Global Netting: Potential Opportunities for Corporate Taxpayers

Business, Investment & Transactional Tax Alert

        Two recent judicial decisions addressing the so-called "global netting" of interest in tax cases potentially offer corporate taxpayers new opportunities. Taxpayers may be able to obtain at least partial netting relief on underpayments and overpayments of federal tax in some circumstances where it had been commonly assumed to be unavailable, and are well-advised to take a second look at their IRS account transcripts in search of previously overlooked claims that may be filed before the statute of limitations expire.  

        Under Section 6621 of the Internal Revenue Code (the "Code"), interest is calculated at a higher rate for underpayments of corporate tax than it is for corresponding overpayments.  Congress and others have recognized that this can produce unfair results when a corporation simultaneously owes money to the Government and is owed money from the Government in different tax accounts for overlapping time periods, but the underpayment and the overpayment are not actually offset against one another.  (The Code generally eliminates interest on balances that are offset against one another, but not when the amounts are collected and refunded separately.)

        When Congress first provided for the interest rate differential in 1986, it assumed the Internal Revenue Service (the "Service") would provide for "comprehensive netting" (that is, netting of offsetting balances that are not simultaneously resolved) within three years.1  This policy was never implemented, so corporate taxpayers were left having to pay an interest differential of up to 4.5% on offsetting balances despite not owing any net tax.

        In 1998, as part of the IRS Restructuring and Reform Act of 1998 ("RRA"), Congress amended Section 6621 to provide for a "net interest rate of zero" on reciprocal tax debts that are outstanding at the same time for the same taxpayer. This provision generally applies to interest that accrued after enactment, but an uncodified transition rule allows netting to apply to interest accrued earlier, under certain conditions and "subject to any applicable statute of limitation not having expired with regard to either a tax underpayment or a tax overpayment."  RRA § 3301(c)(2).

        The Service implements the "net interest rate of zero" by equalizing interest rates on "equivalent" over- and underpayment balances that are outstanding over the same period.  The IRS can reduce the interest rate that it charges on tax underpayments to the lower overpayment rate, or it can increase the interest rate it pays on tax overpayments to equal the higher underpayment rate.  The Service normally uses the first method (reducing the interest rate on the underpayment and refunding any "excess" interest charged) when the statute of limitations situation permits.

The Decisions

        In Exxon-Mobil Corp. v. Commissioner, the Second Circuit ruled against the long-standing Service interpretation of the transition rule language quoted above which required that the statute of limitations on both the underpayment and the overpayment used in a netting computation be open on the date the RRA was enacted (July 22, 1998) in order for the transition rule to apply.2  The decision created a decisional split with the Federal Circuit, which had previously upheld the Service's interpretation in Federal National Mortgage Ass'n v. United States, 379 F.3d 1303 (Fed. Cir. 2004).

        The question of when consolidated groups of corporations are the "same taxpayer" also presents thorny issues, particularly where one group joins another pre-existing group or the common parent of the group changes. There has never been clear guidance on this issue and the Service's administrative practice has changed over time. The Court of Federal Claims, in Magma Power v. United States, allowed the taxpayer to claim the benefit from netting its underpayment against its "share" of a consolidated group's overpayment for a later taxable year.3    

        The reported decision on the legal issue came out at the end of 2011, but the parties continued to wrangle over allocation issues, so a final order in the case did not issue until September, 2012.  In December, the government withdrew its notice of appeal, apparently in the context of a settlement.  It is not clear whether and how the IRS will change its administrative practices in light of the case.

        The Magma court's focus on the individual members of the group in deciding the "same taxpayer" issue could pose significant practical hurdles in applying netting to consolidated groups.  On the other hand, the decision potentially allows taxpayers at least some benefit in situations where the Service has not previously allowed netting. 

                                                EXXON-MOBIL AND THE TRANSITION RULE

        As explained above, Congress provided that the interest netting requirement not only would operate prospectively, but also would apply to prior periods under certain circumstances.  The transition rule ("special rule") read as follows:

        Special Rule. Subject to any applicable statute of limitation not having expired with regard to either a tax underpayment or a tax overpayment, the amendments made by this section shall apply to interest for periods beginning before the date of the enactment of this Act [July 22, 1998] if the taxpayer:


reasonably identifies and establishes periods of such tax overpayments and underpayments for which the zero rate applies; and 


not later than December 31, 1999, requests the Secretary of the Treasury to apply section 6621(d) of the Internal Revenue Code of 1986 ... to such periods.

Revenue Procedure 99-43
        In 1999 the Service issued guidance regarding the application of Section 6621(d) and the Special Rule to interest accruing before October 1, 1998.  Revenue Procedure 99-43 interprets the introductory language of the special rule to require that "both periods of limitation applicable to the tax underpayment and to the tax overpayment . . . must have been open on July 22, 1998" in order to obtain retrospective interest netting.  On the other hand, the revenue procedure also waives the December 31, 1999 notification requirement if one of the applicable statutes of limitations expires after December 31, 1999.  In many cases, there was no way to predict what underpayments and overpayments might later be determined for past years, and the IRS did not want to be submerged in protective filings in cases where final tax liabilities might not be determined for years.

Federal National Mortgage Association v. United States
        The U.S. Court of Appeals for the Federal Circuit, in Federal National Mortgage Association v. United States, 379 F.3d 1303 (Fed. Cir. 2004), was the first federal circuit court to address the interpretation of the transition rule. Federal National Mortgage Association ("FNMA") filed a netting claim with the Service under the transition rule in December, 1999, which was rejected to the extent that it implicated underpayments for years for which the statute of limitations had run before July 22, 1998.  Reversing the Court of Federal Claims – which had held in FNMA's favor – the Federal Circuit ruled that the transition rule was a waiver of sovereign immunity against suit and had to be strictly construed in favor of the government, and upheld the Service in requiring that both statutes of limitation have been open upon enactment. 

Exxon Mobil Corp. v. Commissioner

        Exxon Mobil's dispute related to overlapping income tax underpayment and overpayment balances for its 1975 through 1980 tax years.  Again, the statute of limitations for some of the underpayments -- but not the overpayments -- had expired before July 22, 1998.  At the conclusion of the Tax Court litigation, Exxon-Mobil applied for netting relief in computations.  In February, 2011, the Tax Court held for Exxon-Mobil, expressly rejecting the Federal Circuit's reasoning in Federal National Mortgage Association v. United States. The Tax Court concluded that the critical language was ambiguous and that "section 6621(d), as modified by the special rule, is a remedial statute that must be interpreted to achieve the remedial purpose Congress intended; i.e., taxpayer relief from disparate interest rates."  

        The Second Circuit affirmed the Tax Court's decision.  Rejecting the Federal Circuit's conclusion that the transition rule operated as a waiver of sovereign immunity, the court considered the Special Rule's structure, history, and purpose, noting that since the zero net rate can be achieved by adjusting the rate on either the overpayment or underpayment "leg" of the transaction it would be anomalous to require that the statute of limitations for both legs be open.   In addition, like the Federal Circuit, the Second Circuit held that the interpretation of the transition rule in Rev. Proc. 99-43 was not entitled to administrative deference because it was not promulgated pursuant to an explicit or implicit Congressional delegation of law-making authority and the revenue procedure did not set forth any reasoning in support of its conclusion regarding the language of the Special Rule. 


        The Second Circuit noted that because of the Special Rule's requirement that request for interest netting be made prior to December 31, 1999, the court's opinion was unlikely to affect many taxpayers.   The court does not appear to have considered that Revenue Procedure 99-43 generally waived the December 31, 1999 deadline when the statute of limitations remained open after that date, so that it is possible that later claims might be affected.  On the other hand, considering the court's strong dismissal of the relevance of Rev. Proc. 99-43 in interpreting the Special Rule, a taxpayer may not be able to rely on the same procedure's waiver of a statutory deadline for filing a netting claim.


Administrative Practice

        The IRS has generally treated a corporate consolidated group as the "same taxpayer" so long as the same entity remains as common parent.  However, thorny questions arise in cases where the netting occurs between the consolidated group and one of its members or between a consolidated group and as successor consolidated group with a different common parent.  Such situations fall into two general classes, illustrated by the examples below (in each case, Group A is a consolidated group some of the members of which later continue into Group B). 

  • In the first pattern, Group A is entitled to an overpayment for a pre-combination year and Group B is liable for an underpayment for a post-combination year. Group A's common parent receives the refund, to which individual group members' rights will generally be proportionate to their contribution to the overpayment. Those members of Group A that later become members of Group B will be jointly and severally liable for the underpayment. 
  • The second fact pattern involves the reverse situation: Group A is liable for an underpayment for a pre-combination year and Group B is entitled to an overpayment for a post-combination year. All members of Group A will be jointly and severally liable for the underpayment; those that survive as members of Group B may be entitled to a portion of the refund depending on their contribution.

        For some time, the IRS' administrative practice was to allow "forward cross-netting" in the first fact pattern, but deny "reverse cross-netting" in the second fact pattern.  The reasoning appeared to be that in the first situation, the Group A members collectively entitled to the refund were jointly and severally liable for Group B's entire underpayment, while in the second situation, the group A members liable for the underpayment would probably not be entitled to the whole of Group B's overpayment (and might not be entitled to any of it).  The IRS seems to have changed its practice around 2009, and it is now not clear whether or when it will allow netting between two consolidated groups with different common parents.

Energy East and Magma Power

        Energy East Corp. v. United States upheld the Service's consistent position that two consolidated groups whose memberships did not overlap when the over- and underpayments arose were not the "same taxpayer" even though they later combined into a single group.4   The fact pattern in Energy East did not correspond to either example above: the question was whether group A's pre-combination underpayment and group B's pre-combination overpayment could be netted because they later combined into group C.  

        When the IRS sought to extend Energy East to consolidated groups with overlapping membership in Magma Power, however, it ran into a roadblock.  Magma Power ("Magma"), which had joined the CalEnergy consolidated group in 1995, paid a substantial deficiency, with interest, for its taxable year 1993.   The CalEnergy group had overpayments for its taxable years 1995 through 1998, "a substantial part" of which were attributable to Magma.  Magma filed a refund claim for 1993 claiming a reduced interest rate based on global netting with the consolidated overpayments.  The IRS denied the claim on the grounds that Magma and the CalEnergy consolidated group were not the "same taxpayer." 

        The court decided the  "same taxpayer" issue in favor of the taxpayer on cross-motions for summary judgment.   The court concluded that the "taxpayers" were the component group members rather than the group as a whole:  "Following the government's reasoning to its natural conclusion, the members of a consolidated group have lost their separate identity. . . However... [t]he group itself is not a "taxpayer" under the Code nor does it have a separate EIN for tax purposes.   For purposes of our plain meaning analysis, we are concerned only with the individual member of that group as identified by its EIN, which is responsible for equivalent amounts of underpayments and overpayments in separate tax years."

Potential Implications

        Magma Power may point the way to obtaining substantial netting relief for overlapping consolidated groups in both the fact patterns described above (including the second fact pattern under which netting was generally not allowable even under the Service's pre-2009 practice).  Taxpayers may be able to obtain at least partial netting relief to the extent that they can attribute an overpayment to individual group members liable for the underpayment.   Taxpayers in this situation would be well-advised to take a second look at their IRS account transcripts in search of previously overlooked claims that may be filed before the pertinent statute of limitations expire.  On the other hand, the decision raises some basic questions about how consolidated groups should be treated in netting computations that remain unresolved, especially where members join and leave an existing group.  Depending on future legal developments and whether and how the Service changes its administrative procedures, some consolidated taxpayers may lose some of their expected netting benefit.

        If you have any questions about this alert, please contact:

James E. Salles 

Charles M. Ruchelman

 Michael Lloyd 

1 Conf. Rep. No. 841, 99th Cong., 2d Sess. (1986).
2 Exxon-Mobil Corp. v. Commissioner, 689 F.3d 1 (2d Cir. 2012), aff'g 136 T.C. 99 (2011).
3 Magma Power v. United States, 101 Fed. Cl. 562 (2011).
4 Energy East Corp. v. United States, 92 Fed. Cl. 29 (2010), aff'd, 645 F.3d 1358 (Fed Cir. 2011).


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