Interest Netting Between Merging Corporations
In general, taxpayers pay interest on tax underpayments and receive interest on overpayments, but for corporations the interest rate on underpayments is higher than the rate on overpayments. Thus, if a corporation has an underpayment from one year and an overpayment in the same amount from another year, it will owe interest even though it owes no net tax. For corporations with significant tax deficiencies and overpayments, the rate differential may be as much as 4½ percentage points.
To alleviate this problem, Congress enacted section 6621(d) of the Code, an “interest
netting” rule. Under section 6621(d), if “the
same taxpayer” has “equivalent” amounts of underpayment and overpayment,
“the net rate of interest on such amounts” is zero.
There have been several court decisions and IRS chief
counsel advice memoranda addressing the issue of what is “the same taxpayer” in
the context of corporate acquisitions.
Wells Fargo Decision
On June 27, the Court of Federal Claims announced a
decision construing “the same taxpayer” in the context of corporate mergers. Wells Fargo & Co. v. United States, No. 11-808T, ___ Fed. Cl. ___, 114
AFTR 2d 2014-___ (Ct. Fed. Cl. 2014). The decision deals with several
acquisitive mergers by Wells Fargo and its corporate predecessors. In each of the mergers, the
parent of a consolidated group merged into the parent or a subsidiary member of
another group. Ultimately all the target corporations, or their successors by
merger, were merged into Wells Fargo, which was the parent of a consolidated group.
The
parties filed cross motions for partial summary judgment on the issue of
whether interest netting was permitted. Wells Fargo argued that the target
and the acquiror in a merger were “the same taxpayer,” and that, therefore,
underpayments and overpayments by the targets and the acquirors could be netted
against each other for periods both before and after the mergers. The Government argued that
netting was permitted only if the corporation making the overpayment and the
underpayment had the same TIN at the time of both events.
The court
described mergers as presenting three potential interest-netting scenarios:
- Netting
of pre-merger underpayments (or overpayments) by the acquiror against pre-merger
overpayments (or underpayments) by the target.
- Netting
of pre-merger underpayments (or overpayments) by the acquiror against
post-merger overpayments (or underpayments) by the acquiror.
- Netting
of pre-merger underpayments (or overpayments) by the target against post-merger
overpayments (or underpayments) by the acquiror.
The court granted Wells Fargo’s motion and denied the Government’s
motion, holding that interest netting was permitted in all three scenarios.
This holding was based on the rationale that, as a matter of state law, in a
statutory merger, “the acquired and acquiring corporations have no post-merger
existence beyond the surviving corporation; instead, they become one and the
same by operation of law, and thereafter the surviving corporation is liable
for the pre-merger tax payments of both the acquired and acquiring corporations….[F]ollowing
a merger, the law treats the acquired corporation as though it had always been
part of the surviving entity.” Wells
Fargo, slip op. at 16-17.
Unresolved Issues
The scope of the Wells Fargo holding is not clear, and a
number of issues remain unresolved:
- Taxable
Mergers. The mergers in Wells Fargo
were tax-free reorganizations, but the court’s opinion concentrates on the corporate
law consequences of a merger—combining the identities of the target and the
acquiror. Thus, the Wells Fargo
holding may also apply to mergers that do not qualify for tax-free treatment.
Rev. Rul. 69-6, 1969-1 C.B. 104 (forward merger for nonstock consideration treated
as taxable sale of target assets and liquidation of target); Rev. Rul. 73-427,
1973-2 C.B.301 (reverse merger for cash consideration treated as sale of target
stock).
- Mergers
of Target Corporation into Disregarded Entity. It is common for a target
corporation to be merged into a disregarded entity, such as an LLC, that is owned
by a corporation. Such a merger can qualify as a tax-free “statutory merger or
consolidation” of the two corporations. IRC § 368(a)(1)(A); Reg.
§ 1.368-2(b)(1)(ii). As a corporate law matter, however, the merger
combines the target corporation and the disregarded entity, not its owner.
Thus, it is not clear whether the Wells
Fargo holding would support interest
netting between the target and the corporate owner of the disregarded entity.
- Consolidated
Returns. The mergers in Wells Fargo
involved common parents of consolidated groups, but the court’s opinion does not address netting within
a single consolidated group or between groups. The background to this issue can
be described as follows:
- Netting within a consolidated
group where there is no change in the composition of the group does not appear
to be a subject of controversy.
- In Energy East Corp. v. United States, 645 F.3d 1358, 107 AFTR
2d 2011-2606 (Fed. Cir. 2011), the
Federal Circuit held that, if a target corporation joins a group (not in a
merger), netting is not permitted between interest on the target’s pre-acquisition
overpayments (or underpayments) and interest on the group’s pre-acquisition underpayments
(or overpayments).
- In Magma Power Co. v. United States, 101 Fed. Cl. 562, 108
AFTR 2d 2011-6943 (Ct. Fed. Cl. 2011), the Court of Federal Claims held that,
if a target corporation joins a group (again, not in a merger), interest on the
target’s pre-acquisition underpayments (or overpayments) may be netted against
interest on the group’s post-acquisition overpayments (or underpayments), to
the extent the group’s overpayment (or underpayment) can be traced to the
target.
- See also FSA
200212028 (Jan. 16, 2002) (interest netting requires liability for the underpayment
by the entity with the overpayment).
What happens if, as in Wells Fargo, the common parent of one consolidated
group merges into the common parent of another group? Does netting apply to
interest on underpayments and overpayments generated by both groups on a
consolidated basis, or just to interest on underpayments and overpayments
generated by the target and the acquiror as separate entities? The parties’
motions for partial summary judgment in Wells
Fargo did not require the court to address this issue, and the court’s
opinion does not do so.
Take-Away
Under the Wells
Fargo holding, it is clear that interest netting applies between the target
and the acquiror in a two-party corporate merger that qualifies as a tax-free
reorganization.
Netting may also apply even if the merger does not
qualify for tax-free treatment, and/or a corporate target merges into a
disregarded entity, but the Wells Fargo
opinion does not address these points. Also, the Wells Fargo opinion does not clarify the application of netting
where the target or the acquiror (or both) is a consolidated group parent.
In many instances, an acquisition (tax-free or
taxable) can be structured in a number of ways, including a two-party merger.
Often such a merger is rejected, e.g.,
to prevent the acquiror from assuming the target’s contingent liabilities. Such
concerns are important, but the availability of interest netting may be a
tangible factor in favor of a two-party merger acquisition structure.
If you have questions or comments, please contact Bob
Wellen or Pat Smith.
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