Brooklyn Journal of Corporate, Financial & Commercial Law

First Page



The foreign tax credit, which saves U.S. taxpayers from paying both foreign and domestic income taxes on the same income, is critical to facilitating global commerce. However, as savvy taxpayers discover increasingly complicated ways to abuse the foreign tax credit regime through the structuring of business transactions, courts have become increasingly skeptical of the validity of those transactions. Using the economic substance doctrine, a common law doctrine codified in 2010 at I.R.C. § 7701(o), courts will disallow tax benefits stemming from a transaction that is not profitable absent its tax benefits, and which the taxpayer had no incentive to undertake except for its tax benefits. While the statute seems clear on its face, there is a deep split among the U.S. Courts of Appeals over what constitutes the exact transaction to be analyzed. In Bank of New York Mellon Corp. v. Commissioner, the U.S. Court of Appeals for the Second Circuit held that, while a court will not consider a foreign tax credit received as profit arising from a transaction, it will also deduct the costs of paying foreign taxes as a cost of the transaction. Conversely, the U.S. Courts of Appeals for the Fifth and Eighth Circuits consider tax credits earned as profit and subtract the costs of paying foreign taxes when applying the doctrine. This Note argues that the Second Circuit decision renders taxpayers all but powerless to survive economic substance scrutiny, and that the Supreme Court should create bright-line precedent defining what constitutes a transaction for economic substance purposes, more closely adhering to the Fifth and Eighth Circuit approaches.