On March 31, 2014 Atlantic Legal filed an amicus brief in support of a petition for certiorari in WFC Holdings Corp. v. United States, which raises the issue of the IRSs aggressive and arbitrary application of the Sham Transaction doctrine to disallow losses incurred in a complex corporate transaction.
The Supreme Court and virtually all of the federal courts of appeal for more than 75 years have interpreted the common-law sham transaction doctrine (also sometimes referred to as the economic substance doctrine) to allow the IRS to disregard a transaction that complies with the terms of the Internal Revenue Code only if it is a pure paper shuffle that does not change the taxpayers economic position apart from taxes. The sham transaction exception is rooted in two principles: (1) a taxpayer has the legal right . . . to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits. Gregory v. Helvering, 293 U.S. 465 (1935) and (2) except in the most extreme circumstances courts are not free to override the literal terms of the tax laws enacted by Congress.
The transaction at issue complied with the plain language of the Code and resulted in substantial profits wholly independent of tax benefits, but nevertheless was ignored by the IRS for federal income tax purposes under the sham transaction doctrine. The district court and the Eighth Circuit held that a transaction involving the transfer of under-performing lease obligations from a bank to a non-banking affiliate that generated tens of millions of dollars of profits (far in excess of transaction costs) was a sham that could be disregarded for tax purposes. The court held that the transaction lacked economic substance because two of its three steps were not independently profitable and were designed solely to obtain tax deductions, even though the third step in the overall transaction generated significant non-tax profits.
The Supreme Court has long held that a transaction may be disregarded for tax purposes under the sham transaction doctrine only if there is nothing of substance to be realized . . . from [the transaction] beyond a tax deduction. Knetsch v. United States, 364 U.S. 361, 366 (1960). The Eighth Circuits disregard of that principle threatens a significant expansion of the sham transaction doctrine. Moreover, the Eighth Circuits holding that the transaction in this case lacked economic substance simply because certain steps of the transaction were not independently profitable is inconsistent with the rulings of other circuits concerning substantially similar transactions, and makes it difficult for companies and their tax advisors effectively to design and implement business strategies.
We argued that a taxpayer is permitted, under the economic substance doctrine, to structure an objectively profitable transaction so as to achieve tax benefits provided for in the Code even if each step of the transaction is not independently profitable. We also argued that the Eighth Circuit improperly imposed a new test requiring that every step of a transaction be independently profitable to satisfy the economic substance doctrine.
To view Atlantic Legals brief, please click here.