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Supreme Court Decision Creates Uncertainty for Tax Refunds

Posted on Feb. 26, 2020

The Supreme Court’s decision to eliminate a long-standing federal common law rule could create inconsistent results for consolidated groups fighting over tax returns.

The Court held February 25 that the federal common law doctrine known as the Bob Richards rule was invalid and couldn’t be used to settle disputes over tax refunds in bankruptcy.

“This is not going to help predicting outcomes in the future at all,” Lee G. Zimet of Alvarez & Marsal told Tax Notes. Zimet said that is because the other methods courts have used to settle those disputes — like looking to tax allocation agreements and state corporate law — have yielded unpredictable results.

“The only unifying theme for these cases has been federal common law, where generally the company that produced the losses was entitled to the refund,” Zimet said. “If we don’t have that, it’s going to be anybody’s guess as to who’s going to win these cases going forward.”

The case centers on a $4 million tax refund owed to subsidiary United Western Bank. Before the refund could be issued, the bank was taken over by the FDIC, and the bank’s parent company — United Western Bancorp Inc. — filed for bankruptcy.

The parent argued that as the designated agent of the affiliated group, it was entitled to the refund, and the bankruptcy court agreed. But the district court and Tenth Circuit sided with the FDIC as receiver for the bank. In a June 2018 decision, the Tenth Circuit found that the tax allocation agreement created an agency relationship between the parent holding company and the subsidiary bank, which meant the bank was entitled to the refund.

No Unique Federal Interests

In his unanimous opinion, Justice Neil M. Gorsuch vacated the Tenth Circuit’s decision and remanded with the instruction that the court of appeals decide the case without relying on the Bob Richards rule.

As Gorsuch noted, the rule initially said that in the absence of a tax allocation agreement, a refund belongs to the group member whose losses generated the refund. But the rule has since evolved in some jurisdictions to provide that the refund always goes to this member unless the agreement unambiguously says otherwise. Much of the oral argument in the case focused on the rule’s role in the outcome.

Gorsuch said disputes like the one here weren't the kind that justified the creation of a federal common law doctrine, which requires the need to protect unique federal interests. The government may have such interests in how it receives taxes and delivers tax refunds, he said.

“But what unique interest could the federal government have in determining how a consolidated corporate tax refund, once paid to a designated agent, is distributed among group members?” Gorsuch asked. He said that “state law is well equipped to handle disputes involving corporate property rights,” and the fact that this case involves federal bankruptcy and tax issues makes little difference.

Zimet said he knew that repealing federal common law was a possibility, but that he was surprised the Court went that way given that the rule had been in wide use for the last 47 years. “In retrospect, it seems like the Supreme Court took this case just to basically eliminate the idea of federal common law being used to decide these cases,” he said.

These types of tax refund disputes will likely wane given that carrybacks are no longer allowed for net operating losses arising after 2017, Zimet said.

The petitioner in Rodriguez v. Federal Deposit Insurance Corp., Sup. Ct. No. 18-1269 (2020), is represented by  Hogan Lovells US LLP.

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