On June 13, 2014 the U.S. federal banking regulators issued updated joint supplemental guidance (the "Updated Guidance") about tax allocation agreements between holding companies and their bank subsidiaries. The regulators issued this guidance in response to recent bankruptcy litigation involving holding companies and their failed bank subsidiaries, where some courts have concluded that tax refunds generated by the subsidiary bank and held by the holding company pursuant to a tax allocation agreement were property of the holding company rather than the bank.
The Updated Guidance supplements a 1998 interagency policy statement that states, in relevant part, that a holding company that receives a tax refund obtains the refund as an agent for the subsidiary bank and holds the refund in trust. The Updated Guidance builds on this policy statement by directing banks and their holding companies to review their tax allocation agreements to make sure that, consistent with this policy, the agreements specifically state that the holding company receives as an agent for the bank any tax refunds attributable to income earned by the bank. The Updated Guidance includes sample language for holding companies and banks to include in tax allocation agreements to clarify this agency relationship.
The Updated Guidance also reminds financial institutions that affiliate transaction restrictions in sections 23A and 23B of the Federal Reserve Act apply to tax allocation agreements. As an example, if a tax allocation agreement does not clearly state that the holding company receives tax refunds as an agent for a bank subsidiary, the bank subsidiary could be deemed to have extended credit to the holding company – triggering certain affiliate lending limitations and collateral requirements, and potentially violating certain "arms length" transaction requirements of sections 23A and 23B.
In light of the Updated Guidance, we recommend that bank holding companies review their tax allocation agreements to ensure they comply with the Updated Guidance. If a holding company does not have a formal tax allocation agreement, we strongly recommend implementing a tax allocation agreement to avoid regulatory criticism and/or alleged violation of sections 23A and 23B and Federal Reserve Regulation W.
The U.S. federal banking regulators, consisting of the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, expect all depository institutions and their holding companies to comply with the Updated Guidance by October 31, 2014, and we expect an increased focus during upcoming regulatory examinations on the existence of tax allocation agreements and inclusion of language from the Updated Guidance.
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