In re Washington Mutual, Inc.

Citations: 485 B.R. 510; 2012 Bankr. LEXIS 5821; 57 Bankr. Ct. Dec. (CRR) 93; 2012 WL 6623678Docket: No. 08-12229 MFW

Court: United States Bankruptcy Court, D. Delaware; December 19, 2012; Us Bankruptcy; United States Bankruptcy Court

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The Court, presided over by Bankruptcy Judge Mary F. Walrath, is addressing the Objection from WMI Liquidating Trust, representing Washington Mutual, Inc. (WMI), against a proof of claim filed by the Oregon Department of Revenue. The Court has decided to sustain this Objection. 

Background information includes that WMI was a bank holding company that owned Washington Mutual Bank (WMB), which utilized real estate investment trusts (REITs) for funding since the late 1990s. In 1999, these REITs became subsidiaries of WMI and relocated to Oregon. From 1999 to 2005, WMB and certain subsidiaries operated in Oregon and filed consolidated federal tax returns as part of the Consolidated Tax Group. Following a credit downgrade and ensuing bank run in September 2008, WMB was seized by the Office of Thrift Supervision (OTS) and sold to JPMorgan Chase. Subsequently, WMI and WMI Investment Corp. filed for Chapter 11 bankruptcy.

During an audit in 2008, Oregon claimed that WMI owed additional corporate excise taxes for the years 2002 to 2006. After an informal conference in March 2009, Oregon upheld its tax assessment in October 2009, leading WMI to file a timely appeal. Meanwhile, Oregon filed a proof of claim for $29,381,722.91 in taxes, interest, and penalties, which the Debtors contested, stating that the taxes were owed by other entities. Oregon countered that WMI was jointly liable for the WMB Entities' obligations under state law. An amended claim was filed by Oregon, which the Debtors again contested, arguing the tax was unconstitutional due to lack of substantial nexus with Oregon. 

WMI’s Seventh Amended Plan of Reorganization designated a liquidating trust to manage the trust assets, confirmed on February 24, 2012. The Trust subsequently supported the objection to Oregon's claim. The Court has jurisdiction over this matter as a core issue under 28 U.S.C. 1334(b), 157(b)(2)(A, B). The matter is now ready for decision.

Oregon claims that WMI is liable for the excise tax owed by its subsidiaries under Oregon law, asserting WMI filed consolidated corporate tax returns for itself and its subsidiaries. According to Oregon tax laws, consolidated returns are to be filed by the common parent corporation. If the common parent is not subject to Oregon taxation, the return must be filed by a member of the affiliated group doing business in Oregon, which is defined under ORS 317.010(4). Oregon argues that by including WMI in the consolidated return, WMI effectively admitted it was doing business in Oregon and thus is liable for the excise tax. The state seeks to impose joint and several liability on WMI due to its inclusion in the consolidated return.

In response, the Trust argues that WMI’s inclusion does not constitute an admission of tax liability, referencing the case Estee Lauder Serv. Inc. v. Dep’t of Revenue, which established that members of an affiliated group are not treated as a single taxpayer for tax liability purposes. The Trust contends WMI was included in the Oregon return due to being part of a consolidated federal tax group. Additionally, the Trust claims that if WMI is found liable, such tax would be unconstitutional.

The Trust further argues the tax's constitutionality, citing limitations imposed by the Due Process and Commerce Clauses of the U.S. Constitution. It asserts that due process requires a minimum connection between the state and the entity being taxed, along with a rational relationship between the income and the state. The Trust contends WMI lacks sufficient contacts with Oregon, emphasizing that WMI’s primary business operations are based in Seattle, Washington, with no offices or property in Oregon.

The Trust contends that WMI did not engage in any business activities in Oregon nor generate revenue from Oregon sources, characterizing WMI as a holding company that was not represented by WMB in Oregon transactions. In contrast, Oregon asserts that WMI, via its banking subsidiaries (the WMB Entities), was conducting business and earning income in Oregon. The Court supports the Trust’s position, ruling that the Due Process Clause prevents Oregon from taxing WMI since WMI and WMB are distinct legal entities and WMI did not actively conduct business in Oregon. WMI's income from Oregon was limited to cash dividends from its subsidiaries, which Oregon is not attempting to tax directly. The Court emphasizes that without piercing the corporate veil, there is no legal basis for taxing a non-resident parent company for its subsidiary’s income.

Oregon also claims that WMI's intellectual property was used by its subsidiaries in Oregon, allegedly generating benefits for WMI. However, the Court finds that while the subsidiaries utilized trademarks owned by WMI, this use did not equate to substantial revenue for WMI, as it did not earn income from such activities. Consequently, WMI lacked sufficient minimum contacts with Oregon, making the Oregon tax unconstitutionally disconnected from WMI’s income.

In addition, the Trust argues that the Oregon excise tax infringes upon the Commerce Clause, which prohibits state actions that disrupt interstate commerce. For a state tax to withstand a Commerce Clause challenge, it must have a substantial nexus with the state, be fairly apportioned, not discriminate against interstate commerce, and relate to state-provided services. The Trust's challenge hinges on the substantial nexus requirement, with the parties debating the applicable standard for establishing this nexus, as the Supreme Court has indicated that a mere slight presence in a taxing state is insufficient.

Substantial nexus requires a more significant presence than the minimum connection needed for due process considerations. While the Due Process Clause focuses on fairness regarding individual governmental actions, the Commerce Clause evaluates the impact of state regulation on the national economy. The Supreme Court in Quill clarified that the minimum contacts required by the Due Process Clause and the substantial nexus under the Commerce Clause are not equivalent. The Trust argued it lacked physical presence in Oregon for taxation under the physical presence standard established in Bellas Hess and Quill. However, Oregon contended that Quill's physical presence requirement only applies to sales and use taxes, not corporate excise taxes. The Quill decision ruled that taxing out-of-state entities without physical presence violates the Commerce Clause, but subsequent courts have limited Quill's application to sales and use taxes. The Trust maintained that a bright-line test should apply, while Oregon argued that modern electronic commerce makes such a test outdated. The Court sided with Oregon, noting that Quill did not establish a uniform physical presence requirement across all tax types, concluding that Oregon's corporate excise tax is constitutional despite WMI's lack of physical presence.

Oregon further asserted that WMI met the substantial nexus standard through its economic presence in the state. Although the significant economic presence test has not been formally recognized by the Supreme Court, the Court determined that the constitutionality of the Oregon excise tax hinges on the substantial nexus test from Complete Auto, with economic presence being a relevant factor. Oregon argued that WMB acted as WMI’s agent in Oregon, maintaining control over its subsidiaries and their assets, supported by evidence from WMI’s Board of Directors Minutes showing the management of employee benefit plans for its Oregon operations.

WMI contends that its ownership of subsidiaries does not establish a substantial nexus with Oregon, as it only set general policies and did not make business decisions for WMB, which operated independently. Oregon counters that WMI's intangible property, such as trade names and trademarks, creates a sufficient connection to justify imposing a corporate excise tax. WMI owns various trademarks, including “WAMU” and “Washington Mutual,” which enhance the goodwill of WMI through advertising and informing customers about its subsidiaries' services.

Oregon cites the case of New York ex rel. Whitney v. Graves, where the Supreme Court upheld a tax on profits from the sale of a stock exchange seat despite the taxpayer's lack of physical presence in New York. However, the Court finds Graves inapplicable because Oregon seeks to hold WMI liable for taxes incurred by its subsidiaries' operations rather than taxing the proceeds of any sale of intangibles owned by WMI.

Oregon also references the Supreme Court's upholding of a state's income tax on dividends from in-state corporations, noting that Wisconsin provided benefits to corporate activities in-state, which generated the dividend income. The Court clarifies that this case involved a Due Process Clause challenge, not a Commerce Clause issue regarding substantial nexus. Consequently, it concludes that International Harvester does not limit the substantial nexus requirement established by Complete Auto and Quill. The Court distinguishes its facts from International Harvester, emphasizing that Oregon is not taxing WMI's dividend income but rather seeking to hold WMI accountable for tax liabilities from its subsidiaries' Oregon activities, again relying on the use of trademarks to assert a substantial nexus with the state.

A substantial nexus for Commerce Clause purposes has typically been established by courts only when intangible property generates income for the taxpayer. In this case, WMI did not receive any royalty payments, license fees, or other income from the WMB entities using its intellectual property, meaning WMI did not gain a measurable benefit from such use in Oregon. Oregon's tax imposition is not limited to royalty income but is an excise tax on WMI for its subsidiaries’ operations in the state. Consequently, the Court determined that WMI lacked the substantial nexus with Oregon necessary under the Commerce Clause, leading to the conclusion that Oregon's tax claim violates this clause. The Court supports the Trust’s Objection to Oregon’s claim, citing violations of both the Due Process and Commerce Clauses of the U.S. Constitution. Additionally, the REITS were not part of the Consolidated Tax Group and were excluded from consolidated federal and Oregon tax returns, meaning their income was not reported in those contexts. For a state to tax dividend income from a subsidiary, the recipient corporation and the subsidiary must be engaged in a unitary business, as established in various case law.