Wells Fargo & Co. v. United States

• Decision Date: 24 April 2020
• Docket Number: No. 17-3578,17-3578
• Citation: 957 F.3d 840
• Parties: WELLS FARGO & COMPANY, on behalf of itself and the members of its affiliated group filing a consolidated return Plaintiff - Appellant v. UNITED STATES of America Defendant - Appellee
• Court: U.S. Court of Appeals — Eighth Circuit

957 F.3d 840

WELLS FARGO & COMPANY, on behalf of itself and the members of its affiliated group filing a consolidated return Plaintiff - Appellant
v.
UNITED STATES of America Defendant - Appellee

No. 17-3578

United States Court of Appeals, Eighth Circuit.

Submitted: November 12, 2019
Filed: April 24, 2020

Deborah Ann Ellingboe, Walter A. Pickhardt, Charles F. Webber, Faegre & Drinker, Jeffrey A. Sloan, Wells Fargo & Company, Minneapolis, MN, Alan Swirski, Nathan P. Wacker, B. John Williams, Jr., Skadden & Arps, Washington, DC, for Plaintiff-Appellant.

Dennis M. Donohue, Judith Ann Hagley, U.S. Department of Justice, Tax Division, Matthew Steven Johnshoy, Gilbert Steven Rothenberg, Senior Attorney, U.S. Department of Justice, Tax Division, Appellate Section, Harris Phillips, Trial Attorney, U.S. Department of Justice, Tax Division, Civil Trial Section, Central Region, Washington, DC, for Defendant-Appellee.

Before SHEPHERD, GRASZ, and KOBES, Circuit Judges.

SHEPHERD, Circuit Judge.

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Wells Fargo & Company (Wells Fargo) appeals from the district court’s¹ determination that it was not entitled to a tax credit on its 2003 tax return arising from a transaction that Wells Fargo entered into with a British bank. It also appeals from the court’s determination that Wells Fargo was liable for a "negligence penalty" after claiming that credit. Having jurisdiction under 28 U.S.C. § 1291, we affirm the judgment in its entirety.

I.

In 2002, Wells Fargo, a United States corporation, entered into a structured trust advantaged repackaged securities transaction (STARS) with Barclays Bank PLC (Barclays), a corporate citizen of the United Kingdom. Wells Fargo asserts that the purpose of STARS was to borrow a significant amount of money from Barclays at a very low interest rate, to diversify its funding sources, to reduce its liquidity risk, and to provide a stable source of funding for five years. The government, however, argues that STARS was an elaborate and unlawful tax avoidance scheme, designed to exploit the differences between the tax laws of the U.S. and the U.K. and generate U.S. tax credits for a foreign tax that Wells Fargo did not, in substance, pay.

Wells Fargo claimed foreign-tax credits on its 2003 federal tax return arising from STARS. The Internal Revenue Service (IRS) disallowed those credits and notified Wells Fargo that it owed additional taxes. Wells Fargo paid the resulting tax deficiency and filed this lawsuit in order to challenge the IRS’s decision and to obtain a refund. The government defended the IRS’s position, and it sought to impose a "negligence penalty" on Wells Fargo as an offset defense because Wells Fargo underpaid its 2003 taxes after claiming this credit. Following a jury trial, the government prevailed in part below, and Wells Fargo appeals.

A.

Before discussing STARS and the facts giving rise to this case, it is useful to briefly analyze the particular tax credit at issue. The U.S. government taxes the income of its citizens, including corporations, even when that income is earned abroad or is otherwise subject to taxation by another country. See 26 U.S.C. § 61(a) (defining gross income as "all income from whatever source derived"). To avoid the problem of double taxation on income that is taxed by a foreign jurisdiction, the Internal Revenue Code permits a taxpayer to claim a

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dollar-for-dollar tax credit against its federal tax liability for taxes paid to another country. See 26 U.S.C. § 901 ; see also Burnet v. Chicago Portrait Co., 285 U.S. 1, 7, 52 S.Ct. 275, 76 L.Ed. 587 (1932) ("[T]he primary design of [the foreign-tax credit] was to mitigate the evil of double taxation."). This credit, which is known as the "foreign-tax" credit, is subject to various rules and limitations, see 26 U.S.C. §§ 901 - 909, including that the underlying transaction giving rise to the foreign-tax credit is a "valid transaction," not a "sham transaction." This means that the transaction must have some economic substance outside of its tax consequences. Bank of New York Mellon Corp. v. Comm’r (BNY), 801 F.3d 104, 108 (2d Cir. 2015).

To illustrate how the foreign-tax credit works, suppose a taxpayer earned $100 abroad and was subject to $22 of U.K. tax and $35 of U.S. tax. Without foreign-tax credits, the taxpayer would have an overall tax liability of $57 and would be double taxed on that income—once by the U.K. and once by the U.S. However, with the foreign-tax credit, the taxpayer could claim credits of $22 on its federal tax return, reducing its U.S. tax liability to $13 and its overall tax liability to $35. Now the taxpayer would effectively be taxed once on that income. The foreign-tax credit is, in short, supposed to create an economic "wash" to the taxpayer: every $1 it pays in foreign taxes offsets $1 of U.S. tax liability. Practically, this means that a taxpayer has no financial incentive to engage in a transaction simply to generate foreign-tax credits.

B.

Turning to the facts of this case, we note that STARS is a sophisticated financial transaction with a fairly complex structure. See Wells Fargo & Co. v. United States (Wells Fargo I ), 143 F. Supp. 3d 827, 831 (D. Minn. 2015) ("The STARS transaction was extraordinarily complicated—so complicated, in fact, that it almost defies comprehension by anyone (including a federal judge) who is not an expert in structured finance."); Santander Holdings USA, Inc. v. United States, 977 F. Supp. 2d 46, 48 (D. Mass. 2013) (noting that STARS was "surpassingly complex and unintuitive; the sort of thing that would have emerged if Rube Goldberg had been a tax accountant"). By now, STARS has been thoroughly examined and explained by several circuit courts. See, e.g., Santander Holdings USA, Inc. v. United States, 844 F.3d 15 (1st Cir. 2016) ; BNY, 801 F.3d at 104; Salem Fin., Inc. v. United States, 786 F.3d 932 (Fed. Cir. 2015).

In this iteration of STARS, Wells Fargo placed approximately $6.7 billion of income-producing assets into a Delaware trust that had, as a trustee, another Wells Fargo entity. The trustee was a U.K. resident for tax purposes, which subjected the income generated by the trust to U.K. taxes, which the trust paid. Barclays then loaned Wells Fargo $1.25 billion, for a term of five years, by purchasing an interest in the trust. Wells Fargo was obligated to repay Barclays by repurchasing Barclays’s interest in the trust at the end of the five-year period. By virtue of its ownership of part of the trust, Barclays was also subject to taxation in the U.K. on the income produced and distributed to Barclays by the trust. As a result of certain features of U.K. tax law, Barclays obtained certain U.K. tax benefits from its ownership interest—these tax benefits were central to STARS.

Each month, Wells Fargo paid Barclays interest on the loan, while Barclays paid Wells Fargo a fixed cash payment called "Bx." The Bx payments totaled approximately $32 million per year for each of the five years that STARS was operational. Wells Fargo and Barclays negotiated Bx

957 F.3d 844

to be equal to approximately 47.5% of the U.K. tax benefits that Barclays was expected to receive by participating in STARS, regardless of whether Barclays was actually allowed such benefits by the U.K. tax agency, Her Majesty’s Revenue and Customs (HMRC). Either party could terminate STARS before the end of the five-year period by giving the other party 30-days’ notice.

Stated differently—and more specifically—STARS comprises both a loan component and a trust component. In the loan component, as discussed above, Barclays lent to Wells Fargo $1.25 billion by purchasing an ownership interest in the trust. Wells Fargo paid monthly interest payments to Barclays. At the end of five years, Wells Fargo would repay the principal of the loan by repurchasing Barclays’s ownership interest in the trust. In the trust component, also discussed above, Wells Fargo transferred income-earning assets into the trust, which generated a certain amount of U.K. taxes. The trust set aside an amount to pay those taxes. Simultaneously, the trust also distributed income to Barclays, which had an ownership interest in the trust by virtue of the loan component, by placing those distributions into a "blocked account" at Wells Fargo. Barclays could not actually access the funds held in this blocked account, which were quickly returned to the trust before being distributed to Wells Fargo. By nominally holding the funds, even though it could not access them, and by reinvesting the funds into the trust, Barclays could claim a U.K. tax loss and a deduction on its U.K. taxes. Barclays also received a U.K. tax credit for the U.K. taxes already paid by Wells Fargo on behalf of the trust, and it received a separate U.K. tax deduction for making Bx payments to Wells Fargo. Through its Bx payments, Barclays gave to Wells Fargo an amount equal to 47.5% of the U.K. tax benefits that it generated from participating in STARS.

To understand how STARS generated the relevant tax benefits to both parties, consider the following hypothetical. Santander, 844 F.3d at 20-21 ("The benefits for both parties can be illustrated by a hypothetical also employed by the Second and Federal Circuits."). Suppose Wells Fargo places its...