It is surprising how often international tax planning lawyers ignore the importance of business purpose doctrine to international tax planning. It seems that a lot of U.S. accountants and, to a smaller degree, attorneys have been limited to the parochial view of the application of the doctrine within the borders of the United States, whereas they seem to lose caution in the context of international business transactions. In this article, I urge the readers to consider the very important role of the business purpose doctrine to international tax planning.
International Tax Planning Lawyers: Business Purpose Doctrine; Combination with the Economic Substance Doctrine
This short writing does not pretend to do justice to the complex analysis of the history, development and interpretation of the business purpose doctrine. I will merely attempt to broadly sketch some important points and the general meaning of the doctrine to provide the necessary background to the discussion below.
The Business Purpose Doctrine (“the Doctrine”) is often cited to have originated in the old Supreme Court case Gregory v. Helvering, 293 U.S. 465 (1935) (even though, upon detailed consideration, it appears that this case stands for a much more limited proposition than the current Doctrine). In reality, the modern Doctrine received a much broader development in the seminal case of Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966), which incorporates the economic substance doctrine into the Doctrine.
The combined effect of both legal developments can be summarized as a two-prong test which says that the IRS will respect a business transaction if: (1) the transaction has objective economic substance (i.e. whether transaction affected the taxpayer’s financial position in any way); and/OR (2) the taxpayer has a subjective non-tax business purpose for conducting the transaction (i.e. whether the transaction was motivated solely by tax avoidance considerations to such a degree that the business purpose is no more than a facade). Notice, the capital “OR” – there is a disagreement among the courts on whether the both, subjective (business purpose doctrine) and objective (economic substance doctrine) prongs should be satisfied, or is it enough that one of them is satisfied.
International Tax Planning Lawyers: the Doctrine is Relevant to International Tax Planning
The application of the Doctrine has been extremely important to International Tax Planning, and international tax planning lawyers should take care to make sure that their tax plans are not merely done for tax avoidance purposes, but reflect the real business purpose behind engaging into the transaction. Moreover, the international tax planning lawyers should impress upon their clients this understanding of importance of the Doctrine to the tax consequences of their business transactions.
A recent IRS victory stand as a stark reminder of the importance of the Doctrine and why international tax planning lawyers must not ignore it. In Chemtech Royalty Associates , L.P. v. United States of America (February of 2013), the federal district court in Louisiana rejected two separate tax shelter transactions entered into by The Dow Chemical Company (“Dow Chemical”) that purported to create approximately $1 billion in tax deductions.
The first transaction rejected by Chief Judge Jackson was created by Goldman Sachs and basically allowed Dow Chemical to claim royalty expense deductions on its own patent through a scheme called Special Limited Investment Partnerships (“SLIPs”). The basic idea behind SLIPs is to create a tax shelter known as a “lease-strip” – the U.S. taxable income is stripped away to a non-US partnership. In the process, some small Swiss tax was paid, but only minor U.S. tax consequences were triggered on Dow Chemical’s US tax return.
The second transaction that was rejected by Chief Judge Jackson involved depreciation by Dow Chemical of a chemical plan asset that had already, for the most part, been fully depreciated. The second scheme (created by King & Spalding) arose due to changes in U.S. tax law which made the first transaction unprofitable from the tax standpoint.
While the economic substance was not the only doctrine discussed by court (the Sham Partnership Doctrine played a large role in the decision as well), it certainly occupied the central role in the decision.
The end result for Dow Chemical – disallowance of $1 billion of deductions and an imposition of 20% penalty (i.e. $200 million) plus interest. As the readers can see, it is highly important for international tax planning lawyers to pay attention to the Doctrine.
Contact Sherayzen Law Office for Professional Help with International Tax Planning
While the precedent-setting cases usually involve large corporations, international tax planning concerns any company that does business internationally. Equally important for all companies is to make sure that they comply with all of the numerous complex U.S. tax reporting requirements concerning international business transactions.
If you have a substantial ownership interest in or an officer of a small or mid-size company that does business internationally, contact Sherayzen Law Office for professional help with international tax planning and compliance. Attorney Eugene Sherayzen will thoroughly analyze your case, create an ethical business tax plan to make sure that you do not over-pay taxes under the Internal Revenue Code provisions, and prepare all of the tax and legal documents that are required for your U.S. tax compliance.