Tax News
New Guidance on Economic Substance
December 07, 2010
Administrative Actions
As many know, year 2010 was a very notable year when it comes to the economic substance doctrine.  After several years, finally Congress enacted new Section 7701(o) as part of the Health Care and Education Reconciliation Act of 2010, and thus finally codified the long standing doctrine that emanated from Gregory v. Helvering many years ago. On its face, the enactment seemed simplistic enough, but it left practitioners with too many questions.  In an attempt to address some of these questions, the IRS issued Notice 2010-62 on December 4th, 2010.  The guidance addresses four principal issues: (1) the application of the so called "conjunctive test," (2) ascertaining what transactions are succeptible to the application of the economic substance doctrine, (3) calculating the net present value of the reasonably expected pre-tax profit, and (4) treatment of foreign taxes as expenses in appropriate cases.

The application of the economic substance doctrine and the Notice is by no means limited to private equity, hedge funds and their investors and managers. To the contrary, it potentially has an application to any transaction that on its face lacks an element of business purpose or an expectation for profit aside from tax considerations.  The participants in the fund industry could be directly or indirectly exposed to these rules every time they engage in an aggressive tax position. Considering the substantial penalties, the doctrine and the Notice are something to keep in mind at all times.
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Tags: economic substance, economic substance doctrine