Advising clients that are considering highly structured tax shelter transactions is difficult, in part because of the conflicting authorities. These sophisticated transactions involve large nominal dollar amounts, but generally little or no economic consequences apart from the tax benefits that are sought.
While the Tax Court has generally been comfortable imposing a requirement of business purpose and economic substance to justify U.S. federal income tax consequences, other federal courts, including now at least two Circuit Courts, have effectively reduced this condition to a mere formality. Late last year the U.S. Court of Appeals for the Fifth Circuit reversed the Tax Court and upheld Compaq Computer’s use of a dividend-stripping transaction to obtain a large U.S. federal income tax benefit. This came on the heels of a federal District Court decision approving American Home Product’s exploitation of an apparent loophole in the installment sale regulations to generate an artificial tax loss.
