June 18, 2013
Bank of New York Case Tests IRS Power to Halt Foreign Tax Abuses
Posted on Apr 16, 2012
By Megan Murphy and Vanessa Houlder, Financial Times, and Jeff Gerth, ProPublica
This piece originally appeared at ProPublica.
In November 2001, Bank of New York, a mid-tier U.S. bank, transferred nearly $8 billion of its own assets to a trust in the small, business-friendly state of Delaware through several layers of newly created companies.
A mixture of home mortgages, shares and other securities, the transferred assets made up almost 10 percent of the bank’s total assets at the time. Yet, the transaction was not discussed with BNY’s regulators; nor was it noted in the bank’s financial statements or annual report. It had little practical effect on the lender’s day-to-day operations—the assets continued to be managed and serviced by the same employees in New York.
But it was a critical first step in setting up a complex structure known as STARS—structured trust advantaged repackaged securities—which U.S. tax authorities claim was used by several American banks as an abusive tax shelter that has cost the government more than $1 billion in tax revenue in the past decade.
The arguments heard this week will pose a crucial test of the U.S. government’s resolve to rein in sophisticated corporate tax planning that has sapped vast amounts of potential revenue. Tax authorities worldwide, notably in the U.S. and U.K., are under mounting pressure to show that large companies are shouldering their share of the tax burden as part of a broader political debate about fairness and corporate social responsibility.
“We are upping our game in the large business area, particularly as it relates to international tax issues,” Douglas Shulman, the U.S. internal revenue commissioner, said in a speech this month in Washington, D.C.
For the IRS, losing the STARS disputes would be a serious blow to its strategy in high-value cases, tax lawyers said. For the banks, the risk is both financial—$900 million is at stake in the BNY case alone—and to their reputations.
An investigation last year by the Financial Times and ProPublica first detailed how STARS produced tax benefits for U.S. banks beginning in 1999. In all, six banks—BNY (now Bank of New York Mellon), BB&T, Sovereign (now a unit of Santander), Wachovia (now part of Wells Fargo), Washington Mutual and Wells Fargo—participated in STARS deals with Barclays between 1999 and 2006.
Five of those banks are challenging IRS rulings that disallowed foreign tax credits generated in those transactions. WaMu has settled a STARS dispute in bankruptcy court by agreeing to forgo $160 million in claimed tax credits. In total, the IRS says, the STARS deals created $3.4 billion in foreign tax credits.
Now, documents filed in BNY’s case in the past few weeks—the court proceedings begin Monday—provide unprecedented detail about how STARS was crafted at a time when banks and accounting firms were offering deals for multinational corporations to take advantage of loopholes in rules governing foreign tax credits.
At the simplest level, foreign tax credits are designed to prevent U.S. companies from being taxed twice on overseas income by allowing them to claim credit for taxes paid in foreign jurisdictions.
In the BNY case, the IRS claims STARS allowed both Barclays and BNY to claim credits for the same “illusory” foreign tax charges, ultimately reducing the U.S. government’s tax revenue by $18.15 for every $100 of income funneled through the Delaware trust. “The record will establish that STARS was a pricey financing that no prudent banker would undertake but for the tax benefits generated by the meaningless circulation of cash flows,” according to a court filing by the IRS on March 27.
BNY has argued that the deal was a complex but entirely legal, allowing the bank access to low-cost financing from Barclays for its everyday business activities.
Brainchild of Barclays
Like hundreds of other foreign-tax-driven transactions sold to companies in the boom years before the financial crisis of 2008, STARS was developed by Barclays’ famed structured finance group, known as Structured Capital Markets. Roger Jenkins, one of Britain’s best-known dealmakers, and Iain Abrahams, the expert behind most of the bank’s tax arbitrage transactions, led SCM. The idea was for STARS to manufacture tax credits for Barclays and a U.S. corporate taxpayer by circulating U.S. income through an entity taxed in the U.K., the IRS said in its filing.
Because of the differences between U.S. and U.K. accounting rules, STARS would allow Barclays to reimburse a U.S. company for half the tax paid in the U.K. while not reducing the amount of foreign tax credits that could be claimed by either party, the IRS said. Barclays is not a party to the IRS dispute with BNY and has not been accused of wrongdoing by U.S. authorities.
According to the IRS, blue-chip U.S. companies including Microsoft and insurers AIG and Prudential Life passed on early versions of STARS for unspecified reasons. But the IRS said BNY, which bought the deal in 2001, had grown “addicted” to tax-driven transactions, which provided it with an important source of revenue.
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