Part III - Administrative, Procedural, and Miscellaneous
Interim Guidance under the Codification of the Economic
Substance Doctrine and
Related Provisions in the Health Care and Education
Reconciliation Act of 2010
Notice 2010-62
PURPOSE
This notice provides interim guidance regarding the
codification of the economic
substance doctrine under section 7701(o) and the related
amendments to the penalties
under sections 6662, 6662A, 6664, and 6676 by section 1409
of the Health Care and
Education Reconciliation Act of 2010 (Act), Pub. L. No.
111-152. The notice applies
with respect to transactions entered into on or after March
31, 2010, which is the
effective date for the amendments made by section 1409 of
the Act.
BACKGROUND
Section 1409 of the
Act added new section 7701(o) to the Code. Section
7701(o)(1) 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 2
transaction. Section 7701(o)(5)(A) states that the term
“economic substance doctrine”
means the common law doctrine under which tax benefits under
subtitle A with respect
to a transaction are not allowable if the transaction does
not have economic substance
or lacks a business purpose.
that the
determination of whether the economic
substance doctrine is relevant to a transaction shall be
made in the same manner as if
section 7701(o) had never been enacted. With respect to
individuals, however, section
7701(o)(5)(B) states that the two-prong analysis in section
7701(o)(1) shall apply only to
a transaction entered into in connection with a trade or
business or an activity engaged
in for the production of income. In addition, section
7701(o)(5)(D) states that the term
“transaction” as used in section 7701(o) includes a series
of transactions.
Section 7701(o)(2)(A)
provides that a transaction’s potential for profit shall be
taken into account in determining whether the requirements
of section 7701(o)(1) are
met only if the present value of the reasonably expected
pre-tax profit is substantial in
relation to the present value of the claimed net tax
benefits. For purposes of computing
pre-tax profit, section 7701(o)(2)(B) provides that the
Secretary shall issue regulations
treating foreign taxes as a pre-tax expense in appropriate
cases.
The Act also added section 6662(b)(6), which provides that
the accuracy-related
penalty imposed under section 6662(a) applies to any
underpayment attributable to any
disallowance of a claimed tax benefit because of a
transaction lacking economic
substance (within the meaning of section 7701(o)) or failing
to meet any similar rule of
law (collectively a section 6662(b)(6) transaction). The Act
also added section 6662(i), 3
which increases the accuracy-related penalty from 20 to 40
percent for any portion of an
underpayment attributable to one or more section 6662(b)(6)
transactions with respect
to which the relevant facts affecting the tax treatment are
not adequately disclosed in
the return or in a statement attached to the return.
Furthermore, new section 6662(i)(3)
provides that certain amended returns or any supplement to a
return shall not be taken
into consideration for purposes of section 6662(i).
The Act amended section 6664(c) so that the reasonable cause
exception for
underpayments found in section 6664(c)(1) shall not apply to
any portion of any
underpayment attributable to a section 6662(b)(6)
transaction. The Act similarly
amended section 6664(d) so that the reasonable cause
exception found in section
6664(d)(1) shall not apply to any reportable transaction
understatement (within the
meaning of section 6662A(b)) attributable to a section
6662(b)(6) transaction. The Act
also amended section 6676 so that any excessive amount
(within the meaning of
section 6676(b)) attributable to any section 6662(b)(6)
transaction shall not be treated
as having a reasonable basis.
APPLICATION OF THE ECONOMIC SUBSTANCE DOCTRINE WITH RESPECT
TO
TRANSACTIONS ENTERED INTO AFTER THE EFFECTIVE DATE OF THE
ACT
A. Application of the Conjunctive Test
For transactions
entered into on or after March 31, 2010, to which the economic
substance doctrine is relevant, section 7701(o)(1) mandates
the use of a conjunctive
two-prong test to determine whether a transaction shall be
treated as having economic
substance. The first prong, found in section 7701(o)(1)(A),
requires that the transaction 4
change in a meaningful way (apart from Federal income tax
effects) the taxpayer’s
economic position. The second prong, found in section
7701(o)(1)(B), requires that the
taxpayer have a substantial purpose (The second prong, found
in section 7701(o)(1)(B), requires that the
taxpayer have a substantial purpose (apart from Federal
income tax effects) for entering
into the transaction.
The IRS will continue
to rely on relevant case law under the common-law
economic substance doctrine in applying the two-prong
conjunctive test in section
7701(o)(1). Accordingly, in determining whether a
transaction sufficiently affects the
taxpayer’s economic position to satisfy the requirements of
section 7701(o)(1)(A), the
IRS will apply cases under the common-law economic substance
doctrine (as identified
in section 7701(o)(5)(A)) pertaining to whether the tax
benefits of a transaction are not
allowable because the transaction does not satisfy the
economic substance prong of the
economic substance doctrine. Similarly, in determining
whether a transaction has a
sufficient nontax purpose to satisfy the requirements of
section 7701(o)(1)(B), the IRS
will apply cases under the common-law economic substance
doctrine pertaining to
whether the tax benefits of a transaction are not allowable
because the transaction
lacks a business purpose.
The IRS will challenge taxpayers who seek to rely on prior
case law under the
common-law economic substance doctrine for the proposition
that a transaction will be
treated as having economic substance merely because it
satisfies either section
7701(o)(1)(A) (or its common-law corollary) or section
7701(o)(1)(B) (or its common-law
corollary). For all transactions subject to section 1409 of
the Act that otherwise would
have been subject to a common-law economic substance
analysis that treated a 5
transaction as having economic substance merely because it
satisfies either section
7701(o)(1)(A) (or its common-law corollary) or section
7701(o)(1)(B) (or its common-law
corollary) the IRS will apply a two-prong conjunctive test
consistent with section
7701(o).
B. Determination of Economic Substance Transactions
Section 7701(o)(5)(C)
provides that the determination of whether a transaction is
subject to the economic substance doctrine shall be made in
the same manner as if
section 7701(o) had never been enacted. In addition, section
7701(o)(1) only applies in
the case of any transaction to which the economic substance
doctrine is relevant.
Consistent with these provisions, the IRS will continue to
analyze when the economic
substance doctrine will apply in the same fashion as it did
prior to the enactment of
section 7701(o). If authorities, prior to the enactment of
section 7701(o), provided that
the economic substance doctrine was not relevant to whether
certain tax benefits are
allowable, the IRS will continue to take the position that
the economic substance
doctrine is not relevant to whether those tax benefits are
allowable. The IRS anticipates
that the case law regarding the circumstances in which the
economic substance
doctrine is relevant will continue to develop. Consistent
with section 7701(o)(5)(C),
codification of the economic substance doctrine should not
affect the ongoing
development of authorities on this issue. The Treasury
Department and the IRS do not
intend to issue general administrative guidance regarding
the types of transactions to
which the economic substance doctrine either applies or does
not apply.
C. Calculating Net
Present Value of the Reasonably Expected Pre-tax Profit.
In determining whether
the requirements of section 7701(o)(1)(A) and (B) are
met, the IRS will take into account the taxpayer’s profit
motive only if the present value
of the reasonably expected pre-tax profit is substantial in
relation to the present value of
the expected net tax benefits that would be allowed if the
transaction were respected for
Federal income tax purposes. In performing this calculation,
the IRS will apply existing
relevant case law and other published guidance.
D. Treatment of Foreign Taxes as Expenses in Appropriate
Cases.
Section 7701(o)(2)(B) provides that the Secretary shall
issue regulations
requiring foreign taxes to be treated as expenses in
determining pre-tax profit in
appropriate cases. The Treasury Department and the IRS
intend to issue regulations
pursuant to section 7701(o)(2)(B). In the interim, the
enactment of the provision does
not restrict the ability of the courts to consider the
appropriate treatment of foreign taxes
in economic substance cases.
ACCURACY-RELATED PENALTIES
Unless the transaction is a reportable transaction, as
defined in Treas. Reg.
§ 1.6011-4(b), the adequate disclosure requirements of
section 6662(i) will be satisfied
if a taxpayer adequately discloses on a timely filed
original return (determined with
regard to extensions) or a qualified amended return (as
defined under Treas. Reg.
§ 1.6664-2(c)(3)) the relevant facts affecting the tax
treatment of the transaction. If a
disclosure would be considered adequate for purposes of
section 6662(d)(2)(B) (without
regard to section 6662(d)(2)(C)) prior to the enactment of
section 1409 of the Act, then it 7
will be deemed to be adequate for purposes of section
6662(i). The disclosure will be
considered adequate only if it is made on a Form 8275 or
8275-R, or as otherwise
prescribed in forms, publications, or other guidance
subsequently published by the IRS
consistent with the instructions and other guidance
associated with those subsequent
forms, publications, or other guidance. Disclosures made
consistent with the terms of
Rev. Proc. 94-69 also will be taken into account for
purposes of section 6662(i). If a
transaction lacking economic substance is a reportable
transaction, as defined in Treas.
Reg. § 1.6011-4(b), the adequate disclosure requirement
under section 6662(i)(2) will
be satisfied only if the taxpayer meets the disclosure
requirements described earlier in
this paragraph and the disclosure requirements under the
section 6011 regulations.
Similarly, a taxpayer will not meet the disclosure
requirements for a reportable
transaction under the section 6011 regulations by only
attaching Form 8275 or 8275-R
to an original or qualified amended return.
EFFECT ON OTHER DOCUMENTS
The IRS will not
issue a private letter ruling or determination letter pursuant to
section 3.02 (1) of Rev. Proc. 2010-3, 2010-1 I.R.B. 110 (or
subsequent guidance),
regarding whether the economic substance doctrine is
relevant to any transaction or
whether any transaction complies with the requirements of
section 7701(o).
Accordingly, Rev. Proc. 2010-3 is modified.
REQUEST FOR COMMENTS
The IRS is interested
in comments concerning the disclosure requirements set
forth in this notice with regard to section 6662(i),
especially with regard to the interplay
8
between Rev. Proc. 94-69, proposed Schedule UTP, and the
LMSB compliance
assurance process (CAP) program. Interested parties are
invited to submit comments
on this notice by December 3, 2010. Comments should be
submitted to: Internal
Revenue Service, CC:PA:LPD:PR (Notice 2010-62), Room 5205,
P.O. Box 7604, Ben
Franklin Station, Washington, DC 20224.
www/offerincompromiseform656.com
Alvin Brown & Associates, PLLC
212-588-1113
www.irstaxattorney.com (212) 588-1113
ab@irstaxattorney.com
