Global Netting: Potential Opportunities For Corporate Taxpayers

Two recent judicial decisions addressing the so-called "global netting" of interest in tax cases potentially offer corporate taxpayers new opportunities. Taxpayers may be able to obtain at least partial netting relief on underpayments and overpayments of federal tax in some circumstances where it had been commonly assumed to be unavailable, and are well-advised to take a second look at their IRS account transcripts in search of previously overlooked claims that may be filed before the statute of limitations expire.

Background

Under Section 6621 of the Internal Revenue Code (the "Code"), interest is calculated at a higher rate for underpayments of corporate tax than it is for corresponding overpayments. Congress and others have recognized that this can produce unfair results when a corporation simultaneously owes money to the Government and is owed money from the Government in different tax accounts for overlapping time periods, but the underpayment and the overpayment are not actually offset against one another. (The Code generally eliminates interest on balances that are offset against one another, but not when the amounts are collected and refunded separately.)

When Congress first provided for the interest rate differential in 1986, it assumed the Internal Revenue Service (the "Service") would provide for "comprehensive netting" (that is, netting of offsetting balances that are not simultaneously resolved) within three years.1 This policy was never implemented, so corporate taxpayers were left having to pay an interest differential of up to 4.5% on offsetting balances despite not owing any net tax.

In 1998, as part of the IRS Restructuring and Reform Act of 1998 ("RRA"), Congress amended Section 6621 to provide for a "net interest rate of zero" on reciprocal tax debts that are outstanding at the same time for the same taxpayer. This provision generally applies to interest that accrued after enactment, but an uncodified transition rule allows netting to apply to interest accrued earlier, under certain conditions and "subject to any applicable statute of limitation not having expired with regard to either a tax underpayment or a tax overpayment." RRA § 3301(c)(2).

The Service implements the "net interest rate of zero" by equalizing interest rates on "equivalent" over- and underpayment balances that are outstanding over the same period. The IRS can reduce the interest rate that it charges on tax underpayments to the lower overpayment rate, or it can increase the interest rate it pays on tax overpayments to equal the higher underpayment rate. The Service normally uses the first method (reducing the interest rate on the underpayment and refunding any "excess" interest charged) when the statute of limitations situation permits.

The Decisions

In Exxon-Mobil Corp. v. Commissioner, the Second Circuit ruled against the long-standing Service interpretation of the transition rule language quoted above which required that the statute of limitations on both the underpayment and the overpayment used in a netting computation be open on the date the RRA was enacted (July 22, 1998) in order for the transition rule to apply.2 The decision created a decisional split with the Federal Circuit, which had previously upheld the Service's interpretation in Federal National Mortgage Ass'n v. United States, 379 F.3d 1303...