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The Bank of New York Mellon Corporation (BK - Analyst Report) recently found itself in a tight spot with a tax court judge ruling against the bank in a high profile case. The case, filed by U.S. Internal Revenue Service (IRS), will cost BNY Mellon a loss of $850 million.

IRS had filed the lawsuit against several banks including BB&T Corporation (BBT - Analyst Report) and Wells Fargo & Company (WFC - Analyst Report), accusing these of creating bogus foreign tax credits through loans from London-based Barclays PLC (BCS - Analyst Report). The case against BNY Mellon was the first one to go for the trial.

IRS had accused BNY Mellon of fraudulently generating a tax credit of $900 million by obtaining a $1.5 billion loan from Barclays. The loan was obtained at very cheap rates and it is widely speculated that Barclays paid BNY Mellon to take the loan. BNY Mellon, in turn sued IRS.  

However, the judge found the transactions pertaining to BNY Mellon and Barclays to be driven by vested interests and devoid of any meaningful economic goals. The judge further added that this transaction was designed to create, monetize and shift the value of foreign tax credits.

BNY Mellon, in its defense, has maintained that all the transactions carried out were consistent with the statutory and judicial requirements. Further, the bank is willing to challenge the verdict in court.

BNY Mellon is planning to charge the $850 million loss against its first quarter profits. Earlier, it had deliberated to create a reserve of up to $850 million in the event of an adverse ruling in the case. However, the bank expects its capital position to remain robust in spite of a 55 basis points decline in its Basel III Tier 1 common equity ratio.

American authorities have diverted their focus on deals worth billions of dollars between the banking giants of U.S. and the U.K to monitor abusive tax evasion practices. The companies exploit the loopholes in the international tax systems for their own benefit.

For instance, foreign tax credits are meant to prevent taxpayers from being taxed twofold However, as per IRS, some of the deals involve a one-time tax payment by a company in one country, which yields tax credit and benefits for two taxpaying companies in two countries. Foreign tax credit deals are glaring instances of how global financial institutions over the years have abused tax arbitrage to boost their own bottom line.

We believe that the charging of estimated losses stemming from the unfavorable ruling will likely result in losses at BNY Mellon in the first quarter. However, the company’s strong fundamentals are likely to absorb the spillover effects.

BNY Mellon carries a Zacks Rank #4 (Sell).

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