According to Law360  the First Circuit Court of Appeals overturned an earlier $234 million victory for Santander Holdings USA Inc. after ruling on December 16, 2016 that an internal securities transaction the bank had engaged in lacked economic substance and does not qualify for foreign tax credits.  

On November 16, 2015 we posted Judge Rules Thant IRS Owes $234M To Sovereign Bancorp  where we discussed that a Massachusetts federal judge ruled that Sovereign Bancorp can recover some $234 million that it paid in taxes, interest and penalties to the federal government over an international securities transaction, finding the deal had a business purpose outside its tax benefits.

Granting a motion for summary judgment by Sovereign, now Santander Holdings USA Inc. and denying a cross motion for partial summary judgment by the federal government, U.S. District Judge George A. O’Toole Jr. decided that the so called structured trust advantaged repackaged securities, or STARS, transaction had economic substance. 

Now a three-judge panel unanimously held that the structured trust advantaged repackaged securities, or STARS, transactions set up by Sovereign Bancorp Inc., Santander’s predecessor, had only tax avoidance features with no bona fide business purpose or real economic risks. 

“The STARS Trust transaction itself does not have a reasonable prospect of creating a profit without considering the foreign tax credits, and, as a result, it is not a transaction for which Congress intended to give the benefit of the foreign tax credit,” Circuit Judge Sandra Lynch wrote on behalf of the panel, saying that the lower court had erred in concluding otherwise.

The transaction involves a process in which Sovereign created a trust in 2003 into which it ultimately contributed about $6.7 billion of its U.S. located income producing assets. The trustee was a U.K. citizen subject to British taxes, and while the trust was also subject to U.S. federal income tax, it could claim a tax credit for taxes paid to the U.K. government.

Sovereign then partnered with Barclays Bank, which acquired a $1.15 billion interest in the trust, but sold it right back to Sovereign for the same amount. Sovereign treated the $1.15 billion contribution from Barclays as a loan, and the trust entered into a series of transactions that generated a U.K. tax benefit for Barclays.

The transactions involved the trust distributing funds to a blocked Barclays account that Barclays could not access but which allowed it to formally hold the funds in its name and be subjected to U.K. taxes. The blocked account then immediately returned the funds to the trust, resulting in Barclays being entitled to a tax credit and allowed to deduct its re-contributions to the trust as a tax loss.

The panel agreed with the U.S. government that Sovereign’s U.K. tax was artificially generated through a series of circular cash flows through the trust and that Sovereign subjected its property and income to U.K. taxation “only because it anticipated it could avoid U.S. taxes through the resulting U.S. tax credit.”

The case is Santander Holdings USA v. United States, case number 16-1282, in the U.S. Court of Appeals for the First Circuit.

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