                                      BANK OF NEW YORK MELLON CORPORATION, AS SUCCESSOR                                             IN
                                         INTEREST TO THE BANK OF NEW YORK COMPANY, INC.,
                                              PETITIONER v. COMMISSIONER OF INTERNAL
                                                       REVENUE, RESPONDENT
                                                        Docket No. 26683–09.                 Filed February 11, 2013.

                                                  B and its subsidiaries are an affiliated group (Ps). Ps
                                               engaged in a Structured Trust Advantaged Repackaged Secu-
                                               rities transaction (STARS transaction). The STARS trans-
                                               action provided Ps with purportedly below-market-cost
                                               financing from a U.K. bank. As part of the STARS trans-
                                               action, Ps transferred income-producing assets to a trust with
                                               a U.K. trustee and subject to U.K. tax on its income. Ps
                                               claimed foreign tax credits and expense deductions on its 2001
                                               and 2002 Federal consolidated returns in connection with the
                                               STARS transaction. Ps also reported income from the assets
                                               transferred to the trust as foreign source on the consolidated
                                               returns. R determined that the STARS transaction lacked eco-
                                               nomic substance and consequently disallowed the foreign tax
                                               credits, the expense deductions and the reporting of the asset
                                               income as foreign source. Ps contend that the STARS trans-
                                               action had economic substance and that Congress intended
                                               the foreign tax credit to apply to transactions like the STARS
                                               transaction. Held: The STARS transaction lacked economic
                                               substance and is disregarded for Federal tax purposes. Held,
                                               further, because the STARS transaction lacked economic sub-
                                               stance, Ps are not entitled to the claimed foreign tax credits,
                                               the claimed expense deductions or the foreign-source-income
                                               treatment.

                                                                                                                                     15




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                                      16                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                        B. John Williams, Jr., Alan J.J. Swirski, Julia M. Kazaks,
                                      Cary D. Pugh, Andrew J. McLean, Daniel C. Davis, Melissa
                                      R. Middleton, Shira M. Helstrom, Brendan T. O’Dell, Bryon
                                      Christensen, 1 John Marston, Manoj Viswanathan, Ilana
                                      Yergin, Daniel Davis, and Kristin R. Keeling, for petitioner.
                                        Jill A. Frisch, Curt M. Rubin, Anne O’Brien Hintermeister,
                                      Matthew J. Avon, Justin L. Campolieta, and Michael A.
                                      Sienkiewicz, for respondent.
                                         KROUPA, Judge: Respondent determined deficiencies in
                                      petitioner’s Federal income tax of $100 million 2 and $115
                                      million for 2001 and 2002 (years at issue), respectively.
                                      There are three issues for decision. The first issue is whether
                                      petitioner is entitled to foreign tax credits under section 901 3
                                      claimed in connection with a Structured Trust Advantaged
                                      Repackaged Securities transaction (STARS transaction or
                                      STARS). We hold that petitioner is not because the STARS
                                      transaction lacked economic substance. The second issue is
                                      whether petitioner is entitled to deduct certain expenses
                                      incurred in furtherance of the STARS transaction. We hold
                                      petitioner is not for the same reason. The final issue is
                                      whether income attributed to a trust with a U.K. trustee
                                      used to effect the STARS transaction is U.S. source income
                                      rather than foreign source income. We hold that the income
                                      is U.S. source income. 4

                                                                          FINDINGS OF FACT

                                      I. Background
                                         Petitioner is a Delaware corporation that maintained its
                                      principal place of business in New York, New York, when it
                                      filed the petition. Petitioner succeeded to the tax liabilities of
                                      The Bank of New York Company, Inc. (BNY Parent) when
                                        1 Bryon Christensen, John Marston, Manoj Viswanathan, Ilana Yergin,

                                      Daniel Davis and Kristin R. Keeling all withdrew as counsel after trial.
                                        2 All monetary amounts have been rounded to the nearest million unless

                                      otherwise indicated.
                                        3 All section references are to the Internal Revenue Code (Code) for the

                                      years at issue, unless otherwise indicated.
                                        4 There is also a question of whether respondent properly adjusted inter-

                                      est expenses allocated to the foreign source income. We need not address
                                      this issue because of our holding that the trust income reported as foreign
                                      source income is U.S. source income.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    17


                                      Mellon Financial Corporation merged with BNY Parent in
                                      2007. BNY Parent was the common parent of an ‘‘affiliated
                                      group’’ (as that term is defined in section 1504(a)) of corpora-
                                      tions that filed consolidated U.S. Federal income tax returns
                                      on an accrual and calendar year basis. The Bank of New
                                      York (BNY) was a wholly owned subsidiary of BNY Parent.
                                      BNY was in the banking business with worldwide banking
                                      operations. Its business activities included taking in deposits,
                                      borrowing money and investing in loans and securities.
                                         The affiliated group through BNY entered into the STARS
                                      transaction in 2001 with Barclays Bank, PLC (Barclays), a
                                      global financial services company headquartered in London,
                                      United Kingdom. The STARS transaction generated approxi-
                                      mately $199 million in foreign tax credits for the combined
                                      years at issue.
                                      II. Introduction and Negotiation of STARS
                                         Barclays and KPMG, an audit, tax and advisory firm,
                                      developed and promoted STARS to U.S. banks. KPMG intro-
                                      duced STARS to BNY during discussions with BNY’s tax
                                      director. Thereafter, tax professionals at KPMG and Barclays
                                      presented STARS to BNY through various meetings, discus-
                                      sions, promotional materials and correspondence.
                                         STARS was represented as a ‘‘below market loan’’ in
                                      KPMG’s initial presentation. KPMG indicated that STARS
                                      required a U.K. counterparty and a certain trust structure
                                      holding income-producing assets. KPMG explained that the
                                      below-market cost would be achieved by the U.K.
                                      counterparty ‘‘sharing’’ U.K. tax benefits from STARS
                                      through an offset to the cost of the loan. Finally, KPMG
                                      indicated that the U.K. tax benefits would be generated by
                                      subjecting income-producing assets held by a trust to U.K.
                                      tax and thus generating foreign tax credits that BNY could
                                      use to offset its U.S. tax liability.
                                         BNY notified KPMG in August 2001 that it was prepared
                                      to move forward with a STARS transaction with Barclays as
                                      the U.K. counterparty. BNY proposed that it would con-
                                      tribute assets that would generate $93 million of annual
                                      U.K. tax costs and expected Barclays to reduce the loan’s
                                      annual cost by half that amount. Shortly thereafter, BNY
                                      agreed to supplement STARS by engaging in a ‘‘stripping




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                                      18                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      transaction.’’ The effect would be to accelerate and increase
                                      the tax benefits STARS produced (i.e., foreign tax credits).
                                      And just before STARS closed, BNY indicated to Barclays
                                      that it had decided to increase the targeted benefit.
                                      III. The STARS Transaction
                                        BNY closed the STARS transaction with Barclays in
                                      November 2001. The key components of STARS were as fol-
                                      lows.
                                           A. The STARS Structure
                                        BNY used existing subsidiaries and created special-pur-
                                      pose entities to create a structure (STARS structure) to carry
                                      out the STARS transaction. BNY accomplished this by
                                      engaging in the following steps.
                                           1. Step 1: REIT Holdings Funded
                                        BNY contributed $6.46 billion of assets (BNY assets) to
                                      BNY REIT Holdings, LLC (REIT Holdings), an existing BNY
                                      subsidiary treated as a corporation for U.S. tax purposes.
                                      The BNY assets consisted of participating interests in resi-
                                      dential mortgage loans, commercial mortgage loans and con-
                                      sumer loans (participation interests) and various asset-
                                      backed and agency securities. REIT Holdings assumed $2.55
                                      billion of BNY’s liabilities (BNY liabilities) in connection with
                                      the contribution.
                                           2. Step 2: InvestCo Organized and Funded
                                        BNY organized BNY Investment Holdings (DE), LLC
                                      (InvestCo), as a Delaware limited liability company. InvestCo
                                      elected to be taxed as a corporation for U.S. tax purposes and
                                      was part of BNY’s affiliated group. REIT Holdings capital-
                                      ized InvestCo by contributing $10.409 billion of assets, con-
                                      sisting of the BNY assets and BNY Real Estate Holdings,
                                      LLC’s common stock (the REIT share), with a stated value
                                      of $3.95 billion (collectively, the STARS assets). In exchange,
                                      InvestCo assumed the BNY liabilities and issued a 100%
                                      ownership interest in InvestCo to REIT Holdings.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    19


                                           3. Step 3: DelCo Organized and Funded
                                         BNY organized BNY Delaware Funding (DE), LLC (DelCo),
                                      as a Delaware limited liability company. DelCo elected part-
                                      nership tax treatment for U.S. tax purposes. InvestCo
                                      capitalized DelCo by contributing $9.243 billion worth of the
                                      STARS assets. In exchange, DelCo assumed the BNY liabil-
                                      ities and issued to InvestCo all of its class 1 ordinary shares
                                      (DelCo class 1 shares) worth $65 million and its class 2 ordi-
                                      nary shares (DelCo class 2 shares) worth $6.628 billion.
                                         The DelCo class 1 shares held all the voting rights in
                                      DelCo. The DelCo class 2 shares had the right to receive
                                      approximately 99% of DelCo’s distributions. The holders of
                                      DelCo class 1 shares had the exclusive right to appoint
                                      DelCo’s managers. DelCo’s income was distributable in the
                                      absolute discretion of DelCo’s managers.
                                           4. Step 4: Organization, Funding and Terms of the STARS
                                              Trust
                                         BNY formed the BNY STARS Trust (trust) as a common
                                      law trust. The trust was authorized to issue class A units, a
                                      class B unit, a class C unit and a class D unit (collectively,
                                      the trust units). The trust unit holders were contractually
                                      entitled to monthly distributions in the following order. The
                                      class A unit holders were entitled to 1% of the trust
                                      distributable income. The class D unit holder was entitled to
                                      trust distributable income equal to $25 million × (1-month
                                      LIBOR 5 + 415 basis points (basis points)) × 0.78. The class
                                      B unit holder was entitled to 99% of the remaining distribut-
                                      able income, if the class C unit was in issue, or all remaining
                                      distributable income if the class C unit was not in issue. The
                                      class C unit holder was entitled to the remaining trust
                                      distributable income unless a default occurred.
                                         InvestCo transferred the remaining STARS assets
                                      (approximately $1.2 billion) and the DelCo class 2 shares to
                                      the trust in exchange for the class A units and the class B
                                      unit, which had stated values of $6.3 billion and $1.494 bil-
                                      lion, respectively.
                                           5 ‘‘LIBOR’’
                                                   is an acronym for ‘‘London Interbank Offering Rate.’’ See gen-
                                      erally Bank One Corp. v. Commissioner, 120 T.C. 174, 189 (2003), aff ’d in
                                      part, vacated in part and remanded sub nom. J.P. Morgan Chase & Co.
                                      v. Commissioner, 458 F.3d 564 (7th Cir. 2006).




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                                      20                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                        The initial trustee was BNY, acting through its London
                                      branch (U.S. trustee). The Bank of New York (DE), a wholly-
                                      owned subsidiary of BNY Parent, served as the trust man-
                                      ager. Only the holder of all the class A units could nominate
                                      a replacement trustee.
                                           5. Step 5: Organization and Ownership of NewCo
                                        BNY organized BNY NewCo Funding (DE), LLC (NewCo),
                                      as a Delaware limited liability company, with InvestCo as its
                                      sole member. NewCo elected partnership treatment for U.S.
                                      tax purposes. InvestCo contributed 49% of the class A units
                                      to NewCo in exchange for a membership interest with a
                                      $3.089 billion stated value. This resulted in InvestCo having
                                      a 100% ownership interest in NewCo. InvestCo then distrib-
                                      uted 1% of its NewCo interest to REIT Holdings.
                                        In sum, the above steps moved approximately $7.86 billion
                                      in net assets into DelCo and the trust. The following chart
                                      summarizes steps 1 through 5.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    21




                                           B. The STARS Loan
                                        BNY and Barclays entered into the following agreements
                                      and transactions, the net effect of which was to create a $1.5
                                      billion loan to BNY from Barclays.
                                           1. Class C Unit and Class D Unit Subscription
                                         First, Barclays purchased the class C unit for $1.469 bil-
                                      lion and the class D unit for $25 million from the trust by
                                      a subscription agreement. The subscription agreement
                                      required Barclays to pay further subscription amounts to the
                                      trust equal to the amount of any distributions on the class
                                      C unit. To ensure this, BNY established a blocked account in
                                                                                                                                                                          u:\files\figureC1.eps




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                                      22                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      Barclays’ name that Barclays could not access or control
                                      (Barclays blocked account). Also, BNY and Barclays agreed
                                      that all class C unit distributions were to be paid to the
                                      Barclays blocked account, and all further subscription
                                      amounts Barclays owed were to be paid from the Barclays
                                      blocked account.
                                           2. Trust Class C Unit and Class D Unit Forward Sale
                                              Agreements
                                         Second, InvestCo and Barclays entered into a forward sale
                                      agreement obligating InvestCo to purchase the class C unit
                                      (class C unit forward sale agreement) from Barclays in
                                      November 2006, or earlier in the event of default or accelera-
                                      tion, for $1.498 billion. The sale price under the class C unit
                                      forward sale agreement was equal to the $1.475 billion prin-
                                      cipal plus interest compounded annually at 4.338% less a
                                      fixed amount based on the amount of U.K. taxes paid on the
                                      trust income.
                                         Investco and Barclays entered into another forward sale
                                      agreement obligating InvestCo to purchase the class D unit
                                      (class D unit forward sale agreement) from Barclays within
                                      90 days of the purchase by InvestCo of the class C unit, for
                                      $25 million plus any additional amount for any accrued but
                                      unpaid distributions on the class D unit. The sale price
                                      under the class D unit forward sale agreement was the same
                                      as the original subscription price of the class D unit.
                                           3. Zero Coupon Swap
                                        Third, InvestCo and Barclays entered into a zero coupon
                                      swap agreement that required InvestCo to make monthly
                                      payments equal to one-month dollar LIBOR plus 30 basis
                                      points by reference to a $1.475 billion notional amount, less
                                      a spread amount (spread). The spread was a fixed amount
                                      equal to one-half of the present value of the expected U.K.
                                      taxes on the target class C unit income (discussed below)
                                      each month. In exchange for InvestCo’s monthly payments,
                                      Barclays agreed to pay $23 million to InvestCo on the zero
                                      coupon swap maturity date in November 2006. The payment
                                      was designed to equal the amount that exceeded the $1.475
                                      billion InvestCo was obligated to pay under the class C unit
                                      forward sale agreement if it continued in force until its
                                      expiration in November 2006.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    23


                                           4. Guaranty and Security for InvestCo’s Obligations Under
                                              the Forward Sale Agreements and Zero Coupon Swap
                                           a. Guaranty
                                        Barclays and BNY entered into a credit default swap in
                                      November 2001. Under the credit default swap, BNY guaran-
                                      teed all obligations of InvestCo under the forward sale agree-
                                      ments and the zero coupon swap to Barclays in case of
                                      InvestCo’s bankruptcy or default. In exchange, Barclays paid
                                      a fixed rate of 10 basis points on the notional amount of
                                      $1.475 billion.
                                           b. Security Arrangements
                                         To secure InvestCo’s obligations under the forward sale
                                      agreements and the zero coupon swap, the trust and DelCo
                                      each pledged a portion of the STARS assets (consisting of
                                      asset-backed and agency securities) as collateral. The trust
                                      transferred $1.432 billion of securities (trust collateral securi-
                                      ties) to a collateral account, and DelCo transferred $1.166
                                      billion of securities (DelCo collateral securities) to another
                                      collateral account (DelCo securities account). Proceeds from
                                      the securities were held in the same accounts, respectively.
                                      Barclays was granted a security interest in the trust securi-
                                      ties account and the DelCo securities account (collectively,
                                      collateral accounts). BNY acted as the securities inter-
                                      mediary for the assets held in these accounts. BNY guaran-
                                      teed through a participation agreement that the trust and
                                      DelCo together would hold at least $2.25 billion worth of
                                      high-quality securities as collateral for so long as Barclays
                                      held the class C unit.
                                           5. Net Effect of the Subscription Agreements, Forward Sale
                                              Agreements and Zero Coupon Swap
                                        In sum, the forward sale agreements, the zero coupon swap
                                      and the security arrangements converted Barclays’ initial
                                      subscriptions for the class C unit and class D unit into a
                                      secured loan from Barclays to BNY for $1.5 billion at LIBOR
                                      plus 20 basis points (loan). 6 BNY would pay the interest on
                                           6 For
                                              simplicity, we net the zero coupon swap floating leg, the credit de-
                                      fault swap payment and the class D unit distributions in referring to the
                                                                                                        Continued




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                                      24                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      the loan through the monthly LIBOR-based amounts                                        under
                                      the zero coupon swap, excluding the spread. BNY                                         would
                                      repay the principal through the forward sale prices,                                    net of
                                      the fixed payment of the zero coupon swap.
                                        The following diagram broadly reflects the terms                                      of the
                                      various agreements making up the loan.




                                           C. Use of the STARS Loan Proceeds
                                        The trust immediately redeemed InvestCo’s class B unit
                                      with the $1.494 billion the trust received from Barclays’ pur-
                                      chase of the class C unit and the class D unit. InvestCo then
                                      placed $1.5 billion on deposit with a BNY branch office in the
                                      Cayman Islands (Cayman branch). After an initial 11-day
                                      term, the money was held on deposit at the Cayman branch
                                      in 1-month terms for the duration of STARS. The Cayman
                                      branch booked this deposit as a liability to Barclays.
                                      interest rate (LIBOR plus 20 basis points) on the loan.
                                                                                                                                                                         u:\files\figureC2.eps




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    25


                                           D. Replacement of the U.S. Trustee
                                        BNY and Barclays replaced the U.S. Trustee with The
                                      Bank of New York Trust and Depositary Company Limited
                                      (U.K. trustee), which was treated as a U.K. resident for U.K.
                                      tax purposes. The U.K. trustee was a wholly-owned sub-
                                      sidiary of BNY parent.
                                           E. The Stripping Transaction
                                         The parties entered into a series of agreements slightly
                                      over a month after STARS closed to accelerate the U.K. taxes
                                      due on trust income by converting periodic cashflows into an
                                      up-front taxable lump-sum payment (stripping transaction).
                                      These agreements contemplated the following steps.
                                         First, BNY would contribute $402 million to DelCo through
                                      REIT Holdings, InvestCo and the trust. Second, the U.K.
                                      trustee would transfer the trust collateral securities to BNY
                                      as ‘‘custodian’’ in exchange for principal-only receipts and
                                      interest-only receipts. Third, DelCo would use the contrib-
                                      uted funds to purchase the interest-only receipts from the
                                      trust for $402 million. Fourth, the collateral arrangements
                                      would be amended so that Barclays obtained a security
                                      interest in the principal-only receipts and the interest-only
                                      receipts.
                                         To effect the stripping transaction, the trust exchanged the
                                      trust collateral securities for the interest-only receipts and
                                      principal-only receipts, which represented beneficial owner-
                                      ship in the interest payments and principal payments,
                                      respectively. DelCo then purchased the interest-only receipts
                                      for $402 million from the trust. The funds used to purchase
                                      the interest-only receipts were not transferred in accordance
                                      with steps contemplated in the transaction documents.
                                      Instead, BNY transferred $402 million directly to the trust’s
                                      bank account.
                                         Barclays was granted a security interest in the principal-
                                      only and interest-only receipts that were transferred to a
                                      trust security account and DelCo security account, respec-
                                      tively.
                                         For U.K. tax purposes, the trustee treated the $402 million
                                      from the sale of the interest-only receipts as taxable income
                                      at the time of the sale. The U.K. trustee was required to pay




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                                      26                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      U.K. taxes on the taxable income. Under U.S. tax rules, how-
                                      ever, the trust did not report a gain or loss.
                                        The post-tax income from the stripping transaction was
                                      distributed to the class C unit holder in the next monthly
                                      period. BNY received its benefit, a portion of the spread, over
                                      a period of 14 months.
                                        Net the stripping transaction added $402 million in income
                                      to the trust, over and above the monthly target amount, that
                                      was taxable in the United Kingdom and generated additional
                                      trust taxes and foreign tax credits of $88 million in 2001.
                                        BNY ignored the stripping transaction in managing and
                                      disposing of the stripped securities. When the trust manager
                                      sold a stripped security, the trust manager would reconsti-
                                      tute the security and withdraw it from the collateral pool.
                                           F. Management and Control of Trust Assets and DelCo
                                             Assets
                                        The trust manager held absolute discretion in managing
                                      the trust assets. The trust manager delegated its authority
                                      to BNY through a servicing agreement for which BNY
                                      received a monthly fee. BNY also agreed to manage DelCo’s
                                      assets for a monthly fee and was authorized to take any nec-
                                      essary action.
                                           G. Allocation of STARS Risk
                                        BNY and Barclays also took steps to apportion risk associ-
                                      ated with STARS. These steps are as follows.
                                           1. Trust Class C Target Distributions and Indemnity Pay-
                                              ments for Shortfalls
                                         BNY and Barclays executed agreements to protect against
                                      trust target income shortfalls. The class C unit forward sale
                                      agreement provided that InvestCo would pay an indemnity
                                      amount if any class C unit distribution was less than a cer-
                                      tain target amount for each period ($12 million for period 1,
                                      $338 million for period 2 and $30 million for all other
                                      periods). The class C unit indemnity amount equaled addi-
                                      tional U.K. trust taxes (future valued) that the trust would
                                      pay if it met the target class C unit distribution.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    27


                                           2. STARS Termination Rights
                                        BNY and Barclays also included contractual mechanisms
                                      for each party to terminate the STARS transaction on short
                                      notice. Barclays and InvestCo each had the right, with or
                                      without cause, to accelerate the class C unit or the class D
                                      unit forward sale date by serving a notice of a forward sale
                                      date not less than 5 days nor more than 30 days after the
                                      notice (exit provision).
                                           3. Allocation of U.K. Tax Risk
                                         Additionally, BNY and Barclays agreed to certain provi-
                                      sions allocating U.K. tax risk. BNY agreed under one provi-
                                      sion to pay Barclays half of any trust tax that was refunded
                                      if the U.K. tax authority did not respect Barclays’ U.K. tax
                                      position with respect to the trust. In addition, Barclays and
                                      InvestCo agreed under another provision to indemnify each
                                      other for one-half of any U.K. stamp duty reserve tax
                                      imposed as a result of either forward sale agreement.
                                      IV. U.K. Tax Treatment of STARS
                                           A. Disclosure of STARS to the U.K. Tax Authority
                                        Barclays engaged in transactions substantially similar to
                                      STARS with other U.S. banks. Barclays disclosed one of
                                      those transactions to the U.K. tax authority in June 2001
                                      while it was negotiating STARS with BNY. Barclays dis-
                                      closed the STARS transaction in April 2002 to the U.K. tax
                                      authority. The U.K. tax authority advised Barclays that it
                                      agreed with Barclays’ tax reporting of the STARS transaction
                                      in June 2002. The STARS transaction increased tax revenue
                                      for the United Kingdom.
                                           B. U.K. Tax Treatment of the Trust
                                        The trust was treated as an unauthorized unit trust under
                                      U.K. law that qualified as a collective investment scheme
                                      under the applicable U.K. regulatory laws. When the U.K.
                                      trustee replaced the U.S. trustee, the trust became subject to
                                      U.K. tax as a collective investment scheme for purposes of
                                      U.K. law. As a result, the income arising from the trust
                                      assets was treated as income of the U.K. trustee, which was
                                      subject to a 22% U.K. income tax under section 469 of the
                                      U.K. Income and Corporations Taxes Act 1988. That U.K.




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                                      28                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      income tax paid was a liability of the U.K. trustee and not
                                      of any of the trust unit holders. The U.K. trustee owed the
                                      U.K. income tax whether or not the trust made actual dis-
                                      tributions to the trust unit holders.
                                           C. U.K. Tax Treatment of Barclays
                                        Under U.K. law, Barclays, as a trust unit holder, was
                                      deemed to receive annual payments from the trust. Barclays
                                      owed U.K. corporation tax at a 30% rate on those deemed
                                      annual payments even if Barclays did not receive any trust
                                      distributions. The deemed annual payments were equal to
                                      the income available for distribution from the trust to
                                      Barclays as holder of the class C unit and class D unit,
                                      grossed up for 22% U.K. income tax. Barclays was entitled
                                      to a U.K. tax credit of 22% on the deemed annual payment.
                                      Barclays could also claim a U.K. deduction for contributing
                                      the class C unit distributions and for the spread amount paid
                                      to InvestCo through the zero coupon swap.
                                      V. STARS Cashflows
                                        The STARS participants made various payments and
                                      monthly distributions throughout STARS. These payments
                                      and distributions are explained as follows.
                                           A. DelCo Distributions
                                        DelCo held most of the STARS assets at closing. DelCo
                                      made monthly distributions to InvestCo (class 1 shareholder)
                                      and the trust (class 2 shareholder) with InvestCo receiving
                                      1% and the trust receiving the remaining 99%. The monthly
                                      distributions to the trust were sufficient for the trust to meet
                                      the target distributions to Barclays. When DelCo’s income
                                      did not meet projected DelCo distributions, DelCo satisfied
                                      the difference from its cash on hand. BNY also arranged for
                                      the contribution of more income-producing assets to DelCo.
                                           B. Trust Distributions
                                        The trust generated income from the trust assets and
                                      DelCo class 2 distributions. The trust set aside 22% of the
                                      trust income in reserves for U.K. taxes, which were periodi-
                                      cally sent to the U.K. tax authority. The remaining income
                                      was distributed monthly to trust unit holders.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    29


                                         The trust made monthly class C unit distributions to the
                                      Barclays blocked account. Those distributions were approxi-
                                      mately equal to the corresponding target distribution
                                      amounts. Barclays immediately contributed these distribu-
                                      tions to the trust to satisfy its obligation to pay further
                                      subscription amounts. The trust also made the required
                                      monthly class D unit distributions to Barclays. Barclays
                                      retained all of these distributions, totaling $7 million over
                                      the term of STARS.
                                         Finally, the trust made monthly contributions to DelCo of
                                      amounts at least equaling but often substantially exceeding
                                      the corresponding contributed income amount from the
                                      Barclays blocked account starting after the first nine months
                                      of STARS.
                                           C. Zero Coupon Swap and Credit Default Swap Payments
                                        InvestCo or Barclays made monthly payments as required
                                      under the zero coupon swap. LIBOR was 2.09% when STARS
                                      closed and stayed below 3% until almost mid-2005. During
                                      that period, the spread due from Barclays under the zero
                                      coupon swap was greater than the LIBOR plus 30 basis
                                      points amount due from InvestCo. Barclays made net pay-
                                      ments to InvestCo under the zero coupon swap of $12 million
                                      for 2001 and $51 million for 2002. Over the life of STARS,
                                      Barclays made net payments to BNY of $82.6 million under
                                      the floating leg of the zero coupon swap. Additionally,
                                      Barclays made all required payments to BNY under the
                                      credit default swap.
                                      VI. Termination of STARS
                                        STARS wound down and eventually terminated in late
                                      2006 when InvestCo and Barclays fulfilled their obligations
                                      under the forward sale agreements and the zero coupon
                                      swap.
                                      VII. BNY Tax Reporting of STARS
                                        The trust, DelCo and NewCo each filed Forms 1065, U.S.
                                      Return of Partnership Income, for the years at issue. BNY
                                      reported the income from the STARS assets as income on its
                                      U.S. consolidated return. It reported this income, however, as
                                      foreign source. BNY claimed foreign tax credits of




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                                      30                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      $98,607,973 and $100,285,767 for 2001 and 2002, respec-
                                      tively, for payments made to the U.K. tax authority with
                                      respect to the trust income.
                                         BNY treated the payments made to Barclays on the class
                                      D unit distributions as a component of interest on the loan.
                                      With respect to the floating leg of the zero coupon swap, BNY
                                      netted the spread component and the LIBOR plus 30 basis
                                      points component of the zero coupon swap. This treatment
                                      effectively resulted in BNY claiming an interest deduction for
                                      the LIBOR plus 30 basis points interest amount (zero coupon
                                      swap interest) for the years at issue as the spread component
                                      exceeded the zero coupon swap interest component for each
                                      year. BNY reduced unrelated interest expense by the net
                                      payments Barclays made to InvestCo under the zero coupon
                                      swap for the years at issue.
                                         BNY claimed $835,100 and $6,753,720 as deductible
                                      expenses, fees and transaction costs for 2001 and 2002,
                                      respectively.
                                      VIII. Deficiency Notice
                                        Respondent timely issued a deficiency notice to petitioner
                                      and adjusted petitioner’s taxable income by disallowing the
                                      foreign tax credits, disallowing deductions for interest and
                                      transaction costs, and reclassifying income related to the
                                      STARS transaction as U.S. source income.

                                                                                  OPINION

                                         This complex transaction presents a case of first impres-
                                      sion in this Court. We are asked to decide whether petitioner
                                      is entitled to foreign tax credits and certain expense deduc-
                                      tions from the STARS transaction and also whether peti-
                                      tioner is entitled to report income generated from the STARS
                                      assets as foreign source income. Respondent argues that the
                                      STARS transaction lacked economic substance. Respondent
                                      asserts consequently that the foreign tax credits and
                                      expenses attributable to STARS should be disallowed and the
                                      income from the STARS assets should be characterized as
                                      U.S. source. 7 Petitioner, in contrast, contends the STARS
                                        7 Respondent also argues that the foreign tax credits BNY claimed are

                                      disallowed under substance over form doctrines (including the step trans-
                                      action doctrine) and under the statutory anti-abuse rule in sec. 269(a). We




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    31


                                      transaction had economic substance. In this regard, peti-
                                      tioner asserts that BNY entered into STARS to obtain low-
                                      cost funding for its banking business and that it reasonably
                                      expected to earn a pre-tax profit from STARS. Additionally,
                                      petitioner contends that the U.S. foreign tax credit was
                                      intended for transactions like STARS.
                                         We agree with respondent. The STARS transaction was
                                      structured to meet the relevant requirements in the Code
                                      and the regulations for claiming the disputed foreign tax
                                      credits. The STARS transaction in essence, however, was an
                                      elaborate series of pre-arranged steps designed as a subter-
                                      fuge for generating, monetizing and transferring the value of
                                      foreign tax credits among the STARS participants. We now
                                      turn to the merits of the STARS transaction under the eco-
                                      nomic substance doctrine.
                                      I. Merits of the STARS Transaction Under the Economic Sub-
                                         stance Doctrine
                                           A. Overview
                                         Taxpayers may structure business transactions in a
                                      manner that results in the least amount of tax. See Boulware
                                      v. United States, 552 U.S. 421, 430 n.7 (2008) (citing Gregory
                                      v. Helvering, 293 U.S. 465, 469 (1935)); Gerdau Macsteel, Inc.
                                      v. Commissioner, 139 T.C. 67, 168 (2012). Courts have also
                                      long recognized, however, that even if a transaction complies
                                      literally with the Code, it does not necessarily follow that
                                      Congress intended to cover the transaction and allow a tax
                                      benefit. Knetsch v. United States, 364 U.S. 361, 365 (1960);
                                      Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), aff ’d,
                                      293 U.S. 465 (1935). In Frank Lyon Co. v. United States, 435
                                      U.S. 561, 583–584 (1978), the Supreme Court explained the
                                      circumstances in which a transaction should be respected for
                                      tax purposes:
                                           [W]here, as here, there is a genuine multiple-party transaction with eco-
                                           nomic substance which is compelled or encouraged by business or regu-
                                           latory realities, is imbued with tax-independent considerations, and is
                                           not shaped solely by tax-avoidance features that have meaningless labels
                                           attached, the Government should honor the allocation of rights and
                                           duties effectuated by the parties. * * *

                                      need not decide these arguments because of our other holdings.




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                                      32                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                         The Courts of Appeals have interpreted that language as
                                      creating an ‘‘economic substance doctrine’’ with the following
                                      two prongs: (1) whether the transaction had economic sub-
                                      stance beyond tax benefits (objective prong), and (2) whether
                                      the taxpayer had shown a non-tax business purpose for
                                      entering into the disputed transaction (subjective prong). See
                                      Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. at 169;
                                      Reddam v. Commissioner, T.C. Memo. 2012–106; see also
                                      New Phoenix Sunrise Corp. & Subs. v. Commissioner, 132
                                      T.C. 161, 175 (2009), aff ’d, 408 Fed. Appx. 908 (6th Cir.
                                      2010); Blum v. Commissioner, T.C. Memo. 2012–16.
                                         There is a split among the Courts of Appeals, however, as
                                      to the proper application of the economic substance doctrine,
                                      and alternative approaches have emerged. Some Courts of
                                      Appeals require that a valid transaction have economic sub-
                                      stance or a non-tax business purpose. See, e.g., Horn v.
                                      Commissioner, 968 F.2d 1229, 1236–1238 (D.C. Cir. 1992),
                                      rev’g Fox v. Commissioner, T.C. Memo. 1988–570; Rice’s
                                      Toyota World, Inc. v. Commissioner, 752 F.2d 89, 91 (4th Cir.
                                      1985), aff ’g in part, rev’g in part 81 T.C. 184 (1983). Other
                                      Courts of Appeals require a valid transaction have both eco-
                                      nomic substance and a non-tax business purpose. See Dow
                                      Chem. Co. v. United States, 435 F.3d 594, 599 (6th Cir.
                                      2006); Winn-Dixie Stores, Inc. v. Commissioner, 254 F.3d
                                      1313, 1316 (11th Cir. 2001), aff ’g 113 T.C. 254 (1999); United
                                      Parcel Serv. of Am., Inc. v. Commissioner, 254 F.3d 1014,
                                      1018 (11th Cir. 2001), rev’g T.C. Memo. 1999–268. Still other
                                      Courts of Appeals adhere to the view that a lack of economic
                                      substance is sufficient to invalidate a transaction regardless
                                      of the taxpayer’s subjective motivation. See, e.g., Coltec
                                      Indus., Inc. v. United States, 454 F.3d 1340, 1355 (Fed. Cir.
                                      2006). And still other Courts of Appeals treat the objective
                                      and subjective prongs merely as factors to consider in deter-
                                      mining whether a transaction has any practical economic
                                      effects beyond tax benefits. See, e.g., ACM P’ship v. Commis-
                                      sioner, 157 F.3d 231, 248 (3d Cir. 1998), aff ’g in part, rev’g
                                      in part T.C. Memo. 1997–115.
                                         An appeal in this case would lie to the Court of Appeals
                                      for the Second Circuit absent stipulation to the contrary,
                                      and, accordingly, we follow the law of that circuit to the
                                      extent it is directly on point. See Golsen v. Commissioner, 54
                                      T.C. 742 (1970), aff ’d, F.2d 985 (10th Cir. 1971). The Court




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    33


                                      of Appeals for the Second Circuit has endorsed applying a
                                      flexible analysis in assessing economic substance. Gilman v.
                                      Commissioner, 933 F.2d 143 (2d Cir. 1991), aff ’g T.C. Memo.
                                      1989–684; Long Term Capital Holdings v. United States, 330
                                      F. Supp. 2d 122 (D. Conn. 2004), aff ’d, 150 Fed. Appx. 40 (2d
                                      Cir. 2005). The analysis evaluates both the subjective busi-
                                      ness purpose of the taxpayer for engaging in the transaction
                                      and the objective economic substance of the transaction.
                                      Gilman v. Commissioner, 933 F.2d at 148; Long Term Cap-
                                      ital Holdings, 330 F. Supp. 2d at 171. These distinct aspects
                                      of the economic substance inquiry do not, however, constitute
                                      discrete prongs of a rigid two-step analysis. Long Term Cap-
                                      ital Holdings, 330 F. Supp. 2d at 171 n.68; see also Gilman
                                      v. Commissioner, 933 F.2d at 148. They are instead simply
                                      more precise factors to consider in the overall inquiry of
                                      whether the transaction had any practical economic effects
                                      other than the creation of tax losses. Altria Grp. Inc. v.
                                      United States, 694 F. Supp. 2d 259, 282 (S.D.N.Y. 2010),
                                      aff ’d, 658 F.3d 276 (2d Cir. 2011); Long Term Capital
                                      Holdings, 330 F. Supp. 2d at 171 n.68. A finding of a lack
                                      of either economic substance or a non-tax business purpose
                                      can be but is not necessarily sufficient for a court to conclude
                                      that a transaction is invalid for Federal tax purposes. Altria
                                      Grp., Inc., 694 F. Supp. 2d at 282; Long Term Capital
                                      Holdings, 330 F. Supp. 2d at 171 n.68. The ultimate deter-
                                      mination of whether a transaction lacks economic substance
                                      is a question of fact. See Nicole Rose Corp. v. Commissioner,
                                      320 F.3d 282, 284 (2d Cir. 2003), aff ’g 117 T.C. 328 (2001).
                                      We now turn to the scope of the economic substance doctrine.
                                           B. Scope of the Economic Substance Inquiry
                                         The first step in the economic substance inquiry is to iden-
                                      tify the transaction to be analyzed. See, e.g., Sala v. United
                                      States, 613 F.3d 1249, 1252 (10th Cir. 2010). Petitioner
                                      argues that we should analyze the components of the STARS
                                      transaction as an integrated arrangement for purposes of
                                      testing economic substance. In contrast, respondent argues
                                      that we should bifurcate the STARS transaction and focus on
                                      the STARS structure, not the loan, for purposes of testing
                                      economic substance. We agree with respondent.
                                         The relevant transaction to be tested is the one that pro-
                                      duces the disputed tax benefit, even if it is part of a larger




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                                      34                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      set of transactions or steps. 8 See Nicole Rose Corp. v.
                                      Commissioner, 320 F.3d at 284; Kipnis v. Commissioner, T.C.
                                      Memo. 2012–306; Country Pine Fin., LLC v. Commissioner,
                                      T.C. Memo. 2009–251; Long Term Capital Holdings, 330 F.
                                      Supp. 2d at 183; see also Sala, 613 F.3d at 1252; Klamath
                                      Strategic Inv. Fund v. United States, 568 F.3d 537, 545 (5th
                                      Cir. 2009); Coltec Indus., Inc., 454 F.3d at 1352–1355; Black
                                      & Decker Corp. v. United States, 436 F.3d 431, 436 (4th Cir.
                                      2006); ACM P’ship v. Commissioner, 157 F.3d at 260 n.57.
                                      Stated another way, the requirements of the economic sub-
                                      stance doctrine are not avoided simply by coupling a routine
                                      transaction with a transaction lacking economic substance.
                                      See, e.g., Long Term Capital Holdings, 330 F. Supp. 2d at
                                      183; see also ACM P’ship v. Commissioner, 157 F.3d at 260
                                      n.57. A contrary application would undermine the flexibility
                                      and efficacy of the economic substance doctrine.
                                         Accordingly, we focus our economic substance inquiry on
                                      the transaction that gave rise to the disputed foreign tax
                                      credits. The disputed foreign tax credits were generated by
                                      circulating income through the STARS structure. In contrast,
                                      the loan was not necessary for the STARS structure to
                                      produce the disputed foreign tax credits. It is the use of the
                                      STARS structure then that is relevant and that we test for
                                      economic substance.
                                           C. Economic Substance of the STARS Structure
                                           1. Objective Economic Substance
                                        We first consider whether BNY’s use of the STARS struc-
                                      ture had objective economic substance. The Court of Appeals
                                      for the Second Circuit in evaluating objective economic sub-
                                      stance focuses on whether the relevant transaction created a
                                      reasonable opportunity for economic profit; i.e., profit exclu-
                                      sive of tax benefits. Gilman v. Commissioner, 933 F.2d at
                                           8 Congress
                                                    noted when codifying the economic substance doctrine in sec.
                                      7701 in 2010 that under present law courts could ‘‘bifurcate a transaction
                                      in which independent activities with non-tax objectives are combined with
                                      an unrelated item having only tax avoidance objectives to disallow those
                                      tax motivated benefits.’’ Staff of Jt. Comm. on Taxation, Technical Expla-
                                      nation of the Revenue Provisions of the ‘‘Reconcilliaton Act of 2010’’ as
                                      amended, in combination with the ‘‘Patient Protection and Affordable Care
                                      Act’’ 153 & n.352 (J. Comm. Print 2010).




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    35


                                      148; Long Term Capital Holdings, 330 F. Supp. 2d at 172.
                                      Accordingly, we must determine whether use of the STARS
                                      structure created a reasonable opportunity for economic
                                      profit. Respondent argues that it did not. We agree and thus
                                      find that the use of the STARS structure lacked objective
                                      economic substance.
                                         The record reflects that BNY did not have a reasonable
                                      expectation that it would make a non-tax economic profit
                                      from using the STARS structure. First, the STARS structure
                                      did not increase the profitability of the STARS assets in any
                                      way. To the contrary, it reduced their profitability by adding
                                      substantial transaction costs, e.g., professional service fees
                                      and foreign taxes incurred as result of using the STARS
                                      structure. 9
                                         Additionally, the activities or transactions that the STARS
                                      structure was used to engage in did not provide a reasonable
                                      opportunity for economic profit. The STARS structure’s main
                                      activity was to circulate income between itself and Barclays.
                                      Every month, as pre-arranged, DelCo would transfer pre-
                                      determined amounts of income to the trust. Substantially all
                                      of the trust income was distributed to the Barclays blocked
                                        9 We have previously held that foreign taxes are economic costs for pur-

                                      poses of the economic substance doctrine. See Compaq Computer Corp. v.
                                      Commissioner, 113 T.C. 214 (1999), rev’d, 277 F.3d 778, 785 (5th Cir.
                                      2001). We are mindful that the Courts of Appeals for the Fifth and Eighth
                                      Circuits have subsequently held that foreign taxes should not be taken
                                      into account in evaluating pre-tax effects for purposes of the economic sub-
                                      stance analysis. See IES Indus., Inc. v. United States, 253 F.3d 350 (8th
                                      Cir. 2001); Compaq Computer Corp. v. Commissioner, 277 F.3d 778, 785
                                      (5th Cir. 2001), rev’g 113 T.C. 214 (1999). Nevertheless, the Supreme Court
                                      and the Court of Appeals for the Second Circuit have yet to consider the
                                      issue, and we are not bound by Fifth and Eighth Circuit precedent here.
                                        We maintain the position we took in Compaq Computer with respect to
                                      foreign taxes in the economic substance context. Economically, foreign
                                      taxes are the same as any other transaction cost. And we cannot find any
                                      conclusive reason for treating them differently here, especially because
                                      substantially all of the foreign taxes giving rise to the foreign tax credits
                                      stemmed from economically meaningless activity, i.e., the pre-arranged cir-
                                      cular cashflows engaged in by the trust.
                                        Additionally, excluding the economic effect of foreign taxes from the pre-
                                      tax analysis would fundamentally undermine the point of the economic
                                      substance inquiry. That point is to remove the challenged tax benefit and
                                      evaluate whether the relevant transaction makes economic sense. See In
                                      re CM Holdings, Inc., 301 F.3d 96, 105 (3d Cir. 2002).




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                                      36                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      account, which in turn was immediately recontributed to the
                                      trust and then passed back to DelCo where it was available
                                      for BNY’s use. These circular cashflows or offsetting pay-
                                      ments had no non-tax economic effect.
                                         Courts have consistently recognized that the presence of
                                      circular cashflows strongly indicates that a transaction lacks
                                      economic substance. See Altria Grp., Inc., 658 F.3d at 289
                                      (citing AWG Leasing Trust v. United States, 592 F. Supp. 2d
                                      953, 983 (N.D. Ohio 2008)) (circular payments from and back
                                      to foreign bank ‘‘strongly indicate’’ that SILO transaction
                                      ‘‘has little substantive business purpose other than gener-
                                      ating tax benefits’’); Merryman v. Commissioner, 873 F.2d
                                      879, 882 (5th Cir. 1989) (tax structuring disregarded where
                                      ‘‘money flowed back and forth but the economic positions of
                                      the parties were not altered’’), aff ’g T.C. Memo. 1988–72;
                                      Prof ’l Servs. v. Commissioner, 79 T.C. 888, 928 (1982) (dis-
                                      regarding pre-arranged circular cashflows through a trust);
                                      see also Knetsch, 364 U.S. at 366 (offsetting payments on
                                      annuity bond and notes resulted in sham). This follows from
                                      the common sense proposition that a taxpayer is not entitled
                                      to benefits from circular transfers the net result of which is
                                      effectively nothing.
                                         The STARS structure was also used in connection with the
                                      stripping transaction. The stripping transaction too resulted
                                      in a circular cashflow and did not provide a reasonable
                                      opportunity for economic profit. In particular, the trust sold
                                      its right to interest income from the trust collateral securi-
                                      ties to DelCo for a lump-sum payment taxable in the United
                                      Kingdom, which DelCo made with funds provided by BNY.
                                      This reallocated the income and principal payments associ-
                                      ated with the trust collateral securities within the STARS
                                      structure. It did not alter the amount and timing of the
                                      cashflows generated by the underlying assets. And because
                                      the sale of the interest rights was funded by BNY and
                                      between entities within the STARS structure, the stripping
                                      transaction had no potential to generate a non-tax economic
                                      profit on the aggregate.
                                         Petitioner argues that we should consider the income gen-
                                      erated by the STARS assets in evaluating whether the
                                      STARS structure had a reasonable opportunity for economic
                                      profit. We disagree. Economic benefits that would result
                                      independent of a transaction do not constitute a non-tax ben-




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    37


                                      efit for purposes of testing its economic substance. See
                                      Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. at 174.
                                      Stated otherwise, benefits that are unrelated to the trans-
                                      action cannot be what motivates a taxpayer to engage in the
                                      transaction and therefore are of no aid in determining
                                      whether the taxpayer would have engaged in the transaction
                                      absent the tax effects. Id.
                                         Here, BNY’s control and management over the STARS
                                      assets did not materially change as a result of their transfer
                                      to the STARS structure. 10 Additionally, the STARS structure
                                      had no effect on the income stream generated by the STARS
                                      assets. Accordingly, the STARS assets would have generated
                                      the same income regardless of being transferred to the trust.
                                      Thus, income from the STARS assets was not an incremental
                                      benefit of STARS.
                                           2. Subjective Economic Substance
                                         We now turn to the subjective prong of the economic sub-
                                      stance analysis. This prong requires us to determine whether
                                      BNY had a legitimate non-tax business purpose for the use
                                      of the STARS structure. See Long Term Capital Holdings,
                                      330 F. Supp. 2d at 186. We find it did not. Petitioner claims
                                      that it used the STARS structure to obtain ‘‘low cost
                                      financing’’ from Barclays. 11 The record does not support peti-
                                      tioner’s claimed business purpose. The STARS structure
                                      lacked any reasonable relationship to the loan. And the loan
                                      was not ‘‘low cost.’’ To the contrary, it was significantly over-
                                      priced and required BNY to incur substantially more trans-
                                      action costs than a similar financing available in the market-
                                      place. We find that petitioner failed to establish a valid busi-
                                           10 DelCoheld most of the income-generating STARS assets with the
                                      trust holding the remaining STARS assets. BNY directly or indirectly held
                                      all the voting rights of DelCo, the initial and successor trustee of the trust
                                      and the trust manager, and thus effectively controlled those entities. In ad-
                                      dition, BNY executed servicing agreements that gave BNY control over the
                                      management of the STARS assets the trust and DelCo held.
                                        11 Petitioner’s experts opined on several other potential business pur-

                                      poses at trial. The record does not support, however, that BNY con-
                                      templated those suggested business purposes at the time it participated in
                                      STARS. We therefore reject these after-the-fact rationalizations. See, e.g.,
                                      Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. 254, 285–286 (1999),
                                      aff ’d, 254 F.3d 1313 (11th Cir. 2001).




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                                      38                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      ness purpose and BNY’s true motivation was tax avoidance.
                                      We base our finding on our analysis of the following factors.
                                           a. The STARS Structure Lacked a Reasonable Relationship
                                              to Petitioner’s Claimed Business Purpose.
                                         Using unreasonable means to achieve a claimed business
                                      purpose indicates that the taxpayer’s true motivation for the
                                      transaction is tax avoidance. See Long Term Capital
                                      Holdings, 330 F. Supp. 2d at 186–187; see also Cherin v.
                                      Commissioner, 89 T.C. 986, 993–994 (1987); CMA Consol.,
                                      Inc. & Subs. v. Commissioner, T.C. Memo. 2005–16. We now
                                      consider the relationship between the STARS structure and
                                      petitioner’s claimed business purpose. Petitioner suggests
                                      that the class C unit and the class D unit Barclays held
                                      served as collateral for the loan. We are not persuaded.
                                         BNY’s obligation with respect to the loan was more than
                                      adequately secured by other arrangements independent of
                                      the trust. Barclays held a security interest in a pool of high-
                                      quality assets valued at $2.25 billion, creating a
                                      collateralization level of 150%. Respondent’s expert Steven
                                      Schwarcz concluded that the collateralization level (e.g.,
                                      securitization) in a structured finance transaction is usually
                                      around 10% and that the loan was substantially over
                                      collateralized. In addition to the collateral arrangements,
                                      Barclays effectively had full recourse to BNY itself for repay-
                                      ment through the credit default swap.
                                         Petitioner’s expert W. Clifford Atherton suggested that the
                                      special-purpose entities making up the STARS structure
                                      served a project financing (a type of structured financing
                                      transaction) function. We disagree. Respondent’s expert Mr.
                                      Schwarcz emphasized that special-purpose entities are typi-
                                      cally used in connection with a structured financing trans-
                                      action to efficiently reallocate risk and reduce information
                                      asymmetry. 12 Mr. Schwarcz also highlighted that structured
                                      financing transactions generally involve special-purpose enti-
                                      ties incurring debt and using the proceeds to finance the
                                        12 Mr. Schwarcz defined ‘‘information asymmetry’’ as a scenario in which

                                      one party has more information than the other party. According to Mr.
                                      Schwarcz, structured financing transactions reduce information asymmetry
                                      by allowing parties taking on risk to more efficiently assess that risk, typi-
                                      cally by creating well-defined, easily-valued and bankruptcy-protected
                                      sources of repayment.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    39


                                      acquisition of income-producing assets. And the lenders look
                                      to the cash produced by those assets for repayment, bearing
                                      the risk that the cash will be insufficient to repay the debt.
                                         These common indicia of a structured financing transaction
                                      are not present in STARS. The loan proceeds were not used
                                      to purchase the STARS assets, and Barclays did not look to
                                      any assets purchased with the financing proceeds for repay-
                                      ment. And unlike a typical structured financing transaction,
                                      the special-purpose entities in STARS did not function to effi-
                                      ciently reallocate risk.
                                         In this regard, Mr. Schwarcz observed that STARS simply
                                      involved a full-recourse secured financing. Mr. Schwarcz cor-
                                      rectly concluded that, given the characteristics of the loan,
                                      Barclays could have made the same $1.5 billion loan to BNY,
                                      secured by the same assets constituting the collateral for the
                                      loan, using only a loan agreement and a security agreement.
                                      Such an arrangement would have been much simpler,
                                      avoided the use of the special-purpose entities and had
                                      substantially lower transaction costs than STARS.
                                         Efficiency aside, Mr. Schwarcz concluded that the special-
                                      purpose entities used in the STARS transaction did not ‘‘real-
                                      istically’’ function to transfer risk between the parties. Mr.
                                      Schwarcz opined that the overcollateralization level of the
                                      loan and the other security arrangements minimized
                                      Barclays’ risk with respect to the loan. Accordingly, there
                                      was no significant risk for the special-purpose entities to
                                      transfer.
                                         Finally, Mr. Schwarcz concluded that the STARS structure
                                      did not reduce information asymmetry between the parties.
                                      In contrast, he opined that STARS was excessively complex
                                      given the economics of the loan and arguably increased
                                      information asymmetry. We agree with Mr. Schwarcz that
                                      the STARS structure did not perform a structured financing
                                      function.
                                         Petitioner finally argues more generally that Barclays
                                      made the loan contingent on the STARS structure and there-
                                      fore the two transactions were ‘‘commercially linked.’’ Again,
                                      we are not persuaded. Making a routine business transaction
                                      contingent on an economically meaningless transaction, like
                                      the STARS structure, is insufficient to establish that the
                                      nexus between the two is reasonable. See, e.g., Long Term
                                      Capital Holdings, 330 F. Supp. 2d at 183.




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                                      40                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                        In sum, the record does not support that the STARS struc-
                                      ture performed any significant banking, commercial or busi-
                                      ness function with respect to the loan. Consequently, we find
                                      that the STARS structure did not bear a reasonable relation-
                                      ship to the loan. This lack of reasonableness indicates BNY’s
                                      true motivation—tax avoidance.
                                           b. The STARS Financing Was Not Low Cost.
                                        We now evaluate petitioner’s claimed business purpose
                                      that the loan was ‘‘low cost.’’ Respondent argues that the
                                      spread should be disregarded in determining the cost of the
                                      loan and that the loan was overpriced absent the spread. We
                                      address each of respondent’s contentions in turn.
                                           i. The Spread Was Not a Component of Interest.
                                         We now consider whether the spread should be disregarded
                                      in determining the cost of the loan. Respondent argues that
                                      it should because the spread in substance was a tax effect
                                      and not a component of interest. We agree.
                                         We are mindful in evaluating the substance of the spread
                                      that labels and characterizations do not determine the tax
                                      consequences where they are inconsistent with economic
                                      realities. Frank Lyon Co., 435 U.S. at 583–584 (labels must
                                      be economically meaningful); TIFD III–E, Inc. v. United
                                      States, 459 F.3d 220 (2d Cir. 2006); Saba P’ship v. Commis-
                                      sioner, T.C. Memo. 2003–31 (payments characterized as con-
                                      sulting fees held to be a guaranteed return to a purported
                                      partner).
                                         The stated interest rate on the loan was LIBOR plus 30
                                      basis points less the spread. The spread was a fixed amount
                                      equal to one-half the present value of the U.K. taxes the
                                      trust was expected to pay on the target class C unit income
                                      each month. We acknowledge the spread was part of the for-
                                      mula for calculating the interest expense on the loan. Its
                                      substance did not match, however, its form.
                                         Respondent’s expert Anthony Saunders opined on the
                                      commerciality of the loan’s pricing. Mr. Saunders noted that
                                      the pricing of a loan generally depends on the time value of
                                      money and the risks presented to the lender through the par-
                                      ticular loan transaction. Mr. Saunders also noted that here
                                      the loan’s cost was such that Barclays could not reasonably
                                      expect that the return (i.e., interest) it received from BNY




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    41


                                      would exceed Barclays’ cost of funds. He further noted that,
                                      independent of Barclays’ cost of funds, the interest rate was
                                      ‘‘negative’’ for most of the tenure of the loan. That is, the
                                      ‘‘lender’’ (Barclays) was paying the ‘‘borrower’’ (BNY) to bor-
                                      row its funds. Mr. Saunders concluded that the loan’s pricing
                                      did not reflect the risk inherent in the STARS transaction
                                      and more generally that the loan fundamentally deviated
                                      from attributes of a standard banking transaction. He fur-
                                      ther concluded that there were no unique economic condi-
                                      tions that might explain the non-economic pricing.
                                          Respondent’s expert Mr. Schwarcz also opined on the
                                      commerciality of the loan. Like Mr. Saunders, Mr. Schwarcz
                                      noted that the loan had a ‘‘negative interest rate.’’ Mr.
                                      Schwarcz opined that, in an arm’s-length commercial lending
                                      transaction, a loan would not bear a negative interest rate,
                                      absent unique circumstances external to the loan, e.g., to
                                      avoid a loss or to effect government policy, such as stimulus.
                                      He noted that it makes no economic sense for a lender to pay
                                      a borrower interest on a loan absent such a circumstance. He
                                      concluded there were no special circumstances that war-
                                      ranted the loan bearing a ‘‘negative interest rate’’ and the
                                      loan was not commercially reasonable.
                                          Respondent’s expert Michael Cragg analyzed the pricing of
                                      the loan, including the economics of the spread. He concluded
                                      that circulating income through the STARS structure gen-
                                      erated the economic benefit labeled the ‘‘spread’’ by com-
                                      bining certain U.S. and U.K. tax effects. Mr. Cragg’s analysis
                                      showed that it would not have been economically beneficial
                                      for Barclays to pay BNY the spread absent the U.K. tax
                                      benefits from STARS. Similarly, Mr. Cragg’s analysis showed
                                      that the STARS arrangement would not have been beneficial
                                      to BNY absent the foreign tax credits arising from the pay-
                                      ment of U.K. tax on the trust income. Mr. Cragg ultimately
                                      concluded that the spread was economically derived and
                                      contingent on the parties receiving certain U.S. and U.K. tax
                                      treatment with respect to the STARS structure and as a
                                      result was not a pre-tax cashflow.
                                          Petitioner denies that the spread was a tax effect because
                                      it was not expressly contingent on either Barclays or BNY
                                      receiving any particular U.S. or U.K. tax treatment or ben-
                                      efit. In this regard, petitioner asserts that BNY could under
                                      certain circumstances keep the spread Barclays paid even if




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                                      42                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      Barclays did not realize its expected U.K. benefits. 13 And
                                      petitioner asserts that Barclays’ obligation to pay the spread
                                      did not vary depending on whether BNY’s U.S. tax treatment
                                      was respected.
                                         Petitioner’s argument is unpersuasive. The manner in
                                      which the parties agreed to allocate tax risk does not pre-
                                      clude the spread from being a tax effect. The spread’s value
                                      was derivative of expected U.S. and U.K. tax effects. And it
                                      would not have been paid going forward if either of those
                                      effects had been foreclosed. Indeed, STARS would no longer
                                      be economically beneficial to either BNY or Barclays and
                                      each could terminate STARS on short notice. 14
                                         In sum, we agree with respondent’s experts. The spread
                                      artificially reduced the loan’s cost and lacked economic
                                      reality. In substance the spread was contingent on the par-
                                      ties’ anticipated tax treatment and was unrelated to the time
                                      value of money or the attendant risks associated with the
                                      loan. We conclude, on the record as a whole, that the spread
                                      was in substance not a component of loan interest.
                                         13 If the U.K. tax authority determined that the trust was not a collec-

                                      tive investment scheme before the due date of the U.K. trust tax, BNY
                                      could keep the spread paid to date even though Barclays would not realize
                                      the anticipated U.K. tax benefits. After the first due date of U.K. tax on
                                      trust income, however, BNY was obligated to pay Barclays half of any
                                      STARS trust tax that would be refunded if the U.K. tax authority did not
                                      respect Barclays’ tax position with respect to the STARS structure. That
                                      amount would be roughly equal to spread payments BNY had received.
                                         We note that the risk of having to pay the spread before the first due
                                      date without realizing the anticipated U.K. benefits was likely minimal.
                                      According to petitioner’s U.K. regulatory expert, Michael Brindle, Q.C., the
                                      U.K. tax authority would likely view the STARS structure as a collective
                                      investment scheme. In addition, the STARS structure was promptly sub-
                                      mitted to the U.K. tax authority for approval and a similar transaction
                                      was already under review. And on net the STARS transaction added rev-
                                      enue to the U.K. relative to its position without the STARS transaction,
                                      increasing the likelihood that the U.K. tax authority would view the
                                      STARS structure favorably.
                                         14 Petitioner concedes that Barclays agreed to pay the spread based upon

                                      expected U.K. tax benefits and that the spread was calculated as a per-
                                      centage of the present value of those benefits. Those U.K. tax benefits de-
                                      pended on the vitality of the trust structure whose economic rationality for
                                      BNY depended on BNY receiving a U.S. foreign tax credit for U.K. tax
                                      paid on trust income as the spread equaled only half of the U.K. tax. Ac-
                                      cordingly, Barclays’ U.K. tax benefit could not be achieved without BNY
                                      achieving its U.S. tax benefit.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    43


                                        The spread rather was a tax effect. It was embedded in the
                                      loan to serve as a device for monetizing and transferring the
                                      value of anticipated foreign tax credits generated from
                                      routing income through the STARS structure. That the gen-
                                      erated tax savings were used to offset the cost of the loan
                                      does not provide a valid non-tax purpose. Indeed, courts have
                                      consistently recognized that intending to use tax savings
                                      from a transaction lacking economic substance to underwrite
                                      or enhance the commercial terms of a legitimate business
                                      transaction does not constitute a valid non-tax purpose. See
                                      Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. at 287; see
                                      also Am. Elec. Power Co., Inc. v. United States, 326 F.3d 737,
                                      744 (6th Cir. 2003) (‘‘Money generated by means of abusive
                                      tax deductions can always be applied to beneficial causes, but
                                      the eventual use of the money thus generated is not part of
                                      the economic sham analysis.’’).
                                           ii. The Loan Was Not Low Cost.
                                          We now turn to respondent’s contention the loan was not
                                      ‘‘low cost’’ absent the spread. Mr. Cragg compared the loan
                                      to available market financing. He opined that the loan was
                                      a secured, highly collateralized loan, cancellable within 5 to
                                      30 days. He further opined that comparable short-term
                                      financing, both secured and unsecured, for a borrower similar
                                      to BNY is typically obtained through highly efficient and
                                      standardized interbank relationships at or below an interest
                                      rate of 1-month LIBOR and de minimis transaction costs
                                      (market benchmark loan). Absent the spread adjustment, the
                                      loan’s interest rate (LIBOR plus 20 basis points) was above
                                      the market benchmark loan. Beyond the additional interest
                                      expense, the loan required BNY to incur substantial trans-
                                      action costs in the form of professional service fees and for-
                                      eign taxes that would not exist in a comparable market
                                      financing. 15 In short, BNY could have obtained comparable
                                      financing in the market place at substantially less economic
                                      cost than that obtained through STARS. We find that the
                                      loan was not ‘‘low cost.’’
                                         15 We note that, regardless of how the spread is characterized, the ben-

                                      efit of the spread was more than offset by the additional transaction costs
                                      that BNY incurred to obtain the spread.




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                                      44                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                           D. Economic Substance of the Integrated STARS Arrange-
                                              ment
                                         The STARS transaction still lacks economic substance even
                                      if the STARS structure and the loan are evaluated as an
                                      integrated transaction. Petitioner contends that the
                                      integrated STARS transaction has objective economic sub-
                                      stance because it offered a reasonable opportunity for pre-tax
                                      profit. Petitioner asked its expert Mr. Atherton to calculate
                                      the pre-tax profitability of the STARS transaction. Mr. Ath-
                                      erton concluded that BNY reasonably could have expected a
                                      profit of more than $1.6 billion before taking into account
                                      U.K. or U.S. income taxes over the life of the STARS trans-
                                      action.
                                         We find that Mr. Atherton’s analysis of STARS’ pre-tax
                                      profitability contains several critical flaws and is therefore
                                      not helpful to the Court. One such flaw with Mr. Atherton’s
                                      pre-tax profitability calculation is that he includes income
                                      from the STARS assets as revenues arising from the STARS
                                      transaction. As we previously held, the pre-existing cashflows
                                      from the trust assets are not incremental to the STARS
                                      transaction and therefore irrelevant to the objective economic
                                      substance analysis.
                                         Mr. Atherton’s pre-tax profitability analysis is also flawed
                                      because he includes returns on asset-backed securities he
                                      assumes BNY contemplated acquiring with the loan pro-
                                      ceeds. Only cashflows arising from the transaction whose eco-
                                      nomic substance is at issue are relevant to the pre-tax profit-
                                      ability analysis. See Nicole Rose Corp. v. Commissioner, 320
                                      F.3d at 284 (rejecting the taxpayer’s argument that profits
                                      from an unrelated asset sale should be attributed to a lease
                                      transaction generating the tax benefits at issue); ACM P’ship
                                      v. Commissioner, 157 F.3d at 260 (disregarding profits from
                                      funds acquired in a transaction and invested outside of the
                                      structure being evaluated for economic substance); see also
                                      Kipnis v. Commissioner, T.C. Memo. 2012–306 (economic
                                      substance should be reviewed without reference to expected
                                      profit from an intended real estate investment that the tax-
                                      payer expected to make with proceeds from the ‘‘CARDS’’
                                      transaction); Long Term Capital Holdings, 330 F. Supp. 2d
                                      at 183 (requirements of economic substance are not avoided
                                      by coupling a routine profitable economic transaction with no




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    45


                                      inherent tax benefits to a unique transaction that otherwise
                                      lacks profit potential).
                                         Here, the integrated STARS transaction’s net pre-tax effect
                                      was to create a $1.5 billion loan at LIBOR plus 20 basis
                                      points. It did not generate any revenue, only an obligation to
                                      repay the loan principal and interest. Any income from
                                      investing the loan proceeds was not a cashflow arising from
                                      the integrated STARS transaction. Rather, it resulted from a
                                      separate and distinct transaction. Thus, income from
                                      investing the loan proceeds is not relevant to the economic
                                      substance analysis of the integrated STARS transaction and
                                      should have been excluded from the pre-tax profitability
                                      analysis. We note that even if the projected yield on the loan
                                      proceeds Mr. Atherton assumed was relevant that yield is
                                      insufficient to offset the foreign tax costs 16 of the trans-
                                      action.
                                         The last critical flaw in his analysis is his including the
                                      spread in calculating the cost of the loan, the effect of which
                                      is to reduce the cost. As we previously found, the spread is
                                      a tax effect of the STARS structure and its value is effec-
                                      tively funded by the foreign tax credits. Mr. Atherton there-
                                      fore should not have reduced the cost of the loan by the
                                      spread in his pre-tax profitability analysis.
                                         Mr. Atherton’s analysis substantially inflates pre-tax
                                      income by including the non-incremental income from the
                                      STARS assets, the projected yield from the loan proceeds and
                                      the spread as pre-tax income. When these items are omitted,
                                      all that remains is the loan at LIBOR plus 20 basis points.
                                      As we previously discussed, Mr. Cragg’s analysis shows that
                                      the loan was overpriced and therefore not profitable on a pre-
                                      tax basis. Mr. Cragg concluded more generally that it would
                                      have been economically irrational for BNY to enter into the
                                      integrated STARS transaction without the foreign tax credits
                                      BNY derived from it. Accordingly, we find that the integrated
                                      STARS transaction lacks economic substance.
                                         We now address the subjective economic substance of the
                                      integrated STARS transaction. Here, petitioner argues that it
                                      was motivated to enter the STARS transaction to obtain ‘‘low
                                      cost’’ financing. As we previously held, we reject that busi-
                                      ness purpose because it lacks merit. Aside from that claimed
                                           16 See   supra note 9.




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                                      46                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      business purpose, petitioner contends it was motivated to
                                      enter into STARS by a realistic expectation of pre-tax profit.
                                      Specifically, petitioner claims that BNY intended to use the
                                      loan proceeds to grow its ‘‘investment portfolio’’ and earn a
                                      profit by investing in asset-backed securities. As we pre-
                                      viously held, any income from the investment of the loan pro-
                                      ceeds is not income from the integrated STARS transaction
                                      and therefore is irrelevant to the objective economic sub-
                                      stance analysis. Similarly, any profit petitioner expected to
                                      earn from investing the loan proceeds is not relevant to the
                                      subjective economic substance analysis. 17
                                           E. Congressional Intent
                                         We now consider whether the disputed tax benefits are
                                      what Congress intended in establishing the foreign tax
                                      credit. Petitioner contends that the economic substance doc-
                                      trine does not warrant disallowing the disputed tax benefits
                                      because Congress intended the foreign tax credit for trans-
                                      actions like STARS. We disagree.
                                         The United States taxes income of its citizens, residents
                                      and domestic entities on a worldwide basis. A U.S. corpora-
                                      tion must include foreign source income in its U.S. taxable
                                      income even though that income may also be subject to for-
                                      eign tax. Congress enacted the foreign tax credit to alleviate
                                      double taxation arising from foreign business operations. See
                                      United States v. Goodyear Tire & Rubber Co., 493 U.S. 132,
                                      139 (1989); Am. Chicle Co. v. United States, 316 U.S. 450,
                                      451 (1942); Burnet v. Chicago Portrait Co., 285 U.S. 1, 7
                                      (1932). Congress intended the foreign tax credit to neutralize
                                      the effect of U.S. tax on the business decision of where to
                                      conduct business activities most productively. 56 Cong. Rec.
                                      App. 677–678 (1918) (statement of Rep. Kitchin). The enact-
                                      ment of the foreign tax credit was also informed by fairness.
                                      See National Foreign Trade Council, Inc., International Tax
                                      Policy for the 21st Century (Dec. 15, 2001).
                                        17 We note that petitioner failed to substantiate the claimed business

                                      purpose otherwise. None of the STARS transactional documents or any
                                      other persuasive contemporaneous evidence show that BNY considered in-
                                      vesting the loan proceeds in asset-backed securities. Nor did BNY consider
                                      any projected returns from such an investment in evaluating whether to
                                      enter into STARS. And the record does not reflect that loan proceeds were
                                      in fact used to purchase such securities.




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                                      (15)              BANK OF N.Y. MELLON CORP. v. COMMISSIONER                                    47


                                        The STARS transaction was a complicated scheme cen-
                                      tered around arbitraging domestic and foreign tax law
                                      inconsistencies. The U.K. taxes at issue did not arise from
                                      any substantive foreign activity. Indeed, they were produced
                                      through pre-arranged circular flows from assets held, con-
                                      trolled and managed within the United States. We conclude
                                      that Congress did not intend to provide foreign tax credits for
                                      transactions such as STARS.
                                      II. Deductibility of STARS-Related Expenses
                                         We now consider whether petitioner is entitled to deduct
                                      expenses incurred in furtherance of STARS. Petitioner con-
                                      tends that it is entitled to deduct the claimed transactional
                                      expenses and the zero coupon swap interest for 2001 and
                                      2002, and petitioner asks the Court to hold that the U.K.
                                      taxes paid on trust income are deductible if we deny the for-
                                      eign tax credits claimed for those taxes. Respondent counters
                                      that the claimed transactional expenses and the U.K. taxes
                                      are not deductible because the STARS transaction lacked
                                      economic substance as we found. We agree.
                                         Expenses incurred in furtherance of a transaction that is
                                      disregarded for a lack of economic substance are not deduct-
                                      ible. See Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. at
                                      294 (observing that ‘‘a transaction that lacks economic sub-
                                      stance is not recognized for Federal tax purposes’’ and that
                                      ‘‘denial of recognition means that such a transaction cannot
                                      be the basis for a deductible expense’’); see also Gerdau
                                      Macsteel, Inc. v. Commissioner, 139 T.C. at 182–183. The
                                      claimed transactional expenses, the zero coupon swap
                                      interest expense and the U.K. taxes were all incurred in fur-
                                      therance of the STARS transaction, which we previously held
                                      lacks economic substance. Consequently, they are not deduct-
                                      ible.
                                      III. Foreign Source Income Adjustment
                                        We next address respondent’s adjustment to BNY’s foreign
                                      source income. Petitioner reported the income from the trust
                                      assets as foreign source income based on a ‘‘resourcing’’
                                      provision in paragraph 3 of article 23 of the Convention for
                                      the Avoidance of Double Taxation and the Prevention of
                                      Fiscal Evasion with Respect to Taxes on Income and Capital




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                                      48                  140 UNITED STATES TAX COURT REPORTS                                     (15)


                                      Gains, U.S.–U.K., Dec. 31, 1975, 31 U.S.T. 5668 (U.S.–U.K.
                                      tax treaty).
                                        Petitioner contends that the resourcing provision applies
                                      and that respondent’s foreign source income adjustment was
                                      improper. We disagree. U.S. tax laws and treaties do not rec-
                                      ognize sham transactions or transactions that have no eco-
                                      nomic substance as valid for tax purposes. Del Commercial
                                      Props., Inc. v. Commissioner, T.C. Memo. 1999–411 (citing
                                      Gregory v. Helvering, 293 U.S. 465, 470 (1935), and
                                      Johansson v. United States, 336 F.2d 809, 813 (5th Cir.
                                      1964)), aff ’d, 251 F.3d 210 (D.C. Cir. 2001). Because we pre-
                                      viously held that the STARS transaction is disregarded for
                                      U.S. tax purposes, BNY is treated for U.S. tax purposes as
                                      owning the STARS assets and the income is treated as being
                                      derived by BNY within the United States. Consequently, the
                                      U.S.–U.K. tax treaty, including the resourcing provision, does
                                      not apply. We therefore sustain respondent’s adjustment of
                                      petitioner’s foreign source income.
                                      IV. Conclusion
                                         In sum, the STARS transaction (bifurcated or integrated)
                                      lacks economic substance and Congress did not otherwise
                                      intend to provide foreign tax credits for transactions such as
                                      STARS. Accordingly, the STARS transaction is invalid for
                                      Federal tax purposes and the foreign tax credits and expense
                                      deductions claimed in connection with it are disallowed.
                                         We have considered all remaining arguments the parties
                                      made and, to the extent not addressed, we find them to be
                                      irrelevant, moot or meritless.
                                         To reflect the foregoing,
                                                                           Decision will be entered for respondent.

                                                                               f




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