Bank of New York Mellon Corp. v. Commissioner of Internal Revenue
801 F.3d 104
| 2d Cir. | 2015Background
- Two consolidated appeals: AIG sought a $306.1M refund after IRS disallowed foreign tax credits from six "cross-border" SPV transactions; BNY contested Tax Court disallowance of foreign tax credits (and related adjustments) from STARS transactions leading to alleged deficiencies of ~$215M.
- Both arrangements treated cash flows as loans for U.S. tax purposes while foreign counterparties treated them as equity for foreign tax purposes, producing foreign taxes paid by onshore vehicles and tax benefits shared with foreign counterparties.
- AIG claimed substantial pre-tax profits from the deals and full foreign tax credits for SPV taxes; the government argued the transactions lacked economic substance and the credits were not properly claimable.
- BNY’s STARS involved a domestic trust taxed in the U.K., circular distributions, a Barclays loan ($1.5B) with a monthly "tax-spread" payment, and claimed large U.K. taxes (credited in the U.S.) plus interest deductions; Tax Court found the trust sham but later allowed interest deductions on the loan.
- District court (S.D.N.Y.) held economic substance doctrine applies to foreign tax credits and that foreign taxes should be treated as costs in pre-tax profit; Tax Court found STARS trust lacked economic substance but loan had independent substance and its interest was deductible.
- Second Circuit affirmed: economic substance applies to foreign tax credit claims; foreign taxes are costs in pre-tax-profit analysis; AIG summary judgment properly denied on fact issues; STARS trust disregarded but Barclays loan interest deductible.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Applicability of economic substance to foreign tax credits | AIG: foreign tax credits comply with statute/regulations and thus immune from economic-substance review | Government: credits can be abused via sham transactions; doctrine ensures statutory purpose is honored | Held: Economic substance doctrine applies to foreign tax credits generally |
| Treatment of foreign taxes in pre-tax profit | AIG/BNY: pre-tax profit should exclude foreign taxes (or include offsetting tax benefits) | Government: foreign taxes are real economic costs and must be deducted; exclude claimed foreign tax credits | Held: Foreign taxes are economic costs and should be deducted; foreign tax credits excluded from pre-tax profit calculation |
| Economic substance of AIG cross-border transactions | AIG: transactions produced large pre-tax profit and thus had substance | Government: transactions were tax-driven shams lacking real business purpose or profit after foreign-tax costs | Held: Summary judgment denied for AIG; genuine fact disputes (objective and subjective prongs) exist so case proceeds to factfinding |
| Economic substance of BNY STARS trust and loan; deductibility of loan interest | BNY: STARS had substance; loan and trust should be analyzed together; interest deductible | IRS: STARS trust sham (no non-tax purpose/profit); loan may be tainted and interest nondeductible | Held: STARS trust lacked economic substance and is disregarded; $1.5B Barclays loan had independent economic substance and its interest was deductible |
Key Cases Cited
- Gregory v. Helvering, 293 U.S. 465 (1935) (foundation for substance-over-form and limits on tax-driven devices)
- Frank Lyon Co. v. United States, 435 U.S. 561 (1978) (transaction characterization and business purpose analysis)
- Comm’r v. Court Holding Co., 324 U.S. 331 (1945) (substance over form principle)
- Salem Fin., Inc. v. United States, 786 F.3d 932 (Fed. Cir. 2015) (foreign taxes are costs for economic-substance pre-tax analysis in STARS context)
- Compaq Comput. Corp. v. Comm’r, 277 F.3d 778 (5th Cir. 2001) (treating pre-tax dividend as basis for profit calculation; did not deduct foreign taxes)
- IES Indus., Inc. v. United States, 253 F.3d 350 (8th Cir. 2001) (similar to Compaq on excluding foreign taxes)
- Gilman v. Comm’r, 933 F.2d 143 (2d Cir. 1991) (flexible two‑prong economic substance test)
- Altria Grp., Inc. v. United States, 658 F.3d 276 (2d Cir. 2011) (economic substance doctrine discussion)
- Lee v. Comm’r, 155 F.3d 584 (2d Cir. 1998) (interest deduction disallowed where loan lacked economic substance)
- Goldstein v. Comm’r, 364 F.2d 734 (2d Cir. 1966) (sham transaction concept under economic substance)
- DeMartino v. Comm’r, 862 F.2d 400 (2d Cir. 1988) (transactions lacking business purpose are shams)