WASHINGTON, Feb. 11. — The world’s largest custody bank, Bank of New York Mellon Corp. (Marketwatch) lost its bid to keep $900 million in tax benefits after a U.S. Tax Court ruled in the Internal Revenue Services’ favor.
After receiving a $1.5 billion loan in 2001 from Barclays Bank PLC and KPMG LLP, BNY Mellon used intricate foreign tax strategies to lower its tax liability. The IRS denied BNY Mellon’s tax benefits, finding them liable for $199 million; the bank responded by filing a lawsuit against the agency, which a U.S. Tax Court struck down on Monday. BNY Mellon had warned shareholders before the court’s decision it may have to set aside a reserve of more than $800 million as a litigation-related reserve; the court’s ruling only affected two years ($199 million), but the total amount of tax benefits or profit on the transaction is more than $850 million over a span of about 6 years. According to the U.S. Tax Court, the transactions lacked “economic substance.” BNY Mellon has said it will appeal the decision.
“U.S. tax laws and treaties do not recognize sham transactions or transactions that have no economic substance as valid for tax purposes,” the court said in its opinion.
The “sham transactions,” the court is referring to are BNY Mellon’s use of foreign tax credits, which prevent income from being taxed twice by two countries. By treating the Barclays and KPMG transaction as foreign based, BNY Mellon was able to set-up a complex arrangement of subsidiaries to transfer money between and offset their US tax liability by claiming foreign tax credits and related expense deductions.
The financial arrangement BNY Mellon, Barclays and KPMG engaged in is known as a Structured Trust Advantaged Repackaged Securities, or STARS, transaction. Wolter Kluwter’s CCH division commented, “STARS was developed and marketed by Barclays Bank, PLC, and KPMG. Barclays served as the U.K. counterpart. The STARS transaction here generated almost $200 million in foreign tax credits. At least five other U.S. banks entered into STARS transactions with Barclays.” The ruling upholds precedent that the IRS may disallow tax benefits resulting from STARS transactions if they lack economic creditability, i.e. if they only exist for the purposes of creating tax profit. ”The STARS structure lacked objective economic substance because it did not increase the profitability of the transferred assets; in fact, it actually reduced their profitability by adding substantial transaction costs.”
In an age where multinational corporations slight the IRS to the tune of $60 billion/year, the court’s ruling may give firms reason to reconsider taking advantage of foreign tax loopholes. The IRS has after all said it would be cracking down on this sort of activity, going after MNCs such as Amazon.com via its new International Transfer Pricing Operations division.
BNY Mellon operates in 37 countries and serves over 140 markets. They are the world’s leading asset servicer with over $20 trillion in assets under custody. The liability was incurred by The Bank of New York, Co. and carried into its merger with Mellon Financial Corporation in 2007.
The case is Bank of New York Mellon Corp. v. IRS, 09-26683, U.S. Tax Court (Washington).
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