Section of Taxation
The Tax Lawyer vol. 52 no. 3 Spring 1999

The Tax Lawyer
VOL. 52 NO. 3

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Article Absracts

Lewis R. Steinberg


In teaching law students and young tax associates, I often point out that there are two fundamental principles in Subchapter C of the Code: "Substance controls, form does not" and "form controls, substance does not." This intentionally paradoxical formulation is intended to convey one of the greatest challenges of practicing in the corporate tax area (or, for that matter, in most areas of the federal income tax law): when will the transactional form selected by the parties control the tax consequences to them?

Federal income tax advisors often assert, with some measure of disdain, that some other body of tax law (for example, state, local, employee benefits, U.K., etc.) is predominantly form-driven, unlike the federal income tax area, where (so it is averred) practitioners possess highly-developed intuitive powers for divining the economic substance of any transaction and applying the relevant tax principles and rules in accordance with that substance. Yet one of the most extraordinary aspects of the latter claim is that, at least in Subchapter C, it is at best only partially true. How often have clients, corporate lawyers, investment bankers and first year tax associates been surprised to learn that a "B reorganization" can be consummated by means of a merger ( i.e. substance controls, but a transfer of all the assets and liabilities of one corporation to another in exchange for stock of the acquirer will not qualify as an "A reorganization" unless the transfer is by way of a merger under state law (i.e. form controls)? Such differences in result are common traps for inexperienced practitioners.

The flip side of the form/substance distinction is also commonly encountered. In many cases, there may be a number of different formal transactional structures that could be employed to accomplish the substantive commercial goals of the parties. If different tax rules and principles apply to the different transactional forms, resulting in differing levels of tax efficiency for the parties, a question may arise whether the Service will "respect" the form selected by the parties. The determination ultimately turns on the scope of doctrines such as "substance over form," step transaction, agency, tax ownership, etc., in corporate taxation.

A related aspect of Subchapter C is the degree to which "directionality" continues to play a role in corporate taxation. Throughout Subchapter C, tax consequences can differ depending on whether a person is viewed as initiating an action or, instead, as being the person against whom an action is initiated. For example, the tax consequences to the parties under section 368 and its correlative provisions frequently turn on whether a given corporation is the "acquired corporation" rather than the "acquiring corporation" and which is the "distributing corporation." But, as most practitioners know, selection of "acquired" versus "acquiring," or "controlled" versus "distributing," status is ultimately simply a matter of form and frequently of commercial indifference to the parties. Directionality is thus another manifestation of form controlling tax consequences in Subchapter C and, although its influence has been waning in recent years (particularly in the context of section 355), directionality continues to play an important role in corporate taxation.

One of my key conclusions in this Article is that substance does not always control in Subchapter C, both because proper form is sometimes a necessary condition for the desired tax treatment and because where the substance of a transaction is ambiguous or capable of being achieved through more than one transactional approach, form frequently becomes the dispositive factor in determining the tax treatment for the parties. Most experienced practitioners, however, have so completely internalized the process of making form versus substance determinations that they seem no longer aware of the continuing significance of form in corporate taxation.

This Article analyzes the scope and limits of form and directionality principles in Subchapter C, focusing on transactions that, while differing in form and tax consequences to the parties, do not materially differ in substance. Part II of this Article provides a number of examples of where form controls the corporate income tax consequences to the parties to a transaction. Part III discusses the continued importance of directionality in Subchapter C. Part IV sets forth some general principles, distilled from the relevant legal authorities, of when the Service and the courts will disregard the form selected by the parties in applying the rules set forth in Subchapter C. Finally, Part V adduces some explanations for the curious continuing vitality if form-driven analysis in corporate taxation.

My intent in writing this Article is threefold. First, I hope to resensitize experienced corporate tax practitioners to the limits of the "substance controls all" mantra. Second, I want to provide readers with some broad guidelines for determining when the transactional form selected by the parties to a transaction will be respected for corporate tax purposes. And finally, I wish to review for the practicing tax advisor some of the planning opportunities that remain in Subchapter C.

Naftali Z. Dembitzer


The authority of the Treasury Department (the "Treasury") to promulgate regulations is circumscribed by nontax legislation. When issuing tax regulations, the Treasury and, by delegation, the Internal Revenue Service (the "Service") must comply with the requirements of the Administrative Procedure Act of 1946, providing taxpayers with appropriate advance notice and considering comments from the public before issuing final regulations, except in limited circumstances.

The type of guidance that may be issued by administrative agencies in the form of rules and regulations is also limited. For example, the Treasury and the Service cannot make law through tax regulations; the ability to enact laws is the sole province of the legislature under our democratic system of government. Indeed, Congress is grappling with the precise contours of this administrative agency limitation in international tax matters.

Despite these somewhat clear guidelines, the Treasury and the Service recently have (1) issued administrative notices declaring war on certain "abusive" transactions; (2) issued proposed regulations and immediately effective temporary regulations without giving taxpayers advance notice of their impending release; (3) attempted to overrule judicial precedent through tax regulations; and (4) otherwise failed to publish in final form various long-standing proposed regulations and temporary regulations, some of which were issued a decade ago. All of these practices make it difficult for the taxpayer to comply with a complex mix of precedential tax authorities, and makes it increasingly problematic for the tax practitioner to advise clients on a daily basis.

This Article begins by discussing the obligations of the Treasury and the Service under the Administrative Procedure Act, the differences between various tax regulations and the precedential value of the different types of tax regulations. This Article then identifies some of the more recent abuses of the Treasury and the Service involving their rulemaking authority. It concludes by making specific recommendations for change and suggests that, now that the Internal Revenue Service Reform Act, P.L. 105-206, has been enacted (the "IRRA 1998"), Congress should scrutinize the Treasury’s and the Service’s use and misuse in their rulemaking authority.

Robert J. Staffaroni


Recently some of the largest U.S. corporations have entered into business combinations with some of the largest foreign corporations. One example is the combination of Chrysler Corporation with Daimler-Benz AG to form DaimlerChrysler AG. Another is the combination of Amoco Corporation and British Petroleum Co. PLC to form BP Amoco PLC, followed by the announced merger of BP Amoco PLC with Atlantic Richfield Co. In the meantime, Vodafone Group PLC, a U.K. corporation, and AirTouch Communications, Inc., a U.S. corporation, announced a combination that is expected to create a company with a combined value of at least U.S. $110 billion.

Combinations of U.S. and foreign corporations in which the consideration is primarily stock are among the most challenging puzzles for tax advisors. These transactions require a comparative analysis of a variety of potential structures, which inevitably include: (1) a U.S. corporate parent; (2) a corporate parent in the jurisdiction of the foreign party to the combination; (3) a corporate parent in a neutral jurisdiction outside the United States (such as The Netherlands); and (4) more complex structures involving features such as income access shares or dual holding companies. There is often a strong preference from the non-tax constituencies for a single parent company with a simple capital structure. Although all of these potential structures generally involve some tax inefficiencies because of the border-crossing cash flows, the inefficiencies frequently are greatest when the parent is a U.S. Corporation. This result flows from a number of differences between the U.S. federal income tax system and the tax laws of foreign (particularly Western European) countries, including the following:

In a number of countries, dividends received by a parent corporation from foreign subsidiaries are exempt from tax. In contrast, a U.S. parent corporation is subject to U.S. federal income tax on dividends from foreign subsidiaries. Although foreign withholding taxes, as well as foreign income taxes on the profits of the foreign subsidiary out of which the dividends are paid, may be claimed by a U.S. parent as a credit against U.S. federal income tax, such credits often will not fully offset the U.S. tax on the dividend. Even if the foreign tax rate is comparable to the U.S. rate, the complex mechanics of the foreign tax credit computation, including in particular the requirement that the interest of the U.S. group be allocated in part to foreign dividends, can make it difficult to fully credit foreign income taxes.

In a number of countries, shareholders generally are entitled to special credits or exemptions with respect to certain dividends received from a parent corporation organized in their home country, reflecting the integration of the corporate and shareholder tax regimes. Such credits usually are not provided for dividends received from foreign corporations and, thus would be lost with a U.S. parent company. In contrast, the U.S. provides only partial relief from double taxation for corporate shareholders through a dividends received deduction, and no relief to individual shareholders. The loss of integration tax benefits to the foreign company’s shareholders resulting from a U.S. parent company often far outweighs the loss of the dividends received deduction to the U.S. company’s corporate shareholders resulting from a non-U.S. parent company. Because, in neither case, a withholding tax ordinarily must be borne by shareholders who are not resident in the country of the parent company, such withholding frequently is a neutral factor in the analysis.

A U.S. corporate parent would be subject to the complex anti-deferral regime under Subpart F with respect to the interest in the foreign corporation. That regime requires detailed annual information reporting with respect to the foreign corporation and can result in income inclusions by the U.S. parent company even before actual dividends are received from the foreign subsidiary, under a variety of circumstances. Although some other countries also have special tax regimes applicable to investments by a parent company in foreign subsidiaries, those regimes often are less onerous to deal with than Subpart F.

Another key piece to the puzzle when shareholders are to receive consideration wholly or primarily in the form of stock is whether the transaction will be a taxable event to shareholders. Even if a jurisdiction ordinarily permits a deferral of gain recognition in corporate business combinations involving the receipt of stock of a locally-incorporated corporation by shareholders, deferral may be unavailable, or may require compliance with considerably stricter conditions, when the shareholders receive stock in a foreign corporation.

For U.S. shareholders, Subchapter C contains a number of provisions under which the transfer of stock or securities of one corporation in exchange for stock or securities of another corporation may qualify, in whole or in part, for nonrecognition of gain or loss. In particular, gain may qualify for nonrecognition under section 351 when property is transferred to a corporation controlled by the transferors, or under section 354 or 356 when stock or securities of a corporation are exchanged for stock or securities of another corporation in a reorganization. In general, these provisions apply regardless of whether the corporations involved are domestic or foreign. Section 367, however, provides special rules applicable to these and certain other nonrecognition transactions involving one or more foreign corporations.

This Article describes the development of the rules under section 367applicable to transfers by United States persons of stock or securities of a domestic corporation to a foreign corporation in a transaction that would otherwise qualify for nonrecognition of gain under section 351, 354, or 356, and analyzes some of the technical issues that have arisen in practice under the current regulations. As discussed below, many of these issues arise in connection with the "substantiality test," under which the relative size of the combining companies matters a great deal- unless the foreign company is at least as large as the domestic company, a transaction in which the foreign company is the acquirer will be taxable. Finally, this Article attempts to analyze the underlying policy issues and consider whether the regulations appropriately deal with these issues.