The Economic Substance Doctrine
The economic substance doctrine permits a court to disallow
claimed tax benefits if the transaction purportedly giving rise to those benefits
has no business purpose aside from the creation of favorable tax
treatment. The economic substance inquiry
looks to both the transaction’s objective economic consequences and the
taxpayer’s subjective profit motive in undertaking the transaction. However, these aspects of the inquiry do not
constitute separate elements that must be satisfied individually, but rather
represent factors that, when weighed against the transaction’s purported tax
benefits, inform the economic substance analysis.
The main policy driving the economic substance doctrine is the notion that a taxpayer may not claim tax benefits unintended by Congress by way of a transaction that serves no economic purpose apart from the creation of tax savings. Generally, the issues are whether the transaction affects a beneficial interest and has a reasonable possibility of generating a profit. Congress codified the judicial economic substance doctrine in 2010, but the IRS has so far provided precious little guidance on how it intends to apply the statutory doctrine. However, the IRS stated that the economic substance determination “shall be made in the same manner as if [the legislation] had never been enacted,” thus the body of economic substance doctrine case law remains in force in IRS enforcement actions moving forward. Because of the dearth of interpretational guidance with respect to the codified economic substance doctrine, aside from the IRS pronouncement that the existing case law remains undisturbed, the discussion below will focus on the evolution of the judicial economic substance doctrine.
The main policy driving the economic substance doctrine is the notion that a taxpayer may not claim tax benefits unintended by Congress by way of a transaction that serves no economic purpose apart from the creation of tax savings. Generally, the issues are whether the transaction affects a beneficial interest and has a reasonable possibility of generating a profit. Congress codified the judicial economic substance doctrine in 2010, but the IRS has so far provided precious little guidance on how it intends to apply the statutory doctrine. However, the IRS stated that the economic substance determination “shall be made in the same manner as if [the legislation] had never been enacted,” thus the body of economic substance doctrine case law remains in force in IRS enforcement actions moving forward. Because of the dearth of interpretational guidance with respect to the codified economic substance doctrine, aside from the IRS pronouncement that the existing case law remains undisturbed, the discussion below will focus on the evolution of the judicial economic substance doctrine.
