Santander Holdings USA, Inc. v. United States

• Decision Date: 16 December 2016
• Docket Number: No. 16-1282,16-1282
• Citation: 844 F.3d 15
• Parties: SANTANDER HOLDINGS USA, INC., and Subsidiaries, f/k/a Sovereign Bancorp., Inc., Plaintiff, Appellee, v. UNITED STATES of America, Defendant, Appellant.
• Court: U.S. Court of Appeals — First Circuit

844 F.3d 15

SANTANDER HOLDINGS USA, INC., and Subsidiaries, f/k/a Sovereign Bancorp., Inc., Plaintiff, Appellee,

v.UNITED STATES of America, Defendant, Appellant.

No. 16-1282

United States Court of Appeals, First Circuit.

December 16, 2016

Judith A. Hagley , with whom Caroline D. Ciraolo , Acting Assistant Attorney General, Tax Division, Diana L. Erbsen , Deputy Assistant Attorney General, Tax Division, Gilbert S. Rothenberg , Richard Farber , Washington, DC, and Carmen M. Ortiz , United States Attorney, were on brief, for appellant.

Jonathan S. Massey , Washington, DC, with whom Leonard A. Gail , Chicago, IL, Paul J. Berks , Massey & Gail LLP , Rajiv Madan , and Skadden, Arps, Slate, Meagher & Flom LLP were on brief, for appellee.

Martin S. Kaufman , Scarsdale, NY, on brief for Atlantic Legal Foundation, amicus curiae.

Scott P. Martin , Gibson, Dunn & Crutcher LLP , Washington, DC, Kate Comerford Todd , Steven P. Lehotsky , Washington, DC, Warren Postman , and U.S. Chamber Litigation Center on brief for Chamber of Commerce of the United States of America, amicus curiae.

Derek T. Ho , Bradley E. Oppenheimer , William H. Milliken , Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C. , Washington, DC, and K. Richard Foster on brief for Financial Services Roundtable, amicus curiae.

Before Lynch and Selya, Circuit Judges, and Burroughs,^* District Judge.

LYNCH, Circuit Judge.

Under the Internal Revenue Code, taxpayers receive, subject to various technical requirements, credits against owed U.S. income tax for every dollar paid to a foreign country for taxable international business transactions of economic substance. See26 U.S.C. §§ 901 –909. Over the past decade, some banks have engaged in complicated transactions the very purpose of which is to generate a foreign tax credit in order to take advantage of the U.S. deductions, and have done so at the expense of the U.S. taxpayer.

This case concerns whether Sovereign Bancorp, Inc., later acquired by Santander Holdings USA, Inc. (together, "Sovereign"), a U.S. taxpayer, is entitled to a refund from the Internal Revenue Service ("IRS") after the IRS began disallowing its claim for foreign tax credits and imposing accuracy-related penalties in 2008. The credits at issue here were claimed for tax years 2003 to 2005 for taxes arranged to be paid to the United Kingdom as part of a Structured Trust Advantaged Repackaged Securities ("STARS") transaction that Sovereign had engaged in. This STARS transaction was initiated in 2003 and was scheduled to last five years, but it ended early, in July 2007, when STARS and similar transactions became the subject of heightened scrutiny from the IRS. SeeDetermining the Amount of Taxes Paid for Purposes of Section 901, 72 Fed. Reg. 15,081 (proposed Mar. 30, 2007). Sovereign and Barclays Bank ("Barclays"), which is chartered in the United Kingdom, were the two parties to the transaction at issue.

Sovereign brought suit to obtain a refund from the IRS in the District of Massachusetts in 2009. The amount of the refund sought is approximately $234 million in taxes, penalties, and interest. Sovereign asserts that it is entitled to foreign tax credits against its U.S. taxes for taxes it paid to the United Kingdom as part of the STARS transaction at issue. As the government concedes, the STARS transaction complied on its face with then-existing U.S. statutory and regulatory requirements. But the government opposes the refund, arguing that the STARS transaction here is an "abusive tax shelter" and so amounts to a transaction that fails the common law economic substance test.

Congress and the IRS have long been concerned with taxpayers inappropriately seeking foreign tax credits. IRS regulations proposed in 2007 and finalized in 2011 prohibited STARS transactions, but not retroactively. SeeDetermining the Amount of Taxes Paid for Purposes of Section 901, 72 Fed. Reg. 15,081, 15,084 (proposed Mar. 30, 2007) ; Determining the Amount of Taxes Paid for Purposes of the Foreign Tax Credit, 76 Fed. Reg. 42,036 (July 18, 2011) (codified at 26 C.F.R. pt. 1). The regulations reflect an understanding that STARS transactions and similar complex financial structures for which foreign tax credits are sought both pose a danger to the federal fisc and do not serve the purposes intended by Congress in enacting the foreign tax credit regime. Those purposes include avoiding double taxation and enabling the conduct of business affairs abroad by U.S. firms. SeeH.R. Rep. No. 83–1337, at 4103 (1954) ("The [foreign tax credit] provision was originally designed to produce uniformity of tax burden among United States taxpayers, irrespective of whether they were engaged in business in the United States or engaged in business abroad."). This case involves a STARS transaction that took place before such transactions were forbidden by regulation, and no one contends the 2011 regulation applies. This decision thus directly affects only that transaction.

During roughly the same period as the transaction at issue here, from 2001 to 2007, other U.S. banks also entered into STARS transactions with Barclays. They similarly sought tax credits, and the IRS similarly opposed them. In Bank of New York Mellon Corp. v. Commissioner(BNY), 801 F.3d 104, 107 (2d Cir. 2015), the Second Circuit affirmed a judgment disallowing the credits claimed by Bank of New York Mellon for its STARS transaction with Barclays.¹ Using somewhat different reasoning, the Federal Circuit in Salem Financial, Inc. v. United States, 786 F.3d 932, 951, 954–55 (Fed. Cir. 2015), also upheld a determination disallowing credits claimed by Branch Banking & Trust Corporation for a STARS transaction with Barclays. Both circuit court opinions contain extensive factual descriptions of the STARS transactions, which also largely characterize the transaction at issue here.² A third case, involving a Wells Fargo STARS transaction, was tried in a federal district court in the Eighth Circuit. SeeWells Fargo & Co. v. United States, 143 F.Supp.3d 827, 842 (D. Minn. 2015). After trial, a jury found that the transaction lacked economic substance.

The Massachusetts district court in this case awarded summary judgment to Sovereign. It first entered partial summary judgment for Sovereign on the issue of whether a payment Sovereign received from Barclays should be considered income to Sovereign in calculating the STARS Trust transaction's profit. Santander Holdings USA, Inc. & Subsidiaries v. United States(Santander I), 977 F.Supp.2d 46, 48 (D. Mass 2013). It then entered judgment for Sovereign after finding as a matter of law that the Trust and Loan transactions had economic substance, and so Sovereign was entitled to interest-related deductions on expenses for the Loan transaction and a refund on the disallowed foreign tax credits claimed for the Trust transaction and the penalties imposed by the IRS. Santander Holdings USA, Inc. v. United States(Santander II), 144 F.Supp.3d 239, 248 (D. Mass. 2015). The court also denied the government's cross-motion for partial summary judgment in its favor on a number of issues, including whether Sovereign's U.K. taxes should be regarded as expenses in any calculation of Sovereign's profit from the STARS transaction. Id. at 242–44, 248. The government appeals from the grant of summary judgment to Sovereign and the denial of its cross-motion.

Through concessions made by both the government and Sovereign, the appeal has been considerably simplified. The government no longer contends that it is entitled to a jury trial on the tax refund claim; it seeks a jury trial only on the penalties claim. The government also does not contend any longer that the district court improperly excluded evidence, or that there are any material disputes of fact, or that summary judgment was entered prematurely. Rather, the government agrees that the controlling issue is one of law and argues that its cross-motion for summary judgment as to the Trust portion of the STARS transaction should have been allowed.³ Sovereign, for its part, agrees, for the purposes of summary judgment, that the proper focus is on the Trust transaction alone, and not on the Loan transaction.⁴

We hold that the district court committed reversible error and that the government is entitled to summary judgment in its favor as to the economic substance of the STARS Trust transaction. We largely agree with the reasoning of the Federal Circuit opinion in Salem in rejecting the claims that the Trust transaction had economic substance and substantially rely on its analysis.

I.

We give a brief description of the transaction and then of this Circuit's economic substance test.

A. The STARS Transaction

Sovereign entered into the STARS transaction with Barclays in 2003. U.S. banks were then aware of the tax risks of being denied the full amount of U.S. foreign tax credits. See, e.g., Salem, 786 F.3d at 937. Like other STARS transactions, the one Sovereign entered into had, as the district court put it, a "Rube Goldberg" complexity. Santander I, 977 F.Supp.2d at 48. We explain it briefly and rely on BNY and Salem for further details.

In 2003, Sovereign first created a Trust (the Trust half of the transaction) into which it ultimately contributed about $6.7 billion of its U.S.-located income-producing assets. The trustee of the Trust was, by its terms, a U.K. citizen, a fact which subjected the Trust to U.K. taxes. The U.K. taxes were at a rate of 22%. The Trust was also subject to U.S. federal income tax at a rate of 35%, but it could claim a tax credit for the taxes paid to the United Kingdom. The Trust was structured, therefore, to receive foreign tax credits for the amount paid in tax on the Trust to the United Kingdom. It is undisputed that Sovereign paid all U.K. taxes for which it claimed U.S. tax credits.

Barclays acquired an interest in the Trust for $750 million in November 2003 at the Trust's initial creation and acquired an additional $400 million interest almost...