TEI urges rejection of economic substance provisions in the Senate farm bill.

• Position: Tax Executives Institute

On March 13, 2008, Tax Executives Institute renewed its opposition to proposals to codify the Economic Substance doctrine and create a new, related penalty provision. In a letter from President Robert J. McDonough, TEI urged the members of the House and Senate negotiating the fate of the Farm Bill (H.R. 2419, The Food and Energy Security Act of 2007) to reject the proposals, which were in the Senate-passed version of the bill.

Tax Executives Institute urges members of Congress negotiating the provisions of the pending farm bill to reject proposals to codify the economic substance doctrine and related penalty proposals that are incorporated in the Senate version of H.R. 2419, The Food and Energy Security Act of 2007.

TEI's 7,000 members work for 3,200 of the largest companies in the United States, Canada, Europe, and Asia. The Institute is dedicated to the development of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the costs and burdens of administration and compliance to the benefit of taxpayers and government alike.

The Senate-passed version of H.R. 2419 includes provisions to (1) codify the economic substance doctrine and (2) impose a 20-percent penalty for understatements of tax attributable to transactions lacking economic substance that are disclosed to the IRS (and increase the penalty to 30 percent for undisclosed transactions).

The proposed economic substance provisions are an anti-abuse provision. They are intended to clarify that in any case in which the economic substance doctrine is relevant to a transaction a taxpayer must establish that (1) the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer's economic position and (2) the taxpayer has a substantial non-federal-tax purpose for entering into a transaction. Transactions will not be treated as having economic substance solely for having a pre-tax profit unless the present value of reasonably expected pre-federal tax profit is substantial in relation to the present value of expected net federal tax benefits.

Regrettably, the statutory terms relevant, meaningful, substantial, and reasonably expected are all subjective and hence would not make clear when the economic substance doctrine would apply. Most important, the provision does not identify to which transactions of parts of a transaction the doctrine would apply.

The economic substance doctrine was developed by the courts as a...