Economic Substance

Front 1

Frank Lyon Co. v. Comm’r:

Back 1

A transaction is a sham unless the taxpayer shows (1) it has business purpose for the transaction other than tax avoidance and (2) transaction has economic substance beyond creation of tax benefits.

Front 2

Gregory v. Helvering

Back 2

Transaction devoid of economic substance is disregarded.

(Corporation was formed for a few days merely to qualify a transfer as a tax-free reorganization, under the literal wording of the statute.)

Front 3

Codification of Economic Substance Doctrine (7701(o))

In General

Back 3

Under the provision, in a case in which a court determines that the economic substance doctrine is relevant to a transaction, such transaction has economic substance only if the taxpayer establishes that (1) the transaction changes in a meaningful way (apart from Federal income tax consequences) the taxpayer’s economic position, and (2) the taxpayer has a substantial non-Federal-tax purpose for entering into such transaction.

Front 4

Codification of Economic Substance Doctrine (7701(o))

State and Local Benefits

Back 4

Generally not taken into account as a meaningful change in the taxpayer's economic position or as providing or contributing to a substantial business purpose

Front 5

Codification of Economic Substance Doctrine (7701(o))

Apply only When Relevant

Back 5

The determination of whether the economic substance is relevant is made in the same manner as if 7701(o) had never been enacted. This means that if the government would not have made or won an economic substance argument before – at least under the old majority conjunctive version – it should not now, either.

Front 6

The Potential Cost

Section 6662(b)(6)

Back 6

If you’ve disclosed the fact that you’ve got a transaction without economic substance, the accuracy penalty is 20%.

If you haven’t disclosed the fact that you’ve got a transaction without economic substance, the accuracy penalty is 40%.

Front 7

Joint Committee on Taxation Discussion of Business Purpose from the Enron Report.

Back 7

“If the non-tax business purpose of a transaction is not self-evident -- or stated another way, if a taxpayer and its tax advisor have to develop or devise a justification for the taxpayer’s involvement in a particular transaction -- then the transaction in all likelihood lacks a non-tax business purpose and should be challenged accordingly.”