United States

Economic substance found lacking in STARS transaction

First Circuit hands victory to government in STARS transaction


In Santander Holdings USA Inc. v. United States, the United States Court of Appeals for the First Circuit reversed an earlier victory by Santander Holdings USA, in a suit to recover $234 million in tax refunds relating to a claim for foreign tax credits arising from a structured trust advantaged repackaged securities transaction (STARS). Concluding that the trust portion of the STARS transaction did not have a “reasonable prospect of creating a profit without considering the foreign tax credits,” the court held that the transaction lacked economic substance and as such, was not a transaction for which Congress intended to grant foreign tax credits. The case illustrates the need for economic substance in order to support the tax treatment of international transactions.

In Santander, the First Circuit examined several key factors to determine whether the transaction lacked economic substance, including:

  • whether there was a bona fide business purpose
  • a meaningful change to the taxpayer’s economic position
  • a reasonable potential for pre-tax profit generation
  • whether or not the transaction was shaped by tax avoidance features

The court noted that the assets placed in the trust never effectively left the taxpayers control and performed no function inside the trust that could not also be accomplished outside the trust. Based on these facts, the court concluded that the trust structure lacked real business purpose and the transaction did not result in any meaningful change to the taxpayer’s economic position. The court next looked to the potential for pre-tax profit and concluded that, aside from tax savings, the transaction generated no potential for, either long-term or short-term, profit generation aside from the mutual tax savings to the parties involved. Finally, the court looked to whether or not the transaction was shaped by tax avoidance features, and noted that taxpayer’s sole purpose for entering into the transaction was to maximize tax benefits. The lack of pre-tax profit potential arising from the deal convinced the court that the transaction structure was inherently shaped by tax avoidance features. 

The Santander decision is a reminder that, while a taxpayer may legally seek to reduce its tax liability from a transaction, a transaction that lacks pre-tax profit potential is at great risk of being viewed by the courts as lacking in economic substance sufficient to justify any claimed tax benefits.


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