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INTRODUCTION
The economic substance doctrine in the U.S. has its roots in case law that aimed to deny tax benefits generated from certain abusive transactions entered into solely or primarily to obtain tax benefits. The doctrine broadly requires that a transaction have a non-tax-related, economic motivation and effect for the tax benefit to be allowed.
GREGORY V. HELVERING
Gregory v. Helvering1 is an early case on the subject. In Gregory, the taxpayer, Mrs. G, was the sole shareholder of U-Corp, having a cost basis of $350,000 in her U-Corp shares. In turn, U-Corp owned 1,000 shares of M-Corp, which substantially appreciated in value during the period held by U-Corp. Mrs. G expressed an interest in arranging the sale of M-Corp shares. However, were U-Corp to sell those shares and distribute the proceeds to Mrs. G, corporate tax would be imposed on U-Corp's gain and income tax would be paid on the dividend distributed to Mrs. G.
To avoid double taxation, U-Corp dropped the M-Corp shares into Newco and distributed the Newco shares to Mrs. G. Under the law in effect at the time, the dropdown to Newco and the distribution of Newco shares to Mrs. G arguably comprised a tax-free spinoff. A portion of Mrs. G's $350,000 cost basis in U-Corp shares was apportioned to Newco shares received by Mrs. G. Within a few days, Newco adopted a plan of liquidation and distributed the M-Corp shares to Mrs. G. Under the law in effect at the time, neither Newco nor Mrs. G recognized gain. Mrs. G then sold the shares and paid tax on the gain, which was the excess of the sales price over the apportioned tax basis in the Newco shares.
Mrs. G's tax return was challenged by the Bureau of Internal Revenue. It contended that the creation of the Newco was without substance and must be disregarded. Mrs. G should be taxed as if she received a dividend consisting of the amount received upon the sale of the M-Corp shares. The mere organization of Newco for the purpose of enabling Mrs. G and U-Corp to avoid tax followed almost immediately by the dissolution of Newco was a transparent fiction. The determination of the Bureau was appealed to the Board of Tax Appeals, which ruled in her favor,2 but the decision was reversed on appeal3 and the reversal was affirmed by the Supreme Court.
The decision in Gregory v. Helvering took aim at transactions that meet statutory requirements but are "outside the plain intent of the statute."
It is earnestly contended on behalf of the taxpayer that since every element required by the * * * [Code] is to be found in what was done, a statutory reorganization was effected; and that the motive of the taxpayer thereby to escape payment of a tax will not alter the result or make unlawful what the statute allows. It is quite true that if a reorganization in reality was effected within the meaning of * * * [the Code], the ulterior purpose mentioned will be disregarded. The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. * * * But the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended. The reasoning of the court below in justification of a negative answer leaves little to be said.
When [the Code] * * * speaks of a transfer of assets by one corporation to another, it means a transfer made "in pursuance of a plan of reorganization" * * * of corporate business; and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either, as plainly is the case here. Putting aside, then, the question of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, what do we find? Simply an operation having no business or corporate purpose – a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. * * *
In these circumstances, the facts speak for themselves and are susceptible of but one interpretation. The whole undertaking, though conducted according to the terms of * * * [the Code], was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.
OTHER CASES LOOKING TO ECONOMIC SUBSTANCE
Numerous cases of addressed aggressive tax planning using comparable reasoning to attack aggressive tax plans. Examples include the following:
- The incidence of taxation depends upon the substance of the transaction and not mere formalism4
- Taxation is not so much concerned with refinements of title as it is with actual command over the property5
- A mere transfer in form, without substance, may be disregarded for tax purposes6
- A given result at the end of a straight path is not made a different result because reached by following a devious path7
- Where a taxpayer has embarked on a series of transactions that are in substance a single, unitary, or indivisible transaction, the courts have disregarded the intermediary steps and have given credence only to the completed transaction8
- Transactions that are challenged as intermediary steps of an integrated transaction are disregarded only when found to be so interdependent that the legal relations created by one transaction would have been fruitless without the completion of the series9
- A taxpayer cannot insulate himself from taxation merely by assigning a right to income to another10
- The absence of a non-tax business purpose for a partnership is fatal to its validity11
- While taxpayers are allowed to structure their business transactions in such a way as to minimize their tax, these transactions must have a legitimate non-tax avoidance business purpose to be recognized as legitimate for tax purposes12
- A transaction entered into solely for tax benefits without economic, commercial, or legal effect other than expected tax benefits is to be disregarded13
Footnotes
1 293 U.S. 465 (1935).
2 27 B.T.A. 223 (1932).
3 69 F.2d 809 (2nd Cir. 1934).
4 Commr. v. Court Holding Co., 324 U.S. 331, 334 (1945).
5 Corliss v. Bowers, 281 U.S. 376, 378 (1930); see also Commr. v. P. G. Lake, Inc., 356 U.S. 260 (1958); Helvering v. Clifford, 309 U.S. 331 (1940); Griffiths v. Commr., 308 U.S. 355 (1939); Sachs v. Commr., 277 F. 2d 879, 882-883 (8th Cir. 1960), affirming 32 T.C. 815 (1959).
6 Commr. v. P. G. Lake, Inc., supra; Commr. v. Court Holding Co., supra; Commr. v. Sunnen, 333 U.S. 591 (1948); Helvering v. Clifford, supra; Corliss v. Bowers, supra; Richardson v. Smith, 102 F. 2d 697 (2nd Cir. 1939); Howard Cook, 5 T.C. 908 (1945); J. L. McInerney, 29 B.T.A. 1 (1933), affd. 82 F. 2d 665 (6th Cir. 1936).
7 Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613 (1938).
8 Redwing Carriers, Inc. v. Tomlinson, 399 F. 2d 652, 654 (5th Cir. 1968); May Broadcasting Co. v. U.S., 200 F. 2d 852 (8th Cir. 1953); Whitney Corporation v. Commr., 105 F. 2d 438 (8th Cir. 1939), affirming 38 B.T.A. 224 (1938); Commr. v. Ashland Oil & R. Co., 99 F. 2d 588 (6th Cir. 1938), reversing sub nom. Swiss Oil Corporation v. Commr., 32 B.T.A. 777 (1935), certiorari denied 306 U.S. 661 (1939); Kuper v. Commr., 61 T.C. 624 (1974); Kimbell-Diamond Milling Co. v. Commr., 14 T.C. 74 (1950), affirmed per curiam 187 F. 2d 718 (5th Cir. 1951), certiorari denied 342 U.S. 827 (1951).
9 American Bantam Car Co. v. Commr., 11 T.C. 397, 405 (1948), affirmed 177 F. 2d 513 (3rd Cir, 1949), certiorari denied 339 U.S. 920 (1950); see Scientific Instrument Co. v. Commr., 17 T.C. 1253 (1952), affirmed per curiam 202 F. 2d 155 (6th Cir., 1953).
10 Commr. v. Sunnen, supra; Helvering v. Horst, 311 U.S. 112 (1940); Corliss v. Bowers, supra; Lucas v. Earl, 281 U.S. 111 (1930).
11 Andantech L.L.C. et al. v. Commr., 331 F.3d 972 (D.C. Cir. 2003).
12 Boca Investerings Partnership v. U.S., 314 F.3d 625 (2003).
13 Nicole Rose Corp. v. Commr., 320 F.3d 282 (2nd Cir., 2002).
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