140 T.C. 15 (T.C. 2013), 26683-09, Bank of New York Mellon Corp. v. Commissioner of Internal Revenue
|Citation:||140 T.C. 15|
|Opinion Judge:||Kroupa, Judge:|
|Party Name:||Bank of New York Mellon Corporation, as Successor in Interest to the Bank of New York Company, Inc., Petitioner v. Commissioner of Internal Revenue, Respondent|
|Attorney:||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, John Marston, Manoj Viswanathan, Ilana Yergin, Daniel Davis, and Kristin R. Keeling, for petitioner. Jill A. F...|
|Case Date:||February 11, 2013|
|Court:||United States Tax Court|
B and its subsidiaries are an affiliated group (Ps). Ps engaged in a Structured Trust Advantaged Repackaged Securities transaction (STARS transaction). The STARS transaction provided Ps with purportedly below-market-cost financing from a U.K. bank. As part of the STARS transaction, Ps transferred income-producing assets to a trust with a U.K. trustee and subject to U.K. tax on its income. Ps claimed foreign tax credits and expense deductions on its 2001 and 2002 Federal consolidated returns in connection with the STARS transaction. Ps also reported income from the assets transferred to the trust as foreign source on the consolidated returns. R determined that the STARS transaction lacked economic substance and consequently disallowed the foreign tax credits, the expense deductions and the reporting of the asset income as foreign source. Ps contend that the STARS transaction had economic substance and that Congress intended the foreign tax credit to apply to transactions like the STARS transaction.
Held: The STARS transaction lacked economic substance and is disregarded for Federal tax purposes. Held, further, because the STARS transaction lacked economic substance, Ps are not entitled to the claimed foreign tax credits, the claimed expense deductions or the foreign-source-income treatment.
Respondent determined deficiencies in petitioner's Federal income tax of $100 million and $115 million for 2001 and 2002 (years at issue), respectively. There are three issues for decision. The first issue is whether petitioner is entitled to foreign tax credits under section 901 claimed in connection with a Structured Trust Advantaged Repackaged Securities transaction (STARS transaction or STARS). We hold that petitioner is not because the STARS transaction lacked economic substance. The second issue is whether petitioner is entitled to deduct certain expenses incurred in furtherance of the STARS transaction. We hold petitioner is not for the same reason. The final issue is whether income attributed to a trust with a U.K. trustee used to effect the STARS transaction is U.S. source income rather than foreign source income. We hold that the income is U.S. source income.
FINDINGS OF FACT
Petitioner is a Delaware corporation that maintained its principal place of business in New York, New York, when it filed the petition. Petitioner succeeded to the tax liabilities of The Bank of New York Company, Inc. (BNY Parent) when
Mellon Financial Corporation merged with BNY Parent in 2007. BNY Parent was the common parent of an ''affiliated group'' (as that term is defined in section 1504(a)) of corporations that filed consolidated U.S. Federal income tax returns on an accrual and calendar year basis. The Bank of New York (BNY) was a wholly owned subsidiary of BNY Parent. BNY was in the banking business with worldwide banking operations. Its business activities included taking in deposits, borrowing money and investing in loans and securities.
The affiliated group through BNY entered into the STARS transaction in 2001 with Barclays Bank, PLC (Barclays), a global financial services company headquartered in London, United Kingdom. The STARS transaction generated approximately $199 million in foreign tax credits for the combined years at issue.
II. Introduction and Negotiation of STARS
Barclays and KPMG, an audit, tax and advisory firm, developed and promoted STARS to U.S. banks. KPMG introduced STARS to BNY during discussions with BNY's tax director. Thereafter, tax professionals at KPMG and Barclays presented STARS to BNY through various meetings, discussions, promotional materials and correspondence.
STARS was represented as a ''below market loan'' in KPMG's initial presentation. KPMG indicated that STARS required a U.K. counterparty and a certain trust structure holding income-producing assets. KPMG explained that the below-market cost would be achieved by the U.K. counterparty ''sharing'' U.K. tax benefits from STARS through an offset to the cost of the loan. Finally, KPMG indicated that the U.K. tax benefits would be generated by subjecting income-producing assets held by a trust to U.K. tax and thus generating foreign tax credits that BNY could use to offset its U.S. tax liability.
BNY notified KPMG in August 2001 that it was prepared to move forward with a STARS transaction with Barclays as the U.K. counterparty. BNY proposed that it would contribute assets that would generate $93 million of annual U.K. tax costs and expected Barclays to reduce the loan's annual cost by half that amount. Shortly thereafter, BNY agreed to supplement STARS by engaging in a ''stripping
transaction.'' The effect would be to accelerate and increase the tax benefits STARS produced (i.e., foreign tax credits). And just before STARS closed, BNY indicated to Barclays that it had decided to increase the targeted benefit.
III. The STARS Transaction
BNY closed the STARS transaction with Barclays in November 2001. The key components of STARS were as follows.
A. The STARS Structure
BNY used existing subsidiaries and created special-purpose entities to create a structure (STARS structure) to carry out the STARS transaction. BNY accomplished this by engaging in the following steps.
1. Step 1: REIT Holdings Funded
BNY contributed $6.46 billion of assets (BNY assets) to BNY REIT Holdings, LLC (REIT Holdings), an existing BNY subsidiary treated as a corporation for U.S. tax purposes. The BNY assets consisted of participating interests in residential mortgage loans, commercial mortgage loans and consumer loans (participation interests) and various asset-backed and agency securities. REIT Holdings assumed $2.55 billion of BNY's liabilities (BNY liabilities) in connection with the contribution.
2. Step 2: InvestCo Organized and Funded
BNY organized BNY Investment Holdings (DE), LLC (InvestCo), as a Delaware limited liability company. InvestCo elected to be taxed as a corporation for U.S. tax purposes and was part of BNY's affiliated group. REIT Holdings capitalized InvestCo by contributing $10.409 billion of assets, consisting of the BNY assets and BNY Real Estate Holdings, LLC's common stock (the REIT share), with a stated value of $3.95 billion (collectively, the STARS assets). In exchange, InvestCo assumed the BNY liabilities and issued a 100% ownership interest in InvestCo to REIT Holdings.
3. Step 3: DelCo Organized and Funded
BNY organized BNY Delaware Funding (DE), LLC (DelCo), as a Delaware limited liability company. DelCo elected partnership tax treatment for U.S. tax purposes. InvestCo capitalized DelCo by contributing $9.243 billion worth of the STARS assets. In exchange, DelCo assumed the BNY liabilities and issued to InvestCo all of its class 1 ordinary shares (DelCo class 1 shares) worth $65 million and its class 2 ordinary shares (DelCo class 2 shares) worth $6.628 billion.
The DelCo class 1 shares held all the voting rights in DelCo. The DelCo class 2 shares had the right to receive approximately 99% of DelCo's distributions. The holders of DelCo class 1 shares had the exclusive right to appoint DelCo's managers. DelCo's income was distributable in the absolute discretion of DelCo's managers.
4. Step 4: Organization, Funding and Terms of the STARS Trust
BNY formed the BNY STARS Trust (trust) as a common law trust. The trust was authorized to issue class A units, a class B unit, a class C unit and a class D unit (collectively, the trust units). The trust unit holders were contractually entitled to monthly distributions in the following order. The class A unit holders were entitled to 1% of the trust distributable income. The class D unit holder was entitled to trust distributable income equal to $25 million × (1-month LIBOR + 415 basis points (basis points)) × 0.78. The class B unit holder was entitled to 99% of the remaining distributable income, if the class C unit was in issue, or all remaining distributable income if the class C unit was not in issue. The class C unit holder was entitled to the remaining trust distributable income unless a default occurred.
InvestCo transferred the remaining STARS assets (approximately $1.2 billion) and the DelCo class 2 shares to the trust in exchange for the class A units and the class B unit, which had stated values of $6.3 billion and $1.494 billion, respectively.
The initial trustee was BNY, acting through its London branch (U.S. trustee). The Bank of New York (DE), a wholly-owned subsidiary of BNY Parent, served as the trust manager. Only the holder of all the class A units could nominate a replacement trustee.
5. Step 5: Organization and Ownership of NewCo
BNY organized BNY NewCo Funding (DE), LLC (NewCo), as a Delaware limited liability company, with InvestCo as its sole member. NewCo elected partnership treatment for U.S. tax purposes. InvestCo contributed 49% of the class A units to NewCo in exchange for a...
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