CHICAGO (CN) - Wells Fargo's claim for a $177 million tax refund is based on a sham deal with Barclays Bank to exploit loopholes in foreign tax credits, a federal judge ruled.
Almost 15 years ago, U.K. bank Barclays approached American banks with a proposition to make money for both parties by exploiting differences in tax laws between the Great Britain and the United States.
Under the scheme, U.S. banks would purchase a product called "Structured Trust Advantages Repackaged Securities," or STARS, subjecting some of its income to U.K. taxation. Then the U.S. bank would offset the British taxes by claiming foreign-tax credits on its U.S. returns.
Barclays also reaped tax benefits through the U.S. banks' investments, and paid them a portion of the refund for participating in the scheme.
Wells Fargo was one of the banks that chose to engage in a STARS transaction, investing approximately $6.6 billion in a STARS trust.
But when the U.S. banks claimed the foreign-tax credits on their tax returns the Internal Revenue Service refused to grant the credits, finding that the STARS transactions were shams without economic substance.
Wells Fargo sued, seeking to claim a refund of approximately $177 million for the tax year ending in December 2003.
U.S. District Judge Patrick Schiltz in Minnesota upheld the government's decision against Wells Fargo Tuesday, following similar rulings against Bank of New York Mellon in the Second Circuit, and a BB&T subsidiary in the Federal Circuit.
"This court agrees that the Bx payment [a percentage of Barclays U.K. tax credit] was consideration that Barclays paid in exchange for Wells Fargo's act of voluntarily subjecting its assets to U.K. taxation. But that act by Wells Fargo lacked any economic substance whatsoever," Schiltz said. "There was no substantive business reason for Wells Fargo to place those assets in the U.K. trust; it did so only to subject them to U.K. taxation, and it subjected them to U.K. taxation only to generate tax benefits for Barclays."
The fact that Barclays paid Wells Fargo to engage in the transaction does not make it a valid business deal, because the payment was not profit from business activity, but simply a portion of the tax savings, the judge found.
"This court believes that a jury could find that Barclays did not merely pay Wells Fargo to create tax benefits for Barclays, but that Wells Fargo actually funded those benefits with tax revenues extracted from the U.S. Treasury," Schiltz said.
The court calculated that for every $22 claimed as a refund from the U.S. Treasury, Wells Fargo ended up with $10.45, Barclay's with $8.09, and the U.K. Treasury with $3.46.
"The fact that the benefits of the STARS transaction match to the penny the amount of taxes diverted from the U.S. treasury speaks volumes," Schiltz said.
Denying Wells Fargo's motion for summary judgment, the judge said a jury must whether Wells Fargo's claim for a refund was reasonable or not, which will determine whether the IRS may seek penalties against the bank.
A case brought by Santander Holdings seeking the same tax credits is still pending in the District of Massachusetts.