Santander Holdings USA, Inc. v. United States, 844 F.3d 15

Background

Sovereign Bancorp entered a 2003 STARS transaction with Barclays that split into a Trust (UK-taxed) and a Loan; Sovereign contributed ~$6.7 billion of U.S. assets to the Trust and Barclays bought interests then agreed to sell them back for $1.15 billion.
The Trust was structured so Sovereign paid UK tax (22%) on Trust income, claimed full U.S. foreign tax credits for those UK taxes, and Barclays obtained UK tax benefits and paid Sovereign a monthly "Bx" payment equal to 50% of Sovereign's UK tax liability.
The Bx payment was netted against Sovereign's interest obligation on the Loan; parties documented the Bx payment as tied to Sovereign's UK tax and Barclays’ ability to claim UK deductions.
Sovereign sought refunds of disallowed foreign tax credits (tax years 2003–2005) and challenged accuracy-related penalties after the IRS disallowed credits in 2008; district court awarded summary judgment to Sovereign on economic substance and related deductions/refund.
The United States appealed, arguing the Trust lacked economic substance and the credits were impermissible; both sides narrowed issues on appeal (focus on Trust, not Loan; penalties jury-trial issue reserved).
The First Circuit reversed: it held the Trust lacked economic substance because it was profitless absent the U.S. foreign tax credits and remanded for judgment for the government on the refund claim and for trial only on penalties.

Issues

Issue	Plaintiff's Argument (Sovereign)	Defendant's Argument (United States)	Held
Whether the STARS Trust transaction has economic substance	The Trust had economic substance and produced income (Bx payments); any tax benefits were ancillary to a bona fide arrangement	The Trust was a tax‑engineered, profitless scheme whose sole purpose was to generate UK taxes to claim US foreign tax credits	Held: Trust lacked economic substance; profit potential exists only because of tax credits, so credits disallowed
Characterization of the Bx payment (income vs. rebate)	Bx payment is income to Sovereign, not a tax rebate, supporting its taxable treatment	Government argued Bx was effectively a rebate of Sovereign’s UK taxes and undermines claimed credits	Court: characterization unnecessary to decision; even treated as income Sovereign's claim fails because Trust is profitless absent credits
Whether Sovereign’s UK taxes should be treated as an expense in pre-tax profit analysis	Sovereign relied on precedent (Compaq, IES) arguing foreign taxes shouldn't be treated as expenses that defeat profit potential	Government: UK taxes were deliberately incurred and are an economic expense tied to the Bx payment and must be included in profit calculus	Held: UK taxes are expenses for profit analysis; when included the Trust had no reasonable pre-tax profit potential
Whether denying credits conflicts with treaty or statutory framework	Sovereign argued foreign tax credit regime contemplates eliminating double taxation and should allow these credits	Government: credits limited to legitimate business transactions; anti‑abuse doctrines and treaty text permit limitations	Held: Denying credits consistent with treaty (credits subject to U.S. law limits) and with purpose of foreign tax credit regime

Key Cases Cited

Gregory v. Helvering, 293 U.S. 465 (1935) (origin of economic substance/substance-over-form inquiry)
Frank Lyon Co. v. United States, 435 U.S. 561 (1978) (look to objective economic realities of transaction)
Old Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929) (characterization of payments for tax purposes)
Dewees v. Commissioner, 870 F.2d 21 (1st Cir. 1989) (economic substance as device to avoid tax; objective test)
Salem Financial, Inc. v. United States, 786 F.3d 932 (Fed. Cir. 2015) (STARS Trust lacked substance; profit potential must be assessed independent of tax benefits)
Bank of N.Y. Mellon Corp. v. Commissioner, 801 F.3d 104 (2d Cir. 2015) (disallowing credits for a similar STARS transaction)
Compaq Computer Corp. & Subsidiaries v. Commissioner, 277 F.3d 778 (5th Cir. 2001) (authority on characterization of payments and tax consequences cited by parties)
IES Industries, Inc. v. United States, 253 F.3d 350 (8th Cir. 2001) (authority relied on in parties' briefing regarding foreign-tax treatment)
Wells Fargo & Co. v. United States, 143 F. Supp. 3d 827 (D. Minn. 2015) (jury verdict finding lack of economic substance in related STARS case)