Wmi Holdings Corp. v. United States

Citation: 891 F.3d 1016Docket: 17-1944

Court: Court of Appeals for the Federal Circuit; June 4, 2018; Federal Appellate Court

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WMI Holdings Corp. is appealing a decision from the United States Court of Federal Claims regarding a claim for a refund of over $250 million in federal taxes paid by its predecessor. WMI argues that it is entitled to these refunds due to losses and deductions related to intangible assets acquired from the federal government in the 1980s. The appeal involves three parties: WMI, the Federal Deposit Insurance Corporation (FDIC) acting as receiver for Home Savings of America, and Savings of America, Inc. The Claims Court dismissed WMI's refund action, concluding that WMI did not sufficiently establish a cost basis for the disputed assets. This dismissal was affirmed by the Court of Appeals, as the court found the Claims Court's ruling to be not clearly erroneous.

The background of the case ties to the savings-and-loan crisis of the late 1970s and early 1980s, which led to significant financial instability in thrift institutions. The crisis was exacerbated by rising interest rates, which made it difficult for thrifts to remain profitable, as they were locked into lower-rate mortgages while having to offer higher interest rates on deposits. Additionally, many customers withdrew their funds in favor of more lucrative investments, leading to widespread insolvency among thrifts. Between 1981 and 1983, around 435 thrifts failed due to these economic pressures.

The Federal Savings and Loan Insurance Corporation (FSLIC) addressed the crisis of failing thrifts by promoting "supervisory mergers," allowing healthy thrifts to acquire insolvent ones. This strategy relieved FSLIC of deposit insurance liabilities while offering non-cash incentives, including branching rights and regulatory accounting purposes (RAP) rights. Branching rights enabled acquiring thrifts to operate branches outside their home states, a restriction lifted for those involved in supervisory mergers. RAP rights allowed these thrifts to count the acquired thrifts' excess liabilities as "supervisory goodwill," which could be amortized over 40 years (later reduced to 25 years) and counted towards meeting the minimum capital requirement of 3% of liabilities.

Home Savings of America, one of the largest thrifts, participated in four supervisory mergers across six states from 1981 to 1985, gaining branching and RAP rights, later selling branches to refocus on California. In 1988, Home acquired Bowery Savings Bank, which had previously received a RAP right from the FDIC during a 1985 merger. The 1988 acquisition included a new RAP right with a 20-year amortization period, an increase from the prior 14-year period. Home's branching and RAP rights are classified as intangible assets for tax purposes, eligible for abandonment loss deductions under I.R.C. § 165 and amortization deductions under I.R.C. § 167(a).

H.F. Ahmanson Co. filed income tax returns for Home, claiming deductions based on specific transactions, leading to ongoing litigation and a related Ninth Circuit case. In 2008, WMI (formerly Washington Mutual, Inc.) sued the United States seeking refunds for tax years 1990, 1992, and 1993, based on the amortization of RAP rights from supervisory mergers and the abandonment of Missouri branching rights. WMI presented a valuation report and expert testimony from Roger Grabowski, using an income-based approach to assess fair market value. The U.S. District Court for the Western District of Washington ruled in favor of the government, stating that WMI failed to establish Home’s cost basis for the rights in question, a decision later affirmed by the Ninth Circuit, which found flaws in Grabowski's model that undermined its reliability.

Simultaneously, WMI filed a suit in the Claims Court for over $250 million in refunds for tax years 1991, 1994, 1995, and 1998, again based on amortization of RAP rights and abandonment of branching rights in several states. The Claims Court rejected these claims, concluding that WMI did not prove Home’s cost basis for the rights involved. WMI subsequently appealed the Claims Court’s decision.

The analysis establishes that while Home has a cost basis in RAP and branching rights, WMI must allocate that basis individually to qualify for a tax refund. WMI holds the burden of proof, and a legal review indicates that the Claims Court’s application of the law is subject to de novo review. The legal framework acknowledges that the Commissioner of Internal Revenue's rulings are presumed correct, and taxpayers must prove both the error in tax assessment and the specific refund amount due.

To counter the presumption of correctness regarding the Commissioner’s tax determination, the taxpayer must provide sufficient evidence to establish a different finding and demonstrate entitlement to the claimed refund amount. If the taxpayer fails to present adequate evidence regarding the refund, the Commissioner’s assessment remains valid. Relevant case law, including WaMu II and Charron v. United States, reinforces that the taxpayer bears the burden of proof. Specifically, if the taxpayer lacks evidence to support a claimed cost basis, the IRS's zero basis must be accepted. The Claims Court acknowledged that Home had some cost basis in the rights acquired through mergers but focused on whether WMI could allocate the purchase price among the acquired rights based on their relative fair market value. When an asset is bought for a lump sum, the purchase price must be allocated based on each asset’s value relative to the total. While absolute precision in allocation is not required, WMI needed to establish values with reasonable certainty. The court found that WMI did not meet this burden, lacking sufficient evidence for a rational approximation of the asset values. The court adhered to legal principles and determined it was not obligated to make an independent valuation in the absence of adequate taxpayer evidence, noting that only experts could reliably apply the necessary valuation techniques for these complex transactions.

A district judge lacks the authority to determine the value of an asset without supporting evidence, effectively maintaining the burden of proof on the taxpayer. While courts have discretion in valuation methods, they cannot make findings absent evidence, as established in Krapf v. United States. The court must not automatically determine value if the taxpayer fails to allocate a proper valuation to a severable intangible asset. The case of Capital Blue Cross v. Commissioner indicates that a court may assess a taxpayer's valuation despite minor flaws but does not obligate the court to conduct its own analysis or prevent a zero cost basis determination if justified. The Third Circuit's ruling emphasized that the taxpayer has a significant burden to demonstrate that intangible assets can be valued separately and accurately. The Cohan rule, which allows courts to approximate deductions in the absence of detailed records, does not apply when the taxpayer fails to provide sufficient evidence for informed estimates. Courts have warned against the liberal application of the Cohan rule, as it could undermine the burden of proof, particularly in complex valuation scenarios where evidence is fundamentally inadequate.

The Ninth Circuit's agreement with the Claims Court emphasizes that the taxpayer's burden cannot be eliminated entirely on these facts, as established in WaMu II. WMI's argument based on Meredith Broadcasting Co. is deemed inappropriate; in that case, the Court of Claims ruled that the value of television network contracts was inseparable due to their unique nature, necessitating broad estimates. In contrast, the current case involves rights that can be independently severed and valued, with no requirement for prior abandonment of the RAP rights, unlike the rights in Meredith Broadcasting. The Claims Court's determination that WMI did not establish a cost basis for the RAP and branching rights acquired in the supervisory mergers is upheld, with factual findings reviewed for clear error. The Claims Court found WMI mischaracterized the RAP rights, leading to Grabowski's flawed valuation of those rights as merely contractual, rather than recognizing them as a guarantee for amortizing goodwill over 40 years. The court clarified that Home was required to use purchase accounting for goodwill, allowing it to treat goodwill as an asset subject to amortization, which is consistent with regulatory mandates.

Grabowski's valuation of certain rights was flawed due to a misinterpretation of those rights' nature, leading to an inflated valuation. WMI contested the Claims Court's interpretation of Memorandum R-31b, arguing it only authorized regulators to approve amortization of supervisory goodwill upon application by an acquiring thrift, rather than granting outright rights to use the purchase method of accounting. However, the court maintained that the memorandum allowed accounting for goodwill under generally accepted accounting principles (GAAP) for regulatory purposes, which supports the purchase method for mergers. The memorandum's reference to an "application" indicates that all business combinations required regulatory approval, irrespective of the accounting method used. The Claims Court found Grabowski's assumptions about the RAP rights misguided, affecting WMI’s fair market value determinations, and affirmed the court's findings as not clearly erroneous.

Regarding branching rights, the Claims Court deemed Grabowski's valuation unreasonable and unreliable. He used an income-based approach, projecting cash flows based on hypothetical buyer expectations for operating rights in other states. His assumptions included potential new branches, deposit growth, and income from mortgage loans. Grabowski cited Home’s historical expansion into Northern California as a model for future growth, noting that Home significantly increased its branch network and deposits over time. He suggested a hypothetical buyer could replicate this growth in similar markets, estimating a five-year ramp-up period for deposits in new branches.

Grabowski claimed that a hypothetical buyer would assume the ability to convert new deposits into loans based on Home's historical experience. However, this assumption was criticized for relying on outdated market data and not reflecting the actual conditions faced by thrifts during the acquisition of RAP and branching rights, particularly the high interest rates and disintermediation prevalent in the early 1980s. The Claims Court found Grabowski's expectation of significant deposit growth unrealistic, highlighting that a buyer would face challenges attracting depositors in such an environment. The court noted that Grabowski’s methodology lacked consideration of regulatory hurdles for opening new branches, which typically required lengthy approval processes. While WMI argued that the court should have adjusted Grabowski's model to account for these flaws, the court deemed his sensitivity analyses unhelpful and insufficiently detailed, questioning the basis for his assumptions about deposit growth and loan demand. Ultimately, the Claims Court's findings were upheld as not clearly erroneous, and it was emphasized that economic realities must inform tax consequences in transactions.

WMI failed to specify which adjustments the Claims Court should have made, limiting the validity of its claims. The court was not obligated to estimate a value for the Rights sua sponte, as this would negate the taxpayer's burden of proof. The Claims Court deemed it unreasonable to modify Grabowski’s valuation model without clear guidance, highlighting that accurate and reliable inputs are critical for valuation—contrasting cases illustrate the necessity of consistent factual support for valuation methodologies. WMI's argument that the court improperly treated deficiencies in Grabowski’s valuation of RAP rights as grounds for rejecting its claims for branching rights was found unpersuasive. The court's ruling was based on the flawed allocation of cost basis to RAP rights, which cast doubt on the branching rights allocation. Despite WMI's claims, the court found no reasonable or rational basis for its fair market value determinations for the branching rights. WMI also did not demonstrate that the branching and RAP rights were the only assets involved in the supervisory mergers, and the government noted that traditional goodwill could account for some cost basis. The court affirmed its findings, stating that Grabowski’s methodology was undermined by flawed assumptions. Consequently, the Claims Court's ruling was upheld.

WMI Holdings Corp. argued for amortization deductions based on rights obtained from a 1985 merger, claiming these rights remained unchanged in 1988. However, the Claims Court determined that the amortization deductions should be linked to new assets acquired in the 1988 Bowery acquisition, not the 1985 rights. The court characterized the 1988 exchange as a realization event triggering tax obligations under Section 1001(a) of the Internal Revenue Code, which defines a "disposition" to include property exchanges that are materially different. The 1988 assistance provided to Bowery was found to significantly differ from the 1985 assistance by eliminating an income maintenance agreement, reducing the protected asset base, and replacing the 1985 RAP right with a new right that allowed goodwill from the acquisition to count toward regulatory capital. Furthermore, the amortization period was extended from fourteen to twenty years, evidencing legally distinct entitlements and confirming the realization event under tax law. The Claims Court's conclusion was that these changes reflected different legal consequences and entitlements, not merely a modification of the existing rights.

An amendment to a taxpayer's railway franchise, which extended the term by ten years and involved the transfer of bridge ownership, was deemed an exchange for tax purposes, leading to a realization event in 1988, as determined by the Claims Court. WMI contended that the 1988 RAP right was similar enough to the 1985 RAP right to qualify as a “like-kind exchange” under Section 1031(a) of the Internal Revenue Code, which would allow deferral of gain or loss recognition. However, the Claims Court correctly rejected this argument, explaining that "like kind" pertains to the nature or character of the property, and that Bowery's RAP right had fundamentally changed, allowing Bowery to treat goodwill from Home's acquisition as an asset instead of reversing loan write-downs. The Claims Court’s conclusion that Bowery’s receipt of an assistance package in 1988 constituted a realization event was upheld. WMI's claims for tax refund were dismissed due to its failure to adequately value the basis of the assets, and the court affirmed its decision without costs.