            United States Court of Appeals
                        For the First Circuit

No. 16-1282

           SANTANDER HOLDINGS USA, INC., and Subsidiaries,
                   f/k/a Sovereign Bancorp., Inc.,

                        Plaintiff, Appellee,

                                 v.

                      UNITED STATES OF AMERICA,

                        Defendant, Appellant.


            APPEAL FROM THE UNITED STATES DISTRICT COURT
                  FOR THE DISTRICT OF MASSACHUSETTS

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


                               Before

                  Lynch and Selya, Circuit Judges,
                   and Burroughs, District Judge.


     Judith A. Hagley, with whom Caroline D. Ciraolo, Acting
Assistant Attorney General, Tax Division, Diana L. Erbsen, Deputy
Assistant Attorney General, Tax Division, Gilbert S. Rothenberg,
Richard Farber, and Carmen M. Ortiz, United States Attorney, were
on brief, for appellant.
     Jonathan S. Massey, with whom Leonard A. Gail, Paul J. Berks,
Massey & Gail LLP, Rajiv Madan, and Skadden, Arps, Slate, Meagher
& Flom LLP were on brief, for appellee.
     Martin S. Kaufman on brief for Atlantic Legal Foundation,
amicus curiae.
     Scott P. Martin, Gibson, Dunn & Crutcher LLP, Kate Comerford
Todd, Steven P. Lehotsky, Warren Postman, and U.S. Chamber


     
         Of the District of Massachusetts, sitting by designation.
Litigation Center on brief for Chamber of Commerce of the United
States of America, amicus curiae.
     Derek T. Ho, Bradley E. Oppenheimer, William H. Milliken,
Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C., and K.
Richard Foster on brief for Financial Services Roundtable, amicus
curiae.

                        December 16, 2016
            LYNCH, Circuit Judge.         Under the Internal Revenue Code,

taxpayers receive, subject to various technical requirements,

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

foreign country for taxable international business transactions of

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

decade, some banks have engaged in complicated transactions the

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

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

expense of the U.S. taxpayer.

            This case concerns whether Sovereign Bancorp, Inc.,

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

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

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

its claim for foreign tax credits and imposing accuracy-related

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

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

Kingdom    as   part   of     a   Structured    Trust   Advantaged    Repackaged

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

This STARS transaction was initiated in 2003 and was scheduled to

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

similar transactions became the subject of heightened scrutiny

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

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

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


                                       - 3 -
chartered in the United Kingdom, were the two parties to the

transaction at issue.

            Sovereign brought suit to obtain a refund from the IRS

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

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

interest.      Sovereign asserts that it is entitled to foreign tax

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

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

government concedes, the STARS transaction complied on its face

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

But the government opposes the refund, arguing that the STARS

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

transaction that fails the common law economic substance test.

            Congress and the IRS have long been concerned with

taxpayers      inappropriately   seeking   foreign    tax   credits.      IRS

regulations proposed in 2007 and finalized in 2011 prohibited STARS

transactions, but not retroactively.            See Determining the Amount

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

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

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

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

reflect   an    understanding    that   STARS   transactions   and   similar

complex financial structures for which foreign tax credits are

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


                                   - 4 -
purposes intended by Congress in enacting the foreign tax credit

regime.    Those purposes include avoiding double taxation and

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

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

credit] provision was originally designed to produce uniformity of

tax burden among United States taxpayers, irrespective of whether

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

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

took place before such transactions were forbidden by regulation,

and no one contends the 2011 regulation applies.              This decision

thus directly affects only that transaction.

           During roughly the same period as the transaction at

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

STARS transactions with Barclays.             They similarly sought tax

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

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

2015), the Second Circuit affirmed a judgment disallowing the

credits   claimed   by   Bank   of    New    York   Mellon   for   its   STARS

transaction with Barclays.1      Using somewhat different reasoning,


     1    We note that while we discuss the findings of the Second
Circuit in BNY, our opinion does not rely in any sense on the
earlier opinion of the tax court in that case. See Bank of N.Y.
Mellon Corp. v. Comm'r, 140 T.C. 15, as amended by 106 T.C.M. (CCH)
367 (T.C. 2013). Because we do not rely on that opinion, we need
not address Sovereign's argument that the judge in that case
suffered from a conflict of interest, a claim the government
vigorously disputes.


                                     - 5 -
the Federal Circuit in Salem Financial, Inc. v. United States, 786

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

disallowing credits claimed by Branch Banking & Trust Corporation

for   a     STARS     transaction        with     Barclays.       Both   circuit     court

opinions       contain        extensive    factual     descriptions       of   the   STARS

transactions, which also largely characterize the transaction at

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

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

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

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

transaction lacked economic substance.

               The Massachusetts district court in this case awarded

summary judgment to Sovereign.                   It first entered partial summary

judgment for Sovereign on the issue of whether a payment Sovereign

received from Barclays should be considered income to Sovereign in

calculating         the       STARS    Trust    transaction's     profit.      Santander

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

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

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



        2 Although Sovereign argues on appeal that the transaction
in BNY is distinguishable, it conceded below that the transaction
was "very similar" to the one at issue here. And while Sovereign
contends that the bank in Salem adopted a different litigation
strategy than the one pursued by Sovereign, it does little to
demonstrate that the STARS transaction in Salem involved any
materially different facts.


                                               - 6 -
Loan transactions had economic substance, and so Sovereign was

entitled to interest-related deductions on expenses for the Loan

transaction and a refund on the disallowed foreign tax credits

claimed for the Trust transaction and the penalties imposed by the

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

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

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

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

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

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

248.     The government appeals from the grant of summary judgment

to Sovereign and the denial of its cross-motion.

            Through concessions made by both the government and

Sovereign, the appeal has been considerably simplified.         The

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

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

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

district court improperly excluded evidence, or that there are any

material disputes of fact, or that summary judgment was entered

prematurely.    Rather, the government agrees that the controlling

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

judgment as to the Trust portion of the STARS transaction should




                               - 7 -
have been allowed.3         Sovereign, for its part, agrees, for the

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

transaction alone, and not on the Loan transaction.4

              We hold that the district court committed reversible

error and that the government is entitled to summary judgment in

its   favor    as    to   the   economic    substance   of   the   STARS   Trust

transaction.        We largely agree with the reasoning of the Federal

Circuit opinion in Salem in rejecting the claims that the Trust

transaction had economic substance and substantially rely on its

analysis.

                                       I.

              We give a brief description of the transaction and then

of this Circuit's economic substance test.



      3   The government also argued to the district court that
the foreign tax credits claimed by Sovereign should be denied on
the basis of two "substance over form" doctrines, the "step
transaction" and "conduit" doctrines, but the district court
rejected the argument. Santander II, 144 F. Supp. 3d at 244. As
the government focuses its appeal on the economic substance
doctrine, we do not consider the district court's rejection of the
government's substance-over-form argument.
      4   The parties have agreed for purposes of this appeal that
the Trust transaction should be analyzed separately from the Loan
transaction. The bank in Salem similarly accepted the bifurcation
of the tax consequences of the Trust transaction and the Loan
transaction for purposes of that appeal. Salem, 786 F.3d at 940.
          The government no longer contests the economic substance
of the Loan transaction, as long as the Loan transaction is
analyzed separately from the Trust transaction, and does not appeal
the district court's decision that Sovereign may claim certain
interest-expense deductions.


                                      - 8 -
A.         The STARS Transaction

           Sovereign   entered    into    the    STARS   transaction   with

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

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

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

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

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

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

details.

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

of the transaction) into which it ultimately contributed about

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

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

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

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

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

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

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

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

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

           Barclays acquired an interest in the Trust for $750

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

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

when   Sovereign    added     additional        funds    to   the   Trust.


                                  - 9 -
Significantly, Barclays was required to sell its interest in the

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

transaction.

               Sovereign treated this $1.15 billion contribution from

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

accounting       and     regulatory        purposes,   including   in   all     of

Sovereign's filings to the Securities and Exchange Commission and

the Office of Thrift Supervision.              The offsetting agreements that

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

Loan       effectively   resulted     in    Barclays   lending   Sovereign    $750

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

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

               The Trust engaged in a series of actions that generated

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

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


       5  LIBOR stands for "Intercontinental Exchange London
Interbank Offered Rate." Salem, 786 F.3d at 937 n.1. LIBOR "is
a benchmark rate that some of the world’s leading banks charge
each other for short-term loans." Id.
       6  When it first marketed this transaction to potential
counterparties, Barclays did not include this Loan component. See
Salem, 786 F.3d at 936.     The government suggests that Barclays
added the Loan to "disguise the true nature of the [transaction]
and permit U.S. taxpayers to justify STARS as low-cost funding."
Sovereign asserts that "there is no evidence . . . that any non-
loan transaction was ever offered to (or considered by) Sovereign,"
and that "[t]o the extent Barclays may have proposed a non-loan
transaction to other banks, the evidence shows they were
uninterested in it." Because we must analyze the Loan and Trust
transactions separately, this dispute is immaterial.


                                       - 10 -
which allowed Barclays to formally hold the funds in its name.

The Barclays Blocked Account then immediately returned the funds

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

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

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

the Trust, and Barclays also was permitted to deduct its re-

contributions to the Trust as a tax loss.               The combination of the

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

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

to [the STARS transaction]."

           In exchange, Barclays paid Sovereign a monthly sum,

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

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

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

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

technically    a   rebate.       The   Bx   payment      was    "netted   against

Sovereign's interest obligation" on the Loan.

           The benefits for both parties can be illustrated by a

hypothetical also employed by the Second and Federal Circuits.

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

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

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

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

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


                                    - 11 -
claim a credit for the 22% U.K. tax paid on the Trust by Sovereign

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

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

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

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

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

             Upon    redistributing    the   $78   to    the    Trust     from   the

Barclays Blocked Account, Barclays would claim a trading loss

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

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

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

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

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

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

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

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

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

ultimately reduced their tax exposure -- Barclays through the

various     deductions    generated    by    the     Trust      transaction      and

Sovereign through the Bx payment.




                                   - 12 -
B.         The Economic Substance Doctrine

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

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

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

statutory interpretation,8 as then-Judge Breyer characterized it

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

21, 35–36 (1st Cir. 1989).

           The common law economic substance doctrine traces back

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

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


     7    Sovereign argues that the foreign tax credit area is so
heavily populated with IRS regulation that there is no need for
any further regulation by the courts under the guise of the
economic substance doctrine.     On these facts, we reject the
proposition. In practical terms, it takes time for the government
to analyze a new problem, come up with a solution, and promulgate
regulations. "The endless ingenuity of taxpayers in attempting
to avoid taxes means that there will be a first time for
everything," Wells Fargo, 143 F. Supp. 3d at 838, and the economic
substance test guards against abuse of loopholes that Congress and
the IRS have not anticipated.
     8     As one commentator says:
     A related . . . claim is that the legislature assumes
     that long-standing common law doctrines such as economic
     substance will be used to interpret the statutes it
     enacts.   Under this claim, the doctrines have been
     implicitly adopted as part of the statute -- at least
     where the statute does not indicate otherwise.
Joseph Bankman, The Economic Substance Doctrine, 74 S. Cal. L.
Rev. 5, 11 (2000).
     9    In 2010, Congress enacted a statutory economic substance
test. See 26 U.S.C. § 7701(o). The statutory test was not made
retroactive. Our analysis, however, is not in conflict with that
test, as Congress specified that the 2010 codification would be


                              - 13 -
corporate reorganization technically complied with the statutory

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

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

     an operation having no business or corporate purpose —-
     a mere device which put on the form of a corporate
     reorganization as a disguise for concealing its real
     character, and the sole object and accomplishment of
     which was the consummation of a preconceived plan, not
     to reorganize a business or any part of a business, but
     to transfer a parcel of corporate shares to the
     petitioner.

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

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

the statute."      Id. at 470.

             The Court clarified the doctrine further in Frank Lyon

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

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

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

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

the Court has looked to the objective economic realities of a

transaction    rather      than   to   the    particular   form   the   parties

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

             The   First   Circuit      has   addressed    challenges   to   the

economic substance of transactions in a number of cases, although



applied as courts have previously and consistently applied the
economic substance doctrine.      Id. § 7701(o)(5)(C).   If the
codification reveals anything about congressional intent as to
pre-2010 STARS transactions, it supports our conclusion.


                                       - 14 -
the cases often have not invoked the "economic substance doctrine"

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

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

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

This court has been particularly wary of inquiring into the

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

abundantly clear, we do not think tax consequences should be

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

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

at 878.

            Dewees   is   our   most   recent   significant   case   on   the

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

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

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

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

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

the straddle trades were sham transactions and not "entered into

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

Revenue Code.    Id.

            This court upheld the tax court's decision for four

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

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

which the tax court could infer that the transactions were designed

to avoid taxes; that the promotional material for the transactions


                                   - 15 -
focused exclusively on their tax effects; that although margin

accounts were opened for the transactions, none of the investors

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

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

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


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

analyze the taxpayer's subjective motivation under the relevant

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

noted that the tax court had concluded that the transactions were

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

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

his subjective profit motive."            Id. at 35.

           Dewees instructs that the economic substance doctrine is

centered   on    discerning       whether     the    challenged     transaction

objectively     "lies   outside     the    plain    intent   of   the   [relevant

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

It   further    instructs    that    a    transaction    fails    the    economic



      10  To the extent that similar evidence is in the record for
this case, it supports our conclusion.     As in Dewees, we have
examined the pattern that has emerged from comparable STARS
transactions.      We  have   used  Sovereign's   and   Barclays's
communications to each other about the transaction and, in
particular, their emphasis on the connection of the Bx payment to
Sovereign's U.K. taxes and the Trust transaction's "tax risk," to
conclude that the Trust transaction had no objective purpose
outside its tax effect. And we too have noted that the transaction
at issue here was structured such that it exposed neither party to
realistic non-tax risk.


                                     - 16 -
substance test if, "though [it] actually occurred and technically

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

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

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

of transactions that have no business purpose or economic substance

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

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

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

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

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

the Tax Code and so lacks economic substance.

                                II.

            "We review orders granting or denying summary judgment

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

"The general characterization of a transaction for tax purposes is

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

n.16.

            In its first partial summary judgment decision, the

district court rejected the government's argument that the Bx

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

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

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

Federal Circuit reached the same conclusion as the district court

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


                               - 17 -
under the logic of Old Colony Trust Co. v. Commissioner, 279 U.S.

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

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

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

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

argument.    BNY, 801 F.3d at 121–22.

            We     see   no    need      to     address   the      government's

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

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

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

Trust transaction itself does not have a reasonable prospect of

creating a profit without considering the foreign tax credits,

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

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

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

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

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

transaction's      economic   reality,    and    in   particular    its   profit

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

Using similar reasoning, we find that the Trust transaction is

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

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

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

importantly, we agree with the Federal Circuit that the Trust


                                   - 18 -
transaction is profitless, id. at 949, and that it is "not the

type of transaction Congress intended to promote with the foreign

tax credit system," id. at 954.

            The Trust transaction is profitless because the "profit"

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

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

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

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

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

a reasonable potential (or any potential) of generating profit

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

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

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

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

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

into the pre-tax profitability calculation, the Trust transaction

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


     11   Because exposure to U.K. taxation was the necessary and
sufficient condition of the Bx payment, the U.K. taxes were an
expense incurred by Sovereign for the "profit" generated by the
Trust transaction.   And when the U.K. taxes are recognized as
expenses, there is no pre-tax profit, and the Trust transaction
lacks a cardinal feature of an economically substantial
transaction: a reasonable prospect of pre-tax profit.
          Sovereign and the district court rely heavily on Compaq
and IES for the proposition that foreign taxes should not be
treated as expenses.   Santander II, 144 F. Supp. 3d at 242–44.
Those cases did not analyze STARS transactions and so are
distinguishable factually.    We agree with the Salem court's


                               - 19 -
foreign tax credits it claims for the U.K. taxes combined with a

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

          Accordingly,   we   conclude   both   that   the   STARS   Trust

transaction had no objective non-tax economic benefit and that

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

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

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

credits was the Trust transaction's whole function.

          Our conclusion that the Trust transaction lacks economic

substance is entirely consistent with our statement in Dewees that

"taxpayers may lawfully structure transactions that seek real

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




analysis of this issue as to the Trust transaction.          786 F.3d at
947–49.
          Nor does our conclusion that Sovereign's U.K. taxes
should be considered expenses contradict the Supreme Court's
holding in Old Colony. Old Colony did not involve foreign taxes
and says nothing about whether foreign tax liability may ever be
considered an expense. See Old Colony, 279 U.S. at 716.
     12   See John P. Steines, Jr., Subsidized Foreign Tax Credits
and the Economic Substance Doctrine, 70 Tax Lawyer (forthcoming
2017) ("[I]t is virtually impossible for a dispassionate analyst
to reasonably conclude that Congress intended to surrender more
revenue than that captured by the foreign government in a holistic
sense where the U.S. taxpayer and the counterparty split the
remaining spoils solely by reason of carefully exploited
inconsistent international tax rules in an otherwise unprofitable
transaction that is an overly complicated version of an orthodox
deal that would not have given rise to credits at all."). A copy
of this article was filed with the court and disclosed to the
parties.


                                - 20 -
32.    Again, this situation does not involve private parties

structuring an agreement to benefit both parties and only then

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

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

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

           Indeed, the record demonstrates that the Bx payment is

inextricably linked to the deliberate incurring of Sovereign's

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

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

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

able to claim.     An internal communication between the parties

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

tax credits with Sovereign."

           The STARS scheme is profitable only because Sovereign

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

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

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

the Salem court found:

           The evidence thus supports the trial court's
      finding that the STARS Trust was a "prepackaged
      strategy" created to generate U.S. and U.K. tax benefits
      for [the counterparty] and Barclays.    Barclays agreed
      to bear half of [the counterparty's] U.K. tax expense
      under the transaction in exchange for an opportunity to
      claim substantial U.K. tax benefits for itself (through
      the trading loss deduction). [The counterparty], on the
      other hand, benefited by claiming a foreign tax credit
      equal to the entire amount of the Trust's U.K. taxes
      while "getting back one-half of the U.K. tax" from


                               - 21 -
     Barclays.    Absent those tax advantages,            the   STARS
     transaction would never have occurred.

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

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

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

             The Trust transaction did not advance the Tax Code's

interest in providing foreign tax credits in order to encourage

business     abroad   or   in   avoiding   double   taxation.    Nor    does

disallowing foreign tax credits for the STARS Trust transaction

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

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

to the attention of the IRS as a potential impermissible tax

shelter.13




     13   Moreover, there is no tension between denying foreign
tax credits for the STARS Trust transaction and the U.S.-U.K. tax
treaty: As the government correctly notes, the treaty requires the
grant of foreign tax credits "subject to the limitations of the
laws of the United States."    Convention with Great Britain and
Northern Ireland regarding Double Taxation and Prevention of
Fiscal Evasion, art. 24, July 24, 2001, S. Treaty Doc. No. 107-
19.    Among those limitations, of course, are "anti-abuse
principles" such as the economic substance doctrine. See Treasury
Dep't, Technical Explanation of the Convention Between the
Government of the United States of America and the Government of
the United Kingdom of Great Britain and Northern Ireland for the
Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income and on Capital Gains 14. See also
Del Commercial Props., Inc. v. Comm'r, 251 F.3d 210, 214 (D.C.
Cir. 2001) ("[I]f the sole purpose of a transaction with a foreign
corporation is to dodge U.S. taxes, [a] treaty cannot shield the
taxpayer from the fatality of the [substance-over-form] step-
transaction doctrine.").


                                   - 22 -
              Of   course,      as    the   government    readily     admits,    some

transactions       that   are    not    immediately      profitable    without   tax

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

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

transaction is not comparable to such transactions because it does

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

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

              Moreover, unlike long-term investments that may not

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

Trust transaction lacks any real economic risk.                   The Salem court

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

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

the counterparty indemnified Barclays should that happen.                    Id. at

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

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

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

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

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

              Here, too, Sovereign and Barclays "developed contractual

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

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

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

that have survived an economic substance challenge, such as the

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


                                        - 23 -
STARS Trust transaction posed no non-tax risks to Sovereign.

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

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

the    Trust    transaction,   and    it   informed   the    Federal   Deposit

Insurance Corporation that it would "bear the United States tax

risk" of the transaction.

               Further, we agree with the government that Sovereign's

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

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

payment.        The   assets   in    the   Trust   never    effectively    left

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

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

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

payment.       Indeed, when calculating the profit potential of the

STARS transaction, Sovereign deducted the income from the Trust

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

existence.

               Resorting to the uncontroversial principle that the

foreign tax credit regime was designed to avoid double taxation

does not help Sovereign.            If mere invocation of that principle

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

all:

       the fact that the transactions produced a net gain to
       the taxpayer after taking both the foreign taxes and the
       foreign tax credit into account says nothing about the


                                     - 24 -
     economic reality of the transactions, because all tax
     shelter transactions produce a gain for the taxpayer
     after the tax effects are taken into account -- that is
     why taxpayers are willing to enter into them and to pay
     substantial fees to the promoters.

Salem, 786 F.3d at 948.

             Equally fundamental to the purpose of granting foreign

tax credits is the related principle that those credits are

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

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

was originally designed to produce uniformity of tax burden among

United States taxpayers, irrespective of whether they were engaged

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

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

Sovereign.       It furnished Barclays with a tax benefit, which

Barclays    in   turn    shared   with     Sovereign,        effectively   giving

Sovereign    a   tax    benefit   of    its     own   when   combined   with   the

anticipated foreign tax credits.           The Trust transaction was not a

legitimate business and lacked economic substance.

                                        III.

     We reverse the judgment of the district court as to the

economic substance of the Trust transaction and the foreign tax

credits claimed for the Trust transaction and remand for judgment

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

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

appellant.


                                       - 25 -
