In Uncategorized on 02/11/2013 at 17:30

No, not on Alabama, per the 1934 Frank Perkins-Mitchell Parish classic, but on Bank of New York Mellon Corporation, 140 T. C. 2, filed 2/11/13, with a cast of 21 lawyers, 15 for Mellon (of whom 6 bail after trial), and 6 for IRS.

When the footnote says the amounts are rounded to the nearest million, you know you’re in the Big Leagues with the Heavy Hitters. 140 T. C. 2, at p. 2, footnote 2.

It’s another phony transaction tax dodge. Mellon and buddies borrow in the UK, supposedly on the cheap, set up a UK trust with UK trustee, ship over income-producing assets, and claim foreign tax credits and foreign expenses for foreign-source income. They give this roundy-rounder the fetching title STARS, Structured Trust Advantaged Repackaged Securities.

IRS blows up the deal, and Mellon petitions.

STARS was a production of Barclays Bank, recently known for its prominent role in price-fixing the LIBOR, and a certain major US accounting firm. They sold their dream scheme to US banks. Barclays got an offset to the “cheap” financing they provided by sharing UK tax breaks.

So Mellon and buddies set up five (count ‘em, five) entities of various types, and use them to shovel various assets into the UK trust. Judge Kroupa, finding one picture worth thousand words (see my blogpost “OPIS Finis”, 1/18/12), draws us a diagram, 140 T. C. 2, at p. 10. And then draws another at 140 T. C. 2, at p. 15, to show how Barclays and Mellon set up a fully collateralized and oversecured loan.

Finally, Mellon’s UK subsidiary, acting as trustee, elects to front-load a ton of UK taxes, giving Mellon big foreign tax credits and interest expenses, which Mellon takes.

Second Circuit rules here, so Judge Kroupa examines subjective business purpose and objective results as Second Circuit would do it, but neither is a rigid test. “They are instead simply more precise factors to consider in the overall inquiry of whether the transaction had any practical economic effects other than the creation of tax losses. A finding of a lack of either economic substance or a non-tax business purpose can be but is not necessarily sufficient for a court to conclude that a transaction is invalid for Federal tax purposes. The ultimate determination of whether a transaction lacks economic substance is a question of fact.” 140 T. C. 2, at p. 28 (Citations omitted).

Mellon says OK, but look at the entire deal, which was designed to get Mellon low-cost capital to continue its moneylending operations. No, says IRS, look whence come the tax benefits.

Judge Kroupa says IRS got it right: “The relevant transaction to be tested is the one that produces the disputed tax benefit, even if it is part of a larger set of transactions or steps. Stated another way, the requirements of the economic substance doctrine are not avoided simply by coupling a routine transaction with a transaction lacking economic substance. “ 140 T. C. 2, at p. 30. (Footnote and Citations omitted, but Judge Kroupa cites the Kipnis case; see my blogpost “It Ain’t What You Do With What You Got – Part Deux”, 11/1/12).

You have to reckon in the foreign taxes paid in the UK as a cost of the deal. All the STARS did is recirculate the dollars earned by the assets from Mellon to Barclays and back to Mellon. And the expenses Mellon incurred in the process are just in support of the tax scheme, not to make a profit. And the assets shipped to the UK would have earned the same profit if they stayed in the US.

Coupling a tax dodge with a legitimate transaction does not legitimize the tax deal.

Instead of being a structured financing deal with a low-cost loan, Mellon incurred a high-cost loan when the transaction costs are included and didn’t acquire any assets therewith. Barclays was oversecured and had direct recourse to Mellon via a credit default swap that was part of the deal. Nobody was running any risks, or making any real profit. The UK taxes were the result of UK tax laws, whose effects are unrecognized under US law.

Mellon claimed the deal had to have substance, because if the UK didn’t give favorable treatment, they were still locked in, but this was belied by a quickout clause in the deal, giving either Barclays or Mellon an option to unwind at short notice.

And the US-UK tax treaty doesn’t help, because there was no real UK business being done.

So the STARS fell.

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