By Darshan Chulani, Senior Staff Writer

In late September, the U.S. Court of Federal Claims handed down a decision that is widely believed to spell the end of STARS transactions in their current form. Structured Trust Advantaged Repackaged Securities, or STARS, have been in use since the late 90s as a means of generating foreign tax credits.[1] Foreign tax credits are used to offset companies’ and individuals’ U.S. tax liabilities. The future of STARS was put in jeopardy earlier this year by the U.S. Tax Court in Bank of New York Mellon Corp. v. Commissioner of Internal Revenue, and the Court of Federal Claims reaffirmed this line of judicial reasoning in the case at hand.[2] Both courts identified the transactions as lacking economic substance, a key factor in differentiating legitimate transactions from sham transactions.[3]

The current case, Salem Financial Inc. v. United States[4], was brought by BB&T, a North Carolina bank, to file for a refund of the taxes it paid as a result of its participation in a STARS transaction from 2002 to 2007. BB&T also contended that it did not owe penalties as a result of the transaction. The $772 million at dispute includes $498 million for disallowed foreign tax credits and $113 million in penalties.[5]STARS are complicated transactions that serve “to generate large-scale foreign tax credits for a U.S. taxpayer, which could be used to enhance revenue and reduce taxes in the United States.”[6] The complexity of this particular transaction necessitated 21 days of trial, several of which were involved explaining the transaction rather than discussing the relevant legal issues.[7]

The STARS transaction in this case involved a complex series of back-and-forth transactions between BB&T’s U.S. subsidiaries and Barclays, a British bank. The structure of deal can be summarized as follows: BB&T established a Delaware trust containing roughly $6 billion in revenue-producing assets. The monthly revenue from these assets was taxable in the UK rather than in the U.S. because the trust administrator, a BB&T owned company, was based in that country. Barclays was nominated to receive the proceeds from the trust, but in turn was obligated to immediately re-contribute the amount to the trust. The subsequent transfer of revenues out of the UK generated UK tax credits, which were split between BB&T and Barclays. The companies used these credits to offset their UK tax liability, while BB&T retained the US tax credits generated as a result of the trust administrator’s UK domicile.

In an attempt to meet the economic substance doctrine and thus help give the transaction a business purpose, the STARS shelter included a loan of $1.5 billion from Barclays to a BB&T subsidiary. However, the first three years of this loan would be paid back to Barclays by itself. The court found that the loan served “only to add a hoped-for business purpose to the tax avoidance scheme,”[8] and thus failed the economic substance standard. In doing so the court denied BB&T’s request for refund, and upheld the penalties imposed on the BB&T.[9]

This judgment amounts to a vociferous rejection of the legitimacy of STARS. Further, it calls into question the versatility and transferability of foreign tax credits in the financial sector. It will be interesting to observe other challenges to STARS transactions, and whether courts will continue to find a lack of economic substance in similarly structured deals. The next chapter in this saga is BNY Mellon’s appeal of the Tax Court decision to the Second Circuit.