Daily Tax Update - July 15, 2011: IRS Issues Economic Substance Directive

IRS ISSUES DIRECTIVE PROVIDING GUIDANCE TO EXAMINERS ON CODIFIED ECONOMIC SUBSTANCE DOCTRINE AND RELATED PENALTIES:   The IRS issued a LB&I directive dated July 15, 2011, to instruct examiners on how to determine when it is appropriate to seek the approval of the appropriate Director of Field Operations in asserting the codified economic substance doctrine. 

  • The directive provides that the examiner must develop and analyze a series of inquiries in order to seek approval for the ultimate application of the doctrine in the examination.
    • As a first inquiry, an examiner should evaluate whether the circumstances in the case are those under which application of the economic substance doctrine to a transaction is likely not appropriate.  The directive provides a list of facts and circumstances that tend to show that application of the doctrine is likely not appropriate.
    • Second, an examiner should evaluate whether the circumstances in the case are those under which application of the doctrine to the transaction may be appropriate.  The directive provides a list of facts and circumstances that tend to show that application of the doctrine may be appropriate.
    • Third, if an examiner determines that the application of the doctrine may be appropriate, the directive provides a series of inquiries an examiner must make before seeking approval to apply the doctrine.
    • Fourth, if an examiner and his or her manager and territory manager determine that application of the economic substance doctrine is merited, guidance is provided on how to request approval of the appropriate Director of Field Operations.
  • The directive also provides that, until further guidance is issued, the penalties in sections 6662(b)(6) and (i) and 6676 are limited to the application of the economic substance doctrine and may not be imposed with respect to the application of any other "similar rule of law" or judicial doctrine, such as step transaction, substance over form, or sham transaction.
  • The directive indicates that the examiner should notify the taxpayer that he or she is planning to perform an economic substance analysis before commencing that analysis, and that if the Director of Field Operations decides to proceed, the taxpayer should be given an opportunity to be heard regarding whether the doctrine should apply.
  • The directive also provides for various levels of review of an examiner’s decisions, before assertion of the doctrine may proceed; the level of review varies with the nature of the transaction.
  • The directive indicates that, generally, transactions should be looked at as a whole, but that in certain circumstances, particular steps may be analyzed on their own
  • The directive also indicates that certain types of transactions, including corporate organizations or reorganizations, are not likely to be candidates for an economic substance challenge.
  • The directive is not binding on the Service and cannot be cited as precedent.
  • The directive can be accessed here.
  • For additional information, contact Mark J. Silverman - msilverman@steptoe.com, Matthew D. Lerner - mlerner@steptoe.com,  or Aaron P. Nocjar -   anocjar@steptoe.com.

S&P WARNS OF CREDIT DOWNGRADE – OBAMA:  TIME TO "SEIZE THE MOMENT": Today, Standard and Poor's issued a warning that it might lower its debt rating on US government debt if the debt limit is not raised.  S&P’s statement said, "Owing to the dynamics of the political debate on the debt ceiling, there is at least a one-in-two likelihood that we could lower the long-term rating on the US within the next 90 days." Earlier this week, Moody's Investors Service placed the government's triple-A bond rating on review for possible downgrade based on the increasing possibility that the statutory debt limit will not be raised on a timely basis. 

  • Today, President Obama, Republicans and Democratic leaders all held separate press conferences. The President said, "[W]hat is important is that even as we raise the debt ceiling, we also solve the problem of underlying debt and deficits.  I’m glad that congressional leaders don’t want to default, but I think the American people expect more than that.  They expect that we actually try to solve this problem, we get our fiscal house in order.  And so during the course of these discussions with congressional leaders, what I’ve tried to emphasize is we have a unique opportunity to do something big.  We have a chance to stabilize America’s finances for a decade, for 15 years, or 20 years, if we’re wiling to seize the moment.  Now, what that would require would be some shared sacrifice and a balanced approach that says we’re going to make significant cuts in domestic spending."  The President continued, stating that "it would require revenues.  It would require, even as we’re asking the person who needs a student loan or the senior citizen or people -- veterans who are trying to get by on a disability check -- even as we’re trying to make sure that all those programs are affordable, we’re also saying to folks like myself that can afford it that we are able and willing to do a little bit more; that millionaires and billionaires can afford to do a little bit more; that we can close corporate loopholes so that oil companies aren’t getting unnecessary tax breaks or that corporate jet owners aren’t getting unnecessary tax breaks. If we take that approach, then I am confident that we can not only impress the financial markets, but more importantly, we can actually impress the American people that this town can actually get something done once in a while.  Now, let me acknowledge what everybody understands: It is hard to do a big package. My Republican friends have said that they’re not willing to do revenues and they have repeated that on several occasions."
  • House Republicans said that they will vote on legislation next Wednesday to "cap, cut and balance" the budget. The bill would raise the government’s debt limit by $2.4 trillion, cut spending, cap expenditures and include a proposed constitutional amendment to balance the budget. Although the plan is likely to pass the House, it is not expected to pass the Democratic-controlled Senate.  President Obama said, "You’ll probably see the House vote on a couple of things just to make political statements."
  • At today’s press conference held by House Republicans, Speaker John Boehner said, "No one wants the United States to default on our obligations."  Boehner continued, "We need real spending cuts, and spending cuts that would exceed the amount of increase in the debt limit."  "We asked the president to lead, we asked him to put forward a plan, not a speech, a real plan, and he hasn't, but we will."  Boehner added, "it's time for Democrats to get serious."
  • The President’s remarks can be accessed here.

TAX BILLS INTRODUCED JULY 14TH:

1. [112nd] H.R.2545 : To clarify the application of the Small Business Regulatory Enforcement Fairness Act to the Internal Revenue Service, to require the Service to convene a regulatory review panel for certain rules, and for other purposes.
Sponsor: Rep Michaud, Michael H. [ME-2] (introduced 7/14/2011) Cosponsors (1)
Committees: House Judiciary; House Small Business
Latest Major Action: 7/14/2011 Referred to House committee. Status: Referred to the Committee on the Judiciary, and in addition to the Committee on Small Business, for a period to be subsequently determined by the Speaker, in each case for consideration of such provisions as fall within the jurisdiction of the committee concerned.

2. [112nd] H.R.2549 : To amend the Internal Revenue Code of 1986 to allow a business credit for donations for vocational educational purposes.
Sponsor: Rep Young, Don [AK] (introduced 7/14/2011) Cosponsors (2)
Committees: House Ways and Means
Latest Major Action: 7/14/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

3. [112nd] H.AMDT.679 to H.R.2354 An amendment numbered 80 printed in the Congressional Record to prohibit the use of funds to develop or submit a proposal to expand the authorized uses of the Harbor Maintenance Trust Fund described in section 9505(c) of the Internal Revenue Code.
Sponsor: Rep Cravaack, Chip [MN-8] (introduced 7/14/2011) Cosponsors (None)
Latest Major Action: 7/14/2011 House amendment agreed to. Status: On agreeing to the Cravaack amendment (A076) Agreed to by voice vote.

4. [112nd] S.1367 : A bill to amend the Internal Revenue Code of 1986 to permit information sharing with respect to prison inmate information, and for other purposes.
Sponsor: Sen Pryor, Mark L. [AR] (introduced 7/14/2011) Cosponsors (None)
Committees: Senate Finance
Latest Major Action: 7/14/2011 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

5. [112nd] S.1373 : A bill to amend the Internal Revenue Code of 1986 to reduce international tax avoidance and restore a level playing field for American businesses.
Sponsor: Sen Rockefeller, John D., IV [WV] (introduced 7/14/2011) Cosponsors (None)
Committees: Senate Finance
Latest Major Action: 7/14/2011 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

6. [112nd] S.1375 : A bill to amend the Internal Revenue Code of 1986 to provide that corporate tax benefits based upon stock option compensation expenses be consistent with accounting expenses shown in corporate financial statements for such compensation.
Sponsor: Sen Levin, Carl [MI] (introduced 7/14/2011) Cosponsors (1) Committees: Senate Finance
Latest Major Action: 7/14/2011 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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