The Internal Revenue Service has released its first set of guidance on the newly codified economic substance doctrine.
The doctrine has long been part of common law, but was only recently made an official part of the Tax Code, thanks to the passage earlier this year of the health care reform bill.
Notice 2010-62 provides interim guidance regarding the codification of the economic substance doctrine under Section 7701(o) and the related amendments to penalties in the Tax Code by Section 1409 of the Health Care Education Reconciliation Act of 2010.
The term economic substance doctrine is a common law doctrine under which tax benefits with respect to a transaction are not allowable if the transaction does not have economic substance or lacks a business purpose. The new section of the Tax Code 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 the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayers economic position, and if the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into the transaction.
With respect to individuals, a two-prong analysis 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.
A transactions 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, the Treasury Secretary will issue regulations treating foreign taxes as a pre-tax expense in appropriate cases.
The IRS will not issue a private letter ruling or determination letter regarding whether the economic substance doctrine is relevant to any transaction or whether any transaction complies with the requirements of Section 7701(o).
The IRS is asking for comments on the new guidance, which can be directed to Notice.Comments@irscounsel.treas.gov with Notice 2010-62 in the subject line.
The notice is effective with respect to transactions entered into on or after March 31, 2010.
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