BYU Law Review


The economic substance doctrine is used by the IRS and courts to distinguish legal tax avoidance from tax evasion. More specifically, executive and judicial bodies use this doctrine to revoke statutorily compliant tax benefits that arise from transactions that lack, beyond such tax benefits, both a subjective business purpose and an objective economic effect. The most common tool for measuring the objective economic effect of a transaction is the pre-tax profit test. However, disagreement among courts and scholars applying this test has led to taxpayer uncertainty and accusations of reverse-engineered opinions. In this Comment, I reevaluate and propose an alternative, tiered approach to measuring the objective economic effects of a transaction. I begin by outlining the origin of the economic substance doctrine, including Judge Learned Hand’s insistence that the doctrine balance taxpayer certainty with the judicial attempt to ascertain the reality of a transaction. With this historico-economic framing in mind, I next evaluate three approaches to measuring the objective economic substance of a transaction: the predominately used pre-tax profit test as well as two leading variations proposed by scholars—Michael Knoll’s implicit taxation regime and Charlene Luke’s comparables test. Because all three of these tests, applied on their own, fail to balance taxpayer certainty with ascertaining the reality of a transaction, I propose an alternative framework for measuring the objective economic substance of a transaction. Borrowing from antitrust and corporate law, I suggest a three-stage analysis in which certain transactions are subject to a “per se” test, some are subject to a “quick look” (or intermediate scrutiny) test, and others are subject to a “rule of reason” (or entire fairness) analysis. I argue that this tiered analysis will mimic the results of antitrust and corporate law by lowering litigation costs and increasing party certainty. Throughout this Comment, I use the recent circuit split regarding the inclusion of foreign tax expenses in the calculation of pre-tax profit—articulated in Bank of New York Mellon Corp. v. Commissioner, 801 F.3d 104, 118 (2d Cir. 2015)—but my analysis effectively addresses all objective economic substance concerns for essentially all scrutinized transactions.


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