Change, complexity, and increasing uncertainty in the tax law: their impact on our tax system and what we should do about it.

• Author: Gibbs, Lawrence B.

It is a truism that our tax law reflects our economy and our society. It also is true that our economy and society are complex and subject to change, increasingly so as the ramifications of our interconnectedness with the global economy and society have become more apparent. Perhaps the most dramatic; recent example might be the events of September 11 and their aftermath. In New York City and Washington, D.C.--the two cities symbolic of the complexity and change of American economy and society--we and the rest of the world watched events that in two hours changed our society and economy in ways so profound that we could not then and still cannot completely comprehend them. In short, the rate at which change and complexity are occurring in our daily lives often leaves us with a sense of increasing uncertainty.

The same, I submit, is true about our tax law. During the last 30 years, all of us who have worked in the tax area--in the private and public sectors--have watched as our tax law constantly changed and became more complex. More and more legislation, regulations and other forms of guidance, and court decisions have descended upon us all. The rate of change and increasing complexity in the tax law have accelerated as the pace of business in the private and public sectors has accelerated. The uncertainty resulting from the accelerated rate of change and complexity is apparent.

The part of our tax system that traditionally has been the least affected by change and complexity--our judicial system--recently has begun to show the effects of increasing change and complexity. I submit that the uncertainty caused by recent surprises in the tax decisions of our courts is likely to have the most profound impact on our tax system. The reason is that we all look to the courts for guidance to enable us to predict what the tax law will be in the future.

Let's look at some examples. A year ago, the IRS had won almost every case it had tried in the so-called corporate tax shelter area. By my count, the score stood at 12-1 in favor of the IRS. The Tax Court and the federal trial and appellate courts had almost unanimously adopted the Commissioner's economic substance argument. Today, one year later, by my count the score stands at 9-5. (1)

Perhaps the most significant turn of events involved the Merrill Lynch contingent installment sale marketed transaction that led to three of the Commissioner's most impressive initial victories in the corporate tax shelter area in ACM Partnership, ASA Investerings Partnership, and Saba Partnership. ACM involved the Colgate-Palmolive Company; ASA, Allied-Signal; and Saba, the Brunswick Corporation; three large, sophisticated, well-represented corporate taxpayers. In the ACM case, Judge Laro in the Tax Court upheld the IRS, the Third Circuit affirmed, and the Supreme Court denied the taxpayer's request for certiorari. In the ASA case and again in Saba, the Tax Court upheld the IRS. After the District of Columbia Circuit affirmed the Tax Court in the ASA case and Merrill Lynch entered into a well-publicized settlement with the IRS to resolve its liability growing out of these transactions, (2) the law appeared to be well settled that the Merrill Lynch contingent installment sale transaction was without economic substance and, therefore, was not a viable product for taxpayers.

That, of course, was before the recent decision by Judge Friedman, in the U.S. District Court for the District of Columbia in the Boca Investerings Partnership case. Boca upheld American Home Product's purchase of the Merrill Lynch structured transaction and rejected the Commissioner's economic substance doctrine. Like the prior ASA decision, the Boca decision is appealable to the D.C. Circuit. Although the Boca decision purports to distinguish ASA factually, I and others with whom I have discussed these cases thus far have been unable to come up with a way to predict which factual situations in the future will fall within the rationale of Boca and which will fall within the rationale of ASA, ACM, and Saba.

Earlier this year, a trilogy of federal appellate cases dealing with alleged tax shelters transactions were decided. The Eleventh Circuit issued two decisions by the same panel of judges, one in the Winn-Dixie Stores case, involving corporate-owned life insurance arrangement, and the other in the United Parcel Service case, involving an attempt by UPS to transfer offshore the portion of its business involving the insurance of its customers' packages. In Winn-Dixie, the Eleventh Circuit panel affirmed the Tax Court and upheld the Commissioner's economic substance doctrine. In UPS, the same panel reversed the Tax Court and rejected the Commissioner's economic substance doctrine. The third decision in the trilogy, by the Eighth Circuit in the IES Industries case, involved American Depository Receipts transactions creating foreign tax credits. The Eighth Circuit...