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IRS Wins Big Tax Ruling against Bank of New York Mellon

In a major win for the IRS, a federal tax court judge ruled that BNY Mellon improperly claimed foreign tax credits. The bank announced it would take an $850 million charge but that it would also appeal.

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Bank of New York Mellon Corp. headquarters, in June 2009 (Mario Tama/ Getty Images)

A federal tax court judge yesterday ruled that the Bank of New York Mellon had improperly claimed foreign tax credits through a complex deal arranged by Barclays. In the wake of the ruling, BNY Mellon said it will take a charge of $850 million but also said it would appeal.

The closely watched case was the subject of a joint investigation of tax deals in 2011 by ProPublica and the Financial Times.

The opinion was a triumph for the Internal Revenue Service which had challenged six U.S. banks over some two billion dollars of such deals, called Stars, short for Structured Trust Advantage Repackaged Securities. Barclays arranged deals for all of the banks but is not a party to any of the cases.

The cross-border deals took advantage of different countries’ tax rates and rules, effectively allowing American financial firms to minimize their total tax payments.

"The STARS transaction was a complicated scheme centered around arbitraging domestic and foreign tax law inconsistencies" and involving "pre-arranged circular cashflows" that had no economic benefit other than lowering taxes, the court stated. "We conclude that Congress did not intend to provide foreign tax credits for transactions such as STARS."

A leading international tax expert, Reuven Avi-Yonah, who heads the international tax program at the University of Michigan Law School, called the decision the "right result" in an email. "It is clearly good that this latest attempt at tax arbitrage failed," Professor Avi-Jonah added.

But he sounded a note of caution about what might happen on appeal. He cited two cases, decided in 2001, where federal appellate judges overturned opinions that had favored the IRS in cases involving foreign tax credits and arbitraged transactions.

The Stars deals being challenged by the IRS took place between 1999 and 2006. One of the cases has settled, one was being appealed administratively within the IRS, and the others remain in litigation in various federal courts.

It’s hard to be impressed, considering that they make that much profit in two to three weeks, but considering that the IRS only found two hundred million in fraudulent tax credits, I guess that’s proportional to the crime, at least, and potentially a rational disincentive.

On the other hand, the right solution is to get rid of foreign tax credits.  If you’re doing business in the United States, you should be paying United States taxes, rather than siphoning revenue out of the country to avoid the taxes.  Any tax law that encourages such avoidance is explicitly hobbling our economy, after all (dollars that leave the country don’t help us).