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February 11, 2013
Brattle Economists Contribute to Favorable Ruling for the United States Government in STARS Tax Dispute

Economic analysis by Brattle economist proved pivotal in a verdict for the United States government in a foreign tax credit dispute involving the Bank of New York (BNY). The United States Tax Court recently ruled that a foreign tax transaction between BNY and Barclays Bank lacked economic substance, and denied BNY related tax credits and deductions. The transaction, called a Structured Trust Advantage Repackaged Securities (STARS), involved a purportedly below market financing from Barclays to BNY. In order to secure that financing, BNY moved $6.5 billion worth of assets that had been subject to U.S. tax into a trust owned by BNY that was claimed to have been subject to U.K. taxes. STARS circulated that income to Barclays and then back to BNY. BNY claimed that it had paid those U.K. taxes, and that it was entitled to a foreign tax credit of its U.S. income tax liabilities. On behalf of the United States government, Brattle principal Michael Cragg testified on the economic substance of the transaction, and analyzed the pricing and economics of the loan component of the transaction. Dr. Cragg opined that BNY had not paid taxes on the income from the $6.5 billion in assets, and that the transaction lacked economic substance because it did not create an incremental opportunity for pre-tax economic profit. The Court agreed with Dr. Cragg’s testimony, saying that STARS was “an elaborate series of pre-arranged steps designed as a subterfuge for generating, monetizing and transferring the value of foreign tax credits among the STARS participants.” The Court further agreed with Dr. Cragg in finding that: the underlying cash flows were circular and had no non-tax economic effect; the income from the $6.5 billion in assets did not generate incremental benefits in the STARS transaction; the financing was not low cost; and the critical cash flow in STARS, the return of a portion of the tax benefits paid through Barclays to BNY was an after-tax cash flow, and should not be included as part of the pre-tax economics of the transaction to BNY. The court said that “Mr. Cragg concluded more generally that it would have been economically irrational for BNY to enter into [STARS] without the foreign tax credits BNY derived from it. Accordingly, we find that [STARS] lacks economic substance.” The Brattle team consisted of principals Evan Cohen, Darrell Chodorow, and Mark Sarro, associate Christine Polek, and research analysts David Hutchings and Minal Shankar. The team worked closely with the government in all phases of case and trial preparation, including developing expert testimony and providing consulting support for the attorneys in all phases of case development, including the 3-week trial this past April and May.