Wells Fargo & Co. v. United States, Case No. 09-CV-2764 (PJS/TNL)

• Decision Date: 10 November 2015
• Docket Number: Case No. 09-CV-2764 (PJS/TNL)
• Parties: Wells Fargo & Company, on behalf of itself and the members of its affiliated group filing a consolidated return, Plaintiff, v. United States of America, Defendant.
• Court: U.S. District Court — District of Minnesota

143 F.Supp.3d 827

Wells Fargo & Company, on behalf of itself and the members of its affiliated group filing a consolidated return, Plaintiff,

v.United States of America, Defendant.

Case No. 09-CV-2764 (PJS/TNL)

United States District Court, D. Minnesota.

Signed November 10, 2015

B. John Williams, Jr. and Alan Swirski, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP; Charles F. Webber and Deborah A. Ellingboe, FAEGRE BAKER DANIELS LLP; Jeffrey A. Sloan, WELLS FARGO & COMPANY, for plaintiff.

Dennis M. Donohue, John L. Schoenecker, and William E. Farrior, UNITED STATES DEPARTMENT OF JUSTICE, for defendant.

ORDER

Patrick J. Schiltz

, United States District Judge

In 2001, Barclays Bank, PLC—a British financial-services company—started marketing to American banks a product called "Structured Trust Advantaged Repackaged Securities" or "STARS." Barclays proposed to American banks that they partner with Barclays in a series of complicated transactions designed to exploit differences between the tax laws of the United States and the tax laws of the United Kingdom. The plan had four key elements: (1) the American bank would voluntarily subject some of its income-producing assets to U.K. taxation; (2) the American bank would offset those U.K. taxes by claiming foreign-tax credits on its U.S. returns; (3) Barclays would enjoy significant U.K. tax benefits as a result of the American bank's actions; and (4) Barclays would compensate the American bank for engaging in the STARS transaction.

Plaintiff Wells Fargo & Company ("Wells Fargo") was one of a handful of American banks who agreed to engage in a STARS transaction with Barclays. But when Wells Fargo and the other banks claimed foreign-tax credits to offset their tax payments to the United Kingdom, the Internal Revenue Service ("IRS") disallowed the credits on the grounds that the STARS transactions were shams that lacked economic substance and that existed solely to generate tax benefits. Litigation ensued, and four STARS-related cases ended up in the federal courts.

Two of those cases have resulted in very recent opinions by federal courts of appeals: Bank of New York Mellon Corp. v. Commissioner , 801 F.3d 104 (2d Cir.2015)

, and Salem Financial, Inc. v. United States , 786 F.3d 932 (Fed.Cir.2015). In both cases, the court of appeals held, in essence, that the STARS transactions were shams and that therefore the banks were not entitled to take foreign-tax credits in connection with those transactions. See Bank of N.Y. , 801 F.3d at 121–23

; Salem Fin. , 786 F.3d at 940–55. A third case—Santander Holdings USA, Inc. v. United States , 977 F.Supp.2d 46 (D.Mass.2013) —is still pending in the United States District Court for the District of Massachusetts. To date, however, the taxpayer in Santander has fared better than the taxpayers in Bank of New York and Salem Financial.

This is the fourth case. In this case, Wells Fargo seeks a refund of approximately $177 million in taxes and deficiency interest for the taxable year ending on December 31, 2003. The bulk of this claimed refund is attributable to foreign-tax credits that Wells Fargo claimed in connection with the STARS transaction but that the IRS disallowed. This matter is before the Court on the parties' objections to two reports of the special master that collectively address nine motions by Wells Fargo. The Court has conducted a de novo review pursuant to ¶ 8 of the Court's order appointing a special master. See ECF No. 102. Having conducted that review, having read hundreds of pages of submissions by the parties, and having presided over a full day of oral argument, the Court now sustains the government's objection in part and overrules Wells Fargo's objections. Specifically, the Court grants Wells Fargo's motion for partial summary judgment that 26 U.S.C. § 269

does not apply to the STARS transaction and denies the remainder of Wells Fargo's motions.

I. BACKGROUND

At oral argument, the parties confirmed that the basic structure of the STARS transaction involved in this case is the same as the basic structure of the STARS transactions involved in the other pending cases. The parties also confirmed the Court's understanding of the major features of the transaction and, in general, the parties did not object to the special master's description of the transaction.¹ The Court therefore draws this factual summary from the special master's reports, the parties' representations at oral argument, and judicial opinions issued in the other STARS cases.

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. At its core, though, the STARS transaction consisted of Wells Fargo voluntarily subjecting some of its income-producing assets to U.K. taxation. Wells Fargo paid those taxes to the United Kingdom, and then claimed a foreign-tax credit to reduce its U.S. tax burden by the amount that it had paid to the United Kingdom. Thus, Wells Fargo effectively shifted some of its tax payments out of the U.S. treasury and into the U.K. treasury.

In and of itself, this had no impact on Wells Fargo's bottom line. It increased Wells Fargo's tax obligation to the United Kingdom, but it decreased Wells Fargo's tax obligation to the United States in the same amount. The way that Wells Fargo profited from the STARS transaction was by receiving payments from Barclays. And Barclays was willing to make those payments because Wells Fargo's willingness to engage in the STARS transaction generated U.K. tax benefits for Barclays. Indeed, as will be described below, the additional taxes that Wells Fargo paid to the United Kingdom were offset almost dollar-for-dollar by the additional U.K. tax benefits enjoyed by Barclays.

The parties achieved these results by using a trust established by Wells Fargo.² Because the trust had a U.K. trustee—a U.K.-incorporated company controlled by Wells Fargo—the trust was deemed to be a U.K. resident under U.K. law, and its income was therefore subject to U.K. taxation. Under U.S. law, however, the trust was deemed to be part of Wells Fargo, and its income was therefore also subject to U.S. taxation.

Wells Fargo contributed about $6.638 billion of income-producing assets to the trust. For the most part, those assets were already owned by Wells Fargo and had no connection to the United Kingdom. Barclays, for its part, contributed $1.25 billion to the trust. There were several classes of interests in the trust, which were referred to as "units" (labeled "Class A" through "Class E"). Both Wells Fargo and Barclays received units in return for their contributions of assets to the trust.

Wells Fargo agreed that, at the end of five years, Wells Fargo would repurchase all of Barclays' units in the trust for $1.25 billion. For this reason, the parties treated Barclays' $1.25 billion contribution as a loan to Wells Fargo. The loan carried an interest rate of LIBOR³ plus 20 points.

As noted, Wells Fargo was compensated by Barclays for engaging in the STARS transaction. Every month, Barclays would make a payment to Wells Fargo—a payment that the parties called the "Bx payment." The amount of the Bx payment was set at 47.5 percent of the amount of the U.K. tax credits enjoyed by Barclays. The Bx payment actually took the form of a reduction in the interest owed by Wells Fargo on the $1.25 billion loan from Barclays. Netting the Bx payment against Wells Fargo's interest obligation sometimes had the effect of creating a negative interest rate—that is, the lender (Barclays) had to pay the borrower (Wells Fargo).

As described above, the trust consisted of billions of dollars of income-producing assets that were owned by Wells Fargo. Nearly all of the trust's income was allocated to Barclays. Barclays did not actually receive this income, however; instead, the income was credited to a blocked account that was in Barclays' name but that was controlled by Wells Fargo. The income was then immediately reinvested in the trust, in return for which Barclays received more trust units. These trust units were useless to Barclays, however, because Barclays was contractually obligated to sell all of its trust units back to Wells Fargo at the end of the five-year period for $1.25 billion, regardless of how many units Barclays eventually accumulated. For this reason, Barclays was able to treat its additional "investments" in the trust as losses that it could deduct on its U.K. tax return.

Tracing the flow of $100 of trust income helps to illustrate how STARS took money out of the pocket of the U.S. treasury and put that money into the pockets of Wells Fargo, Barclays, and the U.K. treasury:

For every $100 in income received by the trust, Wells Fargo paid approximately $22 in U.K. taxes and claimed a $22 foreign-tax credit in the United States. Barclays was also required to report the entire $100 as income for U.K. tax purposes—that is, under U.K. law, Barclays was taxed both on the $78 of income that had been "paid" to it by the trust (by means of circulating the $78 through the blocked account) and the $22 of income that had been paid as taxes to the United Kingdom. Barclays had to pay 30 percent in taxes on that $100 in trust income, but Barclays was also entitled to a $22 tax credit for the tax that the trust had already paid to the United Kingdom. As a practical matter, then, Barclays paid $8 in U.K. tax on each $100 of income produced by the trust.

At this point, the STARS transaction is a wash for Wells Fargo; it has paid $22 in taxes to the United Kingdom, but it has cut its U.S. tax bill by $22 by use of the foreign-tax credit. Barclays is down the $8 in taxes that it paid to the United Kingdom. And the U.K. treasury is up $30 ($22 from Wells Fargo and $8 from Barclays).

As noted, Barclays "reinvested" the $78 that was paid to it by the trust back into the trust in exchange for additional units. Because Barclays was spending $78 to...