(CN) – Wells Fargo’s participation in an abusive tax shelter with the British bank Barclays will cost it 20 percent of the $350 million worth of foreign tax credits it claimed, a federal judge ruled.
Releasing his decision roughly six months after a three-week jury trial in Minneapolis, U.S. District Judge Patrick Schiltz notes that the STARS transaction in question, short for Structured Trust Advantaged Repackaged Securities, is “extraordinarily complex.”
The jury concluded that Wells Fargo received the foreign-tax credits at issue through a sham trust transaction. Though U.S. companies are allowed to claim foreign tax credits on their U.S. taxes to avoid double taxation, the IRS disregarded certain transactions for tax purposes if they lack a nontax business purpose.
Here Wells Fargo voluntarily subjected a portion of its income-generating assets to taxation by the United Kingdom by placing them in a trust headed by a U.K.-based trustee. Offsetting the U.K.’s taxes, however, Wells Fargo claimed foreign tax credits on U.S. returns.
Barclays meanwhile enjoyed sizable U.K. tax benefits thanks to Wells Fargo’s hand in the transaction. The jury found that the payments Barclays sent Wells Fargo every month amounted to a tax benefit, rather than an item of pretax revenue as Wells Fargo had argued.
In trying to avoid a negligence penalty, Wells Fargo claimed that it had a reasonable basis to believe that it determined its proper tax liability.
Schiltz disagreed Wednesday, however, saying the bank cannot establish this without actually disclosing what authorities it relied on.
“Because Wells Fargo has waived its right to prove actual reliance, Wells Fargo cannot establish the defense,” the ruling concludes. “Wells Fargo is therefore subject to the negligence penalty.”
Schiltz did side with Wells Fargo, however, on the second part of the STARS transaction: a $1.25 billion contribution by Barclays to the Wells Fargo trust, which Wells Fargo was obligated to repay with interest after five years.
Cases involving materially identical STARS transactions have been considered by the First, Second and Federal Circuits, and all of these courts found that the loan was not a sham.
To resolve the dispute between the bank and the IRS, Schiltz predicted that the Eighth Circuit would adopt a flexible approach to the sham-transaction doctrine.
“Applying this approach, the court holds that the loan was not a sham and that Wells Fargo is entitled to deduct its interest expenses,” the 20-page opinion states. “As the jury found, the $1.25 billion loan was a real transaction that had substantial, non‐tax‐related economic effects on the parties. The fact that Wells Fargo would not have entered into the loan but for the opportunity to gain unrelated tax benefits does not change that fact. And although Wells Fargo’s purpose in entering the loan was not to borrow money from Barclays but to disguise the sham nature of STARS, the loan was not economically integral to the trust structure and did not play a role in generating the abusive foreign‐tax credits.”
Schiltz said the government must honor the loan’s actual economic substance, and that Wells Fargo must submit a proposal by June 30, detailing its plans to incorporate the latest ruling into its business model.
Wells Fargo did not return a request for comment.
“The jury verdict is a resounding message to companies trying to exploit an abusive transaction that no matter how sophisticated the scheme, these sham tax shelters will not stand,” said David Hubbert, attorney general for the Justice Department’s tax division. “The court’s opinion is equally clear that taxpayers who engage in such transactions can be subject to significant penalties.”