BEIJING
BOSTON
BRUSSELS
CHICAGO
DALLAS
GENEVA
HONG KONG
HOUSTON
LONDON
LOS ANGELES
NEW YORK
PALO ALTO
SAN FRANCISCO
SHANGHAI
SINGAPORE
The University of Chicago Law School 67th Annual Tax Conference
Busting Tax-Free Treatment
Jeffrey T. Sheffield, Chair
Suresh T. Advani, Presenting
William D. Alexander, Commenting
Lawrence M. Garrett, Commenting
SYDNEY
TOKYO
WASHINGTON, D.C.
Topics to be addressed
I.
Overview of Busting Transactions
II. IRS’s Ability to Recast Transaction into Tax-Free Provision
A. Section 368
1. Generally
2. Grandparent Stock
3. Bankruptcy Reorganizations
B. Section 351
C. Section 332
III. Nominal Consideration
IV. Economic Substance Doctrine
V. Conclusion
2
I.
3
Overview of Busting Transactions
Subchapter C is designed to be non-elective but
results are form driven
Treas. Reg. 1.368-1(b):
The purpose of the reorganization provisions of the Code is to except from
the general rule certain specifically described exchanges incident to such
readjustments of corporate structures made in one of the particular ways
specified in the Code . . .
From 2001 JCT Report on Simplification:
The different, and often overlapping, variations within the merger and
acquisition rules can be viewed as a significant source of complexity. On
the other hand, these rules, as they have been interpreted and clarified
over the years through administrative pronouncements, provide a large
amount of taxpayer selectivity and certainty. Taxpayers are relatively
assured of obtaining a specific tax result so long as the transaction
satisfies the formalistic requirements of the chosen merger and acquisition
provision.
4
Example of formalism of Subchapter C
AGGG
$90 A stock
$10 Cash
T S/H
AGGG
$90 A stock
$10 Cash
T S/H
T Stock
S
(Shell)GGG
Merge
TGGG
Tax-Free (except for $10)
5
TGGG
Taxable
Formalism of Subchapter C makes “busting”
transactions possible
• A Busting Transaction is a transaction that would be
described in a nonrecognition provision of the Code but for
tax planning.
• Typically involves specific sequencing of steps or
creation of additional entities or consideration designed to
make the transaction fall outside of any nonrecognition
provision.
6
Busting: Common tools
• Grandparent stock
• Section 368(c)
• Binding commitment test
• Crossing a statutory numerical line
• Changing direction of merger or transferring assets instead of merging
• Violating “solely” requirement
• Nonqualified preferred stock
• Keeping target alive so as not to liquidate
• LLCs/check-the-box rules
• Esmark v. Commissioner
7
Sample busting transaction: Busting Section 367
to permit loss recognition on inversion
A Public
Nominee
A
Common
Irish Law
Firm
Non-Voting
Preferred
(U.S.)
New A
(Ireland)GGG
S-1
Merge
(Ireland)GGG
S-2
(Netherlands)G GG
S-3
(U.S.)GGG
Merger Sub
(U.S.)GGG
8
T Public
Contribute
T
(Ireland)
• A is a U.S. publicly traded corporation with a
market capitalization of approximately $20
billion.
• T is an Irish corporation with a market
capitalization of approximately $10 billion.
• A and T agree to combine using a “double
dummy” structure, whereby the A shareholders
get stock in New A and the T shareholders get a
combination of cash and stock in New A.
• Prior to combination, New A issues $10,000 of
non-voting preferred stock to an Irish law firm in
exchange for services performed by the firm.
Sample busting transaction (contd.)
A Public
Irish Law
Firm
T Public
Non-Voting
Preferred
Common (75%)
Common (25%)
New A
(Ireland)GGG
S-1
(Ireland)GGG
S-2
(Netherlands)G GG
S-3
(U.S.)GGG
A
(U.S.)GGG
9
T
(Ireland)
• If transaction is viewed as a section 351 transaction or
reorganization, shareholders of A and T will recognize
gain, but not loss, under section 367(a). See Treas. Reg.
§ 1.367(a)-3(c).
• If transaction is viewed as a direct acquisition of the
stock of A by S-3 for great grandparent stock, would not
appear to fit within section 351 or reorganization provision.
• In order to fit transaction within Section 367(a),
• transaction would need to be recast as an
acquisition of the stock of A by New A, followed by
a drop down the chain to S-3; and
• in the case of the acquisition of T, the non-voting
preferred would need to be ignored.
II.
10
IRS’s Ability to Recast Transaction into TaxFree Provision
Potential recast tests available to IRS
1. IRS can not recast a transaction if recast involves same number of (or
more) steps.
2. IRS can recast a transaction if path to end result could have been
accomplished tax-free.
3. IRS can recast a transaction if historical precedent exists to do so.
4. IRS can recast a transaction if a strong policy consideration is at stake.
5. IRS can recast a transaction if it is between related parties.
11
Does Esmark preclude recasting into tax-free
treatment?
• Esmark Inc. v. Commissioner, 90 T.C. 171 (1988) (declining to apply steptransaction doctrine when “recharacterization does not simply combine steps;
it invents new ones”).
• Turner Broadcasting, Inc. v. Commissioner, 111 T.C. 315 (1998) (“In order to
recharacterize the transaction, [the IRS] must have a logically plausible
explanation that accounts for ALL the results of the transaction. The
explanation may combine steps, but if it invents new ones, ‘Courts have
refused to apply the step-transaction doctrine in this manner.’”).
• But neither Esmark nor Turner involved the IRS attempting to recast a
taxable into a tax-free transaction.
• J.E. Seagram Corp. v. Commissioner, 104 T.C. 75 (1995) suggests that
the test might be different in that context (“Esmark, Inc. did not involve a
reorganization, so the facts of that case are not apposite.”).
12
Reorganization authorities inconsistent with
Esmark
• Rev. Rul. 58-93
• Rev. Rul. 78-130
• Rev. Rul. 77-191
• Rev. Ruls. 67-274; 2001-46
Do these rulings stand for a broad proposition that reordering is permitted if
the end result is a tax-free reorganization, or are they historical anomalies?
13
Revenue Ruling 58-93
Step 1
Step 2
X
X stock
X
Individuals
Individuals
79%
21%
Merge
Surrender
Y stock
Y
Y
Assets
and
liabilities
Z stock
Z
(Newco)
14
Z
(Newco)
Revenue Ruling 58-93: Recast
Step 1
X
Step 2
Individuals
X stock
Merge
Individuals
X
Surrender
Y stock
Assets
and
liabilities
Z stock
Y
Z
(Newco)
15
Rev. Rul. 77-191
Step 1
Step 2
X
S/Hs
X
S/Hs
Y
(Newco)
Y stock
Partial
redemption
of X stock
Distribution of
assets of
business unit A
X
X
16
Assets of
business
unit A
Rev. Rul. 77-191: Recast
Step 1
Step 2
X
S/Hs
X
Partial
redemption
of X stock
Y stock
Assets of
business unit A
Y stock
X
Y
(Newco)
Y
(Newco)
17
Revenue Ruling 78-130
Step 1
Step 2
X
Y
Z
S-1
P
All assets
N voting stock
Additional
S-2 voting
stock
S-1
stock
N
S-1
(Newco)
S-2
Step 3
S-2
100%
N
(Newco)
18
X
Y
Z
Y
X
N
(Newco)
Z
S-1
Revenue Ruling 78-130: Recast
Recast:
S1
Recast:
X, Y, Z
P
No recast necessary
S-1
S-2
Partial voting
stock of S-2
“Substantially
all” assets
19
N
(Newco)
Revenue Ruling 67-274
Step 2
Step 1
X
S/Hs
Y
Y voting
stock
X
S/Hs
Y
100%
X stock
X
Surrender
X stock
Distribution
of assets in
liquidation
X
20
Revenue Ruling 67-274: Recast
Step 1
Step 2
X
S/Hs
Y voting stock
Y
“Substantially all”
of X’s assets
X
S/Hs
Y
X
X
21
Liquidated
Rev. Rul. 2001-46
Step 1
Step 2
X
70% X
stock
X
Y stock
Y
T
S/Hs
Surrender
Y stock
Y
Y assets
(including 70%
X stock)
T stock
Merger of Y and T
22
70% X stock,
30% cash
Surrender
T stock
T stock
T
Rev. Rul. 2001-46 cont.
Step 3
T S/Hs
X
Merge T into X
T
23
Rev. Rul. 2001-46: Recast
70% X stock, 30%
cash
X
T
S/Hs
T stock
T
24
Rulings on grandparent stock suggest a narrow
reading of recast authorities
• Rev. Rul. 63-234
• Rev. Rul. 74-564
• Rev. Rul. 74-565
But could it be argued that, even without a recast, grandparent stock is now
permissible consideration based on the demise of the Groman and Bashford
remote continuity doctrine? (See Schultz, “Are Tax Free Mergers with
Grandparent Stock Now Possible?”)
25
Rev. Rul. 63-234
Before
After
X
Group
M
18%
X
Group
78% common
New N voting
preferred
50%
N
N
100%
50%
O
26
Recast
X contributed stock of O for M stock,
which violated continuity.
M
60%
O
Transaction Form
1. N issues new voting preferred to X
for stock of O.
2. X contributes all its stock of N to M.
Is Section 368(a)(1)(G) more susceptible to
recast?
T
Securityholders
T
Securityholders
T
$150 7-year T debt
securities
• Assets with basis of $40, FMV of $60
• NOL of $20
• If T Securityholders exchange their debt for 100% of
equity of reorganized T:
• T will have COD of $90 ($150 liabilities minus
$60 in value delivered to creditors).
• This COD will not produce taxable income, but will
have to be applied against T’s tax attributes as of
beginning of next tax year.
• Net result is that T will have no net operating
losses and zero tax basis.
27
Assets
T
New T
Securities
• If instead T Securityholders form New T and New T can
acquire the assets of Old T in a taxable transaction:
•Old T will be able to offset the $20 gain with the
NOL.
•New T will have a stepped up basis of $60 (but no
NOL).
Busting Section 368(a)(1)(G)
• Is sequencing sufficient to bust?
• Section 368(a)(1)(G) describes “a transfer by a
corporation of all or part of its assets to another corporation
in a title 11 or similar case; but only if, in pursuance of the
plan, stock or securities of the corporation to which the
assets are transferred are distributed in a transaction which
qualifies under section 354, 355 or 356.”
• This language seems to contemplate a transfer of assets
by T to New T in exchange for New T stock that is then
distributed by T to securityholders (2 steps).
• Alternatively, the same end result could be achieved in
the same number of steps by either (i) having
securityholders contribute their securities to New T and
then New T foreclosing on the T assets or (ii) the
securityholders foreclosing on the assets of T and then
contributing them to New T.
• But see PLR 201025018 (6/25/10) (recasting creditor
formation of newco to find a reorganization under section
368(a)(1)(G)) (citing Alabama Asphaltic).
28
T
Securityholders
Assets
T
New T
Securities
Busting Section 368(a)(1)(G)
• Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179 (1942).
• Addressed fact pattern above, where form of transfer was ambiguous. Appeared to be foreclosure by creditors
on assets followed by contribution to newco.
• Court did not think this mattered:
Some contention, however, is made that this transaction did not meet the statutory standard because the
properties acquired by the new corporation belonged at the time to the committee and not to the old
corporation. That is true. Yet the separate steps were integrated parts of a single scheme. Transitory
phases of an arrangement frequently are disregarded under these sections of the revenue acts where they
add nothing of substance to the completed affair.
• But does this really support reordering? Statute was quite different at the time. It applied to “(A) a merger or
consolidation (including the acquisition by one corporation of . . . substantially all the properties of another
corporation).” Arguably the Court was just disregarding the transitory ownership by the creditors to say that newco
acquired substantially all of the assets of oldco.
• Is this reordering principle limited to G reorganizations?
• If a G reorganization is special, does IRS have enhanced ability to reorder in this setting?
• See following examples
29
Busting Section 368(a)(1)(G)
• Assume T securityholders form New T , which forms S-1, which
forms S-2; S-2 effects the acquisition of assets of T.
T
Securityholders
• Can the IRS reorder to treat this as an acquisition of T’s assets by
New T followed by a drop down the chain to S-2?
• Does there need to be a business purpose for S-1 and S-2?
• Do S-1 and S-2 need to do anything other than hold stock?
• When can S-1 and S-2 be liquidated?
New T
• Different answer if T retains nominal asset (e.g., real estate) and
does not liquidate?
• Different answer if S-1 issues non-voting preferred stock to
management? Does it matter how much?
S-1
Assets
T
S-2
Securities
30
Busting Section 368(a)(1)(G)
• Assume T Securityholders organize New T as
an LLC taxed as a partnership.
• Seems little doubt this achieves the goal of a
taxable transaction.
T
Securityholders
• Why should this busting technique be
acceptable, but use of multiple corporate tiers
not be acceptable?
Assets
T
Securities
31
New
T
Busting Section 368(a)(1)(G)
• Assume instead some, but not all, T
securityholders elect to hold their interest in
New T partnership through a newly formed
blocker corporation.
T
Securityholders
• Different answer?
• What if Blocker owns 99% of New T?
Blocker
Assets
T
Securities
32
New
T
Section 351 recast authorities
• Rev. Rul. 70-140
• Rev. Rul. 84-44
• Rev. Rul. 84-111
• Rev. Rul. 2003-51
Is it meaningful that, unlike the reorganization context, there do not appear to
be any authorities recasting a transaction into section 351 treatment? Instead,
what recast authority exists recasts into taxable treatment.
33
Revenue Ruling 70-140
Step 2
Step 1
Y
Y
Agreement
A
(individual)
Y stock
A
(individual)
Sole
proprietorship
assets
X stock
X stock
Final
structure
A
Y
X
X
34
Recast as acquisition
by Y of sole
proprietorship assets
followed by
contribution to X.
Revenue Ruling 84-44
Y
X
S/Hs
P stock
Assets
P stock
X
S/Hs
Y
P
<80%
Y + X S/Hs=>80%
S
X
P
X s/hs not counted as
part of transferor group.
merger
S
35
Revenue Ruling 84-111, Situation 1
Step 1
Step 2
A
B
A
B
Surrender interests
in X
R stock
R stock
X
X
All assets
and liabilities
of X
R stock
R
R
Form respected
36
Revenue Ruling 84-111, Situation 2
Step 1
Step 2
A
Assets
and
liabilities
B
A
Surrender
interests
in Y
S stock
Assets
and
liabilities
Y
B
Assets
and
liabilities
Assets
and
liabilities
S
Form respected
37
Revenue Ruling 84-111, Situation 3
Step 1
Step 2
A
B
B
Interest
in Z
Interest
in Z
Z
T
Form respected
T
T stock
38
A
T stock
Revenue Ruling 2003-51
Step 2
Step 1
W
W
X
40%
60%
Y stock
Business A
assets
Additional
Y stock
Stock
Z stock
Z
Y
Cash and
business A
assets
Z
39
Cash (capital
contribution to
pre-existing
subsidiary)
Distinguished from Rev. Rul. 70140 on the grounds that
transaction could have been
accomplished tax-free without
Step 1.
Busting Section 351
• Assume T S Corp is worth $100; PE Fund
wants to acquire T S Corp and make an
election under section 338(h)(10).
• PE Fund forms Newco; Newco agrees to
acquire 100% of the stock of T S Corp for
$100.
• T Shareholder agrees to reinvest $10 of
sales proceeds in Newco in exchange for
10% of Newco stock.
• On the closing date, PE Fund contributes
$90 cash to Newco; Newco acquires 100% of
the stock of T S Corp from T Shareholder for
$90 cash contributed by PE Fund and
simultaneous offset of T shareholder’s
obligation to subscribe for Newco stock.
• Is taxpayer’s intent that this be taxable and
form enough to bust section 351? (See
Stevens Pass v. Commissioner, 48 T.C.
1967; contrast Baker Commodities Inc. v.
Commissioner, 48 T.C. 374 (1967), aff’d 415
F.2d 519 (9th Cir. 1969)); Gus Russell, Inc. v.
Commissioner, 36 T.C. 965 (1961).
40
PE Fund
$90
T Shareholder
$90
$10
Newco
T
S Corp
Busting Section 351
• Assume same facts except Newco forms Midco to acquire
T S Corp; purchase price is designated as $90 cash plus
10% of Newco stock.
PE Fund
• There are two ways T Shareholder could be deemed to
receive Newco shares: (i) T Shareholder contributes 10% of
T S Corp to Newco in exchange for Newco shares and
Newco then contributes those shares to Midco (tax-free) or
(ii) Midco acquired the Newco shares from Newco and then
used the shares to acquire the T S Corp stock (taxable).
• If form is not clearly stated in purchase agreement, should
default be tax-free or taxable?
• If purchase agreement specifies a form, does that control?
• Is self-serving language “deeming” certain steps to
occur sufficient or do actual steps need to be
followed?
• Does Midco need a business purpose?
$90
Newco
$90
$90
Midco
41
T Shareholder
T
S Corp
(Partially) Busting Section 351
• Assume same facts except T is not an S corporation and
has two shareholders; Shareholder 1 has a built-in gain in its
shares; Shareholder 2 has a built-in loss.
PE Fund
• Can transaction be structured so that Shareholder 1
contributes its share directly to Newco (tax-free) and
Shareholder 2 to Midco (taxable)?
Shareholder1
Shareholder 2
Newco
T
Midco
42
Section 332 recast authorities
• Commissioner v. Day & Zimmermann, Inc., 151 F.2d 517 (3rd Cir. 1945).
• Granite Trust Co. v. United States, 238 F.2d 670 (1st Cir. 1956).
• Avco Mfg. Corp. v. Commissioner, 25 T.C. 975 (1956).
• FSA 201419011 (7/11/01).
• PLR 201330004 (7/26/13).
• PLR 201419011 (5/9/14).
43
PLR 201330004
Step 1
Step 2
P
S1
Cash
contribution
S5
S3
S2
>20% S6 stock
S3
Liquidating
distribution
under sec. 331
S4
Cash
Cash
contribution
44
S5
S6
S6
IRS ruled that
bust was
successful.
Rev. Proc. 2014-3
Added to the no-rule list, the treatment of transactions in
which stock of a corporation is transferred with a plan or
intention that the corporation be liquidated in a transaction
intended to qualify under Section 331.
Is this addition driven by resource constraint issues or a changing view of the
efficacy of these transactions?
45
III.
46
Nominal Consideration
Potential rules for testing nominal consideration
available to IRS
1. Nominal consideration should be respected if it exists as a legal matter and
is not transitory.
2. Nominal consideration should be respected only if it exceeds a specified
percentage or numerical threshold (e.g., 1%/$500,000).
3. Nominal consideration should be respected only if its dollar value exceeds
the fees and expenses of issuing it.
4. Nominal consideration should be ignored if a principal purpose of its
issuance was tax planning.
5. Nominal consideration should be ignored if it was not separately bargainedfor consideration.
Law seems to be #1, but most tax advisors adopt #2.
47
“Solely” Authorities
• Helvering v. Southwest Corp., 315 U.S. 194, 198 (1942) (“’Solely leaves no
leeway.”).
• Mills v. Commissioner, 39 T.C. 393 (1962) (finding $27.36 in cash for
fractional shares out of total deal value of $27,912.50 (less than one-tenth of
one percent) sufficient to bust reorganization under section 368(a)(1)(B)),
reversed 331 F.2d 321 (5th Cir. 1964) (reversing Tax Court on the grounds that
cash was simply a mechanical rounding off; did not address de minimis
argument).
• Rev. Rul. 66-365 (agreeing to follow appellate court decision in Mills as long
as cash in lieu of fractional shares is not separately bargained-for
consideration).
• Rev. Proc. 86-42 (ruling standard requiring representation that cash in lieu of
fractional shares not separately bargained-for consideration and does not
exceed one percent of the total consideration).
48
What is “separately bargained-for consideration”?
• Assume parties negotiate a term sheet for a pure stock-for-stock exchange
that would qualify as a B reorganization. Acquirer’s tax lawyers review term
sheet and decide to bust by issuing nominal cash to target shareholders.
Target shareholders were not expecting cash but happily accept it.
• Does gratuitousness of cash mean it is not separately bargained-for?
• Alternatively, could cash be viewed as consideration for agreeing to bust
transaction as opposed to part of exchange for stock?
49
Authorities ignoring de minimis amounts
• Section 332(a) requires “complete liquidation.”
• But Treas. Reg. §1.332-2(c) permits the retention of a “nominal” amount
of assets for the sole purpose of preserving the corporation’s legal
existence.
• Cf. Rev. Rul. 76-525 (refusing to apply section 332 if the corporation
retains “any property, no matter how small in amount,” to continue
carrying on business.
• Section 368(a)(1)(F) requires “a mere change in identity, form, or place of
organization.”
• But Prop. Treas. Reg. §1.368-2(m) permits the resulting corporation to
issue a nominal amount of stock or hold a nominal amount of assets to
facilitate the transaction.
• Example 3 of the Proposed Regulations suggests that 1% is nominal for
these purposes.
50
Authorities ignoring de minimis amounts (contd.)
• Treas. Reg. §1.368-2(l)(2)(i) applies to transaction otherwise described in
Section 368(a)(1)(D) if the same person or persons own stock in “identical
proportions.”
• Regulatory exception made for de minimis variations in ownership.
• Example suggests 1% is de minimis for these purposes.
• Rev. Proc. 95-10: Pre check-the-box ruling standard on entity classification
required a partner to own at least a 1% interest in profits, losses and capital to
be respected.
• Less than 1% permitted if entity had total contributions exceeding $50
million (i.e., $500,000 was considered “real” regardless of percentage it
represented).
Do these authorities stand for a broad proposition that de minimis amounts
should be ignored or are they context-specific interpretations of statutory
intent?
51
Authorities respecting nominal shares
• Treas. Reg. §1.368-2(l)(2): Deems the issuance of a nominal share to satisfy
the distribution requirement of Section 368(a)(1)(D)/354(b)(1)(B).
• PLR 8822062 (March 7, 1988): Finds the issuance of one share of nonvoting preferred stock sufficient to disqualify merger under Section
368(a)(2)(E).
If a nominal share is sufficient to qualify a transaction under the reorganization
provisions, shouldn’t the same principle apply to disqualify a transaction?
52
If nominal shares should be ignored, how far would
this principle extend?
P
Employee
P
1 existing
voting share
800 out of
999 voting
common
shares
1 newly
issued nonvoting share
S
• S has 999 shares of a single class of common stock
outstanding. P owns 800 shares and wants to contribute
property to S in a busted section 351 transaction. To
accomplish this, P causes S to issue a single share of
non-voting stock to an employee of S for services
rendered.
• Assume share is disregarded because de minimis, and
therefore transfer qualifies under section 351.
53
Employee
799 out of
999 voting
common
shares
S
• If instead P simply transfers a single voting share to
employee (bringing its ownership of voting power under
80%) before P contributes the property to S, should this
too be ignored because employee’s ownership is too
small?
IV.
54
Economic Substance
Code Section 7701(o)
(1) In the case of any transaction to which the economic substance doctrine is
relevant, such transaction shall be treated as having economic substance only
if
(A) the transaction changes in a meaningful way (apart from Federal
income tax effects) the taxpayer’s economic position, and
(B) the taxpayer has a substantial purpose (apart from Federal income
tax effects) for entering into such transaction.
(2)(A) The potential for profit of a transaction shall be taken into account in
determining whether the requirements of subparagraphs (A) and (B) of
paragraph (1) are met with respect to the transaction only if the present
value of the reasonably expected pre-tax profit from the transaction is
substantial in relation to the present value of the expected net tax benefit
that would be allowed if the transaction were respected.
55
LB&I Directive (LB&I-4-0711-015)
• Mirrors legislative history, providing that it is likely not appropriate to raise the
economic substance doctrine if the transaction being considered is related to,
among other things, “[t]he choice to enter into a transaction or series of
transactions that constitute a corporate organization or reorganization under
subchapter C.”
• Also provides that the doctrine may be appropriate in transactions that include
the following:
• Transaction is highly structured
• Transaction creates no meaningful economic change on a present value
basis (pre-tax)
• Transaction accelerates a loss or duplicates a deduction
• Transaction has no credible business purpose apart from federal tax
benefits
• An examiner still must obtain approval to apply the doctrine to a transaction
containing these features if the transaction is subject to a detailed statutory or
regulatory scheme and complies with this scheme.
56
One key issue is definition of the “transaction”
• Notice 2014-58: [W]hen a series of steps includes a tax-motivated step that
is not necessary to achieve a non-tax objective, an aggregation approach may
not be appropriate. In that case, the “transaction” may include only the taxmotivated steps that are not necessary to accomplish the non-tax goals—a
disaggregation approach.
• See also Coltec Industries, Inc. v. U.S., 454 F.3d 1340 (CA Fed. Cir. 2006)
(“the transaction to be analyzed is the one that gave rise to the alleged tax
benefit”).
Can Coltec be distinguished from the typical busting step on the grounds that
in Coltec the tax motivated step was arguably the whole point of the
transaction?
57
Should the economic substance doctrine ever be
relevant to a busting transaction?
• Overall transaction is an undisputed realization event.
• Indeed, almost always stronger case for realization than facts of
Cottage Savings.
• Hard to distinguish from transactions that are unassailable under the
economic substance doctrine (See example on slide 5).
• Transactional electivity a long-recognized feature of subchapter C.
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V.
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Conclusion
Taxpayers should continue to have relatively free
rein to bust
• Historically, busting transactions have been viewed as an appropriate
method of tax planning by both Congress and the IRS.
• Congress has been well aware of the transactional electivity of
subchapter C. Its failure to adopt a pure elective regime could be
attributed to a view that the current system, with all its quirks, is a welldeveloped body of law that works.
• Concerns about loss triggering have usually been addressed through
separate regimes (e.g., Code Section 267) rather than forcing taxpayers
into tax-free treatment.
• With a few narrow exceptions, the IRS has a long history of respecting
the formality of subchapter C in this context.
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No strong policy reason to challenge typical
busting transaction
• An expansive view of recast authority, the de minimis rules, or the
application of the economic substance doctrine in this area would only
increase uncertainty and deal friction.
• Even under the most expansive view of the IRS’s authority to force a
transaction into tax-free treatment, the overall structure of subchapter C
leaves open vast ability to bust. No clear reason to single out transactions
at the edges if no broader policy is being served.
• Clear lines avoid the potential for the IRS getting whipsawed.
• Challenge of busting transactions could also establish bad precedent in
cases where the IRS wants to challenge a transaction that purports to
qualify under a tax-free provision.
• Busting transactions take place in the context of a clear realization event.
Sections 368, 351 and 332 are best viewed as specific exceptions to the
general rule of gain or loss recognition.
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