On September 21, 2023, the United States Court of Appeals for the Federal Circuit decided GSS Holdings (Liberty) Inc. v. United The decision was not earth shattering, but the disagreement between the majority and the dissent about the substance-over-form doctrines demonstrates their indistinct boundaries and the difficulty judges have understanding and applying these related doctrines.
In GSS Holdings, the Federal Circuit reversed the United States Court of Federal Claims decision in GSS Holdings (Liberty) Inc. v. Unitedreasoning that the Claims Court had inappropriately conflated the step transaction and economic substance doctrine, which are “two separate Under the step transaction doctrine, a trial court assesses the intent of the taxpayer when entering the transactions “from the In doing so, the court determines whether the separate transactions “were really component parts of a single transaction intended from the outset to be taken for the purpose of reaching the ultimate In contrast, under the economic substance doctrine, a court focuses solely on the transaction that led to the alleged tax benefit, then analyzes whether that specific transaction had “economic The Claims Court claimed it was applying the step transaction doctrine, but the Federal Circuit found that it focused on the wrong transaction. Surprisingly, neither party disagreed that the Claims Court had conflated the two doctrines. On appeal, the parties’ only disagreement was about which transaction was the “outset” transaction for application of the step transaction doctrine. The Federal Circuit vacated the Claims Court’s judgment granting the government summary judgment and remanded the case, leaving that choice to the lower court.
While the majority and the litigants all agreed that the Claims Court had conflated the doctrines, the dissent disagreed. The dissent argued that the correct doctrine to apply was the substance-over-form doctrine because the step transaction doctrine is merely “a judicial manifestation of the more general tax law ideal that effect should be given to the substance, rather than the form, of aIn other words, the dissent disagreed that the Claims Court had applied an incorrect doctrine because the doctrines are merely different methods of arriving at a substance-over-form analysis.
As I explained many yearssubstance over form serves as a background principle supporting a group of related doctrines, including the step transaction doctrine and the economic substance doctrine. Collectively, these doctrines permit courts and the IRS to reject a taxpayer’s characterization of a business transaction that arguably meets the precise terms of a tax statute but simultaneously seeks tax benefits Congress did not intend. It is not surprising that judges would conflate these doctrines: the doctrines’ boundaries are indistinct and judicial terminology is inconsistent. The general principle underlying all these judicially created, anti-abuse doctrines is that the IRS should give effect to the substance of a transaction rather than its form--hence, the name “substance over form.”
In 1935, the Supreme Court decided Gregory v.While all the common law anti-abuse doctrines can trace their roots to Gregory, this case is perhaps best known for birthing the business purpose doctrine. In Gregory, the taxpayer, a wealthy businesswoman, was the sole shareholder of a corporation that owned stock in a second corporation. Mrs. Gregory wanted to sell the second corporation’s block of stock; however, she did not want to pay the higher ordinary income tax rate on the dividend distributions. To avoid doing so, Mrs. Gregory took the following steps: (1) formed a third corporation; (2) exchanged the block of stock in the second corporation for shares in the newly formed third corporation; (3) liquidated the third corporation; and (4) claimed that the dividend resulted from a reorganization, thus entitling her to substantially reduce her tax liability under reorganization tax laws. The IRS refused to recognize the transaction as a valid reorganization because the taxpayer’s sole motive was tax avoidance. Literally interpreting the term “reorganization” in the Revenue Act of 1928, the Board of Tax Appeals agreed with Mrs. Gregory. Despite the taxpayer’s motivation, the tax court upheld the reorganization on appeal because it complied literally with the law. The United States Court of Appeals for the Second Circuit reversed.
Rejecting literalism, the Supreme Court affirmed. After noting that tax avoidance and minimization are indeed legitimate, the Court criticized Mrs. Gregory’s reorganization as 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
Although acknowledging that the transaction was conducted in accordance with the literal Code language, the Court nevertheless refused to recognize the transaction as a legitimate tax-free reorganization under the statute. “To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all seriousAsking “whether what was done, apart from the tax motive, was the thing which the statute the Court crafted the judicial business purpose doctrine.
Like the business purpose doctrine, the substance-over-form doctrine (oris also a judicially created interpretive tool that allows the IRS and courts to require more than literal compliance with the tax laws. Although referenced in early case law, the substance-over-form principle similarly had its start in Gregory. When denying Mrs. Gregory the tax benefits she claimed, the Supreme Court criticized her transaction as “a mere device which put on the form of a corporate reorganization as a disguise for concealing its real Two later cases built on this idea. In Higgins v. Smith, the Supreme Court stated that “[t]he Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the Then, in Commissioner v. Court Holding Co., the Court refused to “permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities,” because “[t]he incidence of taxation depends on the substance of a