that the Agencies have deemed to be legally sufficient to establish such an agency relationship;
- clarify that holding companies are required to transmit tax refunds received from a taxing authority to their subsidiary IDI under rules governing transactions between an IDI and its affiliates; and
- caution holding companies and their IDIs that any tax allocation agreement that does not clearly acknowledge the existence of an agency relationship may subject the parties to additional requirements applicable to transactions between an IDI and its affiliates.
These four objectives will be addressed in turn.
Express Acknowledgment of Agency Relationship
Together with their counsel, Consolidated Groups should review their tax allocation agreements to ensure the agreements (1) clearly acknowledge that an agency relationship exists between the holding company and its subsidiary IDIs with respect to tax refunds, and (2) do not contain other language to suggest a contrary intent. As noted above, an acknowledgement of the agency relationship is necessary to ensure that subsequently reviewing courts do not interpret the language in the tax allocation agreements as creating a debtor-creditor relationship between the holding company and its IDI.
Amendment to Tax Allocation Agreements to Include Language Provided by the Agencies
The Agencies encourage all Consolidated Groups to amend their tax allocation agreements to include the following paragraph, which the Agencies have determined to be legally sufficient to establish the existence of an agency relationship between the IDI and holding company:
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.
Although the use of the above language is not expressly required by statute or regulation, the Agencies have determined that tax allocation agreements expressly including the exact language provided above fully comply with sections 23A and 23B of the FRA governing transactions between an IDI and its affiliates, the Interagency Policy Statement, and the Guidance. Although substantially similar language may be used, whether the tax allocation agreement is ultimately consistent with such laws will be based on the facts and circumstances of the particular tax allocation agreement. As such, these particular agreements are subject to review and are not deemed to be in compliance ab ibnitio.
Transmittal of Tax Refunds
As noted above, tax allocation agreements should require the holding company to promptly forward any payment due to the IDI under the tax allocation agreement. Ideally, such agreements should also specify the timing of such payments. Agreements that allow a holding company to hold tax refunds received from the taxing authority that are owed to an IDI do not comply with section 23B and may subject the holding company to supervisory action.
Failure to Expressly Acknowledge Agency Relationship Leads to Additional Compliance Obligations
Notably, the failure to clearly acknowledge/recognize the existence of an agency relationship may subject the tax allocation agreement to additional requirements under section 23A of the Federal Reserve Act.
Corporate Groups are encouraged to fully comply with the information provided in the Guidance. Importantly, Corporate Groups should also consult with their legal counsel to ensure that the terms of their tax allocation agreement will be effective in providing mutual benefit to both the holding company and its IDI rather than simply allocating all tax losses, including those generated by the holding company, to be directed to the IDI. Through a carefully drafted tax allocation agreement, legal counsel will be able to ensure that holding companies’ ownership rights in tax refunds are protected.