The bullshit tax shelter does not work, just as it failed to work for other taxpayers in the other courts of appeals. Bank of New York Mellon Corp. v. Commissioner (BNY), 801 F.3d 104 (2d Cir. 2015), here; and Salem Financial, Inc. v. United States, 786 F.3d 932, 951 (Fed. Cir. 2015), here.
The Court offers the following as an introduction to the economic substance doctrine in the tax law, the reason it called the bullshit out:
B. The Economic Substance Doctrine
The federal income tax is, and always has been, based on statute. The economic substance doctrine, n7 like other common law tax doctrines, can thus perhaps best be thought of as a tool of statutory interpretation, n8 as then-Judge Breyer characterized it in his opinion for this court in Dewees v. Commissioner, 870 F.2d 21, 35-36 (1st Cir. 1989).
n7 Sovereign argues that the foreign tax credit area is so heavily populated with IRS regulation that there is no need for any further regulation by the courts under the guise of the economic substance doctrine. On these facts, we reject the proposition. In practical terms, it takes time for the government to analyze a new problem, come up with a solution, and promulgate regulations. "The endless ingenuity of taxpayers in attempting to avoid taxes means that there will be a first time for everything," Wells Fargo, 143 F. Supp. 3d at 838, and the economic substance test guards against abuse of loopholes that Congress and the IRS have not anticipated.
n8 As one commentator says:
A related . . . claim is that the legislature assumes that long-standing common law doctrines such as economic substance will be used to interpret the statutes it enacts. Under this claim, the doctrines have been implicitly adopted as part of the statute -- at least where the statute does not indicate otherwise.
Joseph Bankman, The Economic Substance Doctrine, 74 S. Cal. L. Rev. 5, 11 (2000).
The common law economic substance doctrine traces back to the Supreme Court's decision in Gregory v. Helvering, 293 U.S. 465 (1935). n9 The Court there looked beyond the fact that a corporate reorganization technically complied with the statutory requirement and found that it lacked economic substance. Id. at 468-70. It found as such because the reorganization was:
n9 In 2010, Congress enacted a statutory economic substance test. See 26 U.S.C. § 7701(o). The statutory test was not made retroactive. Our analysis, however, is not in conflict with that test, as Congress specified that the 2010 codification would be applied as courts have previously and consistently applied the economic substance doctrine. Id. § 7701(o)(5)(C). If the codification reveals anything about congressional intent as to pre-2010 STARS transactions, it supports our conclusion.
an operation having no business or corporate purpose —- a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner.
Id. at 469. The Court reached this conclusion from the fact that "the transaction upon its face lies outside the plain intent of the statute." Id. at 470.
The Court clarified the doctrine further in Frank Lyon Co. v. United States, 435 U.S. 561 (1978), where it reversed the Eighth Circuit's decision that a sale-and-leaseback transaction did not meet the economic substance test. Id. at 584. The Court explained that "[i]n applying this doctrine of substance over form, the Court has looked to the objective economic realities of a transaction rather than to the particular form the parties employed." Id. at 573 (emphasis added).
The First Circuit has addressed challenges to the economic substance of transactions in a number of cases, although the cases often have not invoked the "economic substance doctrine" by that name. See, e.g., Stone v. Comm'r, 360 F.2d 737 (1st Cir. 1966); Fabreeka Prods. Co. v. Comm'r, 294 F.2d 876 (1st Cir. 1961); Granite Tr. Co. v. United States, 238 F.2d 670 (1st Cir. 1956). This court has been particularly wary of inquiring into the subjective motivations of taxpayers: "[U]nless Congress makes it abundantly clear, we do not think tax consequences should be dependent upon the discovery of a purpose, or a state of mind, whether it be elaborate or simple." Fabreeka Prods. Co., 294 F.2d at 878.
Dewees is our most recent significant case on the economic substance doctrine. There, this court upheld a tax court decision that a "loss [the petitioners] incurred while engaged in 'straddle' trading on the London Metals Exchange was not an 'ordinary loss' deductible from their income." Dewees, 870 F.2d at 22. The tax court held that the loss was not deductible because the straddle trades were sham transactions and not "entered into for profit" within the meaning of section 108 of the Internal Revenue Code. Id.
This court upheld the tax court's decision for four principal reasons. We emphasized that the case was one of some 1,100 consolidated by the tax court, from the general pattern of which the tax court could infer that the transactions were designed to avoid taxes; that the promotional material for the transactions focused exclusively on their tax effects; that although margin accounts were opened for the transactions, none of the investors in any of the transactions ever received a margin call; and that no investor ever made a net profit or "was ever asked to pay a loss, beyond the initial margin deposit" for the transactions. n10 Id. at 31. We rejected the petitioner's argument that we must analyze the taxpayer's subjective motivation under the relevant statutory framework. Id. at 34. Among other reasons, the court noted that the tax court had concluded that the transactions were "shams in substance," and that "[c]ase law makes clear that a taxpayer cannot deduct a 'sham transaction' loss, irrespective of his subjective profit motive." Id. at 35.
n10 To the extent that similar evidence is in the record for this case, it supports our conclusion. As in Dewees, we have examined the pattern that has emerged from comparable STARS transactions. We have used Sovereign's and Barclays's communications to each other about the transaction and, in particular, their emphasis on the connection of the Bx payment to Sovereign's U.K. taxes and the Trust transaction's "tax risk," to conclude that the Trust transaction had no objective purpose outside its tax effect. And we too have noted that the transaction at issue here was structured such that it exposed neither party to realistic non-tax risk.
Dewees instructs that the economic substance doctrine is centered on discerning whether the challenged transaction objectively "lies outside the plain intent of the [relevant statutory regime]." Id. at 29 (quoting Gregory, 293 U.S. at 470). It further instructs that a transaction fails the economic substance test if, "though [it] actually occurred and technically complied with the tax code, [it] w[as] mere[ly a] device to avoid tax liability." Id. at 30; see also Schussel v. Werfel, 758 F.3d 82, 97 (1st Cir. 2014) (noting that courts may "disregard the form of transactions that have no business purpose or economic substance beyond tax evasion"). In other words, when a transaction "is one designed to produce tax gains . . . [not] real gains," Dewees, 870 F.2d at 31 -- such as when the challenged transaction has no prospect for pre-tax profit -- then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.