* IRS argues "economic substance" in STARS tax disputes
* Obama's 2010 healthcare overhaul gave IRS legal boost
* Major banks take on tax agency over Barclays dealings
By Patrick Temple-West and Kevin Drawbaugh
WASHINGTON, Aug 11 (Reuters) - A sharp tool in the U.S.government's fight against corporate tax shelters will be put tothe test in the months ahead as the Internal Revenue Servicegrapples with four major banks over structured transactions donea decade ago with Barclays Plc.
The IRS contends the transactions, known as STARS deals,were designed purely to facilitate tax dodging. The banks saythe deals were done to enhance their core businesses and arechallenging the IRS over hefty tax bills it has imposed.
To pursue these cases, the IRS is relying heavily on the"economic substance" doctrine, a legal strategy that focusesless on the technicalities of particular financial structuresand more on their purposes and outcomes.
The approach - bolstered recently by legislation buriedinside the Obama administration's landmark 2010 healthcare bill- is a focus of keen debate among tax lawyers and accountants.
The economic substance doctrine is a "club in the closet"for the IRS that it is using too broadly, said Jasper Cummings,a tax lawyer with Alston & Bird LLP.
For the IRS, said Robert Probasco, a partner at Thompson &Knight, the doctrine is a "convenient way to dispose of caseswithout some of the messiness of statutory interpretation."
In the first STARS case to go to trial, the IRS won inFebruary, chiefly on an economic substance argument. New York'sBNY Mellon Corp had sued the tax agency to defend a $900million tax benefit the bank had claimed stemming from STARStransactions done with London-based Barclays.
The U.S. Tax Court ruled that the transactions lacked"economic substance," meaning they were done solely for taxpurposes. A judge called them "a subterfuge for generating,monetizing and transferring the value of foreign tax credits."
BNY Mellon is appealing that decision. Three other banks -BB&T Corp, Santander Holdings and Wells Fargo - are challenging the IRS in separate STARS disputes.
Like BNY Mellon, the other banks are arguing that theirSTARS dealings were perfectly legal and meant to advance theircore businesses. All four banks and the IRS declined to comment.
A decision in BB&T's case is expected later this year.
If BNY Mellon loses its appeal of the Tax Court's Februarydecisions, "it will be the most remarkable extension of theeconomic substance doctrine around," Cummings said.
LOOK TO STARS
STARS is short for "structured trust advantaged repackagedsecurities." The IRS has accused several banks of generatingartificial foreign tax credits through STARS from roughly 1999to 2006 with Barclays' help.
Foreign tax credits are awarded to U.S. companies by the IRSto ensure that they are not taxed twice on the same profits bythe U.S. government and by a foreign government.
BNY Mellon Corp said in mid-February it was taking an $850million charge against first-quarter profits after losing itsfight with the IRS. The bank said then: "We continue to believethe tax treatment of the transaction was consistent withstatutory and judicial authority existing at the time."
Barclays is not a party to the STARS cases and previouslyhas said it complies with tax laws everywhere it does business.
The STARS disputes predate the 2010 codification of, andenhancements to the economic substance doctrine written intoPresident Barack Obama's healthcare system overhaul.
Although they will not bear directly on the STARS cases, the2010 changes give the IRS more flexibility to prove taxavoidance and added punitive penalties of up to 40 percent ofthe disputed tax bill.
BB&T is fighting an $892 million STARS dispute with the IRS.The bank recognized a $281 million expense in the first quarterof 2013 as a result of the BNY Mellon decision. BB&T and IRS hadclosing arguments on July 30 in their court case.
Earlier this month, the government filed arguments in casesinvolving Santander and Wells Fargo.
Barclays (BARC)