2004 TEI Senior Tax Executive Seminar
Managing the Tax Department in the Age of Transparency
Establishing Business Purpose in a Transparent World
May 14, 2004
Phil Cohen
Unilever
Englewood Cliffs, NJ
Mark Silverman
Steptoe & Johnson LLP
Washington, D.C.
Phil West
Steptoe & Johnson LLP
Washington, D.C.
Copyright 2004 Mark J. Silverman and Philip R. West
Contents
2
Contents*
General Observations
The business purpose doctrine: Gregory and its progeny
Will your deal pass the test? What the cases say
Application of business purpose requirement to selected corporate tax
rules
Application of business purpose requirement to selected cross-border
transactions
The way forward: Case law and legislative proposals
Practical tips from the trenches: How should the tax department adapt
to the current environment, including section 6011?
Appendix A: Selected Business Purpose and Related Authorities and
Commentaries
* Our thanks to our colleague, Aaron P. Nocjar, for his assistance in the preparation of this presentation.
3
General Observations
4
General Observations
What is the relationship between the need for transparency and the business
purpose doctrine?
– Tax department has 3 goals relating to corporate governance:
• Further the company’s mission (reduce tax expense)
• Comply with the law (including the business purpose doctrine)
• Facilitate transparency in financial reporting
– How are the latter 2 related?
– To what extent must the second (compliance) inhibit the first (planning)?
– How can the tax department determine the rules?
• Is business purpose just a judicial “smell test” or are there rules that are
capable of being extrapolated and applied?
• “There is no clear line.” ASA Investerings Partnership v. Commissioner,
201 F.3d 505 (D.C. Cir. 2000)
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General Observations
Is all tax planning suspect?
– Deal in search of a structure vs. structure in search of a deal
Are the standards applied differently, depending on the political environment?
What are the administrative costs of a subjective standard?
– Are they reduced if courts use objective indicia of subjective intent?
• What if these indicia create presumptions, but not bright line rules?
– What if the standard is “solely” tax avoidance, rather than “primarily”?
In a rule-based system, should we need to apply judicial doctrines?
– Is our system a pure rule-based system, or a blend of several types?
• Rule-based (defined bright lines applicable to classes of taxpayers)
• Standards-based (broadly applicable norms of behavior)
• Rulings-based (specific transaction’s tax consequences prescribed in
advance by revenue authority)
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General Observations
Is there a business purpose requirement for all transactions?
– Sales
– Financings
– Check-the-box
• See Dover v. Commissioner, 122 T.C. No. 19, fn 19 (May 5, 2004)
– Organization of S corps, partnerships
– Choice of debt or equity
– Specifically legislated consequences
• See Compaq Computer Corp. v. Commissioner, 113 T.C. 214 (1999), rev’d 277
F.3d 778 (5th Cir. 2001) (declining to characterize foreign tax credit as immune
from economic substance scrutiny)
What is the scope of the transaction being analyzed?
– The overall transaction, or
– The manner of execution (and component steps)
Note that multiple standards may apply to the same transaction
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General Observations
Distinguishing among anti-abuse rules and doctrines
– Common law doctrines
• Common law business purpose doctrine
• Other common law doctrines
– Economic Substance/Economic Sham
– Factual Sham
– Step Transaction
– Assignment of Income
– Clear Reflection of Income
– Substance Over Form
– Court Holding/Est. of Kluener
– Waterman Steamship/Esmark
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General Observations
Distinguishing among anti-abuse rules and doctrines
– Codified rules
• General anti-avoidance rules
– 269
– 446
– Proposed codification of economic substance
• Targeted anti-avoidance rules
– Targeted statutory and regulatory business purpose rules (see following
slides)
– Targeted statutory and regulatory anti-abuse provisions other than
business purpose
» 382
» 482
• Treaty-based rules
– Some general rules and some targeted rules
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Targeted Statutory and Regulatory
Business Purpose Rules
Partial list of targeted codified business purpose rules in the Code
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section 183 (hobby loss provisions)
section 269(a) (acquisitions of control for tax avoidance purposes)
section 274(d) (travel and entertainment expenses)
section 302(c)(2)(B) (determining constructive ownership of stock for redemption provisions)
section 355(a)(1)(D)(ii) (retention of Controlled stock by Distributing after spin)
section 357(b) (transfer of liabilities)
section 367(b) (foreign transfers of assets and liabilities)
section 441 (business purpose accounting period)
section 453(e) (second disposition of installment sale note)
section 467(b)(2) (payments for use of property or services)
section 593(d) (qualifying real property loans of banks)
section 706 (taxable years of partners and partnerships)
section 845 (allocation in case of reinsurance agreement involving tax avoidance)
section 877 (expatriation to avoid tax)
section 1022(g)(2) (definition of “tax-exempt beneficiary” for property acquired from decedent dying after
12/31/09)
section 1092(c)(4) (definition of “straddle”)
section 1256(e)(3) (application of mark to market to “hedging transactions”)
section 1272(a)(2)(E) (OID rules applicable to loans between natural persons)
section 1274(b)(3) (determining issue price of certain debt instruments)
section 1378 (taxable year of S corporation)
section 2107(a)(2) (expatriation to avoid estate tax)
section 2501(a)(3) (expatriation to avoid gift tax)
section 7872(c) (exceptions to below-market loan treatment inapplicable to tax avoidance loans)
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Targeted Statutory and Regulatory
Business Purpose Rules
Partial list of targeted codified business purpose rules in the regulations
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Treas. Reg. § 1.58-8(b) (source of capital gains and options)
Treas. Reg. § 1.105-4(a)(3)(i)(B) (definition of “mandatory retirement age”)
Prop. Treas. Reg. § 1.168-4(d) (exclusion of certain property from ACRS)
Treas. Reg. §§ 1.263A-1(j)(4), -4(a)(2)(ii)(B) (valuation of inventory for purposes of capitalization provisions)
Treas. Reg. § 1.341-6(j) (determination of net worth of corporation)
Treas. Reg. § 1.355-2(b) (business purpose requirement for section 355 transactions)
Treas. Reg. § 1.368-1(b), (c), -2(g) (business purpose requirement for reorganizations)
Treas. Reg. § 1.414(s)-1(f) (legitimate business purpose required for crediting prior-employer compensation)
Treas. Reg. § 1.424-1(a)(4) (change in option considered to be by reason of corporate transaction)
Treas. Reg. § 1.442-1 (approval to change annual accounting period)
Treas. Reg. § 1.448-1T(b) (limitation of cash method of accounting)
Treas. Reg. § 1.461-4(d)(5) (economic performance)
Prop. Treas. Reg. § 1.465-4 (rules regarding attempts to avoid the at-risk rules)
Treas. Reg. §§ 1.467-1(f), -3 (treatment of lessors and lessees)
Treas. Reg. § 1.469-4(f) (definition of “activity” under passive loss rules)
Treas. Reg. § 1.514(c)-2(g), (j), (k), (m) (debt financed real property held by partnerships)
Treas. Reg. § 1.537-1 (definition of “reasonable needs of a business” for accumulated earnings tax)
Treas. Reg. § 1.643(h)-1 (distributions by certain foreign trusts through intermediaries)
Treas. Reg. § 1.671-2(e)(4) (grantor trust rules for gratuitous transfers made by partnerships and corporations)
Treas. Reg. § 1.679-3(c) (transfers to foreign trusts by intermediaries)
Treas. Reg. § 1.701-2 (partnership anti-abuse rules)
Treas. Reg. § 1.704-1 (determining whether it is proper to conduct a “book up”)
Treas. Reg. § 1.860L-2 (determining whether FASIT created or used for purposes contrary to FASIT provisions)
Treas. Reg. § 1.861-7(c) (title passage source rule)
Treas. Reg. § 1.881-3 (conduit financing arrangements)
Treas. Reg. § 1.1441-7(f) (determining whether agent is liable for failing to withhold in a conduit financing transaction)
Treas. Reg. § 53.4958-4(a)(2) (definition of excess benefit transactions)
11
The Business Purpose Doctrine:
Gregory and its Progeny
12
The Business Purpose Doctrine:
Case Law Background
Gregory v. Helvering, 293 U.S. 465 (1935)
– Countless forms of authority cite Gregory as the
foundation for the application of a business
purpose requirement to all types of transactions.
– Upon analysis, however, Gregory may stand for
something narrower than a general anti-abuse
business purpose requirement.
13
The Business Purpose Doctrine:
Case Law Background
In Gregory, there was no business purpose. Had there been any
such purpose, the case might have been decided differently.
The Supreme Court and Circuit Court opinions do not say that the
business purpose must predominate, must be the primary purpose, or
must be even a substantial purpose.
The opinions suggest that the business purpose requirement, at least
for reorganizations, is low.
– The Second Circuit suggested that the reorganization must be
actuated by a purpose that is more than just “an ephemeral
incident” to the “conduct of the venture in hand.”
– The Supreme Court suggested that the reorganization must be
actuated by a purpose that has something more than “no relation
to the business of either” the transferor or transferee corporation.
14
The Business Purpose Doctrine:
Case Law Background
Other relevant Supreme Court cases
– Bazley v. Commissioner, 331 U.S. 737 (1947) (purported “E”
reorganization not respected; suggests shareholder business purpose
insufficient)
– Knetsch v. Commissioner, 364 U.S. 361 (1960) (loans are shams; interest
deductions denied; like Gregory, not “what the statute intended”)
– United States v. Consumer Life Insurance Co., 430 U.S. 725 (1977)
(reinsurance agreements respected under Gregory and Knetsch;
suggests having business purpose or economic substance is sufficient)
– Frank Lyon Company v. United States, 435 U.S. 561 (1978) (saleleaseback respected; Gregory not cited; “substance over form”, tax
ownership analysis; dicta forms basis for many subsequent holdings)
– Cottage Savings Ass’n v. Commissioner, 499 U.S. 554 (1991) (loss on
exchange of mortgages respected; neither Gregory nor Frank Lyon cited
in majority opinion (although Gregory cited by 6th Circuit); technical
analysis under sec. 1001; Blackmun dissents (he wrote Frank Lyon);
Stevens in majority (he dissented in Frank Lyon))
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The Business Purpose Doctrine:
Case Law Background
Other relevant circuit court cases
– Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966) (loans not
shams but interest deductions disallowed; taxpayer borrowed
funds to engage in transaction that had no substance or purpose
aside from tax benefits; seminal case using 2-prong subjective
and objective definition of economic substance?)
– Rice’s Toyota World, Inc. v. Commissioner, 752 F.2d 89 (4th Cir.
1985) (interpreting Frank Lyon as requiring lack of economic
substance and lack of business purpose to find “economic sham”)
– Horn v. Commissioner, 968 F.2d 1229 (D.C. Cir. 1992) (court
ruled, under Knetsch, no sham since statute and legislative history
clearly provided for claimed result)
16
Will Your Deal Pass the Test?
What the Cases Say
17
Will Your Deal Pass the Test?
What the Cases Say
The Federal courts have incorporated the business purpose requirement
into the “economic substance” or “economic sham transaction” doctrine
See Gregory, Frank Lyon, Rice’s Toyota, Horn
–
The “economic substance” doctrine is generally applied by the Federal
courts “to prevent taxpayers from claiming tax benefits of transactions,
which, although they may be within the language of the Code, are not
the type of transaction Congress intended to favor.” See Horn v.
Commissioner, 968 F.2d 1229, 1236 (D.C. Cir. 1992).
A general formulation of this doctrine is as follows: The relevant
transaction will be respected if
–
the transaction has objective economic substance; and/or
–
the taxpayer has a subjective non-tax business purpose for entering
into the transaction.
Courts have described the business purpose prong of this doctrine as “an
heir to the ‘business purpose’ requirement applied in earlier cases. See
Gregory. Whether it is a direct descendant, it does play the same basic
role of evaluating whether the taxpayer had a business reason, aside from
tax avoidance, for engaging in the transactions.” See In Re: CM Holdings,
Inc., 301 F.3d 96 (2002).
18
Will Your Deal Pass the Test?
What the Cases Say
The Federal courts disagree as to the proper
application of this standard. For example,
– Is it enough to have a nontax business
purpose for entering into the transaction?
– Is it enough that the transaction has objective
economic substance?
– Will the fact that a transaction has objective
economic substance also automatically mean
that it has a nontax business purpose as
well?
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Will Your Deal Pass the Test?
What the Cases Say
Disjunctive Test
–
The Second Circuit, Fourth Circuit, Eighth Circuit, D.C. Circuit, and Federal
Circuit have applied the two-prong test in a disjunctive fashion.
•
Under this test, for a transaction to satisfy the economic substance doctrine,
it must have objective economic substance or the taxpayer must have a
subjective nontax business purpose for the transaction.
– Johnson v. United States, 32 Fed. Cl. 709 (Cl. Ct. 1995), aff’d sub nom,
Drobny v. United States, 86 F.3d 1174 (Fed. Cir. 1996);
– Horn, 968 F.2d 1229 (D.C. Cir. 1992);
– DeMartino v. Commissioner, 862 F.2d 400 (2d Cir. 1988);
– Rice’s Toyota World, 752 F.2d 89 (4th Cir. 1985);
– IES Industries, Inc. v. United States, 253 F.3d 350 (8th Cir. 2001).
–
Thus, under this approach, the existence of a nontax business purpose alone
would seem to support the form of the transaction.
–
Note also that this approach suggests that a nontax business purpose is not
required at all (i.e., if the transaction has objective economic substance, the
transaction meets the test).
20
Will Your Deal Pass the Test?
What the Cases Say
Conjunctive Test
–
The First Circuit, Seventh Circuit, and Eleventh Circuit have
applied the two-prong standard in a conjunctive fashion.
– Under this test, for a transaction to satisfy the economic
substance doctrine, the transaction must have objective
economic substance and the taxpayer must have a
subjective nontax business purpose for the transaction.
» United Parcel Service of America, Inc. v.
Commissioner, 254 F.3d 1014 (11th Cir. 2001);
» Dewees v. Commissioner, 870 F.2d 21 (1st Cir.
1989);
» Yosha v. Commissioner, 861 F.2d 494 (7th Cir.
1988).
–
Thus, a nontax business purpose alone would not be sufficient
for the form of a transaction to be respected.
21
Will Your Deal Pass the Test?
What the Cases Say
Combination Test
–
The Third Circuit, Fifth Circuit, Sixth Circuit, Ninth Circuit, and Tenth
Circuit have refused to apply a rigid two-part inquiry, but have collapsed
the test.
•
Under this approach, the courts have examined a transaction’s
objective economic substance and the taxpayer’s subjective
business purpose as relevant factors in determining whether the
transaction satisfies the economic substance doctrine.
– Keeler v. Commissioner, 243 F.3d 1212 (10th Cir. 2001);
– ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir.
1998);
– Casebeer v. Commissioner, 909 F.2d 1360 (9th Cir. 1990);
– Merryman v. Commissioner, 873 F.2d 879 (5th Cir. 1989);
– Rose v. Commissioner, 868 F.2d 851 (6th Cir. 1989).
22
Will Your Deal Pass the Test?
What the Cases Say
Positive business purpose factors include:
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Transaction originated in a nontax function of taxpayer. See, e.g.,
Boca Investerings Partnership v. United States, 167 F. Supp. 2d 298
(2001), rev’d on other grounds, 314 F.3d 625 (D.C. Cir. 2003).
–
Even though transaction originated in tax function of taxpayer, structure
was adopted and supported by nontax function and management. See,
e.g., Salina Partnership v. Commissioner, 80 T.C.M. (CCH) 686 (2000).
–
Transaction addressed business concerns/profit seeking efforts raised
by nontax function. See, e.g., Boca Investerings Partnership, 167 F.
Supp. 2d 298; Salina Partnership, 80 T.C.M. (CCH) 686.
23
Will Your Deal Pass the Test?
What the Cases Say
Positive business purpose factors include:
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Ultimate decision whether to undertake transaction
based primarily on nontax factors. See, e.g., Boca
Investerings Partnership, 167 F. Supp. 2d 298; Salina
Partnership, 80 T.C.M. (CCH) 686.
–
Transaction involved restructuring existing business
activity. See, e.g., United Parcel Service of America,
Inc. v. Commissioner, 254 F.3d 1014 (11th Cir. 2001).
–
Transaction involved formation of genuine business.
See, e.g., Sacks v. Commissioner, 69 F.3d 982 (9th
Cir. 1995).
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Will Your Deal Pass the Test?
What the Cases Say
Positive business purpose factors include:
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Taxpayer undertook efforts to structure transaction to maximize
profit and reduce risk of loss. See, e.g., IES Industries, Inc. v.
United States, 253 F.3d 350 (8th Cir. 2001); Compaq Computer
Corp. v. Commissioner, 277 F.3d 778 (5th Cir. 2001).
–
No evidence of side agreements between taxpayer and other
parties to transaction. See, e.g., Boca Investerings Partnership,
167 F. Supp. 2d 298.
–
No timetable describing when each of steps should have been
completed. See, e.g., Boca Investerings Partnership, 167 F.
Supp. 2d 298.
25
Will Your Deal Pass the Test?
What the Cases Say
One commentator has noted additional positive factors
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Transaction has as its origin and purpose making of money by increasing revenues or
reducing nontax expenses, or raising of capital for company’s business
–
Transaction generally arises from commercial contacts, in-house corporate development,
business brokers, and outside investment advisers
–
If transaction not originated in-house, it is marketed to sectors of corporate management
dealing with acquisitions, divestitures, finance, and corporate development
–
Transaction is open-ended in sense that taxpayer expects to generate returns that exceed
its cost of capital but also expects corresponding risk of loss
–
Tax practitioners who get involved with transaction are called upon to cast a desired
business transaction in a form that is most beneficial from tax perspective – not bless
transaction whose form is “set in stone” already
•
See Canellos, Business Purpose, Economic Substance, and Corporate Tax Shelters
54 SMU L. Rev. 47 (2001)
26
Will Your Deal Pass the Test?
What the Cases Say
Negative business purpose factors include:
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Transaction planned and executed without regard to pre-tax economic
consequences. See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d
Cir. 1998); Saba Partnership v. Commissioner, T.C. Memo 1999-359 (1999),
vacated on other grounds, 273 F.3d 1135 (D.C. Cir. 2001).
–
Internal memoranda prepared by taxpayer prior to transaction focused
exclusively on tax benefits of transaction. See, e.g., Saba Partnership, T.C.
Memo 1999-359; UPS v. Commissioner, 78 T.C.M. (CCH) 262 (1999), rev’d,
254 F.3d 1014 (11th Cir. 2001).
–
When management of taxpayer weighed pros and cons of transaction, “chief
dangers” that promoter of transaction noted were all tax-related. See, e.g., CM
Holdings, 301 F.3d 96.
–
Memoranda prepared by taxpayer’s auditor and participating third parties
indicate that taxpayer entered transaction to generate tax benefits alone. See
Saba Partnership, T.C. Memo 1999-359.
27
Will Your Deal Pass the Test?
What the Cases Say
Negative business purpose factors include:
–
–
–
Only testimony at trial regarding business purpose was from taxpayer’s
officers and, therefore, was self-serving. See, e.g., Saba Partnership,
T.C. Memo 1999-359.
Transaction structured in manner where it could not generate pre-tax
profit. See, e.g., CM Holdings, 301 F.3d 96.
The plan marketed to taxpayer by promoter as tax-driven investment.
See, e.g., CM Holdings, 301 F.3d 96 (“Ultimately the most damning
piece of evidence against [the taxpayer] is that the marketing
information presented to its executives showed that, absent tax
deductions, the plan would lose money. . . . A member of the
[promoter] first introduced the plan by describing that ‘the key factor is
being able to absorb the interest deductions.’”); Saba Partnership, T.C.
Memo 1999-359; Compaq, 113 T.C. 214 (1999), rev’d, 277 F.3d 778
(2001).
28
Will Your Deal Pass the Test?
What the Cases Say
Negative business purpose factors include:
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Asserted business purpose for transaction related to use of taxgenerated savings from transaction, not its pre-tax profit
potential. See, e.g., American Electric Power v. United States,
326 F.3d 737 (6th Cir. 2003); CM Holdings, 301 F.3d 96.
–
One step of transaction attempts to carry out stated business
purpose, but another step of transaction offsets (or frustrates)
effect of other step. See, e.g., ACM Partnership, 157 F.3d 231;
Saba Partnership, T.C. Memo 1999-359.
29
Will Your Deal Pass the Test?
What the Cases Say
Negative business purpose factors include:
–
Stated business purpose accomplished by far more meaningful steps
unrelated to transaction in question. See, e.g., Saba Partnership, T.C.
Memo 1999-359 (takeover defense accomplished with other steps
unrelated to contingent installment note sale transaction).
–
Taxpayer’s evaluation of proposed transactions less than businesslike.
See, e.g., Compaq, 113 T.C. 214 (1999), rev’d, 277 F.3d 778 (2001)
(taxpayer’s assistant treasurer committed taxpayer to multi-million
dollar transactions based on one meeting with promoter and one call to
reference provided by promoter).
–
When asserting that stated business purpose is to reduce (or avoid)
particular business risk, taxpayer failed to perform reasonable due
diligence in determining whether risk actually existed. See, e.g., UPS
v. Commissioner, 78 T.C.M. (CCH) 262 (1999), rev’d, 254 F.3d 1014
(11th Cir. 2001) (finding that taxpayer failed to obtain legal opinion
regarding whether business risk actually existed).
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Will Your Deal Pass the Test?
What the Cases Say
Business purpose issues (see reorganization
discussion below):
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Significance of the fact that parties to the transaction
are related
What quantum of business purpose is necessary?
Corporate vs. shareholder business purpose
One party has a business purpose, but not the
other(s)
31
Application of Business Purpose
Requirement to Selected Corporate
Tax Rules
32
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Reorganizations
Section 355
Section 351 transactions
Tax-free liquidations
Non-liquidating distributions
Consolidated returns
33
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-free reorganizations – regulatory standards
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Regulations under section 368 incorporate a business purpose requirement.
•
Treas. Reg. § 1.368-1(b): “The purpose of the reorganization provisions of the Code is to
except from the general rule certain specifically described exchanges incident to such
readjustments of corporate structures made in one of the particular ways specified in the
Code, as are required by business exigencies and which effect only a readjustment of
continuing interests in property under modified corporate forms.”
•
Treas. Reg. § 1.368-1(c): “A plan of reorganization must contemplate the bona fide
execution of one of the transactions specifically described as a reorganization in section
368(a) and for the bona fide consummation of each of the requisite acts under which
nonrecognition of gain is claimed. . . . A scheme . . . such as a mere device that puts on
the form of a corporate reorganization as a disguise for concealing its real character, and
the object and accomplishment of which is the consummation of a preconceived plan
having no business or corporate purpose, is not a plan of reorganization.”
•
Treas. Reg. § 1.368-2(g): “Moreover, the transaction, or series of transactions,
embraced in a plan of reorganization must not only come within the specific language of
section 368(a), but the readjustments involved in the exchanges or distributions effected
in the consummation thereof must be undertaken for reasons germane to the
continuance of the business of a corporation a party to the reorganization.”
34
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-free reorganizations – illustrative cases
– Gregory v. Helvering, 293 U.S. 465 (1935)
– Bazley v. Commissioner, 331 U.S. 737 (1947)
– Survaunt v. Commissioner, 162 F.2d 753 (8th Cir.
1947)
– Estate of Lewis v. Commissioner, 10 T.C. 1080
(1948), aff’d, 176 F.2d 646 (1st Cir. 1949)
– Wortham Machinery Co. v. United States, 521 F.2d
160 (10th Cir. 1975)
– Laure v. Commissioner, 653 F.2d 253 (6th Cir. 1981)
– American Bronze Corp. v. Commissioner, 64 T.C.
1111 (1975); compare Laure
35
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-Free Reorganizations
Public Shareholders
Public Shareholders
Merger
NOL C/F
T
P
Voting Stock
Although the transaction appears to meet all the requirements of an “A,” “C,” and
“D” reorganization, the transaction may not so qualify if it was done solely for the
purpose of permitting P to use T’s NOL carryforward.
See, e.g., Wortham (invalid “C” reorganization since transaction lacked business
purpose – “only attraction shown by the record for the acquisition . . . was the net
operating loss carryover which [the acquirer] used in its tax return to reduce its tax
liability”)
A
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-Free Reorganizations
P
Z Stock
X
Y
Z
Z
Do you need a business
purpose for a related party
reorganization, such as a crosschain “D” reorganization?
B
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-Free Reorganizations – Significance of related party transactions
–
It appears that business purpose only becomes an issue when a
reorganization occurs between related parties. All the previously
mentioned cases involved related party transactions. Gregory involved
a related party transaction.
•
“[I]f P and T are dealing at arm’s length and are not owned by
substantially the same shareholders, the business purpose
requirement ordinarily will not raise a concern.” Ginsburg.
–
This may be one of the reasons why the business purpose test for a
spin-off is more stringent, since a spin-off (or a divisive “D”) is
essentially a related party transaction.
•
“[A]lthough not completely clear, the business purpose requirement
as applied to acquisitive reorganizations probably is substantially
less stringent than the business purpose requirement as currently
applied to Code § 355 transactions.” Ginsburg.
36
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-Free Reorganizations
Shareholders
New C/S
&
Marketable
Bonds
Old C/S
P
Do you need a business purpose for
a recapitalization?
If so, is a shareholder purpose
sufficient?
See Bazley (business purpose
required for “E” reorganization, and
exchange of stock for stock and debt
was invalid “E” reorganization since
only had shareholder purposes for
exchange)
C
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-free reorganizations – shareholder v. corporate business purpose
–
It is unclear whether a valid shareholder-level business purpose alone
(rather than a corporate-level business purpose) will suffice.
•
Treas. Reg. § 1.368-2(g) seems to require a corporate-level
purpose: the reorganization “must be undertaken for reasons
germane to the continuance of the business of a corporation a
party to the reorganization.”
•
TAM 8452004: Gregory requires that “a reorganization transaction
must serve a genuine and legitimate corporate business purpose.”
–
Unlike the regulations under section 355, the regulations under section
368 do not expressly state that a shareholder-level purpose alone is
not sufficient.
37
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-Free Reorganizations – Shareholder v. corporate business purpose (cont’d)
–
Some case law seems to indicate that a shareholder-level purpose will be
sufficient, but only in the case of closely-held corporations where differentiating
between a shareholder-level and corporate-level purpose would amount to
“metaphysical reasoning which has no proper place in such practical matters as
taxation.”
•
See, e.g., Lewis v. Commissioner, 10 T.C. 1080 (1948), aff’d, 176 F.2d 646
(1st Cir. 1949) (court dismissed the argument that the business purpose
only benefited the shareholders and, therefore, was an insufficient purpose
for a valid reorganization. “In almost every instance, corporations are
organized for the convenience of the stockholders in conducting business.
Such is the purpose of their existence. To say that a corporation, as such,
can have motives and purposes apart from its stockholders, the collective
group of individuals who own it, is to indulge in metaphysical reasoning
which has no proper place in such practical matters as taxation. And to say
that what is advantageous to the stockholders collectively in the conduct of
the enterprise is of no advantage to the corporation, is utterly unrealistic.”)
•
Court also noted that the business purpose test was not focused solely on
motives of either the shareholders or the corporation, but, rather, the actual
effect of what was done
–
But see Bazley v. Commissioner, 331 U.S. 737 (1947) (suggesting that
shareholder purpose alone insufficient in context of “E” reorganization)
38
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-free reorganizations – only one party has business purpose
–
Gregory: The Court ruled that the term “reorganization” does
not include “a transfer of assets by one corporation to another in
pursuance of a plan having no relation to the business of either
. . . .”
–
See also Basic, 549 F.2d 740 (dissent) (“In an arm’s length
transaction, the business purpose may also be that of the party
other than the taxpayer, who insisted on it for his own business
reasons.”).
–
Note, however, that a ruling on one side of the transaction that
a transaction does not constitute a reorganization for the failure
of a valid business purpose would necessarily invalidate the
transaction for the other side, since there would no longer be
two corporations that were each a “party to a reorganization.”
39
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
–
–
–
–
–
Tax-free reorganizations – how much business purpose?
In Gregory, the only purpose for the transactions was tax avoidance.
The lower court in Wortham Machinery, 375 F.Supp. 835, aff’d, 521 F.2d 160
(10th Cir. 1975), suggested that a reorganization would not fail for lack of a
nontax business purpose even if a tax avoidance purpose was “dominant.”
However, in such a case, “the taxpayer bears a heavier burden in saving the
reorganization.”
Note also that in Estate of Lewis, 10 T.C. 1080 (1948), aff’d, 176 F.2d 646 (1st
Cir. 1949), the Tax Court found, in ruling that a transfer of assets between
corporations constituted a “D” reorganization, that the transfer was motivated by
a valid business purpose despite the fact that the transaction was “largely
influenced” by tax considerations.
See also TAM 8941004: “The business purpose doctrine provides that
reorganization status will be denied when a transaction is entered into solely for
the purpose of achieving a particular tax result . . . . In analyzing a business
purpose, one 'must not blindly accept as valid any corporate purpose proffered
by the taxpayer, but instead must scrutinize the reasons offered to determine
whether there is any possibility that the . . . [transaction] could achieve the
stated purpose.' Gada v. U.S., 460 F. Supp. 859, 869 (D.C. Conn. 1978).”
(Emphasis added).
See also section 269(a)(2).
40
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 355
Shareholders
How much business purpose is sufficient for
section 355?
S Stock
P
Should a shareholder purpose be sufficient?
Is lack of a tax avoidance motive enough?
Can you get a ruling on business purpose
today?
S
D
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 355
– “[T]he spin-off is subject to the most
thorough-going business purpose test of any
Subchapter C transaction.” Ginsburg
– Similar to the business purpose requirement
for reorganizations, the business purpose
requirement for a section 355 transaction
stems from Gregory and is embodied in
regulations.
41
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 355 – how much business purpose?
– In order to meet the business purpose requirement, a
section 355 transaction must be “motivated, in whole
or substantial part,” by a nontax business purpose
that is “substantial.” See Treas. Reg. § 1.3552(b)(1), (2).
– Furthermore, in cases of divisive “D” reorganizations,
the transfer of assets to Controlled and the transfer
of Controlled stock to Distributing shareholders each
must be supported by nontax business purposes.
See Treas. Reg. § 1.355-2(b)(3).
42
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 355 – shareholder vs. corporate business purpose
–
Section 355 regulations explicitly provide that business purpose of
shareholder not sufficient nontax business purpose - Treas. Reg. §
1.355-2(b)(2)
•
See, e.g., Rev. Rul. 2004-23 (spin-off motivated by a valid business
purpose since it served a business purpose of Distributing although
it also increased the value of the stock of the shareholders of
Distributing and Controlled)
–
But see Parshelsky’s Estate v. Commissioner, 303 F.2d 14 (2d. Cir.
1962), aff’d on remand, 22 T.C.M. (CCH) 911 (1963) (shareholder
purpose alone was sufficient but appears to be limited to closely-held
businesses)
•
See also Hanson v. United States, 338 F. Supp. 602 (D. Mont.
1971) (“reasons for the reorganization arising from the personal or
noncorporate business interests of the stockholders must be
considered”); Estate of Lewis v. Commissioner, 10 T.C. 1080
(1948), aff’d, 176 F.2d 646 (1st Cir. 1949) (shareholder purpose for
an acquisitive “D” reorganization served as sufficient business
purpose).
43
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
–
–
–
–
–
–
–
Examples of Acceptable Nontax Business Purposes under Section 355:
Treas. Reg. § 1.355-2(b):
•
compliance with an anti-trust divestiture order
•
enhancement of two businesses by their separation so that separate shareholders can concentrate
their efforts on the business in which they are more proficient
•
to reduce rates charged to customers in light of a change in regulatory rules applying to Distributing
•
to enable a key employee of Controlled to receive stock of Controlled to avoid his leaving Controlled
Rev. Proc. 96-30 (for purposes of issuing a ruling request under prior law):
•
to facilitate an issuance of a meaningful amount of Distributing or Controlled stock to a key employee
•
to facilitate a borrowing by Distributing or Controlled
•
to facilitate a stock offering by Distributing or Controlled
•
to obtain significant administrative cost savings
•
to improve corporate fit and focus (i.e., to enhance the success of the businesses by enabling the
corporations to resolve management, systemic, or other problems from the operation of different
businesses within a single corporation or affiliated group)
•
to eliminate a competitive disadvantage
•
to facilitate an acquisition of Distributing
•
to facilitate an acquisition by Distributing or Controlled
•
to shield one business from the risks of another business
to reduce state, local, or foreign taxes – Rev. Rul. 76-187
to preserve a franchise – Rev. Rul. 75-337
to increase insurance limits or bonding limits – PLR 9409032
to avoid a hostile takeover – PLR 8819075
to avoid state regulations imposed on Distributing because of Controlled’s business – Rev. Rul. 88-33
44
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Lack of a tax-avoidance purpose alone is insufficient. Commissioner v. Wilson, 353
F.2d 184 (9th Cir. 1965) (taxpayer must have a nontax business purpose -- “We
conclude, however, that even if there is no tax avoidance motive, a reorganization
having no business reason does not result in the tax advantages which section 355
confers.”).
Also, courts addressing the issue of business purpose in a section 355 setting focus
on whether there exists sufficient corroborating evidence of the taxpayer’s
professed business purposes.
–
Lester v. Commissioner, 40 T.C. 947 (1963) ( “We find ample support in the
record for petitioners' contention that the transaction was motivated, in part at
least, by sound business reasons.”).
–
Gada v. United States, 460 F.Supp. 859 (D.C. Conn. 1978) (“The Court must
not blindly accept as valid any corporate purpose proffered by the taxpayer, but
instead must scrutinize the reasons offered to determine whether there is any
possibility that the spin off could achieve the stated purpose.”).
–
Hanson v. United States, 338 F. Supp. 602 (D. Mont. 1971) (“Accordingly, it is
the genuineness of the business purpose that counts. A proper business
purpose for a spin-off may in retrospect turn out to be inadequate or
unnecessary to achieve its hoped for goals. This, by itself, does not disqualify
the reorganization.”).
45
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 355 business purpose rulings
– Taxpayers now cannot generally obtain a ruling on
whether a business purpose exists for purposes of
section 355. Rather, they must represent that such a
business purpose exists. See Rev. Proc. 2003-48
• “Do not provide any documentation or substantiation
in support [of the business purpose for the
distribution by Distributing of the stock of
Controlled].” Issue will be examined on audit.)
– Rev. Proc. 2003-48 does not state that the business
purposes within Rev. Proc. 96-30 are no longer valid.
– Service will issue more general guidance on
acceptable business purposes, see, e.g., Rev. Rul.
2004-23.
46
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 351
Shareholder
Assets &
Liabilities
Shareholder
(2)
(1)
P
LLC
Interest
Check
the
Box
Assets &
Liabilities
(3)
P
C/S
Do you need a business
purpose for a section 351
transaction?
If so, is the business purpose
requirement more like the section
355 requirement or the section
368 requirement?
Does the analysis change if the section 351 transaction occurs by reason of the “check-a-box”
regulations?
See Treas. Reg. § 301.7701-3(g)(2) (“tax treatment of a change in classification . . . is determined under
all relevant provisions of the Internal Revenue Code and general principles of tax law”); see also 62 FR
55768 (1997) (preamble) (“This provision . . . is intended to ensure that the tax consequences of an elective
change will be identical to the consequences that would have occurred if the taxpayer had actually taken
the steps described in the proposed regulations.”)
E
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 351
–
Unlike reorganizations and section 355 transactions, neither the
statute nor the regulations contemplate an explicit business
purpose requirement for section 351 transactions.
–
The applicability of the business purpose doctrine to section
351 transfers has been described as follows: “Not surprisingly,
the pervasive principle that a transaction may be disregarded or
recast by the government if it lacks a business purpose applies
to §351 transactions; and this principle can be applied despite
the fact that neither §351 nor the regulations thereunder contain
a specific business purpose requirement.” Bittker & Eustice,
Federal Income Taxation of Corporations and Shareholders
(2003).
47
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 351
–
Caruth v. United States, 688 F.Supp. 1129 (N.D. Tex. 1987), aff’d, 865
F.2d 644 (5th Cir. 1989) (primary authority for proposition that taxpayer
needs business purpose for section 351; “Therefore, the business
purpose requirement should be applied to section 351, just as it has
been applied to section 368.”)
•
Court described issue as one of first impression.
•
But see W. & K. Holding Corporation v. Commissioner, 38 B.T.A.
830 (1938) (no business purpose requirement for section 351)
•
FSA 199935019 (Service recognizing that Caruth in conflict with W.
& K. Holding, yet still applying business purpose requirement)
–
Kluener v. Commissioner, 154 F.3d 630 (6th Cir. 1998) (section 351
inapplicable since no valid business purpose for transaction; court
enumerated seven factors to consider for business purpose)
48
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Section 351
–
Over years, Service has concluded that if purported section 351 transaction serves no corporate business
purpose, especially where the transferee corporation does not engage in conduct of a trade or business or
corporation’s existence is merely transitory, transaction will not be respected for Federal income tax
purposes
•
CCA 200117039 (section 351 transaction must have “bona fide business purpose;” recognizing that
“courts have not required a strong showing in order to satisfy the section 351 business purpose
requirement”)
•
FSA 200135001 (finding no sufficient evidence of business purpose for transfer of built-in loss assets
to newly-formed corporation)
•
FSA 200043007 (finding no sufficient business purpose for transfer of built-in loss assets to affiliated
corporation and stating that business purpose requirement for section 351 transactions “appears to
be the same as the business purpose requirement for acquisitive reorganizations”)
•
FSA 200020035 (transfer of assets to carry out estate planning purposes of shareholder insufficient
business purpose)
•
PLR 9716001 (“maintaining employee morale” was an acceptable business purpose for the transfer
of vacation pay liability);
•
PLR 8418089 (transfer of stock to newly formed holding company qualified as tax-free section 351
transfer)
•
Rev. Rul. 80-198 (individual taxpayer’s transfer of assets of sole proprietorship to a newly formed
corporation had valid business purpose and qualified for tax-free treatment under section 351);
•
Rev. Rul. 70-140 (transfer of assets of sole proprietorship to existing wholly-owned corporation,
followed by acquisition of corporation by unrelated corporation pursuant to a “prearranged plan” did
not qualify for tax-free treatment under section 351);
•
Rev. Rul. 55-36 (transfer of old stock to newly formed corporation did not qualify for tax-free
treatment under section 351).
49
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Does UPS offer any guidance for section 351 transactions, particularly in context of
“check-a-box” elections? United Parcel Service of America, Inc. v. Commissioner, 254
F.3d 1014 (11th Cir. 2001) (restructuring of existing business of insuring shipped
packages) (discussed later in more detail)
– Restructuring not sham since involved existing, bona fide business (regardless that
external operations of business did not change)
– Court suggested that electing to be treated as particular entity for tax purposes via
check-a-box regulations was example of “tax-influenced” transactions that
nevertheless respected for tax purposes, since to do otherwise would frustrate
legitimate “tax-planning”
– See also Hariton: “In some cases, the Treasury has simply given up and permitted
the taxpayer to choose whichever set of objective rules she prefers to apply to her
transactions (e.g., the taxpayer’s ability to ‘check-the-box’ to determine whether a
non-corporate entity will be treated as a partnership or a corporation for tax
purposes.”
Does UPS offer guidance for tax-free liquidations as well, particularly in context of
“check-a-box” elections?
50
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-Free Liquidating Distributions
Do you need a business purpose for a tax-free
liquidation?
S Stock
P
(1)
Individual Sh/r
Cash
(2)
Assets &
Liabilities
100%
S Stock
25%
Does the analysis change if the liquidation occurs
by reason of the “check-a-box” regulations?
See Treas. Reg. § 301.7701-3(g)(2) (“tax
treatment of a change in classification . . . is
determined under all relevant provisions of the
Internal Revenue Code and general principles
of tax law”); see also 62 FR 55768 (1997)
(preamble)
S
F
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Tax-Free Liquidating Distributions
–
Apparently no business purpose requirement for qualification
under section 332
•
“Court decisions construing Code § 332 uniformly hold that
its provisions are to be applied in a formal way so as to
make the section ‘elective in the sense that with advance
planning and properly structured transactions, a corporation
should be able to render section 332 applicable or
inapplicable.’” Ginsburg.
•
See, e.g., Riggs v. Commissioner, 64 T.C. 474 (1975)
(demonstrating that business purpose not required for taxfree corporate liquidation)
51
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Nonliquidating Distributions
–
Compare . . .
•
United States v. Davis, 397 U.S. 301 (1970) (“the business purpose of a
transaction is irrelevant in determining dividend equivalence under §
302(b)(1)”); see also Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954)
(finding that economic consequences of transactions were consistent with
redemption, and existence of motive to avoid or reduce tax not enough to
recharacterize transaction as dividend)
–
With . . .
•
Esmark v. Commissioner, 90 T.C. 171 (1988), aff’d, 886 F.2d 1318 (7th Cir.
1989) (although primarily step transaction doctrine case, suggesting that
redemption subject to business purpose requirement and ruling that
redemption transaction respected since served “important corporate, as
well as shareholder, purposes” other than tax avoidance)
–
Difference between Davis and Esmark may stem from fact that they dealt with
different issues relating to redemption transactions
•
Davis involved whether one of redemption provisions included business
purpose requirement
•
Esmark involved whether relevant transaction could be considered a
distribution of property from the corporation to shareholder in first place
(prior to determining whether distribution qualified for section 302
treatment)
52
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Nonliquidating Distributions
–
Basic Incorporated v. United States, 549 F.2d 740 (Ct. Cl. 1977) (demonstrating
how a court can use Gregory as foundation of a business purpose requirement
for nonliquidating distributions)
•
“Although Gregory was concerned with a corporate reorganization question,
the rationale of that case has not been confined in application to such
situations alone. Rather, that decision, as Judge Learned Hand explained
in Commissioner v. Transport Trading & Terminal Corp., 176 F.2d 570, 572
(2d Cir.1949), has come to stand for the proposition ‘that in construing
words of a tax statute which describe commercial or industrial transactions
we are to understand them to refer to transactions entered upon for
commercial or industrial purposes and not to include transactions entered
upon for no other motive but to escape taxation’”
•
Dissent suggests there are limits to business purpose requirement:
– The “doctrine of Gregory has enlisted such a following that an inquiry
into whether the substance of a transaction corresponds to its form is
now appropriate in every area of tax law”
– However, “the courts are not licensed to distort the law, to write in new
provisions, or to render present provisions nullities; the doctrine is
reserved to enable the courts to guard against giving force to a
purported transfer [that] gives off an unmistakeably hollow sound when
it is tapped. Thus Gregory is multidimensional”
53
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Consolidated Returns
S2 Stock
P
(1)
X
Do you need a business
purpose to consolidate?
Cash
Does section 269 affect
the analysis?
S1
S2
S2
NOL
(2) P files consolidated return with S1 and S2
G
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Do you need a business purpose
to deconsolidate?
Consolidated Returns
P
Stock
Life
Insur
Co - 1
Life
Insur
Co - 2
New Life
Insur
HoldCo
Life
Insur
Co - 1
Life
Insur
Co - 2
Do you need the consolidated
return regulations to incorporate a
business purpose requirement or
do the business purpose
requirements from other Code
provisions apply automatically (e.g.,
business purpose requirement for
section 351 transactions)?
Does Treas. Reg. § 1.1502-80(a)
affect the analysis?
“The Internal Revenue Code,
or other law, shall be
applicable to the group to the
extent the regulations do not
exclude its application.”
H
Application of Business Purpose Requirement to Selected
Corporate Tax Rules
Consolidated Returns
–
Similar to tax-free liquidations, appears business purpose not required for
affiliation. See, e.g., Fox v. Commissioner, 17 T.C.M. (CCH) 1006 (1958)
(ruling that “the statute prescribes no test of affiliation other than stock
ownership;” observing that even if “primary purpose” for affiliation was to reduce
tax, affiliation would serve “a legitimate purpose”)
•
But see Spreckels v. Commissioner, 41 B.T.A. 370 (1940) (upon review of
legislative history of consolidated return provisions, found business purpose
requirement existed and applied it to acquisition of subsidiary’s stock for
purpose of using subsidiary’s loss in consolidated return)
•
Section 269 preempt Spreckels business purpose requirement? No
» See Treas. Reg. § 1.269-2(b)
» See also Elko Realty v. Commissioner, 29 T.C. 1012 (1958), aff’d
per curiam, 260 F.2d 949 (3d Cir. 1958) (upholding the Service’s
dual arguments of lack of business purpose under Spreckels and
principal purpose of tax avoidance under predecessor to section
269 for corporation’s acquisition of stock of two loss subsidiaries)
54
Application of Business Purpose
Requirement to Selected CrossBorder Transactions
55
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Business purpose under treaties
– Is there a general business purpose rule for treaties?
• Compare Aiken Industries, Inc. v. Commissioner, 56 T.C. 925 (1971), with
Northern Indiana Public Service Co. (NIPSCO) v. Commissioner, 115 F.3d 506
(7th Cir. 1997)
– Treaty surrogates for business purpose
• Limitation of benefits provisions
– Predecessor formulation
– Main purpose test in Italian and Slovenian treaties
• Beneficial ownership
• Residence, including dual residence
• Hybrid entities
• Reinsurance limitations
• Conduit test
– UK version
– Japanese version
• Rules for unique situations
– Remittance system rules in UK treaty
– Repo tax credit denial in UK treaty
56
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
IRS views on selected cross-border strategies
–
Planning blessed, despite tax avoidance motive (Note
dates)
•
•
FSA 200032008
– Disaffiliation for purposes of increasing FTC limitation
– §904(i) N/A; §1504(b) exceptions not implicated
– Tax avoidance purpose in the facts, not in the analysis
TAM 9206005 (disaffiliation to preserve domestic losses)
– Compare business purpose requirement for domestic
affiliation
– Note the facts of the TAM predated § 904(i)
57
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
IRS views on selected cross-border strategies
–
Planning invalidated since 2002 (selected)
•
Temp. Treas. Reg. § 1.704-1T(b) (recent attack on FTC special
allocations does not use business purpose theory)
•
Notice 2004-31 (use of partnership guaranteed payments to avoid
earnings stripping limits)
•
CCA 200408030
– Sec. 482 can apply to a sec. 351 transaction even if there is a
business purpose for the deal.
» Distinguishes Eli Lilly & Co. v. Commissioner, 84 T.C. 996,
(1985), aff'd in part and rev'd in part, 856 F.2d 855, (7th
Cir. 1988)
» Relies on National Securities. Corp. v. Commissioner, 137
F.2d 600 (3d Cir. 1943); G.D. Searle & Co. v.
Commissioner, 88 T.C. 252 (1987).
58
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
FSA 200233016 (stapled stock); Notice 2003-50 (same)
–
Stapled stock transaction intended to maximize foreign tax
credits
•
Both interest allocation and OFL benefits
•
Theories articulated in FSA:
– 269
– 482
– Sham transaction
– Business purpose for “B” reorg or 351
– 907(a) FOGEI separate basketing
59
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Migration of functions/Holdco check-the-box restructurings
– See CCA 200408030 on interaction of business
purpose, 351 and 482.
Check-and-sell
– Dover fn 19: No Business Purpose requirement for CTB
Check-the-box for worthless stock deduction
Double dip leases
Hybrid instruments
UK share subscription treaty arbitrage
Domestic reverse hybrid treaty arbitrage
60
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Other strategies -- foreign tax credit planning:
– What is the state of play?
• What are the limits of Notice 2004-19? (See also Notice 200420)
• Can the “peppercorn of profit” test in Sheldon v. Commissioner,
94 T.C. 738 (1990), be applied in the FTC context after the
revocation of Notice 98-5?
– What about other FTC strategies?
• Foreign reverse hybrid FTC strategy
• Foreign consolidation FTC strategy
• Other foreign tax credit/repatriation strategies
61
Supplemental Cross-Border Questions for Discussion
U.S. parent (P-US) wholly owns a French parent (P-Fr), which in
turn wholly owns a French subsidiary (S-Fr).
P-US
P-Fr
Div.: €100
(€100 P-Fr earnings, Under French law, P-Fr is liable for the French taxes of both P-Fr
and S-Fr (i.e., S-Fr has no joint and several liability for the French
less €90 tax on
group’s tax).
French group
earnings of €300,
P-Fr has €100 of income and S-Fr has €200 of income
plus €90 gross-up
under §78)
The French tax for the French group is €90.
P-Fr Inc.: €100
Consolidated for
French Purposes
S-Fr
S-Fr Inc.: €200
P-Fr dividends all of P-Fr’s earnings and holds back the earnings
of S-Fr; as a result, the dividend bears a very high tax rate.
Absent a revision to Treas. Reg. § 1.901-2(f), should the Service be
able to attack this transaction on business purpose grounds or
otherwise?
I
Supplemental Cross-Border Questions for Discussion
IP and Factories
(1)
P
(2)
IP and Factories
Finished Products
(From X and Y)
S-State X
S-State Y
(3)
Arm’s Length
Transfer Price
Distribution
Co.
Suppose a taxpayer wanted to
undergo a legal restructuring
solely to save state income taxes
and, in that vein, contributed
factories and IP to subsidiaries
which would make finished goods
for a distribution company.
Suppose that the transfer price
between the supply companies
and the distribution company is
arm’s length.
Should the state revenue authorities be able to challenge the transaction for lack of
business purpose or otherwise?
Does it make a difference that the transfers were section 351 transactions?
J
Supplemental Cross-Border Questions for Discussion
P-US
High-Tax
Jurisd.
Assets &
Liab. of Active
Business
What if, instead, a taxpayer moved a real
function offshore to a low-taxed jurisdiction
solely for the purpose of lowering the taxpayer’s
overall tax liability, by reason of shifting income
from a high-taxed to low-taxed jurisdiction?
Foreign Low-Tax
Sub
Jurisd.
K
Supplemental Cross-Border Questions for Discussion
P-US
Loan/Equity
S-US
Interest/
Dividends
Foreign
Lender
Suppose a U.S. subsidiary (S-US) truly
needed financing, but it was done in a way
to take advantage of the lack of symmetry
between the tax law of the borrower and
lender (i.e., S-US treated the financing as
debt in accordance with its substance, and
the foreign lender treated it as an equity
contribution in accordance with its form,
enabling the lender either to eliminate the
dividends or to obtain foreign tax credit
benefits).
Should the Service be able to attack the
structure of this financing transaction on
business purpose grounds?
L
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Repatriation of Residual Foreign Taxes –
Utilization of Operating E&P Deficits*
Check-the-box for CFC Deficit Company
followed by dividend by CFC
Structure
U.S.
Timing of dividend payments
Applicability of the same country or hightaxed exceptions to subpart F
CFC
HoldCo
CFC
Deficit
Company
CFC
Unwind after CFC Deficit Company
becomes profitable
Avoids recapture rules
Hovering deficit rule application
Merger
* These six slides developed with Tom Fuller for use at IFA
USA Annual Conference, February, 2003
Liquidation
62
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Repatriation of Residual Foreign Taxes –
Routing Excess Cash Through First-Tier Subsidiaries
Return of
capital/capital
gain distribution
USP
Pref. Shares
(Or Note)
CFC
E&P
Co.
Cash
USP has a high basis in its CFC
shares.
CFC has high-taxes and little/no e&p
Return of basis and/or capital loss
utilization
Potential recast (recap/Section 304
Sale) mitigated if at least two historical
SHs in CFC
Ongoing treatment of Preferred
Shares
– Withholding taxes
– Taxation at E&P Co.
– Subpart F income
63
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Repatriation of Residual Foreign Taxes –
Segregate E&P and Taxes
Structure
U.S.
CFC
Local country treatment of RH
Application of FTC rules
IRS Notice 2004-19
Dividend planning/§956
RH
First-tier versus lower-tier
Impact on repatriation
64
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Repatriation of Residual Foreign Taxes –
Prepay Foreign Taxes
Structure
U.S.
Taxability of capital contribution in local
country
Reduction of CFCX E&P
Increase in tax pool of CFCX
CFCX
Asset
Transfer
CFC
SubX
Trigger taxation of CFCX E&P
Treat as tax-free capital contribution for U.S.
tax purposes or check-the-box at CFC SUBX
Obtain future tax deduction for local country
step-up in basis
65
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Repatriation of Residual Foreign Taxes –
Use of Hybrid Instruments to Repatriate High-Taxed E&P
USP
Investment
in U.S.
property
FHC
100% Preferred
Shares
[Low-Tax E&P]
CFC1
1% Common
Shares
Preferred Shares provide for a guaranteed
payment
– Debt/Equity dichotomy
– Characterization of the guaranteed
payment for local law purposes should
differ from the U.S. characterization
Same country exception should apply to
guaranteed payments
Analogue to Notice 2004-31? (earnings
stripping through partnership guaranteed
payments)
Use of Section 956 to repatriate CFC2’s
high-tax e&p
CFC2
[High-Tax E&P]
66
Application of Business Purpose Requirement
to Selected Cross-Border Transactions
Repatriation of Residual Foreign Taxes –
Loans and Distributions
$100
Loan
USP
FHC
$100 Tax-Free
Distribution
$100
Loan
CFC1
CFC2
[High-tax e&p]
[Low-tax e&p]
Use of FHC with high basis
Section 961 basis increase in FHC
shares
CFC1 loan to USP: Deemed dividend
(ETR impact)
FHC makes a tax-free return of capital
distribution
– Local law constraints
Two $ Repatriated for every $ taxed
Consequences of loan from CFC1
– U.S. Withholding tax
– Subpart F income
67
The Way Forward
The Case Law
68
The Way Forward
The Case Law
Recent cases involving successful business
purposes continue to suggest that the business
purpose requirement of Gregory is not rigorous.
– IES Industries, Inc. v. United States, 253 F.3d
350 (8th Cir. 2001)
– Compaq Computer Corp. v. Commissioner,
277 F.3d 778 (5th Cir. 2001)
– United Parcel Service of America, Inc. v.
Commissioner, 254 F.3d 1014 (11th Cir.
2001)
69
The Way Forward
The Case Law
IES Industries, Inc. v. United States, 253 F.3d 350 (8th Cir. 2001)
–
Eighth Circuit held that ADR trades were not shams under economic
substance doctrine described in Rice’s Toyota
–
Taxpayer had valid, nontax business purpose for ADR trades
•
“The proper inquiry is whether the taxpayer was induced to commit
capital for reasons only relating to tax considerations or whether a
non-tax motive, or legitimate profit motive, was involved. In other
words, the business purpose test is a subjective economic
substance test . . . .”
–
Court seemed to re-emphasize that business purpose test should have
low threshold
•
Court suggested that a transaction would lack a nontax business
purpose only if the taxpayer was induced to commit capital for
reasons “only relating to tax considerations”
•
No suggestion that nontax business purpose must predominate or
primarily drive transaction
70
The Way Forward
The Case Law
Compaq Computer Corp. v. Commissioner, 277 F.3d 778 (5th Cir.
2001)
–
Court respected ADR trades on facts substantially similar to IES
–
"To treat a transaction as a sham, the court must find that the
taxpayer was motivated by no business purposes other than
obtaining tax benefits in entering the transaction, and that the
transaction has no economic substance because no reasonable
possibility of a profit exists. . . .(‘[S]uch a test properly gives
effect to the mandate of the Court in Frank Lyon that a
transaction cannot be treated as a sham unless the transaction
is shaped solely by tax avoidance considerations.’)
–
Court found that nontax business purpose existed for ADR
trades
71
The Way Forward
The Case Law
Compaq re-emphasizes that Gregory business purpose
requirement has low threshold
–
The ADR trades would have lacked nontax business purpose
only if transaction motivated “solely” by tax avoidance
considerations
–
Furthermore, Fifth Circuit strongly suggested that transaction
still could pass muster even if tax avoidance was “primary”
purpose for transaction
–
Even lower court employed a “rational basis” test for business
purpose, which (by analogy to constitutional law) has historically
involved a very minimal threshold.
72
The Way Forward
The Case Law
How strong a precedent is Compaq?
– The IRS disagrees strongly with the result
(Notice 2004-19), although it withdrew the
comparative tax benefit test of Notice 98-5
– Does Compaq suggest that foreign tax
reduction should be treated the same as U.S.
tax reduction in analyzing business purpose?
• This result, favorable in Compaq, can
boomerang on taxpayers
73
The Way Forward
The Case Law
United Parcel Service of America, Inc. v. Commissioner, 254 F.3d 1014
(11th Cir. 2001) (restructuring of existing business of insuring shipped
packages)
Eleventh Circuit rejected as being too narrow the Tax Court’s position that
the transaction lacked nontax business purpose because external
operation of business never changed
Court then described its view of business purpose requirement
–
“A ‘business purpose’ does not mean a reason for a transaction that is
free of tax considerations. Rather, a transaction has a ‘business
purpose,’ when we are talking about a going concern like UPS, as long
as it figures in a bona fide, profit-seeking business. See ACM P'ship v.
Comm'r, 157 F.3d 231, 251 (3d Cir.1998). This concept of ‘business
purpose’ is a necessary corollary to the venerable axiom that taxplanning is permissible. See Gregory v. Helvering, 293 U.S. 465, 469,
55 S.Ct. 266, 267, 79 L.Ed. 596 (1935).”
Court found that taxpayer satisfied business purpose requirement, because
transaction involved alteration of existing, bona fide business
74
The Way Forward
The Case Law
United Parcel Service of America, Inc. v. Commissioner,
254 F.3d 1014 (11th Cir. 2001)
The court followed with example emphasizing that
nontax business purpose need not predominate over tax
avoidance purpose
– “The Code treats lots of categories of economically
similar behavior differently. For instance, two ways to
infuse capital into a corporation, borrowing and sale
of equity, have different tax consequences; interest is
usually deductible and distributions to equityholders
are not. There may be no tax-independent reason for
a taxpayer to choose between these different ways of
financing the business, but it does not mean that the
taxpayer lacks a ‘business purpose.’ To conclude
otherwise would prohibit tax-planning.”
75
The Way Forward
The Case Law
United Parcel Service of America, Inc. v. Commissioner,
254 F.3d 1014 (11th Cir. 2001)
Similar to IES and Compaq, UPS demonstrates that
business purpose inquiry involves very low threshold,
particularly when relevant transaction involves existing,
bona fide business
Note that court viewed choice to capitalize business with
debt or equity and electing to be treated as particular
entity for tax purposes via check-a-box regulations as
examples of “tax-influenced” transactions that
nevertheless are respected for tax purposes, since to do
otherwise would frustrate legitimate “tax-planning”
– See also Hariton
76
The Way Forward
The Case Law
Disregarding Entities: Sham Entity Doctrine
D.C. Circuit versus Moline Properties and Culbertson
–
Lately, D.C. Circuit has applied additional approach in reviewing
tax-advantaged transactions – disregard entity conducting
transaction rather than disregard transactions themselves
• ASA Investerings Partnership v. Commissioner, 201 F.3d
505 (D.C. Cir. 2000) (treating partnership as sham)
• Saba Partnership v. Commissioner, 273 F.3d 1135 (D.C. Cir.
2001), on remand, 85 T.C.M. (CCH) 817 (2003) (same)
• Boca Investerings Partnership v. United States, 314 F.3d
325 (D.C. Cir. 2003) (same)
77
The Way Forward
The Case Law
Disregarding Entities: Sham Entity Doctrine
D.C. Circuit applying and interpreting Moline Properties in context of
partnership cases
– Supreme Court in Moline Properties ruled that a corporation should be
respected for Federal income tax purposes as long as it:
• created for business purpose or
• carries on business activity after formation
– See Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943);
Campbell County State Bank v. Commissioner, 37 T.C. 430
(1961), rev’d and remanded on other issues, 311 F.2d 374 (8th Cir.
1963)(confirming that doctrine of Moline Properties applies to
partnerships); Betson v. Commissioner, 48 T.C.M. (CCH) 113
(1984), rev’d on other grounds, 802 F.2d 365 (9th Cir. 1986) (apply
test in conjunctive fashion)
– Degree of business purpose or amount of business activity required to
satisfy test is minimal. See Betson
78
The Way Forward
The Case Law
Disregarding Entities: Sham Entity Doctrine
D.C. Circuit creates a new rule?
–
In applying Moline Properties, D.C. Circuit eliminated “business
activity” prong and focused solely on whether taxpayer had
nontax business purpose for formation of entities
–
Further, Boca seems to expand the business purpose
requirement of Moline Properties by focusing on fact that,
although partners may have had nontax business purpose for
forming partnership, partnership was not necessary to
accomplish that purpose.
• Compare ASA (finding sham partnership because partners
had no nontax business purpose for forming partnership);
Saba (same).
79
The Way Forward
The Case Law
Disregarding Entities: Sham Entity Doctrine
Is D.C. Circuit replacing the test of partnership status
laid out by the Supreme Court in Culbertson?
–
Culbertson adopted facts-and-circumstances test
–
Culbertson simply required a business purpose
(among other factors)
Tax Court in ASA and Boca applied the Culbertson test,
but D.C. Circuit applied test based on Moline Properties,
without distinguishing Culbertson
80
The Way Forward
The Case Law
Disregarding Entities: Sham Entity Doctrine
A recent example of the Service endorsing this “sham
entity” approach is Notice 2004-31.
– Service identified use of guaranteed payments to
avoid earnings stripping rules (and substantially
similar transactions) as “listed transactions.”
– Citing ASA, Notice warns taxpayers that it may
disregard the partnership, because the partners “lack
the requisite non-tax business purpose to form a valid
partnership”
– Notice does not cite to Boca with its presumably
stronger “sham entity” rule.
81
The Way Forward
Legislative Proposals
82
The Way Forward
Legislative Proposals
Leading legislative proposal contains 4 elements
–
Codification of economic substance doctrine
–
Disclosure, reporting, and penalty enhancements
–
Targeted anti-avoidance (e.g., anti-Enron) provisions
–
CEO tax return signature requirement
Other legislative proposals contain other items
–
–
Tax haven measures
150%-of-fees promoter penalties
83
The Way Forward
Legislative Proposals
Proposals to codify economic substance doctrine naturally contain
codification of business purpose requirement
One of the most recent proposals is S. 2210 – “The Tax Shelter and
Tax Haven Reform Act”
–
Proposal contains language with respect to business purpose
that substantially similar to several other current and previous
proposals. See S. 476 (passed by Senate on April 9, 2003 as
The CARE Act of 2003); see also S.1637, S. 2155, H.R. 5095.
–
The following slides present details of the proposals by
describing the initial version (Thomas Bill -- H.R. 5095) and the
most significant subsequent modification (Senate Bill -- the
CARE Act of 2003)
84
The Way Forward
Legislative Proposals
Thomas Bill of 2002 (H.R. 5095)
– “Clarify and, in certain circumstances, enhance” the economic substance
doctrine
– Conjunctive test
• “Meaningful” change in taxpayer’s economic position
– Internal restructurings?
– Hedged transactions
• Substantial non-tax business purpose
– Financial statement benefit generally should not qualify
– Financial statement income from tax deduction does not qualify
• “A” “reasonable” means of accomplishing such purpose
– Note that
• Proposal continues to leave to the courts when the doctrine applies
• Also leaves to courts whether to respect form despite lack of economic
substance
85
The Way Forward
Legislative Proposals
Senate (CARE Act) tighteners
–
Adds a vague profit test, if profit is used to show meaningful change in
economic position
–
Specifies that foreign taxes reduce profit in this calculation
–
Tougher on financial statement impact as business purpose
•
Financial statement benefit “will” not qualify
– (Compare “generally should not” of H.R. 5095)
•
Financial statement income from tax deduction does not qualify
–
Specific rules on transactions with tax-indifferent parties
•
Financings and income- and basis-shifting
•
Compare Thomas Bill (reg authority only)
“Traditional” leasing gets a pass
Proposal not intended to disallow tax benefits “clearly contemplated and
expected by the language and purpose of the relevant authority.” S. Rep.
No. 108-011.
86
The Way Forward
Legislative Proposals
Proposals do not describe circumstances under which
courts or Service should apply economic substance
doctrine.
– Some commentators believe that this is the major
flaw of the proposals. See, e.g., NYSBA, Economic
Substance Codification Tax Notes, June 23, 2003.
Proposals also leave to courts determination whether to
respect form of transaction despite failing economic
substance doctrine.
87
The Way Forward
Legislative Proposals
Business purpose aspects of proposals seem to raise bar
–
An acceptable nontax business purpose must be “substantial.”
•
Purpose of achieving financial accounting benefit shall not be taken
into account “if the origin of such financial accounting benefit is a
reduction of income tax or achievement of a tax benefit.” S. 2210.
–
Transaction must be “a reasonable” means of accomplishing such
purpose.
•
Intended to curb transactions where subsidiary step of overall
transaction serves nontax business purpose but primary step (or
steps) of overall transaction lack such purpose. See S. Rep. No.
108-011; see, e.g., ACM (taxpayer’s legitimate business purpose of
acquiring its own debt was not sufficient to cleanse other steps of
CINS transactions, which were not necessary to accomplish debt
acquisition).
–
Use of terms “substantial” and “reasonable” appears to be intended to
require that “the non-tax purpose for the transaction . . . bear a
reasonable relationship to the taxpayer’s normal business operations or
investment activities.” S. Rep. No. 108-011.
88
The Way Forward
Legislative Proposals
Proposals suggest that proper time in which to
determine whether “substantial nontax purpose” exists
is at time of “entering into such transaction.”
– Board approval?
– Agreement by the parties?
– Execution of first step of transaction?
– Execution of last step of transaction?
Proposals do not seem to incorporate “sham entity”
approaches of Saba, ASA, and Boca (i.e., bill addresses
whether “transaction satisfies the economic substance
doctrine”)
– However, could view relevant “transaction” as being
formation of partnership
89
The Way Forward
Legislative Proposals
Should we codify a business purpose requirement in the form of general anti-abuse rule, like
other countries have?
–
An example: Canadian Income Tax Act § 245
•
Rule: “ Where a transaction is an avoidance transaction, the tax consequences to a
person shall be determined as is reasonable in the circumstances in order to deny a tax
benefit that, but for this section, would result, directly or indirectly, from that transaction
. . . .”
–
Language suggests that rule would be applied after all other rules in Tax Act
(including any targeted anti-abuse rules)
•
Definition of an “avoidance transaction”: “[A]ny transaction . . . that . . . would result . . .
in a tax benefit, unless the transaction may reasonably be considered to have been
undertaken or arranged primarily for bona fide purposes other than to obtain the tax
benefit . . . .“
–
Creates presumption that all transactions are “avoidance transactions”
–
This formulation of business purpose requirement seems to be more stringent
than business purpose requirements in U.S.
•
Use of qualifiers such as “as is reasonable in the circumstances” and “reasonably be
considered” and use of taxpayer adverse presumption (not surprisingly) injects “in
terrorem” flavor into rule, analogous to partnership anti-abuse rule of Treas. Reg. §
1.701-2
–
UK has not moved forward with similar rule, despite more form-based system, providing
more planning opportunities for taxpayers.
90
The Way Forward
Legislative Proposals
Treasury opposes the codification of the economic substance
doctrine
Other comments on the recent proposals include:
–
–
–
–
–
–
–
Proposals would seriously impair transparency of Code by imposing second-tier
minimum tax of uncertain application;
Proposals will invalidate transactions that ought not be invalidated;
Proposals improperly make taxpayer motivation (as opposed to objective
effects) test of transactional validity;
Proposals may be largely ineffective against abusive transactions targeted;
Flexibility U.S. courts have demonstrated in applying judicial doctrines, such as
business purpose, militate against codification of general anti-abuse rule in U.S.;
Disclosure rules and related penalty provisions should be given opportunity to
curb “tax shelter problem” before resorting to more drastic measures;
Statutory general anti-abuse rule would still leave real issues to courts.
91
The Way Forward
Legislative Proposals
But see Yin, Thoughts on Tax Shelters Tax
Notes (Feb. 16, 2004)
– Disclosure might not be enough, since may
only “provide the Treasury with a head start in
proposing legislation to change the result in
the future” and “by that time, promoters will
have long gone ahead to later generations of
the transaction, or to new transactions
altogether.”
92
Practical Tips from the Trenches:
How Should the Tax Department
Adapt to the Current
Environment, Including §6011?
93
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
What are other companies doing, and what should you do?
– Have business purpose for every transaction,
– Make sure there is an economic benefit without tax benefits,
– Exception to 2 above if there is clear congressional intent through
a provision of the Code specifically allowing the tax benefit (e.g.,
low income housing),
– Make sure you get an appropriate opinion from a competent,
trustworthy and independent advisor,
– Talk to your auditors about appropriate financial reserves,
– Make sure everyone knows in advance that you will disclose the
matter on the tax return if there is any doubt about it, and
– Always keep senior management informed.
94
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
Identifying reportable transactions
– Do what you can to make sure lines of communication are good
between the tax department and the business units.
• “Embedding” a tax person may or may not be practical
• Try to make it known that you should be consulted
– Set up a process to identify reportable transactions
• Pressure relieved somewhat with recent modifications to the
definition of “conditions of confidentiality”
• Either educate the business units, or make sure they alert the
tax department to deals
– If the deals are too numerous, have the business units
identify classes of deals
95
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
Once transactions are identified,
– Elevate issues within the organization when appropriate
– Obtain second opinions on non-routine tax matters
– Place little weight on promoter opinions in assessing planning
ideas
96
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
Using the factors from the cases:
– Prefer deals that originate in a nontax function
– Prefer deals that are adopted and supported by nontax function
and management
– Prefer deals that address business concerns/profit seeking efforts
raised by nontax function
– Prefer deals in which the ultimate decision whether to undertake
transaction based primarily on nontax factors
97
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
Using the factors from the cases:
– Prefer deals that involve formation of genuine business or at least
restructuring existing business activity
– Prefer deals in which company undertakes efforts to structure
transaction to maximize profit and reduce risk of loss
– Prefer deals that do not contain evidence of side agreements
between taxpayer and other parties to transaction
– Prefer deals that do not have tax-driven timetable describing when
each of steps should have been completed
98
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
Using the factors from the cases:
– Prefer deals that have as their origin and purpose making money by
increasing revenues or reducing nontax expenses, or raising of capital for
company’s business
– Prefer deals that arise from commercial contacts, in-house corporate
development, business brokers, and outside investment advisers
– Prefer deals that, if not originated in-house, are marketed to sectors of
corporate management dealing with acquisitions, divestitures, finance, and
corporate development
– Prefer deals that are open-ended in sense that taxpayer expects to
generate returns that exceed its cost of capital but also expects
corresponding risk of loss
– Prefer deals in which tax practitioners who get involved with transaction
are called upon to cast a desired business transaction in a form that is
most beneficial from tax perspective – not bless transaction whose form is
“set in stone” already
99
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
Using the factors from the cases:
– Scrutinize deals that are planned and executed without regard to
pre-tax economic consequences
– Scrutinize deals that involve internal memoranda prepared by
taxpayer prior to transaction focused exclusively on tax benefits of
transaction
– Scrutinize deals in which “chief dangers” that management
considered are tax-related
– Scrutinize deals in which memoranda prepared by taxpayer’s
auditor and participating third parties indicate that taxpayer entered
transaction to generate tax benefits alone
100
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
Using the factors from the cases:
– Scrutinize deals in which only testimony regarding business
purpose can come from taxpayer’s officers
– Scrutinize deals in which transaction structured in manner where it
could not generate pre-tax profit
– Scrutinize deals in which the plan is marketed to taxpayer by
promoter as tax-driven investment
– Scrutinize deals in which asserted business purpose for
transaction relates to use of tax-generated savings from
transaction, not its pre-tax profit potential
101
Practical Tips from the Trenches:
How Should the Tax Department Adapt to the Current Environment?
Using the factors from the cases:
– Scrutinize deals in which one step of transaction attempts to carry
out stated business purpose, but another step of transaction
offsets (or frustrates) effect of first step
– Scrutinize deals in which stated business purpose accomplished
by far more meaningful steps unrelated to transaction in question
– Scrutinize deals in which taxpayer’s evaluation of proposed
transactions less than businesslike
– Scrutinize deals in which taxpayer fails to perform reasonable due
diligence in determining whether risk actually existed that stated
business purpose is intended to reduce or avoid
102
Appendix A:
Selected Business Purpose
and Related Authorities
and Commentaries
103
Selected Business Purpose
and Related Authorities and Commentaries
Case Law
–
ACM Partnership v. Commissioner, 157 F.3d 231 (3rd Cir. 1998)
–
ACM Partnership v. Commissioner, 73 T.C.M. (CCH) 2189 (1997)
–
ASA Investerings Partnership v. Commissioner, 201 F.3d 505 (D.C. Cir. 2000)
–
ASA Investerings Partnership v. Commissioner, 76 T.C.M. (CCH) 325 (1998)
–
Aiken Industries, Inc. v. Commissioner, 56 T.C. 925 (1971)
–
American Bronze Corporation v. Commissioner, 64 T.C. 1111 (1975)
–
American Electric Power Company v. United States, 326 F.3d 737 (6th Cir. 2003)
–
Basic Incorporated v. United States, 549 F.2d 740 (Ct. Cl. 1977)
–
Bazley v. Commissioner, 331 U.S. 737 (1947)
–
Bazley v. Commissioner, 155 F.2d 237 (3rd Cir. 1946)
–
Bazley v. Commissioner, 4 T.C. 897 (1945)
–
Betson v. Commissioner, 802 F.2d 365 (9th Cir. 1986)
–
Betson v. Commissioner, 48 T.C.M. (CCH) 113 (1984)
–
Boca Investerings Partnership v. United States, 314 F.3d 625 (D.C. Cir. 2003)
–
Boca Investerings Partnership v. United States, 167 F.Supp.2d 298 (D.C. Dist. Ct. 2001)
–
Internal Revenue Service v. C.M. Holdings, Inc., 301 F.3d 96 (3rd Cir. 2002)
–
Campbell County State Bank v. Commissioner, 311 F.2d 374 (8th Cir. 1963)
–
Campbell County State Bank v. Commissioner, 37 T.C. 430 (1961)
–
Caruth Corp. v. United States, 865 F.2d 644 (5th Cir. 1989)
–
Caruth Corp. v. United States, 688 F.Supp. 1129 (N.D. Texas Dist. Ct. 1987)
–
Casebeer v. Commissioner, 909 F.2d 1360 (9th Cir. 1990)
–
Commissioner v. Culbertson, 337 U.S. 733 (1949)
–
Compaq Computer Corp. v. Commissioner, 277 F.3d 778 (5th Cir. 2001)
–
Compaq Computer Corp. v. Commissioner, 113 T.C. 214 (1999)
104
Selected Business Purpose
and Related Authorities and Commentaries
Case Law
–
Cottage Savings Assoc. v. Commissioner, 499 U.S. 554 (1991)
–
Cottage Savings Assoc. v. Commissioner, 890 F.2d 848 (6th Cir. 1990)
–
Cottage Savings Assoc. v. Commissioner, 90 T.C. 372 (1988)
–
DeMartino v. Commissioner, 862 F.2d 400 (2d Cir. 1988)
–
Dewees v. Commissioner, 870 F.2d 21 (1st Cir. 1989)
–
Dover Corp. v. Commissioner, 122 T.C. No. 19 (2004)
–
Drobny v. United States, 86 F.3d 1174 (Fed. Cir. 1996)
–
Eli Lilly & Co. v. Commissioner, 84 T.C. 996, (1985), aff'd in part and rev'd in part, 856 F.2d 855, (7th Cir. 1988)
–
Elko Realty Co. v. Commissioner, 260 F.2d 949 (3rd Cir. 1958)
–
Elko Realty Co. v. Commissioner, 29 T.C. 1012 (1958)
–
Esmark, Inc. v. Commissioner, 886 F.2d 1318 (7th Cir. 1989)
–
Esmark, Inc. v. Commissioner, 90 T.C. 171 (1988)
–
Fox v. Commissioner, 17 T.C.M. (CCH) 1006 (1958)
–
Frank Lyon Company v. United States, 435 U.S. 561 (1978)
–
G.D. Searle & Co. v. Commissioner, 88 T.C. 252 (1987)
–
Gada v. United States, 460 F.Supp. 859 (D. Conn. Dist. Ct. 1978)
–
Gilbert v. Commissioner, 248 F.2d 399 (2d Cir. 1957)
–
Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966)
–
Gregory v. Commissioner, 293 U.S. 465 (1935)
–
Commissioner v. Gregory, 69 F.2d 809 (2d Cir. 1934)
–
Gregory v. Commissioner, 27 B.T.A. 223 (1932)
–
Hanson v. United States, 338 F.Supp. 602 (D. Mont. Dist. Ct. 1971)
–
Horn v. Commissioner, 968 F.2d 1229 (D.C. Cir. 1992)
105
Selected Business Purpose
and Related Authorities and Commentaries
Case Law
–
IES Industries, Inc. v. United States, 253 F.3d 350 (8th Cir. 2001)
–
IES Industries, Inc. v. United States, 1999 WL 973538 (N.D. Iowa Dist. Ct. 1999)
–
Johnson v. United States, 32 Fed.Cl. 709 (Ct. Fed. Cl. 1995)
–
Keeler v. Commissioner, 243 F.3d 1212 (10th Cir. 2001)
–
Kluener v. Commissioner, 154 F.3d 630 (6th Cir. 1998)
–
Knetsch v. United States, 364 U.S. 361 (1960)
–
Laure v. Commissioner, 653 F.2d 253 (6th Cir. 1981)
–
Lester v. Commissioner, 40 T.C. 947 (1963)
–
Lewis v. Commissioner, 175 F.2d 646 (1st Cir. 1949)
–
Lewis v. Commissioner, 10 T.C. 1080 (1948)
–
Merryman v. Commissioner, 873 F.2d 879 (5th Cir. 1989)
–
Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943)
–
National Securities. Corp. v. Commissioner, 137 F.2d 600 (3d Cir. 1943)
–
Nicole Rose Corp. v. Commissioner, 320 F.3d 282 (2d Cir. 2003)
–
Nicole Rose Corp. v. Commissioner, 117 T.C. No. 27 (2001)
–
Northern Indiana Public Service Co. v. Commissioner, 115 F.3d 506 (7th Cir. 1997)
–
Parshelsky v. Commissioner, 22 T.C.M. (CCH) 911 (1963)
–
Parshelsky v. Commissioner, 303 F.2d 14 (2d Cir. 1962)
–
Rice’s Toyota World, Inc. v. Commissioner, 752 F.2d 89 (4th Cir. 1985)
–
Riggs v. Commissioner, 64 T.C. 474 (1975)
–
Rose v. Commissioner, 868 F.2d 851 (6th Cir. 1989)
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Case Law
–
SABA Partnership v. Commissioner, 85 T.C.M. (CCH) 817 (2003)
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SABA Partnership v. Commissioner, 273 F.3d 1135 (D.C. Cir. 2001)
–
SABA Partnership v. Commissioner, T.C. Memo 1999-359 (1999)
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Sacks v. Commissioner, 69 F.3d 982 (9th Cir. 1995)
–
Salina Partnership v. Commissioner, 80 T.C.M. (CCH) 686 (2000)
–
Sheldon v. Commissioner, 94 T.C. 738 (1990)
–
Spreckels Co. v. Commissioner, 41 B.T.A. 370 (1940)
–
Survaunt v. Commissioner, 162 F.2d 753 (8th Cir. 1947)
–
UPS v. Commissioner, 254 F.3d 101 (11th Cir. 2001)
–
UPS v. Commissioner, 78 T.C.M. (CCH) 262 (1999)
–
United States v. Davis, 397 U.S. 301 (1970)
–
United States v. Consumer Life Insurance, 430 U.S. 725 (1977)
–
W. & K. Holding v. Commissioner, 38 B.T.A. 830 (1938)
–
Commissioner v. Wilson, 353 F.2d 184 (9th Cir. 1965)
–
Wortham Machinery Co. v. United States, 521 F.2d 160 (10th Cir. 1975)
–
Yosha v. Commissioner, 861 F.2d 494 (7th Cir. 1988)
–
Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954)
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and Related Authorities and Commentaries
Administrative Guidance
– Treasury Dec. 8627, 60 FR 56117 (1995)
– Revenue Ruling 2004-23, 2004-11 I.R.B. 585 (2004)
– Revenue Ruling 89-103, 1989-2 C.B. 65 (1989)
– Revenue Ruling 88-33, 1988-1 C.B. 115 (1988)
– Revenue Ruling 80-198, 1980-2 C.B. 113 (1980)
– Revenue Ruling 76-187, 1976-1 C.B. 97 (1976)
– Revenue Ruling 75-337, 1975-2 C.B. 124 (1975)
– Revenue Ruling 70-140, 1970-1 C.B. 73 (1970)
– Revenue Ruling 55-36, 1955-1 C.B. 340 (1955)
– Revenue Procedure 2003-48, 2003-29 I.R.B. 86 (2003)
– Revenue Procedure 96-30, 1996-1 C.B. 696 (1996)
– Notice 2004-31, 2004-17 I.R.B. 830 (2004)
– Notice 2004-19, 2004-11 I.R.B. 606 (2004)
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Selected Business Purpose
and Related Authorities and Commentaries
Administrative Guidance
– TAM 9716001 (1996)
– TAM 9206005 (1991)
– TAM 8941004 (1989)
– TAM 8452004 (1984)
– CCA 200408030 (2004)
– CCA 200117039 (2001)
– FSA 200233016 (2002)
– FSA 200135001 (1999)
– FSA 200043007 (2000)
– FSA 200032008 (2000)
– FSA 200020035 (2000)
– PLR 9409032 (1993)
– PLR 8819075 (1988)
– PLR 8418089 (1984)
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Selected Business Purpose
and Related Authorities and Commentaries
Treasury Regulations
– Temp. Treas. Reg. § 1.704-1T(b)
– Treas. Reg. § 1.269-2
– Treas. Reg. § 1.355-2
– Treas. Reg. § 1.368-1
– Treas. Reg. § 1.368-2
– Treas. Reg. § 1.701-2
– Treas. Reg. § 1.1502-80(a)
– Treas. Reg. § 301.7701-3(g)
Codification Proposals
– S. 476, § 701 – “CARE Act of 2003” (passed by Senate April 9, 2003)
– S. 1637, § 401 – “Jumpstart Our Business Strength (JOBS) Act” (April 6, 2004)
– S. 2210, § 301 – “Tax Shelter and Tax Haven Reform Act” (March 17, 2004)
– S. 2155, § 301 – “Growing Our Manufacturing Employment Act” (March 4, 2004)
– H.R. 5095, § 101 – “American Competitiveness and Corporate Accountability Act of
2002” (July 11, 2002)
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Legislative History
– S. Rep. No. 108-11 (2003) (regarding CARE Act of 2003)
– H. Conf. Rep. No. 101-386 (1989) (section 904(i))
– H. Rep. No. 101-247 (1989) (section 904(i))
– H.R. Rep. No. 704 (1934) (regarding reorganizations)
– H.R. Rep. No. 350 (1921) (regarding reorganizations)
Canadian Income Tax Act § 245 – General Anti-Avoidance Rule –
“GAAR”
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Treatises and Articles
–
Bankman, Joseph, The New Market in Corporate Tax Shelters, Tax Notes 1775 (June 21, 1999)
–
Bittker, Boris I. & Eustice, James S., Federal Income Taxation of Corporations and
Shareholders (2003)
–
Bittker, Boris I., What is “Business Purpose” in Reorganizations? 8th Ann. N.Y.U. Inst. on Fed.
Tax. (1950)
–
Blum, Walter J., Motive, Intent and Purpose in Federal Income Taxation 34 U. Chi. L. Rev. 485
(1966-1967)
–
Bowen, Stephen S., Whither Business Purpose? in Tax Strategies for Corporate Acquisitions,
Dispositions, Spin-Offs, Joint Ventures, Financings, Reorganizations & Restructurings 2003
(PLI)
–
Canellos, Peter C., Business Purpose, Economic Substance, and Corporate Tax Shelters 54
SMU L. Rev. 47 (2001)
–
Cohen, Edwin S., Tax Avoidance Purpose as a Statutory Test in Tax Legislation in Proceedings
of the Ninth Annual Tulane Tax Institute 229 (1960)
–
Culbertson, Rob, Effing the Ineffable: Proposed Codification of the Economic Substance
Doctrine (WITSG 2002)
–
Gideon, Kenneth W., Mrs. Gregory’s Grandchildren: Judicial Restriction of Tax Shelters 5 Va.
Tax Rev. 825 (1986)
–
Ginsburg, Martin, Mergers, Acquisitions, and Buyouts (2003)
–
Gunn, Alan, Tax Avoidance 76 Mich. L. Rev. 733 (1977-1978)
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Treatises and Articles
–
Hariton, David P., Economic Substance Complaint No. 1: “Too Vague and Too Broad” 2002
TNT 190-30 (Sept. 30, 2002)
–
Hariton, David P., Treasury’s Proposal to Codify the Economic Substance Doctrine, Tax Notes
937 (Aug. 14, 2000)
–
Hariton, David P., Sorting Out the Tangle of Economic Substance 52 Tax Law. 235 (1999)
–
Isenbergh, Joseph, Musings on Form and Substance in Taxation 49 U. Chi. L. Rev. 859 (1982)
–
Katcher, Robert, Section 351: Business Purpose and Deferral (WITSG 2004)
–
Keyes, Kevin M. & Light, Russell S., Developments in the Economic Substance Doctrine in Tax
Strategies for Corporate Acquisitions, Dispositions, Spin-Offs, Joint Ventures, Financings,
Reorganizations & Restructurings 2003 (PLI)
–
Kingson, Charles I., The Confusion Over Tax Ownership, Tax Notes International 499 (Oct. 29,
2001)
–
Kleinbard, Edward D., Corporate Tax Shelters and Corporate Tax Management The Tax
Executive (May-June 1999)
–
Lipton, Richard M. & Dixon, Steven R., When Is a Partner Not a Partner? When Does a
Partnership Exist? 100 J. Tax’n 73 (2004)
–
McKee, William S., Nelson, William F. & Whitmire, Robert L., Federal Taxation of Partnerships
and Partners (2003)
–
McMahon, Martin J., Jr., Economic Substance, Purposive Activity, and Corporate Tax Shelters,
Tax Notes 1017 (Feb. 25, 2002)
–
Michaelson, Arthur M., “Business Purpose” and Tax-Free Reorganization 61 Yale L. J. 14
(1952)
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Treatises and Articles
–
New York State Bar Association, Economic Substance Codification 2003 TNT 121-26 (June 23,
2003)
–
Nijenhuis, Erika W., et al., The New Disclosure and Listing Regulations For Tax Shelters, Tax
Notes 943 (Nov. 18, 2002)
–
Novack, Janet, Are You a Chump, Forbes, Inc. (March 5, 2001)
–
Paravano, Jeffrey H. & Reynolds, Melinda L., Tax Shelters (2003)
–
Peaslee, James M., More Thoughts on Proposed Economic Substance Clarification, Tax Notes
747 (May 5, 2003)
–
Shaviro, Daniel N., Economic Substance, Corporate Tax Shelters, and the Compaq Case 88
TNT 221 (July 10, 2000)
–
Smith, Robert Thornton, Business Purpose: The Assault Upon the Citadel 53 Tax Law. 1
(1999)
–
Sutherland, William A., Taxpayers' Motive as a Basis for Taxability N.Y.U. 8th Ann. Inst. on Fed.
Tax. (1950)
–
Weisbach, David, It’s Time to Get Serious About Shelters, Tax Notes 1677 (Sept. 25, 2000)
–
Weisbach, David, Business Purpose, Economic Substance, and Corporate Tax Shelters: The
Failure of Disclosure as an Approach to Shelters, 54 S.M.U. L. Rev. 73 (2001)
–
Yin, George K., Thoughts on Tax Shelters, Tax Notes 931 (Feb. 16, 2004)
114