Economic Substance, Purposive Activity, and Corporate Tax Shelters
10 Pages Posted: 22 Feb 2002 Last revised: 17 Nov 2010
Date Written: November 16, 2010
Abstract
This report argues that rigorous application of the judicial anti-abuse doctrines, such as business purpose, economic substance, and purposive activity, is necessary to police an overly literal application of the code and regulations that produces results that are absurd or "too good to be true." It argues that the "economic substance" test applied by the Courts of Appeals in cases like Compaq v. Commissioner and IES v. United States has become a useless mechanistic test. The classic Supreme Court jurisprudence supports the application of a "purposive activity" test that is closer to the analysis employed by the Tax Court in corporate tax shelter cases. Any planning uncertainty created by the application of these judicial anti-abuse doctrines should not be viewed as a problem worse than the problem their application is intended to remedy. In the face of aggressive marketing of and investment in loss generating tax shelters, the government has an obligation to the taxpayers who are not investing in these shelters to avoid settling tax shelter cases for less than full payment of the deficiency (and interest). Otherwise, at least as far as large corporations are concerned, there is a risk that our tax system will devolve into a negotiated tax system. In the face of the conflicting results in recent corporate tax shelter cases, the report suggests that the government should either pursue a litigation strategy designed to produce another Supreme Court opinion regarding the economic substance and purposive doctrines or seek legislation codifying the purposive activity doctrine.
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