Law360, Los Angeles (February 10, 2014, 8:27 PM ET) -- A Washington federal judge dismissed claims in Washington Mutual Inc.'s $15 million suit seeking to recover excess taxes it paid after buying up faltering savings and loan associations, ruling Monday that the bank hadn't established a cost basis for the alleged overpayments.
Granting judgment in favor of the federal government, U.S. District Judge Barbara J. Rothstein said WaMu failed to establish its entitlement to a tax refund because it hadn't proven what cost basis a predecessor had to rights over maintaining branches in other states and using the purchase method of accounting for regulatory capital reserve purposes.
The Ninth Circuit in March 2011 remanded the matter to the lower court to determine the cost basis, after reversing the district court's ruling that WaMu couldn't deduct from its taxes the liabilities that Home Savings of America FSB had taken on by buying three failing savings and loan associations.
But Judge Rothstein said Monday that while the Ninth Circuit accepted WaMu's argument that a taxpayer in Home Savings’ position had a cost basis in the branching and so-called RAP rights, the plaintiff didn't properly identify the cost basis.
"Given that the plaintiff failed to establish the fair market value for the Missouri branching right, the court is unable to ascertain the cost basis for either the branching rights or the RAP right or, for that matter, to the incentive package," the judge wrote.
WaMu acquired three savings and loan associations, also called thrifts, by buying Home Savings, which had originally bought the thrifts during the savings and loan crisis of the early 1980s, according to court papers.
The crisis stemmed from the thrifts' inability to pay high interest rates to depositors with revenue from lower-interest loans they had extended earlier that left many thrifts near insolvency, including the three at issue in the case.
Like many banks, Home Savings agreed to take on the thrifts, and their hefty liabilities, in response to U.S. government incentives that allowed it to change how it valued the banks' assets to make it easier to meet federal capital requirements, the Ninth Circuit said.
The government created the incentives to avoid having to cover the banks through its Federal Savings and Loan Insurance Corp. insurance program, according to the Ninth Circuit.
The banks were allowed to use the “purchase method” of accounting for capital reserve purposes, gaining so-called RAP rights. WaMu argued that the RAP rights had tax implications, and said it was owed at least $15.5 million because certain deductions had been disallowed.
The IRS denied the claim, saying those RAP rights, if recognized, would make the mergers inconsistent with their classification under tax law.
On appeal, the Ninth Circuit ruled that the banks negotiated favorable tax treatment as part of their merger, and the government had a “pretty clear picture” all along that the bank was doing it a favor by taking on the liabilities from the three failing companies.
WaMu argued that its costs in acquiring the thrifts could be calculated simply by comparing their assets to their liabilities, but the Ninth Circuit countered that the calculation was more complicated than that and sent the case to the district court for further proceedings.
Judge Rothstein said Monday that while the appeals court held that the branching and RAP rights had a cost basis that could qualify Home Savings for a tax refund, the plaintiff relied on erroneous projections and unrealistic assumptions in attempting to establish the fair market value for all the rights. Thus, WaMu couldn't pursue tax refund claims for the 1990, 1991 and 1993 tax years, she said.
Moreover, WaMu also wasn't entitled to a refund for abandonment loss for the 1993 tax year because it hadn't persuaded the court that Home Savings permanently abandoned its right to operate branches in Missouri, according to the judge.
Attorneys for both parties didn't immediately respond to requests for comment late Monday.
WaMu is represented by Thomas D. Johnston and Richard J. Gagnon Jr. of Shearman & Sterling LLP; David J. Burman and Jeffrey M. Hanson of Perkins Coie LLP; and Maria O. Jones and Steven R. Dixon of Miller & Chevalier Chartered.
The case is Washington Mutual Inc. v. U.S., case number 2:06-cv-01550, in the U.S. District Court for the Western District of Washington.
--Additional reporting by Richard Vanderford. Editing by Edrienne Su.