Economic substance was at issue in another case, only this time the taxpayer won.

The US government has won two cases involving a complicated transaction called STARS for “structured trust advantaged repackaged securities” that KPMG arranged between Barclays Bank in the UK and various banks in the United States. The courts said the transactions lacked economic substance and had as the main aim generating foreign tax credits for use in the United States. (For prior coverage, see the April 2013 NewsWire starting on page 31.)

Sovereign Bank won a partial judgment in the third such case to reach the courts in October. Its case is before a federal district court in Massachusetts.

The judge called the transaction “surpassingly complex and unintuitive; the sort of thing that would have emerged if Rube Goldberg had been a tax accountant.”

Barclays made a loan to Sovereign Bank. However, the loan was set up as a transaction run on paper through a trust in the United Kingdom with an elaborate series of agreements a number of which involved circled cash. The main reason for interposing the trust and for some of the arrangements surrounding the trust was to trigger taxes at a 22% rate in the United Kingdom on earnings on $6.7 billion in Sovereign collateral held by the trust over the term of the loan, but to allow Sovereign to claim foreign tax credits for the UK taxes in the United States. Barclays received tax benefits from the arrangement in the United Kingdom. It reimbursed Sovereign for roughly half the UK taxes Sovereign paid in the form of a “Barclays payment.”

In a similar case before the US Tax Court last February, the government persuaded the court to view the foreign tax credit leg of as a separate transaction that lacked substance. In order to have substance, the taxpayer must expect a profit from the transaction apart from tax benefits and there must be a business purpose apart from generating tax benefits.

Sovereign moved for a partial summary judgment on the issue whether the payment it received from Barclays for half the UK taxes it incurred should be counted as revenue in assessing whether Sovereign had a reasonable prospect of profit from the transaction. The IRS argued the amount should be excluded as a “tax effect” of the transaction.

The judge sided with Sovereign. It would have been different if the payment had come actually or constructively from the UK government because a US foreign tax credit cannot be claimed on taxes that are not paid in fact. However, this was a payment from a private party. The judge declined to analyze each leg as if it were a separate transaction.

The case is Sovereign Bank v. United States. At issue are $234 million in taxes, penalties and interest.