Wells Fargo & Company v. United States of America
Filing
486
REPORT OF SPECIAL MASTER. (Written Opinion). Signed by Special Master Charles H. Gustafson on July 21, 2014. (CLG) cc: Charles Gustafson on 7/22/2014 (JAM).
UNITED STATES DISTRICT COURT
DISTRICT OF MINNESOTA
WELLS FARGO & COMPANY, et al.,
)
)
)
) Civil No. 09-cv-02764-PJS-TNL
)
)
)
) Report of Special Master
)
Plaintiff
v.
UNITED STATES OF AMERICA,
Defendant
REPORT RESPONDING TO EIGHT MOTIONS BY PLAINTIFF
AS LISTED AND DESCRIBED HEREIN
I.
Introduction
1. Motions Addressed in This Report
The principal focus of this case is upon the U.S. income tax consequences
of the STARS transaction implemented by the Plaintiff (“Wells Fargo”) and a
British bank. Wells Fargo claims a number of U.S. tax benefits from the
transaction, most importantly foreign tax credits attributable to income taxes paid
to the United Kingdom under U.K. tax law and expenses attributable to the
1
transaction.1 The Defendant (the “Government”) contends that the STARS
arrangement is a “sham transaction” the consequences of which should be
disregarded under U.S. tax law. Wells Fargo claims that the Government has
wrongfully denied the tax benefits to which it is legally entitled and has sued to
recover for tax payments that were been made and not refunded.2
Wells Fargo has filed the following eight motions in connection with this
case:
--Renewed Motion for Determinations of U.K. Law.
--Motion for Partial Summary Judgment that “Bx” Was Pretax.
--Motion for Partial Summary Judgment that the STARS Transaction Was
Motivated by an Economic Purpose Outside of Tax Considerations.
--Motion for Partial Summary Judgment that 26 U.S.C. § 269 Does Not
Apply to the STARS Transaction as a Matter of Law.
.
--Motion for Partial Summary Judgment that Wells Fargo’s Tax Reporting
Position Had a Reasonable Basis.
--Renewed Motion to Exclude Expert Testimony of Dr. David LaRue.
1
The STARS transaction has a number of parts. Unless otherwise indicated, they are
referred to herein collectively as the “STARS transaction.”
2
The taxable year of this case is 2003, but the result of the case will apply to subsequent
years during which the STARS transaction was being implemented.
2
--Motion to Exclude Expert Testimony of Dr. Ira Kawaller.
--Motion To Exclude Expert Testimony of Dr. Michael Cragg.
This Report responds to each of the eight motions. They are addressed in
the order indicated in the foregoing listing. The Report is accompanied by a series
of Orders giving effect to the determinations explained herein.
The motions have been thoroughly briefed by both parties. Sometimes
lengthy hearings have been held with respect to each of them. It might be noted
that the approaches and strategies taken by the parties to the issues raised in the
case have been somewhat different. As this Report will demonstrate, the motions
here addressed are part of a continuing effort by Wells Fargo to focus upon
specific issues with respect to the tax treatment of the STARS transaction. By
contrast, the Government has tended to rely upon a more broadly structured line of
argumentation that challenges the transaction in more general terms. This
difference of strategies occasionally produces some apparent non-sequiturs and
inconsistencies which the Report will endeavor to identify and explain.
While many of the facts and arguments raised by these motions have been
described, explained and discussed in Reports responding to prior motions, many
are repeated here for purposes of coherence and clarity.
Each motion is addressed separately in the Report even though some
3
considerations and some sources of law are common to more than one motion. It
is recognized that this approach involves a degree of unavoidable repetition.
However, it is very likely that some or all of the decisions reflected in the Report
will be challenged to the Court. The separate, though sometimes repetitious,
explanations of the context and analysis of the different motions are intended to
provide a sharper focus to facilitate the resolution of any such challenges.
Unless otherwise indicated, the decisions contained in this Report are not
interdependent. Each is a specific response to a specific motion advanced and
opposed by specific arguments. Should any of the decisions set forth in the Report
be successfully challenged to the Court, it is intended that the other decisions
remain unless they are successfully challenged.
As the Report is rather long and somewhat complex, a table of contents is set
forth on the following page.
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2. Table of Contents of This Report
Title
Page Number
I.
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
II.
The STARS Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
III.
Some General Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
IV.
Motion to Determine Issues of U.K. Law . . . . . . . . . . . . . . . . . . .24
V.
Motion that the Bx was “Pre-Tax” . . . . . . . . . . . . . . . . . . . . . . . .27
VI.
Motion that the STARS Transaction Had a
Business Purpose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
VII. Motion for Partial Summary Judgment that Code § 269
Does Not Apply to the STARS Transaction . . . . . . . . . . . . . . . . 80
VIII. Motion That Its Tax Reporting Had a Reasonable
Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97
IX.
Motion to Exclude Expert Testimony of Dr. David LaRue . . . 114
X.
Motion to Exclude Expert Testimony of Dr. Ira Kawaller . . . 119
XI.
Motion to Exclude Expert Testimony of Dr. Michael Cragg . 122
XII. Summary of Orders Issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124
5
II. The STARS Transaction
1. In Brief
The STARS transaction was implemented by a highly structured series of
steps taken by Wells Fargo and Barclays Bank PLC (“Barclays” is a financial
services corporation headquartered in the United Kingdom) in which both Wells
Fargo and Barclays were to receive tax benefits (Wells Fargo in the United States
and Barclays in the United Kingdom) as a result of income taxes paid to the United
Kingdom by a trust with a U.K. trustee (the “U.K. Trust”) that was treated as a part
of Wells Fargo for U.S. tax purposes. The transaction as conceived would thus
exploit differences in the tax laws and practices of the United States and the United
Kingdom to provide benefits to both banks from the same U.K. income tax
payments. There follows a brief summary of the principal elements of the STARS
transaction relevant to the consideration of these motions. A more detailed
description of specific steps taken to implement the transaction is set forth
thereafter.
In the STARS arrangement, Wells Fargo3 effectively transferred incomeproducing assets to the U.K. Trust. The assets so transferred did not arise in the
3
The reference to “Wells Fargo” herein includes all entities that are included in the
calculation of its U.S. income tax liability. Many of the steps in the STARS transaction involve
subsidiaries and disregarded entities that are so included. Some were “special purpose” entities
created to implement the STARS transaction.
6
United Kingdom, had no relationship to the United Kingdom and in general were
assets already owned by Wells Fargo. The U.K. Trust was deemed to be a U.K.
resident under U.K. law. As such, the income realized by the U.K. Trust from the
contributed assets was subjected to a U.K. income tax of about 22 percent. As the
U.K. Trust was treated under U.S. law as a part of Wells Fargo, the income
realized by the U.K. Trust and the U.K. income taxes paid by it were treated as
received and paid by Wells Fargo for purposes of its consolidated U.S. income tax
return. The Government concedes that the U.K. income taxes paid by the U.K.
Trust would normally be eligible for a foreign tax credit under Section 901 of the
Internal Revenue Code (the “Code”) and U.S.-U.K. income tax treaties,4 but
denies the availability of such credits and other U.S. tax benefits in this STARS
transaction because it has been determined by the IRS to be a sham.
Barclays was provided with certain beneficial interests in the U.K.
Trust. Under U.K. law, almost all of the after-U.K. tax income of the trust was
treated as a distribution to Barclays. Despite the allocation of income for U.K.
purposes, however, there was no material transfer of monies by the U.K. Trust to
Barclays. The after-U.K. tax trust income allocated to Barclays was immediately
credited to a blocked account in the name of Barclays that was maintained by
4
September 17, 2013 Hearing Transcript, pages 44-47.
7
Wells Fargo and then reinvested in the trust. These amounts were eventually to
be recovered by Wells Fargo at the conclusion of the STARS arrangement for a
pre-determined fixed price. The result was that almost all of the trust income, net
of the U.K. income taxes paid by the trust, eventually accrued to the benefit of
Wells Fargo (although having been allocated to Barclays).
The application of U.K. tax law to Barclays was a bit complex. Barclays
was required to report as income for U.K. tax purposes the net trust income
allocated to it plus the 22 percent U.K. tax paid by the trust in respect of such
income (an arithmetic practice often referred to as “grossing up” in tax parlance).
The total amount resulting from the gross up was subject to a 30 percent U.K. tax.
Barclays was then entitled to a credit of the 22 percent tax that had been paid by
the trust. As a result, Barclays was required to pay an additional amount which
was approximately 8 percent of the grossed up trust income deemed under U.K.
law to have been allocated to it.
If the analysis ended at this point, the transaction would obviously have been
highly undesirable for Barclays. However, the income allocated to Barclays (but
maintained in the blocked account and then credited to the U.K. Trust for the
eventual benefit of Wells Fargo) was deducted by Barclays in the calculation of its
U.K. income tax liability imposed at the rate of 30 percent.
8
Another degree of complexity was added because Barclays was obligated to
pay consideration to Wells Fargo of a fixed amount each month that was
calculated to be a percentage of the U.K. tax credits that Barclays expected to
enjoy as a result of the allocation of trust income. This consideration (called the
“Bx payments or amounts” throughout these proceedings) was approximately 47.5
percent of the U.K. tax credits (for the 22 percent tax) to be enjoyed by Barclays,
as described in the previous paragraphs. Barclays also deducted the Bx amounts
in the calculation of its U.K. income tax liability. The combination of U.K. tax
credits and U.K. deductions (for the amounts allocated to the blocked account and
contributed back to the trust and the Bx payments) created a net profit to Barclays
under U.K. tax law as a result of its involvement in the STARS transaction. This
favorable result for Barclays was not challenged by U.K. tax authorities.
Barclays effectively loaned $1.25 billion to Wells Fargo at an interest rate of
LIBOR plus 20 points (.2 percent). The periodic payments from Barclays to Wells
Fargo (described as the Bx in the previous paragraph) were netted against interest
owed by Wells Fargo to Barclays in respect of the loan, thereby reducing the
interest burden on the loan by about 2 percent. However, because LIBOR (a rate
that varies periodically) was sometimes very low, the periodic Bx payments from
Barclays sometimes exceeded the interest owed by Wells Fargo. In either event,
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Wells Fargo received an economic benefit from the periodic payments, either as a
reduction in its net interest payments to Barclays (that were deducted for U.S. tax
purposes), as a reduction in unrelated interest expense (that was deducted for U.S.
tax purposes) or as net payments to Wells Fargo (that were included in its income
for U.S. tax purposes).5
2. Detailed Description of Transactional Steps
The detailed implementation of the STARS transaction was even more
complex than the summary description suggests. Many of the detailed steps were
required by Barclays so that it would enjoy the U.K. tax benefits which made the
transaction beneficial to it. The steps involved a number of entities owned and
controlled by Wells Fargo, some of which were specially created to implement the
transaction. However, each of the entities was considered to be part of Wells
Fargo for purposes of its U.S. consolidated tax return. As such, the consequences
of transactions between and among them were generally eliminated in the
determination of its consolidated tax liability. However, some of the motions
5
The treatment of the payments from Barclays to Wells Fargo in the periods when
LIBOR was very low has been described in several ways. At one hearing, it was described as an
increase in income. September 17, 2013, Hearing Transcript, pages 77-78. The Memorandum
submitted by Wells Fargo in support of its motion for partial summary judgment regarding the
characterization of the Bx payment, addressed in a subsequent portion of this Report, indicates
that it was applied to reduce “unrelated interest expense.” Memorandum, page 16. The effect
on the taxable income of Wells Fargo is the same in either case.
10
addressed in this Report require an examination of specific steps in the transaction
and the role of the specific entities. The steps described below are not disputed by
the parties.
The trust was initially organized in the United States. There were several
classes of interests in the trust (labeled Class A through Class E Units). Carnation
Asset Management, Inc. (“Carnation”), an existing U.S. subsidiary of Wells
Fargo, subscribed to the Class A and B Units by transferring about $6.638 billion
of income-producing assets to the trust. The assets included debt, cash, and shares
of Sirius LLC (“Sirius”), a Delaware limited liability company that elected to be
treated as a partnership for U.S. tax purposes (as a transparent entity for tax
purposes, its actions were attributed to Wells Fargo). These assets, already owned
by Wells Fargo or its related entities, had no particular connection to the United
Kingdom.
Barclays subscribed for the Class C and E Units and transferred $1.225
billion to the trust. It subscribed for the Class D Unit and transferred $25 million
to the trust. As a result, Barclays transferred a total of $1.25 billion to the trust.
The trust redeemed the Class B Unit from Carnation by transferring $1.25
billion to Carnation. The Class B Unit was not reissued. Carnation then
transferred approximately 50 percent of its Class A Units to Rigil Finance, LLC
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(“Rigil”) in exchange for all of the membership interests in Rigil. Rigil was a
newly created limited liability company that elected to be treated as a corporation
for U.S. tax purposes and was also deemed to be part of Wells Fargo for purposes
of its U.S. consolidated tax return.
At this point, the trust was transformed into the U.K. Trust by the
appointment as trustee of Arcturus Trustee Limited, a U.K. incorporated company
that was also controlled by Wells Fargo.
The holders of the various trust units were entitled to:
Class A (held by Carnation and Rigil)–monthly distributions of 1 percent of
the Trust income;
Class D (held by Barclays)–monthly distributions at a floating interest rate
on $25 million;
Class C (held by Barclays)–entitled to the distribution of the remaining Trust
income;
Class E (held by Barclays)–entitled to no distributions.
The Class B Units were not reissued.
Wells Fargo, through its related entities, was required to assure that the U.K.
Trust would realize sufficient amounts of income needed to generate the amount of
U.K. taxes that would provide the benefits required by Barclays in the deal. The
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distributions to Barclays in respect of its Class C Units were deposited in the
blocked account maintained by Wells Fargo that were then used to make further
subscription payments for the Class E Units held by Barclays (even though the
Class E Unit holder was not entitled to any distribution of trust income).
As a result of these steps, Wells Fargo had the use of the $1.25 billion
provided by Barclays and was required to pay interest to Barclays of LIBOR plus
.2 percent and Barclays was required to provide the Bx consideration. While the
Bx amount was negotiated by reference to the U.K. tax credits anticipated by
Barclays, its obligation to pay the Bx was not dependent upon the realization of the
U.K. tax benefits. However, the transaction could be terminated by either party
with relatively short notice (5 to 30 days). Further, Wells Fargo was obliged to
make some payments to Barclays in certain circumstances if the U.K. tax
expectations were not fulfilled.
Unless either party elected to terminate the arrangement, at the end of five
years Carnation was to buy the Class C and E Units from Barclays for $1.225
billion and the Class D Units for $25 million, resulting in total payments of about
$1.25 billion, which was the amount originally invested by Barclays in the trust.
These prices were fixed and would apply regardless of the additional amounts
considered to have been contributed by Barclays for the Class E Units. Neither
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party elected to terminate the arrangement before its planned termination.
3. Reporting for U.S. Tax Purposes
There are many cases in which the government has argued that the substance
of a transaction (rather than its form) should determine its tax consequences. In
this case, Wells Fargo did not report the transaction according to its form (for
example, the purchase and sale of interests in the trust), but rather according to its
substance. The transaction was treated and reported by Wells Fargo for U.S. tax
purposes as a borrowing of $1.25 billion at a rate of interest of LIBOR plus .2
percent less the Bx amount. As indicated previously, the effect of the Bx payment
generally was to reduce the interest expense deducted or increase income reported
by Wells Fargo. In either event, the taxable income of Wells Fargo for U.S. tax
purposes was increased.
Wells Fargo reported the U.K. Trust income for U.S. tax purposes and
claimed foreign tax credits equal to the amount of U.K. taxes that had been paid or
accrued by the U.K. Trust.
As indicated previously, the Government’s position is that the STARS
arrangement was a sham and that, as a result, Wells Fargo is not entitled to foreign
tax credits in respect of the U.K. income taxes paid by the trust and is not entitled
to any deductions in respect of the transaction.
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15
III. Some General Observations
1. Treatment of Motions for Partial Summary Judgment
Motions for summary judgment and partial summary judgment are
specifically authorized by FRCP 56. They provide a significant avenue for
expediting the process of litigation by resolving issues at earlier stages of the
litigation process to reduce its complexity and costs.
Rule 56 prescribes standards and methods that apply in determining such
motions. Rule 56(a) provides that “The court shall grant summary judgment if the
movant shows that there is no genuine dispute as to any material fact and the
movant is entitled to judgment as a matter of law.”
In response to most of the Wells Fargo motions for partial summary
judgment addressed in this Report, the Government contends that there are
“genuine disputes as to . . . material facts.” The motions determined in this Report
have been addressed with a full recognition of the utility of summary judgments
and an understanding of the burden that is placed upon the movant to show that
there are no material facts in dispute affecting the disposition of the motion.
2. The Sham Transaction Doctrine in Brief
The sham transaction doctrine is one of several defense mechanisms that
have evolved over time through a series of judicial decisions to defend against the
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unacceptable exploitation of generally applicable tax provisions. Such doctrines
are sometimes characterized as the “common law of federal taxation” even though
the basic source of federal tax law is the particularly long and complex Internal
Revenue Code (the “Code”). When such doctrines are applied, tax benefits sought
by taxpayers are generally denied even though a transaction satisfies the technical
requirements normally applicable with respect to the issue. If the transaction is
regarded as a sham, the tax consequences are generally ignored as if the transaction
had never occurred. The sham transaction doctrine has been explained and applied
in many cases over the years. There follows in a subsequent portion of this Report
a brief review of the evolution of the doctrine and its application in specific cases
of particular relevance to the issues raised by the motions here considered and by
this case generally.
3. Background: International Tax Planning and the Foreign Tax Credit
The Government emphasizes several general arguments in support of its
view that the STARS transaction is a sham. They include:
—The attempted exploitation of the foreign tax credit provisions by Wells
Fargo is inconsistent with the legislative purpose for which they were
adopted.
—The provision of the Bx consideration by Barclays means that Wells
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Fargo has not borne the financial incidence of the U.K. income taxes paid by
the U.K. Trust.
The purpose of this portion of the Report is to provide some context for the
evaluation of these arguments.
The foreign tax credit has been a part of the federal income system for a very
long time. It was introduced in 1918, just five years after the original adoption of
the modern income tax. The basic purpose was clear: to mitigate the double
taxation of income derived primarily by domestic taxpayers from international
transactions in which the same income was subject to tax by other countries. A
further intended consequence of the foreign tax credit mechanism was to reduce
the importance of differing tax burdens on decisions as to where to invest and
undertake business activities. The foreign tax credit rules are prescribed by Code
§§ 901 et seq.
Since the 1930's, the United States has concluded many bilateral income tax
treaties with other countries. At the present time there are more than 60 such
treaties in force. A principal objective of these treaties is to allocate primary taxing
jurisdiction between the two countries, both of which are entitled under principles
of customary international law to tax the same income to the same taxpayer. In
virtually all of these treaties, the United States undertakes to provide tax credits for
18
income taxes imposed by the other country as permitted by the terms of the treaty.
The Government vigorously argues that Wells Fargo is claiming foreign tax
credits in circumstances vastly different from those contemplated by Congress
when the foreign tax credit was adopted. It contends that the legislative purpose of
the foreign tax credit is to mitigate the total income tax burdens arising from truly
international transactions. Allowing Wells Fargo to enjoy the benefit of foreign
tax credits in the contrived STARS transaction is inconsistent with that legislative
purpose because Wells Fargo has voluntarily subjected income to U.K. tax that did
not arise in and had no connection with the United Kingdom and that would
otherwise be considered to be U.S.-source income under the generally applicable
provisions of Code.
The Government’s description of the legislative purpose is generally correct.
However, the way in which the foreign tax credit mechanism actually applies in
some instances provides considerable opportunity for tax planning that may go
beyond that simple statement of the legislative purpose.
Two examples of relatively common international tax planning techniques
provide a bit of context. First, it is possible for a U.S. taxpayer to benefit from the
foreign tax credit mechanism even when no foreign taxes have been paid in respect
of certain foreign income in some circumstances. Through a process known as
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cross-crediting, a U.S. corporation may apply foreign taxes paid in a highly taxed
country to reduce the U.S. tax on income deriving from a low- or no-tax country.
Such opportunities are subject to limitations too technical to pursue here as they do
not arise in this case. It is obvious that there is no problem of double income
taxation with income realized by a domestic taxpayer in a foreign country that
imposes no income tax. Nevertheless, Congress has explicitly authorized a
reduction in U.S. taxes arising from that untaxed country if opportunities for crosscrediting are present.
The Government emphasizes that the payment of the Bx amount means that
Barclays assumed at least a portion of the financial burden arising from the
imposition of U.K. income taxes on the U.K. Trust (considered to be part of Wells
Fargo) in the STARS transaction. It characterizes the Bx as an “effective rebate”
of the U.K. taxes and strongly argues that the assumption of the financial burden
by Barclays is a prime element in demonstrating that the transaction is a sham so
that the U.S. tax benefits claimed by Wells Fargo should be denied. However, the
assumption of the financial burden of foreign taxation by other parties in several
circumstances has been found not to jeopardize the availability of foreign tax
credits. As a result, and of particular relevance to the transaction here under
consideration, a U.S. taxpayer may be entitled to a foreign tax credit on foreign
20
taxes actually paid by other parties to a transaction.
A simple example can demonstrate this phenomenon. In many international
lending arrangements, it is not uncommon for a borrower to be responsible for
withholding taxes imposed on interest payments to a foreign lender. Suppose, for
example, that a U.S. bank lends $1,000 to a foreign borrower and that the loan
agreement requires the borrower to make an interest payment to the U.S. lender of
$100 each year, regardless of any taxes imposed by the borrower’s country.
Suppose further that there is a 20 percent withholding tax on such interest
payments imposed by the borrower’s country. Such taxes are generally deemed to
be an income tax imposed on the lender even though the obligation is expected to
be satisfied by the payment of the tax by the borrower (sometimes called the
“withholding agent”). Under the terms of the loan agreement, the foreign
borrower makes a payment of $100 to the U.S. lender and a payment of $20 to the
tax administration of the foreign country. Under long-standing authority, the net
result is that the U.S. lender is treated as having realized income of $120 (the cash
received plus the satisfaction of its foreign tax obligation); but the U.S. lender is
also entitled to a foreign tax credit of $20. In other words, the result is the same as
if the U.S. lender had received $120 and then paid a foreign income tax of $20.
Treas. Reg. § 1.901-2(f)(2)(ii), Ex. 1. This result has applied even in
21
circumstances in which the borrower was an agency of the tax-collecting foreign
government. Riggs Nat’l Corp. v. Commissioner, 295 F.3d 16 (D.C. Cir. 2002).
Another example is set forth in the regulations. In that instance, a U.S.
corporation contracts with a foreign party to perform services in another country.
The foreign party agrees to pay any income taxes that may be owing by the U.S.
corporation to the foreign country. The regulations make it clear that the taxes
paid must be considered to be additional income to the U.S. company, but also
make clear that the U.S. corporation is entitled to a foreign tax credit. Treas. Reg.
§ 1.901-2(f)(2)(ii), Ex. 3. This result was upheld by the Tax Court6 and the Court
of Appeals for the Seventh Circuit even when the foreign contractor was an agency
of the Egyptian Government. Amoco Corp. v. Commissioner, 138 F.3d 1139 (7th
Cir. 1998).
As indicated previously, such practices form a part of the context in which
this case should properly be considered. They demonstrate that, while the
objectives of the foreign tax credit provisions are perfectly clear–to mitigate double
income taxation of international transactions– certain accepted practices that go
well beyond that basic purpose have been sanctioned by the Code. Moreover, the
failure to bear the full financial burden of a foreign tax obligation by a taxpayer
6
T.C. Memo. 1996-159, 71 T.C.M. (CCH) 2613.
22
does not automatically deny the benefit of a foreign tax credit.
The Government, of course, contends that neither of these practices is
relevant to this case because the STARS transaction goes so far beyond such
relatively common forms of international tax planning and avoidance that it
amounts to a “sham” that must be wholly disregarded for federal income tax
purposes.
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IV. Motion to Determine Issues of U.K. Law
1.
The Motion
Wells Fargo has moved for renewed “consideration of its request for
determinations of U.K. law.” (Doc 426) For the reasons explained below, this
motion is addressed in the context of specific issues raised by other motions
addressed in this Report.
2.
Context of the Motion
In March, 2013, Wells Fargo moved under FRCP 44.1 for a number of
determinations of U.K. law. (Doc 299) The motion correctly noted that questions
of foreign law are now treated as questions of law in federal courts, a change from
an earlier time when questions of foreign law were regarded as questions of fact.
The earlier motion was based upon the expectation that many issues of U.K.
law would be relevant, if not determinative, of issues arising in this case even
though the case depends primarily upon principles of U.S. tax law. The
Government opposed the motion on several grounds. It argued that “this case does
not present any issue requiring a definitive determination of U.K. law.”7
Therefore, the process, which might include eliciting expert testimony from U.K.
legal experts, would be unnecessarily time consuming and expensive. Further, it
7
Government Memorandum in Opposition to Motion, page 1.
24
argued that any attempt to decide the issues of U.K. law in a vacuum (that is, with
no specific relationship to the issues in this case) was likely to be confusing and
could lead to erroneous conclusions.
The earlier motion was denied with leave granted to renew all or a part of
the requests for foreign law determinations at a later point. Report of Special
Master, dated June 18, 2013. (Docs 339 and 340) The Report explained:
“The better course . . . will be to consider specific U.K. legal issues as they
are raised by either Party in the context of motions or other matters in this
case. That procedure will allow the court fully to consider the relevance of
the U.K. laws in question and their impact on this case. It will also avoid the
necessity of asking and answering U.K. legal questions that may not
contribute to the resolution of U.S. tax issues that must be determined in this
case.”
Among the motions made by Wells Fargo that are being addressed in this
Report, Wells Fargo has moved again under FRCP 44.1 for determinations of
U.K. law on the grounds that they are “necessary and appropriate.” It emphasizes
that contested issues of U.K. law are of particular relevance to its challenges to
three of the expert witnesses used by the Government and cite U.K. law
determinations in connection with several other motions.
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After a discussion of the issues raised by this motion and the process of
reaching any required determinations, it still seemed inadvisable to consider the
proposed determinations in a vacuum. Therefore, counsel for Wells Fargo were
directed during hearings on the various motions to identify any specific issues of
U.K. law they believed to be necessary to the determination of any particular
motion. Counsel for the Government were directed to indicate whether they agreed
with any formulations of U.K. law asserted by Wells Fargo and, if not, to state
their position with respect to the relevance and necessity of rendering
determinations with respect to the U.K. law question in issue.8
The procedure outlined in the preceding paragraph was followed during the
hearings with respect to the motions here under consideration. In the discussions
that follow, the Report will identify determinations of U.K. law urged by Wells
Fargo and explain the resolution of the issues raised thereby. As explained in
subsequent portions of this Report, no determinations of U.K. law are deemed to be
necessary at this time to resolve the motions addressed herein.
8
Transcript of telephone conference of March 3, 2014, pages 9 et seq.
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V. Motion That the Bx Was “Pre-Tax”
1. The Motion
Wells Fargo has moved “for partial summary judgment that the ‘Bx’ was
pre-tax.” (Doc 386) The intended object of the motion is that the so-called Bx
consideration would be regarded as an item of income for purposes of applying the
economic substance test and perhaps the business purpose test as part of the sham
transaction analysis. For the reasons set forth below, the motion is granted.
2. Context of This Motion
A principal element in the application of the sham transaction analysis is the
reasonability of profit expectations for the taxpayer participating in the challenged
transaction. Wells Fargo previously moved for a partial summary judgment that
there was a reasonable possibility of pre-tax profit arising from the STARS
arrangement because the net cost of the loan from Barclays (interest less the Bx
amount) and the costs of implementing the STARS transaction were substantially
less than the average return on capital invested by Wells Fargo. That motion was
denied by the Special Master primarily because of factual issues raised by the
Government with respect to the transaction, including whether the use of the U.K.
Trust and the loan are properly to be treated a single transaction for purposes of the
sham transaction tests (sometimes called the “bifurcation issue”), whether the loan
27
in fact added to the profit of Wells Fargo and whether certain other aspects of the
detailed implementation of the transaction distinguished it from an earlier decision
by the Court of Appeals for the Eighth Circuit.
While it may seem to be obvious, it should be noted that the denial of the
motion for partial summary judgment meant only that the motion was denied. That
decision did not constitute a determination that Wells Fargo’s position could not be
sustained at trial. Rather, the motion raised disputed issues of fact that in a case
bound for a possible jury trial could not properly be decided in favor of the moving
party at that stage of the proceedings. Report of the Special Master Report, dated
October 25, 2013. (Doc 384)
The motion here considered is the second motion directed to the
determination of profit expectations as part of the economic substance doctrine.9
However, this motion differs from the prior motion. It is narrowly focused on
another aspect of the STARS transaction: the treatment of the Bx consideration.
The motion is neither based upon the loan from Barclays nor is it dependent in any
way on the loan or profits that may have been derived from investing the proceeds
of the loan. Further, the denial of Wells Fargo’s prior motion for partial summary
9
The Government criticizes Wells Fargo’s strategy as a piecemeal approach that is
calculated to produce distorted results. The various motions addressed in this Report have been
considered with an awareness of these concerns.
28
judgment based upon the use of the loan proceeds does not affect the analysis of
this motion. As both motions were directed at the same principle and invoke
common elements of legal analysis, a portion of the analysis and explanation here
will be familiar.
The basic elements and the steps required for the implementation of the
STARS transaction have been described in this Report. Importantly for purposes
of the motion here under consideration, as a part of the STARS transaction Wells
Fargo was to receive the Bx consideration (a specific amount negotiated by the two
banks) every month. Whether the Bx consideration resulted in the reduction in
interest paid by Wells Fargo to Barclays or payment from Barclays to Wells Fargo,
the taxable income reported by Wells Fargo (and the affiliates that were included
in the preparation of its consolidated tax return) for U.S. income tax purposes was
increased. Wells Fargo’s motion here under consideration asks that this effect be
recognized and applied primarily in determining whether the STARS transaction
has economic substance. It should be noted that the motion does not ask for a
judgment that the economic substance test has been satisfied.
The Government opposes the motion essentially on the grounds that the
STARS transaction is a sham, that the Bx amount is simply an “effective rebate”
of U.K. income taxes paid by Wells Fargo (through the U.K. Trust that is included
29
in its consolidated U.S. tax return) and that the transaction is simply a series of
circular payments having no economic substance. As such, the Bx payment cannot
properly be construed to be pre-tax income for purposes of the economic substance
test that is part of the sham transaction doctrine.
3. Evolution of the Sham Transaction Doctrine
As noted previously, the sham transaction doctrine is one of several
judicially created limitations on the entitlement to tax benefits that have been a part
of U.S. income tax jurisprudence for many years. When such doctrines apply, tax
benefits are denied even though the challenged transactions satisfy the technical
requirements of the Code and other relevant sources of tax law.
A foundational source of the current version of the sham transaction doctrine
is the U.S. Supreme Court decision in Frank Lyon Co. v. United States, 435 U.S.
561 (1978). In that case, the taxpayer had taken depreciation and other deductions
with respect to a building in a sale-leaseback transaction. The IRS challenged the
deductions on the ground that the taxpayer was not the real owner of the building
(a substance-over-form line of analysis). The District Court held the tax benefits
being contested to be allowable. The Court of Appeals for the Eighth Circuit
reversed that decision and held for the IRS. The Supreme Court noted that the
Eighth Circuit had undertaken “its own evaluation of the facts” to support its
30
decision. The Supreme Court in turn set forth its own analysis, agreed with the
conclusions of the trial court, reversed the Court of Appeals decision and held that
the sham transaction doctrine did not apply. In so doing, it outlined the nature of
the sham transaction doctrine in language that has been cited in many later
decisions and is often considered to be the cornerstone articulation of the modern
application of the doctrine:
“ . . . [W]e are not condoning manipulation by a taxpayer through arbitrary
labels and dealings that have no economic significance. . . . In short, we hold
that where, as here, there is a genuine multiple-party transaction with
economic substance which is compelled or encouraged by business or
regulatory realities, is imbued with tax-independent considerations, and is
not shaped solely by tax avoidance features that have meaningless labels
attached, the Government should honor the allocation of rights and duties
effectuated by the parties.”10
The Court observed that “ the underlying pertinent facts [were] undisputed”11 and
explained that “[t]he general characterization of a transaction for tax purposes is a
question of law subject to review. The particular facts from which the
10
11
435 U.S. at 583-4.
Id. at 563.
31
characterization is to be made are not so subject.”12
The Supreme Court decision in the Frank Lyon case was interpreted in many
courts to contemplate two areas of inquiry that were characterized in some later
decisions as a “two-pronged test”: whether the transaction had “economic
substance” and whether the taxpayer acted with a “business purpose.”
In Rice’s Toyota World, Inc. v. Commissioner, 752 F.2d 89 (4th Cir. 1984),
the IRS challenged depreciation and certain interest deductions taken in another
sale-leaseback transaction. The Tax Court ruled for the IRS. The Court of
Appeals affirmed and explained the Supreme Court decision in Frank Lyon in the
following way:
“To treat a transaction as a sham [as the Tax Court had held], the court must
find that the taxpayer was motivated by no business purposes other than
obtaining tax benefits in entering the transaction, and that the transaction has
no economic substance because no reasonable possibility of a profit exists. .
. . We agree that such a test properly gives effect to the mandate of the
Court in Frank Lyon that a transaction cannot be treated as a sham unless the
transaction is shaped solely by tax avoidance considerations.” 13
12
13
Id. at 584, fn 16.
752 F.2d at 91-92.
32
The court then affirmed a Tax Court decision that the taxpayer had flunked both
tests:
“Hence, we affirm as not clearly erroneous the tax court’s finding that Rice’s
transaction is a sham because Rice subjectively lacked a business purpose
and the transaction objectively lacked economic substance.”14
The decision in Rice’s Toyota World has been widely cited as an explanation
of the consequences of Frank Lyon. Different circuit courts of appeal have,
however, applied the two tests in different ways. Some have held that taxpayers
must pass both tests. Others have held that the taxpayer must pass at least one of
the tests. Others have held that the economic substance test must be satisfied
regardless of the taxpayer’s subjective intentions. Still others have held that the
two tests are part of an integrated analysis in determining whether a transaction is a
sham.15
In the IES16 case, discussed in detail in the next section of this Report, the
14
Id. at 95.
15
A lengthy summary of the different ways that different circuit courts had dealt with the
question of how the two tests apply that has been noted by a number of courts can be found in
Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. 67, at 168-69 (T.C. 2012).
16
IES Industries, Inc. v. Commissioner, 253 F.3d 350 (8th Cir. 2001).
33
Court of Appeals for the Eighth Circuit in 2001 concluded that a definitive
determination of the posture of the two tests had not then been made in that
circuit. Moreover, it was unnecessary to make the determination because the
transaction had both economic substance and business purpose.
A recent decision by the Court of Appeals for the Eighth Circuit confirmed
that both tests are applicable in this circuit, but the court again found it unnecessary
to indicate whether the taxpayer must prove that both tests have been satisfied.
WFC Holdings Corporation v. United States, 728 F.3d 736 (8th Cir. 2013). In this
decision, the court noted again that different approaches to the posture of the two
tests have evolved in different circuits. The court concluded that the Eighth
Circuit “has not yet adopted a particular approach to the sham transaction test” and
that it was not necessary to “definitively resolve that issue” because the transaction
under review had neither economic substance nor business purpose. The decision
of the District Court to that effect was affirmed. The Court of Appeals did not
expressly indicate the extent to which it considered the matter to constitute
questions of fact or questions of law.
4. Eighth Circuit Precedent: The IES Case
The principal case upon which Wells Fargo’s motion for partial summary
judgment is based is IES Industries, Inc. v. Commissioner. 253 F.3d 350 (8th Cir.
34
2001). In that case the taxpayer, a U.S. corporation, in effect purchased shares of
stock in foreign corporations17 just prior to record dates for dividend distributions.
At virtually the same time, the taxpayer contracted to resell the shares back to the
original seller on a closing date just after the dividend had been paid. As a result,
the taxpayer was the shareholder on the record date for the dividend distributions.
The dividends were distributed to the taxpayer, but were subject to foreign
withholding taxes. The taxpayer thus received a payment equal to the amount of
the dividend less the amount of the taxes withheld and paid over to the foreign
governments. Corporations paying the dividends were organized in the United
Kingdom, the Netherlands and Norway. The withholding tax rate in each instance
was 15 percent, as authorized by applicable bilateral income tax treaties.
As explained previously in this Report, although such withholding taxes are
actually paid by the corporations making the dividend distributions, the taxes are
considered to be income taxes imposed on the shareholder to which the dividends
are being distributed. Such withholding taxes on dividend income are generally
creditable under the Code. However, the original owners of the shares were
entities, such as pension funds, that were exempt from U.S. tax and that could not
17
The taxpayer in fact purchased American Depository Receipts, or ADRs, which
represent shares of a foreign corporation held in trust by a U.S. bank.
35
benefit from a foreign tax credit because the credit must be subtracted from income
taxes otherwise payable.
The purchase and resale prices of the shares were based upon the market
trading price of the stock. The stock was originally purchased for a price equal to
the market plus 85 percent of the dividend (which was the net amount to be
received after the withholding tax had been subtracted). The resale price was the
market price of the shares after the dividend had been paid. In general the
difference between purchase and selling price would approximate the amount of
the dividend distribution, thereby generating a loss to the taxpayer when the shares
were sold. In addition, certain fees and commissions were paid to an intermediary
that effected the transaction and interest was paid because the shares were
purchased by the taxpayer on a margin account. At the end of the related series of
steps, the tax exempt entities once again owned the shares in question.
The principal tax results reported by the taxpayer were:
1. The gross amount of declared dividend was ordinary income
(which is the dividend actually paid to the shareholder plus the foreign
tax liability satisfied by the withholding mechanism);
2. A foreign tax credit equal to the withholding tax was claimed;
3. A short-term capital loss was taken, which derived from the resale
36
of the stock after the distribution of the dividend.18 (Capital losses
may only be deducted against capital gains. The taxpayer had realized
capital gains in prior years. The capital losses realized in the
challenged transactions were applied to those capital gains, thereby
generating additional tax savings.)
The net results of the transactions in purely monetary terms were losses.
When the foreign tax credits and capital loss deductions were taken into account,
however, the taxpayer’s financial position had been substantially enhanced. The
Government contended that the transaction was a sham transaction driven by the
desire of a tax exempt entity to market tax benefits to a taxable entity and denied
the availability of the foreign tax credits, the short-term capital losses and the
deduction for the expenses of the transaction.
The case was submitted to the District Court on the basis of stipulated facts
and cross motions for summary judgment. The District Court granted summary
judgment against the taxpayer and concluded that the transactions constituted
shams that would not be recognized for tax purposes because the transactions
18
The taxpayer treated commissions as a part of the cost of the shares or as a reduction
of the proceeds of the sale and deducted the interest expense attributable to the margin account.
37
“were shaped solely by tax avoidance considerations, [and] had no other practical
economic effect . . . .” In reaching its decision, the court compared the income
generated by the linked transactional steps to the costs of the transaction, which
included the foreign income taxes paid through the withholding mechanism. The
result of this calculation for the taxpayer was a clear financial loss.
As noted previously, the Court of Appeals for the Eighth Circuit observed
that the posture of the two-pronged test described in Rice’s Toyota World had not
been determined for that circuit. It applied both tests and concluded that the
transactions had both economic substance and a business purpose, so it was not
necessary to prescribe the relationship between the two tests. As the transactions
were not properly characterized as shams, the decision of the District Court was
reversed. The taxpayer was thus entitled to the foreign tax credits and other tax
benefits.
The application of the economic substance doctrine by the Court of Appeals
was based in substantial measure upon an examination of the “economic benefit”
realized by the taxpayer in the related transactions. The Government had argued
that the foreign taxes should not be considered in this analysis because it was
exactly those taxes whose creditability was being challenged:
“The government insists that, ‘absent the tax benefits that were the sole
38
reason for the transactions, each series of ADR trade pairs resulted, as preplanned, in an economic loss.’ . . . Under that view, economic benefit
accrues to IES only if it receives the foreign tax credit. In other words, the
government would have us regard only 85% of the dividends as income to
IES, notwithstanding that the IRS treats 100% as income for tax purposes.”
The Court of Appeals disagreed:
“We reject the government’s argument and agree with IES that the law
supports our contrary conclusion: the economic benefit to IES was the
amount of the gross dividend, before the foreign taxes were paid. IES was
the legal owner of the ADRs on the record date. As such, it was legally
entitled to retain the benefits of ownership, that is, the dividends due on the
record date. While it received only 85% in cash, 100% of the amount of the
dividends was income to IES.”19
The court concluded that the trades “did not, as a matter of law, lack business
purpose or economic substance.”20
19
253 F.3d at 354.
20
Id. at 356
39
5. IES and the STARS Transaction
Wells Fargo’s present motion for partial summary judgment is largely based
the decision of the Eighth Circuit in the IES case. It contends that IES has not been
modified and must, therefore, be applied by a District Court in the Eighth Circuit.
Because the Court of Appeals held “as a matter of law” that the foreign taxes should
not be considered as a cost in the calculation of the economic substance (profit
expectations) of the transaction, Wells Fargo in this action seeks a ruling at this
time that the Bx consideration is appropriately considered to be a pre-tax item of
income in determining potential profitability in the context of the economic
substance test.
The Government concedes that the Eighth Circuit decision must be followed
in litigation before the District Courts of the Circuit, but contends that the IES
decision does not support the proposition asserted by Wells Fargo in its motion.
The details of the STARS transaction obviously differ from the transactions
that occurred in the IES case in a number of material respects. It is, therefore,
necessary to consider whether these differences might support the conclusion that
the Eighth Circuit decision in the IES case with respect to the treatment of foreign
taxes does not automatically apply to the foreign taxes paid in the STARS
transactions.
40
Several elements of the IES decision raise questions about its applicability to
the STARS transaction. First, the court explicitly stated that:
“It also is important to note that these were not transactions conducted by
alter-egos of IES or straw entities created by IES simply for the purpose of
conducting ADR trades. . . . All of the parties involved–the foreign
corporations, the trusts issuing the ADRs, the tax-exempt ADR owners . . .
other brokers involved, the counterparties–were entities separate and apart
from IES, doing legitimate business before IES started trading ADRs and (as
far as we know) continuing such legitimate business after that time.”21
Some of the entities involved in the implementation of the STARS transaction were
created specifically to implement the transaction. Moreover, at a hearing with
respect to an earlier motion, counsel for Wells Fargo was not certain whether such
entities continued to exist after the STARS transaction was completed.22
The court in the IES case also emphasized that:
“‘[T]he transaction[s] must be viewed as a whole, and each step, from the
commencement of negotiations to the consummation of the sale, is relevant.’
Comm’r v. Court Holding Co., 324 U.S. 331 . . . (1945). Each trade was an
21
Id. at 356.
22
October 14, 2011, Hearing Transcript, page 50.
41
arm’s-length transaction: ‘what was actually done is what the parties to the
transaction purported to do.’ Gran v. IRS (In re Gran), 964 F.2d 822, 825
(8th Cir. 1992).”23
In this respect the court seemed to be relying upon the fact that the prices paid and
received for the ADRs in the paired transactions were determined by public trading.
In the STARS transaction, Wells Fargo observes that the interest rate arrangements
between it and Barclays reflected market interest rates, but does not contend that
the financial arrangement between it and Barclay’s with respect to the magnitude of
the Bx consideration was fixed by an identifiable and independently determined
market rate. Again, it was a negotiated amount calculated on the basis of U.K. tax
benefits expected by Barclays.
Finally, the court in the IES case concluded that its decision rested upon a
broad analysis of the transactions under review: “We hold, considering all the facts
and circumstances of this case, that the ADR trades in which IES engaged did not,
as a matter of law, lack business purpose or economic substance.24
There are differences in the way in which the foreign taxes paid by IES and
the U.K. taxes effectively paid by Wells Fargo occurred. The foreign taxes paid by
23
253 F.3d at 356.
24
253 F.3d at 356 (emphasis added).
42
IES (through the withholding mechanism in place in the foreign countries) took
place as the dividend income was distributed by foreign corporations to IES as a
shareholder. In other words, once IES was a shareholder of the foreign corporation
on the dividend date and once a withholding obligation had been satisfied by the
foreign corporation (paying a tax imposed upon IES as the shareholder), then IES
was a domestic taxpayer that had paid a foreign creditable tax. This conclusion
was, moreover, supported by an early “classic” decision of the U.S. Supreme Court
in which the Court held that the payment by a corporation of its president’s income
taxes constituted income to the president. Old Colony Trust Co. v. Commissioner,
279 U.S. 716 (1929).
In the STARS transaction, Wells Fargo placed existing U.S. assets into a
U.K. Trust solely for the purpose of subjecting such income to the U.K. income tax.
Like IES, Wells Fargo’s rationale for such an apparently peculiar decision was that
it would realize economic benefits from doing so. As indicated, Wells Fargo in its
previous motion identified the use of the proceeds of the loan from Barclays as
providing such economic benefits and moved for a partial summary judgment based
upon a comparison of the net cost of the loan and other costs of the transaction with
its average return on investments (an argument that will presumably be made to the
jury at trial). Wells Fargo now proffers an alternative financial benefit argument to
43
support the argument for economic substance: the Bx consideration paid by
Barclays to Wells Fargo either as a reduction in interest paid to Barclays or as an
occasional payment from Barclays.
Certain facts are clear and undisputed. Wells Fargo chose to subject U.S.
assets that it owned and controlled to U.K. income tax. The assets had no
connection with the United Kingdom. The U.K. tax was imposed because the trust
was a U.K. resident under U.K. law because it had a U.K. trustee. Income tax
treaties between the United States and the United Kingdom authorized treatment of
the trust as a U.K. resident if U.K. law so provided. The U.K. Trust was treated as a
part of Wells Fargo for purposes of its consolidated U.S. tax return. The U.K. Trust
(and, therefore, Wells Fargo) was subjected to and paid U.K. income taxes at the
rate of 22 percent. Under the terms of the U.K. Trust arrangement, Barclays was
treated under U.K. tax law as the recipient of almost all of the after-U.K.-tax
income. For U.K. tax purposes, Barclays was thus treated as having realized
taxable income equal to the U.K. Trust income so allocated plus the U.K. tax
attributable thereto. The total income deemed to have been so realized was subject
to a U.K. income tax in the hands of Barclays at a rate of 30 percent. Barclays was
entitled to a credit against that tax equal to the 22 percent U.K. tax paid (or owing)
by the U.K. Trust that was attributable to the trust income so allocated. Most of the
44
trust income “distributed” to Barclays was not in fact paid to Barclays. Rather, it
was treated as a deposit in a blocked account maintained by Wells Fargo and then
treated as an additional contribution to the U.K. Trust by Barclays that would enure
to the benefit of Wells Fargo at the end of the transaction. Wells Fargo effectively
borrowed $1.25 billion from Barclays at an interest rate of LIBOR plus .2 percent.
Barclays then paid consideration on a regular basis to Wells Fargo equal to
approximately 47.5 percent of the U.K. income taxes paid by U.K. Trust. This was
the Bx amount.
6. Role of U.K. Law in Determining This Motion
Wells Fargo has twice moved under FRCP 44.1 for determinations of U.K.
law that it contends are necessary for the resolution of issues raised in this case.
The prior motion was denied with leave to raise such arguments in the context of
specific issues. The renewed motion, as explained previously in this Report, is
being addressed in the context of specific motions being considered in this Report.
Wells Fargo here urges that it is necessary to address a number of potentially
contested determinations of U.K. law in order to rule on this motion for partial
summary judgment. During the Hearing with respect to this motion, Wells Fargo
submitted that the following determinations were appropriate and necessary:
1.
The U.K. Trust qualified as a Collective Investment Scheme under
45
U.K. law and was “unauthorized unit trust.”
2.
Because the trust was an unauthorized unit trust under U.K. law, the
U.K. trustee was subject to a U.K. income tax of 22 percent.
3. and 4"The specific aspects of the transaction, Rigil and the D unit, ensured
– or were designed to ensure - - that the arrangement was a CIS.”
5.
“Under U.K. law the income arising on the assets held in the trust
[included] any income from the securities held directly in the trust
including distributions on the Sirius shares.”
6.
The U.K. income tax owed by the U.K. trustee on the income arising
on the assets held in trust was a liability of [the] U.K. trustee and not of
any of the unit holders.
7.
By operation of U.K. law Barclays was deemed to receive annual
payments from the U.K. trustee equal to the income available for
distribution.
8.
Barclays was subject to U.K. corporation tax at rate of 30 percent on
deemed annual payments.
9.
Barclays was entitled to a U.K. tax credit of 22 percent.
10.
Barclays could claim the credit against either of two U.K. tax
obligations.
46
11.
Barclays could deduct payments of further subscription amounts to the
trust for the Class E Unit.25
The Government argues that such determinations are unnecessary.26 We
agree with the Government. Wells Fargo, while considering the STARS
transaction, was responding to representations about the application of U.K. law in
particular to the U.K. Trust and to Barclays. If tested, these representations may or
may not have been correct. They were not tested because the U.K. tax authorities
chose not to challenge the benefits asserted by Barclays in the various STARS
transactions in which it participated. In any event, the issues raised by the Bx
motion here considered are directed to the expectations of Wells Fargo at the time
the transaction was negotiated and concluded. Those expectations are not contested
by the Government in this case. Indeed, the very same expectations form a major
element of the Government’s rationale for denying tax benefits to Wells Fargo.
7. Analysis of the Bx Consideration
The appropriate response to the motion here under consideration obviously
requires a determination of the origin of the foreign tax credits that are in issue.
They clearly derive from the subjection of U.S. assets to a foreign tax. If no assets
25
March 19, 2014, Hearing Transcript, pages 28-40.
26
March 19, 2014, Hearing Transcript, page 111.
47
were contributed by Wells Fargo to the U.K. Trust, no U.K. income tax liability
would have been incurred.
If the analysis were to stop at this point, there could be no economic
substance to the transaction. Wells Fargo realized no income from the U.K. Trust
itself that would not otherwise have been realized from the previously owned assets
contributed to the trust. Whether or not the U.K. taxes themselves should be
considered to be costs, there were substantial transactional costs involved. If
marginal revenue is zero and there are any costs, no profit is possible.
It would, however, be inappropriate to end the analysis at this juncture. Even
the Government does not argue for such an approach. While not deciding at this
point whether the loan constitutes a separate transaction for purposes of the sham
transaction analysis, it must be noted that Wells Fargo was clearly paid for
establishing the U.K. Trust, undertaking the other steps to implement the STARS
transaction and for submitting U.S. income to the grasp of the U.K. tax
administration. That compensation came in the form of the Bx consideration.27
The Government contends that the Bx consideration proves the STARS
transaction to be a sham in large measure because of the view that Barclays bore a
27
This conclusion is quite consistent with a statement set forth in the Government’s
Memorandum in Opposition to this Motion: “The evidence establishes beyond doubt that
Barclays made the Bx payments to compensate Wells Fargo for subjecting its income from its
U.S. based assets to a U.K. tax.” Memorandum, page 34.
48
portion of the economic incidence of the U.K. tax. But the Government’s position
is not limited to the portion of the U.K. tax that was not borne by Wells Fargo.
That position seems strained in light of the clear authority for the proposition
(evidenced in the regulations and judicial decisions cited previously) that a foreign
tax credit is not denied even when an unrelated foreign party to the transaction pays
100 percent of the foreign tax for the U.S. taxpayer--not merely 47.5 percent as in
this case.
The Government’s position would seem to invite the conclusion that the use
of a mechanism such as the U.K. Trust would not be a sham if no consideration was
received from another party. For example, suppose that a U.S. corporation was in
an excess credit position and chose to establish a trust in a low–tax country with a
treaty having the same provisions as the U.S.-U.K. tax treaties for the sole purpose
of trying to use the excess credits. When asked whether the possible use of a
foreign trust for such tax avoidance purposes would be considered to be a sham, the
Government declined to respond, noting that such a transaction was factually
different from the STARS case.28
The example is, of course, materially different from the STARS case. In
STARS, Wells Fargo was paid the Bx consideration for taking the steps necessary
28
March 19, 2014, Hearing, pages 128 et seq.
49
to implement the transaction. If a U.S. corporation were able to place U.S. assets in
a foreign trust solely to enlarge its entitlement to foreign tax credits, the only
financial return would be those enlarged tax credits. This suggests that any
vulnerability in the STARS transaction is primarily attributable to the use of the
U.K. Trust itself and not to the compensation paid by Barclays to Wells Fargo
(albeit measured by reference to the magnitude of U.K. income taxes paid by the
U.K. Trust).
Neither counsel nor the Special Master has been able to cite a case in which
the “pure” use of a foreign trust to achieve tax benefits has been contested. It thus
seems appropriate to consider the Bx consideration to be income to Wells Fargo at
least for purposes of applying the economic substance test. The Bx consideration,
after all, increases the taxable income to Wells Fargo, one way or another. As a
result, the total income tax burden on Wells Fargo is increased, even though a
portion of that income tax burden is attributable to the payment of U.K. income
taxes.
This result places the STARS transaction on a dramatically different footing
from almost all other cases involving the sham transaction doctrine. In most of
those cases, the taxable income of the taxpayer has been reduced, usually by
questionable deductions or losses. In this case, the taxable income of Wells Fargo
50
has been increased even without considering any profits generated from the use of
the loan proceeds. But tax credits are, of course, arithmetically different than tax
deductions exactly because credits do not reduce taxable income. There follows a
summary of the limited number of decisions in which the sham transaction doctrine
has been used to challenge foreign tax credits.
8. Challenges to Foreign Tax Credits under “Common Law” Doctrines
The sham transaction doctrine and other “common law” defense mechanisms
have been asserted to challenge foreign tax credits in very few cases. One, of
course, is the IES case determined by the Court of Appeals for the Eighth Circuit
and discussed in detail in an earlier portion of this Report. In the same year, another
court of appeals ruled on virtually the same transaction. Compaq Computer Corp.
v. Commissioner, 277 F.3d 778 (5th Cir. 2001), involved a transaction almost
identical to the IES transactions. The taxpayer purchased ADRs representing
ownership of stock in a foreign corporation just prior to a dividend distribution.
The dividends were paid, but were subject to foreign withholding taxes. The shares
were immediately resold after the dividends had been paid. The transaction was
proposed by a firm specializing in arbitrage transactions. The purchase price of the
ADRs was about $887.6 million. The ADRs were resold for about $868.4 million.
The gross dividend was about $22.5 million, but $3.4 million was paid in
51
withholding tax to the Netherlands. The cost of the transaction was about $1.5
million. The resulting capital losses were used to offset capital gains.
As in the IES case, the IRS denied the tax benefits of the transaction on the
ground that the arrangements constituted a sham transaction. The Tax Court ruled
in favor of the IRS and disallowed the gross dividend income, the foreign tax credit,
the capital losses and the claimed deductions for expenses. The court of appeals
reversed, expressly agreeing with the analysis of the Eighth Circuit in the IES case.
The court proffered the following explanation of the mix of legal and factual issues
that inhere in the application of the sham transaction doctrine.
“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. . . . This is true even though the Tax Court
has characterized some of its determinations as “[u]ltimate findings of fact.”29
The Government in this case cites Pritired 1, LLC v. United States, 816 F.
Supp. 2d 693 (S.D. Iowa 2011), as an analogous case in which a taxpayer’s
entitlement to foreign tax credits was successfully challenged.30 The case involved
29
30
277 F.3d at 781.
March 19, 2014, Hearing Transcript, pages 153-4.
52
a complex arrangement that included the establishment of a partnership with French
banks in which U.S. corporations were allocated foreign tax credits. The District
Court reached its conclusion on several grounds. One ground was that the supposed
“equity investment” upon which the foreign tax credits were based was in substance
“debt” which would not support the allocation of credits. So the substance of the
transaction prevailed over its form. But the court also added the conclusion that the
transaction in question did not pass either the economic substance or business
purpose test cited and applied in IES. No appellate court decision has been
rendered in that case.
Three courts have addressed challenges by the government to STARS
transactions undertaken by other banks. While none of the three is determinative of
this case, they have been cited by both parties (for obviously different propositions),
so it is appropriate to note them here. The Tax Court and the U.S. Court of Federal
Claims ruled in favor of the government after a trial in each case. The District
Court for the District of Massachusetts granted a motion by the taxpayer for partial
summary judgment that the Bx payment constituted pre-tax income.
In Bank of New York Mellon Corp. v. Commissioner, 140 T.C. 15 (2013), a
STARS transaction challenge was tried in the Tax Court. The Tax Court stated that
“The ultimate determination of whether a transaction lacks economic substance is a
53
question of fact.”31 It applied the approach used in the Second Circuit (to which any
appeal would be taken) that considered both the objective and subjective tests
together (rather than as separate and distinct “prongs”) in deciding whether a
transaction is a sham. It concluded that the transaction was a sham and that tax
benefits be denied to the bank. Although stating that it was not required to do so
under the approach employed in the Second Circuit, the Tax Court went on to
conclude that the transaction lacked both economic substance and a business
purpose. The court explicitly stated that it was not bound by the IES decision of the
Eighth Circuit or the Compaq Computer decision of the Fifth Circuit.32
The Tax Court concluded that the legislative intention of the Congress in
enacting the foreign tax credit provisions did not extend to the STARS transaction:
“The STARS transaction was a complicated scheme centered around
arbitraging domestic and foreign tax law inconsistencies. The U.K. taxes at
issue did not arise from any substantive foreign activity. Indeed, they were
produced though pre-arranged circular flows from assets held, controlled and
managed within the United States. We conclude that Congress did not intend
31
140 T.C. at page 33.
32
140 T.C. 35 at footnote 9.
54
to provide foreign tax credits for transactions such as STARS.”33
The U.S. Court of Federal Claims also ruled in favor of the government after
a trial in a STARS transaction case. Salem Financial, Inc. v. United States, 112
Fed. Cl. 543 (2013). The court applied a substance-over-form analysis, held that
the transaction had neither economic substance nor non-tax business purpose, and
concluded that the Bx payments constituted a “U.S. tax effect” which was a rebate
of U.K. taxes to the taxpayer.
In the third judicial decision that has been rendered in connection with a
STARS transaction, the District Court in Massachusetts granted a motion for partial
summary judgment on the ground that the Bx payment constituted pre-tax income
to the taxpayer in determining whether it had a reasonable prospect of profit in the
transaction. Santander Holdings USA, Inc. v. United States, 977 F.Supp. 2d 46
(2013). The court explicitly rejected the argument that the Bx consideration
constituted a rebate of U.K. taxes to the taxpayer. It cited both IES and Compaq
Computer in support of its decision.
All three cases are being appealed as this Report is being written. Again,
these decisions are not binding for purposes of this case.
33
Id. At page 47.
55
9. The Impact of Treaty Law
Wells Fargo contends that tax treaties in force between the United States and
the United Kingdom explicitly authorized the United Kingdom to impose a tax on
the income of the U.K. Trust and obligated the United States to grant a foreign tax
credit in respect of such U.K. taxes. Two treaties are relevant to these contentions:
a treaty concluded in 1975 applied to the first months of the STARS transaction in
2003; and a successor treaty signed in 2002 that came into force during 2003 and
applied during the remainder of the implementation of the STARS transaction. In
some instances they are referred herein collectively as “the Treaties.”
An income tax treaty is essentially a deal between two governments that
allocates primary taxing jurisdiction between them. Such treaties commit both
governments to take steps (either by exempting income or providing credits) to
mitigate double taxation when the other country has permissibly taxed a resident of
the treaty partner. The failure to satisfy the commitment in a treaty is generally
regarded as a violation of international law by the treaty partner.
The Treaties shared some common provisions relevant to the treatment of the
STARS transaction. Article 4(1)(a)(i) of the 1975 Treaty defines a “resident of the
United Kingdom” to include “a . . . trust . . . to the extent that the income derived by
such . . . trust is subject to United Kingdom tax as the income of a resident, either in
56
its hands or in the hands of its . . . beneficiaries.” Article 3(1)(a) of the 2002 Treaty
defines a “person” to include a “trust.” Article 3(1)(j)(ii)(B) defines a “national” of
the United Kingdom to include “any . . . entity deriving its status as such from the
laws in force in the United Kingdom.” The parties to this dispute agree that the
U.K. Trust was treated as a U.K. person under the laws of the U.K.
The Treaties authorize the United Kingdom to “tax its residents . . . and its
nationals as if this Convention had not come into effect.” Article 1(3) of the 1975
Treaty; Article 1(4) of the 2002 Treaty.
The Treaties commit the United States (with certain exceptions not here
relevant) to allow a credit for U.K. income taxes permissibly imposed on U.S.
domestic taxpayers under the Treaties. Article 23(1) of the 1975 Treaty; Article
24(1)(a) of the 2002 Treaty.
As a result of the Treaties, the deal was that the U.K. could, if it chose to do
so, tax all of the income of trusts that were regarded as U.K. residents under U.K.
law. The Government does not challenge that proposition. However, the
Government argues that treaty provisions cannot apply to a transaction with no
substance (such as a sham transaction). In support of that position, it cites the
Technical Explanation of the 2002 Treaty issued by the U.S. Treasury Department,
which included the following cautionary note:
57
“Article 23 and the anti-abuse provisions of domestic law complement each
other, as Article 23 effectively determines whether an entity has a sufficient
nexus to the Contracting State to be treated as a resident for treaty purposes,
while domestic anti-abuse provisions (e.g., business purpose, substance-overform, step transaction or conduit principles) determine whether a particular
transaction should be recast in accordance with its substance.”
The impact of this portion of the Technical Explanation to this case is not self
evident. It refers to Article 23 of the treaty, which deals with the problem of “treaty
shopping,” and contains the so-called “limitation of benefits” provision. Such
provisions have become a standard element of bilateral tax treaties concluded in the
past several decades. Their purpose generally is to defend against the unacceptable
exploitation of treaty benefits by nonresidents of the treaty country, for example,
through simply organizing investments and/or businesses in corporations organized
in the treaty country (thus the term “treaty shopping”). However, it is Article 24 of
the 2002 treaty that obligates the United States to give a credit for income taxes
properly imposed by the United Kingdom as authorized by the treaty. It is not clear
whether the Technical Explanation refers to that U.S. obligation and other parts of
the treaty as well as Article 23.
58
There is a second ambiguity as well. The Technical Explanation refers to the
issue of “substance over form.” As noted previously, Wells Fargo reported the
STARS transaction on the basis of its substance, rather than its form. In the Bank of
New York Mellon case, the Tax Court explicitly concluded that the Treaties did not
protect the taxpayer in that case because “U.S. tax laws and treaties do not
recognize sham transactions or transactions that have no economic substance as
valid for tax purposes.”34 The Federal Claims Court did not address the status and
effect of the Treaties in its decision in the Salem Financial case.
The application of treaty benefits has been rejected in some cases on the basis
of judicially created doctrine. The Tax Court opinion in the Bank of New York
Mellon case cited Del Commercial Properties, Inc. v. Commissioner, 251 F.3d 210
(D.C. Cir. 2001), in support of its ruling. In that case a U.S. corporation borrowed
from a related Dutch corporation that in turn borrowed from a Canadian
corporation. Interest was thus paid by the U.S. borrower to a Dutch lender. The
Dutch company then paid interest to the Canadian lender. Under the Code, such
interest paid by a U.S. borrower to a foreign lender is generally subject to a 30
percent withholding tax. However, the U.S.-Netherlands Treaty exempted interest
payments from a U.S. borrower to a Dutch lender. The U.S.-Canada Treaty reduced
34
140 T.C. at page 48.
59
withholding rates, but did not exempt such interest payments from the withholding
tax. The court applied the step-transaction doctrine (another example of the
“common law of taxation”) to treat the transaction as an interest payment from a
U.S. borrower to a Canadian lender that was subject to a withholding tax. The court
explained:
“. . . [I]f the sole purpose of a transaction with a foreign corporation is to
dodge U.S. taxes, the treaty cannot shield the taxpayer from the fatality of the
step-transaction doctrine. For the taxpayer to enjoy the treaty’s tax benefits,
the transaction must have a sufficient business or economic purpose.”35
Although not arising under the U.S-U.K. Treaties, the Del Properties case seems
clearly to come within the ambit of the portion of the Technical Explanation cited
by the Government. Other cases have applied a similar step-transaction analysis to
deny treaty benefits where an intermediary entity has been established in a treaty
country and used to avoid U.S. withholding taxes. See, e.g., Aiken Industries, Inc.
v. Commissioner, 56 T.C. 925 (1971).
The step-transaction doctrine has not been asserted in this case.
10. Factual Disputes
As indicated previously, the earlier motion by Wells Fargo directed to the
35
251 F3d at 214.
60
economic substance of the transaction was narrowly limited to the profitable
investment of the loan proceeds. That motion was rejected because it raised a
number of factual issues, including the linkage between the loan and the use of the
U.K. Trust and the relative financial benefits of the arrangement to Wells Fargo.
With respect to such questions, the Court of Appeals in the IES case had
emphasized that “all of the facts and circumstances” must be weighed in applying
the sham transaction tests.
Wells Fargo argues that this particular motion is sharply focused and raises
no relevant factual issues. The issues specifically cited by the Government and
characterized as factual include the differences between the form and substance of
the transaction; whether Wells Fargo did what it purported to do; differences
between STARS and the IES transaction; the effect of using special purpose
entities; the role of artificial features in implementing the transaction; and the
impact of the “make whole” provisions (which would come into play in some
circumstances if anticipated results for the transaction were not realized). The
Government further argues that the transaction was a tax shelter driven by tax
considerations; the Bx amount was an “effective rebate” of the U.K. tax; the
transaction had been marketed as a tax shelter by KPMG and Barclays to banks and
other U.S. corporations; and the net financial consequences (putting aside the usage
61
of the loan proceeds) was a clear loss when the costs of the transaction including the
unnecessarily incurred U.K. income taxes were compared to the zero additional
income realized by Wells Fargo from the use of the U.K. Trust (as all of its income
would have been realized by Wells Fargo in any case).
The Government’s arguments clearly raise questions about the transaction.
However, after careful consideration, these arguments do not persuade that there are
material factual differences with respect to the calculation, substance and effect of
the Bx consideration. Accordingly, a determination of the motion here under
consideration is not prohibited by FRCP 56.
11. Decision: Plaintiff’s Motion for Partial Summary Judgment is Granted
Wells Fargo argues that the Bx consideration was an unconditional payment
which Barclays was required to make under the applicable contracts. Therefore, it
concludes, the Bx payment cannot properly be regarded as conditioned upon the
realization of tax benefits. While the terms of the contracts appear so to provide,
the virtually unlimited ability of either party to terminate the transaction on very
short notice (5 to 30 days) suggests that it would be unrealistic to conclude that this
factor was an appropriate basis for ruling in favor of Wells Fargo.
Unlike most of the tax shelter cases that have been cited in these proceedings,
Wells Fargo realized benefits from the STARS transaction because it was paid by
62
Barclays for its participation in the deal. The payment came in the form of the Bx
consideration. As a result of the Bx consideration, the taxable income of Wells
Fargo was increased. Its income tax burden was also increased, even though a
portion was paid to the United Kingdom. It must be emphasized again that this
conclusion is reached without reference to Wells Fargo profits arguably supported
by the loan proceeds (which was the subject of its earlier motion).
No legal authority has been cited or found to support the view that payments
from one bank to another constitute tax rebates or tax refunds. It is absolutely clear
that the magnitude of the Bx clearly was derived by reference to anticipated U.K.
tax benefits to Barclays, but that reference does not convert the private payment into
some kind of government disbursement or refund.
Wells Fargo frequently cites the decision of the U.S. Court of Federal Claims
in Doyon v. United States. 37 Fed.Cl. 10 (1996), rev’d on other grounds, 214 F.3d
1309 (Fed. Cir. 2000) In that case, the government successfully argued to the trial
court that a payment by another corporation to an Alaska Native Corporation in
return for the use of net operating loss carryovers and tax credits was not treated as
a tax rebate or refund to the taxpayer even though the actual use of those loss
carryovers would have reduced its tax liability. We note, but do not rely upon, that
decision here as it was focused upon a particular statutory provision that does not
63
arise in this case. More telling is the absence of any legal authority (other than the
decisions in two of the three other STARS cases) for the conclusion asserted here
by the Government that a payment by one bank to another is a tax rebate.
It should also be noted that the treatment of the Bx consideration as income
(rather than a rebate or refund of taxes) does not necessarily mean that the economic
substance test has been satisfied. The Government bases it challenge in part upon
the ground that nothing foreign actually happened in the STARS transaction. There
was no substance to the use of the U.K. Trust as all of the income was derived from
the United States. There were no meaningful distributions ever made from the U.K.
Trust to Barclays. The transaction was implemented through circular bookkeeping
entries of the type criticized by the court’s language in the IES case. Since nothing
foreign happened to generate the foreign taxes, the transaction must be a sham. In
that sense, this is truly a case of first impression. The decision on the specific
motion here under consideration does not address these arguments.
The Government makes a further argument that the face amount of the
interest obligation on the loan from Barclays (not counting the impact of the Bx
consideration) was higher than the rate of interest otherwise available and usually
paid by Wells Fargo. It must be noted that this places the Government in a
somewhat ambiguous position. It has argued forcefully that the loan arrangement
64
is separable from the trust for purposes of applying the sham transaction doctrine
(the bifurcation argument). In any event, while a comparison of the cost of the loan
to alternative sources of capital may raise relevant issues in the case, it does not
alter the appropriate characterization of the Bx consideration.
There appears to be no authority with respect to the consequences of simply
using a foreign trust to exploit treaty provisions to generate foreign tax credits.
Taking into account the considerations outlined here and the arguments advanced in
the written submissions and oral arguments of the parties, the decision of the Eighth
Circuit in the IES case and the absence of contrary authority, Wells Fargo’s motion
for partial summary judgment that the Bx consideration is properly considered to be
pre-tax income is GRANTED. An Order giving effect to this decision is being
transmitted herewith.
65
VI. Motion That the STARS Transaction Had a Business Purpose
1. The Motion
Wells Fargo has moved (Doc 401) for “partial summary judgment that the
STARS transaction was motivated by an economic purpose outside of tax
considerations.” The purpose of this motion is to address the so-called “business
purpose” test that (along with the “economic substance” test discussed in the prior
sections of this Report) has evolved as an element in the application of the sham
transaction doctrine. For the reasons set forth below, the motion is denied.
2. The Business Purpose Test
As indicated previously, a foundational source of the current version of the
sham transaction doctrine is the U.S. Supreme Court decision in Frank Lyon Co. v.
United States, 435 U.S. 561 (1978). That case was discussed in detail in a prior
section of this Report. The Supreme Court decision in the Frank Lyon case was
interpreted in many courts to contemplate two areas of inquiry that were
characterized in some later decisions as a “two-pronged test”: whether the
transaction had economic substance and whether the taxpayer acted with a business
purpose. These factors have been applied in different ways in different circuits.
Some have held that taxpayers must pass both tests. Others have held that the
taxpayer must pass at least one of the tests. Others have held that the economic
66
substance test must be passed. Still others have held that the two tests are part of an
integrated and not clearly differentiated analysis in determining whether a
transaction is a sham.
In 1990, the Court of Appeals for the Eighth Circuit proffered the following
formulation, citing Frank Lyon and Rice’s Toyota World:
“ . . . [A] transaction is a sham if (1) it is not motivated by any economic
purpose outside of tax considerations, and (2) is without economic substance
because no real potential for profit exists.”36
This formulation suggests that a transaction is a sham only if both tests have been
flunked. However, in the IES case, discussed in detail in the previous section of
this Report, the Court of Appeals for the Eighth Circuit concluded that a definitive
determination of the posture of the two tests had not then been made in that circuit.
The relatively recent decision by the Court of Appeals for the Eighth Circuit in
WFC Holdings confirmed that both tests are applicable in this circuit, but the court
again found it unnecessary to indicate whether the taxpayer must prove that both
tests have been satisfied
The reason why the court in IES and WFC Holdings was not required to
specify the method of applying the two tests or describing how they might differ
36
Shriver v. Commissioner, 899 F.2d 724 (8th Cir. 1990), at 725-26 (emphasis added).
67
was that the two tests generated the same answers. In IES, the court found that
there was both economic substance and business purpose. In WFC Holdings, the
court found that there was neither economic substance nor business purpose. In fact
the difference between the two tests is not always readily ascertainable because
courts almost always seem to answer the two questions in the same way.
The two prongs of the sham transaction doctrine are sometimes described as
the objective (profit expectations) and subjective (business purpose) test. As the
subjective test, the existence of a business purpose raises a clearly factual question.
The business purpose test was articulated by the Eighth Circuit in the Shriver case
(again citing Frank Lyon) in the following way: “. . . [A] transaction is a sham if it
is not motivated by any economic purpose outside of tax considerations. . . .” The
court (further quoting Frank Lyon) stated that the test asked whether a taxpayer’s
motivation in concluding a transaction was “shaped solely by tax avoidance
features.”37 In any event, it is generally accepted that the presence of a tax motive
will not disqualify the transaction if non-tax motives are also present.
The two prongs of the sham transaction test are thus often mentioned, but the
difference between them is almost never fully explained. Neither party cites a case
in which a court finds a business purpose, but no economic substance or economic
37
899 F.2d 724, 725 (8th Cir. 1990).
68
substance, but no business purpose. One possible construction is that any
transaction that passes the economic substance test (based upon reasonable profit
expectations) is by definition motivated by a business purpose. In that event, the
subjective test would only become relevant if there was no economic substance. If
that analysis is appropriate, however, it would be reasonable to expect clear
authority to that effect.
The IES case provided just such an opportunity. Having concluded that the
transactions had economic substance, the court could have announced that the
business purpose test had thereby been satisfied. Instead, the court went on to
explain why the business purpose test had been satisfied by describing some of the
steps taken by IES leading to the conclusion of the challenged transactions:
“As for the business purpose test, the Shriver court explained that the proper
inquiry is ‘whether the taxpayer was induced to commit capital for reasons
only relating to tax considerations or whether a non-tax motive, or legitimate
profit motive, was involved’. . . . In other words, the business purpose test is
a subjective economic substance test. . . . The Shriver Court considered the
district court’s ‘subjective analysis of the taxpayer’s intent’ and the court’s
review of such factors as the depth and accuracy of the taxpayer’s
investigation into the investment. . . . To the extent the taxpayer’s subjective
69
intent is material, we too will consider factors that are arguably relevant to
the inquiry. We do so, however, mindful of the fact that ‘[t]he legal right of a
taxpayer to decrease the amount of what otherwise would be his taxes, or
altogether avoid them, by means which the law permits, cannot be doubted.’
Gregory v. Helvering, 293 U.S. 465 . . . (1935). A taxpayer’s subjective
intent to avoid taxes thus will not by itself determine whether there was a
business purpose to a transaction.
“In their briefs, both parties discuss the risk of loss inherent in the
trades, evidently presuming that the degree of risk goes to IES’s subjective
intent in engaging in the transactions. The government argues that the
transactions must be characterized as shams because there was no risk of loss.
We disagree. The risk may have been minimal, but that was in part because
IES did its homework before engaging in the transactions.”38
The court noted that IES officials had met with representatives of an intermediary,
studied the materials provided and consulted with outside accountants and its
securities counsel with respect to the legality of the transactions and tax
consequences. Further IES had rejected some of the proposed trades.
The court concluded:
38
253 F.3d at 355.
70
“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’s
disinclination to accept any more risk than necessary in these circumstances
strikes us as an exercise of good business judgment consistent with a
subjective intent to treat the ADR trades as money-making transactions.” 39
The recent decision of the Eighth Circuit in the WFC Holdings case, provided
further insight into appropriate methodology for determining whether the business
purpose test was satisfied. As indicated previously, the court stated again that the
relative posture of the two tests had not been determined for the circuit. However,
after concluding that the challenged transaction in question had no economic
substance, the court proceeded to consider whether there was a business purpose for
it. One might reasonably infer from the court’s analysis that the existence of a
business purpose might have produced a decision for the taxpayer despite the
absence of economic substance.
The court addressed the possible existence of a business purpose by
summarizing and analyzing the taxpayer’s asserted business rationales for the
transactions. The taxpayer had argued that the transactions were motivated by a
39
Id. at 355.
71
desire to avoid certain governmental regulations, to strengthen its hand with good
bank customers and to create management efficiencies. The court of appeals
rejected challenges to the trial judge’s methodology in addressing the issue and
concluded that “the district court did not err in finding that WFC failed to prove by
a preponderance of the evidence” that any of the reasons asserted by the taxpayer
were its business purpose.
3. Arguments For and Against Business Purpose for the STARS Transaction
Wells Fargo urges two grounds to support its motion that there were non-tax
motives leading to its participation in the STARS transaction. It relies heavily upon
the $1.25 billion loan from Barclays as proof of a non-tax economic purpose. It
contends that the need to finance the banking activities in which it was engaged
demonstrates a very common non-tax purpose for the transaction, a proposition that
would apply to any banking business.
Alternatively, Wells Fargo contends that the receipt of the Bx consideration
analyzed in the previous section of this Report proves the existence of a non-tax
business purpose.
Wells Fargo contends that there is no factual dispute with respect either to
the existence of the loan or the realization of the Bx consideration. Therefore, it
concludes that it has demonstrated that the STARS transaction was not undertaken
72
“solely” for purposes of tax avoidance, and that it was clearly motivated by “any
economic purpose outside of tax considerations.” It asserts, therefore, that the
motion here under consideration must be granted as a matter of law.
As with respect to other motions addressed in this Report, the Government
contends here that the loan must be separated from the use of the U.K. Trust for
purposes of applying the sham transaction doctrine. Therefore, it argues, the loan
and the use of its proceeds are not proof of a business purpose for the voluntary
subjection of U.S. income to U.K. tax through the use of the U.K. Trust.
The Government also contends that there are factual issues that must be
answered in its favor under the customary procedure for dealing with summary
judgment motions. Most importantly, it contends that the “only logical inference
that can be drawn is that Wells Fargo’s only purpose . . . was to obtain U.S. tax
benefits.”40 It argues that the evidence submitted by Wells Fargo, including
particularly memoranda prepared for its Board of Directors, is not conclusive with
respect to the purpose of the STARS transaction, noting the description of the
STARS transaction as a “tax motivated financing transaction.” Wells Fargo cites
exactly the same language to prove the existence of dual motivation so that tax
considerations are not the “sole” reason for the transaction.
40
Government Memorandum Opposing Motion, page 2.
73
The Government’s expert witnesses suggest that the cost of the loan from
Barclays (not counting the value of the Bx consideration) exceeded the cost of loans
from other sources, thereby at least putting into question whether the loan element
of the STARS transaction could have been motivated by a business purpose. This
contention, as well as the question of whether the loan is a separate transaction,
raises factual questions with respect to the purpose of the loan arrangement.
As indicated earlier, the court in the IES case discussed the potential impact
on the business purpose test of the degree of risk undertaken by the taxpayer. It is
not clear whey a higher risk suggests a stronger business purpose. In the STARS
transaction, Wells Fargo endured almost no risk as it controlled the income
producing assets (less the U.K. taxes paid by the U.K. Trust) at all times. We do
not consider that this aspect of the transaction impairs any finding of business
purpose based upon other relevant considerations.
4. Effect of Prior Decisions in This Case
The Government further supports its argument by reference to earlier
decisions of the Special Master and a decision of the Court. In particular, motions
by Wells Fargo to disqualify an expert witness and for partial summary judgment
that the income supported by the loan proceeds proves the existence of reasonable
profit expectations have been denied by the Special Master. The denial of the
74
motion challenging an expert witness was affirmed by the Court after a challenge.
Such denials should not be too broadly interpreted. They simply mean that the
particular motion based upon the particular line of argumentation was denied at the
time each was made. Neither of those decisions is determinative of the possible
presence or absence of a “business purpose,” as that term is used in the context of a
sham transaction analysis.
5. Analysis: Application of the Business Purpose Test
The issue of motivation is a consummate question of fact. Answering the
question depends upon identifying the transaction whose motivation is in question.
The Eighth Circuit in IES held that the application of the sham transaction doctrine
will depend upon “all of the facts and circumstances.” Whether it is appropriate to
consider that there was only one or more than one transaction in this case depends
upon such an analysis. The Tax Court held that bifurcation was appropriate. The
U.S. Court of Federal Claims held that it didn’t matter because the taxpayer lost
either way. While those decisions are not determinative in this case, they support
the view that a partial summary judgment based upon the loan and the use of the
proceeds of the loan is inappropriate at this time in a case in which a jury trial is
contemplated.
The previous portion of this Report concludes that the Bx consideration
75
should be treated as pre-tax revenue for purposes of applying the economic
substance test. While that conclusion is not necessarily determinative of the
economic substance test because revenue is only one part of the determination of
probable profitability, it seems likely on the basis of data to which both parties
agree that the transaction as contemplated had a reasonable possibility of profit. In
that event, it seems logical to conclude that there was a business purpose to the
transaction.41 However, the language of the Eighth Circuit leaves open a line of
inquiry. The Shriver court said that the test asked whether a taxpayer’s motivation
in concluding a transaction was “shaped solely by tax avoidance features;” and the
IES court said “. . . [A] transaction will be characterized as a sham if ‘it is not
motivated by any economic purpose outside of tax considerations.’” (emphasis
added)
The U.S. tax benefits being contested derive from the willingness of Wells
Fargo voluntarily to subject income produced by U.S. assets to a U.K. income tax.
The Government implies that such an act alone cannot possibly be regarded as a
business purpose other than to generate foreign tax credits, and that such a motive
41
Such a proposition seems to have be been accepted by Government counsel during a
hearing in respect of this motion. Asked whether “the two motions [economic substance and
business purpose] have to be decided exactly the same way,” Government Counsel responded “I
think in this instance, yes. On the Bx issue, yes.” March 25, 2014, Hearing Transcript, pages
119- 120. However, no concession to this effect is found in any of the written submissions of the
Government.
76
cannot be regarded as “outside of tax considerations.” Further, even if the
borrowing has a business purpose, that conclusion does not necessarily extend to
the voluntary subjection of U.S. income to a foreign tax, which is the immediate
source of the foreign tax credits.
There is no question that the STARS transaction was solidly based upon “tax
considerations.” This Report concludes that the Bx consideration was
compensation to Wells Fargo for taking the steps necessary to provide benefits to
Barclays, including the voluntary subjection of its U.S.-source income (as defined
by the Code without considering the impact of the U.K.-U.S. Treaties) to U.K. tax.
While generating revenue for Wells Fargo, the revenue derives from a transaction
having “tax avoidance features” and is motived by “tax considerations,” as reflected
in a memorandum prepared for the Board of Wells Fargo that characterizes the
transaction as a “tax motivated financing transaction.” Wells Fargo and the
Government disagree about the meaning of “tax motivation.” The Government
contends that the term refers to the U.S. tax motives of Wells Fargo. Wells Fargo
contends that the term refers to the U.K. tax motives of Barclays.
6. Decision: the Motion Is Denied
The STARS transaction presents a very unusual vehicle for testing the “two
prongs” of the sham transaction doctrine. A STARS transaction was accurately
77
characterized by the Tax Court as “a case of first impression.”42 As noted
previously, almost all tax shelter cases deal with losses. In this case, Wells Fargo
has made a profit, albeit a profit that would not be realized if foreign taxes were
regarded as a cost of the transaction. Unless and until the Eighth Circuit or the
Supreme Court modifies the conclusion in IES or concludes that the factual
differences between that case and the STARS transaction require another line of
analysis, one is left at least with the possibility that Wells Fargo made a profit, but
that transactions generating compensation for subjecting U.S. income to foreign tax
do not satisfy the business purpose test.
No authority has been cited or found for the proposition that voluntarily
submitting to the taxation of another country is itself a “business purpose.” It has
not yet been determined whether the STARS transaction passes the economic
substance test. Even if it has, there is no clear authority for the proposition that a
business purpose exists whenever there is economic substance.
In light of the decisions of the Eighth Circuit that there are two identifiable
tests (albeit without an explanation of their relationship and impact) and in light of
the burden imposed upon the moving party to demonstrate that there are no relevant
factual issues, the motion here under consideration is DENIED. This denial should
42
140 T.C. at 30.
78
not be regarded as a decision that there is no business purpose to the STARS
transaction. Rather, it leaves open for further proceedings the question of defining
the way in which the “two prongs” of the sham transaction analysis should properly
apply and the factual questions attending the intention of Wells Fargo in concluding
the transaction.
An Order implementing this decision is attached hereto.
79
VII. Motion for Partial Summary Judgment that Code § 269 Does Not Apply
to the STARS Transaction
1. Plaintiff’s Motion
Wells Fargo has moved (Doc 396) under FRCP 56 “for partial summary
judgment that 26 U.S.C.[Code] § 269 does not apply to the STARS transaction as a
matter of law.” The Government opposes the motion, effectively arguing that a
transaction such as STARS was the reason why Section 269 was enacted by
Congress. For reasons set forth below, the motion is granted.
2. Code Section 269
Section 269(a) of the Code provides that if:
“(1) any person or persons acquire, or acquired . . . directly or indirectly,
control of a corporation, or
(2) any corporation acquires, or acquired . . . directly or indirectly, property
of another corporation, not controlled, directly or indirectly, immediately
before such acquisition, by such acquiring corporation or its stockholders, the
basis of which property, in the hands of the acquiring corporation, is
determined by reference to the basis in the hands of the transferor
corporation,
and the principal purpose for which such acquisition was made is evasion or
80
avoidance of Federal income tax by securing the benefit of a deduction,
credit, or other allowance which such person or corporation would not
otherwise enjoy, then the [IRS] may disallow such deduction, credit, or other
allowance.”
Control is defined to be “the ownership of stock possessing at least 50 percent of
the total combined voting power of all classes of stock entitled to vote or at least 50
percent of the total value of shares of all classes of stock of the corporation.”
3. Portions of the STARS Transaction Are within the Potential Ambit of
Section 269
Three primary questions arise with respect to the possible application of
Section 269:
1.
Are there any acquisitions of control or property as described in the
section?
2.
If so, is the principal purpose of the acquisition the evasion or
avoidance of Federal income taxes by securing tax benefits?
3.
If so, would taxpayers in the transaction have enjoyed the tax benefits
if the acquisitions had not occurred?
There are several transfers made in connection with the implementation of
the STARS transaction that come within the general ambit of Section 269: the
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transfer of assets from Wells Fargo to Carnation with a carryover basis and the
acquisition of control of Rigil by Carnation and the transfer of assets thereto.43
The Government argues that the principal purpose of the STARS transaction
was the “evasion or avoidance of Federal income taxes.” Its argument does not,
however, focus on the special tax consequences of the acquisition of control or
transfer of assets referred to in the preceding paragraph. In fact, it concedes that
these are not taxable events because the entities are part of Wells Fargo for purposes
of its consolidated return.44 Rather, the Government contends that, since there were
such transfers as part of the implementation of the STARS transaction, the entire
transaction is tainted by Section 269 so that Wells Fargo must be denied the foreign
tax credits and other possible tax benefits arising from it.
Wells Fargo denies that tax evasion or avoidance was the principal purpose
of any portion of the STARS transaction. However, even if it were (an assumption
necessary for its motion for partial summary judgment), it argues that the
acquisition of control and asset transfers to which Section 269 is arguably
applicable did not themselves establish entitlement to any tax benefit that Wells
Fargo would not have enjoyed if it had participated directly in the transaction
43
March 25, 2014, Hearing Transcript, pages 10 and 23.
44
March 25, 2014 Hearing Transcript, page 24.
82
instead of using subsidiary corporations and other controlled entities. Thus, it
concludes, Section 269 is inapplicable.
4. Application of Section 269: Regulations and Judicial Interpretations
The language of Section 269 is obviously very broad. Regulations
promulgated under Section 269 offer some guidance as to its specific objectives.
Treas. Reg. § 1.269-2(b) provides:
“Under the Code, an amount otherwise constituting a deduction, credit, or
other allowance becomes unavailable as such under certain circumstances.
Characteristic of such circumstances are those in which the effect of the
deduction, credit, or other allowance would be to distort the liability of the
particular taxpayer when the essential nature of the transaction or situation is
examined in the light of the basic purpose or plan which the deduction, credit,
or other allowance was designed by the Congress to effectuate. The
distortion may be evidenced, for example, by the fact that the transaction was
not undertaken for reasons germane to the conduct of the business of the
taxpayer, by the unreal nature of the transaction such as its sham character, or
by the unreal or unreasonable relation which the deduction, credit, or other
allowance bears to the transaction. The principle of law making an amount
unavailable as a deduction, credit, or other allowance in cases in which the
83
effect of making an amount so available would be to distort the liability of
the taxpayer has been judicially recognized and applied in several cases. . . .”
Treas. Reg. §1.269-3(a)(2) provides:
“In either instance [the acquisition of control or carryover basis transfer] the
principal purpose for which the acquisition was made must have been the
evasion or avoidance of Federal income tax by securing the benefit of a
deduction, credit, or other allowance which such other person, or persons, or
corporation, would not otherwise enjoy.”
The regulations set forth three examples of transactions to which Section 269
would apply. The first is a situation in which a corporation with net operating loss
carryovers acquires a profitable business (in the form of an asset acquisition) from
an individual who owns all of the stock of the acquiring corporation so that the
acquisition of the profitable business can absorb the loss carryovers. Treas. Reg. §
1.269-3(b)(1).
The second example described in the regulations arises when investors form
two or more corporations instead of a single corporation to obtain the benefit of
multiple surtax exemptions under Section 11(c) of the Code or multiple minimum
84
accumulated earnings credits under Section 535(c)(2) and (3). Treas. Reg. § 1.2693(b)(2).
The third example set forth in the regulations involves a taxpayer with high
earning assets who transfers them to a newly organized controlled corporation while
retaining assets producing net operating losses that are used in an attempt to secure
refunds from loss carrybacks. Treas. Reg. § 1.269-3(b)(3).
In each of the three situations described in the regulations, the denial of tax
benefits is directly attributable to the transaction described in Section 269:
exploiting net operating loss carryovers; creating multiple surtax exemptions or
minimum accumulated earnings credits; and disgorging a profitable business to
create an opportunity to seek refunds through the generation of net operating losses.
In other words, the acquisition itself created a tax benefit that would not otherwise
have been available under the applicable federal income tax laws if the transaction
had not occurred.
The Tax Court provided a relatively early interpretation of what is now
Section 269. [Section 129 under prior law was identical in all material effects to the
current Section 269.] In so doing, the court noted the statement of legislative
purpose that accompanied the adoption of the provision. In Commodores Point
Terminal Corp. v. Commissioner, 11 T.C. 411 (1948), a controlling interest in
85
Piggly Wiggly Corporation was sold by an individual shareholder to another (not so
successful) corporation wholly owned by the seller. After the sale, dividends paid
by Piggly Wiggly to the new corporate shareholder were eligible for a “dividends
received credit” (then available under the Code) that would not have been available
on dividends paid to an individual shareholder.
The IRS invoked the authority of then Section 129 to deny the dividends
received credit and certain other deductions related to the transaction. The Tax
Court ruled in favor of the taxpayer and provided a lengthy description of the
legislative history of the provision:
“Section 129 was introduced at the first session of the 78th Congress . . . .
In the accompanying report of the Committee on Ways and Means of the
House it was stated that ‘this section is designed to put an end promptly to
any market for, or dealings in, interests in corporations or property which
have as their objective the reduction through artifice of the income or excess
profits tax liability.’ . . .
“In the Senate, this section . . . was amended . . . . [One] amendment was
made by the addition of the phrase ‘which such person would not
otherwise enjoy.’ This qualification limited the applicability of the
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section to those cases where the deduction, credit, or allowance resulted
from, or was attributable to, the acquired control. The report of the Senate
Committee on Finance stated that the objective of the section was ‘to
prevent the distortion through tax avoidance of the deduction, credit, or
allowance provision of the code, particularly those of the type represented
by the recently developed practice of corporations with large excess
profits (or the interests controlling such corporations) acquiring
corporations with current, past, or prospective losses or deductions,
deficits, or current or unused excess profits credits, for the purpose of
reducing income and excess profits taxes. . . .”
“The applicability of section 129, upon which respondent has based his
disallowance of the deductions in issue, is contingent upon the existence
of two conditions: (1) The ‘person’ [meaning the taxpayer] must have
acquired . . . control of a corporation, and (2) the principal purpose for
which the acquisition was made must have been the evasion or avoidance
of Federal income . . . tax by securing the benefit of a deduction, credit, or
other allowance which such person or corporation would not otherwise
87
enjoy.”45
The court went on to explain the relationship between the two elements of
the rule:
“ . . . [C]ontrol in itself is not determinative. This section condemns tax
avoidance only when there is acquisition of control and the employment
of that control for the principal purpose of avoiding or evading tax, the
acquiring person thereby securing the benefit of a deduction, credit, or
allowance ‘which such person or corporation would not otherwise enjoy.’
The word ‘otherwise’ can only be interpreted to mean that the deduction,
credit, or allowance, if it is to be disallowed, must stem from the acquired
control” 46
The court noted that the availability of the dividends received credit did
not depend upon the acquisition of control:
“There is no evidence, nor does the respondent suggest, that petitioner
received its dividends by virtue of its controlling interest. In this case the
45
11 T.C. at 415-17.
46
Id. (emphasis added).
88
number of shares held by petitioner was determinative only of the amount
of dividends received, and the control acquired was incidental to the
primary purpose of the acquisition which was to increase the petitioner’s
gross income.”47
It must be noted that the decision of the court is not without a possible
ambiguity. Having explained that the Code provision did not apply because no
tax benefits were attributable to the acquisition of control, the court went on to
conclude that there was a “real and substantial business purpose . . . and not a
sham or unrealistic plan primarily designed for tax evasion or avoidance.”
Thus, the court seemed to confirm that the nonapplicability of Section 269 is not
a defense for a taxpayer engaged in a sham transaction.
The earlier version of Section 269 seems to have been created
in substantial measure to deal with the potential market in loss corporations and
other ways in which losses realized by corporations can be set off against
profitable operations. See, e.g., Coastal Oil Storage Co. v. Commissioner, 242
F.2d 396 (4th Cir. 1957).48 In these cases, the tax benefits sought derived
47
11 T.C. at 417.
48
See Bittker and Lokken, Federal Taxation of Income, Estates and Gifts, ¶ 95.4.
89
directly from the challenged transactions and would not otherwise have been
available.
Litigation with respect to the applicability of Section 269 is generally
consistent with the examples in the regulations. Section 269 has been used in a
number of cases to challenge the availability of multiple surtax exemptions
where shareholders had established more than one corporation with no evident
business purpose. See, e.g., Your Host, Inc. v. Commissioner, 489 F.2d 957 (2d
Cir. 1973); Concord Supply Corp. v. Commissioner, 37 T.C. 919 (1962). In
these cases, once again the tax benefits sought derived directly from the
challenged transactions that would not otherwise have been available.
5. Section 269 and the STARS Transaction
The Government’s position in this case is somewhat different from the
circumstances contemplated by the regulations and judicial decisions. It
expressly does not contend that the specific transfers of control or assets treated
by Section 269 themselves created tax benefits that would not otherwise be
available to Wells Fargo.49 Rather, it takes the position that the inclusion of
these steps in the STARS transaction invokes the adverse taxpayer consequences
for the entire transaction.
49
March 25, 2014, Hearing Transcript, pages 23 et seq.
90
The Government asserts the usual principle that, in deciding a motion for
summary judgment, any factual disputes must be assumed to be resolved against
the moving party. As such, it must be assumed that all factual questions in this
instance must be resolved in the Government’s favor. Wells Fargo does not
contest this principle, but argues that there are no factual questions raised by its
motion.
There is no factual dispute about the acquisition of control of a
corporation or of the transfer of assets to a corporation with a carryover basis as
part of the STARS transaction. Wells Fargo had acquired Carnation before the
STARS transaction was even contemplated. Carnation acquired Rigil as part of
the implementation of the transaction. Assets were transferred among
corporations and other entities, all of which were treated for U.S. tax purposes as
elements of Wells Fargo that gave rise to no immediate tax consequence as they
were generally negated in the preparation of its consolidated tax return.
The Government contends that factual issues arise because Wells Fargo
itself would have been incapable of participating in the STARS transaction.
First, U.K. tax law requirements would not have been satisfied so that the
benefits sought by Barclays to make the transaction profitable to it would not
have been available. Secondly, there is no evidence that Wells Fargo itself
91
could have satisfied the contractual requirements to make sufficient income
available to the U.K. Trust. Therefore, the Government argues, the STARS
transaction would never have been implemented, requiring the conclusion that
the acquisition of control of Rigil by Carnation and the transfers of property to
Carnation and Rigil were essential ingredients to the viability of the transaction.
In other words, if the two entities had not been used in the way that they were
used, Barclays would never have entered into the transaction. It concludes that
whether Wells Fargo could itself have participated in the STARS transaction is a
question of fact the answer to which for purposes of this motion must be
assumed to be “no.”
Wells Fargo responds that this motion presents an issue of U.S. tax law.
If Wells Fargo had itself been subjected to U.K. income taxes without using a
controlled entity, it would have been entitled to foreign tax credits. In fact, the
entities used to implement the transaction were either treated as corporations
included in the U.S. consolidated return of Wells Fargo or as transparent entities
again included in its U.S. consolidated return. Therefore, from the perspective
of U.S. tax law, Wells Fargo is claiming no potential U.S. tax benefits beyond
those that would have resulted from its direct participation in the transaction.
6. The Role of U.K. Law with Respect to this Motion
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As indicated previously, Wells Fargo has on several occasions moved for
determinations of U.K. law under FRCP 44.1, inter alia, to the effect that the
use of a new entity was necessary for Barclays to enjoy the U.K. tax benefits
which it sought in the transaction. However, it was not created or used to exploit
U.S. income tax benefits to which Wells Fargo would not otherwise be entitled.
The Government has vigorously opposed Wells Fargo’s motion for U.K. law
determinations on the ground that they were irrelevant to the determination of
the issues raised by Wells Fargo’s other motions, including the one here under
consideration.
Whether it was required under U.K. law or not, there is no disagreement
with the proposition that the actions taken by Wells Fargo and its affiliates
(treated as a part of Wells Fargo for U.S. tax purposes) to implement the
STARS transaction were undertaken in order to assure Barclay’s participation in
it. It is not, therefore, necessary to determine whether Wells Fargo, as a
corporate entity, could itself have transferred assets to the U.K. Trust and owned
units of it. If it had done so and if the same U.K. taxes were paid, it would be in
the same U.S. tax position that it currently occupies. As the Government
generally argues in this case (although not on this motion), it is, therefore,
unnecessary for purposes of this motion to determine the posture and application
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of U.K. trust and tax law
7. Analysis of the Applicability of Section 269 to the STARS Transaction
As indicated previously, the Government correctly insists that all factual
differences be resolved against Wells Fargo for purposes of this motion for
partial summary judgment. Therefore, it must be assumed that Barclays would
be unwilling to implement the STARS transaction directly with Wells Fargo.
It is quite possible that Barclays could not gain the U.K. tax advantages that it
sought by dealing directly with Wells Fargo. However, that is not the
appropriate question. Rather, the question raised by the Code is whether Wells
Fargo gained any U.S. tax advantage specifically by the acquisition of control
and/or transfer of assets when all of the relevant entities were treated as part of
Wells Fargo in the preparation of its consolidated tax return. We find that it did
not.
The regulations and the litigation together indicate that the application of
Section 269 should properly focus on whether the acquisition of control or
transfer of assets themselves created a tax benefit not otherwise available. The
STARS transaction may or may not turn out to be a sham transaction, as the
Government contends. If it is, Wells Fargo will not be entitled to the foreign tax
credits which it has claimed. If it is not, Wells Fargo will be entitled to those
94
foreign tax credits. In either event, the acquisition of control of Rigil by
Carnation and the transfer of assets to related entities with a carryover basis did
not create the tax benefits under U.S. tax law which Wells Fargo here claims.
The Government further argues that the broad scope of the language of
Section 269 does not limit its application to the tax consequences of the transfers
that trigger its application. However, while the language of Section 269 is
indeed very broad, the Government cites no authority for the proposition that the
relevant transfers themselves do not have to be the source of the U.S. tax
benefits at risk under Section 269.
8. Decision: the Motion is Granted
All of the entities involved in implementing the STARS transaction for
Wells Fargo were included in its consolidated tax return. Thus, Wells Fargo
gained no apparent U.S. tax law advantages from the acquisition of control and
asset transfers covered by Section 269 that it would not have enjoyed if it had
directly participated in the STARS transaction. Therefore, the motion here
under consideration is GRANTED. Section 269 does not apply in determining
the results of this controversy. However, as implied in the decision of the Tax
Court in Commodores Point Terminal Corporation, issues with respect to the
application of the sham transaction doctrine generally to the STARS transaction
95
are not affected by the grant of this motion.
An Order implementing this decision is being transmitted herewith.
96
VIII. Motion That Its Tax Reporting Position Had a Reasonable Basis
1. Plaintiff’s Motion
Wells Fargo has moved (Doc 407) “for partial summary judgment that
[its] . . . tax reporting position had a reasonable basis.” For the reasons set
forth below, the motion is granted.
2. Context of the Motion
In addition to denying the right to recover any amounts in respect of the
STARS transaction, the Government in its Amended Answer included a defense
in the form of an offset or recoupment on the ground that Wells Fargo is subject
to negligence penalties under Code § 6662(b)(1). Wells Fargo’s motion to strike
the Government’s offset or recoupment defense was denied by Order, dated July
15, 2010, of United States Magistrate Judge Arthur J. Boylan, leaving the issue
of penalties to be resolved. Wells Fargo’s motion here under consideration
would, if granted, eliminate the negligence issue and its consequences from this
litigation.
3. Liability for Negligence
The Code and regulations establish a somewhat complex array of
penalties, the impact of which is raised by the Government’s Amended Answer.
Section 6662(a) of the Code imposes a penalty in certain situations equal to 20
97
percent “of an underpayment of tax required to be shown on a return.”
The penalty is imposed for a series of reasons specified in Section 6662(b)
of the Code. Section 6662(b)(1) imposes the penalty for the underpayment of
taxes attributable to “[n]egligence or disregard of rules or regulations.” The
Government is contending that Wells Fargo was negligent in the preparation of
its tax returns and is subject to the negligence penalty of 20 percent of the
underpayment of taxes resulting from the wrongful claims to tax benefits.
Section 6662(c) defines “negligence” to include “any failure to make a
reasonable attempt to comply with the provisions of [the Code] . . . and the term
‘disregard’ includes any careless, reckless, or intentional disregard.”
The statutory definition of negligence suggests that an inquiry into the
reasonability of the “attempt to comply” will be determinative of the existence of
negligence, thus compelling an examination of a taxpayer’s behavior leading to
the preparation and filing of its tax return. However, the regulations further
amplify the definition:
“The term ‘negligence’ includes any failure to make a reasonable attempt
to comply with the provisions of the internal revenue laws or to exercise
ordinary and reasonable care in the preparation of a tax return. . . . A
return position that has a reasonable basis as defined in paragraph (b)(3)
98
of this section is not attributable to negligence.”
Treas. Reg. § 1.6662-3(b)(emphasis added). Thus, under the express language
of the regulations, if there is a “reasonable basis” for the return position, there is
no negligence. If there is no negligence, no negligence penalty would seem to
be authorized.
A number of different legal standards potentially come into play when
possible penalties are at issue. The regulations emphasize that the “reasonable
basis” test imposes a very stringent standard and compares it to the rigor of other
tests:
“Reasonable basis is a relatively high standard of tax reporting, that is,
significantly higher than not frivolous or not patently improper. The
reasonable basis standard is not satisfied by a return position that is
merely arguable or that is merely a colorable claim. If a return position is
reasonably based on one or more of the authorities set forth in § 1.66624(d)(3)(iii) (taking into account the relevance and persuasiveness of the
authorities, and subsequent developments), the return position will
generally satisfy the reasonable basis standard even though it may not
satisfy the substantial authority standard. . . .”
Treas. Reg. § 1.6662-3(b)(3).
99
The regulations provide a long list of permissible and impermissible forms
of authority that may be used in connection with the reasonable basis test. The
permissible authorities include “applicable provisions of the [Code],” “tax
treaties” and “court cases.” However, “[c]onclusions reached in treatises, legal
periodicals, legal opinions or opinions rendered by tax professionals are not
authority.” Treas. Reg. § 1.6662-4(d)(3)(iii).
As suggested by the language of the regulations describing the gravity of
the reasonable basis requirement, several other provisions of the Code and
regulations establish other formulations with respect to applicable standards,
some of which are more and some less rigorous than the “reasonable basis”
standard. Code § 6662(d)(2)(B), for example, provides that penalties for
“substantial understatement of income tax” (which are based upon a comparison
of the tax reported on the return to the magnitude of the deficit, a provision not
applicable in this case) will not apply to a “portion of the understatement which
is attributable to . . . the tax treatment of any item by the taxpayer if there is or
was substantial authority for such treatment.” As expressly stated in the
Regulations, the “substantial authority” test is regarded as more rigorous than
the “reasonable basis” test.
Code § 6664(c)(1) provides that “No penalty shall be imposed under
100
section 6662 . . . with respect to any portion of an underpayment if it is shown
that there was a reasonable cause for such portion and that the taxpayer acted in
good faith with respect to such portion.” This formulation is regarded as less
stringent than the reasonable basis standard, but obviously requires an inquiry
into the specific behavior of the taxpayer. The regulations affirm this
proposition by noting that, if there was negligence (meaning that there was no
“reasonable basis,” according to the regulations), the Code provides a further
defense if the taxpayer has a “reasonable cause” for the negligence:
“In addition, the reasonable cause and good faith exception in § 1.6664-4
may provide relief from the penalty for negligence or disregard of rules or
regulations, even if a return position does not satisfy the reasonable basis
standard.”
Treas. Reg. § 1.6662-3(b)(3). This “reasonable cause” defense depends
generally upon an examination of the facts and circumstances leading to the
negligence, which will normally include an analysis of the taxpayer’s subjective
efforts to comply with applicable standards. Such an inquiry often includes the
extent to which the taxpayer reasonably and in good faith relied upon the advice
of reputable tax counsel or other tax professionals. The Government has argued
in connection with an earlier dispute with respect to the scope of permissible
101
discovery that a “reasonable cause” defense might even depend in part upon a
pattern of dealing by a taxpayer that includes reference to other transactions that
were based upon the availability of tax benefits.
4. U.S. Tax Reporting of the STARS Transaction by Wells Fargo
There are many cases in which the government has successfully argued
that the substance of a transaction should determine its tax consequences rather
than its form. In this case, Wells Fargo did not report the transaction according
to its form (for example, the purchase and sale of interests in the U.K. Trust), but
rather its substance. The transaction was treated and reported by Wells Fargo
for U.S. tax purposes as a borrowing of $1.25 billion at a rate of interest of
LIBOR plus .2 percent less the periodic amount due from Barclays to Wells
Fargo called the Bx payment. As previously described in this Report (several
times) the effect of the Bx payment generally was to reduce the interest expense
deducted by Wells Fargo. However, in certain periods, it resulted in a payment
from Barclays to Wells Fargo which was treated as an item of income or as a
reduction in miscellaneous interest expense by Wells Fargo for U.S. income tax
purposes. In any event, the taxable income of Wells Fargo for U.S. tax purposes
was increased.
Wells Fargo reported the results of the STARS transaction in its U.S.
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consolidated return for the relevant tax years in the following way:
—The gross income realized by the U.K. Trust was reported as income.
—The U.K. income taxes paid by the U.K. Trust were treated as having
been paid by Wells Fargo.
—Foreign tax credits were claimed in respect of the U.K. income taxes
imposed upon the U.K. trust.
—Interest paid to Barclays on an effective borrowing of $1.25 billion was
deducted. The amount of interest so deducted was calculated at the rate of
LIBOR plus .2 percent less the Bx payment.
—During periods when the Bx payment exceeded LIBOR plus .2 percent,
the excess was reported as an addition to gross income or a reduction in
unrelated interest expense.
—Expenses of implementing the STARS transaction were deducted.
5. Stipulation to Narrow Defenses Available to Wells Fargo
After a rather extensive exchange between counsel about the scope of
discovery, the following stipulation (Doc 94) was concluded on April 21, 2011:
“1.
Defendant’s Penalty Claim pertains solely to its allegation of
negligence under Section 6662(b)(1), and to no other penalty
provision of the Internal Revenue Code.
103
2.
Wells Fargo’s defenses to Defendant’s Penalty Claim are as
follows:
a.
There is no underpayment of tax required to be shown on a
return, within the meaning of Section 6662(a), attributable to
the STARS transaction; and,
b.
Objectively viewed, there is a “reasonable basis,” as defined
by Treas. Reg. § 1.6662-3(b)(3) and the authorities
thereunder, for Wells Fargo’s reporting of the STARS
transaction.
3.
Wells Fargo agrees that it will not assert the following defenses to
the Defendant’s Penalty Claim:
a.
Any contention that relies upon Wells Fargo’s efforts to
exercise ordinary and reasonable care in the preparation of its
tax return, or Wells Fargo’s efforts to determine its proper tax
liability under the internal revenue laws arising out of the
STARS Transaction, to establish reasonable basis;
b.
Any contention pursuant to or based on Section 6664;
c.
Any defense or argument not specifically identified in
paragraph 2, above.
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4.
This stipulation resolves any dispute regarding the adequacy of
Wells Fargo’s responses to the United States’ Second Set of
Interrogatories, served on January 5, 2011.
5.
Nothing in this stipulation limits the arguments, evidence, or
contentions that Wells Fargo may present or rely upon with respect
to the merits of counts one through three of Wells Fargo’s
Amended Complaint [which deal with the STARS transaction].”
The Government asserts that the stipulation amounts to a concession on
the part of Wells Fargo that a negligence penalty is appropriate if the Court
concludes that STARS is a sham transaction:
“Wells Fargo has admitted that in preparing its 2003 federal tax return it
failed ‘to exercise ordinary and reasonable care in the preparation of its
tax return,’ or ‘determine its proper tax liability’ in reporting the STARS
tax benefits on it return. It did so when it expressly stipulated that in
defending against the negligence penalties, it waived the right to challenge
the Government’s position that it failed to meet these fundamental
regulatory and judicial requirements defining the statutory concept of
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negligence.”50
The Government contends that the transaction has “no appreciable
purpose beyond conferring tax benefits. . . . The law is clear, that, ‘when the
underlying merits determination is that transaction lacks economic substance, [a]
taxpayer cannot cite authority . . . to support the claimed tax treatment.’”51 The
Government further contends that “[T]he question of reasonable basis or
substantial authority only becomes relevant and ripe once the fact finder
determines whether STARS has economic substance.”52 Moreover, IES is not
authority because of factual differences in the transactions.
6. Can There Be a Reasonable Basis for Reporting a Sham Transaction?
The Government’s position with respect to this particular motion appears
to be that a taxpayer found in the end to have participated in a sham transaction
was necessarily negligent in its reporting of the transaction. In other words, the
legal obligation of reporting is congruent with the obligation to pay income taxes
that are found to be owing. If this position is correct, it is obvious that the
50
Government Memorandum in Opposition to Motion, page 14.
51
Government Memorandum in Opposition to Motion, page 16, quoting Stobie Creek
Invs., LLC v. United States, 82 Fed. Cl. at 706, n.64, aff’d 608 F.3d 1366 (Fed Cir. 2010).
52
Government Memorandum in Opposition to Motion, page 19.
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motion here under consideration must be denied as the issue of penalties for
negligence cannot be resolved until the merits of the underlying case have been
determined.
The Government’s alternative position is that reporting that has a
reasonable basis cannot avoid the negligence penalty unless there is proof that
the taxpayer and its employees, counsel or other advisers actually analyzed and
applied the sources leading to the reasonable basis conclusion. In other words,
even though there was a reasonable basis for the tax return, it does not matter
unless someone analyzed and thought about it.
Without strong support in the Code and regulations, legislative history or
practice, the Government’s position cannot be accepted. It seems clear that a
negligence penalty is not applicable if there is no negligence. The regulations
expressly state that there is “no negligence” if there is a “reasonable basis” for
the taxpayer’s reporting. Therefore, it seems quite inappropriate to conclude
that a taxpayer that eventually loses a sham transaction case cannot avoid the
negligence penalty even when there was a reasonable basis for its reporting.
That leaves the question for these purposes of whether Wells Fargo had a
reasonable basis for reporting the STARS transaction as it did.
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7. Basis for Reporting
Wells Fargo submits that four permissible sources of authority extant at
the time its tax returns were prepared support the way in which it reported the
STARS transaction: the Code; regulations; treaties; and judicial decisions.
First are the provisions of the Internal Revenue Code that authorize
domestic taxpayers to take a credit for foreign income taxes or taxes in lieu of
income taxes. Code §§ 901 et seq. The Government agrees (while challenging
its availability in this particular case under the sham transaction doctrine) that
the U.K. income tax paid by the U.K. Trust was in general a creditable tax.
Second are the regulations that explicitly state that there is no negligence
if there is a reasonable basis for reporting and that identify permissible sources
of authority.
Third is the text of U.S.-U.K. Tax Treaties. As explained previously, the
1975 Treaty applied to the first months in which the STARS transaction was
being implemented. The 2002 Treaty applied to the remaining period during
which the STARS transaction was being implemented.
The Treaties shared some common provisions with respect to the
treatment of the STARS transaction. Article 4(1)(a)(i) of the 1975 Treaty
defines a “resident of the United Kingdom” to include “a . . . trust . . . to the
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extent that the income derived by such . . . trust is subject to United Kingdom tax
as the income of a resident, either in its hands or in the hands of its . . .
beneficiaries.” Article 3(1)(a) of the 2002 Treaty defines a “person” to include a
“trust.” Article 3(1)(j)(ii)(B) defines a “national” of the United Kingdom to
include “any . . . entity deriving its status as such from the laws in force in the
United Kingdom.” The parties to this dispute agree that the U.K. Trust was
treated as a U.K. person under the laws of the U.K.
The Treaties authorize the United Kingdom to “tax its residents . . . and its
nationals as if this Convention had not come into effect.” Article 1(3) of the
1975 Treaty; Article 1(4) of the 2002 Treaty.
The Treaties obligate the United States to take steps to mitigate double
taxation by providing a foreign tax credit for taxes appropriately paid to the
United Kingdom under the authority of the Treaties. Article 23(1) of the 1975
Treaty; Article 24(1)(a) of the 2002 Treaty.
The Treaties further provide that income properly taxed by the United
Kingdom would be treated as having been sourced there. Article 23(3) of the
1975 Treaty; Article 24(2)(a) of the 2002 Treaty. Sections 901 et seq. of the
Code provide that a taxpayer is entitled to take a foreign tax credit for income
taxes paid in respect of foreign-source income.
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The fourth sources cited by Wells Fargo are several judicial decisions, of
which the most important was the IES decision rendered by the Court of Appeals
for the Eighth Circuit shortly before the STARS transaction was closed. The
IES case has been discussed in great detail in earlier portions of this Report.
Importantly for purposes of this motion, it involved a series of pre-arranged
transactions structured so that the taxpayer, a U.S. corporation, would be entitled
to foreign tax credits. There was no question but that the exploitation of tax
rules for the benefit of the taxpayer was a major reason for the transactions.
In applying the economic substance test in the IES case, the court
explained that it would “first consider whether there was a ‘reasonable
possibility of profit . . . apart from tax benefits.’” Wells Fargo has argued that
there were two sources of revenue supporting the conclusion that there was a
reasonable basis for its reportage. First, the proceeds of the loan from Barclays
were used to finance its investments and investment income that returned a yield
that was much higher than the cost of the loan. Second, Barclays regularly
provided consideration in the form of the Bx amount that effectively increased
the taxable income of Wells Fargo by reducing interest expense or adding to its
reported income.
The first contention has been challenged by the Government on the
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ground, inter alia, that the effect of the loan from Barclays to Wells Fargo
should properly be analyzed separately from the use of the U.K. Trust. A
motion for partial summary judgment filed by Wells Fargo based upon the
contention that the proceeds of the loan contributed to Wells Fargo’s profits was
denied because there were unresolved factual issues arising from the loan and
other elements of the STARS transaction. As noted previously, the denial of the
motion for partial summary judgment did not constitute a final determination
that the loan is a separate transaction. As the court in IES indicated, the
application of the sham transaction doctrine will depend upon an analysis of “all
of the facts and circumstances.”
The second contention (that the Bx consideration effectively increased
taxable income) is the subject of the new motion for partial summary judgment
that is addressed previously in this Report. Regardless of the disposition of that
motion if challenged, Wells Fargo’s reporting finds support in the IES case.
While the STARS transaction is materially different from the transactions
contested in the IES case, the court there clearly concluded that the taxpayer was
not required to consider foreign income taxes as a cost. While the Government
argues forcefully that IES does not require a decision in favor of Wells Fargo,
the issue for purposes of the specific motion here under consideration is limited
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to whether there was a reasonable basis for the method of reporting by Wells
Fargo.
The Government acknowledges the existence of the authorities cited here,
but contends that the result of the STARS transaction was simply “too good to
be true” under the circumstances and that Wells Fargo “failed to exercise
ordinary and reasonable care in preparing its tax returns and reporting the
transaction.”53 The Government cites the language of the Code and regulations
in defining negligence as including “any failure to make a reasonable attempt to
comply with the provisions of the internal revenue laws or to exercise ordinary
and reasonable care in the preparation of a tax return” and is strongly indicated
“where a taxpayer fails to make a reasonable attempt to ascertain the correctness
of a deduction, credit, or exclusion on a return that would seem to a reasonable
and prudent person to be ‘too good to be true’ under the circumstances.” Treas.
Reg. § 1.6662-3(b)(1)(ii).
8. Decision on the Motion
The Government forcefully argues that a decision on the motion at this
point is premature. That argument is understood and appreciated. However, in
the absence of clear authority to the contrary, we conclude that the statement in
53
Government Memorandum in Opposition to Motion, page 9.
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regulations that “there is no negligence if there was a substantial basis for the
reporting” means what it says.
Wells Fargo cites four permissible sources of authority for its reporting:
the Code, the regulations, the Treaties and judicial decisions dealing with the
treatment of foreign tax credits in the context of the sham transaction doctrine.
The sources were extant at the time the tax returns were prepared. It may
eventually be determined that the STARS transaction was a sham. Even so, the
sources cited above persuade that there was reasonable basis for reporting the
results of the complicated transaction in a way that reflected its financial
realities, as Wells Fargo endeavored to do. Accordingly, the motion is
GRANTED.
An order giving effect to this decision is being transmitted herewith.
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IX. Wells Fargo’s Motion to Exclude Expert Testimony of Dr. David
LaRue
1. Plaintiff’s Motion
Wells Fargo has renewed an earlier motion under Federal Rules of
Evidence 702 and Daubert v. Merrell Dow Pharmaceuticals, 509 U.S. 579
(1993) to exclude the expert testimony of Dr. David LaRue. (Doc 421) The
same motion was made in 2013. (Doc 281) That motion was denied by the
Special Master. Report of Special Master, dated June 14, 2013. (Doc 338) After
a challenge, the decision of the Special Master was confirmed by the Court.
(Doc 373) This motion is one of three challenges to expert witnesses for the
Government.
The memoranda and extensive array of exhibits submitted by both parties
at this time and in connection with the prior challenge have been studied. For
reasons set forth below, a decision with respect to this motion is deferred at this
time.
2. Grounds for the Motion
Wells Fargo contends that Dr. LaRue’s reports and testimony during
depositions ignore the loan from Barclays, misconceives the impact of U.K. law,
erroneously interprets the impact of the Bx consideration, disregards decisions of
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the Eighth Circuit, includes tax policy analyses irrelevant to the issues in the
case and asserts conclusions that are little more than advocacy on the part of the
Government’s position in the case.
Although Wells Fargo asserts somewhat different grounds for the motion
here considered, similar arguments were made when the prior challenge to Dr.
LaRue was initially made. The denial of that motion was based upon a number
of considerations. Dr. LaRue’s record indicated that he was highly qualified to
analyze complex financial transactions. The decision of the Eighth Circuit in the
IES case emphasized the need to examine the effect of “all facts and
circumstances.” Some of the grounds for the challenge went to the weight of Dr.
LaRue’s testimony, rather than to his qualifications or methodology. Finally,
Dr. LaRue’s likely testimony can be challenged during the trial, and did not
derive from “deep scientific knowledge which might be beyond the
comprehension of the jury.”
3. The Government’s Response
The Government in effect argues that the current motion to disqualify Dr.
LaRue has already been determined by the prior decisions of the Special Master
and the Court.
The Government further contends that the analyses of Dr. LaRue and the
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two other experts challenged by Wells Fargo provide a useful explanation of the
financial and economic consequences of the STARS transaction. The experts,
including Dr. LaRue, are highly qualified in analyzing complex financial
arrangements. Their expert testimony must be restricted to questions of fact and
not law. There will be ample opportunity for Wells Fargo counsel to question
and challenge them at trial. Thus, even if the motion were permissible in light of
the earlier decisions, it is inappropriate to disqualify Dr. LaRue from
contributing to the trial process at this point.
4. The Motion Is Not Barred
The renewed motion is not prohibited by the prior decisions. The Report
of the Special Master contemplated the possibility of a further challenge to Dr.
LaRue at a later date if circumstances justified such a challenge:
“It should be emphasized that the foregoing conclusions are necessarily
based only upon the argumentation and materials presented to the court at
this time. As the time for trial approaches, it is expected that further
evidence will be developed with respect to the issues that are addressed by
Dr. LaRue’s report and potential testimony and the evidence proffered by
other expert witnesses.”
5. Developments Since the Prior Decision
116
Since June, 2013, there have been several developments in the case that
could justify reconsideration of the challenge to Dr. LaRue.
Wells Fargo moved for a partial summary judgment that there was a
reasonable expectation of profits because the interest on the loan from Barclays
and other expenses of the transaction were significantly less than its usual return
on investment capital. That motion was denied by the Special Master. Report
dated October 25, 2013. One of the reasons for the denial was that there were
disputed facts with respect to whether the loan was a separate transaction for
purposes of the sham transaction doctrine (the bifurcation issue) and the
marginal impact of the loan on Wells Fargo’s overall profits.
Further developments are reflected in earlier portions of this Report which
find that the Bx consideration can appropriately be considered to be pre-tax
revenue for purposes of the economic substance test and that Wells Fargo is not
entitled to a determination at this time that the business purpose test has been
satisfied. The treatment of the Bx consideration would tend to support Well
Fargo’s claim that portions of the report and testimony of Dr. LaRue are
inconsistent with at least one of the legal premises of the case. However, it is
not clear that Dr. LaRue’s analysis has no utility in explaining aspects of the
complex STARS transaction.
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5. Decision on the Motion Is Deferred
As a result of the decisions summarized in the preceding portions of this
Report, the posture of this case has been modified substantially. Moreover, it is
impossible at this time to predict how the inevitable challenges to various
decisions of the Special Master (including those set forth in this Report) will be
determined. It seems prudent, therefore, to postpone decisions with respect to
challenges to Dr. LaRue and the other expert witnesses until the posture of the
case becomes clearer as a trial date approaches.
Therefore, the determination of the challenge to Dr. LaRue is deferred at
this time. When the results of a previous challenge to a decision of the Special
Master and any challenges to decisions reflected in this Report have been
determined, further consideration of the motion, if necessary and appropriate,
will be undertaken. Both sides will be provided an opportunity to submit further
argumentation with respect to the issue at that time to take into account the then
current status of the case.
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X. Wells Fargo’s Motion to Exclude Expert Testimony of Dr. Ira Kawaller
1. The Plaintiff’s Motion
Wells Fargo has also moved to exclude the expert testimony of Dr. Ira
Kawaller under Federal Rule of Evidence 702 and Daubert v. Merrell Dow
Pharmaceuticals, Inc, 509 U.S. 579. (Doc 414) No previous motion to exclude
Dr. Kawaller’s testimony and report has been made.
Again, the submissions of memoranda and extensive array of exhibits by
both parties with respect to Dr. Kawaller’s status as an expert witness have been
carefully reviewed. However, for reasons set forth below, a determination with
respect to the motion is deferred at this time.
2. Grounds for the Motion
The grounds for challenge are slightly different with respect to each of the
Government’s expert witnesses. Well Fargo cites five reasons for its challenge
to Dr. Kawaller:
–Lack of analysis to support opinion regarding the bifurcation issue.
–Lack of analysis to support treatment of Bx as a rebate.
–Failure to apply the Eighth Circuit legal test for economic substance.
–Proffer of legal conclusions instead of factual analysis.
–Use of comparative analysis of hypothetical loans to determine marginal
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profit.
3. Government Response
The Government asserts that Dr. Kawaller is eminently qualified as a
financial expert, that his conclusions are of fact, not law, and that his analysis
helps to explain the economics of the transaction.
4. Determination of Motion
Unlike the renewed challenge to Dr. LaRue, this is the first challenge by
Wells Fargo to Dr. Kawaller. Nevertheless, because a decision rendered
previously by the Special Master and decisions rendered in other portions of this
Report are subject to challenge to the court, it is impossible at this time to
predict how the posture of the case may or may not be changed. It seems
prudent, therefore, to postpone decisions with respect to the challenges to Dr.
Kawaller and the other expert witnesses until the posture of the case becomes
clearer as a trial date approaches.
Therefore, the determination of the challenge Dr. Kawaller is deferred at
this time. When the results of the prior challenge to a decision of the Special
Master and any challenges to the decisions reflected in this Report have been
determined, further consideration of the motion, if necessary and appropriate,
will be undertaken. Both sides will be provided an opportunity to submit further
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argumentation with respect to the issue at that time to take into account the then
current status of the case.
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XI. Wells Fargo’s Motion To Exclude Expert Testimony of Dr. Michael
Cragg
1. The Plaintiff’s Motion
Wells Fargo has also moved to exclude the expert testimony of Dr.
Michael Cragg under Federal Rule of Evidence 702 and Daubert v. Merrell Dow
Pharmaceuticals, Inc, 509 U.S. 579. (411 ) No previous motion to exclude Dr.
Cragg’s testimony and report has been made.
The submissions of memoranda and extensive array of exhibits by both
parties with respect to this motion have been carefully reviewed. However, for
reasons set forth below, a determination with respect to the motion is deferred at
this time.
2. Grounds for the Motion
Wells Fargo cites several reasons for its motion. It contends that
--Dr. Cragg’s work fails to conform to Eighth Circuit law with respect to
the measure of profits.
-- His conclusions are of law and not of fact.
–His bifurcation of the loan from the trust creates a transaction that, in
fact, did not occur.
–He uses an “opportunity cost” analysis that has no legal basis (thereby
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introducing hypothetical, non-existent transactions into his analysis.
3. Government Response
The Government asserts that Dr. Cragg is eminently qualified as a
financial expert, that his conclusions are of fact, not law, and that his analysis
helps to explain the economics of the transaction.
4. Determination of Motion
This is the first challenge to Dr. Cragg’s participation as an expert
witness. For the reasons explained in the prior portion of this Report, it seems
prudent to postpone decisions with respect to challenges to Dr. Cragg and the
other expert witnesses until the posture of the case becomes clearer as a trial date
approaches.
Therefore, the determination of the challenge Dr. Cragg is deferred at this
time. When the results of the decisions reflected in this Report and any
challenges to them have been determined, further consideration of the motion, if
necessary and appropriate, will be undertaken. Both sides will be provided an
opportunity to submit further argumentation with respect to the issue at that time
to take into account the then current status of the case.
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