957 F.3d 840
8th Cir.2020Background
- Wells Fargo entered a 2002 STARS transaction with Barclays (UK) that placed ~$6.7 billion of assets into a Delaware trust whose trustee was a U.K. tax resident; Barclays bought an interest in the trust and provided Wells Fargo a $1.25 billion loan for five years.
- The transaction generated U.K. taxes paid by the trust and produced Bx cash payments from Barclays to Wells Fargo equal to ~47.5% of Barclays’ expected U.K. tax benefits; cash in a “blocked account” and circular flows produced UK tax attributes for Barclays.
- Wells Fargo claimed about $70 million in U.K. foreign-tax credits on its 2003 U.S. return; the IRS disallowed the credits, assessed a deficiency, and Wells Fargo paid and sued for refund.
- At trial a jury found the STARS trust component was a sham (lacked objective pre-tax profit and subjective business purpose) but the loan component was not; the district court treated Bx as a tax benefit and imposed a negligence penalty, netting Wells Fargo a partial refund (~$13.65M).
- On appeal the Eighth Circuit affirmed: it held the trust component lacked economic substance and affirmed imposition of the negligence penalty, but rejected Wells Fargo’s §6751 challenge to the penalty in the refund-offset context.
Issues
| Issue | Plaintiff's Argument (Wells Fargo) | Defendant's Argument (United States) | Held |
|---|---|---|---|
| Whether STARS trust component is a sham under the economic-substance test | Trust had economic substance and reasonable possibility of pre-tax profit (Bx = pre-tax income); business purposes (diversify funding, reduce liquidity risk) | Trust lacked realistic pre-tax profit apart from tax benefits and was entered into for tax purposes | Affirmed: trust component is a sham (no real pre-tax profit; no valid non-tax business purpose) |
| Characterization of Bx and U.K. taxes for profit analysis (pre-tax income v. post-tax benefit/expense) | Bx is pre-tax income and U.K. taxes are post-tax expenses (so trust could be profitable) | Even if Bx is pre-tax income, U.K. taxes must be treated as pre-tax expenses because they are inextricably linked to generation of Bx, eliminating pre-tax profit | Court: characterization of Bx immaterial; treating U.K. taxes as pre-tax expense shows no pre-tax profit |
| Whether reasonable-basis defense to §6662 negligence penalty requires actual reliance on authorities | Objective reasonableness under cited authorities suffices; no need to show subjective reliance | Reasonable-basis defense requires evidence taxpayer actually relied on the authorities when forming the return position | Held: reasonable-basis defense requires actual reliance; Wells Fargo failed to prove reliance, so negligence penalty applies |
| Whether §6751(b)(1) prior written supervisory approval is required where penalty is asserted as an offset in refund litigation | §6751(b)(1) applies and government failed to show prior written approval | §6751(b)(1) applies to administrative assessments, not to penalties asserted as litigation offsets | Held: §6751(b)(1) prior-approval requirement does not apply to penalties asserted as an offset in refund suits |
Key Cases Cited
- Santander Holdings USA, Inc. v. United States, 844 F.3d 15 (1st Cir. 2016) (analyzing STARS and holding trust component profitless when UK taxes are treated as expenses)
- Bank of New York Mellon Corp. v. Comm'r, 801 F.3d 104 (2d Cir. 2015) (STARS analysis concluding trust lacked economic substance)
- Salem Financial, Inc. v. United States, 786 F.3d 932 (Fed. Cir. 2015) (STARS is profitless and structurally circular; Bx characterization discussed)
- WFC Holdings Corp. v. United States, 728 F.3d 736 (8th Cir. 2013) (economic-substance/sham-transaction framework; test formulation)
- Frank Lyon Co. v. United States, 435 U.S. 561 (U.S. 1978) (legal standard: characterization of transactions for tax purposes is a question of law)
- Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89 (4th Cir. 1985) (two-part Rice test for sham: objective profit potential and subjective business purpose)
- Lewis v. Reynolds, 284 U.S. 281 (U.S. 1932) (government may retain payments by setoff even if statute of limitations would bar assessment)
- Chakales v. Comm'r, 79 F.3d 726 (8th Cir. 1996) (burden on taxpayer to show due care to avoid negligence penalty)