Monday, June 10, 2013

Ways & Means Hearing June 13, 2013

Written Statement of
Alvin S. Brown, Esq.,
The Committee on Ways and Means
U.S. House of Representatives
Hearing on Tax Reform: Tax Havens, Base Erosion and Profit-Shifting
June 13 2013

Chairman Camp, Ranking Member Levin, and distinguished members of the Committee on Ways and Means.  I am a tax attorney specializing in IRS controversies. I previously had a full career in the Office of the IRS Chief Counsel as an interpretative attorney and manager with signature authority for the IRS on many complex tax matters. 
To resolve many of the tax minimization issues and tax abuses that are the subject of this hearing, the IRS could easily apply section § 7701(o) and its prevailing judicial precedent.  Section 7701(o) is the codification of the “economic substance doctrine”[1]  which provides that, in the case of any transaction to which the “economic substance doctrine” is relevant, the transaction shall be treated as having economic substance only if
(i)                         the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and
(ii)                        the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into the transaction. Section 7701(o)(5)(A) states that the term “economic substance doctrine” means the common law doctrine under which tax benefits are not allowable if the transaction does not have economic substance or lacks a business purpose.
The IRS is remiss in its failure to apply the explicit language of § 7701(o) to individuals and corporations creating foreign subsidiaries for the primary purpose and intent of minimizing, evading or avoiding their tax liabilities.  For example, the IRS could easily apply the explicit two-prong standards of § 7701(o) to the Irish subsidiaries of Apple as well as other manipulative corporate formations in offshore locations.   Those shell entities or other organizations, formed primarily to reduce U.S. taxation, can be treated as “sham” entities or disregarded by the IRS under the plain language of § 7701(o).   U.S. parents of these tax abusive organizations will find it difficult to establish that the offshore organization did not change their “economic position” in any “meaningful way” or that a “substantial purpose” was not tax motivated under § 7701(o) as well as judicial precedent establishing that the “substance” of a tax transaction prevails over its “form.”
The IRS is also remiss in not applying § 7701(o) to organizations formed solely to manufacture “carried interest” capital gain income.  Partnerships or corporations formed for the sole reason of converting ordinary income into capital gain could be disregarded under the plain language of § 7701(o), in addition to the application of judicial precedent for the “economic substance” doctrine.   “Carried interest” is manufactured by the general partners of private equity, venture capital, real estate, hedge funds and other investment vehicles organized as limited partnerships.  It is beyond understanding why the IRS does not attack these partnerships or corporations under the two-prong test of § 7701(o).   In substance, there are two parts of a carried interest transaction:  1) commission income or other income is received and 2) the income is utilized to generate capital gain income.    Any “carried interest” transaction can be bifurcated into the above two-part analysis either under § 7701(o) or the judicial precedent dealing with “substance over form”  articulated in classic cases such Commissioner v. Court Holding Co., 324 U.S. 331 (1945); Gregory v. Helvering, 293 U.S. 465 (1935).   The “carried interest” transactions are also technically tainted because income earned cannot be assigned after it is earned[2]
Unfortunately, the IRS has largely ignored its Congressional mandate to administer § 7701(o) to prevent the abuses identified by this Committee.


[1] Enacted s part of the Health Care and Education Reconciliation Act of 2010 (Act), Pub. L. No. 111-152. t. for transactions entered into on or after March 31, 2010.

[2] Lucas v. Earl, 281 U.S. 111 (1930) (212) 588-1113

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