The Economic Substance Doctrine (Portfolio 508)

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Yoram Keinan

Yoram Keinan, SJD, Greenberg Traurig; B.A., LL.B., Tel Aviv University; LL.M. (Taxation), Hebrew University; M.B.A., Bar Ilan University; M.P.A., LL.M. (International Taxation), Harvard University; LL.M. (Taxation), J.S.D., University of Michigan. As Counsel with Greenberg Traurig, Mr. Keinan specializes in United States taxation of financial products and institutions and represents major investment banks and financial institutions in the United States. Prior to joining Greenberg Traurig, Mr. Keinan was with Ernst & Young's National Tax Department in Washington, D.C. Before that, Mr. Keinan practiced with Shearman & Sterling and with Ernst & Young's tax department in Israel. He has authored numerous articles and has taught Harvard's International Tax Program, Kennedy School of Government, and School of Arts and Sciences (Department of Economics).

Table of Contents

Detailed Analysis

I. Introduction and Scope of Portfolio

A. Role of Anti-Abuse Doctrines

B. Coverage and Scope of Portfolio

II. History

Introductory Material

A. Gregory v. Helvering

B. Higgins v. Smith

C. Moline Properties, Inc. v. United States

D. United States v. Cumberland Public Services Company

E. Knetsch v. United States

F. Goodstein v. Commissioner

G. Goldstein v. Commissioner

H. Franklin Est. v. Commissioner

I. Frank Lyon Company v. United States

J. Rice's Toyota World Inc. v. Commissioner

K. Glass v. Commissioner (Option–Straddle Cases)

L. Cottage Savings Association v. Commissioner

M. Contingent Installment Sale Cases (CINS)

N. Corporate Owned Life Insurance (COLI)

O. Lease Stripping

P. Taxpayers’ Victories

Q. IRS Pronouncements

R. Cases in 2004 and Later

III. Judicial Anti-Abuse Doctrines in General

Introductory Material

A. Substance over Form

B. Taxpayers’ Ability to Disavow Their Own Form: Strong Proof/Danielson

1. Overview

2. Applicable Standard

3. The Strong Proof Standard

a. Articulation

b. What Constitutes a “Strong Proof?”

4. Danielson

C. Sham Transactions

1. Sham-In-Substance

2. Sham-In-Fact

D. Step Transaction

1. Overview

2. Application of the Step Transaction Doctrine

3. The Three Alternative Threshold Tests

a. The Binding-Commitment Test

b. The End-Result Test

c. The Mutual-Interdependence Test

4. The Timing Difference Between Each Step

E. Business Purpose

F. The Relationship Between the Economic Substance Doctrine and the Other Common Law Doctrines

G. Conclusion

IV. Economic Substance

A. In General

B. The Role of the Economic Substance Doctrine and Its Relationship with the Legislative Purpose

C. The Two-Prong Test

1. Overview

2. Conjunctive/Disjunctive/Unitary

3. Objective or Subjective Test?

a. The Objective Prong

b. The Subjective Prong

D. The Conjunctive Test

E. Applying Only the Objective Test

F. Disjunctive Test

1. General

2. Fourth Circuit

3. D.C. Circuit

4. Federal Circuit

5. Eighth Circuit

6. Second Circuit

7. Third Circuit

8. Tax Court

9. The Disjunctive Test under the Moline Properties Doctrine

G. The Unitary Analysis

H. Generic Tax Shelter

V. The Profit Requirement

A. Overview

B. The Role of the Profit Requirement

C. Profit Requirement - Subjective or Objective

1. Overview

2. Objective Determination of Profit Potential

a. General

b. Cost-Benefit Analysis in Lease Cases

3. Subjective Analysis of the Profit Requirement

D. How Much Profit Is Enough?

1. Overview

2. Minimum Expected Rate of Return

3. Comparison with Similar Taxpayers

4. Comparison of Non-Tax Profit with Tax Benefits

5. More than De Minimis Profit

6. Any Profit

7. The Reasonable Means Approach

E. Economic Risk

VI. Economic Substance of an Entity

A. Overview

B. Corporations: Piercing the Corporate Veil for Tax Purposes

C. The Validity of a Partnership

D. Trusts

E. The Importance of Control

VII. Integration or Bifurcation of a Series of Transactions

A. Identifying the Transaction that Generated the Benefits

1. Integration

2. Bifurcation

B. Allowing the Benefits for a Particular Portion

VIII. Legislative Proposals to Codify the Economic Substance Doctrine

A. Overview

B. The Evolution of the Proposed Codification

1. 1999–2000: Treasury's and Joint Committee on Taxation's Reports on Tax Shelters

2. 2001-2002: First Drafts

3. 2003-2004: Jobs Acts and Various Similar Proposals

C. JOBS Act of 2004

1. Purpose of the Proposed Codification

2. Scope of the Doctrine

3. Conjunctive Two-Prong Test

4. Relying on Potential for Profit

5. Certain Business Purposes (GAAP Benefits) Are Ignored

6. Special Rules for Certain Transactions with Tax-Indifferent Parties

7. Understatement Penalty for Transactions Lacking Economic Substance

D. Joint Committee Proposal (January 27, 2005)

1. Reason for Codification

2. Application of the Doctrine

3. Conjunctive Test

4. Subjective Business Purpose

5. Objective Prong

6. Applicable Transactions

7. Reporting and Penalty Assumptions

E. The Future of the Proposed Codification

IX. Cases on Economic Substance by Topic

Introductory Material

A. Transactions Involving Transitory Holding of American Depository Receipts

1. Overview

2. Compaq Computer Corp v. Comr.

a. Facts

b. The Parties’ Arguments

c. The Tax Court's Holding

d. Reversal by the Fifth Circuit

3. IES Industries Inc. v. U.S.

a. Facts

b. District Court

c. Eighth Circuit

B. The CINS Transactions

1. Background

2. ACM Partnership v. Comr.

a. Facts

b. Tax Court

c. Third Circuit

3. ASA Investerings v. Comr.

a. Facts

b. Tax Court

c. D.C. Circuit

4. Saba Partnership v. Comr.

a. Facts

b. Tax Court

c. D.C. Circuit

d. Remand to Tax Court

5. Boca Investerings v. Comr.

a. Facts

b. District Court

c. D.C. Circuit

C. Corporate Owned Life Insurance (COLI)

1. Overview

2. Winn Dixie Stores Inc. v. Comr.

a. Facts

b. Tax Court

c. Eleventh Circuit

3. Internal Revenue Service v. CM Holdings, Inc.

a. District Court

b. Third Circuit

4. American Electric Power v. U.S.

a. Facts

b. District Court

c. Sixth Circuit

5. Dow Chemicals Co. v. U.S.

a. Facts

b. The Decision

(1) Economic Substance Analysis

(2) Sham Transaction Analysis

(3) Sham in Substance

(4) Sham in Fact

c. Sixth Circuit

D. Lease Stripping Cases

1. Andantech, L.L.C. v. Comr.

a. Facts

b. Tax Court

c. D.C. Circuit

2. CMA Consolidated Inc. v. Commissioner

a. Facts

b. Economic Substance Analysis

c. Accuracy-Related Penalties

E. Partnership Cases - TIFD III Inc. v. U.S.

1. Facts

2. District Court

a. Economic Substance Analysis

b. Business Purpose

c. Economic Substance of the Partnership

3. Second Circuit

F. Restructuring of Business Activity - United Parcel Service of America, Inc. v. Comr.

1. Facts

2. Tax Court

3. Eleventh Circuit

G. High Basis Low Value Stock

1. Long Term Capital Holdings v. U.S.

a. Facts

b. District Court

(1) Economic Substance Analysis

(2) Objective Economic Substance

(3) Subjective Business Purpose

(4) Step Transaction Analysis

(5) Penalties

c. Second Circuit

2. Santa Monica Pictures, LLC v. Comr.

a. Overview

b. Facts

c. Issues

d. Application of the Partnership Rules

e. Economic Substance Analysis

f. Step Transaction

g. Penalties

H. Contingent Liabilities

1. Black & Decker Corp. v. U.S.

a. Facts

b. District Court

c. Fourth Circuit

2. Coltec Industries Inc. v. U.S.

a. Facts

b. Court of Federal Claims

(1) Section 357(b) - Tax Avoidance (or Business Purpose) Test

(2) Economic Substance Analysis

c. Federal Circuit

X. Conclusions and Observations

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Excerpts on the Economic Substance Doctrine from S. 1637, “Jumpstart Our Business Strength (JOBS) Act,” 108th Cong., 2nd Sess.

Worksheet 2 Excerpts from S. Rep. No. 192, S. 1637, the “Jumpstart Our Business Strength (JOBS) Act,” 108th Cong., 1st Sess. (Nov. 7, 2003)

Worksheet 3 Joint Committee Staff Recommendations Relating to Corporate Tax Shelters, excerpted from Joint Committee on Taxation Interest and Penalty Study (JCS-3-99) (July 22, 1999)

Worksheet 4 United States Department of the Treasury, White Paper on Corporate Tax Shelters (July 1, 1999)

Worksheet 5 Excerpt from Staff of the Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditures (JCS-02-05) (January 27, 2005)

Worksheet 6 Internal Revenue Service, Coordinated Issue Paper on “Notice 2002-65” Tax Shelter (May 9, 2005)




Treasury Regulations:


Legislation Reports:

IRS Pronouncements:

Court Cases: