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UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE
---------------------------------------------------------------x
:
In re
:
:
WASHINGTON MUTUAL, INC., et al.,1
:
:
:
Debtors.
:
:
---------------------------------------------------------------x
Chapter 11
Case No. 08-12229 (MFW)
(Jointly Administered)
Hearing Date: February 20, 2014 at 10:30 a.m.
Objection Deadline: February 3, 2014 at 4:00 p.m.
WMI LIQUIDATING TRUST’S (A) OBJECTION TO
PROOF OF CLAIM FILED BY CALIFORNIA FRANCHISE TAX
BOARD (CLAIM NO. 3908) AND (B) MOTION FOR DETERMINATION
OF TAX LIABILITY UNDER SECTION 505 OF THE BANKRUPTCY CODE
WMI Liquidating Trust (“WMILT”), as successor in interest to Washington
Mutual, Inc. (“WMI”) and WMI Investment Corp., formerly debtors and debtors in possession
(collectively, the “Debtors”), pursuant to sections 502 and 505 of title 11 of the United States
Code (the “Bankruptcy Code”) and Rule 3007 of the Federal Rules of Bankruptcy Procedure (the
“Bankruptcy Rules”), (i) submits this objection (the “Objection”) to Proof of Claim No. 3908
(including all attachments thereto, the “California Claim”), filed by the California Franchise Tax
Board (the “FTB”) and (ii) seeks a determination of tax liability, and respectfully represents as
follows:
Jurisdiction
1.
This Court (the “Bankruptcy Court”) has jurisdiction to consider this
matter pursuant to 28 U.S.C. §§ 157 and 1334. This is a core proceeding pursuant to 28 U.S.C.
§ 157(b). Venue is proper before the Bankruptcy Court pursuant to 28 U.S.C. §§ 1408 and 1409.
1
The Debtors in these chapter 11 cases along with the last four digits of each Debtor’s federal tax identification
number are: (i) Washington Mutual, Inc. (3725); and (ii) WMI Investment Corp. (5395). The principal offices of
WMI Liquidating Trust are located at 1201 Third Avenue, Suite 3000, Seattle, Washington 98101.
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Section 38.1 of the Plan2 provides that the Bankruptcy Court shall retain
jurisdiction to hear, among other things, timely objections to Claims, any motions filed by
WMILT, and any matters concerning state taxes under section 505 of the Bankruptcy Code,
including any matters related to Tax Refunds.
Preliminary Statement
3.
For several years, WMILT has attempted to resolve its outstanding issues
with the FTB. Specifically, WMILT, and the Debtors before it, have sought to recover
approximately $441 million of owed tax refunds and rid the estate of a Disputed Claim of
approximately $280 million. Unfortunately, and despite the tacit acknowledgement of the FTB
as to the merits of many of WMILT’s positions, the issues remain unresolved. Such lack of
consensus redounds to the detriment of Creditors by way of the ongoing accrual of interest on
Allowed Claims and the inability and delay in making payments thereon. Moreover, under
California law, no interest is or has been payable on tax refunds for the period beginning July 1,
2009 through the date hereof. Accordingly, WMILT seeks a determination that WMI, on its own
behalf and on behalf of the Combined Tax Group (as defined below), overpaid its California
income tax liability by $441,157,986, excluding interest, as a result of tax payments made during
years 1994, 1998 and 2000 through 2008, and objects to the California Claim on the basis that it
is not liable under California law for the vast majority of the taxes, penalties, and interest
asserted therein.
4.
The FTB’s calculated audit assessments, as set forth in the California
Claim and the Notices of Proposed Assessments (the “NOPAs”), are incorrect. Therein, the FTB
2
All defined terms used but not defined herein shall have the meanings ascribed to them in that certain Seventh
Amended Joint Plan of Affiliated Debtors Pursuant to Chapter 11 of the United States Bankruptcy Code [D.I. 9178]
(as modified, the “Plan”).
2
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asserts that WMI is liable for approximately $280 million,3 which amount consists of taxes,
penalties, and interest related to years 1997 through 2006 (the “Taxable Years”). To arrive at
this amount, the FTB contends, among other things, that (i) certain deductions – referred to as
“dividends-paid-deductions” – taken by WMI and its direct and indirect domestic corporate
subsidiaries (collectively, the “Combined Tax Group”)4 operating in California are invalid
because the “consent dividends”5 issued by the WMB REITs and WMB RIC (each as defined
below) are, in fact, not “dividends” under California law, and (ii) consent and cash dividends
should have been taken into account in determining the taxable income of the WMB REITs’ and
WMB RIC’s shareholders. Moreover, the FTB contends that WMB RIC was not a true RIC
under California law and federal income tax law, and that, separately, the Combined Tax Group
improperly carried forward certain losses into the 2004 Taxable Year.
5.
The FTB’s position is untenable. Contrary to the FTB’s claims, applicable
federal and state law makes clear that (i) the WMB REITs and WMB RIC were not prohibited
from claiming dividends-paid-deductions for consent dividends; (ii) cash and consent dividends
should not be taken into account in determining the taxable income of the WMB REIT and
WMB RIC shareholders; (iii) WMB RIC was formed for legitimate business purposes;
(iv) California Revenue & Taxation Code (“CR&TC”) § 25102 cannot be utilized to deny the
3
Similarly, in the Auditor’s Issue Presentation Sheets, the FTB asserts that WMI is liable for approximately
$268 million, which amount consists of taxes, penalties, and interest related to years 2000 through 2007. The
difference in the amounts asserted primarily reflects the difference in the Taxable Years contained in the California
Claim (1997 through 2006) and the Auditor’s Issue Presentation Sheets (2000 through 2007). In any event, WMILT
also objects to this amount to the extent it is not already included in the California Claim, and the FTB seeks to
assert such additional amounts as due and owing as part of the California Claim.
4
The Combined Tax Group includes any predecessor tax group to which WMI became the successor. Such
predecessors include H.F. Ahmanson & Co., but exclude Hawthorne Financial Corporation and Commercial Capital
Bancorp, Inc.
5
A “consent dividend” is a deemed dividend that is treated as having been paid in cash and then re-contributed back
to the dividend-paying company as additional capital (with no money changing hands) in accordance with Internal
Revenue Code (“IRC”) § 565.
3
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elimination of the RIC dividends from the income of WMB RIC’s parents; and (v) certain net
operating losses (“NOLs”) are appropriately carried forward into Taxable Year 2004.6
Additionally, as reflected in its amended tax returns, the Combined Tax Group is entitled to
certain reductions to its originally filed tax liability for Taxable Years 1994, 1998 and 2000
through 2008 due to (a) IRS-allowed adjustments to its federal income tax returns, to which the
FTB has already agreed, and (b) Combined Tax Group having erroneously reported as income,
interest earned from United States (“U.S.”) Treasury bonds.
6.
As described more fully below, WMILT requests that the Bankruptcy
Court enter an order reducing the California Claim to $24,650,970 (excluding interest on such
amount), and determining that WMILT overpaid its taxes to California by $441,157,986,
excluding interest.7
Background
7.
On September 26, 2008, each of the Debtors commenced with the
Bankruptcy Court a voluntary case pursuant to chapter 11 of the Bankruptcy Code.
8.
On December 12, 2011, the Debtors filed the Plan. Pursuant to the
Confirmation Order [D.I. 9759], the Bankruptcy Court confirmed the Plan upon satisfaction or
waiver of the conditions described in the Plan, and the transactions contemplated by the Plan
were substantially consummated on March 19, 2012 [D.I. 9933].
6
WMILT also objects to the portion of the California Claim relating to Taxable Years 1997 through 1999.
WMILT’s records indicate that the California taxes for Taxable Year 1998 are fully paid and the FTB has provided
no documentation to support any tax liability for such Taxable Year. For Taxable Year 1999, WMILT’s records
indicate that it owes $6,665,854 to California, not $25,634,807, the amount asserted by the FTB. For Taxable Year
1997, WMILT’s tax liability is contingent and unliquidated. See infra pp. 41-42 for additional information relating
to Taxable Year 1997.
7
In support of this Objection, WMILT relies upon the Declaration of Curt Brouwer in Support of WMI Liquidating
Trust’s (A) Objection to Proof of Claim Filed by California Franchise Tax Board (Claim No. 3908) and (B) Motion
for Determination of Tax Liability Under Section 505 of the Bankruptcy Code, dated December 31, 2013 (the
“Brouwer Declaration” or “Brouwer Decl.”), filed contemporaneously herewith.
4
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The Plan provides that, “[f]or all taxable periods ended on or before
December 31, 2009,” the Liquidating Trustee has the “full and exclusive authority and
responsibility in respect of all Taxes of the Debtors (including, without limitation, as the
common parent or other agent of any consolidated, combined or unitary tax group of which the
Debtors were the agent), to the same extent as if the Liquidating Trustee was the Debtor-inPossession.” Plan § 27.7(b). Further, the Liquidating Trustee has the authority to “object to
Claims.” Id. § 27.6.
I.
The WMB REITs and WMB RIC
A.
Formation of the WMB REITs and WMB RIC
10.
In 1999, WMI, on behalf of itself and its subsidiaries, including
Washington Mutual Bank (“WMB”), retained KPMG, LLP to provide, among other things,
consulting services related to the establishment of certain new subsidiaries, including (i) three
real estate investment trusts (“REITs”), Marion Street, Inc. (“Marion Street”), University Street,
Inc. (“University Street”) and Seneca Street, Inc. (“Seneca Street,” and, together with Marion
Street and University Street, the “WMB REITs”)8 and (ii) a regulated investment company
(“RIC”), Snoqualmie Asset Fund, Inc. (“WMB RIC”). Brouwer Decl. ¶ 5.9
8
On December 27, 1999, each of the WMB REITs became the directly owned subsidiary of a holding company, i.e.,
WMB contributed its common and preferred stock in Seneca Street to Seneca Holdings, Inc. (“Seneca Holdings”),
and Washington Mutual Bank, FA (“WMBfa”) contributed its common and preferred stock in Marion Street and
University Street to its subsidiary, Marion Holdings, Inc. (“Marion Holdings” and, together with Seneca Holdings,
the “WMB REIT Holding Companies”). A summary of the corporate ownership of the WMB REITs and certain
related transactions is annexed to the Brouwer Declaration as Exhibit A.
9
The use of REIT and RIC subsidiaries to monetize certain assets was common among banks and thrifts as their
formation offered substantial benefits to banks. See Brouwer Decl. ¶ 6. For example, the issuance of REIT
preferred securities benefited banks because the ownership of REIT preferred securities, with appropriate provisions,
could assist in satisfying certain bank regulatory capital requirements. See Alan Kline, Small Banks Jump Aboard
REIT-Preferred Bandwagon, Am. Banker, Feb. 11, 1998, at 1 (observing that, in the late 1990s, this potential benefit
was “most important to banks, many of which [were] struggling with liquidity”).
5
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RICs are regulated by the Securities and Exchange Commission (the
“SEC”) under the Investment Company Act of 1940 (the “ICA”). A RIC is an investment
company that typically allows a broad sector of the public to invest in certain investments and
passes along its capital gains, dividends, and/or interest on fund investments directly to its
shareholders, who, thereafter, must account therefor for income tax purposes. Brouwer Decl.
¶ 6. With respect to financial institutions, RICs were considered good vehicles to raise Tier One
Capital. See infra ¶ 51. In order to qualify as a RIC for income tax purposes, the entity must,
among other requirements, derive at least ninety percent (90%) of its gross income from
investment activities. REITs operate in a somewhat comparable fashion to RICs for income tax
purposes, but are required to hold predominantly real estate related assets.
12.
Although a RIC is generally more flexible than a REIT in terms of the
assets it can hold and the manner in which it can operate for tax purposes, RICs have less
flexibility in other areas. Brouwer Decl. ¶ 6. Even though REITs and RICs are subject to
specific qualification requirements under the IRC, a RIC is also regulated by the SEC as an
investment company. Id. Specifically, as it relates to RICs, the ICA, which the SEC
administers, imposes, among other things, strict limitations on affiliated transactions, board of
director membership, and also requires separate audited financial statements and bi-annual asset
reviews. Id. For those banks and thrifts holding real estate assets and non-real estate assets (e.g.,
WMB), both REIT and RIC structures can be utilized, thus maximizing the institution’s use of its
collateral to raise Tier One Capital. Id.
13.
Here, WMB RIC was established and capitalized in 2000, with Marion
Holdings and WMBfa as its majority and minority shareholders, respectively (collectively, the
“WMB RIC Parents”), and on July 21, 2000, WMB RIC was incorporated in the State of
6
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Maryland to conduct and operate the business of a closed-end management investment company
pursuant to the ICA. Id. ¶ 7. In furtherance of the foregoing, on August 28, 2000, WMB RIC
filed Form N-8A, Notification of Registration Filed Pursuant to Section 8(a) of the ICA, and
filed Form N-2 as its Registration Statement for Closed-End Management Investment
Companies on November 21, 2000. Id. Exs. B & C. To comply with ICA requirements, WMB
RIC, among other things, hired auditors to opine on its stand-alone financial statements and filed
annually, Form N-17f-2, Certificate of Accounting of Securities and Similar Investments in the
Custody of Management Investment Companies, and, semi-annually, Form N-SAR, SemiAnnual Report of Registered Investment Companies. Id. ¶ 7.
14.
In connection with the formation of WMB RIC, Washington Mutual
Specialty Mortgage, LLC (“WMSM”) was established on June 30, 2000 by WMBfa. Id. ¶ 9.
Thereafter, WMBfa transferred approximately $8 billion in loan portfolios to WMSM as a
capital contribution. Id. On August 25, 2000, WMBfa, via Marion Holdings, contributed its
99.9% interest in WMSM to WMB RIC in exchange for 116,000,000 shares of WMB RIC
common stock. Id.
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The following diagram illustrates WMB RIC’s ownership structure from
August 25, 2000 through April 30, 2003:
Washington Mutual Bank, fa
100%
.039%
Marion Holdings, Inc.
99.961%
Snoqualmie Asset Fund, Inc.
(WMB RIC)
)
99.9%
100% Common
.1%
Marion Street, Inc.
16.
WM Specialty Mortgage, LLC
WMSM was formed to consolidate WMB’s subprime loan purchases in a
single legal entity. Id. ¶ 10. At the time of its creation, it was projected that WMSM would also
reduce the administrative burden associated with SEC reporting requirements imposed on its
parent, WMB RIC. Id. If WMB RIC had held the assets of WMSM directly, WMB RIC would
not only have been required to disclose its interest in WMSM, it would have been required to
disclose separately the tens of thousands of individual loans held by WMSM, including borrower
name, interest rate, and loan amount. Id.
17.
Notably, WMB RIC, whose operations were conducted through its
subsidiaries, Marion Street and WMSM, turned consistent profits. See id. Ex. D. WMB RIC’s
SEC filings confirm that WMB RIC’s revenues exceeded its expenses in 2000, 2001 and 2002.
8
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See id. In addition, WMB RIC implemented appropriate corporate governance controls, such as
preparing audited financials and engaging independent board members. Brouwer Decl. ¶ 11.
The officers of WMB RIC prepared financial statements, managed WMB RIC’s assets, acquired
new assets, monitored the loan servicing and advisory services provided by WMBfa, and
presented their results to WMB RIC’s Board of Directors. Id. The officers also periodically
evaluated proposals by investment banks for the issuance of RIC securities. Id.
18.
By the end of 2002, WMB RIC was wound down, and on January 2, 2003,
it filed with the SEC an application to deregister voluntarily as an investment company (Form N8F, Application for Deregistration of Certain Registered Investment Companies). Id. ¶ 17. On
February 26, 2003, the SEC formally acknowledged the deregistration, and on April 30, 2003,
the State of Maryland accepted the Articles of Dissolution of WMB RIC. Id. The SEC never
audited WMB RIC (either before or after deregistration) and WMB RIC never received SEC
notices regarding any investigation or inquiry. Id.
19.
During the Taxable Years at issue, the Combined Tax Group, including,
among others, WMB, WMBfa, the WMB REIT Holding Companies,10 the WMB REITs, and
WMB RIC filed combined reports for California income tax purposes. Id. ¶ 18. During the
same period, the Combined Tax Group filed consolidated returns for federal income tax purposes
(the “Consolidated Federal Returns”), with the exception of the WMB REITs and WMB RIC
which were required to file their own separate federal tax returns.11 Id. The Consolidated
10
Marion Holdings and Seneca Holdings, which comprised the WMB REIT Holding Companies, were wholly
owned subsidiaries of WMBfa and WMB, respectively, through December 31, 2004. On January 1, 2005, WMB
merged into WMBfa, followed immediately by WMBfa changing its corporate title to “Washington Mutual Bank.”
A diagram of the corporate ownership of the WMB REITs and WMB RIC is annexed to the Brouwer Declaration as
Exhibit A.
11
Federal law prohibits the inclusion of REITs or RICs in consolidated federal income tax returns. See IRC
§ 1504(b). For this reason, the WMB REITs and WMB RIC were not included in the Consolidated Federal Returns.
Id.
9
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Federal Returns were audited for each of the Taxable Years by the Internal Revenue Service (the
“IRS”). Notably, the IRS never challenged or contested the WMB REITs’ status as REITs or
WMB RIC’s status as a RIC under the IRC. Id.
B.
REIT and RIC Dividends
20.
Between 2000 and 2002, the WMB REITs declared consent dividends to
the WMB REIT Holding Companies in the aggregate amount of $2,055,933,802, and WMB RIC
declared consent dividends to the WMB RIC Parents in the aggregate amount of $838,959,208,12
and cash dividends in the aggregate amount of $1,089,331,508. Id. ¶ 19. As mentioned supra in
footnote 5, a consent dividend is a deemed dividend that is treated as having been paid in cash
and then re-contributed back to the dividend-paying company as additional capital (with no
money changing hands) in accordance with IRC § 565.
21.
Under IRC § 565(c), a copy of which is attached hereto as Exhibit B, the
amount of a consent dividend is treated as a distribution of cash to the extent of the earnings and
profits of the dividend-paying company, followed by the deemed contribution of the same
amount of cash by the shareholder back to the dividend-paying company. For federal income tax
purposes, if a REIT or RIC and its shareholders are party to a consent dividend, the treatment of
the deemed distribution is the same as if the REIT or RIC had simply paid a regular dividend
(i.e., the recipients of such dividends are required to pay income taxes on the dividends).
22.
REITs and RICs are both entitled to a deduction under the IRC for
qualifying dividends paid to their shareholders. In order for a REIT or a RIC to be able to deduct
the amount of dividends paid, such entity must satisfy certain IRC requirements. In order for an
entity to be subject to tax as a REIT, IRC § 857(a), a copy of which is attached hereto as
12
Of this amount, the Combined Tax Group only claimed tax benefits flowing from consent dividends issued in
Taxable Year 2001, which totaled $824,427,835.
10
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Exhibit C, generally requires that a corporation elect to be taxed as a REIT and annually
distribute – either in cash or as a consent dividend – at least ninety percent (90%) of its taxable
income (computed without regard to the dividends-paid-deduction). A REIT failing to meet the
distribution requirement under IRC § 857(a) is not allowed to calculate its tax under the special
REIT provisions in IRC § 857(b) (i.e., it is not entitled to claim a dividends-paid-deduction).
Similarly, IRC § 852(a) generally requires that an entity electing to be taxed as a RIC annually
distribute – either in cash or as a consent dividend – at least ninety percent (90%) of its taxable
income (computed without regard to the dividends-paid-deduction).
23.
In California, Section 24872 of the CR&TC, a copy of which is attached
hereto as Exhibit D, generally provides that, if a REIT satisfies the distribution requirement for
federal income tax purposes, it is deemed to have met the distribution requirement for California
tax purposes and the REIT is eligible to calculate its tax for California purposes under
California’s modified adoption of IRC § 857 (i.e., a REIT can deduct the amount of consent
dividends paid). Similarly, CR&TC § 24871(b) states that “investment company income” for
California tax purposes is defined as investment company taxable income as described in IRC
§ 852(b)(2), which allows for a dividends-paid-deduction for consent dividends. See IRC
§§ 852(b)(2)(D) and 561(a)(2).
24.
Notably, and as discussed below in more detail, although California
follows the IRC regarding the deductibility of consent dividends paid by a REIT or a RIC, there
is no special provision in the CR&TC denying a dividends-received-deduction to the
shareholders of REITs and RICs. Instead, California follows the general rule that intercompany
dividends are eligible for a dividends-received-deduction or elimination and makes no exception
for REIT or RIC shareholders, which differentiates California law from the IRC.
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The California Audit Assessments
25.
On December 29, 2009, the FTB issued eighteen (18) Auditor’s Issue
Presentation Sheets (collectively, the “AIPS”) detailing the issues found during the audit of the
Combined Tax Group for Taxable Years 2000-2007. Brouwer Decl. ¶ 22. On October 14, 2010,
the FTB issued the NOPAs, which reflect the analyses contained in the AIPS. Id. On
December 10, 2010, the Combined Tax Group filed its formal Notices of Protest in response to
the NOPAs objecting to, among other things, the conclusions reached in AIPS 1, 2, 4 and 16-18,
which form the bases for the majority of the California Claim.13 See id., Exs. E & H-I, K-N.
III.
Amended Tax Returns for Years 1994 Through 2008
26.
The Combined Tax Group filed amended tax returns for the Taxable Years
(the “Amended Tax Returns”).14 Based on these Amended Tax Returns, WMILT is entitled to a
net refund (or setoff, as applicable) for the following tax overpayments:
Taxable Year
Overpayment Amount
1994
$36,046,566
1998
$725,242
2000
$9,504,488
2001
$15,277,812
13
As set forth herein, WMILT does not object to the portion of the California Claim reflected in AIPS 3 and 5-15.
Specifically, WMILT does not object to $24,650,970 of the California Claim (excluding interest on such amount),
which also includes $1,765,004.00 reflecting additional taxes and penalties assessed by the FTB as a result of the
audit of H.F. Ahmanson & Co. for the 1997 Taxable Year.
14
For the taxable year 2000, the return was amended on the following dates: March 31, 2005, October 20, 2008,
and October 12, 2010. For the taxable year 2001, the return was amended on the following dates: March 23, 2005,
January 22, 2008, August 3, 2010, and December 27, 2010. For the taxable year 2002, the return was amended on
January 22, 2008. For the taxable year 2003, the return was amended on November 16, 2007 and August 3, 2010.
For the taxable year 2004, the return was amended on November 16, 2007, June 1, 2009, March 24, 2011, and
April 28, 2011. For the taxable year 2005, the return was amended on March 24, 2011. For the taxable year 2006,
the return was amended on June 1, 2009 and March 24, 2011. For the taxable year 2007, the return was amended on
June 1, 2009 and March 24, 2011. Finally, for the taxable year 2008, the return was amended on March 24, 2011.
12
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Taxable Year
Overpayment Amount
2002
$112,713,652
2003
$170,191,710
2004
$33,529,326
2005
$11,889,529
2006
$338,119
2007
$28,254,342
2008
$22,687,200
Total: $441,157,986
27.
As set forth in Exhibit F to the Brouwer Declaration, the FTB has, in
correspondence, formally acknowledged an overpayment of approximately $314 million with
respect to Taxable Years 2000 through 2008 prior to the FTB’s proposed adjustments.
IV.
The California Claim
28.
On March 26, 2009, the FTB filed a proof of claim, Claim No. 2093,
against WMI in the amount of $2,479,959,945.00, asserting amounts for taxes, penalties, and
interest owed for the taxable years from 1994 through 2008.15
29.
By proof of claim, dated May 26, 2010, Claim No. 3845, the FTB
amended and superseded Claim No. 2093, in the amount of $267,378,281.00, asserting amounts
for taxes, penalties, and interest owed for the taxable years from 1997 through 2008.16 By order,
dated August 9, 2010 [D.I. 5245], the Bankruptcy Court granted the Debtors’ Forty-Fifth
15
A duplicate of this claim was filed shortly thereafter, and assigned claim number 3621 for administrative
purposes. By order, dated August 10, 2009 [D.I. 1465], the Bankruptcy Court granted the Debtors’ Fourth Omnibus
(Non-Substantive) Objection to Claims and disallowed such claim, on the basis that it was duplicative of Claim No.
2093.
16
Claim No. 3845 reduced to $0.00 the amount allegedly owed for years 1994 through 1996.
13
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Omnibus (Non-Substantive) Objection to Claims and disallowed Claim No. 2093, on the basis
that it had been amended and superseded by Claim No. 3845.
30.
On September 2, 2010, the FTB filed the California Claim, Claim
No. 3908, amending and superseding Claim No. 3845, in the amount of $280,519,148.00, again
asserting amounts for taxes, penalties, and interest owed for the taxable years from 1997 through
2008. By order, dated October 21, 2010 [D.I. 5656], the Bankruptcy Court granted the Debtors’
Forty- Ninth Omnibus (Non-Substantive) Objection to Claims and disallowed Claim No. 3845,
on the basis that it had been amended and superseded by the California Claim.
31.
Pursuant to Section 26.1 of the Plan, WMILT was required to file and
serve all objections to Claims no later than September 17, 2012 (the “Claim Objection
Deadline”), or such later date if approved by the Bankruptcy Court or as may be agreed to by
WMILT and the Creditor.
32.
On September 14, 2012, and June 7, 2013, respectively, WMILT and the
FTB entered into that certain Stipulation Extending Time to Object to Proof of Claim Filed By
California Franchise Tax Board (Claim No. 3908), and that certain Second Stipulation Extending
Time to Object to Proof of Claim Filed By California Franchise Tax Board (Claim No. 3908),
extending the Claim Objection Deadline until December 31, 2013, while the parties engaged in
negotiations in an effort to resolve the California Claim consensually.
Objection to the California Claim
33.
The California Claim should be reduced, as set forth herein, because
WMI, on its own behalf and on behalf of the Combined Tax Group, is not liable for the vast
majority of the claim and/or has overpaid its taxes for the Taxable Years.
14
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The WMB REITs and WMB RIC
Validly Claimed Dividends-Paid-Deductions on Consent Dividends
34.
California law provides for REITs and RICs to receive a tax deduction for
consent dividends deemed paid to their shareholders. See generally, CR&TC §§ 24871-24872.
The WMB REITs and WMB RIC deducted, in the aggregate, $2,642,003,293 from their taxable
incomes as a result of consent dividends paid to their equity holders in Taxable Years 2000, 2001
and 2002.17 Brouwer Decl. ¶ 20. In addition, WMB RIC deducted $331,023,973 from its
taxable income in Taxable Year 2000, and $758,307,535 from its taxable income in Taxable
Year 2002, as a result of cash dividends paid to its equity holders. Id. Because such deductions
were proper under California’s tax regime, which generally adopts the IRC rules relating to
REIT and RIC consent dividends, California’s rejection of such deductions as set forth in the
NOPAs and the California Claim is erroneous.
A.
IRC Rules Relating to REIT or RIC Consent Dividends
35.
In accordance with the IRC, REIT or RIC dividends paid to shareholders
are deductible from income of the REIT or RIC for purposes of computing federal income taxes.
Indeed, IRC §§ 857(b)(2)(B) and 852(b)(2)(D) provide that a “deduction for dividends paid (as
defined in section 561) shall be allowed . . . .” In turn, IRC § 561(a)(2) provides that “consent
dividends” (as determined under IRC § 565) deemed paid by a REIT or RIC are deductible for
tax purposes. IRC § 565(a), which governs the requirements for making a consent dividend,
provides the following:
If any person owns consent stock (as defined in subsection (f)(l)) in a corporation
on the last day of the taxable year of such corporation, and such person agrees, in
a consent filed with the return of such corporation in accordance with regulations
prescribed by the Secretary, to treat as a dividend the amount specified in such
17
In the Amended Tax Returns, the Combined Tax Group claimed benefits for REIT consent dividends for Taxable
Years 2000, 2001 and 2002, and RIC consent dividends for Taxable Year 2001.
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consent, the amount specified shall, except as provided in subsection (b),
constitute a consent dividend for purposes of section 561 (relating to the
deduction for dividends paid).
IRC § 565(a).
36.
Here, consistent with IRC § 565(a), the WMB REITs and WMB RIC
included, in their respective federal tax returns, consents from their respective shareholders
agreeing to treat the dividends paid during the applicable years as consent dividends. See
Brouwer Decl., Ex. G. Because the IRS accepted the Consolidated Federal Returns (which
included the dividends received from WMB RIC and the WMB REITs) and the tax returns of
WMB RIC and the WMB REITs, there can be no dispute that the dividends claimed by the
WMB REITs and WMB RIC qualified as consent dividends under the IRC. Brouwer Decl. ¶ 21.
Indeed, the FTB has not challenged the fact that the dividends at issue qualified as consent
dividends under the IRC. Id.
B.
California Rules Relating to REIT or RIC Consent Dividends
37.
California tax law, by incorporating the IRC provisions, provides that
REITs and RICs are entitled to receive a deduction for consent dividends deemed paid to their
shareholders. CR&TC § 24872(c) states that “real estate investment trust taxable income” for
California tax purposes is defined as real estate investment trust taxable income as described in
IRC § 857(b)(2), subject to certain modifications not relevant here. Similarly, CR&TC
§ 24871(b) states that “investment company income” for California tax purposes is defined as
investment company taxable income as described in IRC § 852(b)(2), subject to certain
modifications not relevant here. As discussed in the preceding section, IRC §§ 857(b)(2) and
852(b)(2) each incorporate the applicable IRC section relating to the deductibility of consent
dividends.
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There is no dispute that the consent dividends at issue properly qualified
as “consent dividends” as defined under the IRC, nor is there any dispute that the IRS accepted
this treatment. Brouwer Decl. ¶ 21. Accordingly, because California has expressly adopted the
provisions of the IRC relating to the tax treatment of REITs and RICs with respect to the
deductibility of consent dividends, the FTB has no basis to reject the deductibility of these
dividends.
39.
The FTB, however, has alleged that the Combined Tax Group did not have
statutory authority to claim dividends-paid-deductions for consent dividends. See id., Ex. H
(AIPS #1). In AIPS #1, a copy of which is attached to the Brouwer Declaration as Exhibit H, the
FTB asserts that the dividends-paid-deductions at issue are denied in accordance with the FTB
Chief Counsel Announcement 2003-1 (the “Announcement”), which states, in relevant part, that
California has not conformed to the federal consent dividend regime of Internal
Revenue Code Section 565. (see Appeal of CRG Holdings, 97-SBE-009). In
applying the federal REIT provisions under California law, the REIT is not
entitled to deduct a consent dividend and the REIT is subject to California tax for
amounts treated as a consent dividend under the federal tax law . . . .
40.
The Announcement constitutes a “published position of the Franchise Tax
Board” within the meaning of CR&TC § 18407(a)(4)(A). CR&TC § 18407(a)(4)(A), enacted in
2003, provides that the FTB can identify certain “listed transactions” for purposes of
incorporating IRC § 6011 into the CR&TC. See Announcement, 2003 WL 23171638 (Cal. Fran.
Tax. Bd.), at *1. Such “listed transactions” are transactions that have the potential for tax
evasion, must be reported on applicable tax returns, and are subject to penalties. Under the
Announcement, the FTB identified transactions where “the REIT takes a deduction for a consent
dividend but the REIT owners do not report the consent dividend as income.” Importantly, this
Announcement is dated December 31, 2003 – after the transactions and deductions at issue
occurred. Further, the Announcement specifically notes that the “listed transactions” identified
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therein are “listed transactions” for purposes of CR&TC § 18407(a)(4)(A) after the date of the
announcement. See Announcement, 2003 WL 23171638 (Cal. Fran. Tax. Bd.), at *1 (“Pursuant
to [CR&TC § 18407(a)(4)(A),] all ‘listed transactions’ identified by the Secretary of the
Treasury for federal income tax purposes prior to this announcement . . . as well as those
identified as ‘listed transactions’ after this announcement, constitute ‘listed transactions’ for
California income and franchise tax purposes.”). Indeed, because CR&TC § 18407(a)(4)(A) was
enacted in 2003, there were no “listed transactions” prior to its enactment. The relevant statute
itself provides that “listed transactions” identified by the FTB shall be published so the public is
aware of the “new” penalties associated with such listed transactions.18 As a result, the
Announcement cannot retroactively apply to the transactions at issue.19 Moreover, this
Announcement did not and could not alter the substantive law governing the deductibility of
consent dividends. As a result, the FTB cannot ignore the plain language of the CR&TC (that
incorporates the federal provisions) simply because it seeks a different result.
18
Specifically, the statute provides the following:
(A) The Franchise Tax Board shall identify and publish “listed transactions” (whether identified
by the Secretary of the Treasury under Section 6011 of the Internal Revenue Code for federal
income tax purposes or by the Franchise Tax Board) through the use of Franchise Tax Board
Notices or other published positions. In addition, the “listed transactions” identified and published
pursuant to the preceding sentence shall be published on the Web site of the Franchise Tax Board.
(B) The Franchise Tax Board shall conduct a public outreach program to make taxpayers aware of
the new and increased penalties associated with the use of tax avoidance transactions including
deductions, basis, credits, entity classification, dividend elimination, or omission of income.
CR&TC § 18407(a)(4)(A)-(B) (emphasis added).
19
To the extent that the FTB attempts to apply the statute retroactively, at most, the statute could only apply to the
then current tax year (i.e., 2003). See, e.g., River Garden Ret. Home v. Franchise Tax Bd., 186 Cal. App. 4th 922,
947 (2010) (“[G]enerally, California courts have upheld retroactive application of tax laws only where the
retroactivity was limited to the current tax year.”); Modesto v. Nat’l Med., 128 Cal. App. 4th 518, 525 (2005)
(change in tax law that was retroactive for five years was unconstitutional).
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In addition, the case cited by the FTB in the Announcement, In re CRG
Holdings, Inc., 1997 Cal. Tax LEXIS 160, 97-SBE-009 (Cal. State Bd. of Equal. May 8, 1997),20
also does not support the FTB’s position. But, more importantly, the case did not involve a
REIT or a RIC. Rather, the issue was whether the taxpayer was entitled to an adjustment to its
basis in the stock of its foreign subsidiaries based upon a declared consent dividend. Id. at *2.
In any event, the taxpayer in the case conceded that “the California Legislature has not adopted
the federal consent dividend statute” and argued that “the consent dividend is consistent with
other provisions of the IRC previously adopted by the state legislature . . . .” Here, however, the
California statute at issue expressly adopted subchapter M of the IRC (with certain
modifications), including IRC §§ 857(b)(2) and 852(b)(2), which expressly incorporates the
applicable IRC sections relating to consent dividends and their deductibility for REITs and RICs.
Because CRG Holdings does not speak to the portion of the CR&TC that explicitly incorporates
the IRC as it pertains to consent dividends for REITs and RICs, it should be ignored.
42.
In sum, under both federal and California law, so long as a REIT or RIC
pays dividends (including consent dividends) that total at least ninety percent (90%) of such
entity’s taxable income (computed without regard to the dividends-paid-deduction), a REIT or
RIC can generally deduct such dividends from its taxable income.
II.
The Parent Companies of the WMB REITs and WMB RIC
Properly Did Not Take into Account Dividends as Taxable Income
43.
Under California law during the relevant period, intercompany consent
dividends received by a parent or shareholder of a REIT or RIC are not taxable in California
because they are not included in the parent’s calculation of California taxable income. Further,
20
The California State Board of Equalization is the administrative body for franchise and income tax appeals. Its
decisions, however, are neither binding nor dispositive, but typically entitled to deference. See, e.g., Auerbach v.
Assessment Appeals Bd. No. 2 for L.A., 167 Cal. App. 4th 1428, 1442 (2008).
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intercompany dividends (whether consent dividends or cash dividends) received by a parent or
shareholder of a RIC are not taxable in California because they may be eliminated pursuant to
the applicable provisions of the CR&TC permitting the elimination of intercompany dividends
within a unitary group. See CR&TC § 25106. As a result, the WMB REIT Holding Companies
(i.e., the shareholders of the WMB REITs) did not include any amounts related to consent
dividends in their taxable income, and the WMB RIC Parents (i.e., the shareholders of WMB
RIC) eliminated dividends from their taxable income during the applicable years. The FTB
challenges this treatment of dividends by the WMB REIT Holding Companies and WMB RIC
Parents. See Brouwer Decl., Ex. I (AIPS #2).
44.
Although the IRC has special sections that render all dividends (including
consent dividends) from a REIT or RIC taxable at the shareholder level, California has expressly
omitted these IRC sections from the CR&TC. Indeed, the IRC section that requires a
shareholder to recognize dividend income from a consent dividend – IRC § 565 – is not adopted
by the CR&TC. Accordingly, there is no mechanism for a REIT or RIC shareholder to include
consent dividends in taxable income in California. Because such consent dividends cannot be
included in a REIT or RIC shareholder’s California taxable income, the FTB cannot tax an entity
on its receipt of consent dividends.
45.
Further, with respect to RICs, CR&TC § 25106 expressly permits the
elimination of intercompany dividends received by RIC shareholders. This result is confirmed
by CR&TC § 24871(e), which provided the following during the Taxable Years at issue:21
Section 854 of the Internal Revenue Code, relating to limitations applicable to
dividends received from regulated investment companies, is modified to refer to
Section 24402, in lieu of Section 243 of the Internal Revenue Code.
21
CR&TC § 24871(e) was amended in 2003 to include a cross-reference to CR&TC § 25106 (after the transactions
at issue).
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CR&TC § 24871(e). With respect to the cash dividends received by RIC shareholders, this
section modifies California’s incorporation of the RIC provisions of the IRC. As previously
noted, the IRC generally prohibits a RIC shareholder from claiming a dividends-receiveddeduction pursuant to IRC § 243. CR&TC 24871(e) provided that the prohibition of the use of
the dividends-received-deduction under IRC § 243 (which is not adopted by California) applies
only to the dividends-received-deduction normally provided by CR&TC § 24402 (not applicable
here). As a result, no prohibition existed during the Taxable Years at issue to bar the elimination
of intercompany dividends under CR&TC § 25106. Under such section, cash dividends received
by a RIC shareholder from a RIC that is included in a unitary group with the shareholder were
properly eliminated.
46.
Accordingly, California has no operative provisions requiring shareholders
of REITs to be taxed on their receipt of consent dividends, or for RICs to be taxed on their
receipt of either consent dividends or cash dividends paid by unitary group members.
Notwithstanding this fact, the FTB asserts, in AIPS #2, that the elimination of these dividends is
improper and, in support, the FTB asserts that “[t]he type of double deductions taken by taxpayer
is clearly prohibited under federal law [and] [t]he California R&TC substantially conforms to
this federal law.” This statement is incorrect. Although the “dividends-received-deduction” by
the WMB REIT Holding Companies and WMB RIC Parents is prohibited under the IRC, this
fact is only relevant if California had adopted the same rule in the CR&TC. However, because
California has not adopted (and actually declined to adopt) the specific IRC provisions that
prevent the dividends-received-deduction by the WMB REIT Holding Companies and WMB
RIC Parents, IRC treatment of the deduction is irrelevant. Thus, the FTB has no basis under the
CR&TC to reject the deduction.
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Accordingly, WMB RIC Parents and the WMB REIT Holding Companies
were not required to include these dividends as income on their tax returns.
III.
WMB RIC was Properly Formed under
Applicable Law for Legitimate Business Purposes
48.
The FTB claims that (i) WMB RIC was not qualified as an “investment
company” under the ICA as required for regulated investment company status under the IRC,
and (ii) WMB RIC constitutes a “sham transaction” or “sham corporation.” Brouwer Decl., Ex. I
(AIPS #2). As a result, the FTB contends that WMB RIC did not qualify as a RIC for purposes
of the CR&TC, was not permitted to deduct cash dividends paid or consent dividends paid
pursuant to IRC § 852(b)(2)(D) and CR&TC § 24871(b)(4), and that all the income earned by
WMB RIC should be treated as having been earned by WMBfa.
A.
WMB RIC Qualified as an “Investment Company” under the ICA and IRC
49.
WMB RIC, at all relevant times, was validly registered as a non-
diversified closed-end management company under the ICA. Id. ¶ 7. Section 3(a)(1)(A) of the
ICA defines the term “investment company” to mean any issuer which “is or holds itself out as
being engaged primarily, or proposes to engage primarily, in the business of investing,
reinvesting, or trading in securities . . . .” 15 U.S.C. § 80a-3(a)(1)(A). During its existence,
WMB RIC was engaged exclusively in the business of investing in securities (see Brouwer Decl.
¶ 7), thus satisfying 15 U.S.C. § 80a-3(a)(1)(A). Likewise, WMB RIC confirmed its existence as
a RIC by registering with the SEC as an investment company on August 28, 2000, and
significantly, the SEC never challenged or questioned WMB RIC’s status as a regulated
investment company. Id. In fact, the ICA explicitly states that “[a]n investment company shall
be deemed to be registered [as an investment company] upon receipt by the Commission of [the]
notification of registration.” As noted above, because WMB RIC filed its notification with the
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SEC on August 28, 2000, and the SEC never challenged such registration, WMB RIC was
officially registered as an investment company under the ICA during its existence. Id.; see also
id. Ex. B.
50.
Notwithstanding the foregoing, the FTB asserts, without explanation, that
WMB RIC “was not at all times during taxable years 2000 – 2002 (i) a ‘regulated investment
company’ under the 1940 Act and/or (ii) validly registered under the 1940 Act.” Id., Ex. I
(AIPS #2). The FTB’s argument must be rejected as unsupported by the facts and the law.
B.
WMB RIC was Established for Legitimate Business Purposes
51.
WMB RIC was formed based upon a determination that, among other
things, WMB RIC could be effective in raising cost efficient Tier One Capital for WMB, attract
outside investments, and be a potential vehicle for tax savings. Id. ¶ 8. Tier One Capital
provides a first line of defense against losses for a savings association and is a key metric in
determining compliance with regulatory capital standards established by the Office of Thrift
Supervision. Id. The Court is also aware of the Combined Tax Group’s methods of Tier One
Capital-generation utilizing the WMB REITs, given the Court’s familiarity with the Debtors’
bankruptcy proceedings and specifically, the adversary proceeding captioned Black Horse
Capital LP v. JPMorgan Chase Bank (In re Washington Mutual, Inc.), Adv. No. 10-51387. As
noted in the Black Horse Capital pleadings, the regulatory framework involving Tier One Capital
ensured that the savings association had a capital structure that adequately insulates it against
losses, thereby protecting depositors (and the federal deposit insurance fund, which would pay
depositors in the case of a savings association failure). See Opening Brief of Washington
Mutual, Inc. in Support of Motion for Summary Judgment [Adv. No. 10-51387, D.I. 110].
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Nevertheless, the FTB contends that WMB RIC is not a valid RIC
because, according to the FTB, WMB formed WMB RIC for tax evasion, rather than for
legitimate business purposes, and, therefore, WMB RIC lacks economic substance.22 See
Brouwer Decl., Ex. I (AIPS #2). This position must fail as a matter of law based upon
undisputed facts.
53.
The “economic substance” (or “sham transaction”) doctrine originated in
Gregory v. Helvering, 293 U.S. 465 (1935). There, the U.S. Supreme Court established that
taxpayers are not permitted to “exalt artifice above reality” in structuring transactions to avoid
tax. 293 U.S. at 470. The Supreme Court also reinforced the well-settled “legal right of a
taxpayer to decrease the amount of what would otherwise be his taxes, or altogether avoid them,
by means which the law permits . . . .” Id. at 469; see also N. Ind. Pub. Serv. Co. v. Comm’r,
115 F. 3d 506, 511 (7th Cir. 1997) (“A tax-avoidance motive is not inherently fatal to a
transaction. A taxpayer has a legal right to conduct his business so as to decrease (or altogether
avoid) the amount of what otherwise would be his taxes.” (citing Gregory, 293 U.S. at 469)).
Subsequently, in Frank Lyon Co. v. United States, 435 U.S. 561 (1978), the Supreme Court
further limited the applicability of the sham transaction doctrine as follows:
Where . . . there is a genuine multiple-party transaction with
economic substance that [i] is compelled or encouraged by
business or regulatory realities, [ii] that is imbued with taxindependent considerations, and [iii] that is not shaped solely by
22
Although the FTB’s argument is unclear, it appears that the FTB also alleges that WMB RIC was a “sham-infact.” Under that doctrine, “[s]hams in fact are transactions that never occur. In such shams, taxpayers claim
deductions for transactions that have been created on paper but which never took place.” Kirchman v. Comm’r, 862
F.2d 1486, 1492 (11th Cir. 1989). On the other hand, “sham transactions” or “shams in substance” are transactions
that actually occurred, “but which lack the substance their form represents.” Id. Here, the reasoning as to why
WMB RIC was not a sham transaction also explains why WMB RIC was not a “sham-in-fact.” Id. See also Fashion
Valley Mall, LLC v. San Diego, 176 Cal. App. 4th 871, 880 n.10 (Cal. Ct. of App. 2009) (noting that the sham-infact doctrine is a part of the sham transaction doctrine).
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tax-avoidance features to which meaningless labels are attached,
the Government should honor the allocation of rights and duties
effectuated by the parties . . . .
Id. at 562.
54.
The analysis of whether allegedly “sham” transactions had sufficient
economic substance “turns on both ‘the objective economic substance of the transactions’ and
the ‘subjective business motivation’ behind them.” ACM P’ship, 157 F.3d 231, 247 (3d Cir.
1998) (citing Casebeer v. Comm’r, 909 F.2d 1360, 1363 (9th Cir. 1990)); see also Rice’s Toyota
World, Inc. v. Comm’r, 752 F.2d 89, 91-92 (4th Cir. 1985). California courts “consider[ ]
whether appropriate business formalities are employed, industry customs and practices are
followed, and there is compliance with relevant commercial norms.” See Fashion Valley Mall,
LLC v. San Diego, 176 Cal. App. 4th 871, 880 (Cal. Ct. of App. 2009) (citing Dow Chem. Co. v.
United States, 250 F. Supp. 2d 748, 811 (E.D. Mich. 3003)).
55.
To determine whether a transaction has objective economic substance,
courts consider whether “a reasonable possibility of profit from the transaction existed.”
Consol. Edison Co. v. United States, 90 Fed. Cl. 228, 268 (Fed. Cl. 2009) (quoting Coltec Indus.,
Inc. v. United States, 454 F.3d 1340, 1356 (Fed. Cir. 2006)) (emphasis in original). To establish
that a transaction created a reasonable potential for profit, a taxpayer need not show substantial
returns from the transaction; the resulting profit need only be more than de minimis. See Hilton
v. Comm’r, 671 F.2d 316, 317 (9th Cir. 1982), aff’g 74 T.C. 305 (1980) (“No suggestion of a
minimum required rate of return is made. Taxpayers are allowed to make speculative
investments without forfeiting the normal tax applications to their actions.”); Thomas v.
Comm’r, 84 T.C. 412, 440 n.52 (T.C. 1985) (“Since the potential profit here was more than de
minimis, we are satisfied that petitioners should prevail.”).
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The second inquiry of the two-part analysis – “business purpose” –
considers a taxpayer’s subjective motivation for entering into the transaction at issue. See Bail
Bonds by Marvin Nelson, Inc. v. Comm’r, 820 F.2d 1543, 1549 (9th Cir. 1987). The subjective
test examines whether the taxpayer approached the transaction in a prudent, business-like
manner and had good-faith business reasons for entering into the transaction. See, e.g., Levy v.
Comm’r, 91 T.C. 838, 855-56 (T.C. 1988) (concluding that taxpayers had “a good faith and
substantial business purpose for entering into” a multi-party transaction based upon the court’s
finding that, among other things, the taxpayers had relied on a financial advisor’s analysis of the
transaction).
57.
Here, the evidence plainly demonstrates that WMB’s formation of WMB
RIC was not a “sham transaction” or a “sham-in-fact.” First, the formation of WMB RIC
generated a more than reasonable potential for profit and, thus, had economic substance. See
Brouwer Decl. ¶ 11. WMB RIC took possession of and generated income with incomeproducing assets, including loans. See id. In fact, WMB RIC’s SEC filings confirm that WMB
RIC generated profits in 2000, 2001 and 2002. Id. Further, during its existence, WMB RIC
acquired billions of dollars in loans from third parties, incurred loan servicing costs to third
parties, maintained independent directors, carried on an active business of purchasing and
retaining assets, and hired auditors to assist in the filing of audited financials with the SEC. Id.
¶¶ 11 & 14; Ex. D (Form N-30Ds). These benefits, and the costs associated therewith, constitute
a “more than de minimis” gain and, therefore, are objective evidence of the economic substance
of WMB RIC’s formation.
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Second, WMB had a significant, good faith business purpose for forming
WMB RIC unrelated to taxes.23 As mentioned above, WMB formed WMB RIC intending that
such entity would generate Tier One Capital, a significant non-tax, regulatory benefit. Id. ¶ 8.
These facts clearly demonstrate that WMB approached the formation of WMB RIC in a
business-like manner. Because the formation of WMB RIC had economic substance and a
legitimate business purpose, these transactions do not run afoul of the economic substance or
sham transaction doctrines.
59.
The FTB claims, however, that WMB RIC was a “paper entity structured
for the sole purpose of avoiding tax,” and, therefore, WMB RIC did not have economic
substance. See Brouwer Decl., Ex. I (AIPS #2). In support, the FTB alleges that, during the
applicable period, WMB RIC did not (i) have any employees, (ii) engage in any activity with any
unrelated third parties, and (iii) properly own the loans it purported to own. See id. Even
assuming, arguendo, that all the foregoing allegations were true, which WMILT submits they are
not, the FTB has failed to demonstrate that the formation of WMB RIC lacked economic
substance. The FTB’s allegations fail to establish that the formation of WMB RIC did not create
a reasonable potential for profit or that WMB did not have good faith reasons for forming WMB
RIC.
60.
Consistent with common industry practice, WMB RIC, similar to REITs,
did not have any employees. See National Association of Real Estate Investment Trusts,
Frequently Asked Questions about REITs, (2001) at 4 (describing private REITs as “[t]ypically
externally advised and managed”). As is customary in the RIC and REIT industry, WMB RIC
23
Even assuming that WMB’s business purpose was solely to obtain tax benefits, which it was not, the California
Supreme Court has stated that taxpayers “may adopt any lawful means for the lessening of the burden of taxes.” See
Edison Cal. Stores, Inc. v. McColgan, 30 Cal. 2d 472 (1947).
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had management contracts in place whereby related parties performed certain core functions.
See Brouwer Decl. ¶ 12. Pursuant to that certain Fund Accounting Agreement, dated August 25,
2000, by and between WMB RIC and WMBfa (the “Advisory Agreement”), WMBfa managed
certain asset acquisition duties and performed certain “back room” type functions on behalf of
WMB RIC. See Brouwer Decl., Ex. J. WMBfa’s services included, among other things,
(i) administering the day-to-day business operations and affairs of WMB RIC; (ii) advising
WMB RIC with respect to the acquisition, management, financing, and disposition of its assets;
(iii) supervising all aspects and monitoring the credit quality of each of WMB RIC’s
investments, including, but not limited to, the continuous review, supervision, and administration
of all securities owned by WMB RIC; and (iv) performing certain other duties, all as more fully
set forth in the Advisory Agreement. See id.; see also id., Ex. D (Form N-30Ds). For these
services, WMBfa received a fee of $20,000 per month, plus reasonable out-of-pocket expenses.
See id., Ex. D (Form N-30Ds). In addition, in connection with WMBfa’s role as servicer of the
loans held by WMB RIC, WMBfa received a fee equal to 0.25% of the outstanding unpaid
principal balance of these loans. See id.
61.
Additionally, contrary to FTB’s unfounded assertion, WMB RIC engaged
in business activities with unrelated third parties. In fact, with the exception of the initial capital
contribution, the Advisory Agreement with WMBfa, and WMBfa’s role as loan servicer, all of
its transactions were with third parties. For example, through its ownership of WMSM, WMB
RIC was engaged in the acquisition of home mortgage loans from unrelated mortgage
originators, including Ameriquest Mortgage Company and Freemont General Corporation. Id.
¶ 14. The dollar volume of loan purchases by WMSM was in the billions. Id.
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Moreover, WMBfa, again, contrary to the FTB’s assertions, and as set
forth below, did not retain rights in the loans transferred by WMBfa to WMB RIC. Specifically,
•
There was no contractual limitation on WMB RIC’s ability to sell or dispose of its
loans and securities other than statutory RIC requirements.
•
WMBfa could not order the reconveyance of a loan, if WMB RIC sold the loan to
third parties (or related parties).
•
The ownership of the loans by WMB RIC also changed the economic position of
WMBfa. For example, WMBfa was a member of the Federal Home Loan Bank of
San Francisco (“FHLBSF”). The FHLBSF did not allow loans held by bank
subsidiaries to be used by member banks as collateral for bank borrowings.
Accordingly, the $9 billion in assets held by WMB RIC could not be (and were not)
utilized by WMBfa for collateral purposes at the FHLBSF.
•
If WMBfa chose to sell certain types of assets for particular business reasons, such
sales could not include the assets held by WMB RIC until (and if) WMB RIC’s
board of directors, including independent directors, agreed to such sales.
•
WMB RIC engaged in material transactions with unrelated parties, where such
transactions would not have been possible if WMB RIC did not own their assets.
(e.g., selling loans).
Brouwer Decl. ¶ 15.
63.
The FTB also takes issue with the fact that the borrowers of the loans held
by WMSM, a subsidiary of WMB RIC, were not notified that their loans had been sold to
WMSM. See Brouwer Decl., Ex. I (AIPS #2). Instead, these borrowers continued to make
payments to the original lenders, who serviced the loans. This fact is irrelevant to a sham
transaction analysis. As was common in the banking industry during the applicable period, many
lenders did not notify borrowers that their loans had been sold, unless and until the servicing
rights associated with the loan were transferred. Brouwer Decl. ¶ 16.
64.
In sum, WMB RIC engaged in substantive transactions with unrelated
parties. Furthermore, WMB RIC’s acquisition of loans in the secondary market directly
contributed to WMB becoming the largest thrift in the U.S. and a major player in the sub-prime
market.
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The FTB’s argument fails because WMB RIC, and the transactions in
which WMB RIC participated, clearly have economic substance.
IV.
The FTB Lacks Authority under CR&TC § 25102 to Deny the Elimination of the
RIC Dividends Claimed by WMB RIC’s Corporate Parent
66.
CR&TC § 25102 contains provisions allowing for the distribution,
apportionment, or allocation of income between entities under common control. The FTB relies
upon CR&TC § 25102 to deny WMB RIC Parents’ consent and cash dividend deductions, or
alternatively, to reallocate the income of WMB RIC to WMBfa. See Brouwer Decl., Ex. I
(AIPS #2). CR&TC § 25102 provides that,
In the case of two or more persons, as defined in Section 19 of this code, owned
or controlled directly or indirectly by the same interests, the Franchise Tax Board
may permit or require the filing of a combined report and such other information
as it deems necessary and is authorized to impose the tax due under this part as
though the combined entire net income was that of one person, or to distribute,
apportion, or allocate the gross income or deductions between or among such
persons, if it determines that such consolidation, distribution, apportionment, or
allocation is necessary in order to reflect the proper income of any such persons.
CR&TC § 25102. The provisions of CR&TC § 25102 are substantially similar to IRC § 482.24
California courts have concluded that CR&TC § 25102, which was codified in 1955, is based on
IRC § 482 and should be interpreted consistently with the section. See, e.g., Rain Bird Sprinkler
Mfg. Corp. v. Franchise Tax Bd., 229 Cal. App. 3d 784, 790 n.3 (Cal. Ct. App. 1991) (“Internal
Revenue Code section 482 is the federal counterpart to sections 24725 and 25102.”); In re
Envirocal, Inc., 1988 Cal. Tax LEXIS 34 (Nov. 15, 1988) (describing IRC § 482 as the “federal
counterpart” to CR&TC § 25102); In re Revere Copper & Brass Inc., 1977 Cal. Tax LEXIS 38
(July 26, 1977) (describing CR&TC § 25102 as tracing its origins to IRC § 482, the Internal
Revenue Code of 1939, and prior revenue acts).
24
IRC § 482 is codified at CR&TC § 24725.
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IRC § 482 generally ensures that taxpayers clearly reflect income
attributable to transactions among commonly controlled companies. See Treas. Reg. § 1.4821(a)(1). Ensuring the clear reflection of income requires comparing the related party transaction
to a comparable transaction between two unrelated parties, thus placing the related parties on tax
parity with unrelated parties. Id. If a taxpayer successfully establishes that its intercompany
transactions are consistent with or comparable to those of unrelated parties, the transaction
withstands a challenge based on IRC § 482. See Treas. Reg. § 1.482-1(b)(1).
68.
Federal law involving IRC § 482 and state versions of that provision
indicate that, in order for a taxing authority to exercise its discretion in reallocating income, a
taxing authority must show that an intercompany transaction either contains favorable terms (i.e.,
not arm’s length) or lacks a legitimate purpose outside of tax savings. See, e.g., SLI Int’l Corp.
v. Crystal, 671 A.2d 813 (Conn. 1996) (upholding the deductions taken by the taxpayer for
commissions paid to a foreign sales corporation because the arrangements between the affiliated
companies had an “economic purpose” and reflected an “arm’s length relationship”); In re Hilton
Hotels Corp., 1989-1 N.Y. Tax Cas. J-231, J-242 (1989) (holding that the Division of Taxation
could not reallocate a gain realized by the taxpayer on the sale of a hotel because a valid business
purpose existed for the transaction; thus, there was no improper or inaccurate reflection of
income to trigger the adjustment). As applied to WMB RIC, the intercompany transaction
involved WMBfa’s provision of management services, which WMBfa monitored to ensure that
the management fees paid for those services reflected arms-length remuneration. Brouwer Decl.
¶ 13. WMBfa had evaluated the time spent by and the expertise of personnel performing
accounting, cash management, and ministerial functions, as well as established a market rate of
pay for those services. Id. WMB RIC paid the market rate for such services. Id.
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Regarding WMB RIC’s legitimate business purpose, as noted above,
WMB RIC was formed for the purpose of, among other things, raising Tier One Capital for
WMB and attracting outside investments. See supra ¶¶ 51-64.
70.
Moreover, CR&TC § 25102 only allows the FTB to “impose tax due”
under the CR&TC. Because the Combined Tax Group properly deducted the dividends received
by WMB RIC, WMB RIC has paid all taxes due and this section does not allow the FTB to
impose other taxes at will.
71.
Thus, the FTB is unable to satisfy the standard for applying CR&TC
§ 25102 and adjusting the income of the Combined Tax Group.
V.
The Combined Tax Group Properly Carried Forward NOLs for Taxable Year 2004
72.
The Combined Tax Group carried forward NOLs in the amount of
$471,480,711 into the 2004 Taxable Year, but limited the NOL deduction in that year to
$371,249,367 due to IRC regulations. The FTB has asserted that $247,499,578 of such amount
was ineligible for carryforward into the 2004 Taxable Year and has disallowed that portion of the
2004 NOL deduction (the “Disputed NOLs”). See Brouwer Decl. ¶ 25; see also id. Ex. K.
73.
The Combined Tax Group acquired these NOLs in connection with
WMI’s acquisition of Keystone Holdings, Inc. (“Keystone”) and its subsidiaries on
December 20, 1996. Id. ¶ 26. One of the Keystone subsidiaries, American Savings Bank, F.A.
(“ASB”), had substantial NOL carryforwards, all of which the Combined Tax Group utilized,
except for those generated in 1993 (the “1993 NOLs”). Id. The FTB alleges that the Combined
Tax Group was not entitled to use the Disputed NOLs in Taxable Year 2004 because the
Section 382 Limitation (as defined below) applied to such NOLs.
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CR&TC § 23051.5 generally adopts Title 26 of the United States Code,
which includes IRC § 382, a provision imposing an annual limitation (the “Section 382
Limitation”) on the amount of post-change taxable income that may be offset by a loss
corporation’s pre-change NOL carryovers. The Section 382 Limitation is determined by a
formula that may be adjusted upward or downward to reflect, among other things, recognized
built-in gains. See IRC § 382(h)(1)(A). In taxable years where the Section 382 Limitation
exceeds the taxable income for such year, the unused portion of the Section 382 Limitation is
added to the Section 382 Limitation for the subsequent year. See IRC § 382(b)(2). Accordingly,
the unused Section 382 Limitation amount may be accumulated until it is either utilized or the
relevant NOLs expire (in which case the limitation is no longer relevant).25 IRC § 172(b)(2)
provides that an NOL carryover must be carried over to each successive year in the carryforward
period and absorbed in its entirety or, if the carryover exceeds income, to the extent of taxable
income. Any unused NOL carryover is carried into the next year, until the NOL has been fully
absorbed or the NOL expires.
75.
Applying both IRC §§ 172 and 382, if an NOL is carried forward into a
taxable year by operation of IRC § 172, the NOL may be used to offset taxable income in that
taxable year, subject to the Section 382 Limitation. If the NOL carried into the year exceeds the
lesser of (i) the taxable income amount or (ii) the Section 382 Limitation, the excess NOLs will
be carried into the subsequent tax year unless the NOLs expire at the end of the year at issue.
76.
California, with certain exceptions, generally follows the federal regime
with respect to NOLs. See CR&TC § 24416.3(b)(2). CR&TC § 24416.3, however, suspended
the California NOL carryover deduction for tax years 2002 and 2003 and increased the
25
Notably, the Section 382 Limitation is not an NOL. It is a cap on the permitted use of NOLs and the amount of
the cap can fluctuate as herein described.
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carryforward period for NOLs generated prior to January 1, 2002 by two years. Thus, the
carryforward period of the 1993 NOLs was extended to 2005. CR&TC § 24416.3 does not refer
to IRC § 382 and there is no indication that it was intended to limit the use of NOLs in any way
other than as explicitly provided.
77.
As noted, IRC § 382(b)(2) requires the amount of the excess Section 382
Limitation in each year to be accumulated and used in subsequent taxable years. Because the
Section 382 Limitation amount for Taxable Years 2002 and 2003 (i.e., $0) exceeded the NOLs
the Combined Tax Group was permitted to utilize in such years, the excess Section 382
Limitation for such years accumulated and was available for use in Taxable Year 2004. In light
of the foregoing, the Disputed NOLs should be allowed in full. Nevertheless, and with no
support, the FTB asserts that, as a result of California’s suspension of the NOL deduction for two
years, the general provisions of IRC § 382 do not continue to apply. The legislation at issue
neither alters nor refers to California’s previous adoption of IRC § 382, as modified, and the
FTB’s interpretation would impose an additional restriction on the use of NOLs by reducing the
cap available to taxpayers under IRC § 382, which is not provided in the CR&TC. As a result,
the Combined Tax Group should be able to utilize the Disputed NOLs in Taxable Year 2004.
VI.
The FTB Asserts the Tax Liabilities of Commercial Capital
Bancorp, Inc. and Hawthorne Financial Corporation Against the Wrong Taxpayer
78.
In the California Claim, the FTB asserts that WMI is liable for unpaid tax
liabilities incurred by (i) Hawthorne Financial Corporation (“Hawthorne”) related to Taxable
Year 2005, and (ii) Commercial Capital Bancorp, Inc. (“CCBI”) related to Taxable Years 2003
through September 30, 2006. Notwithstanding this assertion, because CCBI and Hawthorne
were not part of the Combined Tax Group when the alleged liabilities were incurred, such
liabilities succeed to WMB, the entity into which CCBI and Hawthorne were ultimately merged.
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Specifically, in June 2004, CCBI and Commercial Capital Bank (“CCB”)
acquired Hawthorne and Hawthorne Savings Bank, respectively. Brouwer Decl. ¶ 27. On
October 1, 2006, after the relevant Taxable Years described above, CCBI merged into New
American Capital, Inc. (“NACI”), formerly a wholly owned subsidiary of WMI, and CCB
merged into WMB. In November 2007, NACI merged into WMB. Id.
80.
As a result, the taxes asserted against WMI, which CCBI and Hawthorne
incurred prior to such entities becoming part of the Combined Tax Group, should be disallowed
as they relate to taxes that are properly asserted against WMB. The appropriate venue for the
FTB to pursue these claims is the Receivership.
VII.
Penalties and Interest
81.
Based upon WMB RIC’s allegedly sham formation and transactions, the
FTB has asserted a “Non-Economic Substance Transaction penalty,” a 100% interest based
penalty, and an accuracy-related penalty (“ARP”), for Taxable Years 2000 through 2002. See
Brouwer Decl., Exs. L & M (AIPS #16 & #17). As discussed in paragraphs 48 through 64 supra,
WMB RIC was formed in accordance with all applicable rules and regulations. As such, none of
these penalties is applicable.
82.
The FTB also asserts an ARP with respect to deductibility of the WMB
REIT consent dividends. As discussed in paragraphs 34 through 42 supra, the deductions
relating to consent dividends were made in accordance with all applicable rules and regulations.
As such, this penalty is inapplicable.
83.
Additionally, the FTB, in AIPS #18, asserts an ARP with respect to certain
dividend timing issues and adjustments contained in AIPS #8. See Brouwer Decl., Ex. N
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(AIPS #18). Although WMILT is not objecting to the portion of the California Claim that
derives from AIPS #8, an ARP should not be assessed with respect to such adjustments.
84.
In AIPS #18, the FTB asserts that the income increases proposed in
AIPS #8 are the result of “negligence or disregard of rules and regulations.” Specifically, the
FTB states that IRC § 6662(c) defines the term “negligence” to include “any failure to make a
reasonable attempt to comply with the provisions of the internal revenue laws, and the term
‘disregard’ includes any careless, reckless or intentional disregard.” The FTB concludes that the
Combined Tax Group “did not exercise reasonable diligence to report the correct amount of
income.” However, there is no analysis of what constitutes “reasonable diligence” or any
attempt to cite specific facts in support of such statements. The mere fact that an income item
was not contained in the applicable tax return for Taxable Year 2006 is not evidence of a lack of
reasonable diligence. Notably, the income in question represented less than one-third of one
percent (1/3 of 1%) of the Combined Tax Group’s gross income for Taxable Year 2006. The
Combined Tax Group, which filed hundreds of annual tax filings, contained a group of
companies with billions of dollars of income. As a result, the inadvertent omission of a small
amount of income does not satisfy the “negligence” standard needed to impose an ARP, and no
facts have been alleged to support a negligence finding.
85.
In addition, the FTB has asserted penalties in Taxable Years for which
there is no tax liability due. Such a position is untenable given that any tax liability for such year
has been offset by tax overpayments made by the Combined Tax Group in the same year.
86.
Furthermore, the FTB has asserted that it is entitled to interest on tax
liabilities from the date the tax liability was incurred through the Petition Date. This argument
should be rejected. WMILT should not be liable for the ongoing accrual of interest for time
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periods in which a net tax refund is due and owing. Tax refunds should be credited to the
Taxable Year for which there is a tax liability as of the date the tax refund would begin accruing
interest.
The Amended Tax Returns for 2000 Through 2008
Taxable Years Establish WMI’s Overpayment
87.
WMILT respectfully requests that the Bankruptcy Court, pursuant to
section 505(a) of the Bankruptcy Code, determine that WMI, on its own behalf and on behalf of
the Combined Tax Group, overpaid a total of $441,157,986 (the “Overpayment Amount”),
subject to any adjustments as a result of the audit of H.F. Ahmanson & Co. (“H.F. Ahmanson”),
as discussed below. Section 505(a) of the Bankruptcy Code, in relevant part, provides the
following:
(1) Except as provided in paragraph (2) of this subsection, the court may
determine the amount or legality of any tax, any fine or penalty relating to a tax,
or any addition to tax, whether or not previously assessed, whether or not paid,
and whether or not contested before and adjudicated by a judicial or
administrative tribunal of competent jurisdiction.
(2) The court may not so determine—
....
(B) any right of the estate to a tax refund, before the earlier of—
(i) 120 days after the trustee properly requests such refund from the governmental
unit from which such refund is claimed; or
(ii) a determination by such governmental unit of such request . . . .
11 U.S.C. § 505(a).
88.
Section 505 of the Bankruptcy Code permits a bankruptcy court to
adjudicate a debtor’s tax liability and its right to a tax refund, provided the conditions set forth
therein are met. Here, because more than 120 days have passed since the Combined Tax Group
properly filed its 2000 through 2008 Amended Tax Returns (see Brouwer Decl. ¶ 23), WMILT
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has met the conditions of section 505, and this Court has the ability to determine the tax liability
of WMI, on its own behalf and on behalf of the Combined Tax Group.
89.
The Third Circuit has interpreted section 505(a) as a “jurisdictional
statute” that confers on the bankruptcy court the broad authority to determine tax claims and tax
refunds. See City of Perth Amboy v. Custom Distrib. Servs. (In re Custom Distrib. Servs.), 224
F.3d 235, 239-40 (3d Cir. 2000); Quattrone Accountants, Inc. v. IRS, 895 F.2d 921, 923 (3d Cir.
1990) (“Section 505 was intended to clarify the bankruptcy court’s jurisdiction over tax
claims.”). In the Third Circuit, bankruptcy courts routinely determine debtors’ tax liability and
entitlement to refunds. See, e.g., In re Indianapolis Downs, LLC, 462 B.R. 104, 112 (Bankr. D.
Del. 2011). Congress provided bankruptcy courts with this broad power under section 505 to
promote prompt and centralized estate administration, and to avoid requiring the estate to
“litigate the tax or assessment in several state jurisdictions.” See id. (quoting In re Cable &
Wireless USA, Inc., 331 B.R. 568, 575 (Bankr. D. Del. 2005)).
90.
Section 38.1(m) of the Plan also provides that the Bankruptcy Court shall
retain jurisdiction “to hear and determine matters concerning state, local, and federal Taxes in
accordance with sections 346, 505, and 1146 of the Bankruptcy Code (including, without
limitation, any matter relating to the Tax Refunds, and any request by the Debtors or by the
Liquidating Trustee, as applicable, for an expedited determination of Tax under section 505(b) of
the Bankruptcy Code with respect to the Debtors, the Liquidating Trust, or the Liquidating Trust
Claims Reserve, as applicable).”
I.
The Court Should Determine WMI’s Tax Liability
in Accordance with Section 505(a) of the Bankruptcy Code
91.
For Taxable Years 2000 through 2007, the Overpayment Amount
primarily resulted from adjustments made by the Combined Tax Group to its Consolidated
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Federal Returns, which were allowed by the IRS as part of the IRS audit process. Once such
process was completed, the Combined Tax Group filed its Amended Tax Returns with California
to report the IRS audit adjustments. The FTB accepted these particular adjustments and formally
acknowledged overpayments totaling approximately $314 million, with respect to Taxable Years
2000 through 2007. Brouwer Decl., Ex. F. For the Taxable Year 2008, the Overpayment
Amount resulted from the Combined Tax Group making estimated tax payments that exceeded
its ultimate tax liability.
92.
With respect to the Taxable Years 2000 through 2005, the Combined Tax
Group mistakenly included interest earned from U.S. Treasury bonds in its calculation of
California taxable income. This mistake resulted in an Overpayment Amount of $42,766,065.
The FTB asserts that the Combined Tax Group is liable for the taxes it already paid on such
interest.
II.
The Combined Tax Group Erroneously
Reported as Income, Interest Earned from U.S. Treasury Bonds
93.
The FTB concluded that the Combined Tax Group properly paid taxes on
interest earned from U.S. Treasury bonds despite California’s discriminatory treatment of U.S.
Treasury obligations. However, certain California bond issuances26 are facially discriminatory
26
Specifically, under California Government Code §§ 67550 through 67591, the San Francisco Bay Area
Transportation Terminal Authority may issue bonds. According to § 67583, those “bonds, and the interest thereon,
are exempt from all taxation by the State of California or any public corporation other than gift, inheritance and
franchise taxes.” (emphasis added). Additionally, the Revenue Bond Law of 1941 (California Government Code
§ 54435), provides in part that: “[t]he bonds and interest or income from the bonds are exempt from taxation in this
State, except from gift, inheritance and estate taxes.” Thus, by comparison, interest income earned on bonds issued
pursuant to the Revenue Bond Law of 1941 is exempt from franchise (income) tax, since the term “franchise taxes”
is not included in the specified taxes that can be imposed on the bond interest. More specifically, Article VI of the
San Francisco Refunding Revenue Bond Act adopts the provision set forth above from California Government Code
§ 54435, including relevant provisions of the Revenue Bond Law of 1941. Those provisions are incorporated into
Article 7, Section 43.6.3 of the San Francisco Refunding Bond Act by reference. Further, the Port Commission of
the City and County of San Francisco issued Refunding Revenue Bonds, Series 2004 that specifically state that the
bonds were issued under Article VI of the City and County Municipal Code and the Revenue Bond Law of 1941. As
a result, the Refunding Revenue Bonds, Series 2004 issued by the Port Commission, and all other bond issuances
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as they exempt any interest income earned on such bonds from California franchise tax, without
providing a corresponding exemption for any interest income earned on U.S. Treasury bonds.
The U.S. Constitution, 31 U.S.C. § 3124, and U.S. Supreme Court jurisprudence require a
corresponding exemption of interest income earned on obligations from the U.S. Treasury when
interest earned on state or local obligations is exempt from tax.
94.
“Under the intergovernmental immunity component of the Supremacy
Clause to the United States Constitution, states may not directly regulate the Federal
Government’s operations or property.” Blackburn v. United States, 100 F.3d 1426, 1435 (9th
Cir. 1996) (citing Hancock v. Train, 426 U.S. 167, 178-80 (1976); McCulloch v. Maryland, 17
U.S. 316 (1819)). Likewise, in the landmark decision Memphis Bank & Trust Co. v. Garner,
459 U.S. 392, 398-99 (1983), the U.S. Supreme Court ruled that a state tax imposing a greater
burden on holders of federal property than on holders of similar state property impermissibly
discriminates against federal obligations. In Memphis Bank, the State of Tennessee levied a tax
on net earnings of banks doing business within the state, and defined net earnings to include
“income from obligations of the United States and its instrumentalities” but excluded interest
from Tennessee’s own obligations. Id. at 393. The U.S. Supreme Court characterized the
Tennessee bank tax as discriminatory because it favored securities issued by Tennessee and its
political subdivisions over federal obligations. See also Brown v. Franchise Tax Bd., 197 Cal.
App. 3d 300, 302-04 (Cal. Ct. App. 1987) (following Memphis Bank and finding that California
state income tax on distributions of income originating in federal securities was a violation of
federal law because it was indirectly imposed on federal obligations).
reliant on the Revenue Bond Law of 1941, should be exempt from all taxation by the State of California, with the
exception of gift, inheritance, and estate taxes.
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In addition, federal statute confirms the longstanding constitutional
protection of interest earned on federal obligations from discriminatory state taxation. Through
31 U.S.C. § 3124, the U.S. Congress decreed the governmental immunity of federal obligations
from state taxation and permits state taxation only in carefully proscribed circumstances. In
relevant part, the statute provides:
a) Stocks and obligations of the United States Government are exempt from
taxation by a State or political subdivision of a State. The exemption applies to
each form of taxation that would require the obligation, the interest on the
obligation, or both, to be considered in computing a tax, except—
(1) a nondiscriminatory franchise tax or another nonproperty tax instead of a
franchise tax, imposed on a corporation; and
(2) an estate or inheritance tax.
Id. (emphasis added).
96.
Based upon the doctrine of intergovernmental immunity and Memphis
Bank & Trust, the exemption of interest income earned on bonds issued by a state or a political
subdivision of a state, without the corresponding exemption of such income associated with U.S.
government bonds, is both an unconstitutional taxation of U.S. government obligations and a
direct violation of 31 U.S.C. § 3124(a), which permits only a nondiscriminatory franchise tax on
corporations. As the California bond terms provide for an exemption of the interest income
earned on the bonds for purposes of computing franchise (income) tax on corporations, such
treatment creates impermissible discriminatory taxation of interest income earned on U.S.
government bonds. As a result, WMILT was not required to pay California franchise taxes on
such interest income, and is entitled to a determination that it erroneously paid taxes on such
interest income for Taxable Years 2000 through 2005.
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Tax Liabilities Relating to H.F. Ahmanson
97.
H.F. Ahmanson was a domestic corporation incorporated in Delaware and,
until its merger with WMI on October 1, 1998, maintained its corporate headquarters in
Irwindale, California. Brouwer Decl. ¶ 28. The FTB conducted an audit of H.F. Ahmanson for
the 1997 Taxable Year and included in its audit computations the amount of $12,055,226 for the
1995 Taxable Year. Id. This amount relates to the correlative California adjustment to an IRS
proposal to include certain deferred loan fees into income in 1995. Id.
98.
On April 30, 2008, WMI and WMB, as successor in interests to H.F.
Ahmanson and Home Savings of America, respectively, and Savings of America, Inc., as
substitute agent for H.F. Ahmanson, filed a complaint against the U.S. with the U.S. Court of
Federal Claims seeking a refund of taxes relating to, among other things, taxes paid on the
deferred loan fees in 1995.27 Id. ¶ 29. On October 31, 2013, the parties filed a joint status report
with the U.S. Court of Federal Claims, disclosing that settlement discussions were ongoing and a
draft agreement was under review by defendant’s trial attorney. Id. On December 11, 2013, the
U.S. filed its answer to the amended complaint. Id. On December 13, 2013, the parties filed
their latest joint status report reiterating that settlement discussions were ongoing and revisions
to a draft agreement were under review by counsel for certain plaintiffs. By court order, another
joint status report is due by February 18, 2014.28
99.
Although settlement negotiations remain ongoing with the U.S., WMI is
confident that a favorable resolution will be reached with the IRS. As a result, the final
determination of the case may alter the Combined Tax Group’s overpayment amount to the FTB.
27
Although WMI did not agree that the deferred loan fee income should be recognized in 1995, WMI paid the
federal income tax and subsequently filed a refund suit in the U.S. Court of Federal Claims. WMI did not pay the
California tax on such income.
28
WMILT has continued to update the FTB on the status of this proceeding.
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Conclusion
100.
For the reasons set forth herein, WMILT requests that the Bankruptcy
Court enter the proposed form of order attached hereto as Exhibit A (the “Proposed Order”)
finding that (i) the Combined Tax Group overpaid its tax liability for the Taxable Years by
$441,157,986 (excluding interest) (ii) reducing the California Claim to $24,650,970 (excluding
interest on such amount), and (iii) authorizing WMILT to set off the reduced California Claim
against the Overpayment Amount, consistent with Section 31.10 of the Plan.29
Notice
101.
Notice of the Objection has been given to: (a) the U.S. Trustee; (b) the
FTB; (c) all persons entitled to receive notice pursuant to Bankruptcy Rule 2002. In light of the
nature of the relief requested, WMILT submits that no other or further notice need be provided.
29
Section 31.10 of the Plan provides, in relevant part, that, “the Disbursing Agent may, pursuant to applicable
bankruptcy or non-bankruptcy law, set off against any Allowed Claim and the distributions to be made pursuant to
the Plan on account thereof . . . .”
43
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WHEREFORE WMILT respectfully requests that the Bankruptcy Court enter the
Proposed Order reducing the California Claim to $24,650,970 (excluding interest on such
amount), finding that WMI, on its own behalf and on behalf of the Combined Tax Group,
overpaid its tax liability for the Taxable Years by $441,157,986 (excluding interest), and
granting WMILT such other and further relief as is just.
Dated: December 31, 2013
Wilmington, Delaware
/s/ Amanda R. Steele
Mark D. Collins (No. 2981)
Paul N. Heath (No. 3704)
Amanda R. Steele (No. 5530)
RICHARDS, LAYTON & FINGER, P.A.
One Rodney Square
920 North King Street
Wilmington, Delaware 19801
Telephone: (302) 651-7700
Facsimile: (302) 651-7701
– and –
Brian S. Rosen, Esq.
WEIL, GOTSHAL & MANGES LLP
767 Fifth Avenue
New York, New York 10153
Telephone: (212) 310-8000
Facsimile: (212) 310-8007
Attorneys for WMI Liquidating Trust
44
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UNITED STATES BANKRUPTCY COURT
DISTRICT OF DELAWARE
---------------------------------------------------------------x
:
In re
:
:
WASHINGTON MUTUAL, INC., et al.,1
:
:
Debtors.
:
:
:
---------------------------------------------------------------x
Chapter 11
Case No. 08-12229 (MFW)
(Jointly Administered)
Hearing Date: February 20, 2014 at 10:30 a.m.
Response Deadline: February 3, 2014 at 4:00 p.m.
NOTICE OF WMI LIQUIDATING TRUST’S (A) OBJECTION TO PROOF OF CLAIM
FILED BY CALIFORNIA FRANCHISE TAX BOARD (CLAIM NO. 3908) AND
(B) MOTION FOR DETERMINATION OF TAX LIABILITY UNDER
SECTION 505 OF THE BANKRUPTCY CODE
PLEASE TAKE NOTICE that on December 31, 2013, WMI Liquidating Trust
(“WMILT”), as successor in interest to Washington Mutual, Inc. (“WMI”) and WMI Investment
Corp., formerly debtors and debtors in possession (collectively, the “Debtors”) filed the WMI
Liquidating Trust’s (A) Objection to Proof of Claim Filed by California Franchise Tax Board
(Claim No. 3908) and (B) Motion for Determination of Tax Liability Under Section 505 of the
Bankruptcy Code (the “Objection”) with the United States Bankruptcy Court for the District of
Delaware (the “Bankruptcy Court”).
PLEASE TAKE FURTHER NOTICE that any responses to the Objection must be
filed in writing with the Bankruptcy Court, 824 North Market Street, 3rd Floor, Wilmington,
Delaware 19801, and served upon and received by the undersigned counsel for WMILT or
before February 3, 2014 at 4:00 p.m. (ET).
1
The Debtors in these chapter 11 cases along with the last four digits of each Debtor’s federal tax identification
number are: (i) Washington Mutual, Inc. (3725); and (ii) WMI Investment Corp. (5395). The principal offices of
WMI Liquidating Trust are located at 1201 Third Avenue, Suite 3000, Seattle, Washington 98101.
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PLEASE TAKE FURTHER NOTICE that, in the event that one or more
responses to the Objection are timely filed, the Objection shall be considered at a hearing before
The Honorable Mary F. Walrath at the Bankruptcy Court, 824 Market Street, 5th Floor,
Courtroom 4, Wilmington, Delaware 19801 on February 20, 2014 at 10:30 a.m. (ET).
PLEASE TAKE FURTHER NOTICE THAT IF NO RESPONSES TO THE
OBJECTION ARE TIMELY FILED, SERVED AND RECEIVED IN ACCORDANCE
WITH THIS NOTICE, THE BANKRUPTCY COURT MAY GRANT THE RELIEF
REQUESTED IN THE OBJECTION WITHOUT FURTHER NOTICE OR HEARING.
Dated: December 31, 2013
Wilmington, Delaware
/s/ Amanda R. Steele
Mark D. Collins (No. 2981)
Paul N. Heath (No. 3704)
Amanda R. Steele (No. 5530)
RICHARDS, LAYTON & FINGER, P.A.
One Rodney Square
920 N. King Street
Wilmington, Delaware 19801
Telephone: (302) 651-7700
Facsimile: (302) 651-7701
- and Brian S. Rosen
WEIL, GOTSHAL & MANGES LLP
767 Fifth Avenue
New York, New York 10153
Telephone: (212) 310-8000
Facsimile: (212) 310-8007
Attorneys for WMI Liquidating Trust
2
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UNITED STATES BANKRUPTCY COURT
DISTRICT OF DELAWARE
---------------------------------------------------------------x
:
In re
:
:
WASHINGTON MUTUAL, INC., et al.,1
:
:
Debtors.
:
:
:
---------------------------------------------------------------x
Chapter 11
Case No. 08-12229 (MFW)
(Jointly Administered)
Hearing Date: February 20, 2014 at 10:30 a.m.
Response Deadline: February 3, 2014 at 4:00 p.m.
NOTICE OF WMI LIQUIDATING TRUST’S (A) OBJECTION TO PROOF OF CLAIM FILED
BY CALIFORNIA FRANCHISE TAX BOARD (CLAIM NO. 3908) AND
(B) MOTION FOR DETERMINATION OF TAX LIABILITY UNDER
SECTION 505 OF THE BANKRUPTCY CODE
PLEASE TAKE NOTICE THAT on December 31, 2013, WMI Liquidating Trust
(“WMILT”), as successor in interest to Washington Mutual, Inc. (“WMI”) and WMI Investment
Corp., formerly debtors and debtors in possession (collectively, the “Debtors”) filed the attached
WMI Liquidating Trust’s (A) Objection to Proof of Claim Filed by California Franchise Tax
Board (Claim No. 3908) and (B) Motion for Determination of Tax Liability Under Section 505
of the Bankruptcy Code (the “Objection”) with the United States Bankruptcy Court for the
District of Delaware (the “Bankruptcy Court”).2 By the Objection, WMILT is seeking to either,
disallow, reclassify or reduce your claim (the “Claim”) as listed in the Objection.
THE OBJECTION SEEKS TO ALTER YOUR RIGHTS. THEREFORE, YOU
SHOULD READ THIS NOTICE (INCLUDING THE OBJECTION) CAREFULLY AND
DISCUSS THEM WITH YOUR ATTORNEY. IF YOU DO NOT HAVE AN ATTORNEY,
YOU MAY WISH TO CONSULT ONE.
Critical Information for Claimants Choosing to File a Response to the Objection
Filing a Response. If you oppose the treatment of your Claim set forth in the Objection,
and if you are unable to resolve the Objection with WMILT before the deadline to object, then
you must file and serve a written response (the “Response”) to the Objection in accordance with
this Notice. If you do not oppose the disallowance of your Claim, then you do not need to file a
written Response to the Objection and you do not need to appear at the hearing on the Objection
(described below).
1
The Debtors in these chapter 11 cases along with the last four digits of each Debtor’s federal tax identification
number are: (i) Washington Mutual, Inc. (3725); and (ii) WMI Investment Corp. (5395). The principal offices of
WMI Liquidating Trust are located at 1201 Third Avenue, Suite 3000, Seattle, Washington 98101.
2
Capitalized terms used but not otherwise defined herein shall have the meanings set forth in the Objection.
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The deadline for filing a Response is February 3, 2014 at
4:00 p.m. (ET) (the “Response Deadline”).
THE BANKRUPTCY COURT WILL ONLY CONSIDER YOUR RESPONSE IF
YOUR RESPONSE IS FILED, SERVED AND RECEIVED BY THE RESPONSE DEADLINE
IN ACCORDANCE WITH THE INSTRUCTIONS SET FORTH IN THIS NOTICE.
Your Response will be deemed timely filed only if the Response is actually received on
or before the Response Deadline in the office of the clerk of the Bankruptcy Court at the
following address:
Clerk of the Court for the
United States Bankruptcy Court
for the District of Delaware
824 North Market Street, 3rd Floor
Wilmington, Delaware 19801
Your Response will be deemed properly-served only if the Response is actually
received on or before the Response Deadline by the following parties (collectively, the “Notice
Parties”):
WEIL, GOTSHAL & MANGES LLP
Attn: Brian S. Rosen
767 Fifth Avenue
New York, New York 10153
RICHARDS, LAYTON & FINGER, P.A.
Attn: Mark D. Collins
Attn: Paul N. Heath
One Rodney Square
920 North King Street
Wilmington, Delaware 19801
Counsel to WMI Liquidating Trust
Contents of Each Response. Every Response to this Objection must contain at a
minimum the following information:
•
•
•
•
•
a caption setting forth the name of the Court, the name of the Debtors, the
case number and the title of the Objection which the Response is directed;
the name of the claimant, his/her/its claim number and a description of the
basis for the amount of the claim;
the specific factual basis and supporting legal argument upon which the
party will rely in opposing this Objection;
any supporting documentation, to the extent it was not included with the
Proof of Claim previously filed with the clerk or claims agent, upon which
the party will rely to support the basis for and amounts asserted in the
Proof of Claim; and
the name, address, telephone number and fax number of the person(s)
(which may be the claimant or the claimant’s legal representative) with
whom counsel for WMILT should communicate with respect to the claim
or the Objection and who possesses authority to reconcile, settle, or
otherwise resolve the Objection to the disputed claim on behalf of the
claimant.
2
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Hearing on the Objection. If a Response is properly filed and served in accordance
with this notice, a hearing on the Objection and the Response will be held on February 20, 2014
at 10:30 a.m. (ET) (the “Hearing”) before The Honorable Mary F. Walrath, United States
Bankruptcy Judge, in the Bankruptcy Court located at 824 North Market Street, 5th Floor,
Courtroom 4, Wilmington, Delaware 19801. If you file a Response to the Objection, then you
should plan to appear at the hearing on the Objection. WMILT, however, reserves the right to
continue the hearing with respect to the Objection and the Response.
IF YOU FAIL TO RESPOND IN ACCORDANCE WITH THIS
NOTICE, THE COURT MAY GRANT THE RELIEF DEMANDED
BY THE OBJECTION WITHOUT FURTHER NOTICE OR HEARING.
Additional Information
Questions. If you have any questions regarding the Objection and/or if you wish to
obtain a copy of the Objection or related documents, please feel free to contact WMILT’s Voting
and Claims Agent, Kurtzman Carson Consultants LLC, by: (a) calling WMILT’s restructuring
hotline at (888) 830-4644 (b) visiting the Debtors’ restructuring website at:
http://www.kccllc.net/wamu and/or (c) writing to Washington Mutual Claims Processing, c/o
Kurtzman Carson Consultants LLC, 2335 Alaska Avenue, El Segundo, California 90245.
Reservation of Rights. Nothing in this notice or the Objection constitutes a waiver of
WMILT’s right to assert any claims, counterclaims, rights of offset or recoupment, preference
actions, fraudulent-transfer actions or any other claims against you of WMILT. Unless the
Bankruptcy Court allows your Claims or specifically orders otherwise, WMILT has the right to
object on any grounds to the Claims (or to any other Claims or causes of action you may have
filed or that have been scheduled by the Debtors) at a later date. In such event, you will receive a
separate notice of any such Objection.
3
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Dated: December 31, 2013
Wilmington, Delaware
/s/ Amanda R. Steele
Mark D. Collins (No. 2981)
Paul N. Heath (No. 3704)
Amanda R. Steele (No. 5530)
RICHARDS, LAYTON & FINGER, P.A.
One Rodney Square
920 N. King Street
Wilmington, Delaware 19801
Telephone: (302) 651-7700
Facsimile: (302) 651-7701
- and Brian S. Rosen
WEIL, GOTSHAL & MANGES LLP
767 Fifth Avenue
New York, New York 10153
Telephone: (212) 310-8000
Facsimile: (212) 310-8007
Attorneys for WMI Liquidating Trust
4
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EXHIBIT A
Proposed Order
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Page 2 of 4
UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE
---------------------------------------------------------------x
:
In re
:
:
WASHINGTON MUTUAL, INC., et al.,1
:
:
:
Debtors.
:
:
---------------------------------------------------------------x
Chapter 11
Case No. 08-12229 (MFW)
(Jointly Administered)
Re: Docket No. ___
ORDER GRANTING WMI LIQUIDATING TRUST’S (A) OBJECTION TO
PROOF OF CLAIM FILED BY CALIFORNIA FRANCHISE TAX
BOARD (CLAIM NO. 3908) AND (B) MOTION FOR DETERMINATION
OF TAX LIABILITY UNDER SECTION 505 OF THE BANKRUPTCY CODE
Upon the objection, dated December 31, 2013 (the “Objection”),2 of WMI
Liquidating Trust (“WMILT”), as successor in interest to Washington Mutual, Inc. (“WMI”) and
WMI Investment Corp., formerly debtors and debtors in possession (collectively, the “Debtors”),
for entry of an order (i) reducing Claim No. 3908 (the “Claim”) filed by the California Franchise
Tax Board, and (ii) determining WMI’s tax liability, on its own behalf and on behalf of the
Combined Tax Group, all as more fully set forth in the Objection; and the Court having
jurisdiction to consider the Objection and the relief requested therein pursuant to 28 U.S.C. §§
157 and 1334; and consideration of the Objection and the relief requested therein being a core
proceeding pursuant to 28 U.S.C. § 157(b); and venue being proper before this Court pursuant to
28 U.S.C. §§ 1408 and 1409; and due and proper notice of the Objection having been provided to
those parties identified therein, and no other or further notice being required; and the Court
1
The Debtors in these chapter 11 cases along with the last four digits of each Debtor’s federal tax identification
number are: (i) Washington Mutual, Inc. (3725); and (ii) WMI Investment Corp. (5395). The principal offices of
WMI Liquidating Trust are located at 1201 Third Avenue, Suite 3000, Seattle, Washington 98101.
2
Capitalized terms used but not otherwise defined herein shall have the meanings ascribed to them in the Objection.
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having determined that the relief sought in the Objection is in the best interests of WMILT, its
creditors, and all parties in interest; and the Court having determined that the legal and factual
bases set forth in the Objection establish just cause for the relief granted herein; and the Court
having determined that
1.
WMB RIC qualified as a regulated investment company for purposes of
the CR&TC, and WMB RIC was not a “sham corporation” and was not formed or utilized as part
of any “sham transaction”;
2.
The WMB REITs and WMB RIC properly claimed dividends-paid-
deductions with respect to dividends for Taxable Years 2000 through 2002;
3.
The WMB REIT Holding Companies and WMB RIC Parents properly did
not take into account dividends as taxable income for Taxable Years 2000 through 2002;
4.
The Combined Tax Group was entitled to utilize the Disputed NOLs in
Taxable Year 2004;
5.
The Combined Tax Group is not liable for any penalties asserted by the
FTB, except with respect to the 1997 Taxable Year in the amount acknowledged by WMILT;
6.
The Combined Tax Group is not liable for the ongoing accrual of interest
for time periods in which a net tax refund is due and owing;
7.
The Combined Tax Group is not liable for the asserted tax liabilities of
Commercial Capital Bancorp, Inc. and Hawthorne Financial Corporation, incurred prior to such
entities becoming part of the Combined Tax Group; and
8.
The Combined Tax Group erroneously reported as income, interest earned
from U.S. Treasury bonds and it properly filed an amended tax return to exclude that income;
and after due deliberation and sufficient cause appearing therefor, it is
2
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ORDERED that the Objection is GRANTED as set forth herein; and it is further
ORDERED that the Claim is hereby reduced to $24,650,970 (excluding interest
on such amount), without prejudice against WMILT to seek a further reduction of the Claim, and
it is further
ORDERED that the Combined Tax Group’s net overpayments of tax total
$416,507,016 (excluding interest) after giving effect to the setoff provisions authorized under
Section 31.10 of the Plan, subject to further adjustment solely based upon the resolution of the
case styled Washington Mutual, Inc., as Successor in Interest of H.F. Ahmanson & Co. and
Subsidiaries, et al. v. United States, Case No. 08-321, currently pending in the U.S. Court of
Federal Claims; and it is further
ORDERED that Kurtzman Carson Consultants, LLC, the Debtors’ courtappointed claims and noticing agent, is authorized and directed to reduce the Claim on the
official claims register in these chapter 11 cases; and it is further
ORDERED that this Court shall retain jurisdiction to hear and determine all
matters arising from or related to the implementation, interpretation and/or enforcement of this
Order.
Dated: February __, 2014
Wilmington, Delaware
______________________________________
THE HONORABLE MARY F. WALRATH
UNITED STATES BANKRUPTCY JUDGE
3
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EXHIBIT B
IRC § 565
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Case 08-12229-MFW
§ 565. Consent dividends,
26 USCA § 565
Doc 11546-4
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Page 2 of 3
KeyCite Yellow Flag - Negative Treatment
Proposed Legislation
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(a) General rule.--If any person owns consent stock (as defined in subsection (f)(1)) in a corporation on the last day of the
taxable year of such corporation, and such person agrees, in a consent filed with the return of such corporation in accordance
with regulations prescribed by the Secretary, to treat as a dividend the amount specified in such consent, the amount so specified
shall, except as provided in subsection (b), constitute a consent dividend for purposes of section 561 (relating to the deduction
for dividends paid).
(b) Limitations.--A consent dividend shall not include--
(1) an amount specified in a consent which, if distributed in money, would constitute, or be part of, a distribution which would
be disqualified for purposes of the dividends paid deduction under section 562(c) (relating to preferential dividends), or
(2) an amount specified in a consent which would not constitute a dividend (as defined in section 316) if the total amounts
specified in consents filed by the corporation had been distributed in money to shareholders on the last day of the taxable
year of such corporation.
(c) Effect of consent.--The amount of a consent dividend shall be considered, for purposes of this title--
(1) as distributed in money by the corporation to the shareholder on the last day of the taxable year of the corporation, and
(2) as contributed to the capital of the corporation by the shareholder on such day.
(d) Consent dividends and other distributions.--If a distribution by a corporation consists in part of consent dividends and
in part of money or other property, the entire amount specified in the consents and the amount of such money or other property
shall be considered together for purposes of applying this title.
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
1
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26 USCA § 565
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(e) Nonresident aliens and foreign corporations.--In the case of a consent dividend which, if paid in money would be subject
to the provisions of section 1441 (relating to withholding of tax on nonresident aliens) or section 1442 (relating to withholding
of tax on foreign corporations), this section shall not apply unless the consent is accompanied by money, or such other medium
of payment as the Secretary may by regulations authorize, in an amount equal to the amount that would be required to be
deducted and withheld under sections 1441 or 1442 if the consent dividend had been, on the last day of the taxable year of the
corporation, paid to the shareholder in money as a dividend. The amount accompanying the consent shall be credited against
the tax imposed by this subtitle on the shareholder.
(f) Definitions.--
(1) Consent stock.--Consent stock, for purposes of this section, means the class or classes of stock entitled, after the payment
of preferred dividends, to a share in the distribution (other than in complete or partial liquidation) within the taxable year
of all the remaining earnings and profits, which share constitutes the same proportion of such distribution regardless of the
amount of such distribution.
(2) Preferred dividends.--Preferred dividends, for purposes of this section, means a distribution (other than in complete or
partial liquidation), limited in amount, which must be made on any class of stock before a further distribution (other than in
complete or partial liquidation) of earnings and profits may be made within the taxable year.
CREDIT(S)
(Aug. 16, 1954, c. 736, 68A Stat. 200; Oct. 4, 1976, Pub.L. 94-455, Title XIX, § 1906(b) (13) (A), 90 Stat. 1834.)
Notes of Decisions (1)
26 U.S.C.A. § 565, 26 USCA § 565
Current through P.L. 113-57 (excluding P.L. 113-54 and 113-56) approved 12-9-13
End of Document
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
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EXHIBIT C
IRC § 857
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USCA § 857 Page
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(a) Requirements applicable to real estate investment trusts.--The provisions of this part (other than subsection (d) of this
section and subsection (g) of section 856) shall not apply to a real estate investment trust for a taxable year unless--
(1) the deduction for dividends paid during the taxable year (as defined in section 561, but determined without regard to
capital gains dividends) equals or exceeds--
(A) the sum of--
(i) 90 percent of the real estate investment trust taxable income for the taxable year (determined without regard to the
deduction for dividends paid (as defined in section 561) and by excluding any net capital gain); and
(ii) 90 percent of the excess of the net income from foreclosure property over the tax imposed on such income by
subsection (b)(4)(A); minus
(B) any excess noncash income (as determined under subsection (e)); and
(2) either--
(A) the provisions of this part apply to the real estate investment trust for all taxable years beginning after February 28,
1986, or
(B) as of the close of the taxable year, the real estate investment trust has no earnings and profits accumulated in any
non-REIT year.
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
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USCA § 857 Page
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For purposes of the preceding sentence, the term “non-REIT year” means any taxable year to which the provisions of
this part did not apply with respect to the entity. The Secretary may waive the requirements of paragraph (1) for any
taxable year if the real estate investment trust establishes to the satisfaction of the Secretary that it was unable to meet such
requirements by reason of distributions previously made to meet the requirements of section 4981.
(b) Method of taxation of real estate investment trusts and holders of shares or certificates of beneficial interest.--
(1) Imposition of tax on real estate investment trusts.--There is hereby imposed for each taxable year on the real estate
investment trust taxable income of every real estate investment trust a tax computed as provided in section 11, as though the
real estate investment trust taxable income were the taxable income referred to in section 11.
(2) Real estate investment trust taxable income.--For purposes of this part, the term “real estate investment trust taxable
income” means the taxable income of the real estate investment trust, adjusted as follows:
(A) The deductions for corporations provided in part VIII (except section 248) of subchapter B (section 241 and following,
relating to the deduction for dividends received, etc.) shall not be allowed.
(B) The deduction for dividends paid (as defined in section 561) shall be allowed, but shall be computed without regard
to that portion of such deduction which is attributable to the amount excluded under subparagraph (D).
(C) The taxable income shall be computed without regard to section 443(b) (relating to computation of tax on change of
annual accounting period).
(D) There shall be excluded an amount equal to the net income from foreclosure property.
(E) There shall be deducted an amount equal to the tax imposed by paragraphs (5) and (7) of this subsection, section 856(c)
(7)(C), and section 856(g)(5) for the taxable year.
(F) There shall be excluded an amount equal to any net income derived from prohibited transactions.
(3) Capital gains.--
(A) Alternative tax in case of capital gains.--If for any taxable year a real estate investment trust has a net capital gain,
then, in lieu of the tax imposed by subsection (b)(1), there is hereby imposed a tax (if such tax is less than the tax imposed
by such subsection) which shall consist of the sum of--
(i) a tax, computed as provided in subsection (b)(1), on the real estate investment trust taxable income (determined
by excluding such net capital gain and by computing the deduction for dividends paid without regard to capital gain
dividends), and
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
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(ii) a tax determined at the rates provided in section 1201(a) on the excess of the net capital gain over the deduction for
dividends paid (as defined in section 561) determined with reference to capital gains dividends only.
(B) Treatment of capital gain dividends by shareholders.--A capital gain dividend shall be treated by the shareholders
or holders of beneficial interests as a gain from the sale or exchange of a capital asset held for more than 1 year.
(C) Definition of capital gain dividend.--For purposes of this part, a capital gain dividend is any dividend, or part thereof,
which is designated by the real estate investment trust as a capital gain dividend in a written notice mailed to its shareholders
or holders of beneficial interests at any time before the expiration of 30 days after the close of its taxable year (or mailed
to its shareholders or holders of beneficial interests with its annual report for the taxable year); except that, if there is an
increase in the excess described in subparagraph (A)(ii) of this paragraph for such year which results from a determination
(as defined in section 860(e)), such designation may be made with respect to such increase at any time before the expiration
of 120 days after the date of such determination. If the aggregate amount so designated with respect to a taxable year of
the trust (including capital gain dividends paid after the close of the taxable year described in section 858) is greater than
the net capital gain of the taxable year, the portion of each distribution which shall be a capital gain dividend shall be only
that proportion of the amount so designated which such net capital gain bears to the aggregate amount so designated. For
purposes of this subparagraph, the amount of the net capital gain for any taxable year which is not a calendar year shall be
determined without regard to any net capital loss attributable to transactions after December 31 of such year, and any such
net capital loss shall be treated as arising on the 1st day of the next taxable year. To the extent provided in regulations, the
preceding sentence shall apply also for purposes of computing the taxable income of the real estate investment trust.
(D) Treatment by shareholders of undistributed capital gains
(i) Every shareholder of a real estate investment trust at the close of the trust's taxable year shall include, in computing his
long-term capital gains in his return for his taxable year in which the last day of the trust's taxable year falls, such amount
as the trust shall designate in respect of such shares in a written notice mailed to its shareholders at any time prior to the
expiration of 60 days after the close of its taxable year (or mailed to its shareholders or holders of beneficial interests with
its annual report for the taxable year), but the amount so includible by any shareholder shall not exceed that part of the
amount subjected to tax in subparagraph (A)(ii) which he would have received if all of such amount had been distributed
as capital gain dividends by the trust to the holders of such shares at the close of its taxable year.
(ii) For purposes of this title, every such shareholder shall be deemed to have paid, for his taxable year under clause (i),
the tax imposed by subparagraph (A)(ii) on the amounts required by this subparagraph to be included in respect of such
shares in computing his long-term capital gains for that year; and such shareholders shall be allowed credit or refund as
the case may be, for the tax so deemed to have been paid by him.
(iii) The adjusted basis of such shares in the hands of the holder shall be increased with respect to the amounts required by
this subparagraph to be included in computing his long-term capital gains, by the difference between the amount of such
includible gains and the tax deemed paid by such shareholder in respect of such shares under clause (ii).
(iv) In the event of such designation, the tax imposed by subparagraph (A)(ii) shall be paid by the real estate investment
trust within 30 days after the close of its taxable year.
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(v) The earnings and profits of such real estate investment trust, and the earnings and profits of any such shareholder which
is a corporation, shall be appropriately adjusted in accordance with regulations prescribed by the Secretary.
(vi) As used in this subparagraph, the terms “shares” and “shareholders” shall include beneficial interests and holders of
beneficial interests, respectively.
(E) Coordination with net operating loss provisions.--For purposes of section 172, if a real estate investment trust pays
capital gain dividends during any taxable year, the amount of the net capital gain for such taxable year (to the extent such
gain does not exceed the amount of such capital gain dividends) shall be excluded in determining--
(i) the net operating loss for the taxable year, and
(ii) the amount of the net operating loss of any prior taxable year which may be carried through such taxable year under
section 172(b)(2) to a succeeding taxable year.
(F) Certain distributions.--In the case of a shareholder of a real estate investment trust to whom section 897 does not
apply by reason of the second sentence of section 897(h)(1), the amount which would be included in computing long-term
capital gains for such shareholder under subparagraph (B) or (D) (without regard to this subparagraph)--
(i) shall not be included in computing such shareholder's long-term capital gains, and
(ii) shall be included in such shareholder's gross income as a dividend from the real estate investment trust.
(4) Income from foreclosure property.--
(A) Imposition of tax.--A tax is hereby imposed for each taxable year on the net income from foreclosure property of
every real estate investment trust. Such tax shall be computed by multiplying the net income from foreclosure property
by the highest rate of tax specified in section 11(b).
(B) Net income from foreclosure property.--For purposes of this part, the term “net income from foreclosure property”
means the excess of--
(i) gain (including any foreign currency gain, as defined in section 988(b)(1)) from the sale or other disposition of
foreclosure property described in section 1221(a)(1) and the gross income for the taxable year derived from foreclosure
property (as defined in section 856(e)), but only to the extent such gross income is not described in (or, in the case
of foreign currency gain, not attributable to gross income described in) section 856(c)(3) other than subparagraph (F)
thereof, over
(ii) the deductions allowed by this chapter which are directly connected with the production of the income referred to
in clause (i).
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(5) Imposition of tax in case of failure to meet certain requirements.--If section 856(c)(6) applies to a real estate
investment trust for any taxable year, there is hereby imposed on such trust a tax in an amount equal to the greater of--
(A) the excess of--
(i) 95 percent of the gross income (excluding gross income from prohibited transactions) of the real estate investment
trust, over
(ii) the amount of such gross income which is derived from sources referred to in section 856(c)(2); or
(B) the excess of--
(i) 75 percent of the gross income (excluding gross income from prohibited transactions) of the real estate investment
trust, over
(ii) the amount of such gross income which is derived from sources referred to in section 856(c)(3),
multiplied by a fraction the numerator of which is the real estate investment trust taxable income for the taxable year
(determined without regard to the deductions provided in paragraphs (2)(B) and (2)(E), without regard to any net operating
loss deduction, and by excluding any net capital gain) and the denominator of which is the gross income for the taxable
year (excluding gross income from prohibited transactions; gross income and gain from foreclosure property (as defined
in section 856(e), but only to the extent such gross income and gain is not described in subparagraph (A), (B), (C), (D), (E),
or (G) of section 856(c)(3)); long-term capital gain; and short-term capital gain to the extent of any short-term capital loss).
(6) Income from prohibited transactions.--
(A) Imposition of tax.--There is hereby imposed for each taxable year of every real estate investment trust a tax equal to
100 percent of the net income derived from prohibited transactions.
(B) Definitions.--For purposes of this part--
(i) the term “net income derived from prohibited transactions” means the excess of the gain (including any foreign
currency gain, as defined in section 988(b)(1)) from prohibited transactions over the deductions (including any foreign
currency loss, as defined in section 988(b)(2)) allowed by this chapter which are directly connected with prohibited
transactions;
(ii) in determining the amount of the net income derived from prohibited transactions, there shall not be taken into
account any item attributable to any prohibited transaction for which there was a loss; and
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(iii) the term “prohibited transaction” means a sale or other disposition of property described in section 1221(a)(1) which
is not foreclosure property.
(C) Certain sales not to constitute prohibited transactions.--For purposes of this part, the term “prohibited transaction”
does not include a sale of property which is a real estate asset (as defined in section 856(c)(5)(B)) and which is described
in section 1221(a)(1) if--
(i) the trust has held the property for not less than 2 years;
(ii) aggregate expenditures made by the trust, or any partner of the trust, during the 2-year period preceding the date of
sale which are includible in the basis of the property do not exceed 30 percent of the net selling price of the property;
(iii) (I)during the taxable year the trust does not make more than 7 sales of property (other than sales of foreclosure
property or sales to which section 1033 applies), or (II) the aggregate adjusted bases (as determined for purposes of
computing earnings and profits) of property (other than sales of foreclosure property or sales to which section 1033
applies) sold during the taxable year does not exceed 10 percent of the aggregate bases (as so determined) of all of the
assets of the trust as of the beginning of the taxable year, or (III) the fair market value of property (other than sales of
foreclosure property or sales to which section 1033 applies) sold during the taxable year does not exceed 10 percent of
the fair market value of all of the assets of the trust as of the beginning of the taxable year;
(iv) in the case of property, which consists of land or improvements, not acquired through foreclosure (or deed in lieu
of foreclosure), or lease termination, the trust has held the property for not less than 2 years for production of rental
income; and
(v) if the requirement of clause (iii)(I) is not satisfied, substantially all of the marketing and development expenditures
with respect to the property were made through an independent contractor (as defined in section 856(d)(3)) from whom
the trust itself does not derive or receive any income.
(D) Certain sales not to constitute prohibited transactions.--For purposes of this part, the term “prohibited transaction”
does not include a sale of property which is a real estate asset (as defined in section 856(c)(5)(B)) and which is described
in section 1221(a)(1) if--
(i) the trust held the property for not less than 2 years in connection with the trade or business of producing timber,
(ii) the aggregate expenditures made by the trust, or a partner of the trust, during the 2-year period preceding the date
of sale which--
(I) are includible in the basis of the property (other than timberland acquisition expenditures), and
(II) are directly related to operation of the property for the production of timber or for the preservation of the property
for use as timberland,
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do not exceed 30 percent of the net selling price of the property,
(iii) the aggregate expenditures made by the trust, or a partner of the trust, during the 2-year period preceding the date
of sale which--
(I) are includible in the basis of the property (other than timberland acquisition expenditures), and
(II) are not directly related to operation of the property for the production of timber, or for the preservation of the
property for use as timberland,
do not exceed 5 percent of the net selling price of the property,
(iv)(I) during the taxable year the trust does not make more than 7 sales of property (other than sales of foreclosure
property or sales to which section 1033 applies), or
(II) the aggregate adjusted bases (as determined for purposes of computing earnings and profits) of property (other than
sales of foreclosure property or sales to which section 1033 applies) sold during the taxable year does not exceed 10
percent of the aggregate bases (as so determined) of all of the assets of the trust as of the beginning of the taxable year, or
(III) the fair market value of property (other than sales of foreclosure property or sales to which section 1033 applies)
sold during the taxable year does not exceed 10 percent of the fair market value of all of the assets of the trust as of
the beginning of the taxable year,
(v) in the case that the requirement of clause (iv)(I) is not satisfied, substantially all of the marketing expenditures with
respect to the property were made through an independent contractor (as defined in section 856(d)(3)) from whom the
trust itself does not derive or receive any income, or, in the case of a sale on or before the termination date, a taxable
REIT subsidiary, and
(vi) the sales price of the property sold by the trust is not based in whole or in part on income or profits, including income
or profits derived from the sale or operation of such property.
(E) Special rules.--In applying subparagraphs (C) and (D) the following special rules apply:
(i) The holding period of property acquired through foreclosure (or deed in lieu of foreclosure), or termination of the
lease, includes the period for which the trust held the loan which such property secured, or the lease of such property.
(ii) In the case of a property acquired through foreclosure (or deed in lieu of foreclosure), or termination of a lease,
expenditures made by, or for the account of, the mortgagor or lessee after default became imminent will be regarded
as made by the trust.
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(iii) Expenditures (including expenditures regarded as made directly by the trust, or indirectly by any partner of the trust,
under clause (ii)) will not be taken into account if they relate to foreclosure property and did not cause the property to
lose its status as foreclosure property.
(iv) Expenditures will not be taken into account if they are made solely to comply with standards or requirements of
any government or governmental authority having relevant jurisdiction, or if they are made to restore the property as
a result of losses arising from fire, storm or other casualty.
(v) The term “expenditures” does not include advances on a loan made by the trust.
(vi) The sale of more than one property to one buyer as part of one transaction constitutes one sale.
(vii) The term “sale” does not include any transaction in which the net selling price is less than $10,000.
(F) Sales not meeting requirements.--In determining whether or not any sale constitutes a “prohibited transaction” for
purposes of subparagraph (A), the fact that such sale does not meet the requirements of subparagraph (C) or (D) shall not
be taken into account; and such determination, in the case of a sale not meeting such requirements, shall be made as if
subparagraphs (C), (D), and (E) had not been enacted.
(G) Sales of property that are not a prohibited transaction.--In the case of a sale on or before the termination date,
the sale of property which is not a prohibited transaction through the application of subparagraph (D) shall be considered
property held for investment or for use in a trade or business and not property described in section 1221(a)(1) for all
purposes of this subtitle. For purposes of the preceding sentence, the reference to subparagraph (D) shall be a reference to
such subparagraph as in effect on the day before the enactment of the Housing Assistance Tax Act of 2008, as modified
by subparagraph (G) as so in effect.
(H) Termination date.--For purposes of this paragraph, the term “termination date” has the meaning given such term
by section 856(c)(8).
(7) Income from redetermined rents, redetermined deductions, and excess interest.--
(A) Imposition of tax.--There is hereby imposed for each taxable year of the real estate investment trust a tax equal to
100 percent of redetermined rents, redetermined deductions, and excess interest.
(B) Redetermined rents.--
(i) In general.--The term “redetermined rents” means rents from real property (as defined in section 856(d)) to the
extent the amount of the rents would (but for subparagraph (E)) be reduced on distribution, apportionment, or allocation
under section 482 to clearly reflect income as a result of services furnished or rendered by a taxable REIT subsidiary
of the real estate investment trust to a tenant of such trust.
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(ii) Exception for de minimis amounts.--Clause (i) shall not apply to amounts described in section 856(d)(7)(A) with
respect to a property to the extent such amounts do not exceed the one percent threshold described in section 856(d)
(7)(B) with respect to such property.
(iii) Exception for comparably priced services.--Clause (i) shall not apply to any service rendered by a taxable REIT
subsidiary of a real estate investment trust to a tenant of such trust if--
(I) such subsidiary renders a significant amount of similar services to persons other than such trust and tenants of
such trust who are unrelated (within the meaning of section 856(d)(8)(F)) to such subsidiary, trust, and tenants, but
(II) only to the extent the charge for such service so rendered is substantially comparable to the charge for the similar
services rendered to persons referred to in subclause (I).
(iv) Exception for certain separately charged services.--Clause (i) shall not apply to any service rendered by a taxable
REIT subsidiary of a real estate investment trust to a tenant of such trust if--
(I) the rents paid to the trust by tenants (leasing at least 25 percent of the net leasable space in the trust's property) who
are not receiving such service from such subsidiary are substantially comparable to the rents paid by tenants leasing
comparable space who are receiving such service from such subsidiary, and
(II) the charge for such service from such subsidiary is separately stated.
(v) Exception for certain services based on subsidiary's income from the services.--Clause (i) shall not apply to
any service rendered by a taxable REIT subsidiary of a real estate investment trust to a tenant of such trust if the gross
income of such subsidiary from such service is not less than 150 percent of such subsidiary's direct cost in furnishing
or rendering the service.
(vi) Exceptions granted by Secretary.--The Secretary may waive the tax otherwise imposed by subparagraph (A) if
the trust establishes to the satisfaction of the Secretary that rents charged to tenants were established on an arms' length
basis even though a taxable REIT subsidiary of the trust provided services to such tenants.
(C) Redetermined deductions.--The term “redetermined deductions” means deductions (other than redetermined rents)
of a taxable REIT subsidiary of a real estate investment trust to the extent the amount of such deductions would (but for
subparagraph (E)) be decreased on distribution, apportionment, or allocation under section 482 to clearly reflect income
as between such subsidiary and such trust.
(D) Excess interest.--The term “excess interest” means any deductions for interest payments by a taxable REIT subsidiary
of a real estate investment trust to such trust to the extent that the interest payments are in excess of a rate that is
commercially reasonable.
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(E) Coordination with section 482.--The imposition of tax under subparagraph (A) shall be in lieu of any distribution,
apportionment, or allocation under section 482.
(F) Regulatory authority.--The Secretary shall prescribe such regulations as may be necessary or appropriate to carry
out the purposes of this paragraph. Until the Secretary prescribes such regulations, real estate investment trusts and their
taxable REIT subsidiaries may base their allocations on any reasonable method.
(8) Loss on sale or exchange of stock held 6 months or less.--
(A) In general.--If--
(i) subparagraph (B) or (D) of paragraph (3) provides that any amount with respect to any share or beneficial interest
is to be treated as a long-term capital gain, and
(ii) the taxpayer has held such share or interest for 6 months or less,
then any loss on the sale or exchange of such share or interest shall, to the extent of the amount described in clause (i),
be treated as a long-term capital loss.
(B) Determination of holding periods.--For purposes of this paragraph, in determining the period for which the taxpayer
has held any share of stock or beneficial interest--
(i) the rules of paragraphs (3) and (4) of section 246(c) shall apply, and
(ii) there shall not be taken into account any day which is more than 6 months after the date on which such share or
interest becomes ex-dividend.
(C) Exception for losses incurred under periodic liquidation plans.--To the extent provided in regulations,
subparagraph (A) shall not apply to any loss incurred on the sale or exchange of shares of stock of, or beneficial interest
in, a real estate investment trust pursuant to a plan which provides for the periodic liquidation of such shares or interests.
(9) Time certain dividends taken into account.--For purposes of this title, any dividend declared by a real estate investment
trust in October, November, or December of any calendar year and payable to shareholders of record on a specified date in
such a month shall be deemed--
(A) to have been received by each shareholder on December 31 of such calendar year, and
(B) to have been paid by such trust on December 31 of such calendar year (or, if earlier, as provided in section 858).
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The preceding sentence shall apply only if such dividend is actually paid by the company during January of the following
calendar year.
(c) Restrictions applicable to dividends received from real estate investment trusts.--
(1) Section 243.--For purposes of section 243 (relating to deductions for dividends received by corporations), a dividend
received from a real estate investment trust which meets the requirements of this part shall not be considered a dividend.
(2) Section (1)(h)(11)--
(A) In general.--In any case in which--
(i) a dividend is received from a real estate investment trust (other than a capital gain dividend), and
(ii) such trust meets the requirements of section 856(a) for the taxable year during which it paid such dividend,
then, in computing qualified dividend income, there shall be taken into account only that portion of such dividend
designated by the real estate investment trust.
(B) Limitation.--The aggregate amount which may be designated as qualified dividend income under subparagraph (A)
shall not exceed the sum of--
(i) the qualified dividend income of the trust for the taxable year,
(ii) the excess of--
(I) the sum of the real estate investment trust taxable income computed under section 857(b)(2) for the preceding
taxable year and the income subject to tax by reason of the application of the regulations under section 337(d) for
such preceding taxable year, over
(II) the sum of the taxes imposed on the trust for such preceding taxable year under section 857(b)(1) and by reason
of the application of such regulations, and
(iii) the amount of any earnings and profits which were distributed by the trust for such taxable year and accumulated
in a taxable year with respect to which this part did not apply.
(C) Notice to shareholders.--The amount of any distribution by a real estate investment trust which may be taken into
account as qualified dividend income shall not exceed the amount so designated by the trust in a written notice to its
shareholders mailed not later than 60 days after the close of its taxable year.
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(D) Qualified dividend income.--For purposes of this paragraph, the term “qualified dividend income” has the meaning
given such term by section 1(h)(11)(B).
(d) Earnings and profits.--
(1) In general.--The earnings and profits of a real estate investment trust for any taxable year (but not its accumulated
earnings) shall not be reduced by any amount which is not allowable in computing its taxable income for such taxable year.
For purposes of this subsection, the term “real estate investment trust” includes a domestic corporation, trust, or association
which is a real estate investment trust determined without regard to the requirements of subsection (a).
(2) Coordination with tax on undistributed income.--A real estate investment trust shall be treated as having sufficient
earnings and profits to treat as a dividend any distribution (other than in a redemption to which section 302(a) applies) which
is treated as a dividend by such trust. The preceding sentence shall not apply to the extent that the amount distributed during
any calendar year by the trust exceeds the required distribution for such calendar year (as determined under section 4981).
(3) Distributions to meet requirements of subsection (a)(2)(B).--Any distribution which is made in order to comply with
the requirements of subsection (a)(2)(B)--
(A) shall be treated for purposes of this subsection and subsection (a)(2)(B) as made from earnings and profits which,
but for the distribution, would result in a failure to meet such requirements (and allocated to such earnings on a first-in,
first-out basis), and
(B) to the extent treated under subparagraph (A) as made from accumulated earnings and profits, shall not be treated as
a distribution for purposes of subsection (b)(2)(B) and section 858.
(e) Excess noncash income.--
(1) In general.--For purposes of subsection (a)(1)(B), the term “excess noncash income” means the excess (if any) of--
(A) the amount determined under paragraph (2) for the taxable year, over
(B) 5 percent of the real estate investment trust taxable income for the taxable year determined without regard to the
deduction for dividends paid (as defined in section 561) and by excluding any net capital gain.
(2) Determination of amount.--The amount determined under this paragraph for the taxable year is the sum of--
(A) the amount (if any) by which--
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(i) the amounts includible in gross income under section 467 (relating to certain payments for the use of property or
services), exceed
(ii) the amounts which would have been includible in gross income without regard to such section,
(B) any income on the disposition of a real estate asset if--
(i) there is a determination (as defined in section 860(e)) that such income is not eligible for nonrecognition under
section 1031, and
(ii) failure to meet the requirements of section 1031 was due to reasonable cause and not to willful neglect,
(C) the amount (if any) by which--
(i) the amounts includible in gross income with respect to instruments to which section 860E(a) or 1272 applies, exceed
(ii) the amount of money and the fair market value of other property received during the taxable year under such
instruments, and
(D) amounts includible in income by reason of cancellation of indebtedness.
(f) Real estate investment trusts to ascertain ownership
(1) In general.--Each real estate investment trust shall each taxable year comply with regulations prescribed by the Secretary
for the purposes of ascertaining the actual ownership of the outstanding shares, or certificates of beneficial interest, of such
trust.
(2) Failure to comply
(A) In general.--If a real estate investment trust fails to comply with the requirements of paragraph (1) for a taxable year,
such trust shall pay (on notice and demand by the Secretary and in the same manner as tax) a penalty of $25,000.
(B) Intentional disregard.--If any failure under paragraph (1) is due to intentional disregard of the requirement under
paragraph (1), the penalty under subparagraph (A) shall be $50,000.
(C) Failure to comply after notice.--The Secretary may require a real estate investment trust to take such actions as the
Secretary determines appropriate to ascertain actual ownership if the trust fails to meet the requirements of paragraph (1).
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If the trust fails to take such actions, the trust shall pay (on notice and demand by the Secretary and in the same manner as
tax) an additional penalty equal to the penalty determined under subparagraph (A) or (B), whichever is applicable.
(D) Reasonable cause.--No penalty shall be imposed under this paragraph with respect to any failure if it is shown that
such failure is due to reasonable cause and not to willful neglect.
(g) Cross reference.-For provisions relating to excise tax based on certain real estate investment trust taxable income not distributed during
the taxable year, see section 4981.
CREDIT(S)
(Added Pub.L. 86-779, § 10(a), Sept. 14, 1960, 74 Stat. 1006; amended Pub.L. 88-272, Title II, § 201(d)(11), Feb. 26, 1964,
78 Stat. 32; Pub.L. 91-172, Title V, § 511(c)(3), Dec. 30, 1969, 83 Stat. 637; Pub.L. 93-625, § 6(c), (d)(2) to (4), Jan. 3, 1975,
88 Stat. 2113, 2114; Pub.L. 94-455, Title XIV, § 1402(b)(1)(P), (2), Title XVI, §§ 1601(c), 1602(b), 1603(b), (c)(5), 1604(c)
(2), (f)(3)(B), (j), (k)(2)(B), 1605(b)(2), 1606(a), (d), 1607(a), (b)(1)(A), (2), (3), Title XIX, §§ 1901(a)(112), (b) (1)(V), (33)
(K), 1906(b)(13)(A), Oct. 4, 1976, 90 Stat. 1732, 1746 to 1748, 1750 to 1757, 1783, 1792, 1801, 1834; Pub.L. 95-600, Title III,
§§ 301(b)(12), 362(d)(3), 363(b), Title IV, § 403(c)(3), Nov. 6, 1978, 92 Stat. 2822, 2851, 2852, 2868; Pub.L. 96-222, Title I, §
103(a)(1), Apr. 1, 1980, 94 Stat. 208; Pub.L. 96-223, Title IV, § 404(b)(8), Apr. 2, 1980, 94 Stat. 307; Pub.L. 97-34, Title III, §
302(c)(5), (d)(1), Aug. 13, 1981, 95 Stat. 273, 274; Pub.L. 98-369, Title I, §§ 16(a), 55(b), Title X, § 1001(b)(13), (e), July 18,
1984, 98 Stat. 505, 572, 1011, 1012; Pub.L. 99-514, Title VI, §§ 612(b)(7), 661(b), 664, 665(a), (b)(1), 666, 668(b)(1)(A), (2),
(3), Oct. 22, 1986, 100 Stat. 2251, 2300, 2303 to 2305, 2307, 2308; Pub.L. 100-647, Title I, §§ 1006(r), (s)(2), (4), (5), 1018(u)
(28), Nov. 10, 1988, 102 Stat. 3418, 3419, 3591; Pub.L. 101-508, Title XI, § 11704(a)(37), Nov. 5, 1990, 104 Stat. 1388-520;
Pub.L. 105-34, Title XII, §§ 1251(a), 1254(a), (b)(1), 1255(b)(2), (3), 1256, 1259, 1260, Aug. 5, 1997, 111 Stat. 1030 to 1035;
Pub.L. 105-206, Title VI, § 6012(g), July 22, 1998, 112 Stat. 819; Pub.L. 106-170, Title V, §§ 532(c)(2)(L), (M), 545, 556(a),
(b), 566(a)(2), (b), Dec. 17, 1999, 113 Stat. 1930, 1944, 1949, 1950; Pub.L. 106-554, § 1(a)(7) [Title III, § 311(b)], Dec. 21,
2000, 114 Stat. 2763, 2763A-640; Pub.L. 107-147, Title IV, §§ 413(a), 417(13), Mar. 9, 2002, 116 Stat. 54, 56; Pub.L. 108-27,
Title III, § 302(d), May 28, 2003, 117 Stat. 763; Pub.L. 108-311, Title IV, § 402(a)(5)(E), Oct. 4, 2004, 118 Stat. 1185; Pub.L.
108-357, Title II, § 243(c), (e), (f)(4), Title III, § 321(a), Title IV, § 418(b), Oct. 22, 2004, 118 Stat. 1442, 1445, 1473, 1512;
Pub.L. 109-135, Title IV, §§ 403(d)(3), 412(ii), Dec. 21, 2005, 119 Stat. 2622, 2639; Pub.L. 110-172, § 11(a)(17)(B), Dec. 29,
2007, 121 Stat. 2486; Pub.L. 110-234, Title XV, §§ 15311(c), 15315(a) to (d), May 22, 2008, 122 Stat. 1503, 1504; Pub.L.
110-246, § 4(a), Title XV, §§ 15311(c), 15315(a) to (d), June 18, 2008, 122 Stat. 1664, 2265, 2266; Pub.L. 110-289, Div. C,
Title II, §§ 3033, 3051, 3052, July 30, 2008, 122 Stat. 2900, 2901.)
26 U.S.C.A. § 857, 26 USCA § 857
Current through P.L. 113-57 (excluding P.L. 113-54 and 113-56) approved 12-9-13
End of Document
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
14
Case 08-12229-MFW
Doc 11546-6
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EXHIBIT D
CR&TC § 24872
RLF1 9744649V.1
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§ 24872. Real estate
investment
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TAX § 12/31/13
24872
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(a) A real estate investment trust shall be deemed to have satisfied the distribution requirements of Section 857(a)(1) of the
Internal Revenue Code 1 for purposes of this part if it satisfies the distribution requirements of Section 857(a)(1) of the Internal
Revenue Code for federal purposes.
(b)(1) Section 857(b)(1) of the Internal Revenue Code, relating to imposition of tax on real estate investment trusts, shall not
apply.
(2) Every real estate investment trust shall be subject to the taxes imposed under Chapter 2 (commencing with Section 23101)
and Chapter 3 (commencing with Section 23501), except that its “net income” shall be equal to its “real estate investment trust
income,” as defined in subdivision (c).
(c) “Real estate investment trust income” means real estate investment company taxable income, as defined in Section 857(b)
(2) of the Internal Revenue Code, modified as follows:
(1) In lieu of Section 857(b)(2)(A) of the Internal Revenue Code, relating to special deductions for corporations, no deduction
shall be allowed under Section 24402.
(2) Section 857(b)(2)(D) of the Internal Revenue Code, relating to an exclusion for an amount equal to the net income from
foreclosure property, shall not apply.
(3) Section 857(b)(2)(E) of the Internal Revenue Code, relating to a deduction for an amount equal to the tax imposed in the
case of failure to meet certain requirements for the taxable year, shall not apply.
(4) Section 857(b)(2)(F) of the Internal Revenue Code, relating to an exclusion for an amount equal to any net income derived
from prohibited transactions, shall not apply.
(d) Section 857(b)(3) of the Internal Revenue Code, relating to an alternative tax in case of capital gains, shall not apply.
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
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(e) Section 857(b)(4)(A) of the Internal Revenue Code, relating to the imposition of tax on income from foreclosure property,
shall not apply.
(f) Section 857(b)(5) of the Internal Revenue Code, relating to the imposition of tax in case of failure to meet certain
requirements, shall not apply.
(g) Section 857(b)(6)(A) of the Internal Revenue Code, relating to the imposition of tax on income from prohibited transactions,
shall not apply.
(h) Section 857(b)(7) of the Internal Revenue Code, relating to income from redetermined rents, redetermined deductions, and
excess interest, shall not apply.
(i) Section 857(c) of the Internal Revenue Code, relating to restrictions applicable to dividends received from real estate
investment trusts, is modified to refer to Sections 24402, 24406, 24410, and 25106, in lieu of Section 243 of the Internal
Revenue Code.
(j) The amendments to this section by Chapter 878 of the Statutes of 1993 are clarifications of legislative intent and shall apply
to taxable years beginning on or after January 1, 1987.
Credits
(Added by Stats.1992, c. 698 (A.B.2425), § 26, eff. Sept. 15, 1992. Amended by Stats.1993, c. 873 (A.B.35), § 45.6, eff. Oct.
6, 1993; Stats.1993, c. 877 (S.B.673), § 78, eff. Oct. 6, 1993; Stats.1993, c. 878 (A.B.65), § 20; Stats.2001, c. 4 (A.B.10), § 2,
eff. March 29, 2001; Stats.2005, c. 691 (A.B.115), § 73, eff. Oct. 7, 2005.)
Footnotes
Internal Revenue Code sections are in Title 26 of the U.S.C.A.
1
West's Ann. Cal. Rev. & T. Code § 24872, CA REV & TAX § 24872
Current with all 2013 Reg.Sess. laws, all 2013-2014 1st Ex.Sess. laws, and Res. c. 123 (S.C.A.3)
End of Document
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
© 2013 Thomson Reuters. No claim to original U.S. Government Works.
2