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BB&T Seeks Supreme Court Review of Denial of FTCs in STARS Case

SEP. 29, 2015

Salem Financial Inc. v. United States

DATED SEP. 29, 2015
DOCUMENT ATTRIBUTES
  • Case Name
    SALEM FINANCIAL, INC., AS SUCCESSOR-IN-INTEREST TO BRANCH INVESTMENTS LLC, Petitioner, v. UNITED STATES OF AMERICA, Respondent.
  • Court
    United States Supreme Court
  • Docket
    No. 15-380
  • Authors
    Sloan, Clifford M.
    Madan, Rajiv
    Bowers, Christopher P.
    Clement, Paul D.
    Bartolomucci, H. Christopher
  • Institutional Authors
    Skadden, Arps, Slate, Meagher & Flom LLP
    Bancroft PLLC
  • Cross-Reference
    Appealing Salem Financial Inc. v. United States, 786 F.3d 932

    (Fed Cir. 2015) 2015 TNT 94-12: Court Opinions.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2015-22137
  • Tax Analysts Electronic Citation
    2015 TNT 192-19

Salem Financial Inc. v. United States

 

IN THE

 

SUPREME COURT OF THE UNITED STATES

 

 

On Petition For A Writ Of Certiorari

 

To The United States Court Of Appeals

 

For The Federal Circuit

 

 

PETITION FOR A WRIT OF CERTIORARI

 

 

Paul D. Clement

 

H. Christopher Bartolomucci

 

Bancroft PLLC

 

500 New Jersey Ave., NW

 

Seventh Floor

 

Washington, DC 20005

 

(202) 234-0090

 

 

Clifford M. Sloan

 

Counsel of Record

 

Rajiv Madan

 

Christopher P. Bowers

 

SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP

 

1400 New York, Ave., NW

 

Washington, DC 20005

 

(202) 371-7000

 

cliff.sloan@skadden.com

 

 

QUESTIONS PRESENTED

 

 

To avoid double taxation by a foreign country and by the United States, Section 901 of the tax code provides U.S. corporations with a foreign tax credit for taxes paid to another country. This case involves the denial of a foreign tax credit for hundreds of millions of dollars in taxes paid by a U.S. corporation to the United Kingdom in connection with a multi-billion dollar cross-border financing transaction. Even though it is undisputed that Petitioner complied with all statutory and regulatory requirements for a foreign tax credit, the Federal Circuit, expressly disagreeing with the Fifth and Eighth Circuits, disallowed that credit because of its view that the multi-billion dollar transaction lacked "economic substance." The questions presented are:

 

1. Whether, as the Federal Circuit and the Second Circuit have held in conflict with the Fifth and Eighth Circuits, it is proper to evaluate the economic substance of a cross-border transaction based on neither its pre-tax nor post-tax viability, but instead based on a hybrid approach that considers the foreign taxes that must be paid without considering the U.S. tax credits that are presumptively available.

2. Whether, and to what extent, the "economic substance" doctrine can be used as a means for disregarding longstanding and well-developed foreign tax credit rules with which the taxpayer has fully complied, as opposed to a means to address questions that arise in the application of specific statutory and regulatory provisions.

CORPORATE DISCLOSURE STATEMENT

 

 

Petitioner Salem Financial, Inc. is a wholly-owned subsidiary of Branch Banking and Trust Company. Branch Banking and Trust Company is a wholly-owned subsidiary of BB&T Corporation, a publicly traded company listed on the New York Stock Exchange.

                          TABLE OF CONTENTS

 

 

 QUESTIONS PRESENTED

 

 

 CORPORATE DISCLOSURE STATEMENT

 

 

 TABLE OF AUTHORITIES

 

 

 PETITION FOR A WRIT OF CERTIORARI

 

 

 OPINIONS BELOW

 

 

 STATEMENT OF JURISDICTION

 

 

 STATUTORY AND REGULATORY PROVISIONS INVOLVED

 

 

 STATEMENT OF THE CASE

 

 

      A. Statutory and Regulatory Background

 

 

      B. The STARS Transaction

 

 

      C. BB&T's U.S. Tax Treatment

 

 

      D. Proceedings Below

 

 

 REASONS FOR GRANTING THE WRIT

 

 

      I. This Court's Review Is Necessary To Unify The Courts Of

 

         Appeals' Approach To The "Economic Substance" Test

 

 

           A. There Is a Square and Well-Developed Circuit Conflict on

 

              How to Account for Foreign Taxes Paid in Determining a

 

              Transaction's Profitability

 

 

           B. This Case Presents a Clean Vehicle for Resolving the

 

              Critical Issue of How to Account for Foreign Taxes When

 

              Applying the "Economic Substance" Doctrine

 

 

     II. The Federal Circuit's Decision Conflicts With This Court's

 

         Formulation Of The "Economic Substance" Doctrine

 

 

 CONCLUSION

 

 

 APPENDICES

 

 

 Appendix A, Federal Circuit Opinion

 

 

 Appendix B, Court of Federal Claims Opinion on Motion to Alter or

 

             Amend Judgment

 

 

 Appendix C, Court of Federal Claims Opinion

 

 

 Appendix D, 26 U.S.C. § 901 -- Selected Sections

 

 

 Appendix E, 26 C.F.R. § 1.901-2 -- Selected Sections

 

 

                          TABLE OF AUTHORITIES

 

 

 Cases

 

 

 Amoco Corp. v. Comm'r, 138 F.3d 1139 (7th Cir. 1998)

 

 

 Bank of N.Y. Mellon Corp. v. Comm'r, 140 T.C. 15 (2013)

 

 

 Bank of N.Y. Mellon Corp. v. Comm'r, --- F.3d ---, 2015 WL

 

 5234396 (2d Cir. Sept. 9, 2015)

 

 

 Benz v. Compania Naviera Hidalgo, S.A., 353 U.S. 138 (1957)

 

 

 Boulware v. United States, 552 U.S. 421 (2008)

 

 

 Burnet v. Chicago Portrait Co., 285 U.S. 1 (1932)

 

 

 Comm'r v. Clark, 489 U.S. 726 (1989)

 

 

 Compaq Computer Corp. v. Comm'r, 113 T.C. 214 (1999)

 

 

 Compaq Computer Corp. v. Comm'r, 277 F.3d 778 (5th Cir. 2001)

 

 

 Cottage Savings Ass'n v. Comm'r, 499 U.S. 554 (1991)

 

 

 Dewees v. Comm'r, 870 F.2d 21 (1st Cir. 1989)

 

 

 Diedrich v. Comm'r, 457 U.S. 191 (1982)

 

 

 Founders Gen. Corp. v. Hoey, 300 U.S. 268 (1937)

 

 

 Frank Lyon Co. v. United States, 435 U.S. 561 (1978)

 

 

 Golsen v. Comm'r, 54 T.C. 742 (1970)

 

 

 Gregory v. Helvering, 293 U.S. 465 (1935)

 

 

 Horn v. Comm'r, 968 F.2d 1229 (D.C. Cir. 1992)

 

 

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

 

 

 In re CM Holdings, Inc., 301 F.3d 96 (3d Cir. 2002)

 

 

 Kirchman v. Comm'r, 862 F.2d 1486 (11th Cir. 1989)

 

 

 Knetsch v. United States, 364 U.S. 361 (1960)

 

 

 Nassau Lens Co. v. Comm'r, 308 F.2d 39 (2d Cir. 1962)

 

 

 Old Colony Trust Co. v. Comm'r, 279 U.S. 716 (1929)

 

 

 Santander Holdings USA, Inc. v. United States, 977 F. Supp. 2d

 

 46 (D. Mass. 2013)

 

 

 United States v. Consumer Life Ins. Co., 430 U.S. 725 (1977)

 

 

 Wells Fargo & Co. v. United States, No. 09-cv-2764 (D. Minn.

 

 filed Oct. 5, 2009)

 

 

 Statutes and Regulations

 

 

 26 C.F.R. § 1.901-2

 

 

 26 C.F.R. § 1.904-6

 

 

 26 C.F.R. § 1.905-2

 

 

 26 U.S.C. § 356

 

 

 26 U.S.C. § 901

 

 

 26 U.S.C. § 904

 

 

 26 U.S.C. § 1001

 

 

 26 U.S.C. § 6662

 

 

 26 U.S.C. § 7701

 

 

 28 U.S.C. § 1254

 

 

 28 U.S.C. § 1491

 

 

 Legislative Materials

 

 

 H.R. Rep. No. 65-767 (1918)

 

 

 H.R. Rep. No. 83-1337 (1954)

 

 

 H.R. Rep. No. 108-755 (2004)

 

 

 Agency Materials

 

 

 I.R.S., Statistics of Income -- 2010, 2011, 2012,

 

 Corporation Income Tax Returns

 

 

 I.R.S. Gen. Couns. Mem. 38,467 (Aug. 11, 1980)

 

 

 I.R.S. Tech. Adv. Mem. 78-40-001 (Sept. 15, 1977)

 

 

 Notice 2010-62, 2010-40 I.R.B. 411

 

 

 Rev. Rul. 83-142, 1983-2 C.B. 68

 

 

 Other Authorities

 

 

 Boris Bittker & James Eustice, Federal Income Taxation of

 

 Corporations and Shareholders (7th ed. Supp. 2014)

 

 

 D. Kevin Dolan, The Foreign Tax Credit Diaries -- Litigation Run

 

 Amok, 71 Tax Notes Int'l (TA) 831 (Aug. 26, 2013)

 

 

 James M. Peaslee, Creditable Foreign Income Taxes and the Economic

 

 Substance Profit Test, 114 Tax Notes 443 (Jan. 29, 2007)

 

 

 Marc D. Teitelbaum, Compaq Computer and IES Industries: The Empire

 

 Strikes Back, 86 Tax Notes 829 (Feb. 7, 2000)

 

 

 Richard Lipton, BNY & AIG -- Using Economic Substance to Attack

 

 Transactions the Courts Do Not Like, 119 J. Tax. 40 (2013)

 

 

 Robert H. Dilworth, The Sky Is not Falling, After Compaq:

 

 The Business Purpose Doctrine is Alive and Well in the Fifth

 

 Circuit, 793 PLI/Tax 323 (2007)

 

PETITION FOR A WRIT OF CERTIORARI

 

 

Petitioner Salem Financial, Inc. respectfully petitions for a writ of certiorari to review the judgment of the United States Court of Appeals for the Federal Circuit in this case.

 

OPINIONS BELOW

 

 

The opinion of the Court of Appeals (Pet. App. 1a-51a) is reported at 786 F.3d 932. The opinions of the Court of Federal Claims (Pet. App. 52a-60a and 61a-177a) are reported at 119 Fed. Cl. 84 and 112 Fed. Cl. 543.

 

STATEMENT OF JURISDICTION

 

 

The Federal Circuit issued its decision on May 14, 2015. On July 14, 2015, Chief Justice Roberts extended the time for filing a petition to and including September 11, 2015. See No. 15A45. On August 17, 2015, Chief Justice Roberts further extended the time for filing a petition to and until October 11, 2015. See id. This Court has jurisdiction under 28 U.S.C. § 1254(1).

 

STATUTORY AND REGULATORY

 

PROVISIONS INVOLVED

 

 

Selected portions of Section 901 of the Internal Revenue Code, 26 U.S.C. § 901, are attached at Pet. App. 178a-179a. Selected portions of Treasury Regulation 1.901, 26 C.F.R. § 1.901, are attached at Pet. App. 180a-190a.

 

STATEMENT OF THE CASE

 

 

Petitioner ("BB&T") paid approximately $500 million in U.K. taxes on income from a trust and claimed a foreign tax credit under U.S. law to ensure it would not be double taxed on that same income. No one doubts that BB&T actually paid the British taxing authorities. And no one doubts that BB&T complied with all requirements of the applicable foreign tax credit rules. Those rules are "a byzantine structure of staggering complexity,"1 that are specifically designed to address the precise circumstances in which foreign tax credits are available and to prevent double taxation of foreign income. Nevertheless, despite BB&T's payment of approximately $500 million in U.K. taxes and its compliance with all applicable statutory and regulatory provisions, the Federal Circuit disallowed a tax credit for the foreign taxes paid on the basis that, in the court's view years later, the multi-billion dollar cross-border transaction that gave rise to the U.K. tax liability lacked "economic substance." The Federal Circuit then upheld tax penalties for good measure. The result of that decision is a crushing burden of double taxation -- BB&T must pay U.S. taxes on the full amount of its income from the trust without any credit or deduction for the hundreds of millions of dollars already paid to the U.K. for that same income.

The Federal Circuit reached this result by employing a counterintuitive mode of analysis that the Fifth and Eighth Circuit have expressly rejected. In particular, in concluding that BB&T's cross-border transaction lacked economic substance, the Federal Circuit evaluated the profitability of the transaction by including the foreign taxes paid as expenses but excluding the foreign tax credits entirely. In other words, rather than view the profitability of the transaction either pre- or post-tax, the Federal Circuit counts taxes paid but not the credits earned by paying those same taxes. That methodology skews the analysis and stacks the deck against cross-border transactions. It directly affects the viability of a wide range of international transactions by U.S. companies implicating hundreds of billions of dollars each year.

The Federal Circuit's holding opens up an explicit conflict with the Fifth and Eighth Circuits, see Compaq Computer Corp. v. Comm'r, 277 F.3d 778 (5th Cir. 2001); IES Indus. Inc. v. United States, 253 F.3d 350 (8th Cir. 2001), which has deepened with the Second Circuit's recent decision siding with the Federal Circuit. Bank of N.Y. Mellon Corp. v. Comm'r of Internal Revenue, --- F.3d ---, 2015 WL 5234396, at *19 (2d Cir. Sept. 9, 2015) ("[I]t is appropriate, in calculating pre-tax profit [for foreign tax credits], for a court both to include the foreign taxes paid and to exclude the foreign tax credits claimed."). The Second Circuit aptly summarized the current state of the law: "In so holding, we agree with the Federal Circuit in Salem and disagree with decisions of the Fifth and Eighth Circuits (Compaq and IES, respectively)." Id. Only this Court can resolve this deep and acknowledged split on an issue that dictates the viability of scores of cross-border transactions.

Even beyond the circuit split, the Federal Circuit's application of the economic substance doctrine creates vast uncertainty about the availability of foreign tax credits and other tax benefits. The Federal Circuit employs the economic substance doctrine not to inform the application of the extensive regulatory framework governing foreign tax credits, but as an amorphous threshold inquiry that threatens to render the entire foreign tax credit regulatory framework (and other tax provisions) irrelevant. Here, BB&T undeniably paid hundreds of millions of dollars in U.K. taxes that satisfied all the relevant regulations. Yet years later -- after substantial amounts of money changed hands and substantial taxes were paid -- BB&T has been denied a tax credit, denied a deduction, and penalized for those same transactions. In light of the Federal Circuit's nationwide jurisdiction over tax refund appeals, this misguided approach now affects every taxpayer seeking a refund for denied credits and other tax benefits. Taxpayers deserve greater certainty than the Federal Circuit's rule provides. Only this Court's review will provide that certainty and resolve the split among the Circuits.

A. Statutory and Regulatory Background

Foreign tax credits play a prominent role in the modern global economy. In recent years, U.S. corporations have claimed more than $100 billion annually in foreign tax credits. The substantial amount of credits claimed is a result of the fact that many critical transactions straddle jurisdictions and require U.S. companies to pay taxes abroad. See IRS, Statistics of Income -- 2010, 2011, 2012, Corporation Income Tax Returns, http://www.irs.gov/uac/SOI-Tax-Stats-Corporation-Complete-Report.

The claiming of these credits is, and long has been, the subject of extensive and detailed government regulation. In recognition of the stifling economic effect of taxing the same income twice, the United States adopted its first foreign tax credit in 1918. That credit attempted to alleviate the "very severe burden" on U.S. companies that resulted from double taxation, H.R. Rep. No. 65-767, at 11 (1918), and, in so doing, "facilitate the[ ] foreign enterprises" of U.S. taxpayers, Burnet v. Chicago Portrait Co., 285 U.S. 1, 9 (1932). See id. at 7 (the "primary design" of the 1918 foreign tax credit "was to mitigate the evil of double taxation").

In the century that has passed since the adoption of that first foreign tax credit, Congress and Treasury have endeavored to revise and refine the statutory and regulatory framework such that it provides clear rules for taxpayers and prevents abuse. Bittker & Eustice, supra, ¶ 15.21; D. Kevin Dolan, The Foreign Tax Credit Diaries -- Litigation Run Amok, 71 Tax Notes Int'l (TA) 831 (Aug. 26, 2013). The result of those efforts is a highly reticulated regime that, while complicated, is meant to provide the certainty necessary to encourage economically desirable cross-border investment. The backbone of that framework is a series of definitions intended to make clear which payments of foreign taxes count -- and which do not -- for foreign tax credit purposes.

Thus, the relevant statutory provisions and regulations clearly define what constitutes a creditable foreign "tax" as opposed to a non-creditable penalty or fee, see 26 U.S.C. § 901(b)(1); 26 C.F.R. § 1.901-2(a)(1)-(3), and establish what constitutes a creditable compulsory tax and a non-creditable voluntary tax, see 26 C.F.R. § 1.901-2(e)(5)(i). The rules also define what amount of foreign taxes is considered paid and not otherwise refunded, directly or indirectly, to the taxpayer or a counterparty by the levying foreign authority. See 26 U.S.C. §§ 901(b)(1), 901(i); 26 C.F.R. §§ 1.901-2(e)(2)-(3), 1.905-2(a)(2).

These comprehensive definitions are complemented by an equally comprehensive set of guidelines with the identical aim of creating certainty and preventing abuse. Among other things, the foreign tax credit rules establish when credits may be claimed for foreign taxes imposed on payments or other items not recognized as income for U.S. tax purposes, including transactions that are treated as circular flows of cash or as non-economic payments under U.S. tax principles but are respected under foreign tax principles. See generally 26 U.S.C. § 904(d)(2)(H); 26 C.F.R. § 1.904-6(a)(1)(iv); H.R. Rep. No. 108-755 at 381-85 (2004); Rev. Rul. 83-142, 1983-2 C.B. 68; I.R.S. Tech. Adv. Mem. 78-40-001 (Sept. 15, 1977); I.R.S. Gen. Couns. Mem. 38,467 (Aug. 11, 1980) ("After losing a number of court cases, the [government] long ago conceded that the amount of creditable foreign tax is the amount paid to the foreign government (assuming the tax examined in its entirely is a qualified income tax) regardless of whether the foreign government taxes some items that under United States law would not be income.").2 The foreign tax credit rules also draw clear lines regarding who is treated as having paid a foreign tax when there are multiple parties to which the tax liability could be attributed, see 26 C.F.R. § 1.901-2(f)(3), or when one party pays or reimburses the foreign tax imposed on another party, see 26 C.F.R. § 1.901-2(f)(2).

If a U.S. corporation's foreign tax payments fall within the relevant definitions and comply with applicable rules and regulations, the corporation is entitled to a tax credit in "the amount of any income . . . taxes paid or accrued during the taxable year to any foreign country." 26 U.S.C. § 901(b)(1); see also id. § 27(a) ("The amount of taxes imposed by foreign countries . . . shall be allowed as a credit against the tax imposed by this chapter to the extent provided in section 901.").

B. The STARS Transaction

In 2002, BB&T was growing rapidly throughout the southern United States. JA280, 294. To fulfill the substantial funding need associated with that growth, BB&T entered into the transaction at the heart of the instant dispute. That transaction, known as a Structured Trust Advantaged Repackaged Securities transaction, or STARS, is undeniably complex. JA280; JA196; JA21346; JA16323. But that complexity only reflects the sophistication of the parties involved and the nature of cross-border transactions that must account for the statutory and regulatory requirements of multiple jurisdictions.

The STARS transaction had three critical components: (1) a $1.5 billion loan from Barclays to BB&T; (2) a Trust, which was a U.K. resident, and a Trust subsidiary used to facilitate the transaction and generate U.K. tax benefits for Barclays; and (3) a series of payments made by Barclays to BB&T (the "Bx payments"). The loan was effectuated through a $1.5 billion contribution by Barclays to the Trust. Pursuant to the STARS agreements, BB&T was permitted to draw that cash from the Trust and obligated to return the entire $1.5 billion -- with interest accrued at a rate of LIBOR + 25 basis points -- within five years to Barclays via a purchase of Barclays' interest in the Trust. Pet. App. 114a.3

BB&T contributed $6.1 billion in assets to the Trust and Trust subsidiary in the form of income-generating auto and home loans and other assets. Id. at 110a-111a. Approximately $1.5 billion of those assets represented collateral for BB&T's obligation to repurchase Barclays' interest in the Trust and return Barclay's $1.5 billion cash. Id. The remaining $4.6 billion generated income for the Trust and Trust subsidiary and was available to satisfy any claims that Barclays might have against BB&T (and ahead of any other creditors of BB&T). The Trust submitted annual U.K. income tax returns reflecting the income earned on these assets and paid all U.K. taxes. Id. at 118a.

With these assets in place, the Trust subsidiary made monthly distributions of cash to the Trust based on income generated from the BB&T loan assets and received monthly re-investments of that cash (net of U.K. taxes owed and minor distributions made on other interests in the Trust). Id. at 114a-116a. Barclays, in turn, received monthly distributions of cash from the Trust and then re-contributed the cash to the Trust. Id. These distributions and re-contributions allowed Barclays to claim certain U.K. tax benefits; those benefits were one of the primary drivers of Barclays' willingness to engage in the STARS transaction.4See id. at 127a-129a. BB&T was not directly involved in and did not receive any direct benefit from these distributions, which related only to Barclays' U.K. tax treatment, not to BB&T's U.S. tax position. In fact, BB&T affirmatively disregarded these distributions and recontributions for U.S. federal income tax purposes.

The last component of the STARS transaction, the "Bx payments," constituted payments from Barclays to BB&T and totaled approximately $240 million over the nearly five-year life of the Trust. Pet. App. 124a-126a. Those payments were intended to provide compensation (and taxable income) to BB&T for entering into the STARS transaction. Id. at 124a-125a. These monthly payments reduced the net cost of the STARS funding well below BB&T's normal cost of funds. JA11723-24. The parties determined the amount of the Bx payments before entering into the transaction; although the amount of the payments was based on Barclays' anticipated UK tax benefits, the payments were negotiated and pre-set according to a fixed schedule at the outset of the transaction and were not dependent upon Barclays' actual realization of these U.K. benefits. JA724, 47347, 50016; Pet. App.6a.

Both Barclays and BB&T realized tangible benefits and incurred real costs as a result of the STARS transaction. Barclays' $1.5 billion contribution to the Trust was unavailable to Barclays during the life of the Trust -- a hard cost for Barclays. In exchange for that cash contribution, Barclays stood to gain the interest BB&T would pay on top of repaying the $1.5 billion and the U.K. tax benefits associated with the operation of the Trust. On the other side of the ledger, BB&T had access to the $1.5 billion in cash provided by Barclays and received the Bx payments from the Trust in exchange for making the loan interest payments and tying up $6.1 billion in auto loans, home loans, and other income-generating assets in the Trust. More than this, BB&T received additional benefits from the STARS transaction because it permitted the bank to diversify its funding base, JA25634; JA25636; JA110, and reduce its liquidity risk, JA295.

C. BB&T's U.S. Tax Treatment

The Trust earned income of approximately $2.3 billion over its approximately five-year life and BB&T paid $500 million in taxes -- the applicable 22-percent U.K. rate -- to the U.K. government based on that income. BB&T's projected U.S. tax liability for that $2.3 billion in income was $805 million based on the U.S. 35-percent corporate tax rate. When BB&T filed its U.S. corporate income tax returns for the years corresponding to the life of the Trust (2002-2007), BB&T claimed a foreign tax credit for the $500 million paid to the U.K., which reduced its STARS-related U.S. tax liability to roughly $305 million.

BB&T's reasons for claiming the credit based on the $500 million paid to the U.K. government were straightforward. BB&T satisfied all applicable statutory and regulatory requirements for such a credit. What is more, in the absence of a credit, BB&T faced double taxation at a rate of 57-percent and a combined tax liability of $1.3 billion on $2.3 billion of income -- $500 million in U.K. taxes and $805 million in U.S. taxes.5 Despite this straightforward justification, the IRS denied BB&T's foreign tax credit claims and imposed accuracy-related penalties on the bank.

D. Proceedings Below

BB&T paid the IRS what it claimed it was due and then filed suit in the Court of Federal Claims seeking a refund based on its full compliance with the foreign tax credit rules discussed supra.6 The Court of Federal Claims denied BB&T's request in its entirety. The court did not conclude that BB&T ran afoul of any of the applicable foreign tax credit statutory provisions or regulations. Instead, ignoring the tangible benefits realized and costs incurred by BB&T and Barclays in connection with the STARS transaction, the court held that key components of the transaction lacked "economic substance" and that, as a result, BB&T was not entitled to the foreign tax credit claimed. In the Court of Claims' view, the components of the STARS transaction -- including the $1.5 billion loan and the Trust and Trust subsidiary payments -- "lack[ed] both objective economic reality and a bona fide non-tax business purpose," which meant that the $500 million in taxes actually paid to the U.K. could not serve as the basis for a foreign tax credit in the U.S. Pet. App. 9a. Despite the fact that BB&T had complied with all relevant statutory and regulatory provisions and received advice from three separate firms about the proper tax treatment of the STARS transaction before claiming a credit, the court held that BB&T was liable for penalties under 26 U.S.C. § 6662 on the basis of negligence and tax understatement.

BB&T appealed and while the Federal Circuit reversed the Court of Claims on the "economic substance" of the $1.5 billion loan, it agreed that the Trust component of the STARS transaction lacked "economic substance." Pet. App. 32a-33a. The Federal Circuit began its analysis by stating that BB&T's compliance with all applicable statutory and regulatory requirements did not control and declined even to consider the import of any of those requirements. Id. at 11a-15a. The court instead explained that, in its view, the economic substance doctrine is "a prerequisite to the application of any Code provision allowing deductions." Id. at 13a (internal quotation marks omitted).

Having cast aside the comprehensive regulatory framework painstakingly developed by Congress and Treasury over the course of a century, the Federal Circuit proceeded to apply a two-prong "economic substance" test under which the court first considered whether the STARS Trust transaction had "economic reality" as an objective matter, and, second, if not, "whether the STARS Trust transaction nonetheless had a bona fide business purpose." Id. at 33a.

Applying the first prong of its "economic substance" test, the Federal Circuit concluded that BB&T incurred a foreign tax expense (approximately $500 million of U.K. taxes) that exceeded BB&T income from the Trust (the $240 million of Bx payments) and that "[t]he Trust transaction therefore is profitless before taking into account BB&T's expected foreign tax credits." Id. at 28a. This meant that the STARS Trust transaction lacked "economic reality" because (i) foreign tax payments should be included in the economic substance profitability analysis and (ii) BB&T had incurred U.K. taxes in excess of the income from the Bx payments. In so holding, the Federal Circuit recognized that it was parting ways with the Fifth and Eighth Circuits, which had both already held that foreign tax payments should not be included when considering a transaction's profitability for purposes of the "economic substance" analysis. Id. at 24a-27a; see Compaq, 277 F.3d at 784-785; IES, 253 F.3d at 354.Had the Federal Circuit not incorporated BB&T's foreign tax payments into its profitability analysis, or taken account of both the tax payments and BB&T's available foreign tax credits, the STARS Trust transaction would have been indisputably profitable.

The Federal Circuit then went on to consider whether despite its view that the STARS Trust transaction lacked economic reality, it "nonetheless had a bona fide business purpose." Pet. App. 33a. While the court had already determined (Pet. App. 15a-23a) that the Bx payment component of the transaction represented real, non-tax, economic income to BB&T pursuant to this Court's reasoning in Old Colony Trust Co. v. Commissioner, 27 U.S. 716 (1929), the court concluded that the $240 million in Bx payments from Barclays could not represent "profit from any business activity" supporting a non-tax business purpose and was instead "the means by which Barclays and BB&T shared the tax benefits of the Trust transaction." Pet. App. 35a-36a. The court summarized its analysis by declaring that "[t]o hold that a transaction has a bona fide business purpose whenever it has a prospect of producing economic benefit for the taxpayer would eliminate the 'business purpose' test altogether, since the taxpayer normally will not engage in a transaction absent the prospect that it will result in some monetary gain." Id. at 36a.

Furthermore, despite recognizing that BB&T had paid in cash U.K. taxes and had received no rebate or refund of those taxes and thus no U.S. tax benefits, the Federal Circuit concluded that the STARS Trust transaction had no bona fide business purpose because it represented a "prepackaged strategy" in which BB&T would "self-inflict" U.S. assets to U.K. tax and generate U.S. and U.K. tax benefits. Id. at 33a, 35a.7

Finally, even though it recognized that it had split with the decision of two other Circuit courts that were issued years before the STARS transaction, the Federal Circuit upheld the Court of Claims' decision to impose accuracy-related penalties. The court rejected BB&T's argument that it had reasonable cause for claiming foreign tax credits related to STARS and did so in good faith. The Federal Circuit justified the imposition of penalties by stating that it did "not regard the application of the economic substance doctrine to this case to present any ambiguity." Id. at 51a.

As already noted, after the decision in this case, the Second Circuit held that a similar STARS transaction lacked economic substance. Bank of N.Y. Mellon, 2015 WL 5234396, at *19. The Second Circuit explicitly agreed with the Federal Circuit's decision here and expressly disagreed with the Fifth and Eighth Circuits, and held that foreign tax expenses (but not foreign tax credits) should be included in the profitability analysis. Id.

 

REASONS FOR GRANTING THE WRIT

 

 

I. This Court's Review Is Necessary To Unify The Courts Of

 

Appeals' Approach To The "Economic Substance" Test.

 

 

A. There Is a Square and Well-Developed Circuit Conflict on How to Account for Foreign Taxes Paid in Determining a Transaction's Profitability.

As the Second Circuit recently affirmed, there is a clear division of authority in the nation's federal appellate courts regarding the application of the economic substance doctrine to cross-border transactions. The Second Circuit in Bank of N.Y. Mellon and the Federal Circuit in this case have both held that in evaluating the profitability of a cross-border transaction, courts must include expected foreign tax expense and must exclude U.S. tax credits that would flow from those foreign taxes. Rather than evaluate the transaction from a purely pre-tax or post-tax standpoint, the Second and Federal Circuits take a hybrid approach in which foreign taxes count, but U.S. credits do not. The Fifth and Eight Circuits have reached the opposite conclusion, holding that neither foreign taxes nor resulting U.S. credits should be taken into account when assessing a transaction's profitability. See Compaq, 277 F.3d 778; IES, 253 F.3d 350; see also Bank of N.Y. Mellon, 2015 WL 5234396, at *19 ("[W]e agree with the Federal Circuit in Salem and disagree with decisions of the Fifth and Eighth Circuits (Compaq and IES, respectively)" -- "it is appropriate, in calculating pre-tax profit [for foreign tax credits], for a court both to include the foreign taxes paid and to exclude the foreign tax credits claimed.").

The division in authority is amply demonstrated by a brief review of Compaq and IES and the Federal Circuit's hostile treatment of those decisions. Compaq and IES involved nearly identical fact patterns, in which U.S. corporations bought and sold shares in a publicly traded foreign company that issued dividends subject to foreign income tax. Compaq, 277 F.3d at 779-80; IES, 253 F.3d at 352.The Tax Court in Compaq had concluded that there was no prospect for gain or profit using what the Fifth Circuit called "a curious method of calculation": the Tax Court included the foreign tax payments, but not the foreign tax credit, in the analysis of profitability. 277 F.3d at 782. As the Fifth Circuit explained, the Tax Court "assessed neither the transaction's pre-tax profitability nor its post-tax profitability," but rather "assessed profitability by looking at the transaction after [the foreign] tax had been imposed but before considering U.S. income tax consequences." Id. Thus, "the court treated the [foreign] tax as a cost of the transaction, but did not treat the corresponding U.S. tax credit as a benefit of the transaction." Id.

On appeal, the Fifth Circuit in Compaq, expressly agreeing with the Eighth Circuit in IES, held that the gross dividend, not the dividend net of foreign taxes, should have been used to compute the taxpayer's pre-tax profit. The Fifth Circuit explained that Compaq's transaction resulted in a pre-tax profit and thus "[t]he transaction had economic substance." Id. at 786; see also IES, 253 F.3d at 354 ("Becausethe entire amount of the . . . dividends was income to IES, the . . . transactions resulted in a profit, an economic benefit to IES."). The Fifth Circuit also strongly rebuked the Tax Court's "half pre-tax, half after-tax" approach, recognizing that the IRS's approach of counting taxes "only when they subtract from cash flow is to stack the deck against finding the transaction profitable," and that it was necessary to "un-stack the deck." 277 F.3d at 782, 785.

The Federal Circuit did exactly what the Fifth Circuit and the Eighth Circuit proscribed in Compaq and IES -- it counted foreign tax payments "only when they subtract[ed] from cash flow" and thereby "stack[ed] the deck against finding the transaction profitable." Id. at 785. In the course of doing so, the Federal Circuit sharply criticized the transactions in Compaq and IES and the Fifth and Eighth Circuit's reasoning. The Federal Circuit commented that the transactions in Compaq and IES "did not meaningfully alter the taxpayers' economic position (apart from their tax consequences); they involved essentially no risk (other than the risk that the transactions would be disallowed for tax purposes); and they offered no opportunity for economic gain (except for the tax benefits)." Pet. App. 26a. Based on that view, and directly contradicting the Fifth and Eighth Circuits, the Federal Circuit concluded that "[t]he Compaq and IES transactions produced no real economic profit." Id. The Federal Circuit emphasized that any apparent profit in those cases was a result of including in income the amount of the dividend "without taking into account the foreign taxes paid on the dividend." Id.8

The Federal Circuit split from the Fifth and Eighth Circuits on this critical issue in another way. Both Compaq and IES heavily relied on this Court's opinion in Old Colony Trust, and the principles announced therein. As the Fifth and Eighth Circuits recognized, Old Colony Trust, supra, establishes that "[t]he discharge by a third person of [a taxpayer's] obligation" is "equivalent to receipt by the person taxed." Compaq, 277 F.3d at 783; see IES, 253 F.3d at 354; see also Diedrich v. Comm'r, 457 U.S. 191, 197 (1982) ("[T]he donor realizes an immediate economic benefit by the donee's assumption of the donor's legal obligation to pay the gift tax"). The Fifth and Eighth Circuits held that this "venerable principle" applies to foreign taxes: when a taxpayer earns income subject to a foreign tax, "the economic benefit to [the taxpayer] [is] the amount of . . . gross [income], before the foreign taxes are paid." IES, 253 F.3d at 354; Compaq, 277 F.3d at 784 ("Pre-tax income is pre-tax income regardless of the timing or origin of the tax."). In disagreeing with the Fifth and Eighth Circuits, the Federal Circuit failed to address this fundamental point.

In short, the Federal Circuit made clear that, under its approach, the transactions in Compaq and IES "produced no real profit" and thus it would have decided those cases differently. Pet. App. 26a-27a. If this case had arisen in the Fifth or Eighth Circuit, the foreign tax expense incurred by BB&T would be excluded; the Trust transaction would have generated substantial pre-tax profit in the form of the Bx payments; the goal of seeking this profit would have represented a valid non-tax business purpose; and BB&T would not be required to pay approximately $500 million in double taxation. The Second Circuit has subsequently deepened the split and underscored that it is open, acknowledged and consequential. See Bank of N.Y. Mellon, supra. This Court should grant certiorari and resolve it.

B. This Case Presents a Clean Vehicle for Resolving the Critical Issue of How to Account for Foreign Taxes When Applying the "Economic Substance" Doctrine.

Lest there be any doubt, the issue presented for review is important and recurring. The decisions of the Federal Circuit and the Second Circuit have cast a fog of uncertainty over a wide variety of cross-border transactions -- and have done so at a time when the global economy makes that issue especially salient. In each of the past three years for which public figures are available, U.S. corporations claimed over $100 billion of foreign tax credits. See IRS, Statistics of Income -- 2010, 2011, 2012, Corporation Income Tax Returns. In sharp conflict with the goals of the foreign tax credits rules, U.S. corporations now do not know whether they will be liable for taxes in more than one country on the same income. Businesses and financial institutions contemplating major international transactions need to know which rule governs -- the rule in the Federal and Second Circuits, which, in determining profitability of a transaction, includes foreign tax expense as a cost, or the rule in the Fifth and Eighth Circuits, which excludes foreign tax expense and thus "unstack[s] the deck" against taxpayers. It is this very form of uncertainty that this Court has long sought to avoid in the application of the tax laws. Founders Gen. Corp. v. Hoey, 300 U.S. 268, 275(1937).9

Moreover, this case presents a clean and compelling vehicle for this Court's consideration of the issue. In light of the parties' agreement on bifurcation (Pet. App. 11a), there is no question whether income from the Bx payments and earnings from investing the Loan proceeds together could exceed the foreign tax expense and create pre-tax profit regardless of whether the foreign tax expense is taken into account or not. Instead, a fundamental, outcome-determinative issue in this case is whether the U.K. tax expense should or should not be used to offset the Bx payments and find the transaction unprofitable. The inclusion or exclusion of foreign tax expense in this case determines whether BB&T has pre-tax profit or loss, whether BB&T's transaction thus represents "genuine business activity," and thus whether BB&T's transaction has economic substance. If the Trust transaction was profitable (as it is without the inclusion of the foreign tax expenditures), the Trust transaction meaningfully changed BB&T's position and BB&T had substantial purpose apart from tax effects for contributing assets to the Trust. Inclusion or exclusion of foreign taxes thus determines the economic substance inquiry. The issue over which the circuits have split is starkly presented for this Court.

Finally, there is no reason to allow this issue to "percolate." There already exists a direct, acknowledged split involving four Circuits. Indeed, one of those courts -- the Federal Circuit -- has national jurisdiction over taxpayers seeking refunds of taxes erroneously collected. Moreover, the Tax Court, which has national jurisdiction, has spoken to this issue definitively in the Compaq case, 113 T.C. 214 (1999), and then again in the Bank of N.Y. Mellon case, 140 T.C. 15 (2013). Under its procedures, the Tax Court's Compaq decision, although reversed by the Fifth Circuit, applies to all Tax Court cases except for those that will go to the Fifth Circuit (and to the Eighth Circuit because of the IES decision). See Golsen v. Comm'r, 54 T.C. 742, 757 (1970) (Court of Appeals opinion reversing Tax Court applies only to Tax Court cases that will be appealed to that Court of Appeals), aff'd, 445 F.2d 985 (10th Cir. 1971); see also Bank of N.Y. Mellon, 140 T.C. at 35 n.9 (confirming that the Tax Court will follow its reversed Compaq decision in cases that are not within the Fifth or Eighth Circuits: "we are not bound by Fifth and Eighth Circuit precedent here").10

The issue presented in this case has thus been extensively discussed and considered by the Second, Fifth, Eighth, and Federal Circuits (along with the Tax Court), and there is no reason to wait for more courts to weigh in on the issue. The issue has direct bearing on several cases already filed; affects even more cases working their way through the administrative process before the Internal Revenue Service; and has a significant impact on a broad swathe of corporate and financial transactions. The Court should accordingly decide this issue now in the interest of judicial and administrative economy, as well as economic predictability, and allow BB&T, which has more than $600 million in taxes and penalties at stake, the chance to have its case heard on this fundamental issue that has divided the Courts of Appeals.

 

II. The Federal Circuit's Decision Conflicts With This

 

Court's Formulation Of The "Economic Substance" Doctrine.

 

 

This case also raises important issues about the scope of the economic substance doctrine and the appropriate role of the judiciary in deciding to rely on its own evaluation of business activities to decide tax consequences, rather than adhere to the otherwise applicable statutory and regulatory provisions.

The Federal Circuit articulated and applied an "economic substance" framework in which the judiciary applies the economic substance doctrine as an independent "prerequisite" unmoored to the applicable statutory and regulatory provisions, rather than as a tool for ensuring that specific, identified provisions are honored in substance as well as form. See, e.g., Pet. App. 13. Thus, in this case, the Federal Circuit never considered or addressed any of the extensive foreign tax credit provisions, including the anti-abuse provisions, and never explained precisely how it needed to use the economic substance doctrine to give effect to a duly enacted or promulgated provision.

This free-floating "threshold" inquiry conflicts with the carefully limited economic substance doctrine explicated by this Court beginning in Gregory v. Helvering, 293 U.S. 465 (1935). In that case, the question was whether a corporate "reorganization" had occurred within the meaning of the Revenue Act of 1928. This Court held that the putative reorganization was not a reorganization in substance because it had "no business or corporate purpose" -- it was a "mere device" to "disguise" the "real character" of the transaction -- and thus the transaction was "outside the plain intent of the statute." Id. at 469-70. This Court explained that "the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended." Id. at 469.

In Knetsch v. United States, 364 U.S. 361 (1960), the question was whether certain payments made by the taxpayer arose from "indebtedness" within the meaning of § 23(b) of the Internal Revenue Code. Applying Gregory, this Court held that there "was nothing of substance" to the "sham" transaction and so there was no "indebtedness" within the terms of the statute. Id. at 366.

Similarly, in Frank Lyon Co. v. United States, 435 U.S. 561 (1978), this Court considered the "objective economic realities" of a sale-and-leaseback transaction to decide if the taxpayer was entitled to claim deductions that accrue only to the owner of property that "held" or "used" the property. Id. at 570, 573, 581.

In each of these cases, the Court examined the economic substance of a transaction to decide whether a particular statutory term applied. See also Boulware v. United States, 552 U.S. 421, 429(2008) ("tax classifications like 'dividend' and 'return of capital' turn on 'the objective economic realities of a transaction'") (quoting Frank Lyon Co., 435 U.S. at 573); Comm'r v. Clark, 489 U.S. 726, 737 (1989) (looking to "the language and history of the statute, as well as a commonsense understanding of the economic substance of the transaction at issue" in deciding whether a stock-for-stock exchange had "the effect of the distribution of a dividend," 26 U.S.C. § 356(a)(2)); United States v. Consumer Life Ins. Co., 430 U.S. 725, 740-41 (1977) (rejecting the Government's argument that the transaction lacked economic substance and should be disregarded because of a lack of risk-shifting where "[t]he word 'risk' does not occur" in the statute); cf. Cottage Savings Ass'n v. Comm'r, 499 U.S. 554, 562 (1991)(rejecting the Government's view that the term "material difference" in 26 U.S.C. § 1001(a) should be construed to mean "differ[ing] in economic substance" where the statute "embodie[d] a much less demanding and less complex test").

Here, the foreign tax credit statute provides: "In the case of . . . a domestic corporation, the amount of any income . . . taxes paid or accrued during the taxable year to any foreign country" "shall be allowed" as a "credit." 26 U.S.C. § 901(b)(1). There is no question that, as a consequence of the STARS transaction, Petitioner incurred a foreign income tax liability of approximately $500 million. Nor is there any question that Petitioner actually paid that sum in income taxes to the United Kingdom and those taxes were not refunded or rebated to Petitioner by any means. The satisfaction of the relevant statutory terms is not in doubt in form or substance. The Federal Circuit did not use economic substance as a tool to construe a disputed statutory term -- such as "reorganization" or "indebtedness" -- but as a judge-made means of denying favorable tax treatment to a taxpayer that has qualified for such treatment under the applicable statutes and regulations.

The First and D.C. Circuits have each followed the precedent of the Court, looking to the applicable statutes and regulations to inform and limit their application of the economic substance doctrine. See, e.g., Horn v. Comm'r, 968 F.2d 1229, 1234 (D.C. Cir. 1992) (judge-made doctrines are tools "for divining and effectuating congressional intent, not for supplanting it"); Dewees v. Comm'r, 870 F.2d 21, 29 (1st Cir. 1989) (citing Gregory quote above)).11

In contrast to this Court, and to the D.C. and First Circuits, the Federal Circuit refused to limit itself to the policies and purposes reflected in the finely reticulated foreign tax credit rules that the Government agrees that BB&T satisfied. Rather than considering any specific statutory or regulatory provisions, the Federal Circuit merely referred broadly to "the kinds of transactions on which Congress intended to confer the benefit of the federal tax credit provision." Pet. App. 14a. The Federal Circuit's misconception about this Court's economic substance doctrine -- and about the appropriate judicial role under that doctrine in declining to enforce otherwise applicable statutory and regulatory provisions -- played a crucial role in the Federal Circuit's erroneous analysis.

Perhaps not surprisingly, the Federal Circuit's use of the economic substance doctrine for a far-reaching judicial inquiry into permissible business practices led to several severe distortions of the comprehensive foreign-tax-credit legal architecture, as well as, at the most basic level, a deeply inappropriate judicial role.

First, Congress's purpose in enacting the foreigntax credit rules was to prevent double taxation and treat foreign taxes as equivalent to U.S. taxes. Congress expressly stated that the rules "treat the taxes imposed by the foreign country as if they were imposed by the United States." H.R. Rep. No. 83-1337 (1954) (emphasis added); see also id. at 4103 ("The provision was originally designed to produce uniformity of tax burden among United States taxpayers, irrespective of whether they were engaged in business in the United States or engaged in business abroad."). In contrast, the Federal Circuit justified its denial of BB&T's foreign tax credits by treating foreign taxes and U.S. taxes disparately, including U.K. taxes but not U.S. taxes in its profit calculations. In so doing, the Federal Circuit now requires taxpayers to evaluate foreign transactions after deducting foreign tax while evaluating domestic transactions as if they were tax free. Such a rule upsets the neutrality and uniformity that Congress sought to achieve with the foreign tax credit and creates a bias against cross-border transactions in sharp conflict with the statutory purpose.

Second, the Federal Circuit's references to BB&T "voluntarily" subjecting or "self-inflict[ing]" income to foreign tax, Pet. App. 32a-33a, contradicts Treasury's own express decision reflected in the compulsory tax regulations (26 C.F.R. § 1.901-2(e)(5)(i)) not to second-guess a taxpayer's reason for incurring foreign tax. The Government has promulgated rules interpreting 26 U.S.C. § 901 acknowledging that taxpayers may structure their investments and otherwise arrange their affairs giving rise to foreign tax in any form and manner that they so wish. See, e.g., 26 C.F.R. § 1.901-2(e)(5)(i). Once taxpayers choose to transact in a foreign country, they need only take reasonable actions to minimize their foreign tax bill. The taxpayer's initial choice to transact in a manner that triggers foreign income tax liability and the form of the transaction are within the taxpayer's permissible discretion under the Government's own regulations.

Third, the Federal Circuit expressly took into account Barclays' U.K. tax benefits and motives to determine the propriety of BB&T's U.S. tax credit. This stretches the economic substance doctrine beyond its bounds, as the focus of this doctrine has solely been on "the taxpayer" whose tax position is at issue, not its counterparties (and certainly not the benefits of a foreign counterparty under foreign tax law). See Frank Lyon, 435 U.S. at 576-77. Relying on Barclays' U.K. tax benefits and motivations is glaringly inconsistent with the foreign tax credit rules, which contain express guidance regarding when a foreign counterparty's tax benefits under foreign law is "in substance" connected to, and thus can be used to deny, a taxpayer's foreign tax credit. See 26 U.S.C. § 901(i); 26 C.F.R. § 1.901-2(e)(3); see also Amoco Corp. v. Comm'r, 138 F.3d 1139, 1145(7th Cir. 1998) ("[I]t is easy to envision circumstances in which a third party pays foreign tax on behalf of a U.S. taxpayer and then receives a refund of that same payment. . . . [I]t seems to us that this is precisely what the indirect subsidy rule of § 1.901-2(e)(3) was designed to cover.") The Government agreed that BB&T satisfied those rules, and thus no further inquiry into Barclays' tax benefits is warranted.

Fourth, the Federal Circuit's requirement that aforeign tax be paid incident to a transaction that is recognized for U.S. tax purposes, Pet. App. 34a-35a, 41a-42a, conflicts with long-standing interpretations of section 901, reflected in rulings and regulations and later codified, that taxpayers may credit foreign taxes that are substantively paid but incurred incident to transactions substantively disregarded for U.S. tax purposes. See supra p. 6. These transactions often arise in the context of taxpayers structuring transactions to generate foreign tax benefits with no U.S. tax effects (other than the claiming of foreign tax credits to offset foreign taxes incurred). See, e.g., Rev. Rul. 83-142, 1983-2 C.B. 68; I.R.S. Tech. Adv. Mem. 78-40-001. As the Government has repeatedly recognized, this policy is compelled by "the statutory language of section 901" and reflects a policy decision to avoid the "monumental tracing problems" that would result from attempting to "adjust the amount of foreign tax to the amount that would have been imposed by using United States standard of income." I.R.S. Gen. Couns. Mem. 38,467. The critical requirement is that a foreign income tax be paid in full and not refunded, and the Federal Circuit agreed that requirement was wholly satisfied in this case. Such full payment highlights why economic substance has been satisfied in this case: BB&T obtained "no [tax] advantage," paying "the same amount of tax, regardless of which country it was paid to." Santander Holdings USA, 977 F. Supp. 2d at 53.

Most fundamentally, the Federal Circuit's interpretation of the "economic substance" doctrine -- as a free-floating judicial inquiry that is a "prerequisite" unhinged from specific statutory and regulatory provisions -- raises fundamental concerns about the appropriate judicial role. The Court has not given guidance on the economic substance doctrine in almost 40 years (since Frank Lyon), and, as in this case, some lower courts have transformed what began as a tool of statutory interpretation into an unbounded roving commission for judicial assessment of business practices when evaluating taxpayer transactions that indisputably comply with the Internal Revenue Code and settled interpretations. This case demonstrates how far courts have stretched the economic substance doctrine beyond its original purpose: the Federal Circuit (which the Second Circuit followed) takes into account taxes in what is supposed to be a pre-tax analysis. Courts must instead carefully tailor application of this doctrine to the relevant, duly enacted and promulgated statutory and regulatory provisions.

Particular care should be afforded to applying this doctrine to the foreign tax credit rules, which implicate sensitive issues of foreign affairs, such as the tax regimes of foreign sovereigns and how our Government, our residents, and our tax system interact with them. The precise and detailed foreign tax credit rules reflect a delicate balance of cross-border policy concerns, and the judicial application of economic substance to prevent the ordinary operation of the foreign-tax-credit statute and rules must proceed with extra care and caution. See, e.g., Benz v. Compania Naviera Hidalgo, S.A., 353 U.S. 138, 147 (1957) ("For us to run interference in . . . a delicate field of international relations there must be present the affirmative intention of the Congress clearly expressed.").12

Quite simply, it is an event with profound separation-of-powers and rule-of-law implications when a court, at the request of the Executive Branch and in the name of "economic substance," overrides specific statutory and regulatory provisions and pre-empts their application. As this Court has long articulated, deploying the powerful "economic substance" weapon is appropriate only when it is necessary to effectuate specific, identified provisions, rather than as a charter for a sweeping, plenary judicial inquiry into what the court views as appropriate business practices. The Federal Circuit's approach here sharply conflicts with an appropriately cabined interpretation of the economic substance doctrine.

 

CONCLUSION

 

 

The Federal Circuit's treatment of foreign tax expense in evaluating the economic substance of transactions giving rise to foreign tax credits conflicts with decisions of the Fifth and Eighth Circuits, contravenes the purposes and history of the foreign tax credit rules and the economic substance doctrine, and defies common sense. The Court should provide guidance on this critical issue to resolve an important Circuit split; to provide legal certainty and clarity for economic actors contemplating major cross-border transactions; and to address the proper judicial role in applying a judicial doctrine that overrides otherwise applicable statutory and regulatory provisions. For the foregoing reasons, the petition for certiorari should be granted.

September 29, 2015

Respectfully submitted,

 

 

Clifford M. Sloan

 

Counsel of Record

 

Rajiv Madan

 

Christopher P. Bowers

 

Skadden, Arps, Slate, Meagher &

 

Flom LLP

 

1440 New York Ave., NW

 

Washington, DC 20005

 

(202) 371-7000 c

 

liff.sloan@skadden.com

 

 

Paul D. Clement

 

H. Christopher Bartolomucci

 

Bancroft PLLC

 

500 New Jersey Ave., NW

 

Seventh Floor

 

Washington, DC 20001

 

(202) 234-0090

 

FOOTNOTES

 

 

1 Boris Bittker & James Eustice, Federal Income Taxation of Corporations and Shareholders, ¶ 15.21[1] [a] (7th ed. Supp.2014).

2 Notably, the government initially promulgated and then rescinded a requirement in the foreign tax credit rules for taxpayers to demonstrate a non-tax business purpose to enter a foreign jurisdiction. JA49627-29. Citations to "JA" refer to the joint appendix filed in the Federal Circuit.

3 LIBOR -- the London Interbank Offered Rate -- is a published interest rate index commonly used to set interest rates on interbank loans.

4 Barclays' U.K. tax treatment can be understood with a straightforward example in which the Trust receives $100 of income from the assets that BB&T contributed. Id. at 127a-128a. Under the U.K. corporate rate of 30%, Barclays was subject to $30 of U.K. corporation tax on the distributions it received from the Trust. Id. at 127a. This tax liability was offset by three tax attributes: (i) a $22 credit for the $22 in taxes already paid by the Trust (based on a 22% tax rate for a trust), thus preventing taxation of the same income twice by the United Kingdom; (ii) a $23.40 trading loss deduction realized under U.K. law on the re-contribution of cash to the Trust; and (iii) a $3.30 deduction for the Bx payments. Id. at 127a-128a. The net result was a tax benefit that Barclays used to reduce its U.K. tax on income wholly unrelated to the Trust or the STARS transaction, thereby increasing its aggregate after-tax income. See, e.g., JA44458; Pet. App. 5a-6a.

5 BB&T also claimed deductions for interest paid on the Loan Transaction and for transaction costs associated with STARS. Those deductions are not at issue in this Petition.

6 The Court of Federal Claims had jurisdiction under 28 U.S.C. § 1491.

7 As structured by BB&T and Barclays, the STARS transaction was a single, integrated financing transaction. The government argued that the transaction should be bifurcated into a loan transaction and a trust transaction. BB&T disagrees with that characterization, but has accepted a bifurcated treatment for purposes of the appeal of this case to focus the discussion on the critical issues raised in this Petition. Pet. App. 11a.

8 While the Federal Circuit referenced commentary arguing that the transactions in Compaq and IES lacked economic substance (Pet. App. 27a n.6), it failed to acknowledge (as the Fifth Circuit had in Compaq, 277 F.3d at 783 n.3) commentary supporting the analysis in those decisions. See, e.g., Marc D. Teitelbaum, Compaq Computer and IES Industries: The Empire Strikes Back, 86 Tax Notes 829, 836 (Feb. 7, 2000); Dolan, supra, at 842; Richard Lipton, BNY & AIG -- Using Economic Substance to Attack Transactions the Courts Do Not Like, 119 J. Tax. 40, 46 (2013); James M. Peaslee, Creditable Foreign Income Taxes and the Economic Substance Profit Test, 114 Tax Notes 443 (Jan. 29, 2007); Robert H. Dilworth, The Sky Is Not Falling After Compaq: The Business Purpose Doctrine is Alive and Well in the Fifth Circuit, 793 PLI/Tax 323, 338 (2007).

9 The Federal Circuit and Second Circuit profitability test tilts the scale even further against taxpayers by refusing to consider the income that gave rise to the foreign tax expense if the income is not new or incremental. In other words, a U.S. person can decide to move $1000 out of a U.S. bank account yielding 6% to a foreign bank account yielding 8% but subject to a 30% creditable foreign income tax. Under the Federal Circuit and Second Circuit's test, one counts only the $20 of "incremental income" and reduces that income by $24 of foreign tax expense, resulting in a $4 loss for a transaction that makes complete economic sense and is exactly what the foreign tax credit is intended to facilitate.

10 Two STARS cases are pending in district court. See Santander Holdings USA, Inc. v. United States, 977 F. Supp. 2d 46, 53 (D. Mass. 2013) (STARS transaction had economic substance; other issues pending); Wells Fargo & Co. v. United States, No. 09-cv-2764 (D. Minn. Filed Oct. 5, 2009). Neither of those cases has reached final judgment in the district court, and they provide no basis for deferring consideration of this important issue.

11 Notably, rather than citing or addressing these decisions from the First and D.C. Circuits (upon which Petitioner had relied), the Federal Circuit cited only the Third and Eleventh Circuits, which also had articulated a "prerequisite" or "threshold" approach. See Pet. App. 13a (citing In re CM Holdings, Inc., 301 F.3d 96, 102 (3d Cir. 2002) and Kirchman v. Comm'r, 862 F.2d 1486, 1491 (11th Cir. 1989)). Compare Nassau Lens Co. v. Comm'r, 308 F.2d 39, 45-46 (2d Cir. 1962) ("[T]he judicial gloss imposed upon the Code must be derived from the congressional purpose underlying the provisions involved in each case.").

12 The importance of resolving this circuit split and correcting the Federal Circuit's flawed analysis is highlighted by Congress's decision, after the tax years in question, to codify the economic substance doctrine in 26 U.S.C. § 7701(o). Pet. App. 16a n.4. The codification provides that the "economic substance doctrine" in the statute refers to the "common law doctrine," 26 U.S.C. § 7701(o)(5)(A). As a result, this Court's elucidation of the economic substance issues presented by this case will illuminate the economic substance doctrine for purposes of the statute. Moreover, the statute provides that the Secretary shall "issue regulations requiring foreign taxes to be treated as expenses in determining pre-tax profit" only "in appropriate cases," id. § 7701(o)(2)(B), not, as the Federal and Second Circuits would have it, in all cases. Notably, the Secretary has failed to issue regulations setting forth any "appropriate cases" for the inclusion of such expenses, but instead has merely declared that the "the enactment of [section 7701(o)(2)(B)] does not restrict the ability of the courts to consider the appropriate treatment of foreign taxes in economic substance cases." Notice 2010-62, 2010-40 I.R.B. 411.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Case Name
    SALEM FINANCIAL, INC., AS SUCCESSOR-IN-INTEREST TO BRANCH INVESTMENTS LLC, Petitioner, v. UNITED STATES OF AMERICA, Respondent.
  • Court
    United States Supreme Court
  • Docket
    No. 15-380
  • Authors
    Sloan, Clifford M.
    Madan, Rajiv
    Bowers, Christopher P.
    Clement, Paul D.
    Bartolomucci, H. Christopher
  • Institutional Authors
    Skadden, Arps, Slate, Meagher & Flom LLP
    Bancroft PLLC
  • Cross-Reference
    Appealing Salem Financial Inc. v. United States, 786 F.3d 932

    (Fed Cir. 2015) 2015 TNT 94-12: Court Opinions.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2015-22137
  • Tax Analysts Electronic Citation
    2015 TNT 192-19
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