Salem Fin., Inc. v. United States
| Decision Date | 20 September 2013 |
| Docket Number | No. 10-192T,10-192T |
| Parties | SALEM FINANCIAL, INC., Plaintiff, v. UNITED STATES, Defendant. |
| Court | Court of Federal Claims |
SALEM FINANCIAL, INC., Plaintiff,
v.
UNITED STATES, Defendant.
No. 10-192T
United States Court of Federal Claims
Filed: September 20, 2013
Rajiv Madan, with whom were John B. Magee, Christopher P. Bowers, Christopher P. Murphy, Royce Tidwell, Nathan P. Wacker, and Nicholas L. Wilkins, Bingham McCutchen LLP, Washington, D.C., and James C. McGrath and Deana K. El-Mallawany, Bingham McCutchen LLP, Boston, Massachusetts, for Plaintiff.
Dennis M. Donohue, with whom were John L. Schoenecker, Raagnee Beri, Kari M. Larson, and William E. Farrior, Trial Attorneys, and Alan S. Kline, Special Attorney, Tax Division, U.S. Department of Justice, Washington, D.C., for Defendant.
WHEELER, Judge.
In this tax refund case, the Court must determine the proper tax treatment for an unusually complex financial transaction known as STARS ("Structured Trust Advantaged Repackaged Securities"). Plaintiff, Salem Financial, Inc. ("Salem"), is a subsidiary of BB&T Corporation, a bank chartered under the laws of North Carolina. Although many entities were involved in the STARS transaction, the real parties in interest were BB&T Bank and Barclays Bank PLC, which is headquartered in the United Kingdom ("U.K."). The other entities were created or became involved to serve some special purpose for the transaction.
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The BB&T STARS transaction was in effect for nearly five years, from August 1, 2002 through April 5, 2007. The purpose of the STARS transaction was to generate large-scale foreign tax credits for a U.S. taxpayer, which could be used to enhance revenue and reduce taxes in the United States. The amount at issue in this case, including the potential assessment of taxpayer penalties, is $772,144,153.45. This amount is comprised of the following: disallowed foreign tax credits ($498,161,951); disallowed interest deductions ($74,551,947.40); the tax paid on "Bx" payments from Barclays to BB&T ($84,033,228.20); disallowed transaction cost deductions ($2,630,125.05); and penalties ($112,766,901.80).
The complexities of the STARS transaction, including the concept of a Bx payment, will become apparent below. Stripped to its essence, however, STARS called for the U.S. taxpayer, in this case BB&T, to establish a trust containing approximately $6 billion in revenue-producing bank assets. The monthly revenue from the trust was then cycled through a U.K. trustee, an act that served as a basis for U.K. taxation. Although the revenue was immediately returned to BB&T's trust, the assessment of U.K. taxes generated U.K. tax credits that were shared 50/50 between Barclays and BB&T. A $1.5 billion loan from Barclays to BB&T also was part of the structured transaction, although the loan was not necessary to the objective of generating foreign tax credits. The Barclays monthly Bx payment to BB&T represented BB&T's share of the tax credits, and had the effect of reducing the interest cost of BB&T's loan. The main question presented is whether the STARS transaction had any purpose other than to generate tax savings, and if not, whether penalties should be assessed against BB&T.1
The parties provided a STARS tax tutorial presentation to the Court on February 13, 2013 before the trial began. The Court held 21 days of trial in Washington, D.C. from March 4 through April 2, 2013. During the trial, the Court heard the testimony of 26 witnesses, of which thirteen were experts. The Court admitted deposition excerpts for eleven additional witnesses, principally from those persons who reside outside the United States or where the parties agreed that a deposition could substitute for relatively brief testimony. The Court received in evidence approximately 1,250 exhibits during the trial. The parties submitted post-trial findings of fact and memoranda of law on June 7, 2013, and post-trial reply briefs on July 3, 2013. The Court heard closing arguments on July 30, 2013.
There are different ways of looking at the BB&T STARS transaction, and the Court has wrestled with the question of how best to analyze its various components. The STARS trust component, where BB&T revenue momentarily is cycled through a U.K.
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trustee to create U.K. taxes and foreign tax credits, and then is returned to BB&T, quite clearly is an abusive tax avoidance scheme. The trust creates a series of instantaneous circular cash flows starting and ending with BB&T where no economic activity has occurred abroad to justify the assessment of a U.K. tax. While inarguably sophisticated and creative, the trust purely and simply is a sham transaction accomplishing nothing more than a redirection of cash flows that should have gone to the U.S. Treasury, but instead are shared among BB&T, Barclays, and the U.K. Treasury. The Court finds that the trust component of STARS lacks economic substance.
However, the Court must consider whether the existence of Barclays' $1.5 billion loan to BB&T at favorable interest rates somehow provides the necessary economic substance to salvage the STARS transaction. In analyzing this question, the Court notes that the loan interest rate actually is higher than normal for BB&T until the Barclays' rebate of U.K. taxes through the Bx payment comes into play. The Barclays' Bx payment each month from the sham trust transaction creates the unusually attractive interest rates. Without the Bx payments, the Court is persuaded that BB&T would not have entered into the STARS transaction. The loan transaction thus is substantially influenced by the payments from the sham trust. The loan lacks economic reality where the interest rate is so low that for nearly the first three years of the transaction, Barclays, the lender, makes Bx payments to BB&T, the borrower, exceeding by millions the interest payments due from BB&T to Barclays. An arrangement where a lender makes payments to a borrower for the first three years of a loan surely would raise the eyebrows of even an experienced financier.
Regardless of whether the Court views the trust and the loan separately or together as one integrated STARS transaction, the Court concludes that the entire arrangement must be disregarded for lack of economic substance. Among the most telling evidence at trial was the revelation that the amount of the loan was unrelated to the amount of the Bx payments. That is, in the relevant formulas created for the STARS transaction, a change in the loan amount does not have any effect on the Bx payment amount. Thus, rather than being intricately linked together with the trust, the loan serves only to add a hoped-for business purpose to the tax avoidance scheme. The Court cannot find economic substance in a loan transaction that is so heavily driven by Bx payments from the sham trust.
For reasons that will be explained, the Court also finds that BB&T is liable for tax penalties for its participation in the STARS transaction. The conduct of those persons from BB&T, Barclays, KPMG, and the Sidley Austin law firm who were involved in this and other transactions was nothing short of reprehensible. Perhaps the business environment at the time was "everyone else is doing it, why don't we?" Perhaps some of those who participated simply were following direction from others. Nevertheless, the professionals involved should have known better than to follow the STARS path, rife with its conflicts of interest, questionable pro forma legal and accounting opinions, and a
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taxpayer with a seemingly insatiable appetite for tax avoidance. One of Defendant's experts, Dr. Michael Cragg, aptly stated that "enormous ingenuity was focused on reducing U.S. tax revenues." Cragg, Tr. 4687. After wading through the intricacies of the STARS transaction, the Court shares Dr. Cragg's view that "[t]he human effort, the amount of creativity and overall effort that was put into this transaction . . . is a waste of human potential." Id.
I. Findings of Fact2
A. Entities Involved in the BB&T STARS Transaction
There are five business entities that each played an important role in this STARS transaction: (1) BB&T, which established controlled subsidiaries to achieve certain transaction-related objectives; (2) Barclays PLC, which developed the concept of STARS and served as a counterparty in the STARS structure; (3) KPMG LLP, an international accounting firm that assisted Barclays in marketing STARS in the United States, and provided tax opinions to BB&T and other U.S. banks who chose to participate; (4) Sidley Austin Brown & Wood LLP, a law firm which supplied tax opinions and legal services in connection with STARS; and (5) PricewaterhouseCoopers LLP ("PwC"), an international accounting firm that served as BB&T's outside auditing firm beginning in 2002 and examined the STARS transaction at BB&T's request. The Court will briefly describe the role of each of these entities below.
1. BB&T
Branch Banking & Trust Corporation ("BB&T") is a financial holding company headquartered in Winston-Salem, North Carolina and incorporated in the State of North Carolina. Stip. ¶ 1. BB&T conducted business primarily through its banking subsidiaries, which during 2002 through 2007 included offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Alabama, Florida, and Washington, D.C. JX 209 at 358414. The largest subsidiary of BB&T is Branch Banking and Trust Company ("BB&T Bank"), a state bank chartered under North Carolina law. Stip. ¶ 3; JX 209 at 358414. BB&T is the oldest bank headquartered in North Carolina, having been chartered in 1872. BB&T Corporation has two other banking subsidiaries: (1) Branch Banking and Trust Company of South Carolina ("BB&T-SC"), headquartered in...
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