"form" Determines "substance": a Call to Reign in Tax Law's Substance-over-form Principle

• Publication year: 2022

53 Creighton L. Rev. 553. "FORM" DETERMINES "SUBSTANCE": A CALL TO REIGN IN TAX LAW'S SUBSTANCE-OVER-FORM PRINCIPLE

"FORM" DETERMINES "SUBSTANCE": A CALL TO REIGN IN TAX LAW'S SUBSTANCE-OVER-FORM PRINCIPLE

CODY A. WILSON ^[D1]

I. INTRODUCTION

The United States Supreme Court should listen when a United States circuit court compares the head of a federal government agency to the Roman Emperor Caligula. Caligula is known for many things: his incestuous relationships, a barbarous temper, the desire to appoint his horse as a chief magistrate of the Roman Empire, and relevant to this article, his propensity for undermining the Rule of Law. ^[1] According to the recent decision by the United States Court of Appeals for the Sixth Circuit in Summa Holdings, Inc. v. Commissioner of Internal Revenue Service, ^[2] a willingness to undermine the Rule of Law is a trait also held by the Commissioner of the Internal Revenue Service ("the Commissioner"). ^[3] Since that decision, the United States Courts of Appeals for the First and Second Circuits have concurred with the Sixth Circuit's comparison. ^[4]

The United States aspires to be a country governed by the Rule of Law rather than the rule of men. ^[5] The Rule of Law may be simply summarized as the idea that governmental power should be restrained rather than being left to the unfettered discretion of governmental leaders. ^[6] The alternative, a society governed by the rule of men, existed in the Roman Empire under Caligula's reign. ^[7] Judges avoid Caligula-like laws and preserve the Rule of Law by ensuring people have a "basis for planning their affairs in light of pre-existing legal consequences" and by protecting people from arbitrary, ad hoc proclamations of power. ^[8] Both of those tasks generally require that judges avoid imposing ex post facto laws. ^[9]

Caligula famously undermined the Rule of Law when it came to taxes. ^[10] In an account by Suetonius Tranquillus, a Roman historian and biographer, Caligula disregarded the Rule of Law with respect to taxes as follows:

Taxes . . . were levied [without being] submitted to public inspection, great grievances were experienced from the want of sufficient knowledge of the law. At length, on the urgent demands of the Roman people, he published the law, but it was written in a very small hand, and posted up in a corner, so that no one could make a copy of it. ^[11]

According to the Sixth Circuit, the Commissioner has similarly attempted to undermine the Rule of Law through misplaced applications of the substance-over-form principle in tax law. ^[12]

Under the substance-over-form principle, "the incident of taxation depends on the substance rather than form of the transaction." ^[13] Courts apply the principle in two distinct types of cases. In the first instance, courts properly apply the principle to recharacterize factual shams. ^[14] Courts are always justified in objectively looking at the substance of the transaction-the underlying facts-rather than solely taking the vantage point of the taxpayer. ^[15] After all, "[w]hen someone calls a dog a cow and then seeks a subsidy provided by statute for cows, the obvious response is that this is not what the statutemeans." ^[16] Since this application of the substance-over-form principle is proper, this article focuses on the second, improper application of the principle.

In the second instance, courts improperly apply the substance-over-form principle to declare that taxpayers are not entitled to tax savings, despite full compliance with the text-the form-of the Internal Revenue Code ("the Code"). ^[17] Courts justify the denial of such tax benefits by declaring that the taxpayer has failed to comply with the Code's substance. ^[18] The example of a cow subsidy statute from above clarifies the inappropriateness of applying the substance-over-form principle to deny a benefit promised by a statute. ^[19] When a statute provides a subsidy for cows, "rich people who would not otherwise have cows buy them to gain cow subsidies. Here, when [courts] say (as they do) that this is not what the statute means, they are in fact saying something quite different." ^[20] Courts that deny a benefit promised by a statute because of a failure to comply with the statute's unannounced substance are stating what they think the law should be, not stating what the law actually is. ^[21]

At a glance, courts that apply the substance-over-form principle to override the text of the Code appear to be following Ronald Dworkin's theory of jurisprudence: when the law runs out, a judge should decide cases by appealing to principles. ^[22] A court declaring that "the incident of taxation depends on the substance rather than form of the transaction" is announcing a principle, ^[23] but when the words of a statute are clear, the law has not run out. ^[24] Accordingly, a closer look reveals that courts are not applying Dworkin's theory when denying Code-compliant taxpayers their deserved benefits.

Instead, when courts improperly apply the substance-over-form principle to override the Code, they are doing so, or at least appear to do so, ^[25] through the jurisprudential theory advanced by Lon Fuller. ^[26] Fuller argued that courts should not apply rules in light of the individual meaning of each word that makes up the rule, but rather by advancing the rule's purpose. ^[27] It may be true that "[a] word is not a crystal, transparent and unchanged, it is the skin of a living thought and may vary greatly in color and content according to the circumstances and the time in which it is used." ^[28] However, Fuller's jurisprudential theory has no place in tax law, especially when the meaning of the Code's text is clear. Many federal judges have realized this, ^[29] but others have not. ^[30]

This Article illustrates that reigning in tax law's substance-over-form principle is necessary to preserve the Rule of Law. The principle is properly applied to restore reality to factual shams, ^[31] but the principle should never be used to justify a reading of the Code that the text will not bear. ^[32] At best, courts are applying Fuller's theory of jurisprudence and in the process are denying people their pre-existing right to obtain benefits provided to them by the Code. ^[33] At worst, courts are deciding cases on an arbitrary, ad hoc basis and then citing cases to support their conclusion. ^[34] Both scenarios are contrary to the Rule of Law. ^[35]

To best understand these issues, the Article begins with Part II describing Gregory v. Helvering, ^[36] the case that gave rise to the sub-stance-over-from principle as it applies to American tax jurispru-dence. ^[37] Part II then briefly explains two specialized doctrinesderived from the substance-over-form principle. ^[38] Next, Part III criticizes the use of the substance-over-form principle to override the text of the Code through two subparts. ^[39] First, Part III explains that applying Lon Fuller's theory of jurisprudence to tax law denies people their pre-existing right to obtain benefits provided to them by the Code. ^[40] The theory's inappropriateness in tax law is made clear by discussing the Supreme Court's application of the substance-over-form principle in three different types of cases: a non-tax case, a quasi-tax case, and a pure tax case. ^[41] Part III continues by discussing how the substance-over-form principle facilitates arbitrary, ad hoc decisions. To start, the principle undermines the U.S. Constitution because courts are tasked with interpreting the Code, not expanding it. ^[42] Also, the principle allows courts to mask the true basis for their decisions, which may very well be arbitrary. ^[43] Part IV concludes this Article by calling on the Supreme Court to overrule Gregory v. Helvering to the extent it allows judges to deny Code-compliant taxpayers their deserved benefits. ^[44]

II. THE BIRTH OF THE SUBSTANCE-OVER-FORM PRINCIPLE IN AMERICAN TAX JURISPRUDENCE AND TWO SPECIALIZED DOCTRINES

The Internal Revenue Code ("the Code") is complex. ^[45] One former president described it as "a complicated mess . . . . [and] a million pages long." ^[46] The Code is well short of a million pages, but it does contain millions of words, each carefully chosen during the legislative process. ^[47] The Code's complexity is necessary to account for the "infinite number of possible tax transactions." ^[48]

To further complicate tax law, the Code is often supplemented by the U.S. Department of the Treasury, the Internal Revenue Service, and, of course, the courts. ^[49] The U.S. Department of the Treasury and Internal Revenue Service interpret the Code and provide guidance by issuing regulations, rulings, procedures, and announcements. ^[50] Courts also add meaning to the words of the Code because, after all, "[i]t is emphatically the province and duty of the judicial department to say what the law is." ^[51] With the infinite number of ways that a transaction may be structured, this sharing of interpretive authority among the three branches of government is justified as a means of effectuating the Code's purpose-to raise revenue for the federal government ^[52] and, at times, to promote certain types of transactions. ^[53]

However, courts as a whole have gone too far when it comes to interpreting the Code, which they then justify as an application of the substance-over-form principle. This is not to say courts should never interpret...