BNY Mellon (BK) is facing a $900 million tax bill after a U.S. judge rejected its attempt to claim hundreds of millions of dollars in foreign tax credits.
The ruling on Monday by Judge Diane Kroupa of the U.S. Tax Court followed a determination by the Internal Revenue Service that BNY Mellon underpaid federal income taxes in 2000 and 2001. A transaction designed to generate roughly $199 million in foreign tax credits caused the shortfall.
Because the transaction "lacked economic substance," Kroupa ruled, BNY Mellon cannot claim the tax credits or deduct roughly $7.8 million in expenses, fees and costs the company says it incurred.
BNY Mellon, the nation's largest custody bank, established the Structured Trust Advantaged Repackaged Securities (STARS) deal in conjunction with Barclays and KPMG in 2001. The British bank and the auditing firm developed and promoted STARS to U.S. banks as a legal way to minimize tax liability, the court said.
"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," Kroupa wrote. "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 transaction was a complicated scheme centered around arbitraging domestic and foreign tax law inconsistencies," Kroupa added.
BNY Mellon will appeal the decision, spokesman Kevin Heine said in an email. "We continue to believe the tax treatment of the transaction was consistent with statutory and judicial authority existing at the time," Heine said.
BNY Mellon expects to take an after-tax charge of roughly $850 million during the first quarter as a result of the ruling, the company said late Monday.
The transaction consisted of a complex series of steps undertaken by BNY Mellon and Barclays that were designed to enable BNY Mellon to claim income from the deal as having come from a foreign source, thereby enabling BNY Mellon to claim foreign tax credits for payments made to tax authorities in the U.K.
BNY Mellon maintained the transaction enabled the company to obtain low-cost funding for its banking business and that the company expected to earn a pre-tax profit from the deal. It also argued that Congress intended the foreign tax credit, which enables taxpayers who pay taxes to a foreign country to reduce their U.S. tax liability, to cover arrangements such as STARS. The IRS said that income from the deal should have been characterized as U.S. income for tax purposes.