A federal court in Minneapolis has found Wells Fargo liable for a 20 percent negligence penalty for participating in a tax shelter sold by Barclays Bank that generated $350 million in foreign tax credits.

The long‐running tax litigation arose from a complex transaction that Wells Fargo engaged in with Barclays called STARS, short for Structured Trust Advantaged Repackaged Securities. In the transaction, Wells Fargo would voluntarily subject some of its income-producing assets to U.K. taxation by placing them in a trust with a U.K. trustee. It would then offset those U.K. taxes by claiming foreign‐tax credits on its U.S. returns. Barclays would in turn get significant U.K. tax benefits as a result of Wells Fargo’s actions and it would compensate Wells Fargo for engaging in STARS by making a monthly “Bx payment.” Wells Fargo claimed foreign‐tax credits for the U.K. taxes that it paid in connection with STARS, but the IRS disallowed the credits on the ground that STARS was a sham and violated the “economic substance” requirements.

Wells Fargo bank branch window
Bloomberg News

After a three-week trial, the jury was asked to determine whether Wells Fargo’s STARS transaction had economic substance. Wells Fargo argued that STARS was a single, integrated transaction that resulted in low-cost funding, but the jury found the transaction actually consisted of two economically distinct and independent transactions: a loan and a trust. The jury found the trust structure had no reasonable potential for pretax profit and that Wells Fargo entered into the trust structure solely for tax reasons. The jury also found Wells Fargo entered into the loan solely for tax-related reasons.

A Wells Fargo spokesman pointed that there was a split ruling in the case, however, and the judge ruled in its favor. “We are pleased that the judge ruled in our favor regarding the $1.2 billion loan that Wells Fargo received as part of the transaction,” said a statement emailed by spokesman Ancel Martinez. “However, we are disappointed with the other ruling. At this time we are reviewing the case to determine our next steps.”

Wednesday’s ruling came after a Minnesota jury issued a verdict last November finding Wells Fargo was not entitled to the foreign tax credits because the transaction lacked both economic substance and a non-tax business purpose.

In an earlier decision in the case, the court noted Barclays marketed the STARS transaction to U.S. banks to leverage differences between the tax laws in the U.S. and the U.K. Three other courts have also rejected STARS tax shelters purchased by three other banks: Bank of New York, BB&T Bank and Santander Bank.

“The jury verdict is a resounding message to companies trying to exploit an abusive transaction that no matter how sophisticated the scheme, these sham tax shelters will not stand,” said Acting Assistant Attorney General David A. Hubbert of the Justice Department’s Tax Division in a statement. “The court’s opinion is equally clear that taxpayers who engage in such transactions can be subject to significant penalties.”

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Michael Cohn

Michael Cohn

Michael Cohn, editor-in-chief of AccountingToday.com, has been covering business and technology for a variety of publications since 1985.