Andy Grewal (Georgetown University Law Center) has posted Economic Substance and the Supreme Court on SSRN. Here is the abstract:
If an individual seeks a benefit under a congressionally-enacted statute, is a court obliged to examine that statute to determine whether he qualifies for that benefit? To many district and circuit courts, the answer to that question is a firm ‘no.’ This article argues that that approach is inappropriate and, despite the lower courts’ assertion to the contrary, is flatly inconsistent with applicable Supreme Court precedent.
Faced with a taxpayer’s argument that he qualifies for a tax benefit, the lower courts have often chosen to apply the so-called economic substance doctrine rather than the internal revenue laws. Under that doctrine, courts will overlook a taxpayer’s ‘mere compliance with the Code,’ Stauffer’s Estate v. Commissioner, 403 F.2d 611, 621 (1968), and instead go ‘outside the statutory framework,’ Dewees v. Commissioner, 870 F.2d 21, 34 (1st Cir. 1989), to determine if he qualifies for the claimed benefit. The doctrine generally provides that if a taxpayer does not have a business purpose for entering into a transaction, or if the transaction does not provide a reasonable expectation of profit, any claimed tax benefits resulting from the transaction will be denied, even if the taxpayer has ‘complied with each and every of the relevant requirements imposed by the Code.’ Heinz v. United States, 76 Fed.Cl. 570, 591 (2007).
If the taxpayer does not pass the ‘prerequisite’ judicial tests, Congress’s statutes ‘do not even come into play.’ Lerman v. Commissioner, 939 F.2d 44, 52 (3d Cir. 1991). A taxpayer can emphasize that the statutory language supports its position, but a court may dismiss that argument by announcing that ‘we can forgo examining the intersection of [] statutory details.’ In re CM Holdings, 301 F.3d 96 (3d Cir. 2002).
Some courts do find the application of judicial doctrines instead of legislative enactments ‘disturbing’ and ‘fundamentally anti-majoritarian,’ and express concern that ‘unelected bureaucrats are given the power to rewrite laws enacted by Congress and the President,’ but nonetheless state that the doctrine is ‘well-settled.’ Jacobs Engineering Group, Inc. v. United States, 1997 WL 314167, Not Reported in F.Supp., (C.D.Cal. 1997).
In finding that the economic substance doctrine can override statutory language, the lower courts emphasize that the Supreme Court has itself established the doctrine.
This article argues that the Supreme Court has never, in fact, sanctioned the economic substance doctrine — the Court has never treated statutes as mere ‘details’ that can be swept aside in favor of judicial tests.
[Note: A much shorter draft of this article dealing with fewer issues was posted for a short time in early January. This article has been substantially revised since the prior posting. Numerous case discussions and an extensive response to counterarguments have been added. This version also touches on penalty-related issues and provides (in footnotes) some thoughts regarding codification.]
And a bit more from the text:
This is not to say that courts should adopt hyperliteral interpretations of the code or blithely sanction sham transactions.286 A fair reading of sections 1 and 11 indicates that their purpose (as reflected by their text) is to raise revenue.287 If a taxpayer offers a hyperliteral interpretation of a substantive provision that would render sections 1 and 11 a dead letter, a court should reject that interpretation.288 But there is a significant difference between an interpretation that (if accepted) would render the code a nullity and one that simply suggests that Congress has (wisely or unwisely) subsidized a transaction.289 If a fair interpretation of the statutory language indicates that Congress did grant benefits to a sham transaction, courts should follow the Supreme Court’s guidance and respect the legislature’s intent.290
Very interesting & highly recommended.