by Linda Beale
ABA Tax Section Report on the Economic Substance Doctrine
crossposted with Ataxingmatter
The ABA Tax Section put together a large working group to write a report on the newly codified economic substance provision–Download ABA Economic Substance. Comments on Notice 2010-62.
The working group was led by several people, including Michael Desmond, who just happened to be at Treasury during the Bush Administration. (There are lots of people in private practice now, writing reports on government decisions, who were in government under Bush just a while ago. Is that a good thing? I suppose it has its pluses and minuses. On the plus side, it ensures that there are always those in practice who understand how government works and where important decisions can get hung up or expedited. ON the minus side, the very decisions that were put in place during a person’s tenure in government may be susceptible to persuasive lobbying (using that insider perspective) from those who worked on the provision in government and now comment on it on the outside.)
The practitioner community is generally concerned that the codification of the economic substance doctrine will mean that it will “chill” regular business transactions because of the uncertainty regarding its exact application. So the report asks for clarification–just what are the transactions that are susceptible to the application of economic substance, what is a substantial purpose, what does it mean to have a potential for profit, how do we know when state tax provisions are related to federal tax provisions, and what, in fact, does “economic substance doctrine” mean.
While the desire for absolute clarity is understandable, I am not sure that it is a desire that the Treasury should attempt to satisfy. One of the benefits of judicial doctrines, compared to very specific statutory anti-abuse provisions, is their flexibility. Courts, in the context of particular cases, review the circumstances of a transaction and conclude that it lacks economic substance. The doctrine has developed as part of the federal common law of tax, and it has gone through periods of being particularly useful in curbing super-aggressive tax avoidance shelters.
For people like me who were worried that codification of the doctrine could lead to its demise by narrowing its scope and defining away its power to adapt to unforeseen abusive pattersn (and to create enough uncertainty among tax practitioners to discourage the most aggressive tax return gambits), the ABA’s demand for “clarification” is therefore worrisome. If we take Congress at its word, it expected the courts to continue applying the doctrine in the circumstances in which they applied the doctrine before codification. Codification solves the problem of different tests for economic substance applied in different jurisdictions by settling on one test, but it leaves it to the courts’ careful case-by-case analysis to add more meat to the bones of the test. This is as it should be.
Practitioners would nonetheless like an “angel” list of transactions to which the economic substance doctrine can’t apply. Treasury has wisely refused, since the power of the doctrine is in looking beyond form to substance and recognizing that abusive transactions (shelters) are highly innovational within the confines of existing statutory provisions. The creation of an angel list would be an invitation for creative tax genuises to manipulate code sections to create an abusive transaction out of the angel one.
Let’s be honest. Many practitioners would also like to see the significant test for business purpose narrowed in scope. Here too I disagree. it is important for transactions that are honored in their form for tax purposes to have a significant purpose that is germane to the business and not conjured up solely to achieve favorable tax results.
While some guidance would be helpful, Treasury should be careful not to put the pliable economic substance doctrine into a straitjacket that limits its ability to police aggressive transactions.