On March 3, the U.S. Internal Revenue Service suffered a devastating loss to Washington Mutual in a U.S. Appeals Court decision in a tax-refund case concerning the basis of intangible assets acquired in a reorganization.
Recent as the decision is, the case arose in the long aftermath of the federal government’s efforts to contain the savings-and-loan crisis more than three decades ago.
The case originated in 1981. Home Savings of America agreed to acquire three failing savings-and-loan associations, or thrifts: Southern Federal S&L, Hamiltonian Federal S&L, and Security Federal S&L. The Federal Savings and Loan Insurance Corp. (FSLIC) and Home Savings agreed that the acquisition would be structured as two separate mergers: Hamiltonian and Security Federal would first merge into Southern Federal and Southern Federal would then merge with and into Home Savings.
Although bank regulators tried to mitigate the crisis through deregulation, the liabilities of many already-failed thrifts threatened to exhaust FSLIC’s insurance reserves. To avoid further insurance liability, the Federal Home Loan Bank Board, which chartered and regulated federal thrifts, decided to induce healthy financial institutions to take over troubled thrifts in a series of “supervisory mergers.”
Such transactions, in which the acquiring parties assumed the obligations of thrifts with liabilities that far exceeded their assets, were not alluring to healthy institutions. Further, the FSLIC lacked the cash to promote such acquisitions through direct subsidies alone.
Deals like the one Home Savings enjoyed thus became typical. In exchange for agreeing to do the mergers and accept the liabilities in excess of the assets of the failing thrifts, the FSLIC gave Home Savings a rich package of incentives that included the right to maintain branches in other states (the “branching rights”) and the right to use the purchase method of accounting for regulatory capital reserve purposes (the “RAP rights”).
Later the FSLIC and Home Savings entered into an “Assistance Agreement”(AA) under which the Home Savings-Southern Federal merger would be “. . .a tax-free reorganization. . . .”
Washington Mutual, which later acquired Home Savings, filed amended tax returns with the IRS, seeking refunds for 1990, 1992, and 1993 based on the amortization of the RAP rights and the abandonment of the branching rights. The company claimed that the IRS failed to allow Home Savings amortization deductions for the RAP rights and loss deductions for its abandonment of the Missouri branching rights.
The IRS denied the claims, and Washington Mutual sued in U.S. District Court. The District Court ruled on summary judgment that Home Savings did not have a “cost basis” in the RAP rights and the branching rights. It also rejected Washington Mutual’s amortization and loss deduction-related refund requests.
Washington Mutual appealed the decision in the U.S. Court of Appeals for the Ninth Circuit. In its March ruling, the Appeals Court held that Home Savings did have a cost basis in the RAP rights and the branching rights equal to some part of the excess of the three acquired thrifts’ liabilities over the value of their assets.