Who is Entitled to Tax Refund for a Consolidated Group?

The U.S. Supreme Court may decide who is entitled to a tax refund from a consolidated group’s federal income tax return when the members do not have a clear agreement about ownership of the refund.

The issue is whether a $4 million refund belongs to the bankrupt parent that filed the group’s return, or the bankrupt subsidiary whose losses generated the refund. The decision could depend on a disputed federal common law, referred to as the Bob Richards rule, and could impact millions of dollars tax refunds.

Tax Refunds for Consolidated Groups

An affiliated group of corporations may elect to file a consolidated income tax return each tax year in lieu of filing separate returns by each corporation. An affiliated group generally is a chain (or chains) of corporations connected through stock ownership with a common parent.

Under IRS regulations, the common parent of the consolidated group is authorized to act as the sole agent with respect to all matters relating to the group’s federal income tax liability. For example, the common parent can file claims for refund and make any tentative carryback adjustment of taxes for NOLs, net capital losses, or unused business credits.

Any refund from the group’s consolidated return is paid directly to the common parent. The payment to parent discharges the government’s liability to any subsidiary for the refund.

But nothing in the Code or regulations determines how a tax refund is divided among the consolidated group. Thus, the members of a consolidated group may allocate refunds in any manner they see fit.

Bankrupt Parent and Subsidiary Both Claim Refund

The case before the Supreme Court involves a bank holding company that filed a consolidated return with several affiliated subsidiaries. One subsidiary suffered $35.4 million in net operating loss (NOLs) in 2010. The subsidiary was closed in 2011 and the FDIC was appointed as the bank’s receiver.

The parent holding company filed a claim for refund in 2011 for approximately $4.8 million based on the subsidiary’s NOLs. However, while the claim for refund was pending, the parent company became insolvent and filed for bankruptcy in 2012.

Both the parent’s bankruptcy trustee and the FDIC (as receiver for the subsidiary) argued that the tax refund belonged to them. The 10th Circuit Court of Appeals sided with the FDIC (S. Rodriguez v FDIC, No. 17-1291, January 29, 2019).

Bob Richards Rule: Refund Generally Belongs to Whoever Generated It

The 10th Circuit relied on a federal common law principal known as the Bob Richards rule. It provides that in the absence of a formal or implicit agreement, a refund received by a common parent of an affiliated group is presumed to belong to the member whose income and losses generated the refund.

Here, the group’s tax sharing agreement was not clear about who owned a tax refund. Overall, however, the agreement created an agency relationship, rather than a debtor-creditor relationship, between the parent and the subsidiaries. Thus, the parent received the refund as the subsidiary’s agent, and was obligated to deliver it to the subsidiary.

The Bob Richards rule, however, is not followed by all federal courts. Other courts have found that ownership of an affiliated group’s tax refund should be based on relevant state law. 

Should the Bob Richards Rule Even Exist?

Several Supreme Court justices were skeptical of the Bob Richards rule during oral arguments and even wondered whether they needed to address it all. This was because the FDIC did not actively defend the rule before the court. Instead, the FDICs’ relied on the 10th Circuit’s finding that the group’s tax sharing agreement created agency relationship that entitled the subsidiary to the refund.

On the other hand, the bankruptcy trustee for the common parent argued that while the 10th Circuit interpreted the tax sharing agreement, it did so only through context of the Bob Richards rule. It did not cite to any cases of state law regarding agency. Thus, the lower court relied exclusively on the Bob Richards rule.

The bankruptcy trustee asked the Supreme Court to explicitly state that the Bob Richards rule is wrong to resolve the split in the lower courts. Instead, federal courts should rely only on state law for determining the rights and responsibilities between a common parent and it subsidies.

By John Buchanan, J.D., LL.M.

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CCHTaxGroup

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