The Tax Court held that a bank was not entitled to the tax benefits generated by a Structured Trust Advantaged Repackaged Securities (STARS) transaction because the transaction lacked economic substance.
The Bank of New York Mellon Corp. is a Delaware corporation that maintained its principal place of business in New York City. It is the successor to the tax liabilities of The Bank of New York Co. Inc., which merged with Mellon Financial Corp. in 2007 (after the transaction at issue in the current case took place). The Bank of New York (BNY) was a wholly owned subsidiary of The Bank of New York Co. Inc. 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.
BNY entered into a STARS transaction in 2001 with Barclays Bank PLC (Barclays), a global financial services company based in London. The STARS transaction generated approximately $199 million in foreign tax credits for BNY for the combined years at issue.
Introduction and Negotiation of STARS
Barclays and an accounting firm developed and promoted STARS to U.S. banks. The accounting firm introduced STARS to BNY during discussions with BNY's tax director. STARS was represented by the accounting firm to BNY (and other banks) as a "below market loan" from Barclays, who acted as the U.K. counterparty in the transaction. The below-market cost would be achieved by Barclays's "sharing" U.K. tax benefits from STARS through an offset to the cost of the loan. 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.
The STARS Transaction
As described by the Tax Court, the STARS transaction consisted of three parts: creating the STARS entity structure, using the structure to carry out the STARS loan, and using the loan proceeds and the STARS structure to generate foreign tax credits.
The STARS structure: The STARS structure is illustrated in simplified form in the exhibit. BNY first funded a preexisting REIT (REIT Holdings) subsidiary with $6.46 billion in various loan assets, and the REIT assumed $2.55 billion of BNY's liabilities.
Next, BNY formed and funded InvestCo, a Delaware LLC that elected to be taxed as a corporation and was part of BNY's affiliated group. REIT Holdings capitalized InvestCo with $10.409 billion of assets in exchange for a 100% ownership stake in InvestCo and the assumption of REIT Holdings's BNY liabilities.
Third, BNY formed DelCo, a Delaware LLC that elected partnership treatment. InvestCo capitalized DelCo by contributing $9.243 billion in STARS assets to it, in exchange for all of Del-Co's class 1 and class 2 ordinary shares and DelCo's assumption of the BNY liabilities InvestCo had assumed from REIT Holdings.
Fourth, BNY formed the BNY STARS Trust as a common law trust. The trust was authorized to issue four classes of units (A, B, C, and D units), which each had different income distribution rights. InvestCo transferred its remaining STARS assets ($1.2 billion) and its Delco class 2 shares to the trust in exchange for the class A and class B trust units. BNY was the initial trustee of the trust.
In the final step, BNY formed NewCo, a Delaware LLC that elected to be treated as a partnership with InvestCo as its sole member. InvestCo contributed 49% of the class A units to NewCo in exchange for a 100% membership interest in NewCo. InvestCo then distributed 1% of its NewCo interest to REIT Holdings.
In sum, the above steps moved approximately $7.86 billion in net assets into DelCo and the trust.
STARS loan: BNY and Barclays and the various intermediary STARS entities entered into the following agreements and transactions, the net effect of which was to create a $1.5 billion loan to BNY from Barclays. First, Barclays purchased the class C unit for $1.469 billion and the class D unit for $25 million from the trust by a subscription agreement.
Second, InvestCo and Barclays...