On February 25, 2020, in Rodriguez v. Federal Deposit Insurance Corporation, No. 18-1269 (U.S. 2020), the U.S. Supreme Court effectively ruled that the so-called “Bob Richards rule” should not be used to determine which member of a group of corporations filing a consolidated federal income tax return is entitled to a federal income tax refund. The Supreme Court’s decision has important practical consequences for groups of corporations that file consolidated federal income tax returns, and such groups should act immediately to ensure that the appropriate group members control the group’s tax assets. Tax sharing or allocation agreements entered into by members of such a group should not only indicate which group members are entitled to tax refunds, but should also specify the capacity in which a member holds a tax refund. Lenders offering financing to members of such groups may now be more interested in seeing adequate tax sharing or allocation agreements in place. The need to act is especially critical where a group member has generated net operating losses (NOLs) or may potentially be the subject of bankruptcy proceedings.
Under certain circumstances, a parent corporation and its 80 percent (or more)-owned subsidiaries, may elect to file a consolidated federal income tax return that reports the income (and losses) of the parent and its subsidiaries as a group (often called a “consolidated group”). The subsidiaries appoint the parent as their agent, and the parent becomes responsible for both paying the federal income taxes of each member of the group and collecting any federal income tax refunds due to a member of the group, for a year for which they have filed a consolidated return. While federal tax regulations govern the relationship between the IRS and the parent, they say little about the allocation of refunds among a parent and its subsidiaries, and members of consolidated groups typically enter into agreements governing the obligations owed by members to each other, including the ownership of any tax refunds.
The Bob Richards rule had its genesis in a bankruptcy case, In re Bob Richards Chrysler-Plymouth Corp., Inc., 473 F.2d 262 (9th Cir. 1973), which involved a consolidated group that had no agreement specifying the ownership of tax refunds. The parent had obtained from the IRS a refund based upon NOLs that had been carried back and used to offset income generated by one of its subsidiaries in a prior period. The 9th Circuit acknowledged that the parent and subsidiary could have entered into an agreement specifying the ownership of the refund, but because there was no such agreement, the 9th Circuit had to employ other means to determine the ownership of the refund. The 9th Circuit’s solution was to craft its own rule, which provided that in the absence of an agreement governing the ownership of tax refunds, “a tax refund resulting solely from offsetting the losses of one member of a consolidated filing group against the income of that same member in a prior or subsequent year should inure to the benefit of that member.” 473 F.2d at 265.
By the time the Bob Richards rule was applied by the 10th Circuit in the case that was ultimately appealed to the Supreme Court, In re United Western Bancorp, Inc., 914 F.3d 1262 (10th Cir. 2019), the rule had evolved to mean that unless an agreement among consolidated group members unambiguously specifies the ownership of a tax refund, the refund “generally belongs to the company responsible for the losses that form the basis of the refund.” 914 F.3d at 1269, citing Barnes v. Harris, 783 F.3d 1185, 1195 (10th Cir. 2015). In re United Western Bancorp, Inc. involved a parent corporation and subsidiaries that filed a consolidated federal income tax return. One of the subsidiaries, a bank, generated income in 2008, but a loss in 2010, so the parent filed a claim for refund based upon the carryback of the 2010 loss to 2008. The subsidiary was closed by the Office of Thrift Supervision, and the FDIC was appointed as its receiver. The parent was ultimately forced to file for bankruptcy.
Although the parent and subsidiary did have an agreement that governed the disposition of the refund, it was unclear under the agreement whether the parent had received the refund as the subsidiary’s agent, or whether the agreement merely provided that the parent was indebted to the subsidiary in an amount equal to the amount of the refund. It was, therefore, unclear whether the FDIC, as the subsidiary’s receiver, was the beneficial owner of the refund or was merely an unsecured creditor of the parent. Because of the ambiguity in the agreement, the 10th Circuit applied the Bob Richards rule and concluded that the FDIC was entitled to the refund (and would not have to compete with other creditors for it).
Some circuit courts, including the 6th Circuit, did not follow the Bob Richards rule, and the Supreme Court granted certiorari. In a unanimous opinion authored by Justice Gorsuch, the Supreme Court concluded that federal courts may not create their own common law rules unless “necessary to protect uniquely federal interests.” Since no such interest was at stake in the original Bob Richards case, the 9th Circuit should not have created the Bob Richards rule in 1973, and the 10th Circuit should not have applied the Bob Richards rule in 2019. Accordingly, the Supreme Court remanded the case so that the lower courts could decide the case without applying the Bob Richards rule.
Because corporations that file consolidated returns may no longer assume that the Bob Richards rule will determine which group member owns the group’s NOLs and other tax assets, it is more important than ever that such corporations enter into clear written agreements that specify the ownership of the group’s tax assets. Moreover, such agreements must do more than merely say which member owns a tax asset; such agreements must now specify in what capacity the member owns the asset, as the capacity in which the member holds the asset can be critical in a bankruptcy proceeding.