Is “Form” “Substance” When it Comes to Law? The Future of the Doctrines of Economic Substance and Substance Over Form

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What is the Substance Over Form Doctrine?

Earlier this year, the Sixth Circuit took aim at the “substance-over-form” doctrine, an amorphous jurisprudential concept that has long shadowed the textually-driven Internal Revenue Code. Its opinion is a gem; a forceful rebuke that leads with an attention-grabbing reference to Caligula and raises serious questions about the role (and limits) of the doctrine of substance over form:

Caligula posted the tax laws in such fine print and so high that his subjects could not read them. That’s not a good idea, we can all agree. How can citizens comply with what they can’t see? And how can anyone assess the tax collector’s exercise of power in that setting? The Internal Revenue Code improves matters in one sense, as it is accessible to everyone with the time and patience to pore over its provisions.

. . .

[But] [i]f the government can undo transactions that the terms of the Code expressly authorize, it’s fair to ask what the point of making these terms accessible to the taxpayer and binding on the tax collector is. “Form” is “substance” when it comes to law. The words of law (its form) determine content (its substance). How odd, then, to permit the tax collector to reverse the sequence—to allow him to determine the substance of a law and to make it govern “over” the written form of the law—and to call it a “doctrine” no less.

The Code, a sprawling collection of more than 4 million “carefully”  placed words—words that are supplemented, of course, by even more voluminous regulations, rulings, and various administrative authorities—is obviously designed to raise revenue.  But it is also designed to incentivize certain behavior, generally by decreasing taxes or providing other beneficial treatment.  The Code is, in other words, a policy instrument, and it provides for many tax-based incentives.  Sometimes, however, the IRS takes offense to transactions that provide what it believes to be too much of a good thing—even when those transactions hew exactly to the text of the Code and utilize benefits that Congress (if we are to take it at its word) specifically authorized. The doctrine of substance-over-form is one of the IRS’s weapons of choice in attacking such transactions.  That doctrine holds that the substance rather than the technical form of a transaction governs its tax consequences.

But sometimes the Service’s application of the doctrine looks more like a statutory rewrite than a recasting of economic realities; less of a tool of statutory construction, and more of a results-driven device designed to give unambiguous statutory provisions an interpretation that the Service believes Congress should have meant.  This kind of “interpretive” exposition, however, flies in the face of the Summa Holdings court’s absolutely-correct observation that “[m]any provisions of the Code owe their existence solely to tax-reducing purposes: to lower current taxes or to shelter income from taxes over time.”

Summa Holdings

The decision in Summa Holdings was a somewhat rare rebuke of the Commissioner’s ever-expanding use of the substance-over-form doctrine.  It may signal a tilt-back on a pendulum that has swung pretty far to the government’s side in recent decades.  In Summa Holdings, the IRS invoked the doctrine in an effort to reclassify “Code-compliant” transactions (i.e., a transaction that was consistent with the text of the Code) to conform to what it called “overarching . . . principles of federal taxation”—what some might call, in a nod to philosophical realism (if not its less rhetorically dressed up twin, common sense) the interpretation that would result in more tax.  As the court noted, “[b]oth sides to th[e] dispute . . .  agree[d] that the[] transactions [at issue] . . . complied in full with the Internal Revenue Code.”  “If this case dealt with any other title of the United States Code,” the court remarked, “we would stop there, end the suspense, and rule for [the taxpayer].”  And then the court made clear that it simply was not going to bite on the IRS’s argument, countering that “if there is one title of the United States Code most deserving of attention to text, it is Title 26.”  Here, here!  The court went on to elaborate:

This is the highly reticulated Internal Revenue Code [we are talking about], which uses language, lots of language, with nearly mathematic precision. Is there any other title of the United States Code that has devoted more carefully drawn words to reducing its purpose to text? Perhaps the Commissioner’s approach made some sense decades ago, when the Code was simpler, and before Congress decided to pursue a wide range of policy goals through a complicated set of tax credits, deductions, and savings accounts. But today, of all areas of law that should resist judicial innovation based on misty calls to higher purposes, this would seem to be it.

Famous Tax Quotes

The court’s lofty language calls to mind some of the most oft-quoted judicial platitudes concerning tax law, including Judge Learned Hand’s famous quote:

Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.

Gregory v. Helvering, 69 F.2d 809, 810 (2d Cir. 1934).  And the good Judge’s equally famous quote:

Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere can’t.

Commissioner v. Newman, 159 F.2d 848, 851 (2d Cir. 1947) (dissenting opinion).

The Substance-Over-Form Doctrine

The substance-over-form doctrine traditionally takes its roots from the Supreme Court’s holdings in Gregory v. Helvering, 293 U.S. 465, 469-470 (1935).  “The substance over form doctrine applies when the transaction on its face lies outside the plain intent of the statute and respecting the transaction would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.” Gregory v. Helvering, 293 U.S. at 470.  Subsequent Supreme Court cases have engrained the doctrine into our tax law, making clear that courts will “look[] to the objective economic realities of a transaction rather than to the particular form the parties employed.” Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978).  See also Commissioner v. Court Holding Co., 324 U.S. 331 (1945).

But those broad principles—the precise contours of which are often quite fuzzy— have, over time, fallen victim to a bit of “mission creep,” expanding their “jurisdiction” to undo many transactions that conform to the strict text of the Code.  The court’s opinion in Summa Holdings pushes back on this expansion: “It’s one thing to permit the Commissioner to recharacterize the economic substance of a transaction—to honor the fiscal realities of what taxpayers have done over the form in which they have done it. But it’s quite another to permit the Commissioner to recharacterize the meaning of statutes—to ignore their form, their words, in favor of his perception of their substance.”  This reasoning, though not stated in so many words, gets at a separation-of-powers concern.  It also gets at a concern that taxpayers should be able to rely on the unambiguous text of the law—even when that text does not comport with the IRS’s view of good policy or what the law should mean.  As the court elaborated:

[T]he substance-over-form doctrine does not give the Commissioner a warrant to search through the Internal Revenue Code and correct whatever oversights Congress happens to make or redo any policy missteps the legislature happens to take.

The Summa Holdings decision has built on a handful of cases that have pushed back on the Service’s attempts to read more into the Code than its text provides.  The Sixth Circuit’s decision in Wright v. Commissioner, decided by a different panel of judges only a number of months earlier, came to a similar conclusion.  And the Fifth Circuit’s 2015 decision in Pilgrim’s Pride Corp. v. Commissioner, employed a text-driven analysis to overturn the Tax Court.  Of course, the Supreme Court’s 2001 decision in Gitlitz v. Commissioner reversed the Tax Court by invoking a plain reading of the text of the Code too.

Ultimately, however, the impact of Summa Holdings outside the Sixth Circuit remains to be seen.  Will it be cited liberally by other courts?  Its extension may, perhaps, be cabined by the somewhat recent codification of the economic substance doctrine in section 7701(o)—a codification that did not impact the analysis in Summa Holdings.  At the same time, though, the Sixth Circuit proceedings were one of three related appeals from the underlying case, all of which were appealed to different circuit courts.  The Sixth circuit’s opinion was the first to go to the press.  The two other appeals courts have yet to rule.  If they do not adopt the Sixth Circuit’s view, there will be a clear circuit split (if there is not already), which could make the issue ripe for the Supreme Court to weigh in.