Tax shelters and statutory interpretation: A much needed purposive approach

University of Illinois Law Review

Volumn 2009, Issue 3, 2009, Pages 697-772

  McCormack, Shannon Weeks ^a,b  

^a UNIVERSITY OF CALIFORNIA   (United States)

^b Department of Law ^*

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EID: 68949167349     PISSN: 02769948     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (513)

1. See generally David P. Hariton, Sorting Out the Tangle of Economic Substance, 52 TAX LAW. 235, 236 (1999) ("We tax lawyers are alternatively amused and exasperated by the naive columnists and politicians who maintain that this complexity can be eliminated by changing tax systems."); Stanley S. Surrey, Complexity and the Internal Revenue Code: The Problem of the Management of Tax Detail, 34 LAW & CONTEMP. PROBS. 673 (1969).
2. George K. Yin, Getting Serious About Corporate Tax Shelters: Taking a Lesson from History, 54 SMU L. REV. 209, 215-20 (2001).
3. Joseph Bankman, The New Market in Corporate Tax Shelters, 83 TAX NOTES 1775, 1776 (1999).
4. Id.
5. See, e.g., id. at 1775-95. Although recognizing that there is by no means an agreed upon definition of tax shelters, Bankman stated that "[t]he tax shelter, while supported by a literal reading of statute, regulation, or case law, produces a result that is inconsistent with commonly understood tax principles and is not supported by clearly defined legislative intent." Id. at 1777;
6. see also David P. Hariton, Tax Benefits, Tax Administration, and Legislative Intent, 53 TAX LAW. 579, 583 (2000) ("The question a court must ask in deciding whether to disallow the resulting tax benefits... is whether those benefits frustrate the will of Congress.");
7. Michael L. Schler, Ten More Truths About Tax Shelters: The Problem, Possible Solutions, and a Reply to Professor Weisbach, 55 TAX L. REV. 325, 330 (2002) ("In fact, it seems impossible to define a tax shelter except in terms of congressional or regulatory intent. Whatever words are used, we instinctively compare the alleged results of a transaction (or a portion of a transaction) to the results we think 'should' arise under our understanding of the purpose of the Code and regulations. If we believe the tax result was intended by Congress or the regulations, we do not consider the transaction a tax shelter. If the transaction reaches a tax result that we consider 'too good to be true' under this analysis, we may think of the transaction as a tax shelter. Therefore, all tax shelters reach unintended tax results. Equivalently, a transaction that reaches intended results is not a tax shelter.").
8. See, e.g., James S. Eustice, Abusive Corporate Tax Shelters: Old "Brine" in New Bottles, 55 TAX L. REV. 135,147 (2002); Yin, supra note 2, at 215-18.
9. There are constant ruminations as to whether the economic substance doctrine will be codified. In September 2007 Joshua Odintz, tax counsel to the Senate Finance Committee majority, told the American Bar Association Section of Taxation's Tax Shelter Task Force that economic substance codification was coming. See, e.g., Lee A. Sheppard, Economic Substance Codification Coming, TAX NOTES TODAY, Oct. 10, 2007, available at 2007 TNT 196-3 (LEXIS). The most recent draft suggests that the test will be conjunctive, requiring both an objective possibility of a pretax profit and a subjective business purpose. The drafters believe they are clarifying the existing common law doctrine as opposed to modifying it. Id. As a result, the analysis of the doctrine discussed below, which focuses on the courts' application of the business purpose doctrine, will not be affected in any significant way should codification occur in this form.
10. See id. As of January 2008, government officials predicted that the doctrine would be codified in 2008.
11. See, e.g., Lee A. Sheppard & Jerimiah Coder, Congress Will Pass Economic Substance Codification in 2008, Government Officials Predict, TAX NOTES TODAY, Jan. 23, 2008, available at 2008 TNT 15-5 (LEXIS).
12. See Mark P. Gergen, The Common Knowledge of Tax Abuse, 54 SMU L. REV. 131, 131-32 (2001).
13. See, e.g., id. at 132; Hariton, supra note 1, at 244. Hariton, who is not a defender of the tests, notes that the economic substance doctrine may serve as a necessary but not sufficient condition. He argues that the essential question is whether the tax benefits "are beyond the scope of what the drafters of the relevant rules could reasonably have intended." Id. at 246.
14. See, e.g., Gergen, supra note 8, at 131.
15. See, e.g., id. at 132.
16. See infra Part II.B-C.
17. See infra Part II.C.2.
18. See, e.g., Schier, supra note 5, at 328 (stating that "[o]ne of the biggest problems in any discussion of tax shelters is that there is no established definition of the term"); David A. Weisbach, Ten Truths About Tax Shelters, 55 TAX L. REV. 215, 232 (2002) (acknowledging that "[t]here is no a priori definition of shelters").
19. David P. Hariton, How to Define 'Corporate Tax Shelter, ' 84 TAX NOTES 883, 883 (1999).
20. See sources cited supra note 5.
21. See, e.g., Lawrence Zelenak, When Good Preferences Go Bad: A Critical Analysis of the AntiTax Shelter Provisions of the Tax Reform Act of 1986, 67 TEX. L. REV. 499, 502-03 (1989); Edward A. Zelinsky, Efficiency and Income Taxes: The Rehabilitation of Tax Incentives, 64 TEX. L. REV. 973, 981 (1986) (discussing the various arguments for and against tax preferences).
22. Zelenak, supra note 17, at 503.
23. Richard C. Stark, A Principled Approach to Collection and Accuracy-Related Penalties, 91 TAX NOTES 115, 136 (2001).
24. Henry Ordower, Horizontal and Vertical Equity in Taxation as Constitutional Principles: Germany and the United States Contrasted, 7 FLA. TAX REV. 59, 287 (2006).
25. See Eustice, supra note 6, at 146-47; Yin, supra note 2, at 215-18.
26. See Bankman, supra note 3, at 1776 ("The new corporate tax shelter is much more sophisticated and complex than its 1980s predecessor."); Marvin A. Chirelstein & Lawrence A. Zelenak, Essay, Tax Shelters and the Search for a Silver Bullet, 105 COLUM. L. REV. 1939, 1951-52 (2005) ("Contemporary shelters are considerably more varied in design-and in the Code provisions they exploit than were their predecessors.").
27. See Karen C. Burke, Black & Decker's Contingent Liability Shelter: 'A Thing of Grace and Beauty'?, 106 TAX NOTES 577, 577-78 (2005). Although her article explains why the Coltec shelter, which is discussed in Part IV.A, infra, should have been struck down, Burke's title refers to the Hon. William D. Quarles, Jr.'s description of the transaction and suggests the odd admiration we sometimes feel for these clever structures.
28. See Eustice, supra note 6, at 141. Even when Congress attempts to close down a perceived abuse, it frequently comes late to the rescue, reacts with excessive overkill, and then repents at leisure, if ever, only rarely returning to the scene of the accident. On the other hand, despite the frequency of statutory changes, many parts of the Code have lingered undisturbed for decades, and these provisions have long provided opportunities for creative tax planning. Id.
29. Id. at 147 ("As soon as the Service kills one transaction, several new ones arise to take its place.").
30. See Yin, supra note 2, at 216. [I]ncremental changes in the law intended to stem inefficient tax shelter activity may result instead in greater inefficiency and distortion....The government first identifies a transaction or an outcome that it considers inappropriate and moves to prevent it through some change in the law. If, subsequent to the change, taxpayers still perceive the after-tax return from their desired outcome to be greater than the costs necessary to achieve that outcome, they may respond by attempting to circumvent the change in law. Id.
31. See Chirelstein & Zelenak, supra note 22, at 1950.
32. See Bankman, supra note 3, at 1776.
33. Chirelstein & Zelenak, supra note 22, at 1951-52.
34. See id. at 1951.
35. See id. This is not to imply that there were no other shelters in the 1970s and 1980s. The emergence of commodity straddles, which allowed taxpayers to defer the recognition of prior capital gains, also took place before 1986 and was curbed by the Economic Tax Recovery Act of 1981, specifically I.R.C. §§ 501 and 502. See, e.g., Richard W. Evans, Note, The Tax-Straddle Cases, 1982 DUKE LJ. 114, 121-25 (describing the shelter and its tax advantages).
36. For those interested, however, there is much written on the subject. See, e.g., Calvin Johnson, University of Texas Professor Unveils Report on Passive Activity Regulations, TAX NOTES TODAY, Jan. 31, 1995, available at 90 TNT 9-32 (LEXIS) [hereinafter Johnson, Passive Activity Regulations]; Zelenak, supra note 17, at 509; Letter from Calvin Johnson, Arnold, White & Durkee Centennial Professor of Law, Univ. of Tex., to William F. Nelson, Chief Counsel, IRS (May 26,1987), reprinted in 35 TAX NOTES 1019 (1987) [hereinafter Johnson Letter].
37. Yin, supra note 2, at 218-19; see I.R.C. § 469 (2006). The last tax shelter wars-involving the mass marketing of debt-financed tax shelters to uppermiddle (and even middle-middle) income taxpayers in the 1970s and 1980s-ended abruptly in a sweeping government victory, as a result of the enactment of the passive loss rules of §469 as part of the Tax Reform Act of 1986. Chirelstein & Zelenak, supra note 22, at 1951. This is not to suggest that § 469 ended all abuses. Although this particular abuse has been curbed, so-called leveraged leases, transactions achieving similar effects to the individual real estate shelters discussed above, continue. Such a lease transaction generally involves three parties: a lessor, a lessee and a lender to the lessor. In general, these leases are net leases, the lease term covers a substantial part of the useful life of the leased property, and the lessee's payments to the lessor are sufficient to discharge the lessor's payments to the lender. Rev. Proc. 75-21, 1971-1 C.B. 715.So long as the parties adhere to Service guidelines, the lessor is able to transfer its investment credit to the lessee and maintain the interest and depreciation deductions to offset the received rental income. See Hariton, supra note 5, at 582 n.2. Commentators disagree, however, as to whether this transaction constitutes an abusive transaction. Hariton argues that leveraged leasing allows taxpayers to transfer incentivizing benefits to parties who can use them, thus furthering the purpose of granting the investment tax credit in the first place. See id. at 581-85;
38. see also David P. Hariton, Commentary, Response to "Old 'Brine' in New Bottles" (New Brine in Old Bottles), 55 TAX L. REV. 397, 402 (2002) (arguing that leveraged leases pass "legitimate tax benefits that have been conferred by Congress for investment in U.S. business property from one taxpayer to another (and arguably benefits Congress, since the relevant investment in U.S. business property otherwise might not take place)"). But see Eustice, supra note 6, at 139 (referring to leveraged leasing as the "mother of all corporate tax windfalls").
39. See Eustice, supra note 6, at 147 ("Unlike the previous generation of tax shelter transactions, there appears to be no magic bullet, or stake-in-the-heart solution to the current problem.").
40. See sources cited supra note 22.
41. Sometimes the amendment, the purported solution, actually leads to more problems. See supra note 26.
42. See sources cited supra notes 24-25.
43. See Chirelstein & Zelenak, supra note 22, at 1950-51.The problem is that these targeted fixes are always made prospective only. As Congress closes one loophole, tax shelter designers find other glitches in the Code around which to build new shelters. Like the Dutch boy at the leaky dike, or Hercules attempting to conquer the Hydra by decapitation, or the man in the gospel parable who is rid of one devil only to be possessed by seven devils worse than the first, or Alice and the Red Queen running as fast as they can just to stay in the same place-the literary references go on and on-the government cannot win this game....[T]he always-one-step-behind nature of this approach means that it can never be an adequate response to the proliferation of shelters. Id.
44. Id. at 1939 ("The marketing of tax shelters by leading accounting and investment banking firms has developed into a perfect plague over the past decade.").
45. Bankman, supra note 3, at 1776.
46. Id.
47. Chirelstein & Zelenak, supra note 22, at 1940.
48. Id.
49. Bankman, supra note 3, at 1776.
50. See infra Part II.C.
51. See, e.g., Hariton, supra note 1, at 235.
52. See ACM P'ship v. Comm'r, 157 F.3d 231,248 n.31 (3d Cir. 1998).
53. See, e.g., id. at 253-54.
54. See id.
55. Id.; see infra text accompanying notes 105-08; see also infra Part IV.B.
56. For example, the Fourth Circuit applies a conjunctive test: A transaction is disregarded if (1) "the taxpayer was motivated by no business purpose other than obtaining tax benefits in entering the transaction" and (2) the "transaction has no economic substance because no reasonable possibility of a profit exists." Black & Decker Corp. v. United States, 436 F.3d 431, 441 (4th Cir. 2006) (quoting Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 91 (4th Cir. 1985)). In contrast, the Federal Circuit has used what appears to be something closer to a disjunctive test and has explicitly stated that it believes the Fourth Circuit's conjunctive test is discordant with Supreme Court precedent.
57. See Coltec Indus., Inc. v. United States, 454 F.3d 1340,1355 (Fed. Cir. 2006) ("While the doctrine may well also apply if the taxpayer's sole subjective motivation is tax avoidance even if the transaction has economic substance, a lack of economic substance is sufficient to disqualify the transaction without proof that the taxpayer's sole motive is tax avoidance.").
58. See infra Part II.C.2.
59. ACM, 157 F.3d at 257-63.
60. See David P. Hariton, The Compaq Case, Notice 98-5, and Tax Shelters: The Theory Is All Wrong, 94 TAX NOTES 501 (2002). Hariton has long argued that courts should abandon the profit test because "[t]he answer has nothing to do with whether the transaction lacks economic substance and nothing to do with whether the resulting tax benefits should be disallowed." Id. at 501. He continues, arguing that "the government's profit theory isn't wearing any clothes," as evidenced by recent tax shelter cases. Id.
61. See, e.g., Zelenak, supra note 17; Zelinsky, supra note 17.
62. I.R.C. § 45 (2006).
63. Id. §42.
64. See I.R.S. Priv. Ltr. RuI. 85-31-065 (May 9,1985) (discussing the tax ramifications of a common low-income housing project that is not projected to be profitable for fifteen years); Katherine M. Breaks & Richard Blumenreich, New Guidance on Partner Allocations of Wind Energy Production Tax Credits, 108 J. TAX'N 95, 97 (2008).
65. Consider, for instance, one version of the so-called sale and leaseback transaction (otherwise known as a sale-in-lease-out transaction, or a SILO). A property owner (O) sells its property to a third party (T). T provides a down payment and mortgages the remainder of the property. T then leases the property back to the original owner. The rental payments are designed to be equivalent to T's mortgage payments. The lease will also provide O with various repurchase options. The sales price will be equal to the original down payment and any remaining mortgage payments plus a specified compound interest rate. Thus, T's pretax expected return is the specified compound rate minus transaction costs, a figure that will almost always be lower than T's expected return on a "regular" real estate transaction. Since T is the "owner" of the property, however, she is entitled to take depreciation deductions against her other income, as well as any other deductions that might accompany ownership. It is the availability of these tax savings that make the deals worthwhile for T. See Frank Lyon Co. v. United States, 435 U.S. 561 (1978) (one of the most famous SILO cases). Another common related transaction is the so-called lease-in-lease-out transaction (LILO). See Rev. Proc. 2001-28, 2001-1 C.B. 1156 (setting forth guidelines as to whether LILOs will be respected for federal income tax purposes); Rev. Proc. 75-21, 1975-1 C.B. 715 (general explanation of LILOs). An application of the profit test to this leasing transaction reveals the same problem that is revealed when it is applied to SILOs-i.e., that the test is both under- and over-inclusive. See Lee A. Sheppard, Lease in, Lease out: Safe Harbor Leasing Revisited, 81 TAX NOTES 1167, 1168-69 (1998) (discussing the related LILO transaction).
66. See, e.g., Frank Lyon, 435 U.S. at 576-81. For an excellent summary of various LILO cases, see Mukerji v. Commissioner, 87 T.C. 926 (1986).
67. Compare Frank Lyon, 435 U.S. 561, with Coleman v. Comm'r, 87 T.C. 178 (1986).
68. Commentators have very different opinions as to whether LILOs are abusive transactions. See supra note 33 for some various viewpoints.
69. See, e.g., Alvin C. Warren, Jr., The Requirement of Economic Profit in Tax Motivated Transactions, 59 TAXES 985, 987 (1981).
70. See, e.g., ACM P'ship v. Comm'r, 157 F.3d 231,253 (3d Cir. 1998).
71. Warren, supra note 63, at 987.
72. See id.
73. See id. at 988 (arguing that the only possible solution is to require a mere dollar profit despite the very odd results it creates because to require something like a "reasonable" profit would be unacceptably arbitrary).
74. See, e.g., Long Term Capital Holdings v. United States, 330 F. Supp. 2d 122, 143-63 (D. Conn. 2004), aff'd 150 Fed. App'x 40 (2d Cir. 2005). In Long Term Capital Holdings, taxpayersperhaps realizing that stuffing in income producing assets was too obvious-sought to hide fees instead. For example, the transactions included internal bonuses actually meant to compensate principals for their work on the transaction and legal fees structured as "consulting arrangements" in an attempt to make the arrangements seem less connected with the transaction in question. Id. at 163. There is no question that the fees were structured this way in contemplation of the test. Before the transactions had commenced, Long Term had discussed compensation with Babcock & Brown, the firm that aided them in the transaction, and specifically avoided cash fee arrangement. Long Term feared that "paying a cash fee could be construed as buying tax benefits which would raise questions about the economic substance of the transaction or Long Term's business purpose for it." Id. at 144.
75. The tendency to tack on profits to "pass" the profits test has been referred to as the "stuffing problem." Hariton, supra note 54, at 509. And even if there wasn't any profit in these transactions, you can be sure that there will be in the next 30 transactions that come before the courts, because adding in profit is like taking candy from a baby. All it requires is that the taxpayer add some net equity to the transaction so that it is effectively investing capital for a period of time. Id. But see Mitchell Kane, Compaq and IES: Putting the Tax Back into After-Tax Income, 94 TAX NOTES 1215, 1215 (2002) (arguing that it will not be difficult to separate out the "stuffed in" assets).
76. Hariton, supra note 54, at 508.
77. Id.
78. -277 F.3d 778 (5th Cir. 2001).
79. Id. at 784. The complex manner in which Compaq acquired these credits will be discussed in Part IV.C.
80. Id. at 785.
81. Id. at 785-86; Norwest Corp. v. Comm'r, 69 F.3d 1404,1407 (8th Cir. 1995).
82. See Compaq, 277 F.3d at 784-85.
83. Id. at 784-88.
84. Id. at 785-86.
85. Id.
86. See id. at 785-88.
87. See id. at 785-86.
88. Commentators often agree with this approach in the abstract but do not offer a mechanism by which to conduct the interpretive analysis. See, e.g., Hariton, supra note 54, at 508-09. The proposed test will be applied to the Compaq transaction in Part IV.C.
89. IES Indus., Inc. v. United States, 253 F.3d 350, 353 (8th Cir. 2001).
90. See, e.g., Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1355-60 (Fed. Cir. 2006); United Parcel Serv. of Am., Inc. v. Comm'r, 254 F.3d 1014,1019-20 (11th Cir. 2001).
91. See, e.g., Del Commercial Props., Inc. v. Comm'r, 251 F.3d 210 (D.C. Cir. 2001).
92. See, e.g., Joseph Bankman, The Economic Substance Doctrine, 74 S. CAL. L. REV. 5, 15 (2000). The economic substance doctrine requires that the events giving rise to a particular tax position must have objective economic substance, but does not tell us which of many interrelated events ought to be lumped together and measured for economic substance. In general, the greater the number of events lumped together, the greater the likelihood that a tax position will reflect changes in nontax attributes. Id.; see also Bankman, supra note 3, at 1778 ("In practice, the term 'transaction' is underdefined, so that the effect of [applying the traditional tests] depends on what the 'transaction' is that is subject to scrutiny.").
93. -254 F.3d 1014.
94. -454 F.3d 1340.
95. UPS,254 F.3d at 1014.
96. Id. at 1019.
97. Coltec, 454 F.3d at 1345.
98. See id. at 1358.
99. Id. at 1345.
100. Id. at 1356.
101. See id. at 1358, 1360.
102. Id.
103. Id.
104. -499 U.S. 554 (1991).
105. -157 F.3d 231 (3d Cir. 1998).
106. See Cottage, 499 U.S. at 556.
107. Id. at 557-58.
108. See id. at 554-55.
109. Id. at 567.
110. Id. at 568. In fact, the Commissioner appears to have argued only that the transaction lacked economic substance as a last resort. The argument was stated "in one sentence in a footnote in his brief." Id. at 567-68.
111. ACM P'ship v. Comm'r, 157 F.3d 231, 242-44 (3d Cir. 1998).
112. Id.
113. Id.
114. Id. at 254-60.
115. This will be addressed in Part IV.B.3, which applies the proposed test to the ACM transaction.
116. In ACM, the economic substance doctrine was used to strike down the transaction at issue. 157 F.3d at 260. Judge McKee's notorious dissent stated, "I can't help but suspect that the majority's conclusion to the contrary is, in its essence, something akin to a 'smell test.' If the scheme in question smells bad, the intent to avoid taxes defines the result as we do not want the taxpayer to 'put one over.'"
117. Id. at 265;
118. see also Alexandra M. Walsh. Note, Formally Legal, Probably Wrong: Corporate Tax Shelters, Practical Reason and the New Textualism, 53 STAN. L. REV. 1541, 1558 (2001) ("According to Judge McKee, though the majority might act as if it bases its conclusion on neutral application of an established legal test, in actuality it merely invokes the economic substance doctrine to legitimate the result it wants to achieve (i.e., to prevent the taxpayer from unfairly avoiding taxes).") .
119. Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934), aff'd, 293 U.S. 465 (1935).
120. Id.
121. -364 F.2d 734 (2d Cir. 1966), off g 44 T.C. 284 (1965).
122. Id. at 736-37.
123. Id.
124. Id. at 739.
125. Id. at 741.
126. Id. at 741-42.
127. Id. at 742.
128. See, e.g.,S Arthur M. Michaelson, "Business Purpose" and Tax-Free Reorganization, 61 YALE L.J.14,31n.76(1952).
129. See Goldstein, 364 F.2d at 741.
130. See, e.g., Gergen, supra note 8, at 132. In his article, Professor Gergen defends the anti-abuse tests. See id. Hariton notes that the economic substance doctrine may serve as a necessary but not sufficient condition and that the essential question is whether the tax benefits "are beyond the scope of what the drafters of the relevant rules could reasonably have intended." Hariton, supra note 1, at 246.
131. Gergen, supra note 8, at 132.
132. Some scholars believe fervently that purpose cannot be determined in tax law. For example, Joseph Isenbergh made his viewpoint famous by stating that "there is no natural law of reverse triangular mergers." Joseph Isenbergh, Musings on Form and Substance in Taxation, 49 U. CHI. L. REV. 859, 879 (1982). Other scholars have expressed this sentiment as well.
133. See, e.g., Edward D. Kleinbard, Corporate Tax Shelters and Corporate Tax Management, 51 TAX EXECUTIVE 235, 240 (1999). Kleinbard also espouses this notion by asking, "[H]ow does one ask a model whether the benefits it dispenses were intentional? Models do; they do not speak." Id.;
134. see also Gergen, supra note 8, at 139 (stating that "[i]n much of tax law, the quest for principle is Quixotic" as "tax law is not naturally or intrinsically principled"). As will be shown in Parts III and IV, which develop and apply a purposive test, these claims are overstated.
135. See Gergen, supra note 8, at 132.
136. See Bankman, supra note 86, at 11-12. Professor Bankman discusses the possible relationship between economic substance and statutory interpretation.
137. Id. He notes that in some ways the doctrine can be seen as a method of statutory interpretation in and of itself-that is, the doctrine is derived from the text.
138. Id. at 11. He notes, however, that in reality the relationship is "ambiguous" and concludes that "because the doctrine can be applied without formal discussion of text, intent, or purpose, its application is usually accompanied by, or entwined with, interpretation of the statute.
139. " Id. at 11-12. This intertwining, however, often leads the courts to spend most of their time on the economic substance doctrine, followed by inadequately developed statements regarding the meaning, intent, or purpose of statutory text. The proposed test provides a framework for conducting this needed analysis.
140. See supra Part II.B.
141. See sources cited supra note 5.
142. See, e.g., Peter C. Canellos, A Tax Practitioner's Perspective on Substance, Form and Business Purpose in Structuring Business Transactions and in Tax Shelters, 54 SMU L. REV. 47, 51 (2001) ("While defining tax shelters may be difficult and while there are cases on the borderline, experienced tax professionals can usually readily distinguish tax shelters from real transactions.").
143. See, e.g., Schier, supra note 5, at 333 (arguing that the reality is that congressional intent can often be determined, and tax practitioners, in no small part, make their livings by doing so). Thus, Schier states that inquiries into legislative intent often provide clear-cut answers. After all, the code provisions and their regulations do not exist in a vacuum-"the Code and regulations... have an overall structure" that aids considerably in ascertaining their underlying intent.
144. Id.
145. This fact pattern is based on Helvering v. Owens, 305 U.S. 468 (1939), the result of which is now reflected in Treas. Reg. § 1.165-7(b)(l).
146. See Deborah A. Geier, Interpreting Tax Legislation: The Role of Purpose, 2 FLA. TAX REV. 492,497-98 (1995).
147. Treas. Reg. § 1.165-7(b)(3)(i) (1977).
148. Professor Lawrence Zelenak and Professor Deborah Geier have addressed the issue of what purposes should properly be considered when interpreting tax legislation in general.
149. See Geier, supra note 131, at 493; Lawrence Zelenak, Thinking About Nonliteral Interpretations of the Internal Revenue Code, 64 N.C. L. REV. 623, 637 (1986). The views of these authors also translate well to the area of tax shelters.
150. Geier, supra note 131, at 497.
151. Id.
152. See, e.g., WILLIAM A. KLEIN ET AL., FEDERAL INCOME TAXATION 236 (12th ed. 2000).
153. See Geier, supra note 131, at 497 ("One component of statutory purpose in the income tax is the fundamental structure underlying the income tax. By 'structure,' I mean the theoretical construct that overarches the sum total of the entire Internal Revenue Code and is intended to be captured by it.");
154. see also Zelenak, supra note 133, at 637. Zelenak advocates a "contextual, or whole statute, approach to the discovery of statutory meaning."
155. Id.
156. He continues, "It is generally accepted that particular words in a statute should not be read in isolation; rather, they must be understood in the context of the statute in which they appear."
157. Id.
158. See HENRY M. HART, JR. & ALBERT M. SACKS, THE LEGAL PROCESS: BASIC PROBLEMS IN THE MAKING AND APPLICATION OF LAW 1194-95 (1994). Hart and Sacks oppose this concept entirely and feel that even though the ultimate goal is to interpret statutes in accord with their original purpose, one cannot give meaning to the statute that the words will not bear (even if clearly discordant with that determined purpose).
159. Id.
160. Deborah A. Geier, Commentary: Textualism and Tax Cases, 66 TEMP. L. REV. 445, 474 (1993) (arguing that in tax law even the most "ordinary terms-probably the best that Congress could have chosen-must sometimes assume a counterintuitive meaning in order to protect the structural integrity of the income tax").
161. I.R.C. § 1012 (2006). Professor Geier also discusses the nonliteral interpretation needed to make sense of the term "cost," albeit using different fact patterns. Geier, supra note 139, at 474-75.
162. Treas. Reg. § 1.1012-l(a) (1960).
163. BORIS I. BITTKER & LAWRENCE LOKKEN, FEDERAL TAXATION OF INCOME, ESTATE & GIFTS ¶ 41.2 (3d ed. 2000) ("The term 'cost,' which first entered the tax law in 1918, has never been defined by Congress, and ambiguities in its meaning have been resolved, if at all, only by administrative and judicial rulings." (citations omitted)).
164. E.g., Richard A. Posner, Economics, Politics, and the Reading of Statutes and the Constitution, 49 U. CHI. L. REV. 263,272-74 (1982).
165. Id. at 274.
166. Id.
167. See Zelenak, supra note 133, at 657-58.
168. Id. at 644.
169. -350 U.S. 46 (1955). Professor Zelenak uses this example to illustrate his point. Zelenak, supra note 133, at 644-47.
170. Corn Prods., 350 U.S. at 51.
171. Id. at 51-52 (referring to I.R.C §117 (2006)).
172. Id. at 47.
173. Id. at 52-53.
174. For example, Zelenak notes that with this broad principle of capital asset, it is unclear when an asset is part of the ordinary course of business or not. Thus, taxpayers will roll the dice and give themselves capital gain treatment for gains and ordinary income treatment for losses.
175. See Zelenak, supra note 133, at 645-46.
176. Id.
177. Id.
178. Id.
179. See Treas. Reg. § 1.165-7(b)(3)(i) (1977).
180. See id. §1.165-7(b)(l)(i).
181. See Michael A. Livingston, Congress, the Courts, and the Code: Legislative History and the Interpretation of Tax Statutes, 69 TEX. L. REV. 819, 833 (1991) (suggesting that tax codification is different from the codification process in other areas).
182. Most of my information regarding the legislative process has been garnered from Professor Livingston's excellent article.
183. See id. Those interested in the process are encouraged to read his article in its entirety.
184. Id. at 833.
185. Id.at833n.58.
186. Id. at 833 (emphasis added).
187. Professor Livingston suggests that this process differs from the process conducted by other committees.
188. See id.
189. Even if this is not the case, it does not undermine the general point that legislative history ought to be given more weight, but it may suggest that the argument can be extended to other fields. This discussion is clearly beyond the scope of this Article, however.
190. Id. at 834.
191. Id. at 835.
192. Id.
193. Id. at 834 n.65.
194. Id. at 835.
195. Id.
196. Id. at 835-36.
197. Id.
198. Id. at 836.
199. Id. at 835-36.
200. Id.
201. Id.
202. See supra Part III.A.2.
203. See, e.g., Richard A. Posner, Statutory Interpretation-in the Classroom and in the Courtroom, 50 U. CHI. L. REV. 800, 818 (1983).
204. See Livingston, supra note 159, at 878.
205. See generally id. (discussing reasons for limiting the use of committee reports in determining legislative intent).
206. -436 F.3d 431 (4th Cir. 2006).
207. -454 F.3d 1340 (Fed. Cir. 2006).
208. See, e.g., Reed Dickerson, Statutory Interpretation: A Peek into the Mind and Will of a Legislature, 50 IND. L.J. 206, 223-24 (1975);
209. Posner, supra note 143, at 274-75 (advancing a general argument against this traditional objection, and claiming that the terms of the deal are probably captured accurately in the legislative history, thus warranting that it be given at least some weight).
210. See Livingston, supra note 159, at 836.
211. See Id.
212. I do not mean to imply that there is no existing debate as to whether a purpose-based or intent-based approach is superior. Purposivism, however, is a well-accepted approach, and some believe that it might be the most frequently used approach. For a summary of the debate regarding the two approaches, see William N. Eskridge, Jr. & Philip P. Frickey, Statutory Interpretation as Practical Reasoning, 42 STAN. L. REV. 321 (1990).
213. It is an understatement to say that this description simplifies the two approaches. For a discussion of the different versions of intentionalism, see id. at 326-32.
214. For one of the most famous criticisms of intentionalist approaches, see Max Radin, Statutory Interpretation, 43 HARV. L. REV. 863, 867-68 (1930).
215. Alan Gunn, The Use and Misuse of Antiabuse Rules: Lessons from the Partnership Antiabuse Regulations, 54 SMU L. REV. 159, 160 (2001). My reference to this test is meant to illustrate how an intent-based approach to tax shelters might look, not to criticize Professor Gunn, who recognizes in footnotes that he is being somewhat cavalier with the usage of intent and purpose. It should be noted, however, that Gunn's test seems to track (perhaps unintentionally) Judge Posner's approach of socalled imaginative reconstruction. Posner argues that "[t]he judge should try to think his way as best he can into the minds of the enacting legislators and imagine how they would have wanted the statute applied to the case at bar." Posner, supra note 178, at 817.
216. Radin, supra note 188, at 332-39.
217. Id. at 333.
218. There are, of course, many different versions of purpose-based approaches (as there are of intent-based approaches) and it would certainly go beyond the scope of this Article (and this author's expertise) to scratch the surface. For some of the variations, see, for example, HART & SACKS, supra note 138, at 102-13; Max Radin, A Short Way with Statutes, 56 HARV. L. REV. 388, 389 (1942). Admittedly, the authors are walking a fine semantical line in describing these two approaches. "Purpose" has quite appropriately been referred to as "a vague umbrella term for several distinct notions." Geier, supra note 131, at 496.
219. See, e.g., I.R.C. §§ 1012,1016 (2006).
220. See, e.g., ;d.§ 1001.
221. See, e.g., id. §162(a).
222. See supra Part III.A.2.
223. I.R.C. § 451(a) (2006) (emphasis added).
224. B. DOUGLAS BERNHEIM & JOHN KARL SCHOLZ, JOINT ECON. COMM., 106TH CONG., ENCOURAGING PERSONAL SAVING AND INVESTMENT: CHANGING THE TAX TREATMENT OF UNREALIZED CAPITAL GAINS 2 (2000), http://www.house.gov/jec/tax/mutual/mutual.pdf.
225. Treas. Reg. § 1.451-2(a) (1979).
226. KLEIN ET AL., supra note 136, at 325 (citing Treas. Reg. § 1.451-2(a)).
227. -277 F.3d 778 (5th Cir. 2001).
228. See infra Part IV.C.
229. See, e.g., I.R.C. § 45 (2006) (giveaway to encourage behavior); Victims of Terrorism Tax Relief Act, Pub. L. No. 107-134,115 Stat. 2427 (2002) (codified in scattered sections of 26 U.S.C.) (giveaway to correct perceived unfairness).
230. I.R.C. § 45.
231. Id. § 42.
232. H.R. REP. NO. 103-111, at 843 (1993), as reprinted in 1993 U.S.S.C.A.N. 378, 612.
233. See supra Part III.A.l.
234. See supra text accompanying note 31.
235. I.R.C. § 168 (2006).
236. STAFF OF THE JOINT COMM. ON TAXATION, 97TH CONG., GENERAL EXPLANATION OF THE ECONOMIC RECOVERY TAX ACT OF 1981 75 (Comm. Print 1981) [hereinafter JOINT COMM. ON TAXATION].
237. I.R.C. § 168.
238. See JOINT COMM. ON TAXATION, supra note 210.
239. Assume T borrowed the $100 million on a nonrecourse basis and purchased property with those funds. Assume the interest rate on the loan was 8%. Because the money is borrowed on a nonrecourse basis, T will never be personally liable to repay any amount that exceeds the value of the property. Assume again that T earns $10 million in rental income from the property, the property actually declined in value by $2 million, and T is entitled to take an accelerated depreciation deduction of $5 million. Had T not used borrowed funds, she would again have taxable income of $5 million ($10 million rental income - $5 million depreciation), even though her actual income is $8 million ($10 million rental income - $2 million actual depreciation). These tax savings simply reflect the benefit of an ACRS. Because T used borrowed funds, however, T will pay $8 million in interest, resulting in $0 of actual income ($10 million rental income - $2 million actual depreciation - $8 million interest), and will have a $3 million tax loss ($10 million - $5 million accelerated depreciation deduction - $8 million). T will use this $3 million loss to offset other, completely unrelated income.
240. See Zelenak, supra note 17, at 509. The case being described is a passive real estate shelter, a popular transaction in the 1970s and 1980s.
241. See Johnson Letter, supra note 32 (stating that most of these cases can be "explained economically by the fact that the purchaser is paying for the property with play money, that is, nonrecourse liability to his seller that he cannot be expected to pay");
242. see also Johnson, Passive Activity Regulations, supra note 32. Johnson suggests that many of these loans were in fact abusive in and of themselves: "The most abusive shelters before 1986 took advantage of the law's presumption that an I.O.U. was as good as payment in gold. Confetti money and play money debts allowed taxpayers to get deductions from debts that represented trivial economic detriments, in present value terms."
243. Id.
244. Zelenak, supra note 17, at 512 ("In each case, $100 [million] has been invested in an ACRS asset, and a system designed to encourage such investment should be as ready to grant a tax preference in one case as in the other.").
245. In fact, I believe a strong argument could be made that the taxpayer was not entitled tó the interest deduction because her deduction falls outside the purposes of the provisions granting taxpayers interest deductions on indebtedness. The argument is that this type of nonrecourse indebtedness was not the type contemplated by the statute.
246. Victims of Terrorism Tax Relief Act of 2001, Pub. L. No. 107-134,115 Stat. 2427 (2002).
247. See I.R.C. § 1301 (2006).
248. See, e.g., id. § 32 (allowing an earned income tax credit per taxable year).
249. See H.R. REP. NO. 106-467, pt. 1, at 90 (1999).
250. See I.R.C. § 1301.
251. H.R. REP. No. 106-467, pt. 1, at 90.
252. See, e.g., Steven A. Dean & Lawrence M. Solan, Tax Shelters and the Code: Navigating Between Text and Intent, 26 VA. TAX REV. 879, 880-81 (2007).
253. Importantly, § 1301 has detailed definitions that make this clarification possible, including definitions of who is considered a "farmer" and what types of income is considered derived from a "farming business." See I.R.C. § 1301; Treas. Reg. § 1.1301-1 (as amended in 2008).
254. See I.R.C. §§ 243-246 (2006).
255. BORIS I. BITTKER & JAMES S. EUSTICE, FEDERAL INCOME TAXATION OF CORPORATIONS AND SHAREHOLDERS 5-48 (7th ed. 2006).
256. I.R.C. § 61(a)(7) (2006).
257. Rosanne Altshuler et al., Understanding U.S. Corporate Tax Losses 9 (Nat'l Bureau of Econ. Research, Working Paper No. 14405, 2008), available at http://EconPapers.repec.Org/RePEc:nbr: nberwo:14405.
258. H.R. REP. NO. 98-432, pt. 2, at 1180 (1984), as reprinted in 1984 U.S.S.C.A.N. 697,852.
259. Cf. H.R. REP. NO. 106-467, pt. 1, at 90 (discussing unusual hardships on farmers that led to § 1301).
260. -436 F.3d 431, 433 (4th Cir. 2006).
261. -454 F.3d 1340, 1345 (Fed. Cir. 2006).
262. Joseph T. Sneed, The Criteria of Federal Income Tax Policy, 17 STAN. L. REV. 567, 599 (1965).
263. William D. Andrews, A Consumption-Type or Cash Flow Personal Income Tax, 87 HARV. L. REV. 1113, 1148 (1974).
264. See id. (describing various degrees of compromise that are sometimes necessary to achieve practical administration).
265. See id.
266. See, e.g., KLEIN ET AL., supra note 136, at 178.
267. See supra note 198 and accompanying text.
268. KLEIN ET AL., supra note 136, at 182.
269. This is not to imply that there are not other reasons behind the rule that loan proceeds do not have to be included. For example, taxing the receipt of loan proceeds "would impose a heavy front-end burden on debt financing of investment projects."
270. Id.
271. Id.
272. Id.
273. I.R.C. § 61(a)(12) (2006).
274. KLEIN ET AL., supra note 136, at 236.
275. I.R.C. § 1091 (2006).
276. Id. For an excellent discussion of these conditions see, for example, BITTKER & LOKKEN, supra note 141, § 44.8.
277. I.R.C. § 1091(a).
278. See, e.g., Treas. Reg. § 1.246-5(c) (1995) (outlining how to determine if baskets of stocks are substantially similar);
279. see BITTKER & LOKKEN, supra note 141, ¶ 44.8.3.
280. Treas. Reg. § 1.246-5(c).
281. See supra note 124. I think it fair to assume, however, that these arguments are drastically overstated. There is more than ample evidence that interpreting statutory purpose is possible in light of the many cases in which it is successfully done. Further, there is no reason to believe that tax law is any different from other areas of law in terms of the ascertainability of purpose. The reality is that congressional intent can often be determined, and tax practitioners, in no small part, make their livings doing so.
282. Schier, supra note 5, at 333. Inquiries into legislative intent often provide clear-cut answers. After all, the Code and Regulations do not exist in a vacuum. Instead, they "have an overall structure" that aids considerably in ascertaining their underlying intent.
283. Id.
284. Furthermore, some scholars suggest that taxpayers' claims that they have a right to certainty are overstated, if not entirely unfounded. Moreover, it is not clear whether a taxpayer right to certainty even exists in tax law. Although Learned Hand stated in Gregory v. Helvering that there is no patriotic duty to minimize taxes, such a statement is a far cry from establishing a right to rely on the tax law. No authority supports the proposition that the right exists.
285. Weisbach, supra note 14, at 221 ("[N]o moral or philosophical basis for the right to tax plan has yet been articulated. There is no constitu-tional right. There is not even an explicit statutory right. There is, in short, no basis for a right to tax plan other than statements made up out of thin air by a few judges using questionable theories of statutory interpretation.").
286. Admittedly, there are no studies to date that quantify the level of uncertainty produced by the traditional anti-abuse doctrines. See Weisbach, supra note 14, at 247-51.
287. See, e.g., Zelenak, supra note 133, at 664.
288. See also Hariton, supra note 5, at 585. Hariton summarizes this situation nicely: [I]f a taxpayer applies rules that were designed to function in a specific context (e.g., the passage of congressionally-sanctioned investment-related tax benefits from one taxpayer to another) to an entirely different context (e.g., the creation of unintended tax benefits), the taxpayer is not necessarily entitled by law to the results that the rules appear to dictate. Regulatory and judicial authorities should respond to such a taxpayer not by bending or negating the rules, but rather by explaining that the rules have contextual limitations. After all, any taxpayer sophisticated enough to enter into a tax-motivated financial transaction does so with the guidance and advice of a tax lawyer, and a tax lawyer can be expected to have not merely the capacity to apply technical rules literally but also an understanding of the scope, purpose, and function of the rules and therefore the limits of their application.
289. Id.
290. Weisbach, supra note 14, at 249.
291. Id. at 247-51.
292. See, e.g., Eustice, supra note 6, at 147. [T]he desire of tax practitioners for predictability, while unsurprising and even laudable, may eventually have to yield to a higher necessity-that these highly abusive transactions somehow have to be stopped, or at least seriously impeded, and if menacing ambiguity is the only way to do it, then do it we must. Such an eventual outcome, it should be noted, would be a self-inflicted wound.
293. Id.
294. For completion, I should note that the so-called rule of lenity is also founded upon certainty concerns. This refers to the statutory principle that criminal statutes should be strictly construed in favor of the defendant and against the government or parties seeking to enforce the statutory penalties. NORMAN J. SINGER, STATUTES AND STATUTORY CONSTRUCTION § 59:3 (6th ed. 2001).
295. My Article does not consider the rule of lenity as it is to be applied in the criminal context. I assume it to be irrelevant to the civil questions presented by tax shelter cases-namely the taxpayer's liability-and presently take no position on the criminal elements, such as penalties, that might come with flagrant abuses. For a discussion as to why this assumption might prove questionable, see generally Kristin E. Hickman, Of Lenity, Chevron, and KPMG, 26 VA. TAX REV. 905 (2007). Professor Hickman describes the courts' recent tendency to use the rule of lenity in civil cases and suggests that such application is entirely inappropriate to tax shelter cases.
296. Indeed, this proposition has historical support as well as support in the general literature regarding statutory interpretation. In the Board of Tax Appeals' opinion in Gregory v. Commissioner, the Board held for Mrs. Gregory because she had literally complied with the detailed reorganization provisions. 27 B.T.A. 223, 225 (1932). "A statute so meticulously drafted," the Board stated, "must be interpreted as a literal expression of the taxing policy, and leaves only the small interstices for judicial consideration."
297. Id.
298. Learned Hand, although reversing the decision, still agreed with the general notion "that as the articulation of a statute increases, the room for interpretation must contract." Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), aff'd, 293 U.S. 465 (1935).
299. Eustice, supra note 6, at 158.
300. Zelenak, supra note 133, at 660.
301. Eustice, supra note 6, at 158.
302. For an alternative viewpoint, see Ellen P. Aprill, Tax Shelters, Tax Law, and Morality; Codifying Judicial Doctrines, 54 SMU L. REV. 9 (2001). Professor Aprill applies the general theories of statutory interpretation espoused in Professor Frederick Shauer's book Playing by the Rules to the tax shelter context.
303. Id. at 14-22.
304. Professor Shauer posits through "presumptive positivism" that literal application of the rules should serve as a starting, or default, point. FREDERICK SCHAUER, PLAYING BY THE RULES 12 (Clarendon Press 1991). Purposive application should be used when it is prudent to do so, a determination that can be made by considering the goals of certainty, reliance and predictability. Id. Aprill argues that Shauer's theory supports the general principles of statutory interpretation set forth in Gregory v. Helvering because as the level of detail present in the statute increases, the room for interpretation decreases. Aprill, supra, at 16.
305. -436 F.3d 431 (4th Cir. 2006).
306. -454 F.3d 1340 (Fed. Cir. 2006).
307. See I.R.C. § 351 (2006).
308. Coltec, 454 F.3d at 1343;
309. Black & Decker, 436 F.3d at 433.
310. Coltec, 454 F.3d at 1343;
311. Black & Decker, 436 F.3d at 432.
312. Coltec, 454 F.3d at 1344;
313. Black & Decker, 436 F.3d at 432.
314. Coltec, 454 F.3d at 1345;
315. Black & Decker, 436 F.3d at 433.
316. Coltec, 454 F.3d at 1343;
317. Black & Decker, 436 F.3d at 433.
318. Black & Decker, 436 F.3d at 433.
319. Id.
320. See id. at 434-35.
321. See id. at 435-36.
322. I.R.C. § 358(a) (2006).
323. See Black & Decker, 436 F.3d at 435.
324. I.R.C. § 358(d)(1).
325. Id. § 358(d)(2).
326. Id. § 357(c)(3)(A)(i).
327. Coltec Indus., Inc. v. United States, 454 F.3d. 1340, 1347 (Fed. Cir. 2006);
328. Black & Decker, 436 F.3d at 437-38.
329. I.R.C. § 358.
330. Id. § 357(a).
331. Id. § 357(c).
332. Id. § 357(c)(2)-(3).
333. -454F.3d at l347.
334. -436 F.3d 431, 437-42 (4th Cir. 2006). Black & Decker was on appeal from the granting of a motion for summary judgment. The Fourth Circuit held that questions of fact existed regarding whether B&D had a reasonable expectation of a pretax profit, and the case was eventually settled by the 1RS.
335. See 1RS Accepts Settlement Offer on Contingent Liability Tax Shelter, http://www.irs.gov/ newsroom/article/0id=132350,00.html (last visited Mar. 3, 2009). For this reason, Coltec, which actually provides a final decision, is the case upon which this analysis focuses.
336. -454 F.3d at 1359-60.
337. Id. at 1356.
338. See supra Part II.C.2.a.i.
339. -454 F.3d at 1358.
340. Id.
341. Id.
342. Id.
343. I.R.C. § 358 (2006).
344. Id. This type of deviation was discussed in Part III.B.2.b.ii.
345. Black & Decker Corp. v. United States, 436 F.3d 431,436 (4th Cir. 2006).
346. See S. REP. No. 95-1263, at 183-84 (1978), as reprinted in 1978 U.S.C.C. A.N. 6761, 6947.
347. Id. (emphasis added).
348. S. REP. NO. 96-498, at 62 (1979), as reprinted in 1980 U.S.C.C.A.N. 316, 372 (emphasis added).
349. See supra Part IV.A.l.
350. In Black & Decker, the court found that even on summary judgment, the taxpayer qualified for the deductible liability exception under the plain meaning of the statute. 436 F.3d at 437-38.
351. Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1347 (Fed. Cir. 2006);
352. Black & Decker, 436 F.3d at 436-37.
353. Coltec, 454 F.3d at 1349.
354. It is true that the central purpose of § 357(c)(3) was to protect taxpayers who transferred the assets of their business along with liabilities of their business (such as accounts payable) from having to recognize gain if the liabilities exceeded the assets. The theory was that the transferor corporation should not have to recognize gain when it had lost the tax deduction that would flow from payment of the liabilities.
355. Id. (citing S. REP. NO. 95-1263, at 184-85 (1978), as reprinted in 1978 U.S.C.C.A.N. 6761, 6947-48);
356. see also Black & Decker, 436 F.3d at 437 ("The prototypical transaction Congress had in mind in drafting § 357(c)(3) may well have been one in which a corporation exchanged liabilities as part of a transfer of an entire trade or business to a controlled subsidiary").
357. See Coltec, 454 F.3d at 1349;
358. Black & Decker, 436 F.3d at 437.
359. I.R.C. § 357(c)(3) (2006).
360. For another analysis of these shelters, see Karen C. Burke, Deconstructing Black & Decker's Contingent Liability Shelter: A Statutory Analysis, 108 TAX NOTES 211 (2005).
361. See supra Part III (discussing Corn Products).
362. See infra Part IV.B.3.
363. See Chirelstein & Zelenak, supra note 22.
364. Professors Chirelstein and Zelenak make this very argument, stating:
365. As a matter of tax logic, the basis of stock received in a § 351 incorporation cannot exceed the value of that stock-$1 million in Black & Decker- unless the value of the property transferred had declined in the hands of the transferor prior to the transfer. In the latter circumstance, the loss in value relative to the transferor's basis is properly recognized on a sale of the stock just as it would be on a sale of the property itself.
366. Id. at 1964.
367. See Lee A. Sheppard, A More Intelligent Economic Substance Doctrine, 112 TAX NOTES 325 (2006) (arguing that B&D and Coltec created an end run around the most basic principles of recognition and accounting principles, which seek to match income with associated deductions). "The tax law," she states, "is dead set against premature recognition of expense and loss, as indicated by section 461(h) and the all-events requirement.
368. " Id. Allowing the taxpayers to utilize the deductible liability exception permitted a "do-it-yourself reserve method," which created a mismatch of income and deductions, a principle at the heart of tax accounting rules.
369. Id. Sheppard refers to the schemes of taxpayers like B&D and Coltec as self help reserve accounts that circumvent even the most basic principles of accounting rules and gain and loss recognition.
370. Id.
371. I.R.C. § 461(h) (2006). This requirement is known as the "all events requirement."
372. David B. McGinty, Economic Substance, Business Purpose, and Tax Avoidance in Section 351 Contingent Liability Transactions After Black & Decker, Coltec, and Hercules, 36 CUMB. L. REV. 1,1 (2005-2006).
373. In Holdcroft Transportation Co. v. Commissioner, the court held that the transferee (Newco) was not entitled to deduct transferred liabilities since the liabilities arose out of events occurring before the transfer of the underlying business. 153 F.2d 323, 325 (8th Cir. 1946). Yet there is some doubt as to whether the transferee was entitled to the deductions after the transfer (undertaken for valid business reasons) of all the assets and associated liabilities. Rev. RuI. 95-74, 1995-2 C.B. 36. For an excellent discussion of this issue, as well as the Black & Decker tax shelter in general, see Ethan Yale, Reexamining Black & Decker's Contingent Liability Tax Shelter, 108 TAX NOTES 223 (2005).
374. See Yale, supra note 312, at 223-28.
375. See Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1344-45 (Fed. Cir. 2006);
376. Black & Decker Corp. v. United States, 436 F.3d 431, 433-34 (4th Cir. 2006).
377. See Geier, supra note 131, at 497.
378. See, e.g., id.
379. See Coltec, 454 F.3d at 1349;
380. Black & Decker, 436 F.3d at 438.
381. These types of provisions were discussed in Part III.B.2.b.
382. Hariton, supra note 1, at 262.
383. -157 F.3d 231 (3d Cir. 1998).
384. I.R.C. § 453(b) (2006).
385. See ACM, 157 F.3d at 244.
386. I.R.C. § 453(c).
387. See Henry Ordower, Revisiting Realization: Accretion Taxation, the Constitution, Macomber, and Mark to Market, 13 VA. TAX REV. 1,56 (1993).
388. -157 F.3d at 234.
389. I.R.C. § 453(j)(2); S. REP. NO. 96-1000, at 5-6 (1980), as reprinted in 1980 U.S.C.C.A.N. 4696, 4699-4701.
390. Temp. Treas. Reg. § 15a.453-l(c)(3)(i) (as amended in 1994).
391. Id.
392. S. REP. NO. 96-1000, at 5-6.
393. -46 Fed. Reg. 10,709, 10,714, 10,716 (Feb. 4, 1981);
394. see also Hariton, supra note 1, at 262-63.
395. The Treasury responded by introducing a provision intended to limit abuse. Temp. Treas. Reg. § 15a.453-l(c).
396. See id.
397. Id. § 15a.453-l(c)(7)(v).
398. Hariton suggests that this denial is a "moment of stinginess." Hariton, supra note 1, at 26263. This proposition seems dubious.
399. Temp. Treas. Reg. § 15a.453-l(c)(7).
400. -157 F.3d 231,243-44 (3d Cir. 1998).
401. Id. at 233.
402. Id. at 239.
403. Id. at 240.
404. Id. at 246n.28.
405. For instance, because the foreign bank had an 82.6% interest in the partnership, the bank was allocated that percentage of the gain.
406. ACM reported $100.7 million of gain in the first year. The foreign bank was thus allocated 82.6% of that gain, which totaled $91.5 million. 157 F.3d at 239.
407. Id. at 242.
408. Id. at 245.
409. Id.at 252n.40.
410. Id. at 244, 246 n.29.
411. Id. at 245-63.
412. Id. at 249-52.
413. Id. at 250.
414. Id.
415. Id. The court characterized the transaction as follows:
416. Viewed according to their objective economic effects rather than their form, ACM's transactions involved only a fleeting and economically inconsequential investment in and offsetting divestment from the Citicorp notes. In the course of this brief interim investment, ACM passed $175 million of its available cash through the Citicorp notes before converting 80% of them, or $140 million, back into cash while using the remaining 20%, or $35 million, to acquire an amount of LIBOR notes that was identical, apart from transaction costs, to the amount of such notes that ACM could have acquired by investing its $35 million in cash directly into such assets.
417. Id.
418. Id. at 254-57.
419. Id. at 257.
420. Id. at 260-62. To be precise, ACM was entitled to take the losses that it actually sustained on the sale (as opposed to the artificial losses generated through the literal application of the installment sale regulations), but these real losses were slight.
421. It should be noted that the court in ACM did touch upon issues of statutory and regulatory intent but only in an extremely brief and conclusory fashion. In a footnote, the court stated that although the installment sale regulations contemplated some distortion of income (as discussed above), they did not contemplate the recognition of non-bona fide losses. The court engaged in no further discussion and cited no further authority.
422. Id. at 252 n.41. The court also dismissed the taxpayer's argument that applying the economic substance doctrine was inappropriate because §§1001 and 453 did not contemplate such a requirement.
423. Id. at 253. The court pointed out that the court in Goldstein v. Commissioner had applied the doctrine even though the provision at issue there, §163(a), did not specifically require it. The court in ACM did not discuss how the Goldstein court explicitly found that § 163(a) required it, nor did the court discuss why §§ 1001 and 453 incorporated an economic substance requirement.
424. Id. These cursory comments regarding statutory intent highlight the need for a well-developed test that will lead to an adequate analysis.
425. See supra text accompanying note 324.
426. See supra text accompanying notes 326-30.
427. See Hariton, supra note 1, at 262.
428. See Temp. Treas. Reg. § 15a.453-l(c)(3)(i) (as amended in 1994).
429. Id. § 15a.453-l(c)(7)(i).
430. See supra text accompanying notes 239-42.
431. See BITTKER & LOKKEN, supra note 142, ¶ 44.8.1.
432. -157 F.3d 231, 245 (3d Cir. 1998).
433. See supra Part IV.B.l.
434. See supra note 330 and accompanying text.
435. For more specifics on this earlier argument, see supra Part III.B.2.b.i.
436. See Hariton, supra note 1, at 262.
437. See supra Part III.B.2.b.i.
438. Temp. Treas. Reg. § 15a.453-l(c)(4) (as amended in 1994).
439. -277 F.3d 778, 779 (5th Cir. 2001), rev'g 113 T.C. 214 (1999).
440. Id.
441. Compaq, 113 T.C. at 217. This term means that the buyer has purchased a security with a declared dividend that has not yet been paid.
442. Id. This term means that the share has been sold but that the seller, as opposed to the buyer, is entitled to the dividend.
443. Id. Because of different settlement rules operating with respect to purchase and resale trades, the taxpayer was considered the record holder of the ADRs for purposes of receiving the dividend, even though it was no longer the owner of the stock on the distribution date.
444. Id. at 219.
445. Id.
446. Id. at 221.
447. Id. at 223.
448. Id. at 225.
449. Id. at 222.
450. Id.
451. George K. Yin, The Problem of Corporate Tax Shelters: Uncertain Dimensions, Unwise Approaches, 55 TAX L. REV. 405, 407 (2002) ("These transactions were attractive to the taxpayers because the price of the stock interests did not fully capitalize the value to them of the foreign tax credits. Rather, the price was determined by owners who could not use such credits."). This situation is not especially unique.
452. See Daniel N. Shaviro & David A. Weisbach, The Fifth Circuit Gets It Wrong in Compaq v. Commissioner, 94 TAX NOTES 511, 514 (2002) ("All that this requires is that either taxexempts or locals (who have no U.S. or other overseas tax liability to offset) be the key participants in a given market. Needless to say, there are a lot more worldwide investment dollars held by persons in these categories than by excess-limit American multinationals.").
453. Yin, supra note 382, at 407.
454. Id.
455. Id.
456. Id.
457. Id. at 407.
458. See the court's application of the profit test in Compaq. 277 F.3d 778, 781-88 (5th Cir. 2001).
459. See, e.g., Hariton, supra note 54, at 502-09;
460. Kane, supra note 69, at 1215-18;
461. Shaviro & Weisbach, supra note 382, at 515-16.
462. To be precise, the Fifth Circuit held that the entire dividend amount should be used in the calculation of pre-tax profit because the payment of withholding taxes constituted income from the discharge of a liability under Old Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929). The effect is the same, however, if the withholding taxes were not treated as expenses because under either scenario, the gross dividend amount, as opposed to the net dividend amount, is used, which yields a pretax profit. Compaq, 277 F.3d at 783.
463. Shaviro & Weisbach, supra note 382, at 515-16.
464. Michael S. Knoll, Compaq Redux: Implicit Taxes and the Question of Pre-Tax Profit, 28 VA. TAX REV. 821, 856-57 (2007).
465. S. REP. No. 106-120, at 135 (1999).
466. See Yin, supra note 382, at 407-08.
467. See, e.g., Shaviro & Weisbach, supra note 382;
468. Yin, supra note 382, at 407-08.
469. See, e.g., Shaviro & Weisbach, supra note 382, at 515;
470. Yin, supra note 382, at 415.
471. See Shaviro & Weisbach, supra note 382, at 516.
472. See id.
473. S. REP. NO. 106-120, at 135 (1999).
474. H.R. REP. NO. 108-548, pt. 1, at 190 (2004).
475. Treas. Reg. § 1.901-2(f)(l) (as amended in 2008).
476. See id.
477. Yaron Z. Reich, The Allocation of Foreign Taxes Among Related Persons, 107 TAX NOTES 1013, 1016 (2005).
478. -302 U.S. 573 (1938).
479. Id. at 581.
480. Reich, supra note 403.
481. Id.
482. Id. at 1021.
483. Id. at 1017.
484. I.R.C. § 901(i) (2008).
485. Reich, supra note 403, at 1021.
486. -998 F.2d 513 (7th Cir. 1993).
487. Id. at 518.
488. Id. at 519.
489. While it might seem odd that a taxpayer argued to include more income, it is due to the simple fact that each dollar of income included is taxed at a 35% rate (so that is "costs" the taxpayer thirty-five cents) while each dollar of corresponding credit creates a dollar-for-dollar decrease in taxes (making it worth the entire dollar to the taxpayer). In fact, this is seen in many cases. See, e.g., Riggs Nat'l Corp. v. Comm'r, 295 F.3d 16 (D.C. Cir. 2002). In Riggs, the U.S. lender entered into a gross-up loan with a Brazilian bank. Under Brazilian law, banks were normally exempt from the obligation to pay the withholding tax. In order to ensure the desired tax treatment, however, the U.S. lender received a formal ruling from the Brazilian government that it would make an exception in this case and require the bank in question to remit payments to them. After much controversy, the court finally felt obliged to allow the credit under the state of action doctrine. Because the Brazilian government had issued a formal ruling, the court believed it would be against general principles of comity to disallow the credits.
490. Cont'l Ill. Corp., 998 F.2d at 519-20.
491. In Continental, Judge Posner specifically noted: "It is by no means clear that the Brazilian tax rebate subsidized, in the sense of conferring an actual benefit upon, American net lenders like Continental. Indeed, insofar as the interest rate had been fixed in the loan contract before the rebate was instituted, only the borrowers benefited."
492. Id. at 519 (citations omitted).
493. Joseph Isenbergh, The Foreign Tax Credit: Royalties, Subsidies, and Creditable Taxes, 39 TAX L. REV. 227, 245 (1984).
494. Id. at 247.
495. Id. at 245-246.
496. Cont'l Ill. Corp., 998 F.2d at 518.
497. In discussing the subsidy rule, Judge Posner wrote: "The IRS can hardly be faulted for having chosen a bright-line approach in preference to interminable investigation of the mysteries of public finance." Id. at 520.
498. See, e.g., Shaviro & Weisbach, supra note 382, at 516.
499. Reich, supra note 403, at 1021.
500. See Shaviro & Weisbach, supra note 382, at 517.
501. Isenbergh, supra note 418, at 247.
502. -998 F.2d 513, 516-17 (7th Cir. 1993).
503. Professors Shaviro and Weisbach seem to find the existence of a "bad" motive important. For instance, they present a cross-border transaction similar to Compaq that does not have a pre-tax profit, but that is profitable after one accounts for foreign tax credits and interest deductions. They argue that this transaction is "not a sham, despite the lack of pre-tax profit as computed net of foreign tax." The difference, they state, is that "[t]he taxpayer actually took an economic position in a deal that was not pre-wired or transitory like the supposed investment in Compaq." Shaviro & Weisbach, supra note 382, at 515.
504. Id.
505. William A. Klein & Kirk J. Stark, Compaq v. Commissioner-Where Is the Tax Arbitrage?, 94 TAX NOTES 1335, 1340 (2002).
506. Id. at 1339.
507. In Compaq, the parties stipulated that the taxpayers were legal owners of the stock despite the extremely transitory nature of that ownership. 277 F.3d 778, 781 (5th Cir. 2001). In the absence of this stipulation, the transaction might have been struck down by finding that Compaq never truly owned the stock (i.e., that there was never a true sale) and therefore was never entitled to the dividend or the accompanying tax benefits. I do not address the merits of this argument any further. In response to Compaq, § 901(k) was enacted and requires that stock be held for a minimum holding period before the owner will be eligible for the foreign tax credit. Like motive, if this is to be the sole reason for denying Compaq the claimed credits, it needs to be addressed directly and heartily.
508. Robert Peroni, Professor of Law, Univ. of Tex. School of Law, Commentary at the University of Minnesota Law School Tax Policy Conference: The Future of Tax Shelters (Oct. 27, 2006) (commenting upon the various ways in which commentators had fashioned the profit test to strike down Compaq). Noting them all to be clever, he went on to state that the tests failed to reach this real problem.
509. Id.
510. See generally Michael J. Graetz, Lecture, Taxing International Income: Inadequate Principles, Outdated Concepts and Unsatisfactory Policies, 54 TAX L. REV. 261, 261 (2001) (pointing out that the dollar-for-dollar credit, enacted in the 1900s to facilitate investment abroad, is remarkably outdated and in need of drastic revision). In fact, Graetz argues, due to the technical taxpayer rule, we have witnessed the odd situation of taxpayers fighting to claim more interest income, so that they can claim a foreign tax credit.
511. Id. at 311.
512. These odd situations make sense because the credit is dollar-for-dollar even though each additional dollar of income only costs thirty-five cents. See, e.g., Cont'l Ill. Corp. v. Comm'r, 998 F.2d. 513 (7th Cir. 1993).
513. Professors Klein and Stark state that the "principal function" of the Compaq transaction "should be to draw our attention to the