United States Court of Appeals 

For the First Circuit 

No. 16-1282 

SANTANDER HOLDINGS USA, INC., and Subsidiaries, 

f/k/a Sovereign Bancorp., Inc., 

Plaintiff, Appellee, 

v. 

UNITED STATES OF AMERICA, 

Defendant, Appellant. 

APPEAL FROM THE UNITED STATES DISTRICT COURT 

FOR THE DISTRICT OF MASSACHUSETTS 

[Hon. George A. O'Toole, Jr., U.S. District Judge] 

Before 

Lynch and Selya, Circuit Judges, 

and Burroughs, District Judge. 

 Judith A. Hagley, with whom Caroline D. Ciraolo, Acting 

Assistant Attorney General, Tax Division, Diana L. Erbsen, Deputy 

Assistant Attorney General, Tax Division, Gilbert S. Rothenberg, 

Richard Farber, and Carmen M. Ortiz, United States Attorney, were 

on brief, for appellant. 

 Jonathan S. Massey, with whom Leonard A. Gail, Paul J. Berks, 

Massey & Gail LLP, Rajiv Madan, and Skadden, Arps, Slate, Meagher 

& Flom LLP were on brief, for appellee. 

 Martin S. Kaufman on brief for Atlantic Legal Foundation, 

amicus curiae. 

 Scott P. Martin, Gibson, Dunn & Crutcher LLP, Kate Comerford 

Todd, Steven P. Lehotsky, Warren Postman, and U.S. Chamber 

 

 Of the District of Massachusetts, sitting by designation. 
Litigation Center on brief for Chamber of Commerce of the United 

States of America, amicus curiae. 

 Derek T. Ho, Bradley E. Oppenheimer, William H. Milliken, 

Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C., and K. 

Richard Foster on brief for Financial Services Roundtable, amicus 

curiae. 

December 16, 2016 
- 3 - 

LYNCH, Circuit Judge. Under the Internal Revenue Code, 

taxpayers receive, subject to various technical requirements, 

credits against owed U.S. income tax for every dollar paid to a 

foreign country for taxable international business transactions of 

economic substance. See 26 U.S.C. §§ 901–909. Over the past 

decade, some banks have engaged in complicated transactions the 

very purpose of which is to generate a foreign tax credit in order 

to take advantage of the U.S. deductions, and have done so at the 

expense of the U.S. taxpayer. 

This case concerns whether Sovereign Bancorp, Inc., 

later acquired by Santander Holdings USA, Inc. (together, 

"Sovereign"), a U.S. taxpayer, is entitled to a refund from the 

Internal Revenue Service ("IRS") after the IRS began disallowing 

its claim for foreign tax credits and imposing accuracy-related 

penalties in 2008. The credits at issue here were claimed for tax 

years 2003 to 2005 for taxes arranged to be paid to the United 

Kingdom as part of a Structured Trust Advantaged Repackaged 

Securities ("STARS") transaction that Sovereign had engaged in. 

This STARS transaction was initiated in 2003 and was scheduled to 

last five years, but it ended early, in July 2007, when STARS and 

similar transactions became the subject of heightened scrutiny 

from the IRS. See Determining the Amount of Taxes Paid for 

Purposes of Section 901, 72 Fed. Reg. 15,081 (proposed Mar. 30, 

2007). Sovereign and Barclays Bank ("Barclays"), which is 
- 4 - 

chartered in the United Kingdom, were the two parties to the 

transaction at issue. 

Sovereign brought suit to obtain a refund from the IRS 

in the District of Massachusetts in 2009. The amount of the refund 

sought is approximately $234 million in taxes, penalties, and 

interest. Sovereign asserts that it is entitled to foreign tax 

credits against its U.S. taxes for taxes it paid to the United 

Kingdom as part of the STARS transaction at issue. As the 

government concedes, the STARS transaction complied on its face 

with then-existing U.S. statutory and regulatory requirements. 

But the government opposes the refund, arguing that the STARS 

transaction here is an "abusive tax shelter" and so amounts to a 

transaction that fails the common law economic substance test. 

Congress and the IRS have long been concerned with 

taxpayers inappropriately seeking foreign tax credits. IRS 

regulations proposed in 2007 and finalized in 2011 prohibited STARS 

transactions, but not retroactively. See Determining the Amount 

of Taxes Paid for Purposes of Section 901, 72 Fed. Reg. 15,081, 

15,084 (proposed Mar. 30, 2007); Determining the Amount of Taxes 

Paid for Purposes of the Foreign Tax Credit, 76 Fed. Reg. 42,036 

(July 18, 2011) (codified at 26 C.F.R. pt. 1). The regulations 

reflect an understanding that STARS transactions and similar 

complex financial structures for which foreign tax credits are 

sought both pose a danger to the federal fisc and do not serve the 
- 5 - 

purposes intended by Congress in enacting the foreign tax credit 

regime. Those purposes include avoiding double taxation and 

enabling the conduct of business affairs abroad by U.S. firms. 

See H.R. Rep. No. 83-1337, at 4103 (1954) ("The [foreign tax 

credit] provision was originally designed to produce uniformity of 

tax burden among United States taxpayers, irrespective of whether 

they were engaged in business in the United States or engaged in 

business abroad."). This case involves a STARS transaction that 

took place before such transactions were forbidden by regulation, 

and no one contends the 2011 regulation applies. This decision 

thus directly affects only that transaction. 

During roughly the same period as the transaction at 

issue here, from 2001 to 2007, other U.S. banks also entered into 

STARS transactions with Barclays. They similarly sought tax 

credits, and the IRS similarly opposed them. In Bank of New York 

Mellon Corp. v. Commissioner (BNY), 801 F.3d 104, 107 (2d Cir. 

2015), the Second Circuit affirmed a judgment disallowing the 

credits claimed by Bank of New York Mellon for its STARS 

transaction with Barclays.1 Using somewhat different reasoning, 

 1 We note that while we discuss the findings of the Second 

Circuit in BNY, our opinion does not rely in any sense on the 

earlier opinion of the tax court in that case. See Bank of N.Y. 

Mellon Corp. v. Comm'r, 140 T.C. 15, as amended by 106 T.C.M. (CCH) 

367 (T.C. 2013). Because we do not rely on that opinion, we need 

not address Sovereign's argument that the judge in that case 

suffered from a conflict of interest, a claim the government 

vigorously disputes. 
- 6 - 

the Federal Circuit in Salem Financial, Inc. v. United States, 786 

F.3d 932, 951, 954–55 (Fed. Cir. 2015), also upheld a determination 

disallowing credits claimed by Branch Banking & Trust Corporation 

for a STARS transaction with Barclays. Both circuit court 

opinions contain extensive factual descriptions of the STARS 

transactions, which also largely characterize the transaction at 

issue here. 2 A third case, involving a Wells Fargo STARS 

transaction, was tried in a federal district court in the Eighth 

Circuit. See Wells Fargo & Co. v. United States, 143 F. Supp. 3d 

827, 842 (D. Minn. 2015). After trial, a jury found that the 

transaction lacked economic substance. 

The Massachusetts district court in this case awarded 

summary judgment to Sovereign. It first entered partial summary 

judgment for Sovereign on the issue of whether a payment Sovereign 

received from Barclays should be considered income to Sovereign in 

calculating the STARS Trust transaction's profit. Santander 

Holdings USA, Inc. & Subsidiaries v. United States (Santander I), 

977 F. Supp. 2d 46, 48 (D. Mass 2013). It then entered judgment 

for Sovereign after finding as a matter of law that the Trust and 

 2 Although Sovereign argues on appeal that the transaction 

in BNY is distinguishable, it conceded below that the transaction 

was "very similar" to the one at issue here. And while Sovereign 

contends that the bank in Salem adopted a different litigation 

strategy than the one pursued by Sovereign, it does little to 

demonstrate that the STARS transaction in Salem involved any 

materially different facts. 
- 7 - 

Loan transactions had economic substance, and so Sovereign was 

entitled to interest-related deductions on expenses for the Loan 

transaction and a refund on the disallowed foreign tax credits 

claimed for the Trust transaction and the penalties imposed by the 

IRS. Santander Holdings USA, Inc. v. United States (Santander 

II), 144 F. Supp. 3d 239, 248 (D. Mass. 2015). The court also 

denied the government's cross-motion for partial summary judgment 

in its favor on a number of issues, including whether Sovereign's 

U.K. taxes should be regarded as expenses in any calculation of 

Sovereign's profit from the STARS transaction. Id. at 242-44, 

248. The government appeals from the grant of summary judgment 

to Sovereign and the denial of its cross-motion. 

Through concessions made by both the government and 

Sovereign, the appeal has been considerably simplified. The 

government no longer contends that it is entitled to a jury trial 

on the tax refund claim; it seeks a jury trial only on the penalties 

claim. The government also does not contend any longer that the 

district court improperly excluded evidence, or that there are any 

material disputes of fact, or that summary judgment was entered 

prematurely. Rather, the government agrees that the controlling 

issue is one of law and argues that its cross-motion for summary 

judgment as to the Trust portion of the STARS transaction should 
- 8 - 

have been allowed.3 Sovereign, for its part, agrees, for the 

purposes of summary judgment, that the proper focus is on the Trust 

transaction alone, and not on the Loan transaction.4

We hold that the district court committed reversible 

error and that the government is entitled to summary judgment in 

its favor as to the economic substance of the STARS Trust 

transaction. We largely agree with the reasoning of the Federal 

Circuit opinion in Salem in rejecting the claims that the Trust 

transaction had economic substance and substantially rely on its 

analysis. 

I. 

We give a brief description of the transaction and then 

of this Circuit's economic substance test. 

 3 The government also argued to the district court that 

the foreign tax credits claimed by Sovereign should be denied on 

the basis of two "substance over form" doctrines, the "step 

transaction" and "conduit" doctrines, but the district court 

rejected the argument. Santander II, 144 F. Supp. 3d at 244. As 

the government focuses its appeal on the economic substance 

doctrine, we do not consider the district court's rejection of the 

government's substance-over-form argument. 

4 The parties have agreed for purposes of this appeal that 

the Trust transaction should be analyzed separately from the Loan 

transaction. The bank in Salem similarly accepted the bifurcation 

of the tax consequences of the Trust transaction and the Loan 

transaction for purposes of that appeal. Salem, 786 F.3d at 940. 

The government no longer contests the economic substance 

of the Loan transaction, as long as the Loan transaction is 

analyzed separately from the Trust transaction, and does not appeal 

the district court's decision that Sovereign may claim certain 

interest-expense deductions. 
- 9 - 

A. The STARS Transaction 

Sovereign entered into the STARS transaction with 

Barclays in 2003. U.S. banks were then aware of the tax risks of 

being denied the full amount of U.S. foreign tax credits. See, 

e.g., Salem, 786 F.3d at 937. Like other STARS transactions, the 

one Sovereign entered into had, as the district court put it, a 

"Rube Goldberg" complexity. Santander I, 977 F. Supp. 2d at 48. 

We explain it briefly and rely on BNY and Salem for further 

details. 

In 2003, Sovereign first created a Trust (the Trust half 

of the transaction) into which it ultimately contributed about 

$6.7 billion of its U.S.-located income-producing assets. The 

trustee of the Trust was, by its terms, a U.K. citizen, a fact 

which subjected the Trust to U.K. taxes. The U.K. taxes were at 

a rate of 22%. The Trust was also subject to U.S. federal income 

tax at a rate of 35%, but it could claim a tax credit for the taxes 

paid to the United Kingdom. The Trust was structured, therefore, 

to receive foreign tax credits for the amount paid in tax on the 

Trust to the United Kingdom. It is undisputed that Sovereign paid 

all U.K. taxes for which it claimed U.S. tax credits. 

Barclays acquired an interest in the Trust for $750 

million in November 2003 at the Trust's initial creation and 

acquired an additional $400 million interest almost a year later, 

when Sovereign added additional funds to the Trust. 
- 10 - 

Significantly, Barclays was required to sell its interest in the 

Trust back to Sovereign for $1.15 billion at the end of the 

transaction. 

Sovereign treated this $1.15 billion contribution from 

Barclays as a Loan (the Loan half of the STARS transaction) for 

accounting and regulatory purposes, including in all of 

Sovereign's filings to the Securities and Exchange Commission and 

the Office of Thrift Supervision. The offsetting agreements that 

converted Barclays's purchase of an interest in the Trust into the 

Loan effectively resulted in Barclays lending Sovereign $750 

million at a floating monthly rate of LIBOR5 plus 50 basis points 

and $400 million at LIBOR plus 25 basis points.6

The Trust engaged in a series of actions that generated 

a U.K. tax benefit for Barclays. The Trust distributed funds to 

a Barclays Blocked Account, which Barclays could not access, but 

 5 LIBOR stands for "Intercontinental Exchange London 

Interbank Offered Rate." Salem, 786 F.3d at 937 n.1. LIBOR "is 

a benchmark rate that some of the world’s leading banks charge 

each other for short-term loans." Id. 

6 When it first marketed this transaction to potential 

counterparties, Barclays did not include this Loan component. See 

Salem, 786 F.3d at 936. The government suggests that Barclays 

added the Loan to "disguise the true nature of the [transaction] 

and permit U.S. taxpayers to justify STARS as low-cost funding." 

Sovereign asserts that "there is no evidence . . . that any nonloan transaction was ever offered to (or considered by) Sovereign," 

and that "[t]o the extent Barclays may have proposed a non-loan 

transaction to other banks, the evidence shows they were 

uninterested in it." Because we must analyze the Loan and Trust 

transactions separately, this dispute is immaterial. 
- 11 - 

which allowed Barclays to formally hold the funds in its name. 

The Barclays Blocked Account then immediately returned the funds 

to the Trust. Barclays owed U.K. taxes on the distributions made 

to the Barclays Blocked Account, but, importantly, Barclays was 

entitled to a tax credit for the U.K. tax paid on this income by 

the Trust, and Barclays also was permitted to deduct its recontributions to the Trust as a tax loss. The combination of the 

tax credit and deduction "creat[ed] a net tax deduction for 

Barclays that it could use to offset tax on other income unrelated 

to [the STARS transaction]." 

In exchange, Barclays paid Sovereign a monthly sum, 

referred to as the "Barclays" or "Bx" payment. The amount of the 

Bx payment was calculated to equal 50% of the U.K. tax Sovereign 

paid on the Trust's income. In a sense, the 50% was a return to 

Sovereign of half of its tax payment, whether or not it was 

technically a rebate. The Bx payment was "netted against 

Sovereign's interest obligation" on the Loan. 

The benefits for both parties can be illustrated by a 

hypothetical also employed by the Second and Federal Circuits. 

See BNY, 801 F.3d at 111; Salem, 786 F.3d at 938. Assume $100 of 

income in the Trust for a given month. Through its ownership 

interest in the Trust and the Trust's structure, Barclays would be 

liable for a 30% U.K. corporate tax on the Trust's income, 

amounting to $30. BNY, 801 F.3d at 111. Barclays would then 
- 12 - 

claim a credit for the 22% U.K. tax paid on the Trust by Sovereign 

amounting to $22, bringing Barclays's own tax liability down to 

$8. Id. The Trust would set aside $22 to settle the U.K. tax 

owed by Sovereign; the remaining $78 would be shuttled into and 

out of the Barclays Blocked Account. Id. Sovereign would claim 

a U.S. foreign tax credit for the $22 it paid in U.K. taxes. Id. 

Upon redistributing the $78 to the Trust from the 

Barclays Blocked Account, Barclays would claim a trading loss 

deduction on the $78 which, at the corporate tax rate of 30%, would 

amount to $23.40. Id. Barclays would make a Bx payment to 

Sovereign calculated to be half of the 22% U.K. tax paid by 

Sovereign, which would amount to $11. Id. Barclays then deducted 

this payment at the 30% U.K. tax rate as well, resulting in a $3.30 

deduction. Id. In the end, Barclays would save $7.70 in taxes 

for each $100 of Trust income ($23.40 – $8 – $11 + $3.30), and 

Sovereign would save $11 (the amount of the Bx payment calculated 

against Sovereign's U.K. tax exposure). Id. Both parties 

ultimately reduced their tax exposure -- Barclays through the 

various deductions generated by the Trust transaction and 

Sovereign through the Bx payment. 
- 13 - 

B. The Economic Substance Doctrine 

The federal income tax is, and always has been, based on 

statute. The economic substance doctrine,7 like other common law 

tax doctrines, can thus perhaps best be thought of as a tool of 

statutory interpretation,8 as then-Judge Breyer characterized it 

in his opinion for this court in Dewees v. Commissioner, 870 F.2d 

21, 35–36 (1st Cir. 1989). 

The common law economic substance doctrine traces back 

to the Supreme Court's decision in Gregory v. Helvering, 293 U.S. 

465 (1935).9 The Court there looked beyond the fact that a 

 7 Sovereign argues that the foreign tax credit area is so 

heavily populated with IRS regulation that there is no need for 

any further regulation by the courts under the guise of the 

economic substance doctrine. On these facts, we reject the 

proposition. In practical terms, it takes time for the government 

to analyze a new problem, come up with a solution, and promulgate 

regulations. "The endless ingenuity of taxpayers in attempting 

to avoid taxes means that there will be a first time for 

everything," Wells Fargo, 143 F. Supp. 3d at 838, and the economic 

substance test guards against abuse of loopholes that Congress and 

the IRS have not anticipated. 

8 As one commentator says: 

A related . . . claim is that the legislature assumes 

that long-standing common law doctrines such as economic 

substance will be used to interpret the statutes it 

enacts. Under this claim, the doctrines have been 

implicitly adopted as part of the statute -- at least 

where the statute does not indicate otherwise. 

Joseph Bankman, The Economic Substance Doctrine, 74 S. Cal. L. 

Rev. 5, 11 (2000). 

9 In 2010, Congress enacted a statutory economic substance 

test. See 26 U.S.C. § 7701(o). The statutory test was not made 

retroactive. Our analysis, however, is not in conflict with that 

test, as Congress specified that the 2010 codification would be 
- 14 - 

corporate reorganization technically complied with the statutory 

requirement and found that it lacked economic substance. Id. at 

468–70. It found as such because the reorganization was: 

an operation having no business or corporate purpose —- 

a mere device which put on the form of a corporate 

reorganization as a disguise for concealing its real 

character, and the sole object and accomplishment of 

which was the consummation of a preconceived plan, not 

to reorganize a business or any part of a business, but 

to transfer a parcel of corporate shares to the 

petitioner. 

Id. at 469. The Court reached this conclusion from the fact that 

"the transaction upon its face lies outside the plain intent of 

the statute." Id. at 470. 

The Court clarified the doctrine further in Frank Lyon 

Co. v. United States, 435 U.S. 561 (1978), where it reversed the 

Eighth Circuit's decision that a sale-and-leaseback transaction 

did not meet the economic substance test. Id. at 584. The Court 

explained that "[i]n applying this doctrine of substance over form, 

the Court has looked to the objective economic realities of a 

transaction rather than to the particular form the parties 

employed." Id. at 573 (emphasis added). 

The First Circuit has addressed challenges to the 

economic substance of transactions in a number of cases, although 

 

applied as courts have previously and consistently applied the 

economic substance doctrine. Id. § 7701(o)(5)(C). If the 

codification reveals anything about congressional intent as to 

pre-2010 STARS transactions, it supports our conclusion. 
- 15 - 

the cases often have not invoked the "economic substance doctrine" 

by that name. See, e.g., Stone v. Comm'r, 360 F.2d 737 (1st Cir. 

1966); Fabreeka Prods. Co. v. Comm'r, 294 F.2d 876 (1st Cir. 1961); 

Granite Tr. Co. v. United States, 238 F.2d 670 (1st Cir. 1956). 

This court has been particularly wary of inquiring into the 

subjective motivations of taxpayers: "[U]nless Congress makes it 

abundantly clear, we do not think tax consequences should be 

dependent upon the discovery of a purpose, or a state of mind, 

whether it be elaborate or simple." Fabreeka Prods. Co., 294 F.2d 

at 878. 

Dewees is our most recent significant case on the 

economic substance doctrine. There, this court upheld a tax court 

decision that a "loss [the petitioners] incurred while engaged in 

'straddle' trading on the London Metals Exchange was not an 

'ordinary loss' deductible from their income." Dewees, 870 F.2d 

at 22. The tax court held that the loss was not deductible because 

the straddle trades were sham transactions and not "entered into 

for profit" within the meaning of section 108 of the Internal 

Revenue Code. Id. 

This court upheld the tax court's decision for four 

principal reasons. We emphasized that the case was one of some 

1,100 consolidated by the tax court, from the general pattern of 

which the tax court could infer that the transactions were designed 

to avoid taxes; that the promotional material for the transactions 
- 16 - 

focused exclusively on their tax effects; that although margin 

accounts were opened for the transactions, none of the investors 

in any of the transactions ever received a margin call; and that 

no investor ever made a net profit or "was ever asked to pay a 

loss, beyond the initial margin deposit" for the transactions. 10 

Id. at 31. We rejected the petitioner's argument that we must 

analyze the taxpayer's subjective motivation under the relevant 

statutory framework. Id. at 34. Among other reasons, the court 

noted that the tax court had concluded that the transactions were 

"shams in substance," and that "[c]ase law makes clear that a 

taxpayer cannot deduct a 'sham transaction' loss, irrespective of 

his subjective profit motive." Id. at 35. 

Dewees instructs that the economic substance doctrine is 

centered on discerning whether the challenged transaction 

objectively "lies outside the plain intent of the [relevant 

statutory regime]." Id. at 29 (quoting Gregory, 293 U.S. at 470). 

It further instructs that a transaction fails the economic 

 10 To the extent that similar evidence is in the record for 

this case, it supports our conclusion. As in Dewees, we have 

examined the pattern that has emerged from comparable STARS 

transactions. We have used Sovereign's and Barclays's 

communications to each other about the transaction and, in 

particular, their emphasis on the connection of the Bx payment to 

Sovereign's U.K. taxes and the Trust transaction's "tax risk," to 

conclude that the Trust transaction had no objective purpose 

outside its tax effect. And we too have noted that the transaction 

at issue here was structured such that it exposed neither party to 

realistic non-tax risk. 
- 17 - 

substance test if, "though [it] actually occurred and technically 

complied with the tax code, [it] w[as] mere[ly a] device[] to avoid 

tax liability." Id. at 30; see also Schussel v. Werfel, 758 F.3d 

82, 97 (1st Cir. 2014) (noting that courts may "disregard the form 

of transactions that have no business purpose or economic substance 

beyond tax evasion"). In other words, when a transaction "is one 

designed to produce tax gains . . . [not] real gains," Dewees, 870 

F.2d at 31 -- such as when the challenged transaction has no 

prospect for pre-tax profit -- then it is an act of tax evasion 

that, even if technically compliant, lies outside of the intent of 

the Tax Code and so lacks economic substance. 

II. 

"We review orders granting or denying summary judgment 

de novo." Fithian v. Reed, 204 F.3d 306, 308 (1st Cir. 2000). 

"The general characterization of a transaction for tax purposes is 

a question of law subject to review." Frank Lyon, 435 U.S. at 581 

n.16. 

In its first partial summary judgment decision, the 

district court rejected the government's argument that the Bx 

payment was in effect a tax rebate. Santander I, 977 F. Supp. 2d 

at 50. The district court concluded instead that the Bx payment 

as a matter of law was income to Sovereign. Id. at 52. The 

Federal Circuit reached the same conclusion as the district court 

in our case and held that the Bx payment must be counted as income 
- 18 - 

under the logic of Old Colony Trust Co. v. Commissioner, 279 U.S. 

716 (1929); IES Industries, Inc. v. United States, 253 F.3d 350 

(8th Cir. 2001); and Compaq Computer Corp. & Subsidiaries v. 

Commissioner, 277 F.3d 778 (5th Cir. 2001). Salem, 786 F.3d at 

944–46. By contrast, the Second Circuit accepted the government's 

argument. BNY, 801 F.3d at 121–22. 

We see no need to address the government's 

characterization of the Bx payment as a rebate, not income, because 

we hold that whether the Bx payment is best characterized as a 

rebate or as income, Sovereign's argument still fails. The STARS 

Trust transaction itself does not have a reasonable prospect of 

creating a profit without considering the foreign tax credits, 

and, as a result, it is not a transaction for which Congress 

intended to give the benefit of the foreign tax credit. This 

conclusion mirrors that of the Federal Circuit in Salem, and we 

reach it largely for the reasons stated there. Salem, 786 F.3d 

at 946-55. We agree with that court that we must "assess [the] 

transaction's economic reality, and in particular its profit 

potential, independent of the expected tax benefits." Id. at 948. 

Using similar reasoning, we find that the Trust transaction is 

"shaped solely by tax-avoidance features," id. at 942 (quoting 

Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1375 (Fed. 

Cir. 2010)), that "lack a bona fide business purpose," id. Most 

importantly, we agree with the Federal Circuit that the Trust 
- 19 - 

transaction is profitless, id. at 949, and that it is "not the 

type of transaction Congress intended to promote with the foreign 

tax credit system," id. at 954. 

The Trust transaction is profitless because the "profit" 

to Sovereign from the Bx payment comes at the expense of exposure 

to double the Bx payment's value in U.K. taxes. To return briefly 

to the $100 hypothetical: even if Sovereign receives an $11 Bx 

payment from Barclays (half of the $22 paid by Sovereign to the 

United Kingdom at its 22% tax rate), the Trust transaction lacks 

a reasonable potential (or any potential) of generating profit 

because the $11 Bx payment is earned at the expense of the $22 

U.K. tax. In other words, every $1 the Trust transaction earns 

through the Bx payment costs $2 from the transaction costs of 

subjecting the Trust transaction to U.K. tax. When the primary 

transaction cost of the Bx payment, the U.K. taxes, are factored 

into the pre-tax profitability calculation, the Trust transaction 

is plainly profitless.11 Sovereign's "profit" comes from the 

 11 Because exposure to U.K. taxation was the necessary and 

sufficient condition of the Bx payment, the U.K. taxes were an 

expense incurred by Sovereign for the "profit" generated by the 

Trust transaction. And when the U.K. taxes are recognized as 

expenses, there is no pre-tax profit, and the Trust transaction 

lacks a cardinal feature of an economically substantial 

transaction: a reasonable prospect of pre-tax profit. 

Sovereign and the district court rely heavily on Compaq 

and IES for the proposition that foreign taxes should not be 

treated as expenses. Santander II, 144 F. Supp. 3d at 242–44. 

Those cases did not analyze STARS transactions and so are 

distinguishable factually. We agree with the Salem court's 
- 20 - 

foreign tax credits it claims for the U.K. taxes combined with a 

Bx payment calculated as half its U.K. tax liability. 

Accordingly, we conclude both that the STARS Trust 

transaction had no objective non-tax economic benefit and that 

Congress, in creating the foreign tax credit regime, did not intend 

that it would cover this type of generated transaction.12 Exposure 

to U.K. taxation for the purpose of generating U.S. foreign tax 

credits was the Trust transaction's whole function. 

Our conclusion that the Trust transaction lacks economic 

substance is entirely consistent with our statement in Dewees that 

"taxpayers may lawfully structure transactions that seek real 

gains in a way that also maximizes tax advantages." 870 F.2d at 

 

analysis of this issue as to the Trust transaction. 786 F.3d at 

947–49. 

Nor does our conclusion that Sovereign's U.K. taxes 

should be considered expenses contradict the Supreme Court's 

holding in Old Colony. Old Colony did not involve foreign taxes 

and says nothing about whether foreign tax liability may ever be 

considered an expense. See Old Colony, 279 U.S. at 716. 

12 See John P. Steines, Jr., Subsidized Foreign Tax Credits 

and the Economic Substance Doctrine, 70 Tax Lawyer (forthcoming 

2017) ("[I]t is virtually impossible for a dispassionate analyst 

to reasonably conclude that Congress intended to surrender more 

revenue than that captured by the foreign government in a holistic 

sense where the U.S. taxpayer and the counterparty split the 

remaining spoils solely by reason of carefully exploited 

inconsistent international tax rules in an otherwise unprofitable 

transaction that is an overly complicated version of an orthodox 

deal that would not have given rise to credits at all."). A copy 

of this article was filed with the court and disclosed to the 

parties. 
- 21 - 

32. Again, this situation does not involve private parties 

structuring an agreement to benefit both parties and only then 

seeking to maximize the tax benefits. The Bx payments do not come 

into fruition until and unless Sovereign pays the U.K. taxes (for 

which it will seek a 100% credit on its U.S. taxes). 

Indeed, the record demonstrates that the Bx payment is 

inextricably linked to the deliberate incurring of Sovereign's 

U.K. tax liability. Barclays and Sovereign made clear to each 

other that the Bx payment would be calculated based on Sovereign's 

U.K. tax liability and the credits that Barclays would then be 

able to claim. An internal communication between the parties 

stated that the Bx payment would allow "Barclays [to] share[] U.K. 

tax credits with Sovereign." 

The STARS scheme is profitable only because Sovereign 

plans to obtain U.S. tax credits; that is, the whole existence of 

the Trust transaction depends on getting a U.S. tax credit. There 

is otherwise no business reason to engage in the transaction. As 

the Salem court found: 

The evidence thus supports the trial court's 

finding that the STARS Trust was a "prepackaged 

strategy" created to generate U.S. and U.K. tax benefits 

for [the counterparty] and Barclays. Barclays agreed 

to bear half of [the counterparty's] U.K. tax expense 

under the transaction in exchange for an opportunity to 

claim substantial U.K. tax benefits for itself (through 

the trading loss deduction). [The counterparty], on the 

other hand, benefited by claiming a foreign tax credit 

equal to the entire amount of the Trust's U.K. taxes 

while "getting back one-half of the U.K. tax" from 
- 22 - 

Barclays. Absent those tax advantages, the STARS 

transaction would never have occurred. 

786 F.3d at 952 (citation omitted). Here, Sovereign subjected its 

property and income to U.K. taxation only because it anticipated 

it could avoid U.S. taxes through the resulting U.S. tax credit. 

The Trust transaction did not advance the Tax Code's 

interest in providing foreign tax credits in order to encourage 

business abroad or in avoiding double taxation. Nor does 

disallowing foreign tax credits for the STARS Trust transaction 

interfere with the United Kingdom's authority. After all, it was 

the U.K. authorities who in 2005 first called STARS transactions 

to the attention of the IRS as a potential impermissible tax 

shelter.13 

 13 Moreover, there is no tension between denying foreign 

tax credits for the STARS Trust transaction and the U.S.-U.K. tax 

treaty: As the government correctly notes, the treaty requires the 

grant of foreign tax credits "subject to the limitations of the 

laws of the United States." Convention with Great Britain and 

Northern Ireland regarding Double Taxation and Prevention of 

Fiscal Evasion, art. 24, July 24, 2001, S. Treaty Doc. No. 107-

19. Among those limitations, of course, are "anti-abuse 

principles" such as the economic substance doctrine. See Treasury 

Dep't, Technical Explanation of the Convention Between the 

Government of the United States of America and the Government of 

the United Kingdom of Great Britain and Northern Ireland for the 

Avoidance of Double Taxation and the Prevention of Fiscal Evasion 

with Respect to Taxes on Income and on Capital Gains 14. See also 

Del Commercial Props., Inc. v. Comm'r, 251 F.3d 210, 214 (D.C. 

Cir. 2001) ("[I]f the sole purpose of a transaction with a foreign 

corporation is to dodge U.S. taxes, [a] treaty cannot shield the 

taxpayer from the fatality of the [substance-over-form] steptransaction doctrine."). 
- 23 - 

Of course, as the government readily admits, some 

transactions that are not immediately profitable without tax 

benefits, such as investments in "nascent technologies," may have 

economic substance. See Salem, 786 F.3d at 950. But the Trust 

transaction is not comparable to such transactions because it does 

not "meaningfully alter[] the taxpayer's economic position (other 

than with regard to the tax consequences)." Id. 

Moreover, unlike long-term investments that may not 

initially turn a profit, but which have economic substance, the 

Trust transaction lacks any real economic risk. The Salem court 

pointed out that Barclays ran little risk of having to pay the Bx 

payment in absence of the anticipated U.K. tax benefits because 

the counterparty indemnified Barclays should that happen. Id. at 

943–44. The Bx payments were not truly independent of the expected 

U.K. tax effects. The counterparty's "ability to benefit 

economically from the Bx payments depended on Barclays'[s] receipt 

of its expected tax benefits, which in turn depended on the Trust's 

U.K. tax payments." Id. at 944. 

Here, too, Sovereign and Barclays "developed contractual 

remedies and took other steps to minimize the risk of [a divergence 

between actual effects and the pre-engineered outcome of the Bx 

payment's relationship to the U.K. taxes]." Unlike transactions 

that have survived an economic substance challenge, such as the 

sale-and-leaseback structure in Frank Lyon, 435 U.S. at 577, the 
- 24 - 

STARS Trust transaction posed no non-tax risks to Sovereign. 

Instead, Sovereign's internal discussions focused on the "risk" of 

being unable to claim foreign tax credits for the U.K. taxes on 

the Trust transaction, and it informed the Federal Deposit 

Insurance Corporation that it would "bear the United States tax 

risk" of the transaction. 

Further, we agree with the government that Sovereign's 

U.K. tax was artificially generated through a series of circular 

cash flows through the Trust and was the quid pro quo for the Bx 

payment. The assets in the Trust never effectively left 

Sovereign's control, nor did they perform any function when placed 

in the Trust that they could not without the Trust -- other than, 

of course, creating the tax effect that made possible the Bx 

payment. Indeed, when calculating the profit potential of the 

STARS transaction, Sovereign deducted the income from the Trust 

assets, as that income would have been earned without the Trust's 

existence. 

Resorting to the uncontroversial principle that the 

foreign tax credit regime was designed to avoid double taxation 

does not help Sovereign. If mere invocation of that principle 

were enough, every tax avoidance scheme would pass muster. After 

all: 

the fact that the transactions produced a net gain to 

the taxpayer after taking both the foreign taxes and the 

foreign tax credit into account says nothing about the 
- 25 - 

economic reality of the transactions, because all tax 

shelter transactions produce a gain for the taxpayer 

after the tax effects are taken into account -- that is 

why taxpayers are willing to enter into them and to pay 

substantial fees to the promoters. 

Salem, 786 F.3d at 948. 

Equally fundamental to the purpose of granting foreign 

tax credits is the related principle that those credits are 

extended only to legitimate business transactions. See H.R. Rep. 

No. 83-1337, at 4103 (1954) ("The [foreign tax credit] provision 

was originally designed to produce uniformity of tax burden among 

United States taxpayers, irrespective of whether they were engaged 

in business in the United States or engaged in business abroad." 

(emphasis added)). The Trust transaction provided no business for 

Sovereign. It furnished Barclays with a tax benefit, which 

Barclays in turn shared with Sovereign, effectively giving 

Sovereign a tax benefit of its own when combined with the 

anticipated foreign tax credits. The Trust transaction was not a 

legitimate business and lacked economic substance. 

III. 

We reverse the judgment of the district court as to the 

economic substance of the Trust transaction and the foreign tax 

credits claimed for the Trust transaction and remand for judgment 

to be entered for the United States on the refund claim and for a 

trial limited to the penalties issue. Costs are awarded to the 

appellant.