US Economic Substance Doctrine: Bank of N.Y. Mellon v. Commʹr; Am. Intʹl Grp., Inc. v. United States

By Robert Robillard - 23 September 2015

This blogpost originally appeared on

In Bank of N.Y. Mellon v. Commʹr; Am. Intʹl Grp., Inc. v. United States:

“Appeals and cross‐appeal heard in tandem from a judgment of the United States Tax Court (Kroupa, J.) and an opinion and order of the United States District Court for the Southern District of New York (Stanton, J.) applying the ʺeconomic substance doctrineʺ to transactions involving foreign tax credits. The Tax Court considered the effect of foreign taxes in its pre‐tax analysis and denied the claimed foreign tax credits as lacking economic substance, but allowed interest expense deductions for the loan associated with the transactions. The district court held that the economic substance doctrine applies to transactions involving foreign tax credits generally and that foreign taxes are to be included in calculating pre‐tax profit.        AFFIRMED.”

The conclusions of the Court are as follow:

“(1) We reject AIGʹs contention that foreign tax credits, by their nature, are not reviewable for economic substance.  The purpose of the ʺeconomic substanceʺ doctrine is to ensure that a taxpayerʹs use of a tax benefit complies with Congressʹs purpose in creating that benefit.  Accordingly, we hold that the ʺeconomic substanceʺ doctrine can be applied to disallow a claim for foreign tax credits.

(2) In determining whether a transaction lacks economic substance, we consider: (a) whether the taxpayer had an objectively reasonable expectation of profit, apart from tax benefits, from the transaction; and (b) whether the taxpayer had a subjective non‐tax business purpose in entering the transaction.  Gilman, 933 F.2d at 147‐48.  In our Circuit, we employ a ʺflexibleʺ  analysis where both prongs are factors to consider in the overall inquiry into a transaction’s economic substance.

(3) The focus of the objective inquiry is whether the transaction ʺoffers a reasonable opportunity for economic profit, that is, profit exclusive of tax benefits.ʺ  Gilman, 933 F.2d at 146 (internal quotation marks omitted).  We conclude, as a matter of first impression in this Circuit, that foreign taxes are economic costs and should thus be deducted when calculating pre‐tax profit.  We also conclude that it is appropriate, in calculating pre‐tax profit, for a court both to include the foreign taxes paid and to exclude the foreign tax credits claimed.   In so holding, we agree with the Federal Circuit in Salem and disagree with decisions of the Fifth and Eighth Circuits (Compaq and IES, respectively).

(4) Under the subjective prong, a court asks whether the taxpayer has a legitimate, non‐tax business purpose for entering into the transaction.

(5) As to AIGʹs transactions, we hold that there are unresolved material questions of fact regarding the objective factors ‐‐ i.e., the economic effects of the cross‐border transactions and the reasonableness of AIGʹs expectation of non‐tax benefits.  There are also material questions of fact regarding AIGʹs subjective business purpose for entering the cross‐border transactions.  Because a reasonable factfinder could resolve these questions in favor of the government and conclude therefrom that the cross‐border transactions lacked economic substance, the district court did not err in denying AIGʹs motion for partial summary judgment.

(6) As to BNYʹs transactions, we hold that the Tax Court correctly concluded that the STARS trust transaction lacked economic substance.  We also hold that the Tax Court did not err in concluding that the $1.5 billion loan from Barclays had independent economic substance, and that BNY was therefore entitled to deduct the associated interest expenses.  Accordingly, we affirm the Tax Courtʹs judgment in its entirety.”

Robert Robillard, Ph.D., CPA, CGA, Adm.A., MBA, M.Sc. Econ., M.A.P.
Senior Partner, RBRT Inc.
514-742-8086; robertrobillard “at”

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