By Tim McLaughlin
BOSTON, Feb 11 (Reuters) - BNY Mellon Corp said onMonday it will take an $850 million charge against first-quarterprofit after losing a high-stakes tax case to the U.S. InternalRevenue Service, a move that will also erode some of itscapital.
The BNY Mellon case was the first to go to trial since theIRS accused several U.S. banks of generating artificial foreigntax credits through loans with London-based Barclays Plc.
The IRS challenged a $900 million tax benefit claimed by BNYMellon that stemmed from a $1.5 billion loan from Barclays. Thefunding was so cheap that at one point Barclays actually paidBNY Mellon to take Barclays' money, according to court papers.
The bank sued the IRS to keep the benefit, but the tax courtruled that the transactions lacked "economic substance," meaningthey were done solely for tax purposes.
Tax Court Judge Diane Kroupa wrote in a 55-page decisionthat the transaction "was an elaborate series of pre-arrangedsteps designed as a subterfuge for generating, monetizing andtransferring the value of foreign tax credits."
BNY Mellon said it would appeal the decision.
"We continue to believe the tax treatment of the transactionwas consistent with statutory and judicial authority existing atthe time," the bank said in a statement.
BNY Mellon and the other banks involved used foreign taxcredits in the Barclays transactions. These are given to U.S.companies to prevent them from being double-taxed by twocountries for the same income.
The $850 million charge is more than BNY Mellon has earnedin any single quarter over the past three years. Net income inthe first quarter of 2012 was $619 million.
The bank had previously disclosed that it might have to booka reserve of up to $850 million in the event of an unfavorableruling in the case.
After taking the charge, the bank said it expects it willcontinue to be well capitalized. But its Basel III Tier 1 commonequity ratio will decline by about 55 basis points.
At the end of 2012, the bank's Basel III Tier 1 commonequity ratio was 9.8 percent.
The financing Barclays provided the U.S. banks centered onso-called STARS transactions - or structured trust advantagedrepackaged securities. The arrangements were so opaque andcomplicated that a Harvard-trained federal judge in Minnesotahad to call in an outside expert to help him decipher WellsFargo's arrangement with Barclays, court papers show.
Experts for the government pounced on the fact that Barclayssometimes paid the other banks to take its money.
The banks have argued that the loans from Barclays advancedtheir core business, according to court papers. Barclays offeredthem the opportunity to earn greater profits by providing anultra-cheap source of funding. Any profit would be thedifference between their cost of funding and what they earned onthe money they invested or put out in loans, they said.
Barclays (BARC)