The Form Over Substance Doctrine is a doctrine finding its foundation on equity principals. Tax attorneys have seen the Internal Revenue Service (and courts) use the Form Over Substance Doctrine as a means by which to “attack” certain transactions. Tax attorneys may have represented taxpayers in matters before the IRS when the IRS was attempting to “restructure” a transaction or reclassify an item under the Form Over Substance Doctrine.
The Internal Revenue Service and courts can apply the Form Over Substance Doctrine when a taxpayer has arranged calculated transactions that may appear one way on paper, but operate another way in reality. Generally, a taxpayer would create this discrepancy most often to pay less tax or provide another tax benefit. Tax law requires a relationship between a tax benefit and a profit or business motive to prevent taxpayers from abusing Congress’ true intent as codified in the Internal Revenue Code.
If the applicable court or the Internal Revenue Service detects or feels that the taxpayer’s motive regarding tax benefits prevails over the business or profit motive based on a review of the contemporaneous documents, the Internal Revenue Service or the court may determine that the transaction’s form does not match its substance.
Although, tax law acknowledges a taxpayer’s right to pay as little tax as is legally correct, the Form Over Substance Doctrine applies when the taxpayer crosses a line, creating artificial designs that disguise the transactions true nature. The taxpayer may have created a prearranged plan merely for the tax benefits. Based on public policy, courts will generally not allow or permit a taxpayer to benefit from a noticeably tax advantaged transaction or series of transactions unless these benefits are associated with economic substance and the taxpayer is subject to some form of real economic risk. Economic substance has been discussed by our tax attorneys in previous articles.
In general, if a business or individual proposes a transaction to you, or your business of which the tax benefit appears too good to be true, it probably is. When looking at the transaction, you must see a business or profit purpose or motive that would exceed the tax benefits of the transaction. If the sole purpose of the transaction is the avoidance of tax, the Form Over Substance Doctrine could allow the Internal Revenue Service or a court to deem the transaction in a light not as favorable as projected or anticipated.
If a transaction has been proposed to you that you are questioning, please contact a Denver tax attorney at our office to schedule a free consultation. We can apply the facts of your case to the current tax law and provide our opinion regarding the transaction. It is always better to enter into the transaction knowledgeable.