United States District Court, D. Minnesota
WELLS FARGO & COMPANY, on behalf of itself and the members of its affiliated group filing a consolidated return, Plaintiff,
UNITED STATES OF AMERICA, Defendant.
John Williams, Jr., Alan Swirski, and Nathan Wacker, SKADDEN,
ARPS, SLATE, MEAGHER & FLOM LLP; Walter A. Pickhardt,
Charles F. Webber, Deborah A. Ellingboe, and Blake J.
Lindevig, FAEGRE BAKER DANIELS LLP; Jeffrey A. Sloan, WELLS
FARGO & COMPANY, for plaintiff.
M. Donohue, William E. Farrior, Harris J. Phillips, and
Vassiliki Economides, UNITED STATES DEPARTMENT OF JUSTICE,
Patrick J. Schiltz United States District Judge
long-running tax litigation arises out of an extraordinarily
complex transaction that plaintiff Wells Fargo & Company
(“Wells Fargo”) engaged in with Barclays, a
British financial-services company. The transaction-called
“Structured Trust Advantaged Repackaged
Securities” or “STARS”-included four key
elements: (1) Wells Fargo would voluntarily subject some of
its income-producing assets to U.K. taxation by placing them
in a trust with a U.K. trustee; (2) Wells Fargo would offset
those U.K. taxes by claiming foreign-tax credits on its U.S.
returns; (3) Barclays would enjoy significant U.K. tax
benefits as a result of Wells Fargo's actions; and (4)
Barclays would compensate Wells Fargo for engaging in STARS
by making a monthly “Bx payment.”
Fargo claimed foreign-tax credits for the U.K. taxes that it
paid in connection with STARS. The Internal Revenue Service
(“IRS”) disallowed the credits on the ground that
STARS was a sham. Generally speaking, “a transaction
will be characterized as a sham if ‘it is not motivated
by any economic purpose outside of tax considerations'
(the business purpose test), and if it ‘is without
economic substance because no real potential for profit
exists' (the economic substance test).” IES
Indus., Inc. v. United States, 253 F.3d 350, 353 (8th
Cir. 2001) (quoting Shriver v. Comm'r, 899 F.2d
724, 725-26 (8th Cir. 1990)). The Eighth Circuit has yet to
decide whether a transaction will be characterized as a sham
if it fails only one of these two prongs-i.e., if the
transaction does not have a business purpose but does have
economic substance, or if the transaction does not have
economic substance but does have a business purpose. WFC
Holdings Corp. v. United States, 728 F.3d 736, 744 (8th
Cir. 2013) (“this court has not yet adopted a
particular approach to the sham transaction test”).
case was tried to a jury, which adopted the government's
view that STARS consisted of two separate, independent
transactions-a trust structure and a loan. ECF No. 630 at 1.
As instructed, the jury then determined whether each
transaction had a business purpose and economic substance.
The jury found that the trust structure had neither a non-tax
business purpose nor a reasonable possibility of pre-tax
profit. ECF No. 630 at 2. There is no dispute, then, that
under the jury's findings, the trust structure (which
generated the disputed foreign-tax credits) was a
jury had a different view of the loan, however. The jury
found that the loan had a reasonable possibility of pre-tax
profit but that Wells Fargo entered into the loan solely for
tax-related reasons. ECF No. 630 at 2. The jury's
findings thus squarely present the question that the Eighth
Circuit has avoided in the past: Will a transaction be
disregarded as a sham if it had objective economic substance
but the taxpayer lacked a subjective non-tax business
Court's request, the parties have briefed this difficult
issue, as well as the equally difficult issue of whether
Wells Fargo is subject to a negligence penalty under 26
U.S.C. § 6662(b)(1) in connection with its claim of
foreign-tax credits. Having considered the parties'
arguments, the Court finds that (1) the loan was not a sham
and (2) Wells Fargo is subject to the negligence penalty.
noted, the jury adopted the government's view that STARS
consisted of two independent transactions: a trust structure
and a loan. The loan took the form of a $1.25 billion
contribution by Barclays to the Wells Fargo trust; Wells
Fargo was obligated to repay that contribution (with
interest) after five years. The loan carried an above-market
interest rate of LIBOR plus 20 basis points. Wells Fargo seeks
to deduct its interest payments under 26 U.S.C. §
163(a), which generally permits the deduction of “all
interest paid or accrued within the taxable year on
indebtedness.” The government resists, arguing that,
because the jury found that the loan lacked a non-tax
business purpose, the loan is a sham that must be disregarded
for tax purposes.
other cases involving materially identical STARS transactions
have worked their way through the federal courts. See
Santander Holdings USA, Inc. v. United States, 844 F.3d
15 (1st Cir. 2016), pet. for cert. filed, Mar. 20,
2017 (No. 16-1130); Bank of N.Y. Mellon Corp. v.
Comm'r, 801 F.3d 104 (2d Cir. 2015), cert.
denied, 136 S.Ct. 1377 (2016); Salem Fin., Inc. v.
United States, 786 F.3d 932 (Fed. Cir. 2015), cert.
denied, 136 S.Ct. 1366 (2016). In all three cases, the
courts treated the loan as independent from the trust
structure (as did the jury in this case).
Santander, 844 F.3d at 19 & n.4 (taxpayer
conceded for purposes of summary judgment and appeal that
loan and trust should be bifurcated); Bank of N.Y.
Mellon, 801 F.3d at 121 (rejecting taxpayer's
argument that the Tax Court erroneously bifurcated the
transaction); Salem, 786 F.3d at 940 (for purposes
of appeal, taxpayer did not contest lower court's holding
that transaction should be bifurcated). And in all three
cases, the courts found that the loan was not a sham.
Santander, 844 F.3d at 19 & n.4 (government did
not contest lower court's holding that loan was not a
sham); Bank of N.Y. Mellon, 801 F.3d at 123-24
(rejecting government's argument that loan was a sham);
Salem, 786 F.3d at 955-58 (same).
the fact that all three courts of appeals to have considered
its argument have rejected it, the government continues to
insist that the loan is a sham and that Wells Fargo is not
entitled to deduct its interest expenses. The government
contends that, even if a transaction has objective economic
substance, it must be treated as a sham unless the taxpayer
actually had at least one subjective, non-tax business
purpose. To resolve this issue, it is necessary to predict
which approach to the sham- transaction doctrine the Eighth
Circuit will choose to adopt.
considered the parties' arguments, the Court concludes
that the Eighth Circuit is likely to treat the objective and
subjective components of the sham-transaction test as two
factors in a single flexible analysis rather than as two
separate, rigid tests. After all, courts created the
sham-transaction doctrine in recognition of the fact that
taxpayers display endless ingenuity in exploiting the tax
code, making it impossible for Congress to anticipate and
prevent all abuse. A doctrine that is intended to counter the
creative and ever-evolving abuse of the tax code must
necessarily be flexible. Reducing the sham-transaction
doctrine to two mechanical, all-or-nothing tests would
deprive the doctrine of the flexibility needed to accomplish
flexible approach also reflects the Supreme Court's
often-quoted formulation of the sham-transaction doctrine in
Frank Lyon Co. v. United States, 435 U.S. 561
[W]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.
Id. at 583-84. This language reads more like a list
of factors to weigh than a series of boxes to check.
Moreover, although some courts read this language to require
the taxpayer to have a subjective non-tax purpose, nothing in
it refers to a taxpayer's actual subjective motivation;
the language can just as easily be read to describe the
objective features of the transaction as seen ...