Corporate tax shelters will have to meet stiffer standards | Norton Rose Fulbright
The bill would apply to transactions entered into after February 14, 2004. The committee delayed implementation until early next year to give the IRS time to issue guidance.
Under the bill, transactions would have to have “economic substance” in order for the government to honor the tax results. Two things would have to be true about a transaction for it to have economic substance. First, it would have to change the taxpayer’s economic position in a “meaningful way” apart from the tax results. Second, the taxpayer must not only have a substantial non-tax reason for entering into the transaction, but it would also have to show that the transaction was a reasonable way to achieve its objective. A taxpayer will not be able to do this for transactions that “do not appear to contribute to any business activity or objective that the taxpayer may have had apart from tax planning.” There must be a link to its ordinary business operations or investment activities.
The Senate Finance Committee added a footnote to its report on the bill that should help future investors in synfuel, windpower, low-income housing, landfill gas and similar projects. The footnote says,” If the tax benefits are clearly contemplated and expected by the language and purpose of the relevant authority, it is not intended that such tax benefits be disallowed if the only reason for such disallowance is that the transaction fails the economic substance doctrine as defined in this proposal.”
The reference to the “purpose of the relevant authority” leaves room for debate in resale transactions. The industry would be well advised to get this phrase clarified — perhaps by way of example — when the bill is debated on the Senate floor.