(Bloomberg) BB&T Corp.’s transaction with Barclays Plc to generate tax credits was “simply a money machine” with no economic purpose and can’t be used to seek hundreds of millions of dollars in U.S. tax rebates, an appeals court ruled Thursday.

The decision involves a dispute between BB&T and the Internal Revenue Service, which objected to the bank’s use of foreign tax credits and other deductions between 2002 and 2007 to lower its U.S. tax bill. BB&T was appealing a 2013 court decision it lost in which it had sought recovery of more than $688 million in taxes and penalties.

At issue is an elaborate set of financial exchanges known as Structured Trust Advantaged Repackaged Securities, or STARS, transactions that London-based Barclays established with U.S. banks including BB&T and Bank of New York Mellon Corp. A tax court in 2013 rejected BNY Mellon’s bid for $199 million of foreign tax credits in a case that’s scheduled to be argued before a different appeals court on May 18.

In the BB&T transaction, the bank’s Salem Financial unit established a trust containing about $6 billion in revenue-producing assets. Monthly revenue from the trust was cycled through a British trustee, which served as the basis for U.K. taxation. The assessment of taxes generated British tax credits which were split evenly between Barclays and BB&T.

“An elaborate scheme set up solely to take advantage of a foreign tax system and involving no ‘economically-based business transactions’ is not the type of transaction Congress intended to promote with the foreign tax credit system,” a three-judge panel of the U.S. Court of Appeals for the Federal Circuit in Washington said.

Foreign Credits
The bulk of the refund sought by BB&T was for the foreign tax credits, for $498 million. BB&T was little changed at $39.17 at the close of trading in New York. The stock has increased 0.7 percent this year.
One component of the agreement involved a $1.5 billion loan that Barclays issued to the trust, which was controlled by BB&T. It was then sold back to BB&T for the original $1.5 billion plus interest.

The court did say Winston-Salem, North Carolina-based BB&T can seek a deduction on the interest for that loan, as well as a reduction in some of the penalties that were imposed. The opinion was posted on the court’s electronic docket.

As of March 31, exposure to this transaction was “fully resolved,” the bank said in a regulatory filing.

A complete victory for BB&T could result in a benefit of as much as $700 million, the bank said in a regulatory filing last month before the court’s ruling. That included changes in tax benefits, penalties and interest associated with a final resolution, the filing said.

BB&T Evaluating
BB&T is pleased it will be allowed these deductions and is evaluating the financial impact, said Brian Davis, a spokesman for the bank. BB&T was disappointed the court ruled against the bank’s right to foreign tax credits and the application of penalties, Davis said.

“We continue to firmly believe that BB&T engaged in a legitimate financing transaction and that all of the tax consequences from the transaction should be sustained,” Davis said in an e-mailed statement. “BB&T is considering its options for seeking further judicial review.”

The Justice Department, which argued the case on behalf of the IRS, said it was pleased the STARS transaction couldn’t be used for tax benefits and instead warranted penalties.

“Subversions of the tax code in the absence of economic substance and business purpose have properly and consistently been rejected by the courts,” said Deputy Assistant Attorney General Diana Erbsen of the DOJ’s Tax Division Appellate Section.

The case will now go back to the U.S. Court of Federal Claims to determine how much BB&T can get in the interest deduction and the reassessment of the penalties.
Mark Lane, a spokesman for Barclays, declined to comment.

The case is Salem Financial Inc. v. U.S., 2014-5027, U.S. Court of Appeals for the Federal Circuit (Washington). The lower court case is Salem Financial Inc. v. U.S., 10-192, U.S. Court of Federal Claims (Washington).

—With assistance from Andrew Zajac in Washington.

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