Grappling with the Tax Me If You Cann Era: Configuring a Micro Level Objective Economic Substance Inquiry

Abstract

The Economic Substance Doctrine has been perennially placed at the fulcrum of the IRS’s fight against rising tax shelter activity. The doctrine presupposes that transactions must have economic substance, as the phrasing itself insinuates and should not only be geared at generating tax savings. The Economic Substance inquiry generally involves a two prong test which asks two questions - (i) did the tax payer have a business purpose for engaging in the suspect transaction other than getting tax benefits? (Subjective motivation test), and (ii) did the transaction have economic substance other than tax savings? (Objective analysis test). Most Courts are at par that the two prongs are entirely different standards for economic substance analysis. However, there is still some uncertainty among the Courts as to what each prong really means as different Courts have approached each individual prong differently. Further, there is still ambiguity among the Circuits as at to how the two prong test is to be applied which are evident in the variation in the Circuits’ decisions. Some Courts have said that it is a disjunctive test while others have held that it is a conjunctive test. Elsewhere, there is a simmering revolution that is treating the economic substance inquiry as a unitary analysis which asserts that the two prongs are informed by the same rationale. Practically there are no differences between the unitary analysis and the conjunctive test. A modern species of the Economic Substance Doctrine was evinced in the 1998 decision of ACM Partnership v. Commissioner. In that case it was stated that the objective and subjective motivation tests of the doctrine were not discrete prongs of a rigid “two step analysis” but related factors both of which informed the analysis as to the economic substance of a transaction. It is apt to realize that corporate tax payers desire to do their tax planning under a system of objective rules that espouses certainty and places less emphasis on subjective overtones especially taking into account the factual complexity of day-to-day business transactions. Traversing through literature on the doctrine reveals an area of law that is still riddled with uncertainties which have ultimately been an Achilles heel for its applicability. The recent cases of Black & Decker v. United States and Coltec Industries v. United States have re-invigorated a movement towards an objective economic substance doctrine which incorporates a micro-level analysis such that a transaction is separated into different levels to find out whether each level distinctly had economic substance. This thesis argues that the use of a micro-level objective economic substance analysis which takes into account implicit taxes is a most viable solution to effectively formulating a sturdy objective economic substance inquiry for the coming years. The implication here is that by adopting a micro-level objective economic substance analysis the tax payer will only be denied tax benefits for the distinct levels of a transaction that lacked economic substance and not for the entire transaction. This would bring the IRS and the tax payer to a win-win result and makes more practical and economic sense