The Federal Circuit heard argument on November 5 in the government's appeal in Wells Fargo. The Court of Federal Claims had upheld the taxpayer's claim for interest netting based on overlapping periods of interest for companies that later became part of Wells Fargo following statutory mergers. See our prior report here.
The panel consisted of Judge Lourie and the two most recent appointments to the Federal Circuit, Judges Hughes and Stoll. Although Judge Lourie was silent during the argument, the latter two judges posed questions of both sides. Both of those judges expressed skepticism of the government's position that it is entitled to prevail on the authority of the Federal Circuit's earlier decision in Energy East Corp. v. United States, 645 F.3d 1358 (Fed. Cir. 2011), and of its position that identity of the taxpayer identification number (TIN) should be the litmus test of "same taxpayer." At the same time, the judges expressed concern that the logic of the taxpayer's position could lead to expanding the scope of interest netting beyond the scope of what Congress intended, and even create an improper incentive for companies to merge in order to obtain interest netting benefits. Overall, the questioning was evenhanded, and the outcome of the appeal will remain in doubt until a decision is rendered, although Judge Hughes did appear to lean towards the view that Wells Fargo has a strong case for interest netting on its particular facts.
Shortly after government counsel began the argument, Judge Hughes began to question her about whether Energy East is distinguishable because it involved two companies who filed a consolidated return (and hence were still distinct companies), rather than companies that had merged into one new company. Although she eventually acknowledged that this factual difference could be significant in some cases, government counsel pointed out that the Energy East court did not rely on the fact that the companies were consolidated rather than merged. Instead, that court relied on the non-consolidated status of the companies at the time of the overpayment and underpayment interest payments. That approach of focusing on the time of payment, she argued, was fatal to Wells Fargo's case because the TINs were not the same at the time of the respective interest payments (pre-merger and post-merger respectively). The court returned to Energy East on the government's rebuttal, with Judge Stoll observing that the portion of the opinion on which the government sought to rely did not truly address the "same taxpayer" requirement. Judge Hughes concurred, observing that there never was a "same taxpayer" in Energy East and thus the court there simply did not consider how this requirement applies in the case of a merger. He suggested that the discussion relied upon by the government was best viewed as dicta and hence could not be viewed as controlling in this case. On the other hand, when the taxpayer's counsel embraced the distinction between consolidated and merged taxpayers in his presentation, Judge Hughes echoed the government's argument and pointed out that the Energy East court had not relied upon this distinction, but in fact had relied on a timing-of-payment rationale that would apply equally to Wells Fargo.
The government argued that a relatively narrower reading of "same taxpayer" is necessary because Congress wanted to ensure that obtaining interest netting benefits would not be an incentive for mergers. It proffered Code section 381 as an example of this concern in the context of net operating losses. Judge Hughes remarked that the government's position made more sense in the case of "retroactive" interest netting for past years (where a merger might make preexisting interest netting claims available to a new company that had no connection to the payments), but made less sense on a going-forward basis. Government counsel responded that there would still be an incentive for a company to "shop" for a merger partner whose overpayment interest characteristics could be used to net against an underpayment interest liability.
Judge Stoll then questioned why the government argued for different outcomes in Situations 2 and 3, where the only difference is which company is the acquirer. She characterized the distinction as "arbitrary." Government counsel responded that the different outcomes flowed from its position that identity of the TIN should be the dispositive factor. (In this connection, government counsel stated that it embraced the Court of Federal Claims' holding in Magma Power Co. v. United States, 101 Fed. Cl. 562 (2011), but did not argue for the stricter rule set forth in the CFC's Energy East decision that the taxpayers must be "identical." See our report on Magma Power here.) The TIN rule is "administrable," counsel argued, and taxpayers can plan with the rule in mind if interest netting benefits are going to be affected by which company is the acquirer. Judge Hughes then jumped in to second Judge Stoll's view that there is no significant difference between Situations 2 and 3. He also remarked that the government's proffered policy justification for its position—namely, to prevent interest netting benefits from becoming an incentive for corporate acquisitions—is inapplicable in the Wells Fargo case because the relevant underpayment did not occur until after the particular merger that caused the change in the TIN.
In his argument, taxpayer's counsel stated that it relies on three points: (1) the legal effect of a merger under state law; (2) the principles previously applied by the IRS under Code section 6402 to interest offsetting when both the overpayment and underpayment were still outstanding; and 3) the IRS's administrative practice of looking to the successor corporation in contexts other than interest netting. He particularly emphasized the legal effect of the merger in explaining why Energy East is distinguishable, stating that once a merger occurs the surviving corporation succeeds to the attributes of the precedessor corporations.
At that point, both Judge Stoll and Judge Hughes pressed taxpayer's counsel on why interest netting should be allowed in Situation 1, where the companies had no connection at the time of both the underpayment and overpayment. Judge Hughes sought to illustrate his concern by presenting taxpayer's counsel with the hypothetical situation where interest had stopped running on both the overpayment and the underpayment before the merger, yet the statute of limitations for seeking interest netting remained open after the merger. Taxpayer's counsel maintained that the merged corporation would be able to obtain retroactive interest netting in this situation, stating that merger law establishes that the "history [of the predecessor corporations] passes" to the successor corporation and that this conclusion accords with IRS rulings involving mergers (albeit not in the interest netting context)—specifically, Rev. Rul. 62-60, which involves employment taxes. Both judges suggested that this result appeared to be a windfall for the taxpayer, but taxpayer's counsel emphasized that this result accorded with the way that the IRS has consistently treated mergers. Judge Hughes remarked that there was no unfairness to the taxpayer that needed to be remedied in this situation because at the time of the overlapping interest payments the two companies were completely unrelated. He also criticized that outcome as running afoul of the policy not to encourage the purchase of tax benefits. Judge Hughes went on to suggest in this connection that the taxpayer is "asking for more than you need to win your case."
The other topic raised by the judges during the argument was the extent to which existing law requires that a merger be treated as making two corporations into the same taxpayer. Judge Stoll asked taxpayer's counsel whether Libson Stores, Inc. v. Koehler, 353 U.S. 382 (1957), belied this notion, but he replied that nothing in that case disturbed Helvering v. Metropolitan Edison Co., 306 U.S. 522 (1939), which indicated that state merger law would govern this question. He added that the IRS itself in Rev. Rul. 58-603 recognized that Libson had limited effect in stating that it would not apply Libson in situations covered by section 381. The government for its part stated that merged corporations do not actually become the same taxpayer in all respects under section 381 and that principle supersedes anything to the contrary in Metropolitan Edison or other cases.
In sum, the questioning of the two judges who participated in the Wells Fargo argument focused on three key points and suggested some predisposition by the panel on those points: (1) although statements in the Federal Circuit's Energy East precedent support the government, the case is distinguishable on its facts and does not require a ruling for the government; (2) the court is skeptical of the government's proposed rule that identity of the TIN should be the dispositive factor; and (3) conversely, the panel is concerned that the taxpayer's approach of applying traditional merger law to hold that the merged corporation inherits all the interest netting attributes of the predecessor corporations is a bridge too far and would allow more generous interest netting than intended by Congress—at least when applied to completed pre-merger periods of interest overlap. How the Federal Circuit reconciles all of these predispositions remains to be seen, but there is a good chance that the court's opinion ultimately will stake out a path somewhat different from that argued by either of the parties. Keeping in mind Judge Hughes's comment that the taxpayer is "asking for more than you need to win your case," the outcome could still leave some uncertainty for other taxpayers with post-merger interest netting claims, even if Wells Fargo prevails, depending on their particular facts.
A decision is likely in early 2016, but there is no firm deadline for the court to issue its opinion.
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