The Solicitor General’s Curious Defense of the Economic Substance Doctrine

by Andy Grewal — Monday, Sept. 9, 2019

The taxpayers in Tucker v. Commissioner recently filed a petition for certiorari with the Supreme Court, asking it to review whether their complex transaction generated benefits under the federal tax code. The Fifth Circuit held that compliance with federal tax statutes was not enough, and that the judge-made economic substance doctrine “empowers the federal courts to disregard the claimed tax benefits of a transaction—even a transaction that formally complies with the black-letter provisions of the Code.” 766 F. App’x 132, 137 (5th Cir. 2019) (cleaned up). Under that doctrine, the district and appellate courts have frequently stated that taxpayers must meet subjective and objective tests in order for their transactions to earn tax benefits, even if no statute imposes those tests.[FN1] In their petition for certiorari, the taxpayers argue that this extrastatutory approach finds no basis in the Supreme Court’s decisions.

The Department of Justice’s Office of the Solicitor General has, in the past, denied that lower courts disregard tax statutes in favor of judge-made tests. In Winn Dixie Stores v. Commissioner, 254 F.3d 1313 (11th Cir. 2001), for example, the taxpayer-petitioner argued that the lower court had improperly characterized and employed the economic substance doctrine as a “threshold hurdle that must be overcome before the court analyzes particular code provisions.” See Petition for Certiorari, 2002 WL 32135968, *14-*15. But the Solicitor General argued that the court “did not hold that the [economic substance] doctrine applies independent of the Code.” See Brief in Opposition, 2002 WL 32135972, *14. This, along with other factors, led the Solicitor General to oppose the taxpayer’s petition.

The Solicitor General’s characterization of Winn-Dixie and other cases does not comport with the views commonly accepted elsewhere. Time and again, lower courts have expressly stated that the judge-made economic substance doctrine applies independently of and can override federal statutes. See generally Amandeep S. Grewal, Economic Substance and the Supreme Court, 116 Tax Notes 969 (2007) (contrasting lower courts’ extrastatutory approach with the Supreme Court’s statute-based approach). Additionally, at the trial and appellate levels, the government does not deny that the economic substance doctrine and occasionally other doctrines apply apart from legislative enactments. The IRS Chief Counsel and the Department of Justice routinely argue that taxpayers must satisfy judge-made tests even if they have complied with all relevant statutes and regulations. But the Office of the Solicitor General, across administrations, has resisted this common understanding.

At last, in Tucker, the Solicitor General’s office has unequivocally abandoned its peculiar view.[FN2] The government’s brief in opposition candidly acknowledges that the “economic-substance doctrine is not a canon for construing ambiguous statutory terms,” and that it applies “even if the transactions technically comply with the statutory and regulatory provisions that authorize such benefits.” See Brief in Opposition, Tucker v. Commissioner, pp. 10-11 (emphasis in original). The evolution in the Solicitor General’s position should provide a strong reason to grant certiorari. After all, both taxpayers and the government now agree that lower courts have applied judge-made doctrines rather than federal statutes. This presents a major separation of powers issue that the Court should resolve. Cf. also United States v. Woods, 571 U.S. 31, 37 n.1 (2013) (declining to express any view on the economic substance doctrine, as applied by the lower court).

However, the Solicitor General’s belated admissions may be harmless. The government argues that when Congress codified the economic substance doctrine in 2010, it “confirmed that the economic substance doctrine encompasses sham tax-avoidance transactions that otherwise comply with the Code.” See id. at p.13. Under new Section 7701(o), whenever the economic substance doctrine is “relevant,” a taxpayer must satisfy a statutory two-part test in order to establish its right to claimed tax benefits. See Section 7701(o)(1)(A) & (B). The Solicitor General believes that Section 7701(o) thus blesses, and in fact codifies, the principle that transactions must satisfy requirements “apart from compliance with the Code.” See id. at p.14 (emphasis in original).

We should all welcome clarity from Congress about the economic substance doctrine, but Section 7701(o) does not provide it. The statute defines the doctrine but says that it applies only when it is “relevant.” This returns us to square one: Under what circumstances may courts disregard federal statutes in favor of judge-made tests? See Brief of Amicus Curie Professor Amandeep S. Grewal, WFC Holdings v. United States, pp. 25-26 (S. Ct. 13-1037). It is impossible to tell without Supreme Court guidance. And, critically, the “relevance” issue has nothing to do with whether the Court decides a case before or after Congress enacted the new statute. Under Section 7701(o)(5)(C), “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.”  As the IRS itself acknowledges, Section 7701(o) does “not affect the ongoing development of authorities” on when the economic substance doctrine applies, IRS Notice 2010- 62, at 5 (Oct. 4, 2010).[FN3]

The Tucker petition thus presents a strong case for certiorari. The Supreme Court should provide guidance on when, if ever, courts may use the economic substance doctrine to override federal tax statutes. Case law under Section 7701(o) cannot develop coherently unless the Court resolves that threshold issue. Additionally, extrastatutory doctrines remain highly controversial, with one court even comparing the IRS’s practices to Caligula’s. See Summa Holdings, Inc. v. Commissioner, 848 F.3d 779, 781 (6th Cir. 2017) (Sutton, J.). One hopes that the Court provides guidance on these significant issues soon, whether in Tucker or another case.

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Comments welcome. This post may be updated.


FN1:  Judicial formulations have varied greatly, but in assessing whether a transaction has economic substance, courts have generally examined whether the taxpayer had any purpose for the transaction other than tax avoidance (the subjective test), and have also examined whether the transaction had any meaningful effect on the taxpayer’s economic position, aside from any potential tax reduction (the objective test).

FN2: The shift from Winn-Dixie to Tucker seems to have been gradual. In WFC Holdings v. United States, for example, the Solicitor General’s brief in opposition described the economic substance doctrine in common-law terms, but did not use language quite as forceful as that found in the Tucker opposition brief.

FN3: The Solicitor General thus errs when he asserts that Section 7701(o) necessarily blesses the extrastatutory approach adopted by most lower courts. Rather, it remains undetermined whether courts should apply the two factors listed in the statute in every single case, or instead only when an operative statute could be plausibly interpreted to embrace those two factors. See Brief of Amicus Curiae Professor Amandeep S. Grewal, Woods v. United States, pp. 18-20 (S. Ct. 12-562). For example, because Section 162 refers to deductions paid or incurred while “carrying on any trade or business,” courts have often applied economic substance principles to that section. The quoted language, after all, likely contemplates deductions made in connection with legitimate business activities, not deductions made solely to avoid taxes. But courts had split on how economic substance principles applied to statutes like Section 162.  Section 7701(o) now establishes a uniform approach. See Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 111th Congress, JCS-2-11 No. 19, 2011 WL 940385, *16 (Section 7701(o) “clarifies that the economic substance doctrine involves a conjunctive analysis” and “eliminates the disparity that exists among the Federal circuit courts regarding the application of the doctrine”).

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About Andy Grewal

Law Professor, University of Iowa

2 thoughts on “The Solicitor General’s Curious Defense of the Economic Substance Doctrine

  1. Jack Townsend

    Professor Grewal, thanks for your posting.

    You state that the SG has adopted a new position, abandoning one the SG adopted before. The new position, as you state it is:

    that the “economic-substance doctrine is not a canon for construing ambiguous statutory terms,” and that it applies “even if the transactions technically comply with the statutory and regulatory provisions that authorize such benefits.”

    Perhaps I quibble, but that just does not sound like a new position. As I understand the economic substance doctrine, that is the way it has worked since the beginning.

    In Helvering v. Gregory, 293 U.S. 465, 469 (1935), the Court said:

    But the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended. The reasoning of the court below in justification of a negative answer leaves little to be said.

    And, going to the Court below (the 2d Circuit), as the quote invites us to do, the famous opinion by Judge Learned Hand (Helvering v. Gregory, 69 F.2d 809, 810-811 (2d Cir. 1934) reasons:

    Therefore, if what was done here, was what was intended by section 112 (i) (1) (B), it is of no consequence that it was all an elaborate scheme to get rid of income taxes, as it certainly was. Nevertheless, it does not follow that Congress meant to cover such a transaction, not even though the facts answer the dictionary definitions of each term used in the statutory definition. It is quite true, as the Board has very well said, that as the articulation of a statute increases, the room for interpretation must contract; but the meaning of a sentence may be 811*811 more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create. The purpose of the section is plain enough; men engaged in enterprises — industrial, commercial, financial, or any other — might wish to consolidate, or divide, to add to, or subtract from, their holdings. Such transactions were not to be considered as “realizing” any profit, because the collective interests still remained in solution. But the underlying presupposition is plain that the readjustment shall be undertaken for reasons germane to the conduct of the venture in hand, not as an ephemeral incident, egregious to its prosecution. To dodge the shareholders’ taxes is not one of the transactions contemplated as corporate “reorganizations.”

    * * * *

    We do not indeed agree fully with the way in which the Commissioner treated the transaction; we cannot treat as inoperative the transfer of the Monitor shares by the United Mortgage Corporation, the issue by the Averill Corporation of its own shares to the taxpayer, and her acquisition of the Monitor shares by winding up that company. The Averill Corporation had a juristic personality, whatever the purpose of its organization; the transfer passed title to the Monitor shares and the taxpayer became a shareholder in the transferee. All these steps were real, and their only defect was that they were not what the statute means by a “reorganization,” because the transactions were no part of the conduct of the business of either or both companies; so viewed they were a sham, though all the proceedings had their usual effect.

    Perhaps my quibble has to do with the issue of whether the economic substance doctrine is a canon for construing ambiguous text, sort of like Chevron is a doctrine for interpreting ambiguous text. I think that the economic substance doctrine is a doctrine of statutory interpretation, not of ambiguous text, but the animating principle of the unambiguous text. E.g., Santander Holdings United States v. United States, 844 F.3d 15, 21 (1st Cir. 2016), “The economic substance doctrine, like other common law tax doctrines, can thus perhaps best be thought of as a tool of statutory interpretation.”). And as to other similar doctrines: Benenson v. Commissioner, 910 F.3d 690, 699 (2d Cir. 2018) ((substance over form doctrine “serves to ensure that the tax code’s ;technical language conform[s] more precisely with Congressional intent.,” quoting Benenson v. Commissioner, 887 F.3d 511, 517 (1st Cir. 2018)); and Benenson v. Commissioner, 910 F.3d 690, 702 (2d Cir. 2018) (“the step transaction doctrine, like the substance over form doctrine is a tool of statutory construction”).

    1. Andy Grewal Post author


      Thanks much for reading. I appreciate it. A few points:

      1) You have accurately stated that most people have long followed the extrastatutory articulation of the economic substance doctrine. I fully agree with that — most people believe the doctrine operates independently of statutes. I disagree with that characterization of SCOTUS precedent (my 2007 article and my amicus briefs explain why), but I happily acknowledge I am in the minority here.

      2) My statement about the Solicitor General was limited to his office. Obviously, the rest of the DOJ’s litigators readily believe that the doctrine overrides statutes. But if one reviews the SG’s various filings over the last two decades, he’ll see that the SG has not embraced that approach. It’s only in Tucker and in a lesser extent in Woods and WFC, that the SG has embraced the commonly accepted characterization (though not accepted by me). The Supreme Court has long been more textual than the lower courts, and so the SG has been shy, I believe, about asserting that judges have the power to override the tax code.

      3) I don’t think the economic substance doctrine, as commonly employed by lower courts, can be viewed as an ordinary rule of statutory interpretation. In economic substance cases, courts often expressly refuse to interpret the tax code. I’m aware of no principle of statutory interpretation that counsels against interpreting statutes. My thoughts are expressed in my 2007 article.

      Thank you again for the thoughtful comment.



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