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Supreme Court Will Hear Parent-Subsidiary Tax Refund Dispute (1)

June 28, 2019, 1:45 PMUpdated: June 28, 2019, 4:36 PM

The U.S. Supreme Court will hear a case about whether a parent corporation or its subsidiary owns a $4.1 million tax refund.

The case stems from a shared tax return between a parent company and its subsidiaries, and the petition to the high court calls the issue a “multimillion-dollar question.” If the parent owns the refund, a subsidiary may be treated merely as one of the corporate parent’s creditors. This means that if the parent company declares bankruptcy, the tax refund will become part of the bankruptcy estate that all the creditors—including the subsidiary that is owed the tax refund—will compete over as they try to get repaid.

The individual who requested the review, Simon Rodriguez, said the high court should consider the case to resolve disagreement in lower courts about a rule that sometimes assumes a tax refund belongs to the subsidiary.

“The Court should not permit the rights of corporations, shareholders, and creditors to vary dramatically circuit-by-circuit based on this invented presumption,” the petition said.

Rodriguez’s legal team includes Neal Kumar Katyal, a partner at Hogan Lovells and law professor at Georgetown Law. Katyal was the acting solicitor general of the U.S. under President Barack Obama and is a frequent litigator at the Supreme Court.

The question raised in the case has high economic stakes and could affect up to 35,000 corporate tax returns annually, Katyal said in an emailed statement.

“Tax refunds to affiliated groups often run into the hundreds of millions of dollars,” he said.

Argument Next Term

The Supreme Court, which has completed its 2018-2019 term, announced it would hear the case June 28.

Katyal said the court will likely hear arguments in late 2019 or early 2020. Mitchell Reich, an associate at Hogan Lovells, will argue before the court, Katyal said.

The case was initially heard in bankruptcy court. Rodriguez, the trustee for the bankruptcy estate of a parent company called United Western Bancorp Inc. (UWBI), alleged the tax refund for losses incurred by one of its subsidiaries, United Western Bank, belonged to UWBI. As the receiver for United Western Bank, the Federal Deposit Insurance Corporation (FDIC) disputed that claim.

The Internal Revenue Service allows parent companies and their subsidiaries to file one consolidated tax return, which means subsidiaries can offset their losses against each other to reduce the group’s overall tax liability. The IRS calls this collection of the parent company and its subsidiaries an “affiliated group.”

Question to Resolve

Under IRS rules, when such affiliated groups file a consolidated return, any tax refunds owed to members of the group must be paid “directly to and in the name of” the corporate parent.

Rodriguez hopes the Supreme Court will resolve a split between the lower circuit courts. His petition states that three of those circuits, including a lower court that ruled on this case, have adopted what they call the “Bob Richards rule,” where they presume the tax refund belongs to the subsidiary unless the parties “clearly agree otherwise.”

But the petition says four other circuit courts have rejected this rule, which was developed in federal common law. Instead, they decide who owns the tax refund based on applicable state law.

Earlier, the U.S. Court of Appeals for the Tenth Circuit found the subsidiary owned the refund based on the court’s interpretation of language in the pre-existing agreement between the subsidiary and the parent.

The FDIC, speaking for the interests of the subsidiary, argued that the debate over the “Bob Richards rule” is irrelevant in this case because the parties made an agreement on how to handle such tax refunds, and all courts say such agreements should govern who owns the refund.

The case is Rodriguez v. Fed. Deposit Ins. Corp., U.S., No. 18-1269, cert. granted 6/28/19.

To contact the reporter on this story: Aysha Bagchi in Washington at abagchi@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com