## Facts

- IES Industries, Inc. (and subsidiaries) engaged in a series of American Depositary Receipt (ADR) trades timed around dividend record dates of foreign corporations.
- ADR holders receive declared dividends and related gains; foreign jurisdictions imposed withholding taxes on dividends, potentially generating U.S. foreign tax credits.
- In the trades, IES bought ADRs after a dividend was declared but before the record date at a price reflecting market value plus most of the expected dividend.
- After the record date, IES sold the ADRs at the lower ex-dividend price, producing a capital loss.
- IES claimed (i) foreign tax credits for the withholding taxes and (ii) capital loss deductions (including carrybacks) tied to the ex-dividend resale losses.
- The IRS disallowed the credits and losses, treating the transactions as shams lacking economic substance and business purpose.
- Separately, IES faced environmental cleanup assessments payable over 15 years; once the total obligation became fixed and determinable, IES deducted the full amount in that year under the accrual method.
- The district court granted summary judgment to the government on the ADR refund claim (sham transaction) and to IES on the environmental cleanup deduction.
- IES appealed the ADR ruling; the government cross-appealed the environmental cleanup ruling.

## Issues

1. Whether IES’s ADR dividend-capture trades should be disregarded as sham transactions for lack of economic substance and business purpose, thereby disallowing foreign tax credits and capital loss deductions.
2. Whether an accrual-basis taxpayer may deduct, in the year liability becomes fixed, the total amount of multi-year environmental cleanup assessments.

## Decision

- The Eighth Circuit reversed the district court on the ADR transactions and held the trades were not shams.
- The court concluded the ADR trades had objective economic substance when assessed by considering gross dividends relative to capital losses, showing potential for pre-tax profit.
- The court rejected the view that tax motivation alone eliminated business purpose where the taxpayer entered real market transactions recognized by the Internal Revenue Code.
- The Eighth Circuit affirmed the district court on environmental cleanup costs, allowing IES to deduct the full 15-year assessment stream in the year the liability became fixed and reasonably estimable.
- The judgment was affirmed in part and reversed in part.

## Legal Principles

- Sham-transaction analysis asks whether, in substance, a transaction has real economic effects apart from tax consequences and is the type of transaction recognized by the tax laws.
- Objective economic substance may be shown by a realistic pre-tax profit potential; the court evaluated profit by comparing gross dividends received against related capital losses rather than netting out foreign withholding taxes as if the taxpayer purchased only a net dividend stream.
- A taxpayer’s desire to reduce taxes does not, by itself, negate business purpose when the taxpayer uses lawful means and engages in genuine market transactions with real cash flows and market exposure.
- Under the accrual method, a liability is deductible when all events have occurred to establish the fact of liability and the amount is determinable with reasonable accuracy; if satisfied, the entire fixed multi-year obligation may be deducted in the year it becomes fixed even if payable in later years.

## Conclusion

The Eighth Circuit held that IES’s ADR dividend-capture trades were respected for tax purposes because they involved real market transactions with economic substance and could generate pre-tax profit, permitting foreign tax credits and capital loss deductions; it also permitted an accrual-basis deduction for the full amount of fixed, reasonably estimable multi-year environmental cleanup assessments in the year liability was established.


IES Indus., Inc. v. United States, 253 F.3d 350 (8th Cir. 2001)