Bank of New York Mellon Corp. was prohibited by the U.S. Tax Court from claiming $199 million of foreign tax credits generated in a transaction arranged by Barclays Bank Plc and KPMG LLP.
The tax court said BNY Mellon couldn’t claim the tax credits and related expense deductions for 2001 and 2002 because the underlying transaction with London-based Barclays “lacked economic substance.”
“U.S. tax laws and treaties do not recognize sham transactions or transactions that have no economic substance as valid for tax purposes,” Judge Diane Kroupa said in yesterday’s ruling.
BNY Mellon said yesterday in an e-mailed statement that it would take an after-tax charge of about $850 million during the first quarter because of the ruling. While the ruling directly affects only two years, the amount of the charge reflects about six years of tax benefits connected to the disputed transaction, according to the company’s 2011 annual report.
“We will appeal the court’s decision,” Kevin Heine, a spokesman for New York-based BNY Mellon, said in a phone interview. “We continue to believe the tax treatment of the transaction was consistent with statutory and judicial authority existing at the time.”
Kroupa’s decision upholds a ruling by the U.S. Internal Revenue Service disallowing tax benefits resulting from an elaborate set of financial exchanges known as a Structured Trust Advantaged Repackaged Securities, or STARS, transaction.
The 2001 transaction purported to give BNY Mellon below market rate financing from Barclays and involved the transfer of income producing assets from the U.S. bank to a trust with a U.K. trustee and subject to U.K. income tax, according to Kroupa’s ruling.
“The STARS transaction was a complicated scheme centered around arbitraging domestic and foreign tax law inconsistencies,” Kroupa wrote. “The U.K. taxes at issue did not arise from any substantive foreign activity. Indeed, they were produced through pre-arranged circular flows from assets held, controlled and managed with the United States. We conclude that Congress did not intend to provide foreign tax credits for transactions such as STARS.”
Barclays and KPMG developed and promoted STARS to U.S. banks, according to the ruling.
Kerrie Cohen, a spokeswoman for Barclays, declined to comment on the ruling.
Manuel Goncalves, a KPMG spokesman, declined to comment on the decision, citing a confidentiality obligation to its client, BNY Mellon. KPMG LLP is a U.S. affiliate of Zurich-based KPMG International.
The IRS is challenging a total of $900 million of tax benefits, including interest, over six years connected to payment of U.K. corporate income tax credited against BNY Mellon’s U.S. tax liability, according to BNY Mellon’s 2011 annual report.
Kroupa’s ruling applied only to two years worth of disputed benefits.
The liability was incurred by The Bank of New York Co. and was carried into its merger with Mellon Financial Corp. in 2007.
The case is Bank of New York Mellon Corp. v. IRS, 09-26683, U.S. Tax Court (Washington).