Academic journal article Vanderbilt Journal of Transnational Law

Respect for "Form" as "Substance" in U.S. Taxation of International Trusts

Academic journal article Vanderbilt Journal of Transnational Law

Respect for "Form" as "Substance" in U.S. Taxation of International Trusts

Article excerpt


It would be difficult to imagine how the federal tax system of the United States could function without the "substance-overform" principle. Every analysis of the tax treatment of a transaction or transfer must, explicitly or implicitly, address the question: "Will the tax law treat this as what it appears to be? The question of whether the tax rules will be applied according to the "form" or the "substance" of the transaction or transfer has taken on a variety of formulations in the judicial decisions.

A. Is this in Fact a "Sham"?

First, there is the category of cases where the taxpayer's version of events is documented but inconsistent with what actually occurred. The documents were not respected. A change in title was recorded in the name of the new owner but control over and enjoyment of the property never changed hands. Income and expense were recorded on the books of a trust but the trustee served in fact as a mere nominee. Property was leased, but only on paper. The transaction or transfer was a "fake." In effect, the form was not respected by the taxpayer.

B. Is this a "Sham" in Substance?

The next category of cases is much more difficult to categorize. That is unfortunate because they represent the core learning and experience in the application of "substance" over form. While there are a variety of formulations of the appropriate test in these cases, the inquiry always focuses on the lack of an economic dimension to the taxpayer's position. For example, in the leading case of Knetsch v. United States,(1) dealing with a tax shelter investment, the transaction (a leveraged investment in deferred income bonds) was treated as a "sham" because "there was-nothing of substance to be realized by Knetsch from this transaction beyond a tax deduction." On the Court's reading of the facts, the', taxpayer had no credible chance for an economic profit from the investment measured on a pre-tax basis. Some of these cases blend over into the first category: the steps on which the taxpayer relies actually occurred, but the events involve other steps that limit or offset the resulting economic consequences, so that the taxpayer's change in economic position is not meaningful.(2) If a taxpayer claims that his transfer of property to a trust for the benefit of his child is not a gift but a sale, is there any difference between the case where the taxpayer never intended to collect the purchase price (a sham in fact) and the case where the taxpayer loaned the purchase money to the trust on terms that evidenced it would never be paid back (a sham in substance)?(3)

C. Was this what Congress Intended?

The Court may also conclude that the actual events are outside the Congressional intent of the Internal Revenue Code (Code) provision on which the taxpayer relies. In the leading case of Gregory v. Helvering,(4) Justice Sutherland conceded that the taxpayer was legally entitled "to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits." However, he concluded that the real question was "whether what was done, apart from the tax motive, was the thing which the statute intended," and decided the case against the taxpayer.(5) Indeed, it should be inevitable that questions of "substance" over "form" require an analysis of statutory intent whenever the transaction or transfer is not a sham in fact (not a "fake"), and the challenge is made on the ground that the taxpayer's position has no substance apart from tax consequences. Assuming that a particular transaction or investment has some economic substance apart from tax consequences (e.g., the pre-tax profit potential is not de minimus), then it has a non-tax purpose and the question of statutory intent should become paramount. Otherwise, the substance over form doctrine would greatly circumscribe the Congressional prerogative to allow transactions to be taxed according to their form, and to encourage the form to be deliberately structured to take advantage of a tax incentive. …

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