## Facts

- Bank of New York Mellon Corporation (BNY Mellon) entered into a cross-border structured transaction with Barclays known as STARS.
- BNY Mellon created a Delaware trust and arranged for Barclays to contribute income-producing assets and receive trust interests, with a schedule for BNY Mellon to buy back certain interests over five years.
- BNY Mellon appointed a United Kingdom resident trustee, which subjected trust income to UK tax even though the assets remained in Delaware.
- The structure involved circular cash flows, with trust income routed through Barclays accounts and then returned to the trust.
- The parties used agreements that shared or reimbursed US and UK tax liabilities, allowing them to share the value of tax benefits generated by the structure.
- BNY Mellon claimed substantial US foreign tax credits and related deductions tied to UK taxes paid under the arrangement.
- The IRS disallowed the credits and certain deductions under the economic substance doctrine.
- The Tax Court held the STARS transaction lacked economic substance and sustained the disallowance of the foreign tax credits; BNY Mellon appealed and the Commissioner cross-appealed on certain issues.

## Issues

1. Whether the economic substance doctrine applies to transactions structured to generate US foreign tax credits.
2. Whether the STARS transaction had meaningful pre-tax profit potential apart from US tax benefits.
3. Whether the UK taxes paid should be treated as real economic costs in evaluating pre-tax profit and economic effect.
4. Whether the Commissioner properly disallowed BNY Mellon’s foreign tax credits and related deductions arising from the STARS structure.

## Decision

- The Second Circuit affirmed the Tax Court’s judgment against BNY Mellon.
- The court held the economic substance doctrine applies in the foreign tax credit context.
- The court concluded the STARS transaction lacked economic substance because it did not meaningfully change BNY Mellon’s economic position apart from tax effects and lacked a substantial non-tax business purpose.
- The court sustained the disallowance of the claimed foreign tax credits and associated tax benefits tied to the STARS transaction.

## Legal Principles

- Courts may deny claimed tax benefits, including foreign tax credits, for transactions that lack economic substance even if the transactions comply with the literal terms of the Internal Revenue Code.
- Economic substance analysis generally considers: (1) objective economic effect (a meaningful change in the taxpayer’s economic position apart from tax effects) and (2) subjective business purpose (a substantial non-tax purpose).
- In evaluating objective economic effect and pre-tax profit, foreign taxes that are integral to the structure are treated as real economic costs, not ignored or treated as neutral.
- Circular cash flows, formal steps that exist to trigger taxes, and tax-sharing arrangements that monetize credits may support a finding that a transaction is tax-motivated and lacks economic substance.

## Conclusion

The Second Circuit upheld denial of BNY Mellon’s foreign tax credits and related benefits from the STARS transaction, holding that the economic substance doctrine applies to foreign tax credit structures and that the transaction failed both the objective and subjective components of economic substance when foreign taxes were treated as actual costs.


Bank of N.Y. Mellon Corp. v. Comm’r, 801 F.3d 104 (2d Cir. 2015)