Second Circuit: Economic substance doctrine applies to foreign tax credits

Second Circuit: Economic substance doctrine

The U.S. Court of Appeals for the Second Circuit today affirmed a U.S. Tax Court opinion and a federal district court judgment in appeals heard in tandem concerning application of the “economic substance doctrine” to transactions involving foreign tax credits. The Tax Court, having considered the effect of foreign taxes in the pre-tax analysis, denied the claimed foreign tax credits as lacking economic substance, but allowed interest expense deductions for the loan associated with the transactions. The federal district court held that the economic substance doctrine applied to transactions involving foreign tax credits generally, and that foreign taxes were to be included in calculating pre-tax profit.


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The appeals were in the cases: Bank of New York Mellon Corp. v. Commissioner, and American International Group, Inc. v. United States, Docket Nos. 14-704-ag(L), 14-1394(XAP), 14-765-cv (2d Cir. September 9, 2015). Read the Second Circuit’s 52-page decision [PDF 309 KB]

In both cases, the taxpayers asserted they were entitled to tax credits associated with foreign cross-border transactions, but that were disallowed by the IRS based on a finding that the transactions lacked economic substance. 

The Second Circuit concluded that the economic substance doctrine applies to the foreign tax credit regime, and affirmed that both the Tax Court and the federal district court had properly determined the tax implications of the cross-border transactions.

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