In Bank of New York Mellon Corp. v. Commissioner, 140 T.C. No. 2 (2013), here, the Tax Court knocked down yet another another bullshit tax shelter. It is a complex case, and for purposes of this blog, I will not get into the weeds (this genre of tax shelter usually has many weeds designed to obscure the big picture what is really going on -- i.e., pretty much nothing except paper and money shuffling and re-shuffling, with net effect mostly to the promoters). I will just summarize the gravamen of the opinion:
The Court opens the opinion (after finding the bullshit facts) as follows (emphasis supplied):
This complex transaction presents a case of first impression in this Court. We are asked to decide whether petitioner is entitled to foreign tax credits and certain expense deductions from the STARS transaction and also whether petitioner is entitled to report income generated from the STARS assets as foreign source income. Respondent argues that the STARS transaction lacked economic substance. Respondent asserts consequently that the foreign tax credits and expenses attributable to STARS should be disallowed and the income from the STARS assets should be characterized as U.S. source. n7 Petitioner, in contrast, contends the STARS transaction had economic substance. In this regard, petitioner asserts that BNY entered into STARS to obtain low-cost funding for its banking business and that it reasonably expected to earn a pre-tax profit from STARS. Additionally, petitioner contends that the U.S. foreign tax credit was intended for transactions like STARS.The Court then concludes that, on the facts, there was no economic substance. That holding seems solid.
n7 Respondent also argues that the foreign tax credits BNY claimed are disallowed under substance over form doctrines (including the step transaction doctrine) and under the statutory anti-abuse rule in sec. 269(a). We need not decide these arguments because of our other holdings.
Now, let's look at what it said about the taxpayer's claims for economic substance. I have highlighted the key claim above -- that the transaction gave it low-cost funding for its banking business. So said the Court:
Petitioner claims that it used the STARS structure to obtain "low cost financing" from Barclays. The record does not support petitioner's claimed business purpose. The STARS structure lacked any reasonable relationship to the loan. And the loan was not "low cost." To the contrary, it was significantly overpriced and required BNY to incur substantially more transaction costs than a similar financing available in the marketplace. We find that petitioner failed to establish a valid business purpose and BNY's true motivation was tax avoidance.In other words, nothing more than smoke and mirrors; the Court moved past the bullshit and got to the real deal.
Finally, the Court addressed the argument that, despite the smoke and mirrors, Congress really intended to allow the tax benefits of the bullshit.
E. Congressional Intent
We now consider whether the disputed tax benefits are what Congress intended in establishing the foreign tax credit. Petitioner contends that the economic substance doctrine does not warrant disallowing the disputed tax benefits because Congress intended the foreign tax credit for transactions like STARS. We disagree.
The United States taxes income of its citizens, residents and domestic entities on a worldwide basis. A U.S. corporation must include foreign source income in its U.S. taxable income even though that income may also be subject to foreign tax. Congress enacted the foreign tax credit to alleviate double taxation arising from foreign business operations. See United States v. Goodyear Tire & Rubber Co., 493 U.S. 132, 139 (1989); Am. Chicle Co. v. United States, 316 U.S. 450, 451 (1942); Burnet v. Chicago Portrait Co., 285 U.S. 1, 7 (1932). Congress intended the foreign tax credit to neutralize the effect of U.S. tax on the business decision of where to conduct business activities most productively. 56 Cong. Rec. App. 677-678 (1918) (statement of Rep. Kitchin). The enactment of the foreign tax credit was also informed by fairness. See National Foreign Trade Council, Inc., International Tax Policy for the 21st Century, (Dec. 15, 2001).
The STARS transaction was a complicated scheme centered around arbitraging domestic and foreign tax law inconsistencies. The U.K. taxes at issue did not arise from any substantive foreign activity. Indeed, they were produced through pre-arranged circular flows from assets held, controlled and managed within the United States. We conclude that Congress did not intend to provide foreign tax credits for transactions such as STARS.So, that is pretty much it.
One interesting point is found in footnote 9:
n9 We have previously held that foreign taxes are economic costs for purposes of the economic substance doctrine. See Compaq Computer Corp. v. Commissioner, 113 T.C. 214 (1999), rev'd, 277 F.3d 778, 785 (5th Cir. 2001). We are mindful that the Courts of Appeals for the Fifth and Eighth Circuits have subsequently held that foreign taxes should not be taken into account in evaluating pre-tax effects for purposes of the economic substance analysis. See IES Indus., Inc. v. United States, 253 F.3d 350 (8th Cir. 2001); Compaq Computer Corp. v. Commissioner, 277 F.3d 778, 785 (5th Cir. 2001), rev'g 113 T.C. 214 (1999). Nevertheless, the Supreme Court and the Court of Appeals for the Second Circuit have yet to consider the issue, and we are not bound by Fifth and Eighth Circuit precedent here.
We maintain the position we took in Compaq Computer with respect to foreign taxes in the economic substance context. Economically, foreign taxes are the same as any other transaction cost. And we cannot find any conclusive reason for treating them differently here, especially because substantially all of the foreign taxes giving rise to the foreign tax credits stemmed from economically meaningless activity, i.e., the pre-arranged circular cashflows engaged in by the trust.
Additionally, excluding the economic effect of foreign taxes from the pre-tax analysis would fundamentally undermine the point of the economic substance inquiry. That point is to remove the challenged tax benefit and evaluate whether the relevant transaction makes economic sense. See In re CM Holdings, Inc., 301 F.3d 96, 105 (3d Cir. 2002).Since so much money was involved. Apparently at least anticipating the possibility that the Tax Court would recognize the shelter for what it was, the taxpayer promptly entered a press release saying
BNY Mellon Corp (BK.N) said on Monday it will take an $850 million hit against first-quarter profit, a move that also will erode some of its capital after losing a high-stakes tax case to the U.S. Internal Revenue Service.
The world's largest custody bank announced the hit against capital and earnings just hours after the U.S. Tax Court rejected BNY Mellon's bid to keep $900 million in tax benefits. The after-tax charge against profit is about $850 million, the bank said.
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Investors won't be completely blindsided by the profit hit because BNY Mellon previously disclosed in U.S. regulatory filings that it might have to book a reserve of up to $850 million in the event of an unfavorable ruling in the case.Tim McLaughlin, BNY Mellon to take $850 million profit charge in U.S. tax court defeat (Reuters 2/11/13), here.
Here is the cast of attorneys in the litigation:
B. John Williams, Jr., Alan J.J. Swirski, Julia M. Kazaks, Cary D. Pugh, Andrew J. McLean, Daniel C. Davis, Melissa R. Middleton, Shira M. Helstrom, Brendan T. O'Dell, Bryon Christensen, n1 John Marston, Manoj Viswanathan, Ilana Yergin, Daniel Davis, and Kristin R. Keeling, for petitioner.
n1 Bryon Christensen, John Marston, Manoj Viswanathan, Ilana Yergin, Daniel Davis and Kristin R. Keeling all withdrew as counsel after trial.
Jill A. Frisch, Curt M. Rubin, Anne O'Brien Hintermeister, Matthew J. Avon, Justin L. Campolieta, and Michael A. Sienkiewicz, for respondent.Some big names here.
This reminds me of a personal anecdote from my earlier days when I was perhaps, perhaps not, less nuanced than I am in my old age. I happened to see a Houston tax shelter promoter one day and he told me his shelter -- with which I was familiar and of the bullshit genre -- had been disallowed by the IRS, so he and several of the "investors" were meeting later that day with a law firm prominent in the tax litigation business. This law firm, I knew, was also very, very expensive in its hourly rates (and very liberal in how it determined hours). Although I was not in the tax shelter litigation business at the time (really never have been, instead referring that genre of business out), I did tell him that, since he was a friend (I used that term somewhat loosely), I would handle that litigation for far less than the big name firm -- I told him easily less than one-half the fees and more likely less than one-third -- and that I would handle it as competently and achieve at least as good a result -- which I also predicted to be a loss whoever handled the case. I really would not have taken the business if he had offered it, but it was a backhanded way of saying why waste your time and money on that case. My prediction proved correct. The case was a loser, meaning a lot of time and resources was wasted by all -- including the IRS and the Courts. Sometimes, as the song goes, you need to know when the hold 'em and when to fold 'em.
Finally, why is CI not interested in pursuing these bullshit tax shelters? Readers interested in this the criminal angle might be interested in a new article that seems to be a defense piece for promoters and taxpayers who enter bullshit tax shelters. Jasper L. Cummings, Jr., DOJ Criminal Tax Overreach, 138 Tax Notes 745 (Feb. 11, 2013).