[00:00:01] Speaker 05: Good morning, ladies and gentlemen. [00:00:03] Speaker 05: We have three cases to be argued today, two other cases before the court were submitted on brief. [00:00:13] Speaker 05: The first argued case is Salem Financial, Inc. [00:00:16] Speaker 05: versus the United States, docket number 145027. [00:00:20] Speaker 05: Mr. Madan, did I pronounce that correctly? [00:00:25] Speaker 05: Madan? [00:00:25] Speaker 05: Madan. [00:00:27] Speaker 05: Mr. Madden, I understand that you want to reserve three minutes for rebuttal? [00:00:32] Speaker 06: That's correct, Your Honor. [00:00:34] Speaker 05: OK. [00:00:34] Speaker 05: You may begin. [00:00:35] Speaker 06: Thank you. [00:00:44] Speaker 06: May it please the Court, good morning, Your Honors. [00:00:47] Speaker 06: Raj Madden, Skadden Arps for the Appellant. [00:00:50] Speaker 06: I thought I'd start this morning with three foundational points before we get into the substance of the discussion. [00:00:58] Speaker 06: And the first point is that this appeal turns on a legal question. [00:01:06] Speaker 06: Specifically, the question is how the court should characterize, as a matter of law, Barclay's payments to BB&T of approximately $60 million a year, which we refer to and the parties referred to at the time as BX payments. [00:01:27] Speaker 06: More specifically, [00:01:28] Speaker 06: The question is whether those BX payments should be treated as economic income to BB&T as a matter of law. [00:01:38] Speaker 06: BB&T, for purposes of this appeal, does not dispute any of the facts down below on the question of the merits of its entitlement to the foreign tax credits and the loan interest deduction. [00:01:51] Speaker 05: Specifically, there's no... I'll let you get to the next two points so that we know that, but are you saying that the characterization of the BX payments would in and of itself decide the question? [00:02:02] Speaker 06: Yes. [00:02:03] Speaker 05: Okay. [00:02:04] Speaker 05: And your other two points? [00:02:05] Speaker 06: My other two points are an explanation of why that's the central issue, this characterization of the BX payments. [00:02:12] Speaker 06: And the third is to clarify what we are and what we're not arguing with respect to economic substance. [00:02:19] Speaker 06: I want to leave no doubt [00:02:21] Speaker 06: that what we're not arguing is that BB&T's literal compliance with the statutes at issue, including Internal Revenue Code Section 901i, precludes or preempts the application of the economic substance doctrine. [00:02:36] Speaker 06: That is not our argument, and I want to make sure that there is not ambiguity on that point. [00:02:41] Speaker 06: Instead, what our argument in that regard is very consistent with this circuit's precedent, specifically as articulated in Coltech. [00:02:51] Speaker 06: that the economic substance doctrine is a judicial tool for interpreting the statutes, the applicable statutes and regulations. [00:02:59] Speaker 06: It is a canon of statutory construction. [00:03:03] Speaker 06: And our point is that when you look at the applicable statutes here, specifically section 901 I, as it relates to one of the narrow issues associated with economic substance, [00:03:18] Speaker 06: specifically the question of whether these BX payments should be treated as rebates or effective rebates, 901i significantly informs the question that the government is posing with respect to economic substance. [00:03:36] Speaker 06: Now why is that the case? [00:03:38] Speaker 06: The reason is that under section 901i, the first point is that it is the rule that governs when a specific [00:03:48] Speaker 06: benefit that is conferred by a foreign government to any party in the transaction, Barclays, BB&T, will be considered a so-called rebate. [00:04:01] Speaker 05: So you're saying that literal compliance may not be sufficient, but we can't examine the broader question of economic substance without at least reference to the statutory provisions. [00:04:14] Speaker 06: Yes. [00:04:16] Speaker 06: And in this particular case, [00:04:18] Speaker 06: it's more than just a reference to that particular statute. [00:04:23] Speaker 06: Because the inquiry under 901i, in terms of evaluating, assessing, whether this particular BX payment, these BX payments, should be construed as effective rebates, is the same inquiry that the IRS has conducted under economic substance. [00:04:42] Speaker 06: Specifically, 901i, first of all, requires [00:04:47] Speaker 06: a substance-based analysis. [00:04:49] Speaker 06: The applicable regulation says substance not form is the controls, and that's the inquiry. [00:04:58] Speaker 06: So the filter that's applied with respect to the statute is identical to the filter that's applied under economic substance, which is getting at, let's figure out what the substance of the transaction is. [00:05:11] Speaker 06: So the question is, BB&T pays UK taxes [00:05:16] Speaker 06: to the United Kingdom. [00:05:17] Speaker 06: The question is, does any of the benefits that have been conferred to Barclays and then indirectly from Barclays to BB&T constitute in substance a rebate of the taxes that BB&T had paid to the United Kingdom? [00:05:34] Speaker 01: Can I ask you this? [00:05:35] Speaker 01: If you put this money in the trust and you paid the 22% of the tax, [00:05:40] Speaker 01: and the agreement said specifically, Barclays will rebate you 11% of the tax paid. [00:05:47] Speaker 01: Would that violate 901? [00:05:50] Speaker 06: No. [00:05:52] Speaker 06: That would not violate 901 because that's not the question under 901, the 901-I specifically. [00:06:00] Speaker 06: The question under 901-I is let's assume that Barclays, excuse me, BB&T pays in our example that we've used with the $100 example, [00:06:10] Speaker 06: pays $22 of tax to the United Kingdom, the trust does. [00:06:14] Speaker 06: The question that 901 asks is, was that tax, that specific tax, somehow rebated or subsidized to Barclays? [00:06:24] Speaker 06: And then did BB&T confer a benefit from that payment? [00:06:29] Speaker 06: And the reason that any private party contract that references [00:06:37] Speaker 06: the specific statute would never run afoul of that statute, unless there is proof or the government can establish that the United Kingdom somehow subsidized or rebated the taxes to Barclays. [00:06:53] Speaker 06: That's the key inquiry. [00:06:54] Speaker 06: It isn't about the private parties, what Barclays and BB&T decided. [00:06:59] Speaker 06: The question is, was the tax that BB&T paid of $22 rebated or [00:07:05] Speaker 06: refunded or reimbursed as the government uses to bark this. [00:07:08] Speaker 06: And the answer is no. [00:07:11] Speaker 05: I'm a little intrigued by your argument here that this is your position that the economic substance doctrine is a cannon of construction. [00:07:19] Speaker 05: Because generally you don't resort to cannons of construction unless you think that something about the statute is ambiguous. [00:07:27] Speaker 05: You're not arguing that 901i is ambiguous, right? [00:07:30] Speaker 05: That's right. [00:07:30] Speaker 05: I mean, you say that unambiguously it has to be a rebate from the foreign government. [00:07:35] Speaker 06: That's right. [00:07:36] Speaker 05: So how is the economic substance doctrine then effectively a canon of construction? [00:07:42] Speaker 06: That's a good question. [00:07:44] Speaker 06: Maybe I should have characterized that differently. [00:07:47] Speaker 06: My point is that if the Coltech Court in this circuit has already established that at a minimum it is a canon of construction, then certainly you have to start with the statute in order to assess, in this case, [00:08:02] Speaker 06: whether we have an insubstance rebate. [00:08:06] Speaker 06: So in this case, I'm not arguing that you should use the statute to interpret a particular provision. [00:08:14] Speaker 06: What I am saying is that the statute is the beginning and end of the question. [00:08:19] Speaker 06: So the canon of construction point is that there's no question in this circuit that the statute is highly relevant and that you use the statute [00:08:29] Speaker 06: exercising the economic substance doctor. [00:08:31] Speaker 05: Okay, so you're not saying it's the beginning and end of the question in the sense that it decides whether or not there's economic substance, but it's the beginning and end of the question as to what it is you're supposed to be looking at? [00:08:43] Speaker 06: Correct. [00:08:43] Speaker 06: That's exactly right. [00:08:45] Speaker 06: And the reason for that is this. [00:08:47] Speaker 06: The question, the overall economic substance question, as has been established by this court, is did this transaction [00:08:55] Speaker 06: present to BB&T a reasonable possibility of profit? [00:09:01] Speaker 06: That's the objective question. [00:09:03] Speaker 06: And the reason that this BX question is so important is that if it is treated as profit, economic profit, as we think it should, then there's no question that the trust transaction is [00:09:19] Speaker 06: profitable to the $260 million. [00:09:22] Speaker 02: Let me see if I understand. [00:09:22] Speaker 02: When you say this transaction, are you treating the trust portion of the overall transaction as discrete from the loan portion? [00:09:31] Speaker 02: Are you treating the loan and the trust as a single this transaction? [00:09:36] Speaker 06: For purposes of this appeal, we are treating the trust transaction as separate and distinct from the loan transaction. [00:09:44] Speaker 02: When you just mentioned this transaction, you were focusing on the trust aspect of the overall transaction. [00:09:50] Speaker 06: That's correct, Your Honor. [00:09:51] Speaker 06: The trust is the entity that realizes the $60 million of benefit. [00:09:57] Speaker 06: And the question is, is that profit or is it a tax effect? [00:10:01] Speaker 06: Is it a tax item? [00:10:03] Speaker 06: And the reason that this 901i question is so central [00:10:06] Speaker 06: is that the basis for the government's argument, the economic argument, so to speak, that this BX payment of $60 million a year should be treated as a tax item, and therefore it's excluded from the calculation of pre-tax profit. [00:10:24] Speaker 06: Pre-tax profit only includes, both on the income side and on the expense side, those items that are not tax related, because they're assessing [00:10:34] Speaker 06: What are the non-tax effects? [00:10:36] Speaker 05: Is this case different from the other economic substance cases based on who it is that the IRS is attempting to disallow any refund to? [00:10:53] Speaker 05: In the other cases, it is the entity that receives the tax benefit that the IRS is going after. [00:10:59] Speaker 05: And here, Barclays is not within the jurisdiction of the government. [00:11:04] Speaker 05: they're going after a different entity who is essentially there to facilitate the transaction. [00:11:09] Speaker 05: Does that change the analysis? [00:11:11] Speaker 06: Well, we think it changes the analysis. [00:11:13] Speaker 06: Because in this case, as you pointed out, if the court accepts that the $60 million is profit, then BB&T realizes no tax benefits. [00:11:23] Speaker 06: I mean, if you look at any of the economic substance cases in this circuit or in any other circuit, the fundamental common denominator [00:11:31] Speaker 06: is that the taxpayer improves their tax position. [00:11:36] Speaker 06: Here, what happens is, BB&T now pays, in our $100 example, $22 of tax to the United Kingdom, $13 of tax to the US government. [00:11:47] Speaker 06: It pays the exact same 35% tax it would have prior to the transaction. [00:11:53] Speaker 06: So its tax return, its cash out of pocket tax, is identical. [00:11:57] Speaker 06: The only way that the government can argue [00:12:01] Speaker 06: that BB&T has improved its tax position is by saying that this $60 million of cash it receives from Barclays is not an economic profit to them, but in fact is a rebate of the taxes it paid to the UK government. [00:12:18] Speaker 05: Really, that's the question I have. [00:12:20] Speaker 05: When we're looking at economic substance of a transaction as a whole, are we supposed to look at it from this broad worldview, or are we supposed to look at it from the perspective solely of the claimant in this particular case? [00:12:35] Speaker 06: Well, I think you look at it from the perspective of BB&T, because that is the party who, not only does the IRS have jurisdiction over it, but that is the party who is involved in this transaction. [00:12:47] Speaker 06: Barclays is certainly relevant here in the sense that it informs the court about the overall aspects of the transaction. [00:12:55] Speaker 06: And it is very relevant that the benefits that are being realized here are UK tax benefits. [00:13:00] Speaker 06: Unequivocally, Barclays is realizing substantial UK tax benefits by virtue of a credit and two deductions. [00:13:09] Speaker 06: And it is that benefit, the UK tax benefit, that they're passing through to BB&T. [00:13:14] Speaker 06: But the crucial element [00:13:16] Speaker 06: And the reason this is not a rebate is those benefits are detached from the taxes that BB&T paid to the UK government. [00:13:24] Speaker 06: So it cannot be said that there is a rebate under 901i or under economic substance. [00:13:33] Speaker 06: And the reason again for that is if you look at the statute, not only is it the fact that it's a substance-based analysis, but look at the questions that are asked in the statute. [00:13:44] Speaker 06: Is the benefit that's conferred by the UK government, is it an indirect or a direct benefit? [00:13:52] Speaker 06: Is it a benefit that's conferred by virtue of a deduction or a credit? [00:13:57] Speaker 06: Is it a benefit that can be provided to any party in the transaction, including Barclays? [00:14:04] Speaker 06: So the point is, on this narrow question, to go back to your point, Your Honor, on this narrow question of the characterization [00:14:14] Speaker 06: of this Barclays payment. [00:14:18] Speaker 06: The substance of what that payment is, whether it's a rebate or not, is established by the statute. [00:14:24] Speaker 06: And the IRS has conceded that BB&T complied with that statute. [00:14:30] Speaker 06: Now, we're not going to go over to the economic substance analysis and say, now we're going to perform a different analysis. [00:14:37] Speaker 06: We're going to perform a different substance analysis. [00:14:39] Speaker 06: We're going to ask the exact same questions [00:14:42] Speaker 06: And we're going to come to the same conclusion. [00:14:44] Speaker 06: And this fact is particularly important in this circuit. [00:14:48] Speaker 06: In this circuit, it's very clear that the court will not go behind the payment of tax. [00:14:56] Speaker 06: This court will not ask the question about what happened in the UK, as reflected by the Mexican railroad cases, and that's been reaffirmed as late as the Banker's Trust decision in 2000. [00:15:10] Speaker 06: In those cases, [00:15:12] Speaker 06: What happened is this is prior to the establishment of 901-I. [00:15:17] Speaker 06: And very importantly, the court was asked the question about whether they're going to allow a foreign tax credit in a situation where it was abundantly clear, Judge Hughes, that the counterparty, the Mexican Railroad Company, was receiving a rebate of taxes, specifically [00:15:41] Speaker 06: the payment of taxes went from, well actually it didn't go from anywhere, a tax liability, a Mexican tax liability accrued to a U.S. [00:15:53] Speaker 06: taxpayer's counterparty. [00:15:55] Speaker 06: That U.S. [00:15:56] Speaker 06: counterparty received, my time's up? [00:16:00] Speaker 05: We'll let you keep going, we'll give the government some more time. [00:16:03] Speaker 06: Okay, thank you. [00:16:05] Speaker 06: That Mexican counterparty, the U.S. [00:16:08] Speaker 06: taxpayer and the Mexican government [00:16:11] Speaker 06: signed an agreement that said, you Mexican company are going to pay us a dollar of tax. [00:16:19] Speaker 06: You're going to charge the US company $3.40, $1 of which is going to be taxed. [00:16:26] Speaker 06: And we, the Mexican government, are immediately going to rebate that money to you. [00:16:31] Speaker 06: There's no ambiguity. [00:16:33] Speaker 06: There's direct collusion. [00:16:36] Speaker 06: And the court was asked, under Section 901, [00:16:40] Speaker 06: prior to 901i's establishment, is that taxpayer, the US taxpayer, entitled to a foreign tax credit? [00:16:49] Speaker 06: And the answer was, by this court, we are not going to examine the internal affairs of the Mexican government and how they decide to deal with their constituents. [00:17:01] Speaker 06: And the bottom line was that the court determined [00:17:05] Speaker 06: that the taxpayer was entitled to a foreign tax credit, notwithstanding the fact that all of the 100% of the money had been rebated. [00:17:14] Speaker 06: And Bankers Trust involved a situation where the regulation that we're dealing with today, substantially the regulation we're dealing with today, had been established by the Department of Treasury. [00:17:24] Speaker 06: And the court still said, unless there's a statute, we are not going to overturn our earlier precedent where we're going to go into the affairs of the foreign government. [00:17:34] Speaker 06: So now consider. [00:17:36] Speaker 06: The question on the table is, was this a rebate for purposes of determining whether this amount is in or out of the income question? [00:17:46] Speaker 06: The government has agreed that we have complied with Section 901i. [00:17:51] Speaker 06: That tells you we are right back into the precedent by the predecessor to this court in terms of the Mexican railroad car cases and bankers trust this court. [00:18:04] Speaker 06: which said, in the absence of a specific statute, we are not going to go behind BB&T's payment to the UK government and into the affairs of the UK government. [00:18:14] Speaker 02: Now, I know this gets into, if I could just ask a factual question. [00:18:19] Speaker 02: Please. [00:18:19] Speaker 02: I know this gets into UK law. [00:18:22] Speaker 02: And I understand your argument about the problem with looking into transactions at the UK side of the ledger. [00:18:31] Speaker 02: But explain to me factually how it is that Barclays comes up with a $100, we started with in the example, how they come up with what I guess is a $78 trading loss deduction. [00:18:48] Speaker 02: Sure, I can do that. [00:18:50] Speaker 02: What is the actual loss to Barclays? [00:18:54] Speaker 06: Excellent question, Your Honor. [00:18:55] Speaker 06: But let me just say one thing about that first. [00:18:58] Speaker 06: What's very relevant to your question is [00:19:01] Speaker 06: that in the first instance, if we look at Barclays return, the first thing that happens is Barclays reports 100% of the same income that BB&T reported. [00:19:12] Speaker 06: So both BB&T, meaning the trust, and Barclays report $100 of income in the UK. [00:19:20] Speaker 06: And BB&T pays $22 of tax, and Barclays would have paid 30% of tax, meaning another $8. [00:19:28] Speaker 06: Barclays gets a credit for $22, [00:19:31] Speaker 06: which is why they are at $8. [00:19:35] Speaker 06: But this is very important, and this is why there's no rebate, because as it relates to the taxes BB&T paid, Barclays never receives any of that back. [00:19:44] Speaker 06: But now to get to your question. [00:19:46] Speaker 06: What happens is that there is, which we accept, there is a circular cash flow in the transaction where the trust makes the distribution of the net proceeds after tax. [00:19:59] Speaker 06: The trust receives $100. [00:20:01] Speaker 06: They pay $22 to the UK government. [00:20:03] Speaker 06: They're left with $78. [00:20:04] Speaker 06: The trust makes a distribution to Barclays or the blocked account of $78. [00:20:09] Speaker 06: And then there's an immediate recontribution of that $78 back to the trust. [00:20:13] Speaker 02: Which sounds an awful lot like a wash to me. [00:20:16] Speaker 06: And for US tax purposes, to go to your question, for US tax purposes, BB&T treated it as a wash. [00:20:23] Speaker 06: They disregarded that distribution up and distribution back down. [00:20:28] Speaker 02: But Barclays didn't. [00:20:29] Speaker 06: But Barclays didn't. [00:20:31] Speaker 02: Why isn't it a wash? [00:20:33] Speaker 06: Under UK tax rules, that distribution and recontribution generates a deduction for them, and therefore allows them to reduce other... What's the reasoning underlying that? [00:20:47] Speaker 02: Because it sounds bizarre. [00:20:50] Speaker 06: Well, it may sound bizarre in this case, but in actual [00:20:55] Speaker 06: trading where the asset that they have, which is a specific interest in the trust, because it is not receiving distributions off of the trust, they have to effectively reduce the value of that interest in the trust by virtue of the distribution and the re-contribution. [00:21:17] Speaker 06: That's why it's referred to as a trading loss. [00:21:21] Speaker 06: But that is very much the issue [00:21:24] Speaker 06: But Judge, the very important part of that is it has nothing to do with the BB&T's payment of the UK taxes. [00:21:33] Speaker 06: Whether or not BB&T paid those taxes, BB&T could have made the distribution up to the blocked account and back down, and Barclay's entitlement to that deduction would remain the same, which is why it detached from the taxes paid. [00:21:48] Speaker 05: Okay, we need to give the government a chance here, so just try to keep things even. [00:21:53] Speaker 05: We will restore your rebuttal, but we'll give the government an extra six minutes if necessary. [00:21:58] Speaker 05: Okay. [00:21:58] Speaker 05: Thank you. [00:22:00] Speaker 05: You don't have to use it, unless we force you. [00:22:11] Speaker 04: Good morning and may it please the court. [00:22:13] Speaker 04: Let me first address the relationship between the economic substance doctrine and the technical tax rules. [00:22:19] Speaker 04: The technical tax rules, when they're written, are written to apply to substantive business transactions. [00:22:25] Speaker 04: They assume that the underlying transaction has the economic substance and business purpose. [00:22:31] Speaker 04: Economic substance doctrine tests that assumption. [00:22:35] Speaker 04: by analyzing the economic reality to see if this transaction, although they comply with all the technical tax rules, provides the taxpayer an economic benefit and was entered into for a business purpose. [00:22:50] Speaker 04: Those are factual tax rules. [00:22:53] Speaker 04: The general characterization of the transaction is a question of law, but that characterization is not developed in a vacuum to avoid the facts. [00:23:07] Speaker 04: Look at the economic substance and substance-reform cases. [00:23:10] Speaker 04: They're long cases. [00:23:10] Speaker 04: because they're going through detailed analysis of the facts. [00:23:13] Speaker 04: So this court did in Stoby Creek, as it did in Wells Fargo, the Supreme Court in the Frank Lyon case. [00:23:20] Speaker 04: These are very fact-consensus cases. [00:23:25] Speaker 01: OK, I'm sorry. [00:23:26] Speaker 01: Can I just ask you a hypothetical? [00:23:27] Speaker 01: Sure. [00:23:27] Speaker 01: Suppose that Barclays had gone to BB&T and said, there's some good business reason [00:23:38] Speaker 01: you know, for us to have you put some property in a trust that we can claim partial ownership over. [00:23:45] Speaker 01: Maybe they get a loan or whatever. [00:23:47] Speaker 01: And they said, if you put this, it partly says to B&T, if you put this property in a trust like this, we'll pay you X amount of dollars per year. [00:23:58] Speaker 01: And that's considered as income by B&T. [00:24:02] Speaker 01: Would that kind of transaction have, and [00:24:06] Speaker 01: You still have these same kind of foreign tax issues because it's in a trust cycle through the UK and the like, but the reason it's in a trust is not just for tax reasons, it's also maybe for other reasons. [00:24:19] Speaker 01: Would that be something that has economic substance? [00:24:23] Speaker 04: I mean, depending on the facts, but if it's relying on the foreign, if BB&C is relying on the foreign tax credit for its economic return, it wouldn't, as a matter of U.S. [00:24:33] Speaker 04: law, have economic substance. [00:24:35] Speaker 04: And that's, I mean, what happened here sounds different from your situation. [00:24:39] Speaker 01: Well, you know, that's what I'm trying to, so here, [00:24:42] Speaker 01: I think the way the payments are structured from Barclays to BB&T to BX payments seem much closer aligned to the foreign tax credit. [00:24:52] Speaker 01: But there, even though, and I'm sorry, I'm not being very clear about my hypothetical, but there, you know, the trust is, it cycles through the UK, so BB&T has to pay the foreign tax and then can claim the foreign tax credit. [00:25:06] Speaker 01: But Barclays is giving them money unrelated to the tax credit. [00:25:12] Speaker 01: It doesn't use a formula based on the tax credit. [00:25:15] Speaker 01: It's saying it's valuable to us for you to give us ownership of this property and a trust for other reasons. [00:25:24] Speaker 01: So that payment is not really connected to the foreign taxes that BB&T pays, although they're still generating income that may ultimately offset the taxes. [00:25:36] Speaker 04: if in fact the transaction was not artificial, and say for example, BB&T transferred assets to the UK for Barclays to use, and its return was not coming back from Barclays claiming tax credits for tax that BB&T had paid, that transaction may have economic substance, but that is not the transaction here. [00:25:57] Speaker 01: As the court found, the transaction- So I guess the question I have, and this is where I find this a little puzzling, is [00:26:05] Speaker 01: What kind of difference is there in terms of what BB&T cares about, whether they're helping Barclays get a loan or something business purpose, or they're helping Barclays reduce their UK tax burden. [00:26:20] Speaker 01: Either way, Barclays is getting something of value from BB&T and they're willing to pay them for it. [00:26:26] Speaker 04: But the difference in this case is this is not a UK tax shelter. [00:26:30] Speaker 04: This is a US tax shelter. [00:26:32] Speaker 04: The UK came out ahead in this case. [00:26:34] Speaker 04: It's tax added for the UK. [00:26:37] Speaker 04: The US government is the entity that lost. [00:26:40] Speaker 04: And the court found this. [00:26:41] Speaker 04: The entire transaction was funded by the foreign tax credits. [00:26:45] Speaker 04: That is an unchallenged finding. [00:26:47] Speaker 04: It's according to the record. [00:26:48] Speaker 04: We discussed it on page 6 and 45 and 46 of our brief. [00:26:52] Speaker 04: That's why what happens in this case is BB&T obtains a dollar of foreign tax credit for 50 cents of cost and that allowed it to tell its board that STARS provided a positive tax benefit. [00:27:06] Speaker 02: Well this is an issue that on which you and Mr. Maiden are clearly at loggerheads and he says [00:27:12] Speaker 02: that the BX payment does not ultimately derive from the foreign tax credit. [00:27:18] Speaker 02: In other words, they're not reaping the... To take the $100 example, it's useful here, I think. [00:27:25] Speaker 02: He's saying it's not the $22 foreign tax credit that generates the $11 BX payment. [00:27:32] Speaker 02: It sounds like what he's saying. [00:27:35] Speaker 02: when you take the transaction apart, it looks like the most immediate source of the $11 is the $78 deduction that Barclays gets from the UK government. [00:27:52] Speaker 02: Explain to me how it is that I should conclude that you're right and he's not. [00:27:57] Speaker 04: Two points. [00:27:59] Speaker 04: When Barclays presented this to the UK, to get pre-approval. [00:28:03] Speaker 02: Let me just add a little more to my question. [00:28:06] Speaker 02: It does appear that the immediate source of the $11 is the $78 deduction. [00:28:14] Speaker 02: Because without that $78 deduction, Barclays is in a lost position, correct? [00:28:19] Speaker 04: Barclays needed both the credit and the loss. [00:28:22] Speaker 04: That's the testimony in the case. [00:28:24] Speaker 02: Explain that to me so that I can see the connection that you're making [00:28:29] Speaker 02: between the original $22 of BB&T's foreign tax credit and the $11 payment? [00:28:39] Speaker 04: What BB&T told the UK is that you have to look at this as a whole. [00:28:43] Speaker 04: Taking credits or taking losses and told the UK there was not going to be any tax leakage because the tax paid by BB&T was going to be more than the benefits that Barclays was going to take. [00:28:56] Speaker 04: And the way Barclays promoted this transaction [00:28:59] Speaker 04: to BB&T was we are going to claim tax credits for the tax that you pay, and then share that tax credit with you. [00:29:06] Speaker 04: That's the way the parties understood it. [00:29:08] Speaker 04: Whether it's a credit or loss, they had to have both, and money is fungible. [00:29:11] Speaker 04: So whether the benefit is coming mainly from the credit or mainly from the loss, Barclays needed both to be able to provide BB&T the return of BB&T's tax payment. [00:29:22] Speaker 04: And the parties understood that that's exactly what Barclays was doing. [00:29:25] Speaker 04: It was claiming the credit for the tax that was paid, [00:29:28] Speaker 04: and returning it to BB&T, which is why BB&T internally referred to it as a rebate. [00:29:32] Speaker 04: And when BB&T presented this transaction to its board, it said, we're going to pay this tax that Barclays was going to claim tax credits for that tax and return half of its tax. [00:29:45] Speaker 05: The UK is all happy with this, right? [00:29:48] Speaker 05: It's all legitimate under [00:29:50] Speaker 05: under foreign law, correct? [00:29:52] Speaker 04: Well, BB, when it was presented as tax additive to the UK initially, it didn't analyze the transaction, didn't bother to challenge it. [00:30:02] Speaker 04: Resources are scarce, and that's the way that it worked. [00:30:06] Speaker 04: But once the UK started to understand this more in 2005, it actually sent a letter to the United States and said, [00:30:12] Speaker 04: You might want to take a look at this STARS transaction. [00:30:15] Speaker 04: It creates artificial tax credits and appears to be tax credit abuse. [00:30:21] Speaker 04: Once the United States got that letter, we in fact started to look at it. [00:30:24] Speaker 04: It's key to understand that this is a US shelter, not a UK shelter, because it's draining the Treasury, the US Treasury, not the UK Treasury. [00:30:33] Speaker 05: Whose perspective are we supposed to look at the economic substance? [00:30:36] Speaker 04: We are looking at it from the standpoint of BD&T. [00:30:40] Speaker 04: BD&T had no economic reason for engaging in the trust transaction. [00:30:45] Speaker 04: The only thing they obtained was foreign tax. [00:30:48] Speaker 04: We have to look at net impact foreign tax and a return of half of the tax fee. [00:30:52] Speaker 05: That's if we define the BX payments to be a rebate, right? [00:30:58] Speaker 05: You have to win that point. [00:31:00] Speaker 04: No, that's not accurate, Your Honor, because even if you think, even if you reverse the, or disagree with the Court of Federal Claims' factual findings supported by the evidence, including BP&T's own characterization of the BEX as a rebate, if you view it as economic income, it's still just 50% of what it had to pay to get that income. [00:31:23] Speaker 04: Look at their story. [00:31:24] Speaker 04: It doesn't make any sense. [00:31:25] Speaker 04: We took on additional UK tax so that we could get half of it back. [00:31:30] Speaker 04: If you use the BX as economic revenue, then you have to view the UK tax as a cost of obtaining that revenue. [00:31:38] Speaker 04: And that transaction is not profitable until BB&T files its federal tax return and gets the foreign tax credit. [00:31:45] Speaker 04: If you say, build me a house, I'll give you $100, I can't determine whether that's going to be a profitable transaction until I know how much it's going to cost me. [00:31:52] Speaker 05: Well, corporations take into account foreign tax credits all the time with respect to their bottom line profitability, don't they? [00:31:58] Speaker 05: Sure. [00:31:58] Speaker 05: And there's nothing improper about that? [00:32:01] Speaker 04: Absolutely not. [00:32:01] Speaker 04: In this case, what makes it improper is that there's nothing else. [00:32:05] Speaker 04: BB&T to pre-existing U.S. [00:32:08] Speaker 04: income from U.S. [00:32:09] Speaker 04: assets circulated through a trust, an overnight transaction that generated nothing, no positive economic benefit for that income or those assets other than the foreign tax credit. [00:32:21] Speaker 04: and the return of half of its tax payment. [00:32:23] Speaker 04: Whether you view that as a rebate, as supported fully by the evidence in this case, or as economic income, it's still only half of its UK tax cost. [00:32:36] Speaker 02: Do you agree with Mr. Maiden that the analysis of this overall transaction should be segregated into both on the one hand the trust aspect of the transaction and on the other hand the loan aspect? [00:32:52] Speaker 04: Yes, we do and that's what the court found because the loan was artificially taxed to the trust to conceal the transaction. [00:32:59] Speaker 02: But it's not a single unitary integrated transaction as far as you're concerned for analytical purposes, are you? [00:33:07] Speaker 02: No, no. [00:33:07] Speaker 02: Turning to the loan for a moment, I just want to understand [00:33:14] Speaker 02: exactly what your argument is with respect to those. [00:33:16] Speaker 02: Now this is a loan which is above what we'll argue is the market rate. [00:33:26] Speaker 02: But nonetheless, there's no question that the interest that was charged on the loan was paid. [00:33:33] Speaker 02: That's correct. [00:33:34] Speaker 02: Right. [00:33:34] Speaker 02: Why isn't that enough to satisfy the requirements of the loan deduction statute? [00:33:44] Speaker 02: And why isn't that, since the loan is being used for economic purposes, why isn't that enough to satisfy the economic purpose? [00:33:51] Speaker 02: And let me give you an example of what's concerning me here. [00:33:54] Speaker 02: Suppose that I have an option to get a home mortgage, and I could get it at whatever it is these days, 4.5%, but my brother-in-law is a loan officer at a small struggling bank, and I decide, you know what, I'm going to throw some business in my brother-in-law's direction, so I'll go to his bank, and they charge me an extra quarter of a percent. [00:34:17] Speaker 02: I say, I can deal with it. [00:34:19] Speaker 02: Surely the IRS wouldn't. [00:34:22] Speaker 02: regard my loan as not subject to deduction. [00:34:28] Speaker 02: What is different about this case? [00:34:29] Speaker 04: You have a non-tax reason for engaging in that loan, and under this court's case law predecessor, the Rothschild case, where real interest was paid on a loan, [00:34:41] Speaker 04: the court, that's not enough. [00:34:43] Speaker 02: That's not enough to entitle... It sounds like you're bringing the other part of the transaction back into the loan part of the transaction when you start to talk about the tax reasons for the decisions that are made with respect to the loan. [00:34:57] Speaker 04: Only in the sense that if you look at BB&T's purpose for engaging in this loan, it was an illegitimate tax related purpose which was to conceal [00:35:05] Speaker 04: the trust, to give it to the purported low-cost business purpose that was rejected by the tax. [00:35:11] Speaker 05: But as Judge Bryson just said, isn't that inconsistent with your position that these are two separate transactions and that you can't put them together for purposes of analyzing economic substance? [00:35:22] Speaker 04: I don't think so, because I think, as the Court of Federal Claims explained, it's looking at it separately, but realizing that BB&T had tried to put them together artificially to conceal the two. [00:35:34] Speaker 04: And the court, when it analyzed the economic reality, the economic reality is that they were separate, but you're still left alone. [00:35:40] Speaker 04: It was engaged in for no purpose other than concealing. [00:35:42] Speaker 05: But isn't the economic substance analysis supposed to be done, at least under this court's case law, from a purely objective standpoint? [00:35:51] Speaker 04: The court looks at both, and so be it. [00:35:54] Speaker 04: The court noted that if a transaction will be disregarded for tax purposes, one or two things happens. [00:35:59] Speaker 04: Objectively, it lacks any economic benefit or substantial economic benefit for the taxpayer, or subjectively, whether the taxpayer lacks a business purpose. [00:36:10] Speaker 04: There'll be a lot of overlap sometimes in the factual analysis. [00:36:13] Speaker 04: You'll have to test the taxpayer's purported business purpose against the objective realities. [00:36:17] Speaker 04: But the court still looks at subjective evidence, such as how the case was promoted to the taxpayer, what the taxpayer's understanding of the transaction was. [00:36:26] Speaker 04: In here, this case was promoted as a foreign tax credit trade. [00:36:30] Speaker 04: And taxpayer's understanding was that the BX [00:36:33] Speaker 04: payment was a rebate and that understood that the loan and the trust connection was wholly artificial and that the taxpayer was embedding the BX within the formula for the loan in order to disguise the fact that it was a rebate. [00:36:49] Speaker 05: Where do we draw the line in your analysis in terms of deciding when payments between private parties constitute rebates? [00:37:00] Speaker 05: I mean, the law clearly says that a rebate comes from a foreign government. [00:37:04] Speaker 05: So you don't dispute that, right? [00:37:06] Speaker 05: The statute specifically says a rebate has to be from the foreign government. [00:37:11] Speaker 04: The law does not say that. [00:37:12] Speaker 04: But the law says, and this is 901-I, is that if the taxpayer receives a rebate [00:37:18] Speaker 04: from the foreign government, directly or indirectly, that that's going to limit the foreign tax credit. [00:37:26] Speaker 04: But that only applies in a transaction that has substance. [00:37:30] Speaker 04: But the economic substance transaction looks at it as an economic matter. [00:37:35] Speaker 04: Is this a rebate? [00:37:35] Speaker 04: So we're not arguing this is a rebate legally. [00:37:37] Speaker 04: We're arguing it's an economic matter. [00:37:39] Speaker 04: It's a rebate in just the common sense term of a rebate is a return of funds. [00:37:46] Speaker 04: taxpayer can see the child, that's what a rebate is as an economic matter. [00:37:51] Speaker 04: 901-I was not designed to address every situation. [00:37:55] Speaker 04: It was designed to address one situation. [00:37:57] Speaker 04: The economic substance doctrine, and the transaction actually has economic substance, the economic substance doctrine has a different purpose, and that's to prevent transactions that are abusive. [00:38:08] Speaker 04: where the economic reality doesn't reflect the form, which is the case here. [00:38:12] Speaker 02: Let me return briefly to the loan aspect of transaction again. [00:38:16] Speaker 02: Suppose in my hypothetical, my brother-in-law, if you recall hypothetical, my brother-in-law doesn't keep the extra quarter percent, but he hands it back to me in cash. [00:38:29] Speaker 02: Now, that's setting aside the criminal problem. [00:38:36] Speaker 02: I suppose that I would clearly not be able to deduct the full amount of the interest because I've gotten a quarter percent back, but wouldn't I still be able to deduct the rest of the part that is actually bona fide interest? [00:38:51] Speaker 02: even though the transaction is obviously tainted by this conduct. [00:38:55] Speaker 02: But nonetheless, I'm still paying real interest on a real loan for the rest of it. [00:39:00] Speaker 02: I'm just getting part of it is invalid. [00:39:02] Speaker 04: I think in your hypothetical, putting criminal law aside, the transaction will be analyzed under substance over form doctrine. [00:39:09] Speaker 04: And that loan would be recharacterized at the lower rate. [00:39:13] Speaker 04: And in that case, you don't disregard the entire transaction. [00:39:16] Speaker 04: You'd be entitled to your interest. [00:39:17] Speaker 04: So why isn't that this case? [00:39:18] Speaker 04: because the loan lacks a non-tax purpose. [00:39:21] Speaker 02: But it doesn't have a non-tax purpose, isn't it? [00:39:24] Speaker 02: This loan is being used for all sorts of investments of a billion and a half dollars, which is available to the borrower to use and presumably was used for all sorts of legitimate purposes. [00:39:35] Speaker 02: There's no suggestion that the billion and a half was somehow not a legitimate [00:39:43] Speaker 02: loan proceeds, right? [00:39:44] Speaker 04: No, but as the trial court found, the use of the loan proceeds was not an incremental benefit from the STARS transaction. [00:39:53] Speaker 04: And that's an unchallenged finding. [00:39:54] Speaker 04: It's supported by DB&T's contemporaneous analysis. [00:39:57] Speaker 04: They did analyze what they were going to do with the loan proceeds. [00:40:00] Speaker 04: They analyzed just the loan's rate and how it would be lower if they applied the rebates they're getting back from the UK for it. [00:40:07] Speaker 04: But this loan was above market, and the minute [00:40:10] Speaker 04: that the Stars Trust transaction ended, and it ended early when the IRS issued the proposed anti-Stars regulations. [00:40:19] Speaker 04: DB&T didn't try to hold on to the financing from Barclays, because it's an undesirable loan that hindered any investment. [00:40:26] Speaker 04: It was a drag on any investment that could actually use the loan proceeds for, because this is a loan at LIBOR plus 25, and it could borrow funds at LIBOR minus 18 basis points, I believe is what the testimony was. [00:40:40] Speaker 04: One brief comment on penalties. [00:40:43] Speaker 04: With regard to penalties, the only penalty issue that's on appeal is whether BB&T had reasonable cause for its tax entertainment and penalties are critical to the self-enforcing tax system because [00:40:57] Speaker 04: They're designed to deter taxpayers, particularly taxpayers who repeat tax shelter purchasers like BB&T, trying to deter them from entering into these types of transactions and to let other taxpayers who are paying their fair share of the tax know that those who do not are going to pay a penalty. [00:41:15] Speaker 04: And we've detailed in our brief a number of reasons why the trial court correctly found that BB&T lacked reasonable cause. [00:41:23] Speaker 04: It failed to obtain independent tax advice. [00:41:25] Speaker 04: The advice that they did obtain was based on false factual representations regarding BB&T's motives for engaging in the transaction. [00:41:33] Speaker 04: BB&T was a sophisticated bank. [00:41:35] Speaker 04: We're not talking about somebody taking out a small loan. [00:41:37] Speaker 04: We're talking about a sophisticated bank. [00:41:39] Speaker 02: Go ahead, I just want to have a question when you finish your question. [00:41:43] Speaker 04: Okay, almost done. [00:41:44] Speaker 04: They were fully aware of the tax risk and finally they did have that prior experience because there's 37 LILAs in silos that were rejected by the IRS under the substance doctrine before BB&T engaged in the STARS transaction. [00:41:56] Speaker 02: Now between parties there's some back and forth about Sibley's [00:42:01] Speaker 02: Sidley's participation in the whole thing, and particularly Mr. Ruble's, his involvement in this whole star's matter and the advice that was given. [00:42:20] Speaker 02: help me out and factually walk me through briefly the involvement in the opinion granting and the conflict of interest to, for lack of a better term, situation of Sydney as you see it. [00:42:33] Speaker 04: Sure. [00:42:33] Speaker 04: Well, Sidley did draft it, and Mr. Rollins is the primary drafter of the tax opinion that BB&Ts were relying on. [00:42:41] Speaker 04: But Sidley was recommended. [00:42:43] Speaker 04: This wasn't just independent counsel that BB&T went out and got this. [00:42:47] Speaker 04: It was actually recommended by both Barclays and KPMT. [00:42:52] Speaker 02: But he wasn't the person that ultimately gave the final opinion, right? [00:42:56] Speaker 02: He was going by that, if I understand correctly. [00:43:00] Speaker 04: I'm not sure if that's the case. [00:43:01] Speaker 04: Actually, I'm not sure. [00:43:03] Speaker 05: Clearly, Sidley said that they stood by the opinion even after he was gone. [00:43:06] Speaker 05: That was later. [00:43:07] Speaker 04: After he was gone. [00:43:08] Speaker 04: After CB&T got the opinion, shortly after that, it became quite public that KPMG and Sidley, in particular Mr. Ruble, were under investigation for bad tax activity. [00:43:21] Speaker 02: And given that bad feeling... It was an unrelated transaction, right? [00:43:24] Speaker 04: It developed to be, but what was in the press was that these are organizations that develop and sell tax shelters, but that didn't ring a bell for BB&T to go out and get independent tax advice. [00:43:36] Speaker 04: Somewhere it should have been a red flag that Barclays, their counterparty in this case, was recommending Sidley. [00:43:43] Speaker 04: even putting aside the fact that simply was not independent tax advice, the actual tax advice that SISLY provided was insufficient to provide reasonable cause because it was based on factual representations that BB&T knew or should have done were fault regarding its motives for engaging in this transaction. [00:44:01] Speaker 05: Okay. [00:44:02] Speaker 05: Any other questions? [00:44:02] Speaker 05: Thank you. [00:44:03] Speaker 05: Thank you. [00:44:05] Speaker 05: All right, you'll have your three minutes for a rebuttal. [00:44:10] Speaker 06: Thank you. [00:44:12] Speaker 06: I've got two points to make, but let me just clarify the response for the question you asked. [00:44:18] Speaker 06: Mr. Ruble was at Sidley when the initial opinion was issued to BB&T in 2002, and he was a primary drafter. [00:44:27] Speaker 06: The information about his participation in tax shelters [00:44:31] Speaker 06: didn't emerge until 2003, well into 2003. [00:44:36] Speaker 06: And when that occurred, BB&T went back to the head of tax at Sidley and their corporate tax lawyer. [00:44:44] Speaker 06: And at that time, Sidley had a three-person tax team, including the head of tax, re-review the analysis and affirm for BB&T that they stood behind the tax opinion. [00:44:59] Speaker 06: And the issues were unrelated. [00:45:02] Speaker 02: You mean the different tax shelter structures? [00:45:06] Speaker 02: Stars versus them, wasn't the Lilo-SciLo or whatever? [00:45:10] Speaker 06: It was more like the Stobie Creek transaction. [00:45:13] Speaker 02: Son of a boss. [00:45:13] Speaker 06: Son of a boss. [00:45:15] Speaker 06: OK. [00:45:16] Speaker 06: And other. [00:45:19] Speaker 06: The two points I want to make. [00:45:21] Speaker 06: One, Judge Bryson goes back to what you asked in the context of the loan interest deduction. [00:45:26] Speaker 06: If you have an inflated loan interest rate, [00:45:30] Speaker 06: It shouldn't be the case that you at least get the difference between the market rate and the inflated rate. [00:45:36] Speaker 06: Well, that goes directly into the argument we're making with respect to the foreign tax credit issues also. [00:45:43] Speaker 06: In this sense, when Judge O'Malley asked me whether I'm using 901I and the Coltech decision as a vehicle for statutory construction, [00:45:56] Speaker 06: The answer is, in some instances, absolutely yes. [00:46:00] Speaker 06: If you consider that if the actual statute, 901 applied to this case, and there was a rebate, a statutory rebate, only half or 51% of BB&T's foreign tax credits would have been disallowed. [00:46:17] Speaker 06: And that's because the statute specifically says, to the extent of a rebate, [00:46:23] Speaker 06: And when it comes to statutory construction and using economic substance, what economic substance does here is go well beyond the remedy that would have been pursued by the statute if we had failed the statute. [00:46:36] Speaker 06: That can't be the case. [00:46:37] Speaker 06: It can't be the case that the statute reaches a different result and economic substance makes matters worse. [00:46:46] Speaker 06: If you look at the Bankers Trust case, in fact, when the IRS attempted to invoke this very regulation against [00:46:53] Speaker 06: Bankers Trust relating to a Brazilian foreign tax credit where there was clearly a rebate. [00:46:58] Speaker 06: They only sought back, in our case, the 51%, not the 49%. [00:47:03] Speaker 06: I mention that because that should be the worst case scenario for BB&T. [00:47:08] Speaker 06: But I also mention it because of everything else we've talked about, which is once you're in 901i, then you should look at the 49% in the context of the substance analysis that is required by that statute. [00:47:21] Speaker 06: That's point one. [00:47:23] Speaker 06: Am I over? [00:47:24] Speaker 05: Yes, but you could just make your last point. [00:47:29] Speaker 06: My last point is this argument about 901i and that these BX payments are not rebates are not the exclusive basis for our position that the BX payments should be treated as economic income. [00:47:44] Speaker 06: The only two courts of appeals that have addressed [00:47:49] Speaker 06: The application of foreign tax credits in the context of economic substance, let me say that backwards, the application of economic substance in the context of foreign tax credits are the fifth and eighth circuit in Compact and IES. [00:48:03] Speaker 06: And in that case, those are also the only two cases that have addressed the question of what income should be included and not included. [00:48:11] Speaker 06: And in those cases, number one, both circuits decided that that was a question of law. [00:48:16] Speaker 06: And both courts decided that even though the payment made by those taxpayers' counterparties fulfilled their tax obligation, that amount was still income for purposes of pretax profit. [00:48:33] Speaker 06: Here, we have a direct payment. [00:48:36] Speaker 06: Thank you, Ronnie.