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Chief Counsel's Office Advises on Application of Codified Economic Substance Doctrine

(Parker Tax Publishing October 2022)

The Chief Counsel's Office was asked to advise on how to determine whether the economic substance doctrine in Code Sec. 7701(o) applies to a transaction entered into after March 30, 2010. The Chief Counsel's Office advised that under Notice 2014-58, when a transaction involves a series of steps, the IRS can apply an aggregation or disaggregation approach to determine whether the transaction lacks economic substance under Code Sec. 7701(o). CCA 202240019.


Courts have developed several doctrines that can be applied to deny the tax benefits of a tax-motivated transaction, notwithstanding that the transaction may satisfy the literal requirements of a specific tax provision. One common-law doctrine is the "economic substance" doctrine. Under this doctrine, tax benefits arising from transactions that do not result in a meaningful change to the taxpayer's economic position other than a purported reduction in federal income tax are denied.

Closely related doctrines also applied by the courts, which are sometimes interchangeable with the economic substance doctrine, include the "sham transaction doctrine" and the "business purpose doctrine." Certain "substance over form" cases, in which courts examine whether the substance of a transaction comports with the form asserted by the taxpayer, involving tax-indifferent parties, have also involved examination of whether the change in economic position that occurred, if any, was consistent with the form asserted, and whether the claimed business purpose supported the particular tax benefits that were claimed.

In 2010, the Health Care and Education Reconciliation Act of 2010 (Pub. L. 111-152) codified the economic substance test in Code Sec. 7701(o). Effective for transactions entered into after March 30, 2010, Code Sec. 7701(o)(1) provides that, in the case of any transaction, or series of transactions, to which the economic substance doctrine is relevant, the transaction is treated as having economic substance only if:

(1) the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer's economic position; and

(2) the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into the transaction.

The Office of Chief Counsel was asked for advice on how to determine when a transaction was "entered into" for purposes of applying Code Sec. 7701(o). While most of the facts of CCA 202240019 are redacted, it appears that the transaction being analyzed involves the merger of an old entity and a new entity that took place in 2015 and that potentially involves a tax-motivated step.


The Chief Counsel's Office began its advice by observing that there is no case law relating to when a transaction is considered "entered into" for purposes of Code Sec. 7701(o). However, the Chief Counsel's Office noted that the IRS has issued guidance analyzing the term "transaction" for purposes of Code Sec. 7701(o). In Notice 2014-58, the IRS stated that either an aggregation or disaggregation approach can be used to determine whether a transaction lacks economic substance under Code Sec. 7701(o). The aggregation approach interprets a "transaction" to include all of the steps taken together when a plan that generates a tax benefit involves a series of interconnected steps. This means that every step in the series is considered when analyzing whether a "transaction" as a whole lacks economic substance. The disaggregated approach applies when a series of steps includes a tax-motivated step that is not necessary to achieve a non-tax objective. In that case, the "transaction" may include only the tax-motivated steps that are not necessary to accomplish the non-tax goals.

Addressing the transaction at issue, the Chief Counsel's Office noted that a transaction may have been part of a "series of transactions" depending on how factually similar the steps taken before March 30, 2010, were to the steps taken in 2015. According to the Chief Counsel's Office, it appeared that the creation of the new entity and the merger of a current (i.e., "old") entity into that new entity and the issuance of new policies, would be a series of interconnected steps to generate a tax benefit under the aggregation approach. It therefore appeared to the Chief Counsel's Office that "the transaction" was entered into before the effective date of Code Sec. 7701(o), as the steps would be included together.

The Chief Counsel's Office also advised that the disaggregated approach could apply. If the tax-motivated step was entering into new policies, the Chief Counsel's Office explained, there could be an argument that those steps could be viewed in isolation, notwithstanding what took place with the current entity and the new entity. The Chief Counsel's Office said the facts would need to show that what occurred after 2010 was not part of a "series of transactions" and that the tax-motivated step was not necessary to obtain a non-tax goal.

The Chief Counsel's Office noted, however, that the codification of the economic substance doctrine did not supplant the common law doctrine. According to the Chief Counsel's Office, the common law doctrine can be applied to transactions entered into before and after March 30, 2010.

For a discussion of the codification of the economic substance doctrine, see Parker Tax ¶99,730.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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