  United States Court of Appeals
      for the Federal Circuit
                ______________________

SALEM FINANCIAL, INC., as Successor-in-Interest
         to Branch Investments LLC,
               Plaintiff-Appellant

                          v.

                  UNITED STATES,
                  Defendant-Appellee
                ______________________

                      2014-5027
                ______________________

    Appeal from the United States Court of Federal
Claims in No. 1:10-cv-00192-TCW, Judge Thomas C.
Wheeler.
               ______________________

                Decided: May 14, 2015
                ______________________

    RAJIV MADAN, Skadden, Arps, Slate, Meagher & Flom
LLP, Washington, DC, argued for plaintiff-appellant.
Also represented by CHRISTOPHER PAUL BOWERS, ROYCE
TIDWELL, CHRISTOPHER PATRICK MURPHY, NATHAN P.
WACKER; MATTHEW JAMES DOWD, SCOTT M. MCCALEB,
Wiley Rein, LLP, Washington, DC.

    JUDITH ANN HAGLEY, Tax Division, United States De-
partment of Justice, Washington, DC, argued for defend-
ant-appellee. Also represented by TAMARA W. ASHFORD,
GILBERT STEVEN ROTHENBERG, RICHARD FARBER.
2                                SALEM FINANCIAL, INC.   v. US



                  ______________________

    Before O’MALLEY, BRYSON, and HUGHES, Circuit Judges.
BRYSON, Circuit Judge.
     Salem Financial, Inc., a subsidiary of Branch Banking
& Trust Corporation (“BB&T”), challenges a final judg-
ment of the Court of Federal Claims denying BB&T’s
claim for a refund of taxes, interest, and penalties. We
affirm in part, reverse in part, and remand for further
proceedings.
                             I
                             A
    BB&T is a financial holding company chartered under
the laws of North Carolina. In 2002, BB&T entered into a
transaction with Barclays Bank PLC (“Barclays”), which
is headquartered in the United Kingdom. The transac-
tion, known as the Structured Trust Advantaged Repack-
aged Securities transaction (“STARS”), was in effect for
nearly five years, from August 1, 2002, through April 5,
2007.
    At issue in this case is the U.S. tax treatment of sev-
eral aspects of BB&T’s involvement in the STARS trans-
action. When the IRS reviewed BB&T’s tax treatment of
STARS, it disapproved various tax benefits that BB&T
had claimed based on the transaction. In particular, the
IRS disallowed foreign tax credits in the amount of
$498,161,951.00; it disallowed interest deductions in the
amount of $74,551,947.40; it imposed taxes on certain
payments from Barclays to BB&T in the amount of
$84,033,228.20; it disallowed certain transaction cost
deductions in the amount of $2,630,125.05; and it imposed
penalties in the amount of $112,766,901.80.
  STARS was principally developed by Barclays and
KPMG LLP, an international accounting firm. The
SALEM FINANCIAL, INC.   v. US                             3



original version of the STARS transaction was marketed
to non-bank businesses as a means of enhancing invest-
ment yield for large, cash-rich corporations located in the
United States by taking advantage of differences between
the tax systems in the United States and in the United
Kingdom. The central component of this early version of
STARS was a trust having a U.K. trustee and paying U.K.
taxes. The U.S. participant would then realize an eco-
nomic benefit by claiming foreign tax credits for the U.K.
taxes paid by the trust.
    In its original form, STARS failed to attract the non-
bank entities Barclays had targeted. Those entities
responded that the yield enhancement was not high
enough to justify the level of complexity and potential risk
in the transaction. With that feedback, Barclays com-
bined the original STARS structure with a loan compo-
nent in order to attract banks. Barclays and KPMG then
promoted the new version of STARS as a “low cost financ-
ing” program. The economic benefit to the U.S. partici-
pant arising from the foreign tax credits remained the
same, however, for both the early version and the later
version of STARS.
    In November 2001, Barclays representatives contact-
ed the head of BB&T’s Tax Department regarding the
prospect of entering into a STARS transaction. The
parties “discussed in some detail [BB&T’s] appetite to do
a [foreign tax credit] trade.” Shortly thereafter, BB&T
met with KPMG and Barclays. At the time of that meet-
ing, KPMG had participated in the implementation of
STARS transactions between Barclays and two other U.S.
banks, and BB&T was aware of that fact. It was proposed
that BB&T would form a U.K. trust with its U.S.-based
income-generating assets, and Barclays would provide a
large loan to BB&T. KPMG and Barclays represented
that BB&T would obtain foreign tax credits against its
U.S. tax obligations for the U.K. taxes paid by the trust
and also share in the tax benefits that Barclays would
4                               SALEM FINANCIAL, INC.   v. US



obtain from the U.K. based on its participation in the
transaction.
    The tax risks of STARS were apparent to BB&T from
the outset. Those risks included that BB&T might be
denied the full amount of the foreign tax credits on its
U.S. taxes and that Barclays might be unable to obtain
the expected tax benefits from the U.K. After a lengthy
negotiation regarding the allocation of the tax risks,
BB&T and Barclays reached an agreement and closed the
transaction on August 1, 2002.
    On KPMG’s recommendation, BB&T engaged Sidley,
Austin, Brown & Wood LLP (“Sidley”) as its tax advisor
on the STARS transaction. Sidley issued its tax opinion
on STARS in April 2003. In addition, BB&T tasked
accounting firm PricewaterhouseCoopers (“PwC”), its
outside auditor, with evaluating the tax reserve level of
STARS.
                            B
    STARS is a complex transaction consisting of many
components. The trial court conducted a thorough analy-
sis of the various structures and steps that made up
STARS. We summarize below the most salient aspects of
the transaction.
    STARS consisted of a trust component (“the Trust”)
and a loan component (“the Loan”). Although many
intermediary entities were created to implement STARS,
the real parties in interest at all times were BB&T and
Barclays. BB&T created the Trust, to which it contribut-
ed approximately $5.755 billion of U.S.-based income-
generating assets. The Loan consisted of a payment by
Barclays of $1.5 billion in cash to the Trust in return for
subscription to three classes of equity interests in the
Trust. The Trust, however, remained at all times under
BB&T’s control, and Barclays was contractually obligated
to sell its interests in the Trust back to BB&T for $1.5
SALEM FINANCIAL, INC.   v. US                            5



billion when the transaction terminated, so the effect of
that portion of the transaction was a $1.5 billion Loan
from Barclays to BB&T. The interest rate on the Loan
was set at a floating rate of approximately one-month
LIBOR plus 25 basis points. 1
    BB&T appointed a U.K. trustee for the Trust. The
trustee’s U.K. residence subjected the Trust’s income to
U.K. taxation. Pursuant to the STARS agreements,
BB&T would receive monthly distributions of the income
generated from the assets held by the Trust. After setting
aside an amount to pay the U.K. taxes and the manage-
ment fee, the Trust would remit the remaining funds to
BB&T. Before doing so, however, the Trust would tempo-
rarily place the distributions into the “Barclays Blocked
Account” at BB&T, which would then immediately return
those funds to the Trust. That circular movement of the
Trust distributions generated a substantial tax benefit for
Barclays by allowing it to claim a “trading loss deduction”
under U.K. law.
    BB&T had the Trust use its funds to pay the U.K. tax
on the Trust’s income. Barclays would then obtain U.K.
tax deductions and credits for almost all of the U.K. taxes
paid by the Trust based on Barclays’ nominal equity
interest in the Trust and the circulation of funds through
the Barclays Blocked Account.
    As part of the STARS transaction, Barclays would
make a monthly payment to BB&T, known as the “Bx
payment.” The Bx payment was set to be equal to 51
percent of the U.K. taxes paid by the Trust, which had
been paid by BB&T and which resulted in the tax benefits



   1    LIBOR, short for “Intercontinental Exchange
London Interbank Offered Rate,” is a benchmark rate
that some of the world’s leading banks charge each other
for short-term loans.
6                                SALEM FINANCIAL, INC.   v. US



obtained by Barclays. Each month, BB&T’s interest
obligation under the Loan and Barclays’ Bx payment
obligation to BB&T were netted against each other. From
September 2002 until mid-2005, Barclays, the lender,
made net monthly payments to BB&T, the borrower,
because the amount of Barclays’ Bx payment obligation
exceeded the amount of BB&T’s interest obligation.
    The following example illustrates the cash flows in
and out of the Trust based on $100 of Trust income (ignor-
ing fees). The Trust income was subject to U.K. taxation
at a 22 percent rate. Therefore, $22 for every $100 of
Trust income was set aside for payment of the U.K. taxes,
leaving the Trust with $78 after the U.K. tax payment.
Because of its nominal equity interest in the Trust, Bar-
clays was also taxed on the Trust income under U.K. law
at a corporate tax rate of 30 percent, or $30 for every $100
of Trust income. Barclays, however, was able to claim a
$22 U.K. tax credit for the $22 of tax paid by the Trust as
an “imputation credit” that partially offset the higher
corporate tax imposed on the Trust’s distributions. As a
result, Barclays effectively paid $8 in U.K. tax.
    The Trust distributed the after-tax amount of $78 of
Trust income to the Barclays Blocked Account, from
which that sum was immediately re-contributed to the
Trust. Under U.K. law, Barclays was able to treat the re-
contributed $78 as a “trading loss,” thereby claiming a
trading loss deduction. At the 30 percent tax rate, that
deduction was worth $23.40. Barclays’ $8 U.K. tax liabil-
ity was then completely offset by the $23.40 tax deduc-
tion, leaving Barclays with a net tax benefit of $15.40.
    In the example, the Bx payment that Barclays paid to
BB&T, which was predetermined to be equal to 51 per-
cent of the Trust’s U.K. tax payments, would be approxi-
mately $11. Barclays would then deduct the $11 Bx
payment from its U.K. corporate taxes, which at the 30
percent tax rate yielded another tax benefit worth $3.30.
SALEM FINANCIAL, INC.   v. US                            7



The net benefit to Barclays, for every $100 in Trust in-
come, was thus $7.70, based on U.K. tax credits and
deductions (the net tax benefit of $15.40 minus the Bx
payment of $11, plus the tax benefit of $3.30 attributable
to the deduction for the Bx payment).
     For its part, BB&T, having paid the $22 U.K. tax on
the Trust income, would claim a foreign tax credit of $22
for the entire amount of the Trust’s U.K. taxes. However,
having received the $11 Bx payment from Barclays,
BB&T would have a net gain of $11.
    The U.K. government effectively collected $3.30 in tax
for every $100 of Trust income, because the Trust paid
$22 in U.K. taxes while the U.K. government gave back
$18.70 in tax benefits to Barclays ($15.40 attributable to
the trading loss deduction plus $3.30 attributable to the
Bx payment deduction). Based on the structure of the
transaction and the amount of the income-generating
assets in the Trust, BB&T anticipated receiving approxi-
mately $44 million per year from the STARS Trust trans-
action in addition to the revenue generated by the assets
themselves.
     The capacity of the STARS Trust transaction to gen-
erate profits for Barclays and BB&T depended both on
Barclays’ obtaining the expected tax benefits from the
U.K. and on BB&T’s obtaining the expected foreign tax
credits from the U.S. Because of the risks associated with
obtaining those tax benefits, the parties incorporated
features into the Trust agreement that were designed to
minimize those risks. The agreement included a “make-
whole” provision under which BB&T was obligated to
reimburse Barclays if the credits generated by the Trust
failed to match the parties’ expectations. The parties also
agreed to an indemnity provision, which would be trig-
gered if the Trust paid no tax, either because it was not
treated as a collective investment scheme under U.K. law
or because it was not deemed a U.K. resident. BB&T’s
8                                 SALEM FINANCIAL, INC.   v. US



indemnity payment to Barclays would be approximately
one-half of the U.K. tax that the Trust would have paid.
Finally, both parties were entitled to terminate the
STARS transaction for any reason, subject to 30 days’
notice.
    On March 30, 2007, the IRS published proposed regu-
lations entitled “Regulations on Transactions Designed to
Artificially Generate Foreign Tax Credits,” 72 Fed. Reg.
15081 (proposed Mar. 30, 2007). The comments accompa-
nying the proposed regulations noted that “certain U.S.
taxpayers are engaging in highly structured transactions
with foreign counterparties in order to generate foreign
tax credits,” id. at 15081, and explained that the regula-
tions were intended to prohibit the use of “highly engi-
neered transactions where the U.S. taxpayer benefits by
intentionally subjecting itself to foreign tax,” id. at 15084.
Under the regulations, “an amount paid to a foreign
country in connection with such an arrangement is not an
amount of tax paid,” and as a consequence, “a taxpayer
would not be eligible to claim a foreign tax credit for such
a payment.” Id. The notice of the proposed regulation
stated that the IRS would analyze STARS transactions
entered into before the effective date of the final regula-
tion under anti-abuse doctrines, including the economic
substance doctrine. 72 Fed. Reg. 15084 (Mar. 7, 2007).
Six days after the issuance of the proposed regulations,
BB&T terminated the STARS transaction pursuant to its
at-will termination right.
                              C
    BB&T filed corporate income tax returns for the tax
years when it was participating in the STARS transac-
tion. In its returns, BB&T claimed foreign tax credits for
the Trust’s U.K. tax payments and interest deductions for
interest it had paid on the Loan. The IRS denied both
claims and imposed accuracy-related penalties on BB&T.
SALEM FINANCIAL, INC.   v. US                           9



    BB&T filed suit in the Court of Federal Claims, seek-
ing a tax refund for the items listed above. Following a
lengthy trial, the court denied BB&T’s refund request in
its entirety. Salem Fin., Inc. v. United States, 112 Fed.
Cl. 543 (2013). Applying the “economic substance” doc-
trine, the court concluded that the STARS Trust was an
economic sham lacking both objective economic reality
and a bona fide non-tax business purpose. The court
therefore held that the tax consequences of the STARS
transactions had to be disregarded.
    The court ruled that the Trust component, “where
BB&T revenue momentarily is cycled through a U.K.
trustee to create U.K. taxes and foreign tax credits, and
then is returned to BB&T, quite clearly is an abusive tax
avoidance scheme.” 112 Fed. Cl. at 549. The court ex-
plained that the Trust “creates a series of instantaneous
circular cash flows starting and ending with BB&T where
no economic activity has occurred abroad to justify the
assessment of a U.K. tax. While inarguably sophisticated
and creative, the trust purely and simply is a sham trans-
action accomplishing nothing more than a redirection of
cash flows that should have gone to the U.S. Treasury,
but instead are shared among BB&T, Barclays, and the
U.K. Treasury.” Id.
    The court also denied BB&T’s claim for interest de-
ductions on the Loan component of the STARS transac-
tion, based on a finding that the STARS Loan, too, was an
economic sham. The court reasoned that the Loan was
not structured to make a profit, but instead was devised
merely to provide BB&T with a purported business pur-
pose for engaging in the STARS transaction. 112 Fed. Cl.
at 587.
    The court also examined the Trust and the Loan as
part of a single integrated transaction under the economic
substance doctrine. It concluded that, viewed as an
integrated transaction, the components of the STARS
10                               SALEM FINANCIAL, INC.   v. US



transaction still lacked economic substance. 112 Fed. Cl.
at 588-89.
    Finally, the court upheld the accuracy-related penal-
ties assessed by the IRS. The court found that it was
unreasonable for BB&T to rely on tax opinions from
KPMG and Sidley, as well as the additional advice from
PwC. The court thus concluded that the tax opinions
were ineffective to create a reasonable justification for
BB&T’s understatements of its tax liability and that the
imposition of penalties was proper. 112 Fed. Cl. at 589-
94. This appeal ensued. 2
                            II
    The characterization of a transaction for tax purposes
is a question of law that is subject to de novo review,
while the underlying facts are reviewable for clear error.
Frank Lyon Co. v. United States, 435 U.S. 561, 581 n.16
(1978). For purposes of this appeal, BB&T “accepts the
trial court’s holding that the Trust Transaction and the
Loan may be bifurcated.” Appellant’s Br. 18. That is,
both sides treat the tax consequences of the Trust and
Loan transactions separately, rather than considering



     2   Besides the Court of Federal Claims in this case,
the Tax Court in Bank of N.Y. Mellon Corp. v. Comm’r,
140 T.C. 15, 42 (2013), has held that another STARS
Trust transaction lacks substance, and a preliminary
ruling in a district court case involving another STARS
transaction has rejected the taxpayer’s motion for sum-
mary judgment on the business purpose issue. Wells
Fargo & Co. v. United States, Civil No. 09-cv-2764, 2014
WL 4070782, at *26-31 (D. Minn. July 22, 2014) (report of
special master). One district court has ruled that the
STARS transaction in the case before it did not violate the
economic substance doctrine. Santander Holdings USA,
Inc. v. United States, 977 F. Supp. 2d 46 (D. Mass. 2013).
SALEM FINANCIAL, INC.   v. US                              11



them as a single integrated transaction. We accordingly
take the same approach and start with the Trust.
                                A
    The characterization of the Bx payment is important
to the resolution of this case. The government argues
that the Bx payment is in substance a rebate of the U.K.
taxes that BB&T paid on behalf of the Trust. BB&T
contends that under the Internal Revenue Code and the
Treasury Regulations, the Bx payment must be treated as
income to BB&T and not as a tax rebate.
   Section 901(i) of the Code provides that payments
made to a foreign country that result in a subsidy or
rebate to the taxpayer from that country are not credita-
ble taxes. See 26 U.S.C. § 901(i)(1)-(2). Under section
901(i),
   Any income, war profits, or excess profits tax shall
   not be treated as a tax for purposes of this title to
   the extent – (1) the amount of such tax is used (di-
   rectly or indirectly) by the country imposing such
   tax to provide a subsidy by any means to the tax-
   payer, a related person (within the meaning of
   section 482), or any party to the transaction or to
   a related transaction, and (2) such subsidy is de-
   termined (directly or indirectly) by reference to
   the amount of such tax, or the base used to com-
   pute the amount of such tax.
Id. The pertinent Treasury Regulation provides:
   (i) General rule. An amount of foreign income
   tax is not an amount of income tax paid or accrued
   by a taxpayer to a foreign country to the extent
   that—
   (A) The amount is used, directly or indirectly, by
   the foreign country imposing the tax to provide a
   subsidy by any means (including, but not limited
12                                SALEM FINANCIAL, INC.   v. US



     to, a rebate, a refund, a credit, a deduction, a
     payment, a discharge of an obligation, or any oth-
     er method) to the taxpayer, to a related person
     (within the meaning of section 482), to any party
     to the transaction, or to any party to a related
     transaction; and
     (B) The subsidy is determined, directly or indirect-
     ly, by reference to the amount of the tax or by ref-
     erence to the base used to compute the amount of
     the tax.
     (ii) Subsidy. The term “subsidy” includes any
     benefit conferred, directly or indirectly, by a for-
     eign country to one of the parties enumerated in
     paragraph (e)(3)(i)(A) of this section. Substance
     and not form shall govern in determining whether
     a subsidy exists. The fact that the U.S. taxpayer
     may derive no demonstrable benefit from the sub-
     sidy is irrelevant in determining whether a subsi-
     dy exists.
26 C.F.R. § 1.901-2(e)(3). The government concedes that
BB&T received no tax rebate under the literal terms of
section 901(i) and the regulation.
    Seizing upon the government’s concession, BB&T con-
tends that the inquiry regarding the proper characteriza-
tion of the Bx payment should stop with the literal terms
of the Code and regulations. Because the Treasury regu-
lation provides that “substance and not form” determines
whether a particular payment is a tax rebate, 26 C.F.R.
§ 1.901-2(e)(3), BB&T argues that the government’s
concession that BB&T literally complied with section
901(i) means that BB&T in substance received no tax
rebate and thus that BB&T received no tax rebate for
purposes of the economic substance doctrine.
   We disagree that the existence of the “substance-over-
form” provision in the Treasury regulation precludes
SALEM FINANCIAL, INC.   v. US                           13



analysis under the economic substance doctrine. In Coltec
v. United States, 454 F.3d 1340 (Fed. Cir. 2006), we
concurred with the Third Circuit and the Eleventh Circuit
that “economic substance is a prerequisite to the applica-
tion of any Code provision allowing deductions.” Id. at
1356 (citing In re CM Holdings, Inc., 301 F.3d 96, 102 (3d
Cir. 2002), and Kirchman v. Comm’r, 862 F.2d 1486, 1491
(11th Cir. 1989)). We analyzed the transaction at issue in
Coltec under both the statutory “anti-abuse” provision,
which required an inquiry into the substance of the
transaction, and “the general economic substance doc-
trine.” See id. at 1350-52. The economic substance doc-
trine thus applies even to a transaction that is governed
by a statute or regulation that itself contains a “sub-
stance-over-form” provision.
    While courts may perform a concurrent substance
analysis under both the specific provisions of the Internal
Revenue Code and the economic substance doctrine, see
Glass v. Comm’r, 87 T.C. 1087 (1986); DeMartino v.
Comm’r, 862 F.2d 400 (2d Cir. 1988), the analysis under
the two is not always the same. For example, BB&T
offers several reasons why the Bx payment should not be
deemed a tax rebate under section 901(i). Those reasons
include that neither the Bx payment nor Barclays’ trading
loss deduction was tied to any payment of taxes, and that
Barclays’ credit for the U.K. taxes paid by the Trust was
an “imputation credit” and thus was not an indirect tax
rebate.
   Those arguments are highly technical in nature and do
not address the broader inquiry under the economic
substance doctrine: whether the Trust transactions lack
economic reality, whether they lack a bona fide business
purpose, and whether they are not the kinds of transac-
tions on which Congress intended to confer the benefit of
the foreign tax credit provision. See Stobie Creek Invs.
LLC v. United States, 608 F.3d 1366, 1375 (Fed. Cir.
2010) (to distinguish between a real transaction and a
14                               SALEM FINANCIAL, INC.   v. US



sham transaction under the economic substance doctrine,
the court examines the economic reality and business
purpose of the transaction); Coltec, 454 F.3d at 1353 (“The
economic substance doctrine represents a judicial effort to
enforce the statutory purpose of the tax code.”).
    BB&T’s argument that the inquiry begins and ends
with the Code and regulations, if accepted, would largely
eviscerate the common-law economic substance doctrine.
Challenges to assertedly abusive tax shelters have fre-
quently involved transactions devised to comply with the
letter of governing statutes and regulations. As the D.C.
Circuit observed, “[a] tax system of rather high rates gives
a multitude of clever individuals in the private sector
powerful incentives to game the system. Even the smart-
est drafters of legislation and regulation cannot be ex-
pected to anticipate every device.” ASA Investerings
P’ship v. Comm’r, 201 F.3d 505, 512 (D.C. Cir. 2000).
Under the traditional economic substance doctrine, the
issue in such cases is whether the transactions are con-
trivances that are inconsistent with the purposes served
by the Code provisions and should therefore be disregard-
ed. See, e.g., Gregory v. Helvering, 293 U.S. 465, 469-70
(1935). Accordingly, the government’s concession that
BB&T complied with the literal terms of section 901(i)—
although relevant to our consideration of the objective
nature of the transaction—does not bar the government
from arguing that the STARS transaction is an economic
sham. 3



     3  BB&T also argues that our precedent precludes
any further inquiry, beyond section 901(i), into whether
there was an “in substance” rebate of U.K. taxes in the
STARS transaction. BB&T relies on a group of cases
known as the Mexican Railroad Car Cases, which were
decided before the enactment of section 901(i). In those
cases, our predecessor court held that, for purposes of
SALEM FINANCIAL, INC.   v. US                            15



                                B
     We now turn to the government’s arguments under
the economic substance doctrine. “The economic sub-
stance doctrine seeks to distinguish between structuring a
real transaction in a particular way to obtain a tax bene-
fit, which is legitimate, and creating a transaction to
generate a tax benefit, which is illegitimate.” Stobie
Creek, 608 F.3d at 1375. “Under this doctrine, we disre-
gard the tax consequences of transactions that comply
with the literal terms of the tax code, but nonetheless lack
economic reality.” Id. We have also held that transac-
tions must be disregarded if they are “shaped solely by
tax-avoidance features,” i.e., if they have no bona fide
business purpose. Id.; see also Coltec, 454 F.3d at 1355.
     Ultimately, we have treated the economic substance
doctrine as a means to “prevent taxpayers from subvert-
ing the legislative purpose of the tax code” by engaging in
fictitious transactions with no economic purpose other
than the possibility of reaping a tax benefit. Coltec, 454
F.3d at 1353; see Klamath Strategic Inv. Fund ex rel. St.
Croix Ventures v. United States, 568 F.3d 537, 543 (5th
Cir. 2009) (“The economic substance doctrine allows
courts to enforce the legislative purpose of the [Tax] Code
by preventing taxpayers from reaping tax benefits from




determining the amount of creditable foreign taxes, it was
irrelevant that the foreign government later gave a tax
rebate to the taxpayer’s foreign counterparty. See Chica-
go, Burlington & Quincy R.R. Co. v. United States, 455
F.2d 993, 1022-23 (Ct. Cl. 1972), rev’d on other grounds,
412 U.S. 401 (1973); see also Bankers Trust N.Y. Corp. v.
United States, 225 F.3d 1368 (Fed. Cir. 2000). The Mexi-
can Railroad Car Cases and Bankers Trust are inapposite
here, because neither addresses the applicability of the
economic substance doctrine.
16                               SALEM FINANCIAL, INC.   v. US



transactions lacking in economic reality.”). 4 In assessing
a transaction’s economic substance, “all courts have
looked to the objective reality of the transaction.” Coltec,
454 F.3d at 1356.
    We start by examining the “economic reality” of the
STARS Trust transaction. This inquiry is conducted
based on objective evidence, rather than on the taxpayer’s
subjective motivation. Stobie Creek, 608 F.3d at 1375;
Coltec, 454 F.3d at 1356. The “economic reality” inquiry
asks whether a particular transaction or set of transac-
tions meaningfully altered the taxpayer’s economic posi-
tion, apart from their tax consequences. That inquiry
often focuses on whether the taxpayer had a “reasonable
possibility of making a profit from the transaction.”
Stobie Creek, 608 F.3d at 1376-77.
    BB&T asserts that it realized income from the Trust
transaction in the form of the monthly Bx payments. The
IRS initially took the same position and treated the Bx


     4  In 2010, Congress codified the economic substance
doctrine in 26 U.S.C. § 7701(o). That statute provided
that a transaction shall be treated as having economic
substance only if “the transaction changes in a meaning-
ful way (apart from Federal income tax effects) the tax-
payer’s economic position” and “the taxpayer has a
substantial purpose (apart from Federal income tax
effects) for entering into such transaction.”           Id.
§ 7701(o)(1). The statute was made applicable only to
transactions initiated after 2010, and it is therefore
inapplicable to this case; however, our decisions applying
the economic substance doctrine are consistent with the
definition Congress adopted in the 2010 legislation, and
since Congress in that legislation expressed its intention
to codify the existing judge-made rules, our application of
those pre-statutory rules is consistent with Congress’s
endorsement of that approach in 2010.
SALEM FINANCIAL, INC.   v. US                          17



payments as part of BB&T’s gross income. The govern-
ment has since abandoned that position. It now argues
that the Bx payments should be excluded from BB&T’s
gross income because they are “in substance” rebates of
the U.K. tax that was paid by BB&T from the assets
BB&T contributed to the Trust.
    The government treats the Bx payments as tax re-
bates based on the theory that the payments derived from
Barclays’ U.K. tax credits, which in turn derived from the
Trust’s U.K. tax payment. BB&T contends that the Bx
payments should not be characterized as a tax rebate,
because they were independent of Barclays’ actual receipt
of any U.K. tax benefits; Barclays was obligated to make
the Bx payments regardless of whether it received the
expected U.K. tax credits. BB&T further argues that the
Bx payments should be treated as income pursuant to the
Supreme Court’s decision in Old Colony Trust Co. v.
Commissioner, 279 U.S. 716 (1929).
    We are not persuaded by BB&T’s first argument, be-
cause the Bx payments were not truly independent of
Barclays’ U.K. tax benefits. It is true that the amount of
the payments was fixed in the transaction documents and
was not conditioned on Barclays’ actual receipt of any tax
benefits. However, the transaction documents provided
that an indemnity provision would be triggered if Bar-
clays were unable to claim the expected U.K. tax credits,
either because the Trust paid no tax or because the U.K.
authority refused to recognize the Trust as a U.K. resi-
dent for tax purposes. BB&T would then be obligated to
indemnify Barclays for approximately one half of the U.K.
tax that the Trust paid, which was roughly equal to the
Bx payments. The effect of the indemnity provision was
that if Barclays were unable to recover its expected U.K.
tax benefits, BB&T would have to return an amount
approximately equal to the Bx payments to Barclays.
Therefore, the Bx payments were not independent of
Barclays’ expected U.K. tax benefits at all. BB&T’s
18                               SALEM FINANCIAL, INC.   v. US



ability to benefit economically from the Bx payments
depended on Barclays’ receipt of its expected tax benefits,
which in turn depended on the Trust’s U.K. tax payments.
    BB&T’s second argument—that the Bx payments
should be treated as income under Old Colony and its
progeny—has more force. In Old Colony, a taxpayer’s
employer agreed to pay all income taxes imposed on
salary payments to the taxpayer. Old Colony, 279 U.S. at
721. The Supreme Court held that the income tax pay-
ments made by the employer constituted additional
income to the taxpayer (and therefore were not tax ef-
fects), even though those payments were made directly to
the government. That was because, like the taxpayer’s
salary, the income taxes were paid “upon a valuable
consideration, namely, the services rendered by the
employee and as part of the compensation therefor.” Id.
at 729. “The discharge by a third person of an obligation
to [the taxpayer] is equivalent to receipt by the person
taxed.” Id.; see also Diedrich v. Comm’r, 457 U.S. 191,
197-98 (1982) (“[T]he donor realizes an immediate eco-
nomic benefit by the donee’s assumption of the donor’s
legal obligation to pay the gift tax . . . . [T]he economic
benefit to the donors in the discharge of the gift tax
liability is indistinguishable from the benefit arising from
discharge of a preexisting obligation.”).
    Other courts have followed Old Colony in assessing a
taxpayer’s foreign income and tax liability. For example,
in Compaq Computer Corp. & Subsidiaries v. Commis-
sioner, 277 F.3d 778 (5th Cir. 2001), the Fifth Circuit held
that the payment of Compaq’s Netherlands tax obligation
by Compaq’s Netherlands counterparty was income to
Compaq. The Eighth Circuit followed the same approach
in IES Industries, Inc. v. United States, 253 F.3d 350 (8th
Cir. 2001).
   The government does not appear to dispute that, if
Barclays had paid half of the Trust’s U.K. tax on BB&T’s
SALEM FINANCIAL, INC.   v. US                          19



behalf, that direct tax payment would have constituted
income to BB&T under Old Colony. The government
argues, however, that the Old Colony principle is inappli-
cable in this case because Barclays did not pay BB&T’s
U.K. tax directly; rather, it reimbursed BB&T for half of
its U.K. tax expense through the Bx payment.
    That is a distinction without a difference. The Su-
preme Court held in Old Colony that a third party’s
assumption of a taxpayer’s tax liability constituted in-
come to the taxpayer because the tax payments had been
made in consideration of services rendered by the taxpay-
er, and the taxpayer had realized an economic benefit
from the payments. Old Colony, 270 U.S. at 729. That
principle is not limited to a situation in which a third
party paid the taxpayer’s taxes directly to the govern-
ment. Rather, that rationale applies equally if the third
party instead reimbursed all or part of the taxpayer’s tax
expenses in exchange for services rendered.
    In Reading & Bates Corp. v. United States, 40 Fed. Cl.
737 (1998), the Court of Federal Claims held that a tax-
payer realized income when its Egyptian counterparty
contractually assumed the taxpayer’s Egyptian tax liabil-
ity pursuant to a tax indemnification provision in their
contract. The court recognized that if the contract had
provided for the counterparty to reimburse the taxpayer’s
Egyptian tax expenses, instead of assuming the taxpay-
er’s Egyptian tax liability, the change would not have
affected the characterization of the reimbursements as
income to the taxpayer; it would have affected only the
date the taxpayer would be deemed to have received the
income. Id. at 750 n.8.
    Like the taxpayer in Old Colony, BB&T realized an
immediate economic benefit by receiving the Bx payments
from Barclays, which payments effectively repaid half of
BB&T’s U.K. tax expenses. The payments were made in
consideration of BB&T’s services rendered under the
20                              SALEM FINANCIAL, INC.   v. US



STARS transaction, including BB&T’s acts of creating the
STARS Trust and subjecting its U.S.-based assets to U.K.
taxation. Under the principle of Old Colony, the reim-
bursements that BB&T received from Barclays must
therefore be treated as income to BB&T, not tax effects.
     The government nonetheless contends that the specif-
ic circumstances of this case justify treating the Bx pay-
ments as tax rebates. It argues first that the Bx
payments are tax rebates because they were designed as
such. The government points out that, in assessing the
U.S. tax risk of the STARS transaction, BB&T itself
referred to the Bx payments as a “Rebate from Barclays.”
KPMG represented to BB&T that the STARS transaction
would provide a “rate reduction of 50% of [the Trust’s] UK
tax.” Barclays likewise stated that the “benefit under
STARS arises from the ability of both parties [i.e., Bar-
clays and BB&T] to obtain credits for the taxes paid in the
trust.”
    We do not view this evidence as dispositive for pur-
poses of characterizing the Bx payments. We emphasized
in Coltec that the economic reality of a transaction must
be viewed objectively rather than subjectively. See Coltec,
454 F.3d at 1356. The contracting parties’ own subjective
view of the transaction may be pertinent to the existence
of a tax avoidance purpose; however, “all courts have
looked to the objective reality of the transaction in as-
sessing its economic substance.” Id. Furthermore, the
government’s evidence at best establishes that the Bx
payments were designed as a way for Barclays to reim-
burse BB&T for 50 percent of its U.K. tax expenses. It
does not explain why, contrary to the Old Colony princi-
ple, Barclays’ reimbursement of BB&T’s tax expense must
be deemed to be a tax effect rather than income.
   The government next argues that the Bx payment
must be treated as a tax rebate because the payment,
which was calculated by reference to the Trust’s U.K.
SALEM FINANCIAL, INC.   v. US                            21



taxes, was the product of “tax collusion” between BB&T
and Barclays; that is, the two entities used the U.K.
government as a “conduit” to cycle BB&T’s tax payments
to Barclays through Barclays’ U.K. tax credit, after which
Barclays returned 51 percent of the taxes to BB&T and
kept the rest as its fee. The government paints a simple
picture: that money merely changed hands from BB&T to
the U.K. government, then to Barclays, and finally back
to BB&T. The reality, however, is not that simple.
    Barclays was willing to make the payment to BB&T
because BB&T’s participation in the STARS transaction
enabled Barclays to realize substantial tax benefits under
U.K. law. For every $100 of Trust income, Barclays (1)
paid $30 in corporate income tax; (2) claimed a $22 tax
credit for taxes already paid by the Trust; (3) claimed a
trading loss deduction worth $23.40 for the cash it re-
contributed to the Trust; and (4) claimed a deduction for
the Bx payments that was worth $3.30. Those payments,
credits, and deductions gave Barclays a net total of $18.70
in U.K. tax benefits, out of which Barclays paid $11.00 to
BB&T in the form of the Bx payment.
    It is not at all clear that the Bx payments were the re-
sult of “cycling” BB&T’s U.K. tax payments through the
U.K. government and Barclays. The Bx payments were
paid out of Barclays’ net U.K. tax benefits, which consist-
ed of items clearly linked to BB&T’s U.K. taxes (such as
the $22 tax credit), as well as items unrelated to BB&T’s
U.K. tax payments (such as the trading loss deduction
worth $23.40). Thus, the Bx payments could just as well
be said to have been derived from the portion of Barclays’
tax benefits that was independent of BB&T’s U.K. tax
payments, such as the trading loss deduction, as from
BB&T’s U.K. tax payments. The government’s own
expert agreed that the real benefit of STARS was the
trading loss deduction. It is thus impossible to identify
the exact source of the Bx payments, much less to link the
Bx payments directly to BB&T’s payments of U.K. taxes.
22                               SALEM FINANCIAL, INC.   v. US



    That the Bx payments were calculated by reference to
BB&T’s U.K. taxes is insufficient to convince us other-
wise. Contracting parties are free to structure their
transactions based on any payment formula, including
calculating a payment by reference to a party’s tax liabil-
ity. See, e.g., Reading, 40 Fed. Cl. at 738-39 (pursuant to
a drilling contract, a foreign counterparty to the U.S.
taxpayer agreed to assume the taxpayer’s entire foreign
tax liability); Doyon Ltd. v. United States, 37 Fed. Cl. 10,
13 (1996), rev’d on other grounds, 214 F.3d 1309 (Fed. Cir.
2000) (taxpayer contracted to sell its net operating losses
and investment tax credits to unrelated corporations that
sought to shelter some of their income from tax liability).
Such a tax-based payment formula does not convert
income into a tax effect.
     We are aware of no authority, and the government
has provided none, in which courts have treated private
payments as tax effects rather than income simply be-
cause the amount of the payments was calculated based
on a tax-based formula. The government’s position in this
regard cannot be squared with prior judicial decisions
that have held that even when an unrelated party has
paid 100 percent of a taxpayer’s taxes, that payment must
still be considered income to the taxpayer. See Old Colo-
ny, 279 U.S. at 729; Compaq, 277 F.3d at 784; IES, 253
F.3d at 354; Reading, 40 Fed. Cl. at 750.
    We therefore conclude that the Bx payments should
not be characterized as tax effects. Pursuant to Old
Colony and its progeny, the Bx payments are income to
BB&T.
                             C
    The government next argues that even if the Bx pay-
ments are treated as income to BB&T, BB&T realized no
profit from the Trust transaction absent the foreign tax
credit because the Bx payments must be offset against the
Trust’s U.K. taxes that were paid by BB&T. The govern-
SALEM FINANCIAL, INC.   v. US                             23



ment argues that, for every $100 of income from the Trust
assets, even if BB&T were credited with $11 income in
the form of the Bx payment, that $11 would have to be
offset against BB&T’s $22 U.K. tax expense, which would
yield a loss of $11. According to the government, the
Trust transaction produced a net loss and therefore
lacked economic substance. 5
    BB&T contends that the government is wrong in seek-
ing to have the Trust’s U.K. taxes treated as an item of
expense. BB&T relies on Compaq and IES, two cases
with almost identical fact patterns, in which the Fifth and
Eighth Circuits rejected a similar argument. See Com-
paq, 277 F.3d at 785; IES, 253 F.3d at 354. In Compaq,
the taxpayer (Compaq) engaged in a foreign transaction
involving the purchase and immediate resale of certain
publicly traded securities that represented shares of a
foreign corporation held in trust by a U.S. bank. The
settlement dates for the purchase and sale were arranged
so that the securities were purchased cum dividend and
sold ex dividend. The purchase and sale transaction thus
generated a gross dividend for Compaq, which was subject
to a foreign withholding tax. In addition, because the
post-dividend sale price of the securities was lower than
the purchase price (by the amount of the dividend, net of
the foreign withholding tax), Compaq claimed a capital
loss on its U.S. taxes for the transaction. It also claimed a
foreign tax credit for the foreign taxes paid on the gross
dividend. As a result, the purchase and sale transaction



    5   BB&T contends that we should not address this
argument because it is raised for the first time on appeal.
The record shows, however, that the trial court treated
BB&T’s U.K. taxes as its “out-of-pocket” cost in assessing
the profit from the STARS transaction. Because the trial
court addressed this issue, the government’s argument is
properly before us.
24                                SALEM FINANCIAL, INC.   v. US



produced a net gain for Compaq after all taxes were taken
into consideration. See Compaq, 277 F.3d at 782.
     The Tax Court found that the transaction lacked eco-
nomic substance because it was in essence a circular
transaction entailing no risk and no prospect for gain
other than as a result of the various domestic and foreign
tax consequences. Compaq Computer Corp. v. Comm’r,
113 T.C. 214 (1999). In short, it was a classic case of
cross-border tax arbitrage, and not the kind of transaction
that, in the Tax Court’s view, Congress intended to bene-
fit through the foreign tax credit statute. Id. at 225 (“The
foreign tax credit serves to prevent double taxation and to
facilitate international business transactions. No bona
fide business is implicated here, and we are not persuad-
ed that Congress intended to encourage or permit a
transaction such as the [Compaq securities] transaction,
which is merely a manipulation of the foreign tax credit to
achieve U.S. tax savings.”).
    The Fifth Circuit reversed. The court held that the
gross dividend, rather than the dividend net of the foreign
tax, should have been used to compute Compaq’s pre-tax
profit. See Compaq, 277 F.3d at 784. In addition, the
court faulted the Tax Court for failing to include Com-
paq’s foreign tax credits in assessing the after-tax profit of
the entire transaction. See id. at 785. The Fifth Circuit
reasoned that “[i]f the effects of tax law, domestic or
foreign, are to be accounted for when they subtract from a
transaction’s net cash flow, tax law effects should be
counted when they add to cash flow.” Id. “To be con-
sistent, the analysis should either count all tax law effects
[both foreign tax credits and foreign tax expenses] or not
count any of them.” Id.; see also IES, 253 F.3d at 354
(taking the latter approach and treating the gross divi-
dend, not the net dividend, as the economic benefit to the
taxpayer).
SALEM FINANCIAL, INC.   v. US                             25



    The transactions at issue in Compaq and IES in-
volved an almost simultaneous purchase and sale of the
securities in question; the purchase price was greater
than the sale price by the amount of the dividend received
by the taxpayer after foreign taxes on the dividend. The
transactions therefore did not meaningfully alter the
taxpayers’ economic position (apart from their tax conse-
quences); they involved essentially no risk (other than the
risk that the transactions would be disallowed for tax
purposes); and they offered no opportunity for economic
gain (except for the tax benefits). Because of the fees paid
in connection with the transactions, the consequence of
the transactions, but for the foreign tax credits, would
have been a certain loss. Thus, the transactions relied for
their profitability entirely on the availability of a U.S.
foreign tax credit for the taxes paid to the foreign gov-
ernment.
    The Compaq and IES transactions produced no real
economic profit. The taxpayer incurred a loss from the
sale of the securities in the amount of the dividend, net of
the foreign tax. Any apparent profit from the transac-
tions was the result of offsetting that loss by the amount
of the dividend, without taking into account the foreign
taxes paid on the dividend. And the fact that the transac-
tions produced a net gain to the taxpayer after taking
both the foreign taxes and the foreign tax credit into
account says nothing about the 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. 6 The



   6    Academic commentators, sometimes         referring to
the transactions at issue in those cases as a   form of “for-
eign tax arbitrage,” have argued that the       transactions
should have been disregarded as lacking         in economic
26                              SALEM FINANCIAL, INC.   v. US



critical question is not whether the transaction would
produce a net gain after all tax effects are taken into
consideration; instead, the pertinent questions are wheth-
er the transaction has real economic effects apart from its
tax effects, whether the transaction was motivated only
by tax considerations, and whether the transaction is the
sort that Congress intended to be the beneficiary of the
foreign tax credit provision.
    Our precedent, like that of several other courts, sup-
ports the government’s approach, i.e., to assess a transac-
tion’s economic reality, and in particular its profit
potential, independent of the expected tax benefits. For
example, in Rothschild v. United States, 407 F.2d 404 (Ct.
Cl. 1969), our predecessor court examined the economic
reality of a transaction by asking whether there was “a



substance. See Bryan Camp, Form Over Substance in
Fifth Circuit Tax Cases, 34 Tex. Tech. L. Rev. 733, 752-53
(2003); Mitchell Kane, Compaq and IES: Putting the Tax
Back in After-Tax Income, 94 Tax Notes 1215, 1217 (Mar.
4, 2002); Michael S. Knoll, Compaq Redux: Implicit Taxes
and the Question of Pre-Tax Profit, 26 Va. Tax Rev. 821,
840 (2007); Michael J. McIntyre, A Vote in the Compaq
Debate, 94 Tax Notes 1716 (Mar. 25, 2002); Daniel N.
Shaviro and David A. Weisbach, The Fifth Circuit Gets It
Wrong in Compaq v. Commissioner, 94 Tax Notes 511
(Jan. 28, 2002); George K. Yin, The Problem of Corporate
Tax Shelters: Uncertain Dimensions, Unwise Approaches,
55 Tax L. Rev. 405, 407-13 (2002). Professors Klein and
Stark argue that the Compaq transaction was not really
tax arbitrage, but instead was a form of economic arbi-
trage. Nonetheless, they agree that the absence of risk in
the Compaq transaction “may well be an adequate reason
for ignoring the transaction entirely.” William A. Klein &
Kirk J. Stark, Compaq v. Commissioner—Where is the
Tax Arbitrage?, 94 Tax Notes 1335, 1338 (Mar. 11, 2002).
SALEM FINANCIAL, INC.   v. US                                27



possibility [or] an opportunity of profit to the taxpayer
separate and apart from the tax [benefits].” Id. at 412; see
also IES, 253 F.3d at 354 (under the objective economic
substance test, the court “will first consider whether there
was a reasonable possibility of profit . . . apart from tax
benefits”); Rice’s Toyota World, Inc. v. Comm’r, 752 F.2d
89, 94 (4th Cir. 1985) (“The second prong of the sham
inquiry, the economic substance inquiry, requires an
objective determination of whether a reasonable possibil-
ity of profit from the transaction existed apart from tax
benefits.”). In this case, BB&T incurred a large foreign
tax expense ($22 for every $100 of Trust income) only to
obtain a smaller income (the $11 Bx payment for every
$100 of Trust income). The Trust transaction therefore is
profitless before taking into account BB&T’s expected
foreign tax credits.
    With that said, however, we disagree with the gov-
ernment’s contention that a transaction’s lack of potential
for profit before taking U.S. tax benefits into account
conclusively establishes that the transaction lacks eco-
nomic reality. The government argues that a transaction
lacks economic reality if it fails to realize a post-foreign-
tax profit, i.e., if the pre-tax profit is less than the foreign
tax expense. Without foreign tax credits, such a transac-
tion would result in an economic loss. This is in essence
the “economic profit” test contemplated in I.R.S Notice 98-
5, which was never issued as a regulation and was later
withdrawn. See I.R.S. Notice 98-5, 1998-1 C.B. 334, 1997
WL 786882 (1997); I.R.S. Notice 2004-19, 2004-1 C.B. 606,
2004 WL 292126 (2004). The rationale for the “economic
profit” test was to disallow credits if the “reasonably
expected economic profit were determined to be insub-
stantial compared to the value of the foreign tax credits
expected to be obtained” as a result of the transaction.
2004 WL 292126, at *1.
   What is critical is to identify transactions lacking eco-
nomic reality, i.e., those that do not alter the taxpayer’s
28                               SALEM FINANCIAL, INC.   v. US



economic position in any meaningful way apart from their
tax consequences, typically entailing no risk and no
significant possibility of profit other than as a result of
tax considerations. This is to ensure that tax benefits are
available only if “there is a genuine multiple-party trans-
action 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.” Frank Lyon, at 583-84. Even if there is some
prospect of profit, that is not enough to give a transaction
economic substance if the prospect of a non-tax return is
grossly disproportionate to the tax benefits that are
expected to flow from the transaction. See, e.g., Knetsch v.
United States, 364 U.S. 361, 365-66 (1960) (the taxpayer’s
transaction with the insurance company “was a fiction,”
because for a claimed interest deduction of $233,297.68,
the taxpayer’s annual borrowing only kept a net cash
value “at the relative pittance of $1,000”).
    While looking to the potential for economic profit is
useful, the Supreme Court has cautioned that there is “no
simple device available to peel away the form of [a] trans-
action and to reveal its substance.” Frank Lyon, 435 U.S.
at 576. The government’s economic profit test, if applied
rigidly, would implicate a wide range of transactions that,
in the government’s view, have not earned a minimum
profit to justify a finding of economic reality. Yet com-
mentators have identified transactions that would fail the
profit test but nonetheless should be honored as legiti-
mate business transactions meriting the allowance of
foreign tax credits. See Daniel N. Shaviro & David A.
Weisbach, The Fifth Circuit Gets it Wrong in Compaq v.
Commissioner, 94 Tax Notes 511, 515 (2002) (“To be sure,
there are many cases where a foreign transaction without
a pre-tax profit (net of foreign taxes) is not a sham merit-
ing disallowance.”) (giving an example in which a U.S.
company borrows at 8 percent to make a genuine invest-
SALEM FINANCIAL, INC.   v. US                            29



ment, over a significant period, in a foreign bond or busi-
ness opportunity that is expected to earn 10 percent
before foreign tax and 7 percent after foreign tax); James
M. Peaslee, Creditable Foreign Taxes and the Economic
Substance Profit Test, 114 Tax Notes 443, 450 (Jan. 29,
2007) (“On those facts, the taxpayer would have a power-
ful argument that allowing the [foreign tax] credits is
consistent with Congressional intent despite the lack of a
post-foreign tax profit.”); David P. Hariton, The Compaq
Case, Notice 98-5, and Tax Shelters: The Theory Is All
Wrong, 94 Tax Notes 501, 502 (Jan. 28, 2002) (under the
government’s profit test, “any taxpayer who borrowed
money and invested the proceeds in foreign stock would
have lost its right to credit any foreign withholding taxes
it paid, since its interest deductions would invariably
have exceeded its net dividend income”).
    Transactions involving nascent technologies, for in-
stance, often do not turn a profit in the early years unless
tax benefits are accounted for. To brand such transac-
tions as a sham simply because they are unprofitable
before tax benefits are taken into account would be con-
trary to the clear intent of Congress. See Sacks v.
Comm’r, 69 F.3d 982, 990-92 (9th Cir. 1995) (upholding
the taxpayer’s claim for regular investment credit and a
business energy investment credit, where the taxpayer
entered into a sale/leaseback transaction for solar water
heaters, and the IRS deemed the transaction as a sham
because it was unprofitable before tax benefits were
accounted for). Indeed, Congress often provides tax
benefits to encourage socially beneficial activity that
would not be pursued absent tax advantages.
    Therefore, although inquiring into post-foreign-tax
profit can be a useful tool for examining the economic
reality of a foreign transaction, we disagree with the
government that a transaction that fails the profit test
must necessarily be deemed a sham. Nonetheless, if a
taxpayer has incurred a large foreign tax expense that
30                              SALEM FINANCIAL, INC.   v. US



would render the transaction unprofitable absent the
foreign tax credit, that situation demands careful review
of the transaction. In particular, it requires an inquiry
into whether the transaction meaningfully alters the
taxpayer’s economic position (other than with regard to
the tax consequences) and whether the transaction has a
bona fide business purpose. The fact that the transaction
lacks a post-foreign-tax profit does not by itself end the
economic substance inquiry.
    In this case, the trial court’s finding that the Trust
transaction lacked economic reality was supported by
more than just the absence of a prospect for profit. The
trial court found that the Trust transaction consisted of
“three principal circular cash flows,” which, apart from
their intended tax consequences, had no real economic
effect. 112 Fed. Cl. at 585. Through those circular cash
flows, BB&T (1) created an entity that it used to make
monthly distributions to the Trust, which the Trust
immediately returned to that entity, resulting in subject-
ing the income to U.K. taxes; (2) caused the Trust to
deposit a predetermined amount of funds into a blocked
account and then to withdraw those funds immediately,
enabling Barclays to claim a U.K. tax loss even though
the transaction had no net economic effect; and (3) “cycled
tax through the U.K. taxing authority, then to Barclays,
and then back to [BB&T].” Id. None of those transac-
tions, the court found, had any economic substance.
    As explained above, we do not accept the trial court’s
characterization of the Bx payment as simply a rebate of
the Trust’s U.K. tax payments; we agree with the trial
court, however, that the Trust transaction was a contrived
transaction performing no economic or business function
other than to generate tax benefits. The trial court cor-
rectly concluded that the income “from BB&T’s preexist-
ing assets cycled through the STARS Trust was not
[economic] profit from STARS,” but was akin to the
“transfers of income-producing assets to controlled enti-
SALEM FINANCIAL, INC.   v. US                             31



ties that do not imbue an arrangement with substance,”
because “the transfer has no incremental effect on the
taxpayer’s activities.” 112 Fed. Cl. at 586 (citing cases).
As the trial court found, the Trust transaction reflected no
meaningful economic activity by BB&T: the incremental
profit potential of the Trust (beyond the income already
generated by the underlying assets) depended entirely on
Barclays’ and BB&T’s anticipated tax benefits; it exposed
BB&T to no economic risk (other than the risk that the
IRS would challenge the tax treatment of the transac-
tion); and it had no realistic prospect of producing a profit
(apart from the effect of the foreign tax credits).
    Rather than being a genuine business transaction in-
volving economic risk, the STARS Trust transaction was
simply a money machine. By voluntarily subjecting the
Trust income to U.K. taxes, BB&T obtained a post-
foreign-tax-credit “profit” of $11 for every $100 of Trust
income, free of economic risk. If BB&T had increased by
ten-fold the value of the assets it placed in the Trust, it
would have increased by ten-fold its “profit” from the
transaction, quite apart from the legitimate income
generated by the assets. In addition, Barclays’ gain from
the transaction would have increased by the same multi-
ple, as would the U.K.’s receipt of taxes, all at the expense
of the U.S. Treasury. The artificiality of the transaction
is shown by its unlimited capacity to generate gains,
without any additional exposure or commitment of re-
sources. The trial court therefore correctly characterized
the transaction as lacking economic reality, and it proper-
ly found that allowing foreign tax credits for such an
arrangement would be inconsistent with the purposes of
the foreign tax credit statute.
                                D
   We next turn to the second element of the “economic
substance” test—whether the STARS Trust transaction
nonetheless had a bona fide business purpose. The trial
32                              SALEM FINANCIAL, INC.   v. US



court found that the STARS Trust had no non-tax busi-
ness purpose, and that, instead, its sole function was “to
self-inflict US-sourced BB&T income in order to reap US
and UK tax benefits.” That finding is amply supported by
the evidence.
    “Asking whether a transaction has a bona fide busi-
ness purpose is another way to differentiate between real
transactions, structured in a particular way to obtain a
tax benefit (legitimate), and transactions created to
generate a tax benefit (illegitimate).” Stobie Creek, 608
F.3d at 1379 (citing Coltec, 454 F.3d at 1357); see also
Shriver v. Comm’r, 899 F.2d 724, 726 (8th Cir. 1990)
(“The business purpose inquiry examines whether the
taxpayer was induced to commit capital for reasons only
relating to tax considerations or whether a non-tax mo-
tive, or legitimate profit motive, was involved.”); Winn-
Dixie Stores, Inc. v. Comm’r, 254 F.3d 1313, 1316 (11th
Cir. 2001) (“The [sham-transaction] doctrine has few
bright lines, but it is clear that transactions whose sole
function is to produce tax deductions are substantive
shams.”) (internal quotations omitted).
     When BB&T first learned of the STARS transaction,
it expressed to Barclays its “appetite to do an FTC [for-
eign tax credit] trade.” During the two parties’ subse-
quent discussions, Barclays represented to BB&T that
“[t]he benefit under STARS arises from the ability of both
parties to obtain credits for the taxes paid in the Trust.”
KPMG likewise promoted STARS to BB&T as generating
a benefit “based on the U.K. tax credit,” in which the
greater the amount of Barclays’ tax credits, the greater
the benefit to BB&T would be.
    When the STARS transaction was presented to
BB&T’s board of directors in February 2002, BB&T’s chief
financial officer described the expected benefit of the
transaction as “one half of UK tax credit received by
investor [Barclays] for UK income taxes paid by Trust.” A
SALEM FINANCIAL, INC.   v. US                           33



BB&T witness confirmed at trial that STARS “sounded
like a good deal” at the time because it allowed BB&T to
claim a foreign tax credit equal to the entire amount of
the Trust’s U.K. taxes while BB&T was also receiving “a
payment from Barclays that they had used the tax credit
as a basis for calculating.”
    BB&T and Barclays finalized the STARS transaction
in July and August 2002. What emerged from the parties’
agreement was a Trust consisting entirely of BB&T’s
U.S.-based assets, which BB&T voluntarily subjected to
U.K. taxation. Beyond that, BB&T conducted little activi-
ty in the U.K. The monthly Bx payment it received,
sometimes characterized by the parties as a “[loan] inter-
est adjustment,” bore no relationship to the amount of the
STARS Loan; instead, the payment was calculated based
on the Trust’s U.K. tax payments. Aside from income
generated by the Trust’s assets, all incremental cash
flows into the transaction were the U.K. tax benefits that
Barclays claimed under STARS. 7
    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 BB&T
and Barclays. See Stobie Creek, 608 F.3d at 1379. Bar-
clays agreed to bear half of BB&T’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). BB&T, on the other hand, bene-
fited 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 Barclays. Absent those tax



   7    Both parties agree that the analysis of the trans-
action should focus on the transaction’s incremental
income beyond the income already generated by the Trust
assets.
34                               SALEM FINANCIAL, INC.   v. US



advantages, the STARS transaction would never have
occurred.
     BB&T contends that the Trust transaction was moti-
vated by valid, non-tax-related business purposes. Signif-
icantly, although BB&T argued in the Court of Federal
Claims that the purpose of the STARS transaction, in-
cluding the Trust, was to obtain financing, BB&T does not
make that argument in this court. Instead, BB&T argues,
first, that it sought to earn a profit, in the form of the Bx
payment, and that earning a profit is “a quintessential
business purpose, universally accepted by the courts.”
Appellant’s Br. 55. The Bx payment, however, does not
represent profit from any business activity; it is simply
the means by which Barclays and BB&T shared the tax
benefits of the Trust transaction. It therefore is not an
indication that the Trust transaction had a business
purpose. To hold that a transaction has a bona fide
business purpose whenever it has a prospect of producing
economic benefit for the taxpayer would eliminate the
“business purpose” test altogether, since the taxpayer
normally will not engage in a transaction absent the
prospect that it will result in some monetary gain.
    BB&T next argues that the Trust had a legitimate
business purpose because it was established to enable
Barclays to claim certain U.K. tax benefits. BB&T relies
on Northern Indiana Public Service Co. v. Commissioner,
115 F.3d 506, 512 (7th Cir. 1997), for the proposition that
accommodating a counterparty’s tax position is a legiti-
mate business purpose.
    BB&T misconstrues Northern Indiana. In that case,
it was undisputed that the taxpayer had structured the
transaction at issue to access the Eurobond market,
where it could borrow at a lower interest rate, and to
allow foreign lenders to avoid paying a 30 percent U.S.
withholding tax. See Northern Indiana, 115 F.3d at 511.
The Seventh Circuit found that the desire to avoid the 30
SALEM FINANCIAL, INC.   v. US                             35



percent withholding tax was not the taxpayer’s sole
purpose in structuring the transaction, and that the
taxpayer’s foreign counterparty had “engaged in business
activity of borrowing and lending money at a profit,”
which had resulted in “actual, non-tax related” changes in
the taxpayer’s economic position. Id. at 509, 512. The
court held that such a transaction should not be disre-
garded as an economic sham simply because tax avoid-
ance was one of the motives for creating or structuring the
transaction. See id. at 511, 514. Northern Indiana thus
does not stand for the proposition that accommodating a
counterparty’s tax position is always a legitimate business
purpose, as BB&T asserts.
     The Seventh Circuit in Northern Indiana recognized
that a transaction that is “unrelated to any economic
activity” and is created solely to obtain tax benefits should
be disregarded as a sham. 115 F.3d at 511. The creation
and operation of the STARS Trust is just such a transac-
tion. The incremental profit potential of the Trust de-
pended entirely on Barclays’ and BB&T’s anticipated tax
benefits. The risk of the transaction rested on “interpre-
tations of tax laws and regulations of the United States,
the United Kingdom and the State of North Carolina”; the
risk was unrelated to market conditions, “the time value
of money,” or the “attendant risks” associated with the
transaction. See Bank of N.Y. Mellon Corp. v. Comm’r,
140 T.C. 15, 42 (2013) (discussing another STARS trans-
action). Thus, while the transaction before the court in
Northern Indiana was a “real transaction [that was]
structured in a particular way to obtain a tax benefit,” the
STARS Trust was created solely to generate tax benefits;
it therefore lacked a bona fide business purpose. 8 Stobie



    8  BB&T further argues that saving state taxes with
the STARS Trust is a legitimate business purpose. BB&T
avoided North Carolina state tax by shifting the Trust’s
36                              SALEM FINANCIAL, INC.   v. US



Creek, 608 F.3d at 1379; see also Northern Indiana, 115
F.3d at 512 (recognizing that Knetsch and similar cases
“allow the Commissioner to disregard transactions that
are designed to manipulate the Tax Code so as to create
artificial tax deductions”).
     We recognize that most of the “business purpose” cas-
es have dealt with transactions created solely to generate
U.S. tax benefits. The STARS Trust is unusual in that it
was structured to generate both U.S. and U.K. tax bene-
fits, which were then allocated between the two partici-
pating entities. That fact, however, does not change our
conclusion regarding the absence of any business purpose
underlying the Trust transaction.
    Allowing credits for taxes paid to other sovereigns “is
a privilege and a matter of Congressional grace.” Feder-
ated Mut. Implement & Hardware Ins. Co. v. Comm’r, 266
F.2d 66, 70 (8th Cir. 1959); see also Chrysler Corp. v.
Comm’r, 436 F.3d 644, 654 (6th Cir. 2006). Thus, the
ultimate question is “whether what was done, apart from
the tax motive, was the thing which the statute intended.”
Gregory v. Helvering, 293 U.S. 465, 469 (1935); Coltec, 454
F.3d at 1355-56. The enactment of the foreign tax credit
statute “indicates appreciation of the practical exigencies
which lead to the foreign incorporation of subsidiaries for
the extension by domestic corporations of their business




income-producing assets from North Carolina to Dela-
ware. In Coltec, we held that “the transaction to be
analyzed [under the economic substance doctrine] is the
one that gave rise to the alleged tax benefit.” Coltec, 454
F.3d at 1356. At issue in this case is BB&T’s claimed
foreign tax credit, which did not arise from BB&T’s do-
mestic relocation of assets. Therefore, BB&T’s asserted
business purpose regarding its state tax savings fails
because it “focuses on the wrong transaction.” Id. at 1358.
SALEM FINANCIAL, INC.   v. US                           37



abroad.” Burnet v. Chicago Portrait Co., 285 U.S. 1, 9
(1932).
    The foreign tax credit system aims to achieve “capital
export neutrality,” thereby removing a possible disincen-
tive to engage in foreign trades because of the burden of
double taxation. See 56 Cong. Rec. App. 677 (1918)
(statement of Rep. Kitchin) (“We would discourage men
from going out after commerce and business in different
countries if we maintained this double taxation.”); Rich-
ard E. Andersen, Foreign Tax Credits 1-2, 5 (1996); Hart
v. United States, 585 F.2d 1025, 1029 (Ct. Cl. 1978) (“The
purpose of allowing the credit was to avoid the inequity of
double taxation of foreign source income.”). In other
words, the foreign tax credit was intended to remove the
effect of foreign taxation from an investor’s decisionmak-
ing process and to facilitate purely economic decisions
regarding business opportunities overseas. See Elisabeth
A. Owens, The Foreign Tax Credit 3 (1961) (“[T]he result
of the operation of the [foreign tax] credit is that United
States corporations . . . with the same amount of income
bear an equal total tax burden on income whether or not
they are subjected to foreign income taxation.”); Ander-
sen, supra, at 1-2. An elaborate scheme set up solely to
take advantage of a foreign tax system and involving no
“economically-based business transactions” is not the type
of transaction Congress intended to promote with the
foreign tax credit system. See Northern Indiana, 115 F.3d
at 512.
    Although BB&T received income in the form of the Bx
payment, the transaction that generated that income
involved no genuine business activities, and the transac-
tion that produced the Bx payment would not have been
engaged in but for the system of taxes imposed by the U.S
and U.K. governments. See Northern Indiana, 115 F.3d
at 512. Congress could not have intended to allow a
taxpayer to claim a foreign tax credit, at the expense of
U.S. tax revenue, for a transaction involving no commerce
38                               SALEM FINANCIAL, INC.   v. US



or bona fide business abroad and having no purpose other
than to obtain foreign and domestic tax benefits. See
Goldstein v. Comm’r, 364 F.2d 734, 742 (2d Cir. 1966)
(“[T]o allow a deduction for interest paid on funds bor-
rowed for no purposive reason, other than the securing of
a deduction from income, would frustrate [the legislative]
purpose . . . [and] would encourage transactions that have
no economic utility but for the system of taxes imposed by
Congress.”) (citing Knetsch v. United States, 364 U.S. 361,
367 (1960)).
    We therefore sustain the trial court’s finding that the
STARS Trust lacked a bona fide business purpose. The
tax consequences of the STARS Trust accordingly must be
disregarded. 9 See Stobie Creek, 608 F.3d at 1375.
                             E
    BB&T further alleges that the trial court committed
legal error by questioning the U.K. government’s imposi-
tion of taxes on the Trust. Specifically, BB&T argues that
the “act of state” doctrine bars the trial court from recon-
sidering the U.K.’s imposition and collection of income
taxes from the Trust, and that such reconsideration
conflicts with the express allocation of tax jurisdiction in
the U.S.-U.K. Tax Treaty, 2224 U.N.T.S. 247 (July 24,
2001). 10 We do not read the trial court’s determination of




     9  BB&T also argues that if the Bx payment were to
be treated as an “in-substance” tax rebate, BB&T should
be allowed to claim forty-nine percent of the foreign tax
credits because the Bx payment rebated only $51 of every
$100 of U.K. taxes paid on the Trust. Because we disa-
gree that the Bx payment should be deemed as a tax
rebate, we need not address that argument.
    10  The act of state doctrine “requires that, in the
process of deciding, the acts of foreign sovereigns taken
SALEM FINANCIAL, INC.   v. US                            39



the economic substance of STARS to depend in any way
on a repudiation of the U.K.’s authority to impose taxes
on the Trust. Nor do we base our decision on such a
determination. We therefore do not find BB&T’s argu-
ment as to the Treaty or the act of state doctrine to be
persuasive.
                                III
    Aside from the foreign tax credits arising from the
STARS Trust, BB&T also seeks to recover deductions for
the interest it paid on the $1.5 billion STARS Loan. The
trial court disallowed the interest deductions, holding
that the Loan, like the Trust, lacked economic substance.
The court based its decision primarily on two grounds.
First, it emphasized that, putting aside the Bx payment,
the cost of borrowing for the STARS Loan was “signifi-
cantly higher than rates on comparable sources of availa-
ble funds.” 112 Fed. Cl. at 587. The court thus concluded
that the STARS Loan was not the sort of financing trans-
action a large commercial bank such as BB&T would
normally engage in. Second, the court found that the
Loan had no non-tax business purpose, but “simply was a
method by which to camouflage Barclays’ rebate of a
portion of BB&T’s UK payments, through [the Bx] pay-
ment.” We reach a different conclusion regarding the
economic substance of the STARS Loan transaction.
    Section 163(a) of the Internal Revenue Code, 26
U.S.C. § 163(a), permits the deduction of “all interest paid
or accrued within the taxable year on indebtedness.” The
statute speaks in broad terms. See Coors v. United States,
572 F.2d 826, 831 (Ct. Cl. 1978); Goldstein, 364 F.2d at
741. It “does not contain any general requirement that
interest payments, to be deductible, be ordinary, neces-



within their own jurisdictions shall be deemed valid.”
Voda v. Cordis Corp., 476 F.3d 887, 904 (Fed. Cir. 2007).
40                              SALEM FINANCIAL, INC.   v. US



sary, reasonable or for a business purpose.” Coors, 572
F.2d at 831. Nevertheless, “[i]f a transaction underscor-
ing interest payment is considered to be a sham . . . said
payments are not allowed as interest deductions.” Id. at
832.
    Our predecessor court noted that cases dealing with
interest deductions generated by loan transactions that
are challenged as having no prospect for economic gain
lack uniformity. See Rothschild, 407 F.2d at 408. How-
ever, the court explained that the “common denominator
to be found in those cases denying the interest deduction
is the conclusion that the loan transaction could not
appreciably affect the tax payer’s beneficial interest
except to reduce the taxpayer’s federal income tax.”
Coors, 572 F.2d at 837; see also Lee v. Comm’r, 155 F.3d
584, 586 (2d Cir. 1998) (“Interest payments are not de-
ductible if they arise from transactions that can not with
reason be said to have purpose, substance, or utility apart
from their anticipated tax consequences.”) (internal
quotation and citation omitted); see also Knetsch, 364 U.S.
at 366 (disallowing tax deductions when “it is patent that
there was nothing of substance to be realized by [the
taxpayer] from this transaction beyond a tax deduction”).
    The government contends that the STARS Loan
lacked economic reality because, absent the Bx payment,
BB&T had effectively borrowed the Loan funds at an
interest rate that was more than 30 basis points higher
than the rates on comparable sources of funding available
to BB&T. The government thus asserts that the STARS
Loan provided no economic benefit to BB&T (other than
tax benefits) because the proceeds of a loan from another
source would have yielded the same return at a lower
cost.
    The government relies on Kerman v. Commissioner,
713 F.3d 849 (6th Cir. 2013), for the proposition that a
loan transaction is “economically unreasonable” if alter-
SALEM FINANCIAL, INC.   v. US                           41



native, lower-interest funding sources were available to
the taxpayer. We do not interpret Kerman as standing for
that broad proposition or as being otherwise helpful to the
government’s argument in this case.
    While the Sixth Circuit scrutinized the “absurdly high
interest rate” of the loan transaction in Kerman (7000
basis points above market rate), it did not find the trans-
action to be a sham based solely on the interest rate.
Rather, the court examined the cost and returns of the
loan transaction and found that, but for the claimed tax
benefits, the transaction would have resulted in a sure
loss. See 713 F.3d at 865 (“[R]egardless of what invest-
ment Kerman planned to use the loan proceeds for (if
any), financing with [the loan] transaction did not provide
him with a reasonable possibility of profit.”). The Kerman
court thus did not hold that a higher-than-market-rate
interest or the availability of alternative, lower-interest
funding alone established that the underlying loan trans-
action was a sham; rather, it engaged in the same inquiry
that the Rothschild court did, asking whether there was
something of substance to be realized by the taxpayer
from the loan transaction, other than tax deductions.
    We also do not find the Second Circuit’s decisions in
Lee v. Commissioner and Goldstein v. Commissioner to be
helpful to the government. In both of those cases, the
Second Circuit found that interest on the debts in ques-
tion was not deductible because in each case the underly-
ing transaction giving rise to the debt was “devoid of
economic substance,” and had “no prospect of realizing
anything of substance other than tax benefits.” Lee, 155
F.3d at 586, 587; see also Goldstein, 364 F.2d at 740
(deduction for interest paid not available for transactions
“that can not with reason be said to have purpose, sub-
stance, or utility apart from their anticipated tax conse-
quences”).
42                               SALEM FINANCIAL, INC.   v. US



    In this case, the trial court found that there was no
economic substance to the STARS Loan, because it was
only a means to “camouflage” Barclays’ rebate of a portion
of BB&T’s U.K. tax payments. Incorporating a loan
component into STARS to give the entire transaction the
appearance of “low cost financing” no doubt was one
intended purpose of the Loan. However, unlike the sort of
“contrived, ingenious, and complex” loan arrangement
contemplated in Coors, “whose only ultimate and/or
realistic purpose was to secure intended tax deduction
benefits,” Coors, 572 F.2d at 839, the structure of the
STARS Loan appears straightforward. Moreover, unlike
the transactions in Lee and Goldstein, there is no evidence
that BB&T designed the Loan solely to claim the interest
deductions.     Despite the Loan’s higher-than-market
interest rate, it has not been shown that the transaction
would result in an economic loss “regardless of what
investment [BB&T] planned to use the loan proceeds for.”
See Kerman, 713 F.3d at 865.
    While it may be true that the Loan operated partly to
camouflage the Bx payment, it also resulted in a substan-
tive change in BB&T’s economic position. As a result of
the Loan transaction, BB&T obtained unrestricted access
to $1.5 billion in loan proceeds. An impact of that sort
cannot be said to have resulted in no change in the eco-
nomic benefits enjoyed by the taxpayer. See Coltec, 454
F.3d at 1355 (“[T]ransactions, which do not vary control or
change the flow of economic benefits, are to be dismissed
from consideration.”); Kerman, 713 F.3d at 865 (noting
that the taxpayer did not have unfettered access to all the
loan proceeds under the sham transaction).
     Obtaining financing of that magnitude, in and of it-
self, would “appreciably affect” the beneficial interest of a
commercial bank such as BB&T. See ACM P’ship, 157
F.3d at 261-62 (allowing deduction of economic losses that
were “separate and distinct from the $87 million tax loss
that did not correspond to any actual economic loss”); Lee,
SALEM FINANCIAL, INC.   v. US                           43



155 F.3d at 586 (reciting the “undoubted proposition that
interest on loans incurred to support an economically
substantive investment is not disqualified as a deduction
merely because the borrower is also motivated by favora-
ble tax consequences”); Rice’s Toyota World, 752 F.2d at
95-96 (“[I]t does not follow that the sham nature of the
underlying transaction supports the Tax Court’s conclu-
sion that the recourse note debt was not genuine. . . . [A]
sham transaction may contain elements whose form
reflects economic substance and whose normal tax conse-
quences may not therefore be disregarded.”); Coors, 572
F.2d at 835 (“Since plaintiffs received insurance coverage
of this magnitude during the years in issue, it is hard to
accept defendant’s repeated assertion that plaintiffs
during those years received nothing of substance from the
various policy advances or loans except a purported
interest deduction.”).
    The evidence shows that after the failure of the origi-
nal STARS transaction, which lacked a loan component,
Barclays added a financing vehicle (the Loan) to the
transaction in order to attract banks. Thus, entirely
apart from the anticipated tax consequences, the STARS
Loan had real economic utility to BB&T.
    In the Bank of New York Mellon Corp. case, which in-
volved a similar STARS trust and loan transaction, the
Tax Court in its initial opinion did not separately address
the question whether the interest on the loan component
of the transaction was deductible. Bank of N.Y. Mellon
Corp., 140 T.C. at 15. On reconsideration, however, the
court held that the interest on the loan was deductible.
Bank of N.Y. Mellon Corp. v. Comm’r, 106 T.C.M. (CCH)
367 (2013). The court based its ruling in that case on the
same factors that are present here: (1) the loan was not
necessary for the STARS structure to produce the disal-
lowed foreign tax credits; (2) the loan proceeds were not
used to finance, secure, or carry out the STARS structure;
and (3) the loan served a purpose beyond the creation of
44                                SALEM FINANCIAL, INC.   v. US



tax benefits. Even though the interest rate on the loan
was above the market rate, the court held that interest is
deductible under section 163(a) if it accrues “on a real
loan that is used for economically substantive activity . . .
even if the borrower is also motivated by favorable tax
consequences.” Id. at 370. Even though the loan was
overpriced, the court held that the interest was deductible
because “the loan proceeds were available for use in
petitioner’s banking business.” Id.
    We agree with the Tax Court’s analysis of the loan
component of the STARS transaction. It was therefore
error for the trial court to conclude that the STARS Loan
had no economic substance and functioned only to camou-
flage the Bx payment. As in the Bank of New York Mellon
Corp. case, the STARS Loan in this case functioned to
provide financing to BB&T, which is a legitimate business
purpose. Accordingly, we hold that the Loan portion of
the transaction satisfies the economic substance test and
that BB&T is entitled to claim interest deductions for the
interest it paid on the Loan.
                             IV
    The final issue on appeal is whether the trial court
properly upheld the accuracy-related penalties imposed
on BB&T. Section 6662(a) of the Internal Revenue Code
provides that “[m]andatory, accuracy-related penalties
apply to certain underpayments of tax that meet the
statutory requirements.” 26 U.S.C. § 6662(a); Stobie
Creek, 608 F.3d at 1381. Section 6664(c) of the Code
recognizes “a narrow defense” to section 6662 penalties,
provided that the taxpayer can prove that it (1) had
reasonable cause for the underpayment and (2) acted in
good faith. 26 U.S.C. § 6664(c); Stobie Creek, 608 F.3d at
1381. Whether a taxpayer had reasonable cause is a
question of fact reviewed for clear error. 608 F.3d at
1381. The most important factor in determining reasona-
ble cause is “the extent of the taxpayer’s effort to assess
SALEM FINANCIAL, INC.   v. US                            45



the taxpayer’s proper tax liability,” judged in light of the
taxpayer’s “experience, knowledge, and education.” Id.
    BB&T asserts that it had reasonable cause for the
underpayments because it reasonably relied on the favor-
able tax opinion from Sidley and received additional
supportive advice from PwC. 11 For reliance on such
advice to be reasonable for purposes of section 6664(c), the
taxpayer must show (1) that the advice relied on was
based on “all pertinent facts and circumstances and the
law as it relates to those facts and circumstances”; (2)
that the advice was not based on any “unreasonable
factual or legal assumptions” and did not “unreasonably
rely on the representations, statements, findings or
agreements of the taxpayer or any other persons”; and (3)
that the taxpayer’s reliance on the advice was “objectively
reasonable.” Stobie Creek, 608 F.3d at 1381. Reliance is
not reasonable if the advisor has “an inherent conflict of
interest” about which the taxpayer knew or should have
known; nor is it reasonable if the taxpayer knew or should
have known that the transaction was “too good to be
true.” Id. at 1381-82.
    The trial court found that BB&T’s reliance on Sidley’s
tax opinion was unreasonable because Sidley had an
inherent conflict of interest of which BB&T knew or
should have known. That finding is not clearly erroneous.
The evidence shows that BB&T had selected Sidley on the
recommendation of KPMG, the principal marketer of
STARS. Sidley was the tax advisor in a prior STARS
transaction, also marketed by KPMG. A BB&T witness
testified at trial that both KPMG and Sidley, BB&T’s two
principal advisors, were involved in “put[ting] [the STARS
transaction] together.” In a 2001 internal memorandum


   11   On appeal, BB&T no longer argues that it reason-
ably relied on the advice it received from KPMG, the
principal marketer of STARS.
46                               SALEM FINANCIAL, INC.   v. US



regarding Sidley’s compensation package, Mr. Raymond
J. Ruble—BB&T’s initial tax advisor at Sidley—stated
that “I intend to continue to exploit ties with KPMG . . . in
connection with the development of structured tax prod-
ucts.” In light of that evidence, the trial court did not
clearly err in finding that Sidley and KPMG had a signifi-
cant interest in convincing BB&T to engage in the STARS
transaction and that their interest in marketing the
STARS transaction rendered their advice suspect.
    The evidence also supports the conclusion that BB&T
knew or should have known of Sidley’s conflict of interest.
Sidley was recommended to BB&T by KPMG, the princi-
pal marketer of STARS. At the time of the recommenda-
tion, BB&T knew that Sidley had prepared a favorable
tax opinion for a prior STARS transaction. Despite that
knowledge, BB&T’s witness stated that BB&T was ex-
pecting an independent opinion from Sidley because the
facts and circumstances surrounding the STARS transac-
tion offered to BB&T were different from the previous
version of STARS. Yet even before BB&T formally en-
gaged Sidley, Mr. Ruble sent BB&T a redacted copy of a
tax opinion prepared for another client, which endorsed
the STARS transaction. That circumstance alone should
have raised a red flag that Sidley was not a truly “inde-
pendent” advisor, because it was willing to endorse a
transaction before it even started exploring the specific
circumstances of the transaction for the client. The trial
court reasonably concluded from that evidence that Sidley
had an inherent conflict of interest about which BB&T
knew or should have known. The trial court therefore did
not clearly err in finding that BB&T’s reliance on Sidley’s
opinion was unreasonable.
    BB&T also relies on PwC’s participation in the trans-
action to support the reasonableness of its belief in the
validity of its tax position. The trial court, however, found
that PwC’s participation did not give BB&T a reasonable
basis for believing that its tax position was sound, be-
SALEM FINANCIAL, INC.   v. US                           47



cause PwC provided no tax opinion to BB&T. That find-
ing is not clearly erroneous. BB&T reported only Bar-
clays, KPMG, and Sidley as its tax advisors on the STARS
transaction. It instructed PwC, its auditing firm, to focus
solely on the STARS tax reserve issue and not to explore
whether STARS complied with the Internal Revenue
Code. PwC also explicitly informed BB&T that it “in no
way [was] providing an Opinion” regarding STARS.
Thus, PwC’s advice to BB&T was not a tax opinion that a
reasonable taxpayer would have relied on in assessing the
validity of the transaction for tax purposes.
    Moreover, PwC ultimately arrived at a “less than
should” level of comfort that the IRS would accept the
STARS transaction. Despite the qualified nature of
PwC’s advice, BB&T went ahead with the transaction.
BB&T cannot now claim that PwC’s “less than should”
advice provided a reasonable basis for engaging in the
STARS transaction. Therefore, the trial court did not
clearly err in concluding that PwC’s involvement in the
STARS transaction did not provide a reasonable cause for
BB&T’s understatements.
    BB&T’s reliance on its advisors’ opinions was unrea-
sonable for the additional reason that it should have
known that the STARS transaction was “too good to be
true.” Stobie Creek, 608 F.3d at 1383. BB&T’s executives
who had reviewed the STARS transaction were highly
educated and well-versed in banking and financing trans-
actions. The evidence shows that during the early stages
of the discussions between BB&T and Barclays, BB&T’s
executives were extremely skeptical of the tax benefits of
the STARS transaction in light of the potential downside
tax risks. The trial court found that, based on its execu-
tives’ education and experience, BB&T knew or should
have known that claiming nearly $500 million in foreign
tax credits by subjecting income to economically meaning-
less activities was “too good to be true.” That finding is
not clearly erroneous.
48                               SALEM FINANCIAL, INC.   v. US



    Finally, BB&T cites the district court opinion in TIFD
III-E Inc. v. United States, 8 F. Supp. 3d 142 (D. Conn.
2014), for the proposition that when an area of law is
uncertain, a taxpayer cannot be penalized for taking a
position that could have been a reasonable interpretation
of the law. In TIFD, the taxpayer had initially won the
case before the district court. The Second Circuit re-
versed but, as the district characterized the circuit court’s
opinion, “openly acknowledged that the case was not a
slamdunk for the government, because the relevant
statute and regulations are ambiguous and subject to
multiple interpretations.” TIFD, 8 F. Supp. 3d at 150.
On remand for an assessment of penalties, the district
court found that the taxpayer had a “reasonable basis” for
the tax position that the court itself had initially upheld.
    The court in TIFD held that the taxpayer’s position
was reasonable because the Second Circuit had explicitly
acknowledged that the relevant statute and regulations
bearing on the tax issue in that case were ambiguous. We
do not regard the application of the economic substance
doctrine to this case to present any ambiguity. According-
ly, we are not persuaded that BB&T’s position regarding
the appropriate tax treatment of the STARS transaction
was reasonable. In any event, the district court in TIFD
was not construing the “reasonable cause” and “good
faith” exception of section 6664(c), but instead the “rea-
sonable basis” provision of section 6662(d)(2)(B)(ii) which,
as the court explained, is more easily satisfied. See 8 F.
Supp. 3d at 151.
     We conclude that the trial court did not err in impos-
ing accuracy-related penalties on BB&T. The amount of
the penalties, however, requires reassessment, as we have
found that BB&T is entitled to claim interest deductions
for the interest it paid on the STARS Loan. In light of our
decision regarding the interest deductions, there may be
other necessary adjustments in the judgment as well,
which we leave to the trial court on remand.
SALEM FINANCIAL, INC.   v. US                             49



   Each party shall bear its own costs for this appeal.
      AFFIRMED IN PART, REVERSED IN PART,
              AND REMANDED
