AIG Files Reply Brief in Appeal of Foreign Tax Credit Case

AIG sought summary judgment on the grounds that the economic substance doctrine should not apply to AIG's transactions, and that even under that doctrine, AIG's transactions had economic substance as a matter of law. In addressing the latter ground, the district court held that AIG "would be entitled to judgment" if its computation of pre-tax profit were correct, "because 'a transaction has economic substance and will be recognized for tax purposes' if it was expected to result in a significant pre-tax profit." (SPA11 (quoting Gilman v. Comm'r, 933 F.2d 143, 147 (2d Cir. 1991).) The district court held that AIG's computation of profit was incorrect only because, as a legal matter, the computation did not adjust the dividend rate to remove the effect of foreign tax benefits that the lending banks shared with AIG in pricing the transactions. (SPA15-16, 22.)

The district court erred in applying that standard, and the Government does not argue otherwise. The way that AIG computed profit properly followed this Court's precedent: AIG totaled the amounts it expected to receive in each transaction and reduced that amount by expected costs. See Gilman, 933 F.2d at 147-48. Instead of defending the way the district court computed AIG's pre-tax profit, the Government presses arguments that the district court rejected.

The Government primarily contends (at 2) that the district court "correctly held" that "there are genuine disputes of material fact regarding the propriety of AIG's transactions." That is not what the district court held. To the contrary, rejecting the same arguments the Government rehashes now, the district court held that AIG "would be entitled to judgment" if its computation of profit correct. (SPA11.) Certifying its Order for interlocutory review, the district court stated that AIG's alternative arguments each raised potentially dispositive legal issues. (SPA17.) This Court then accepted the case for appeal. The Government's repeated claims that the "record is incomplete" are baseless. Indeed, the Government agreed at the pre-motion conference that the record was sufficiently developed for the district court to consider AIG's motion. (A4999-5000.)¹

There are no factual disputes relevant to the outcome of the case, and the district court referred to none. The Government's description of the structure of the transactions is reasonably accurate and the parties agree on the transactions' material terms and anticipated cash flows. Indeed, to avoid any dispute, AIG adopted and relied on the pre-tax-profit computations prepared by the Government's hired economist in moving for summary judgment. The only difference is that AIG computed pre-tax profit based on the amounts paid and received before foreign taxes, consistent with the decisions of the Fifth and Eighth Circuits in Compaq and IES, whereas the Government did not. As those Circuits concluded, that question is a legal one, properly resolved on summary judgment. See, e.g., Compaq Computer Corp. v. Comm'r, 277 F.3d 778, 784 (5th Cir. 2001); IES Indus. v. United States, 253 F.3d 350, 356 (8th Cir. 2001). This Court likewise has held that the "standard" to be applied to determine whether a transaction has economic substance is a legal issue for the court to resolve. Jacobson v. Comm'r, 915 F.2d 832, 837 (2d Cir. 1990).

The Government agrees (at 26) with AIG that Congress' purposes in enacting the foreign tax credit were to "mitigate double taxation" and to "facilitate [domestic corporations'] foreign enterprises." Contrary to the Government's further assertion (at 27), AIG is not arguing that the "economic substance doctrine cannot apply to transactions involving foreign tax credits." Instead, AIG's position is that the doctrine cannot apply in this case, because the credits claimed by AIG fully comport with Congress' purposes for the credit.

As to the purpose of mitigating double taxation, the Government does not dispute the district court's conclusion "that disallowance of the credits would subject AIG to taxation on the same income in both the U.S. and a foreign jurisdiction." (SPA20.) Nor does the Government deny that disallowing the credits would impose a truly extraordinary tax burden on AIG. In this case, where AIG has satisfied the myriad rules required to claim the credit and it is undisputed that AIG would face double taxation without the credit, allowing the credit serves Congress' purpose of mitigating double taxation.

The credits at issue also served Congress' other purpose, for they made AIG essentially "tax neutral" as to where it domiciled the portfolio company (or "SPV," as the Government calls it) used in each borrowing transaction. In some of its preferred-repurchase borrowing transactions, AIG domiciled the SPV in the United States, and each SPV paid tax on its income only to the United States. In other transactions, AIG domiciled the SPV in a foreign country, and each such SPV paid tax on its income to the foreign country, while AIG also reported that income on its U.S. tax return as required by U.S. tax law. Absent the credit, AIG indisputably would have a strong incentive always to domicile the SPV in the United States, so that its income would be taxed only once. It follows that in this case, the worked as Congress intended, because it eliminated double taxation as a factor AIG's decision where to domicile the SPV.²

The Government's effort to apply the economic substance doctrine here, moreover, is very different from the way that the courts have applied it in other cases. The Government is correct in asserting (at 28) that when the doctrine applies, it overrides "compliance with statutory or regulatory terms." In this case, however, the Government is attempting to use the doctrine to require something that the Supreme Court and governing Treasury regulations provide is not required -- namely, that AIG bear the full economic burden of the foreign taxes for which it indisputably was liable in order to claim a credit for them.

This is made clear in the Government's brief (at 9), where the Government expresses its ultimate complaint -- namely, that the parties purportedly "shifted" to the SPVs the foreign tax liability that the foreign banks would have owed if AIG had paid them taxable interest. The Government contends that the parties then "split" that foreign tax liability through the dividend rate, while AIG claimed "foreign tax credits for all of the SPV tax." (Emphasis added.) But even if that were true (and it is not, as AIG shows further below), AIG showed in its opening brief that the question of who bears the economic burden of a foreign tax is irrelevant in determining eligibility for the credit. See Biddle v. Comm'r, 302 U.S. 573, 581-82 (1938); see also Treas. Reg. § 1.901-2(f)(1).

At bottom, the Government thus is attempting to use the economic substance doctrine to override those authorities. That is inappropriate: As this Court repeatedly has made clear, see, e.g., Nassau Lens, the doctrine is a tool designed to effectuate the purpose of the statute, not to impose requirements that have been rejected by the governing Treasury regulations and Supreme Court precedent.

Even if the economic substance doctrine could apply in this case, AIG's transactions had the "practicable economic effects" required by that doctrine. Jacobson, 915 F.2d at 837. Indeed, as shown above, the Government does not even attempt to defend the district court's rationale for denying AIG's motion -- namely, that the transaction terms had to be adjusted to account for the foreign tax benefits that the foreign banks economically shared with AIG through the transaction pricing.

AIG's opening brief explained why that aspect of the district court's decision was incorrect: It is contradicted by precedent, has been roundly criticized by commentators, and would lead to absurd results casting doubt on a wide variety of everyday transactions whose economics are influenced by foreign tax considerations. Nowhere does the Government's brief refute these points or offer any support for the novel legal premise espoused by the district court. The Government nevertheless argues that the district court was correct to deny summary judgment on the basis of arguments the Government made below and in opposition to AIG's motion for certification, all of which the district court explicitly or implicitly rejected, for good reason.

The Government first claims (at 40) that "[h]ow the transactions actually worked, and their economic effects, are factual questions for a jury." The Government relies (at 41-42) on the Cragg declarations, which conclude that the transactions were not profitable "after accounting for dividend payments, operating expenses, and foreign taxes." (Emphasis added.) That calculation turns on whether to treat the foreign taxes paid by AIG not as a tax, but as an expense that must be subtracted before arriving at a "pre-tax" profit. The Government does not deny this, but claims (at 48) that the proper computation of profit is a "disputed question[ ] of fact." That is flatly incorrect.

There is no dispute about the underlying facts here. The amounts that AIG was entitled to receive and required to pay in connection with the transactions are set out in the undisputed transaction documents. And to avoid any dispute, for purposes of summary judgment, AIG accepted the precise amounts set forth in Dr. Cragg's declaration. The only difference is that in computing pre-tax profit, AIG did not subtract the amount of foreign taxes paid in calculating its net profit, consistent with the decisions of the Fifth Circuit in Compaq and the Eighth Circuit in IES. The Government's argument thus is not about what the facts are, but is instead about the appropriate legal standard for computing "profit" under the economic substance doctrine. AIG says that the measure of profit applied in Compaq and IES is correct, whereas the Government says it is not.

That is not a factual question for a jury. Both the Supreme Court and this Court have held that the proper legal standard for testing economic substance is a legal question. See Frank Lyon Co. v. United States, 435 U.S. 561, 581 n.16 (1977) ("The general characterization of a transaction for tax purposes is a question of law subject to review. The particular facts from which the characterization is to be made are not so subject."); Jacobson, 915 F.2d at 837 (legal standard used in determining economic substance is a legal question for the court to review de novo). In certifying its order for interlocutory appeal, moreover, the district court agreed that the question was a legal one, as did this Court in accepting it. See 28 U.S.C. § 1292(b) (stating that the order at issue must involve a "controlling question of law").

The decisions in Compaq and IES further support that conclusion. In both cases, the Circuits ruled, as a matter of law, that the trial courts had employed an incorrect method to determine pre-tax profit for purposes of economic substance because they had improperly treated foreign income taxes as an expense. Both courts treated this as a legal question, not as a disputed issue of fact to be decided by the fact-finder.

Indeed, IES was decided on summary judgment notwithstanding that the parties disputed the very same legal question at issue here -- whether the undisputed cash flows amount to a "profit" for economic substance purposes. And as in this case, the Government in IES submitted and relied upon an expert affidavit that argued -- just like Dr. Cragg -- that the undisputed cash flows from the transaction did not amount to a profit if foreign taxes were treated as expenses. (Brief for the Appellee-Cross-Appellant at 14-16, IES Indus. v. United States, 253 F.3d 350 (8th Cir. 2001) No. 00-1221, 2000 WL 33980260.) The Eighth Circuit treated the issue as a question of law. See IES, 253 F.3d at 356 ("We hold . . . that the ADR trades in which IES engaged did not, as a matter of law, lack business purpose or economic substance." (emphasis added)). In Compaq, the Fifth Circuit likewise determined the issue as a matter of law, ruling that foreign taxes must be treated as taxes rather than expenses for purposes of computing pre-tax profit. See Compaq, 277 F.3d at 784 ("We agree with the IES court and conclude that the Tax Court erred as a matter of law. . . . Pre-tax income is pre-tax income regardless of the timing or origin of the tax." (emphasis added)). Once the courts in IES and Compaq decided that the law required pre-tax profit to be computed without regard to foreign taxes, they determined that the taxpayers were entitled to judgment as a matter of law because the undisputed facts showed a profit under the correct legal standard. That is equally true in this case.

The Government first attempts to distinguish IES and Compaq, and then argues that they were wrongly decided. The Government's attempts to distinguish IES and Compaq are unavailing for one simple reason: AIG is not arguing that it should prevail here because the taxpayers in those cases prevailed. Instead, AIG is relying on the legal standard established in those cases as to how foreign taxes should be treated in computing pre-tax profit. The profit computation that the Government is offering here through Dr. Cragg is the same one it offered in Compaq and IES. In those cases, the Government argued that the taxpayers should lose because they had no profit after the payment of foreign tax but before foreign tax credits. In this case, it is arguing (at 7) the same thing -- that AIG expected "no meaningful cash return" on the transactions after the payment of foreign taxes but before foreign tax credits. Yet as the Fifth Circuit correctly noted in Compaq, this "curious method" of computing pre-tax profit is not "pre-tax" at all. Compaq, 277 F.3d at 782. It is instead "half pre-tax, half after-tax." Id. Both Circuits rejected that "curious method" as a matter of law, and for good reason: It improperly "stacks the deck" against a finding of profitability by counting only those tax consequences that subtract from profitability (the foreign taxes) while ignoring those that add to it (the corresponding foreign tax credits). Id.; accord IES, 253 F.2d at 354.

The Government offers (at 51-52) a handful of supposed factual differences between the transactions in Compaq and IES and those at issue here. There is no basis to conclude that the computation of pre-tax profit changes depending on the existence (or absence) of any of the factors cited by the Government. The courts in IES and Compaq held that pre-tax profit for economic substance purposes included all amounts the taxpayers were required to report as income for U.S. income tax purposes, unreduced by any amounts used to pay foreign taxes. The courts reasoned that this was because U.S. income tax law required the taxpayers to report (and pay tax on) the full amount earned, including those portions used to pay foreign taxes. The same rationale applies in this case, with respect to the amounts AIG earned.³

The Government also seeks (at 50-51) to distinguish Compaq and IES on the basis that "facts had been determined after discovery, while here they remain disputed and discovery is ongoing." As noted above, that is not true. The Government had years to take fact discovery and agreed at the pre-motion conference that the record was sufficient for summary judgment. The basic transactional facts are not in dispute, and indeed the Government has admitted them in its response to AIG's Statement of Facts.

The Government's cursory argument (at 53-54) that Compaq and IES were wrongly decided fares no better. The Government claims that those courts erred in treating the taxpayers as having received the entire amount of the dividends paid, because the taxpayers received in cash only the net dividend -- that is, the amount of the dividend less the foreign tax required to be withheld from the dividend payment. But the Government does not provide any reason to disagree with the courts' rationale and analysis. As both courts persuasively explained, the entire amount of the dividend was required to be reported, and was reported, as income for U.S. tax purposes, including the portion withheld and used to pay foreign taxes. Compaq, 277 F.3d at 783-84; IES, 253 F.3d at 354. For that reason, the entire amount was income for economic substance purposes as well. See, e.g., IES, 253 F.3d at 354 ("Because the entire amount of the ADR dividends was income to IES, the ADR transactions resulted in a profit, an economic benefit to IES.").

What the Government seeks is a rule that although a U.S. taxpayer is required to pay tax to the United States on income used to pay foreign tax, that income is not counted as profit for economic substance purposes. There is no principled basis for this position, other than to try to "stack the deck" against a finding of profitability. On its U.S. tax returns, AIG was required to report, and did report, all of the investment income earned by the SPVs, even though a portion of that income was used to pay taxes assessed by foreign governments. As a matter of "economic substance," AIG's pre-tax income is the same amount that it reported on its U.S. tax returns, not some other amount.⁴

At their core, the economics of these transactions are simple. Where foreign law treated the transactions as equity investments, AIG's payments qualified as non-taxable dividend payments under the law of the foreign lender. That favorable foreign tax treatment allowed AIG to borrow the funds at a low interest rate. AIG then invested the borrowed funds in investments expected to yield a return in excess of the borrowing rate. When AIG made its investments through a foreign SPV, the investment returns were taxed twice, once by the United States and once by the foreign country, and AIG claimed a foreign tax credit. When it invested through a domestic affiliate, it paid tax only to the United States. Either way, the transactions were profitable to AIG, and thus had the "practicable economic effects" that require the transactions to be respected under the economic substance doctrine. Jacobson, 915 F.2d at 837.⁵

It is true, as the Government complains, that the foreign tax credits claimed by AIG when it decided to domicile the SPV in a foreign country represent a "cost" to the U.S. Treasury. That is true every time a U.S. taxpayer claims a foreign tax credit, and is no ground for denying a credit. The credit reflects a policy choice by Congress to "treat the taxes imposed by the foreign country as if they were imposed by the United States." H.R. Rep. No. 83-1337 (1954).

B. Transactions That Have Objective Economic Effect Have Economic Substance As a Matter of Law.

In a further effort to manufacture a disputed issue of material fact, the Government claims (at 39 n.14) that the district court "erred" in its conclusion that AIG would be entitled to judgment if AIG's computation of profit were correct. The Government contends (at 35) that even if AIG reasonably expected the transactions to be profitable, AIG purportedly must also "satisfy the business purpose prong" of the economic substance doctrine. The Government then claims that there are genuine issues of material fact regarding AIG's purpose.

As an initial matter, if the Government's position were correct, it would eliminate the potential for any economic substance case to be resolved on summary judgment -- a position that is contradicted by the numerous cases that have been so resolved. See, e.g., IES, 253 F.3d 350; Countryside Ltd. P'ship v. Comm'r, 95 T.C.M. 1006 (2008); Leader Fed. Sav. & Loan Ass'n v. Comm'r, 57 T.C.M. 846 (1989); San Antonio Sav. Ass'n v. Comm'r, 55 T.C.M. 813 (1988); Wachovia Bank & Trust Co. v. United States, 499 F. Supp. 615 (M.D.N.C. 1980).

This Court's precedent also contradicts the Government's position. The ultimate question to be determined under the economic substance doctrine is "whether the transaction has any practicable economic effects other than the creation of income tax losses." Jacobson, 915 F.2d at 837. The potential for realizing meaningful profit is the "practicable economic effect" required by the doctrine. Where that potential exists, as it did in this case, any inquiry into "business purpose" is unnecessary.

As this Court has held over many decades, a taxpayer's purpose is irrelevant if the transaction had economic utility apart from tax consequences. See Rosenfeld v. Comm'r, 706 F.2d 1277, 1282 (2d Cir. 1983) ("[W]e decline the appellant's invitation to adopt a business purpose standard of review. Rather, we believe our inquiry should focus on whether there has been a change in the economic interests of the relevant parties."); Nassau Lens Co. v. Comm'r, 308 F.2d 39, 44, 46 (2d Cir. 1962) (holding that the Tax Court "applied an erroneous legal standard" by requiring a taxpayer to show a "business purpose" for its decision to invest in a corporation using debt instruments rather than equity); Kraft Foods Co. v. Comm'r, 232 F.2d 118, 128 (2d Cir. 1956) ("The inquiry is not what the purpose of the taxpayer is, but whether what is claimed to be, is in fact."); Loewi v. Ryan, 229 F.2d 627, 629 (2d Cir. 1956) (L. Hand, J.) ("It is so abundantly settled in decisions of the Supreme Court that a taxpayer's motive is irrelevant in determining his liability that we need not cite the very numerous decisions of the lower courts."); see also ACM P'ship v. Comm'r, 157 F.3d 231, 248 n.31 (3d Cir. 1998) ("[I]t is . . . well-established that where a transaction objectively affects the taxpayer's net economic position, legal relations, or non-tax business interests, it will not be disregarded merely because it was motivated by tax considerations.") (citing this Court's decision in Kraft Foods).

This Court never has held that the economic substance doctrine requires a taxpayer to prove a separate business purpose when the objective facts show that a transaction was expected to be materially profitable and thus had economic effect. Beginning with DeMartino v. Commissioner, 862 F.2d 400 (2d Cir. 1988), this Court repeatedly has held that a "transaction is a sham if it has no business purpose or economic effect other than the creation of tax deductions." Id. at 406 (emphasis added); see also Nicole Rose Corp. v. Comm'r, 320 F.3d 282, 284 (2d Cir. 2003); Gilman v. Comm'r, 933 F.2d 143, 147 (1991).⁶

The Government misreads that standard as though it requires a transaction to have both business purpose and economic effect.⁷ That is not correct. As this Court explained, the "analysis requires a determination whether the transaction has any practicable economic effects other than the creation of income tax losses. A transaction is a sham if it is fictitious or if it has no business purpose or economic effect other than the creation of tax deductions." Jacobson, 915 F.2d at 837 (internal citations and quotations omitted)(emphasis added). And that is still the rule. Only two years ago this Court considered a district court's instruction that "[i]n order to establish that a transaction lacks economic substance" the jury must find both that there was no reasonable possibility of profit and that the taxpayer lacked a business purpose; this Court held that the lower court "accurately stated the law." United States v. Coplan, 703 F.3d 46, 90 n.40 & 42 (2d Cir. 2012).⁸

The Government thus plainly errs in arguing that significant pre-tax profit is insufficient to demonstrate the economic substance of the transactions.

C. If AIG Was Required to Establish a Business Purpose, the Profit Potential Established That Purpose As a Matter of Law.

If non-tax business purpose were relevant to this inquiry, there can be no genuine dispute that AIG has made the necessary showing. In the few cases in which this Court has even considered a taxpayer's purpose for engaging in a transaction, it has determined the taxpayer's purpose solely by reference to objective factors such as the transaction's potential for profit. See Jacobson, 915 F.2d at 838 ("Reliance on these objective factors enables us to focus our scrutiny on the actual mechanics of the transactions, rather than on an ephemeral analysis of subjective intentions."); Gilman, 933 F.2d at 148 (reaffirming importance of "reliance on objective factors in making the analysis"); see also Goldstein v. Comm'r, 364 F.2d 734, 740-43 (2d Cir. 1966). As a leading tax treatise summarizes it, business purpose "may be demonstrated by the existence of a general non-tax motive (including business and regulatory considerations) or an objective pre-tax profit potential expected at the time the transactions were entered into." (A4773.)⁹ AIG reasonably expected the transactions here to generate $168.8 million in pre-tax profits. That profit potential was the "business purpose" for the transactions.

The Compaq and IES cases both demonstrate this point. In both cases, the trial courts held that the taxpayers lacked any business purpose for engaging in the transactions. See Compaq Computer Corp. v. Comm'r, 113 T.C. 214, 215-18, 224-25 (1999); IES Indus., Inc. v. United States, No. C97-206, 1999 WL 973538, at *2 (N.D. Iowa Sept. 22, 1999). The Fifth and Eighth Circuits each reversed, first finding that the taxpayers reasonably could have expected to earn a pre-tax profit from the transactions, and then holding that such profit and other objective economic effects satisfied any requirement of business purpose as a matter of law. See Compaq, 277 F.3d at 787 ("In light of what we have said about the nature of Compaq's profit, both pre-tax and post-tax, we conclude that the transaction had a sufficient business purpose independent of tax considerations."); IES, 253 F.3d at 355 ("A taxpayer's subjective intent to avoid taxes . . . will not by itself determine whether there was a business purpose for the transaction.")

As applied to this case, there is no need to ask a jury to consider AIG's subjective purpose for engaging in the transactions, because the pre-tax profit that AIG reasonably expected to earn establishes its business purpose as a matter of law. In addition, the "evidence" the Government says (at 35-38) would allow a jury to conclude that AIG's sole motivation for entering into the transactions was to realize tax benefits proves nothing relevant to this case, and is the same type of evidence that the circuit courts rejected in Compaq and IES.¹⁰

The Government first cites (at 36-37) a litany of documents for the proposition that foreign tax credits were "fundamental to the transactions" and that the credits "were of supreme importance to AIG." That is true, for without the foreign tax credit AIG would be subject to double taxation on the income from these transactions. In Compaq, the Government likewise argued that Compaq's purpose for entering into the ADR transaction was proven by the fact that it would not have engaged in the transaction "but for" its ability to "use" its capital gain, just as the Government is arguing here that AIG would not have engaged in the transactions at issue "but for" its ability to claim a foreign tax credit. The Fifth Circuit held that Compaq's ability to use the gain was a "sensible" precondition for entering the transaction, "unremarkable and is no evidence that Compaq had an impermissible motive." Compaq, 277 F.3d at 787 n.8 (internal citations omitted). AIG's consideration of its capacity to claim a foreign tax credit (so it would not pay tax twice) is no different than Compaq's ability to use its capital gain to absorb its capital loss. It is not, as the Government claims, any evidence that AIG was motivated to engage in the transaction to secure the credit.

For similar reasons, the Government's claim (at 36) that the form of the transactions was "tax driven" is irrelevant. As the district court found, each borrowing was structured to provide the foreign lending bank with a stream of income expected to be exempt from foreign tax. The bank then shared the benefit of that exemption with AIG in setting the dividend rate on the preferred stock. As AIG explained in its opening brief, however, since there is nothing wrong with a U.S. taxpayer structuring a transaction to secure a foreign tax benefit for itself, there similarly is nothing wrong with a U.S. taxpayer structuring a transaction to produce a foreign tax benefit for a foreign counter-party that the counter-party shares with the U.S. taxpayer in pricing the transaction. The Government offers no meaningful response to this logic.

Instead, the Government argues that AIG's transactions were structured to produce U.S. tax benefits. That argument contradicts the district court, which rejected the same argument and correctly recognized that the transactions were structured to produce a foreign tax benefit. (SPA18.) It cannot be true that AIG's borrowing transactions were structured to produce U.S. tax benefits when even the Government admits that many of them did not produce any U.S. tax benefit.¹¹

No matter where the SPV was domiciled, these transactions were all expected to produce the same tax benefit -- a tax-exempt dividend stream for the foreign lending bank, the value of which the foreign bank shared with AIG. It is true that where the SPV was domiciled in a foreign country, so that AIG was required to pay foreign tax on the SPV's income, it was also necessary that AIG be able to claim a U.S. foreign tax credit in order to avoid the double taxation that would otherwise result from AIG also reporting that income on its U.S. tax return. But that is the same type of "precondition" that Compaq held to be irrelevant.

This 14th day of October, 2014.

² The Government correctly notes (at 18 n.6) that AIG informed the district court that the domestic transactions are not "material," because the tax consequences of those transactions are not at issue in this case. AIG also told the court, however, that the domestic transactions served to demonstrate that AIG's purpose for all of the transactions, whether domestic or foreign, was to raise and invest funds and that the foreign tax credit made AIG tax neutral in deciding where to domicile the SPV. (A5001-02.)

³ In addition, many of the supposed factual distinctions raised by the Government are not distinctions at all. The Government cites (at 51), for example, the fact that the transactions in Compaq and IES occurred on a public market and that the taxpayers in those cases therefore "bore real risks." But the taxpayers took explicit steps to eliminate those risks, a fact that the courts deemed to be irrelevant: "We are not prepared to say that a transaction should be tagged a sham for tax purposes merely because it does not involve excessive risk." IES, 253 F.3d at 355. In addition, the Government's own expert recognizes there were risks in AIG's transactions. (A3765.) The transactions were dependent on the SPVs investing the borrowed proceeds in public markets and earning a return in excess of the borrowing rate over the multiple years the transactions were in effect. While AIG expected that to happen, it was by no means guaranteed. Similarly, the fact that AIG conducted the transactions through SPVs, whereas the taxpayers in IES and Compaq transacted in their own names, is irrelevant to the determination of the proper treatment of foreign taxes in computing profit, and the commonplace use of SPVs has been approved in other economic substance cases. See, e.g., N. Ind. Pub. Serv. Co. v. Comm'r, 115 F.3d 506, 511-13 (7th Cir. 1997).

⁴ In a footnote, the Government cites commentary that it says is critical of the Compaq and IES decisions. Yet much of that commentary is based on concepts -- such as "negative implicit taxes" -- that no court has ever adopted. The Government also fails to note the substantial commentary supporting the decisions. See, e.g., Kevin Dolan, The Foreign Tax Credit Diaries -- Litigation Run Amok, 71 Tax Notes 895, 905-07 (Aug. 26, 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, 338 (2007); James M. Peaslee, Creditable Foreign Taxes and the Economic Substance Profit Test, 114 Tax Notes 443 (Jan. 29, 2007); William A. Klein & Kirk J. Stark, Compaq v. Commissioner -- Where Is the Tax Arbitrage?, 94 Tax Notes 1335, 1340 (Mar. 7, 2002); Marc D. Teitelbaum, Compaq Computer and IES Industries -- The Empire Strikes Back, 86 Tax Notes 829, 836 (Feb. 7, 2000).

⁵ The Government suggests (at 46-47) that the foreign taxes incurred by the SPVs should be treated as "converted" interest payments (and therefore pre-tax expenses), theorizing that the transactions "shifted" to the SPVs the foreign taxes that the foreign banks would have owed if AIG had paid them interest on a direct loan. The Government bases that suggestion on its claims (at 48) that the dividends were tax exempt to the foreign lenders only because the SPVs paid that "shifted" foreign tax liability. But the Government conspicuously fails to cite any evidence to substantiate this claim, and it is contrary to the district court's finding that the dividends were exempt from foreign tax because the relevant foreign government treated the bank as the owner of the preferred stock, not because the SPV paid tax on unrelated income. (SPA 21.) The Government's claim that the SPVs' tax payments effectively satisfied the foreign lenders' tax liability is also contrary to the undisputed facts, because in one of the transactions (Vespucci), the foreign lender (BCI) was domiciled in a different country (Italy) from the country to which the SPV paid taxes (France). (A1442, 1444-46, 1448.)

⁶ The Government claims that Gilman supports its position, but it misreads the Court's decision. The taxpayer in that case contended that the Tax Court had "applied the wrong legal standard" in requiring the taxpayer to prove both economic effect and business purpose. Gilman, 933 F.2d at 147. This Court rejected the taxpayer's characterization of the Tax Court's holding and examined each prong of the test separately, looking first to business purpose and then at objective economic effect to determine whether either prong of the test had been satisfied. Id. at 148-49. Far from supporting the Government, the Gilman Court's analysis contradicts the Government's claim that proof of both elements is required. If the Government's rule were the correct one, it would have been unnecessary for this Court to consider profit potential once it determined that Gilman lacked a business purpose.

⁷ In fact the Government's position is not clear. In parts of its brief (as at 39), the Government argues only that business purpose must be "considered" and that "the relative weights of the subjective and objective prongs are a matter for the jury." At other parts, however, the Government insists (as at 38) that AIG "must satisfy the business purpose prong."

⁸ The Government also cites two district court cases as support for its position, Long Term Capital Holdings v. United States, 330 F. Supp. 2d 122, 171 (D. Conn. 2004), and Altria Group, Inc. v. United States, 694 F. Supp. 2d 259, 283-84 (S.D.N.Y. 2010). The portions of Long Term Capital and Altria relied upon by the Government are plainly dicta (the Altria opinion states this expressly, and Long Term Capital was a case, like Gilman, where the taxpayer satisfied neither element). Both cases were decided before Coplan, and both courts based the dicta on a misreading of this Court's decision in Gilman. Moreover, the reason the Altria court suggested that an additional business purpose requirement might be appropriate was to guard against a situation where a "shelter designer[ ]" would "incorporate just enough non-tax-based profit into a transaction to avoid economic-substance scrutiny." Id. at 283. That is not the case here, where AIG expected pre-tax profit of $168.8 million.

⁹ As the Government notes (at 35 n.12), Congress codified the economic substance doctrine in 2010 to require taxpayers "to satisfy both prongs of the analysis." The Government neglects to explain, however, that consistent with common law, the new statute permits taxpayers to satisfy both the objective and subjective requirements with a showing of "potential for profit." 26 U.S.C. § 7701(o)(2)(A).

¹⁰ In addition, if the Government had been able to prove that AIG was motivated solely to obtain a U.S. tax benefit, that is still permissible given the transactions' potential for profit. As the Eighth Circuit said in IES, the "fact that IES took advantage of duly enacted tax laws in conducting the ADR trades does not convert the transactions into shams for tax purposes." 253 F.3d at 356.

¹¹ As to the Government's assertion (at 38) that the domestic transactions were "schemes to evade non-U.S. taxes," that claim finds no support as a matter of law, as the only foreign court to consider a challenge to the foreign tax benefit claimed by the foreign lender in one of AIG's domestic transactions held the bank was entitled to the benefit. See Hill Samuels Invs. Ltd. v. Comm'rs for Her Majesty's Revenue and Customs [2009] UKSPC SPC00738, at 17-21, available at www.bailii.org/ uk/cases/UKSPC/2009/SPC00738.html.