Last Friday, June 13, the Federal Deposit Insurance Corporation (FDIC), together with the Federal Reserve Board and the Office of the Comptroller of the Currency (the "Agencies") finalized an Addendum to the Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure (the "Addendum"). The Addendum attempts to establish with finality that a bank rather than its holding company is entitled to any tax refund that is paid in connection with a return filed by a consolidated group including both the bank and the holding company and that would have been paid to the bank if it had filed on a stand-alone basis.
The Addendum requires every bank to review its tax allocation agreement and, if necessary to comply with the Addendum, to amend the agreement not later than October 31, 2014. The process may be time consuming if several affiliates are parties to the agreement, and accordingly banks should begin review of their agreements promptly.
The principle that a bank holding company may not keep a tax refund that a subsidiary bank would have received if filing on its own is enshrined a 1998 interagency statement, the Interagency Policy Statement on Income Tax Allocation. In recent years, however, there has been considerable litigation between the FDIC as receiver for failed banks and trustees in bankruptcy for failed bank holding companies without apparent consistency among the federal courts of appeals. Last week, on June 11, the liquidating supervisor for NetBank, Inc., petitioned the U.S. Supreme Court for a writ of certiorari to reverse an Eleventh Circuit ruling in the FDIC's favor. Last week as well, the FDIC sued FBOP Corp. in Illinois to recover a tax refund for its failed subsidiary bank.
In these cases, some courts have upheld a bank's right (or the FDIC's right as receiver) to a refund on the view that the tax allocation agreement required the holding company to serve as an agent or custodian for the bank when the holding company received a tax refund attributable to the bank. In other cases, the courts have determined that the agreement created a debtor-creditor relationship between a bank holding company and its subsidiary bank. If the bank is merely an unsecured creditor, then its prospects for recovery against its holding company in bankruptcy are, as a practical matter, non-existent.
Accordingly, the Addendum does two things. First, it requires every bank to include the following (or substantially similar) language:
The [holding company] is an agent for the [bank 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.
This language not only creates a principal-agent relationship, it also requires a holding company to disclaim an interest in the refund.
Second, the Agencies made it clear that failure to include such language may place a bank in violation of sections 23A and 23B. As to section 23A, if an agreement contains disapproved language that creates a debtor-creditor relationship between a holding company and a bank, then the bank has effectively extended credit to the holding company. The bank accordingly would need to comply with the 23A restrictions on such loans, including obtaining sufficient collateral from its holding company to secure the amount of the refund.
With respect to section 23B, this provision requires transactions between a bank and its holding company to be on the same terms (or terms more favorable to the bank) that nonaffiliated companies would agree on. Because a company that receives a tax refund attributable to another party is acting as agent for the other party, the receiving party would be required to transfer the payment to the other party promptly. Similarly, a bank is entitled to prompt payment of a comparable tax refund from its holding company. The Agencies draw the following conclusion:
Tax allocation agreements should require the holding company to forward promptly any payment due the [bank] under a tax allocation agreement and specify the timing of such payment. Agreements that allow a holding company to hold and not promptly transmit all refunds received from the taxing authority and owed to [a bank] are inconsistent with the requirements of section 23B and subject to supervisory action. However, an Agency's determination of whether such provision, or the tax allocation agreement in total is consistent with section 23B will be based on the facts and circumstances of the particular tax allocation agreement and any associated refund.
Banks should begin reviews of their tax allocation agreements in the very near future. Again, the deadline for compliant tax allocation agreements is October 31, 2014.