Liberty Global and the Economic Substance Doctrine

Brian Reed of Alvarez & Marsal discusses the application of the economic substance doctrine in Liberty Global Inc. v. United States and the questions raised by the Tenth Circuit's interpretation.

For more, read the following articles in Tax Notes:

• Otay Wants to Rebrief Dispute Over Basis Adjustment, IRS Says
• Liberty Global Has Tax Pros Fretting Over Planning Uncertainty
• Government Wins Economic Substance Battle in Liberty Global

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Credits
Host: David D. Stewart
Executive Producers: Jeanne Rauch-Zender, Paige Jones
Producer: Jordan Parrish
Audio Editor: Laura Kondourajian

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This episode is sponsored by Portugal Pathways. For more information, visit portugalpathways.io.

Transcript

David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: the substance.

In April the Tenth Circuit released their decision in Liberty Global Inc. v. United States, a case whose outcome relied on the application of the economic substance doctrine. This decision left the tax community split with questions about interpretation and the statutory meaning of the word "relevant."

So, what is the economic substance doctrine, and how does the uncertainty surrounding it affect future planning?

Here to talk more about this is Brian Reed, managing director at Alvarez & Marsal. Brian, welcome to the podcast.

Brian Reed: Thanks for having me. Excited to be here.

David D. Stewart: So why don't we start off with just a baseline. What is the economic substance doctrine?

Brian Reed: It's a simple question with a not so simple answer. But to try and distill it down to a sentence or two, essentially, the economic substance doctrine is a judicial antiabuse doctrine that has developed through the courts over the last 90 or so years, that can be applied to disallow the tax benefits of a transaction if that transaction lacks economic substance. And we can talk a little bit more about what that means. But generally speaking, a transaction lacks economic substance if it has no real economic effect and doesn't have a nontax business purpose. And so, that's the two-liner as to what is the economic substance doctrine.

David D. Stewart: So what's it really driving at? What's the purpose behind it?

Brian Reed: It sort of acts as like a judicial smell test, for lack of a better word. It comes up a lot of times in instances where a taxpayer has undertaken a transaction and they have gotten a result that is — oversimplifying — maybe too good to be true or too good to be true in the eyes of the court or the IRS. They have either gotten a result that's inconsistent with what the provisions are intending to do or they have gotten a tax benefit that greatly outweighs any other effect of the transaction. So it's sort of an override to what maybe the detailed rules and the code or the regs might otherwise say. And it allows a court a lot of latitude to just turn it off, to just take away the benefit without having to fully explain everything.

David D. Stewart: You mentioned that this has been around for a while. Could you tell us about its origins and where things stand now?

Brian Reed: Yeah, I know. I think the history is important here. I'd say most people would say that its origins go back to probably maybe the most famous tax case of all time. It's Gregory v. Helvering. So this is a 1930s tax case that went all the way to the Supreme Court. And it's very often cited, and a lot of people listening may be aware of Gregory. They may even know the facts of Gregory. But I think it's worth spending a little time just going over a thumbnail sketch of what was the case actually about and what did the court say, because I think sometimes it gets a little misconstrued as to what Gregory was about.

So the facts in Gregory were this. You had an individual, Mrs. Gregory, and she had a wholly owned corporation. And that corporation held appreciated securities, and she wanted to sell them. And she had a couple options. One option would be have the corporation sell them, distribute the cash. Another option might be to have the corporation distribute the appreciated securities to Mrs. Gregory and then she could sell them. And the problem with both of those is that they resulted in a lot of tax to Mrs. Gregory, because in either instance, she would have a dividend, and we're talking 1920s tax law here. So back then, dividends were taxed at a very high rate of income, as compared to capital gains.

And so, what did Mrs. Gregory do? So working with her adviser, she came up with a plan to have the corporation take the appreciated securities, contribute them into a new co, a new corporation. The new co was then distributed up to Mrs. Gregory. A couple days later, she liquidated it. She sold the appreciated securities for cash. And the position that she took was that those steps, the transfer to the new corporation, the distribution of the new corporation up to her, that qualified as a tax-free reorganization.

And again, this is under the 1920s code, a predecessor to some of the current sub[chapter] C provisions that we have today. And the IRS challenged it. And what the court looked at is they said, "Did what you do, did the steps that you undertook, is that actually the thing that the statute intended?" And what the court effectively held, and there's a lot of quotable lines in the court. So the court very much acknowledged that taxpayers are free to arrange their affairs in a way that minimizes taxes. There's the somewhat famous tax line about there's not even a patriotic duty to increase your tax burden. But nevertheless, the court decided that the thing that was done was not what the statute intended. And more specifically, in looking at the statute and it talked about describing the steps that were basically exactly what was done, but those steps were done pursuant to a plan of reorganization.

And what the court concluded is that when Congress enacted those provisions, that Congress was imagining a corporation undertaking these steps in furtherance of some sort of business purpose. And not just steps that were formalistically meeting these requirements solely for the purpose of avoiding shareholder tax. And so, the court essentially overrode the results under the statute and said, "No, Mrs. Gregory had a dividend. She didn't have a tax-free reorg followed by a capital gain transaction."

And so, to me, what Gregory was mostly about is that the courts used the substance of the transaction as a means to interpret the provision that was applicable. And in this case, they found that the provision that was applicable cared about the substance, cared about what it is that you actually did, and was inconsistent with the purposes, and they held no. Since the Gregory case, the law around economic substance, I think, has evolved quite a bit.

One of the difficulties with economic substances and aside is that it is broad and that it can apply kind of all over the place. I spend most of my time in subchapter C or consolidated or cross-border. But it can apply to financing transactions, leasing transactions, foreign tax credit transactions, partnership transactions. It's kind of all over the place. And so, it's sometimes difficult to nail down exactly what the principles are. But where the courts eventually evolved is that first they more distinctly described what does it mean for a transaction to have economic substance. And that generally focused on one of two things. Either was there a meaningful economic impact of the transaction or was there a substantial nontax business purpose for undertaking the transaction? Now, some courts required both; some courts required one. They weighted them a little bit differently, but that was one aspect of the evolution.

The other aspect of the evolution is, I think, it has been historically and maybe continues to be applied a little bit unevenly, in terms of what is the economic substance doctrine a tool to do. So you can find some cases, as an example, where the courts will say — they will just look at the transaction and they won't even get to what code provisions are at play. They'll just say, "This transaction lacks economic substance. We don't even need to worry about what the code says the answer is because we're going to just deny the tax benefits. We'll look at what the taxpayer did. If it's obvious that what they did was tax motivated, didn't have an economic effect, didn't have a business purpose, we don't even need to concern ourselves with whether or not it actually complied with the literal terms of the code. We just take the benefits away."

Other courts have gone the opposite direction. They said, "Well, first, we need to analyze does the transaction actually qualify under whatever code provision that the taxpayer says it does to get the benefit?" And then if it does, then they say, "OK, does the economic substance doctrine then step in to take those benefits away?" And personally, I think both of those are a little bit inconsistent with the origins of the Gregory case, in that they aren't — And this isn't uniformly true. You can't really make any uniform statements about these cases, but they aren't really using it necessarily consistently as a tool of saying, "Does the result under the provision at play, is it consistent with the purpose? And did Congress intend that this result actually derive from a transaction that has economic substance?" And this will become a little bit more clear when we talk about the relevance, but that's largely how the law evolved up until 2010. And if you'd like, we can talk a little bit about 2010 and the statute that was enacted in there.

David D. Stewart: Yeah, absolutely. So we're at 2010. This is the codification of the economic substance doctrine. And so, what effect did that have?

Brian Reed: Yeah. So, 2010, section 7701(o) was enacted. And it was put into the code to do a couple of things. It was there to both clarify and enhance the application of the economic substance doctrine. And so, the first thing it did, and I think it's actually useful to just read the opening line from 7701(o), which says that "in the case of any transaction to which the economic substance doctrine is relevant, such transaction shall be treated as having economic substance only if..." And then it gives this conjunctive test, meaning you have to satisfy both prongs. You have to have this objective test that you've — the transaction meaningfully changed your economic position. And you have to have a substantial nontax business reason for entering into the transaction. So I'd alluded to that through the evolution of this law, different circuits, different courts had applied these tests a little differently.

Some courts would say just having economic effect was enough. Some courts would say just having a nontax business purpose was enough. Some courts would say, no, you need both, but maybe the weighting was different. So Congress came in and called the line here and said, "Actually, you have to have both." So that was the first thing it did. The second thing that it did, and really maybe it's what it didn't do, is that both in the introductory language I just read and then also further down in the statute, it tells you that the determination of whether the economic substance doctrine is relevant to a transaction shall be made in the same manner as if the subsection had never been enacted. That's the text of the statute. The legislative history couldn't be clearer that it does not change the present-law standards for determining when to utilize an economic substance doctrine analysis. And that'll, I think, become much more important as we get into some of the more recent court cases in this area.

And the legislative history sheds a little bit more light on that. So it talks a little bit about if the tax benefits are consistent with congressional purposes. And as examples, Congress uses the tax code a lot of times to incentivize taxpayers to undertake certain activities. So if you want to encourage, I don't know, low-income housing construction, you might offer low-income housing tax credits to taxpayers that do that. And so, you're encouraging those types of activities, or renewable energy credits or whatnot. And if taxpayers are doing that, the economic substance doctrine shouldn't come in and say, "Well, wait a minute, you only did this because you were trying to get this tax benefit." It's like, "Well, yeah, that's kind of the whole point."
So that's an area where the legislative history seems to be pretty clear that this doctrine ought not be relevant. Another area which is subject to more controversy is there's this laundry list of other basic business transactions that under long-standing administrative and judicial practices are not subject to the doctrine, merely because you're making a choice between comparative transactions based on the tax results. And some of the examples given are things like the choice between debt or equity. Generally speaking, you might want to capitalize an entity using debt, because debt is generally taxpayer or tax favorable as compared to equity, because you get to deduct interest expense.

The fact that you're tax motivated in your decision to use debt versus equity should not then be overwritten by economic substance. Other ones, which will come up in the Liberty Global case, is doing basic business transactions under subchapter C, organizing a corporation, doing reorganizations. That is, generally speaking, supposed to be outside the ambit of the economic substance doctrine. I think largely because those provisions already have a business purpose requirement. So they already have the necessary protections to get into those provisions, so you don't need another overlay.

And then maybe lastly, which will also come up is the term "transaction." I've probably said the word transaction 20 times since we've started this. So the question becomes, well, what is the transaction? And the statute basically just says that the transaction can include a series of transactions, but doesn't really offer much else in the way of insight. And probably the most maybe meaningful thing that the 2010 tax law added was not just clarifying some of these points around ESD (economic substance doctrine), but that they added a fairly draconian penalty provision that if a transaction, if you lose on economic substance as a taxpayer, you are subject to either a 20 percent or a 40 percent penalty. And that is a strict liability penalty.

So what that means is unlike other accuracy-related penalties, you can't, for example, rely on a tax opinion from your adviser to avoid the penalty. The penalty applies regardless of the level of advice you've been given, and the 20 percent versus 40 percent depends on whether you've adequately disclosed it or not. So if you do a transaction, you think it works on all fours, you don't put it on a Schedule UTP or something else in your tax return, and you go get opinions from three different reputable firms. If you ultimately lose on that transaction because of ESD, the opinions won't help you on the penalty. And the fact that you didn't disclose it could cost you 40 percent as a penalty on top of the tax liability. So, that, I think, is probably one of the more substantial, and now we're seeing it play out in real life impacts of the 2010 enactment.

David D. Stewart: So we're now 15 years into this new codified world, where Congress dealt with a circuit split, but now we've had a lot of time to develop new areas of law in this. So tell me about some of the more recent cases. What have we been hearing from the courts as they're trying to interpret this new provision?

Brian Reed: So there's been two cases very recently that have gotten a lot of attention. And it's been mostly around the relevancy question. Is the economic substance doctrine relevant to the transaction? So the first one is Liberty Global. So Liberty Global was the district court case in Colorado. And then the taxpayer lost and went on to appeal it to the Tenth Circuit. And in Liberty Global, I think that's another one where it's probably worth just a thumbnail sketch of here were the high-level facts. Somewhat helpfully, the court case, which I haven't seen a lot of this, actually has the step plan that the taxpayer undertook as like an appendix to the court case. So you can actually see the slides. But at a very high level, Liberty Global, they are a U.K.-parented group. So you kind of have a publicly traded U.K. company on top.

That U.K. company owns a U.S. subsidiary. And then that U.S. subsidiary owns — And I’m simplifying, so folks that are familiar with the case are going to be yelling into their phone, "That's not exactly right," but I'm going to simplify a little bit here. The U.S. sub owns a CFC (controlled foreign corporation). And the U.S. had a substantial built-in gain in the stock of the CFC. And the end of 2017 rolls around, and the Tax Cuts and Jobs Act gets enacted, so the TCJA. And the TCJA was a uniform change to international tax law in the U.S. Tons of new provisions came in that worked in very different ways than the legacy system had worked. And the TCJA introduced a new essentially participation exemption system, a dividends received deduction (DRD), where if you're a U.S. corporation and you have a dividend from a CFC effectively, that dividend is subject to a 100 percent DRD.

So that's thing one. Thing two is that the TCJA also, because it was complicated and passed quickly, there were a lot of interactions that, quite frankly, Congress probably hadn't fully thought through in the way different sets of rules interacted. So, what Liberty Global did is they effectively — The CFC that I was describing that was sitting under the U.S., the CFC had a disregarded entity. And the disregarded entity did a check-the-box election. And that transaction resulted in a lot of gain recognition to the CFC, just under U.S. tax principles, because the disregarded entity had some notes and some nonqualified preferred stock that kind of sprung to life.

And so, just take it as fact that the CFC for U.S. purposes recognized several billion dollars of gain in its assets as a result of this check-the-box election. Then the U.S. corporation for the end of the tax year sold the stock of the CFC upstream to the U.K. parent company. And the position that Liberty Global took was that the gain that the CFC recognized as a result of this check-the-box election created billions of dollars of earnings and profits under the U.S. tax rules. And when the stock of the CFC was then sold upstream, the gain on that stock under long-standing rules that are again, fairly clear, the gain on that stock was recharacterized as a dividend. And that those rules have been around before TCJA and continued post-TCJA.

What was new, though, was two things. One was that that dividend now would be eligible for a 100 percent dividends received deduction. And so, now suddenly, that gain on that stock goes from being taxable at the full corporate rate to being completely tax free. And the other thing that happened is normally under the rules at the time, if a CFC has a lot of income, the U.S. shareholder on the last day that that entity as a CFC will pick up all that income as either subpart F or GILTI (global intangible low-taxed income). That was one of the features of TCJA. Well, normally, before TCJA, if you had done this sale upstream, that CFC would've stopped being a CFC.

So all of that gain would've been picked up by that U.S. shareholder on the day of the upstream sale. Well, another thing TCJA changed is that the CFC remained a CFC, even though it wasn't directly owned by the U.S. anymore. And so, effectively, if that wasn't complicated enough, what Liberty Global did is that they took advantage of some interactions between rules that came into effect as part of TCJA. And they were able to take this CFC, sell it out from underneath the U.S. completely tax free.

Two more interesting points on this and then we'll come back to economic substance. One was that the Treasury Department hated this. They were very aware of this interaction. They thought it was an unintended glitch in the system. And they actually issued regulations in 2019, after Liberty Global had done their transaction, that would have denied the dividends received deduction, these [section] 245A-5 regs.

And so, they initially challenged Liberty Global under those regs. And Liberty Global successfully asserted that those regulations were invalid under the APA (Administrative Procedure Act). So they actually won on this APA challenge. So the regs didn't apply. But then the government, as an alternative, argued that Liberty Global's transaction lacked economic substance and therefore they should be denied the [section] 245A DRD. And that was the issue that the government won on and Liberty Global lost on at the district court level and then again more recently at the Tenth Circuit level. And I think what most people were surprised by in the district court case was that Liberty Global made a lot of arguments obviously as to why they should be allowed this result.

And one of them was that the economic substance doctrine simply is not relevant to the steps that they did, because effectively checking the box is both a basic business transaction, because you're just deemed to incorporate a new entity, and it is one which on its face really could never have economic substance. So how can an economic substance doctrine apply to a transaction that is more or less just a fiction for U.S. tax purposes? And the district court had an analysis that I still am a little bit baffled by, which was to basically say that "We think that the economic substance doctrine applies anytime a transaction lacks economic substance." So they kind of just blew through what seemed to be the fairly plain reading of the statute and the legislative history. And they just said, "This lacked economic substance; therefore, the doctrine is relevant. And we're going to use it to then override the plain results of the code."

On appeal, Liberty Global really pushed all their chips in the middle of the table on this relevance point. And they went to appeal, and they said, "Listen, the first couple steps I described to check-the-box elections, they did not have any nontax business purpose. They did not meaningfully change our ending economic effect, but we just don't think it's relevant."

And very unfortunately in my mind, the Tenth Circuit sort of sidestepped the issue. There's a long footnote that carries on for a couple of pages where they call the relevancy point a red herring. And they say, "Liberty Global's making a big deal out of its relevancy point. We think it's a red herring because clearly here the doctrine is relevant and clearly here you didn't have economic substance, so therefore we're going to deny the [section] 245A DRD." And so, that's where things sit today with Liberty Global. It remains to be seen whether they'll appeal this onto the Supreme Court. And if they do, whether the Supreme Court will pick it up. But for now, it is most certainly probably something that will embolden the government in making stronger arguments that the ESD is relevant in a lot of other context.

One of the other aspects on the relevancy point was that, going back to the point I was making earlier, you got to figure out, well, what is the transaction? And the court basically said, "You don't get to look at just the check-the-box election and say that transaction is not subject to ESD because it's not relevant to that transaction." They said, "Here in these transactions or in this case, the transaction is all the steps. And clearly, you did this really complicated internal restructuring with the help of sophisticated advisers. So this is far from a basic business transaction and shouldn't be carved out, because we're going to look at the transaction holistically." And that's noteworthy for a couple of reasons, because I'd say typically, pre-Liberty Global actually, whether a taxpayer won or lost on economic substance, a lot of times, it turned on to how the transaction was framed by the IRS and the taxpayer and the court.

And usually, the more narrowly it was framed, the worse off the taxpayer did. So if the IRS was able to go to a court and successfully say, "No, the transaction is this very discreet step they did over here that drove the tax benefit, and that's all we need to look at. The only reason they did step seven was to save taxes. And we don't need to look at the other 20 steps they did or what business reasons they might've had." The IRS usually did very well. If the taxpayer was successful in saying, "No, no, no, you can't just look at step seven in isolation to make something up, you have to look at everything we did," and it was kind of achieving this broader objective, the taxpayer tended to do very well. And this is a case where it was the opposite, where the taxpayer was actually trying to frame the transaction relatively narrowly. And the IRS and the courts framed it a little bit more broadly.

Actually, there's a great article on this topic that predates all these cases by [David Hariton] called "The Frame Game." That goes through an amusing set of transaction structures through the '80s, '90s, and 2000s, and frames out how what you view as the transaction really impacts the results that the courts landed on.

David D. Stewart: Have any other courts taken up this relevance question?

Brian Reed: Yeah. So very close in time to Liberty Global, which again was District Court of Colorado, then Tenth Circuit, there was a separate case in the Tax Court called Patel. And Patel involved something very far from the facts of Liberty Global and very far from anything I know anything about, but it dealt with like a microcaptive insurance company. And the IRS again sought to disallow the benefits of this microcaptive insurance company by arguing that it lacked economic substance. And the Tax Court goes through a fairly thorough analysis on the relevance inquiry. And it looks to the plain text of the statute, and it looks to the legislative history. And it concludes very clearly that there is a first-step inquiry to determine whether the economic substance doctrine is relevant to the transaction.

There's actually, I think there's a quote in the case that — because they referenced to Liberty Global, because Liberty Global was cited, I think, in some of the briefs and they actually describe the district court. So remember the district court [in] Liberty Global was the one that said if a transaction lacks economic substance, then the economic substance doctrine is relevant. And it describes that analysis as bordering on the absurd, because it's just so clearly not what the statute says. Now, having said that, in Patel, they go through this long and detailed analysis of concluding that there is a separate inquiry into relevance. Then they say, but here, this is a case about insurance, and we can find lots of instances where economic substance is relevant to insurance cases. So it is relevant. And by the way, you fail it.

So the taxpayer still lost in Patel, wasn't like an overall taxpayer win, but it is a very clear, I think, articulation of how the relevancy test in 7701(o) ought to work. And I guess just to add it to the Tenth Circuit case in Liberty Global, it was a 2-1 decision. And so, the dissenting judge also, I think pretty clearly and in line with Patel, lays out a relevancy argument that seems much more in line with what the statute says. And in the dissent says that the relevancy error made by the district court was so much that should've been enough for the case to be remanded back down.

David D. Stewart: So are you expecting to see a lot more development in this area?

Brian Reed: I am for a couple reasons. And I guess there's one other point that is probably worth raising, which is if you go back in time to 2010, the economic substance doctrine gets enacted. And then you have to look at the enforcement backdrop that happened shortly after that. So in 2011, not long after the ESD was codified, LB&I (Large Business and International division) at the IRS, they issued this field directive that had some formal procedures for revenue agents on their ability to raise economic substance and the associated penalties on exam. And this directive had a very high threshold, or at least that's my understanding. There was a four-step framework around looking at existing law, and it had to be precleared by the director of field operations. And so, I don't do a ton of work in the controversy space, but my understanding is that that was a very high hurdle for Exam agents to raise economic substance in the course of a routine audit.

So if they saw a planning transaction and they didn't like it, they had to do a lot of work, and go and get a lot of approvals before they were allowed to raise ESD. In 2022 that went away. So, that directive got pulled. And now, I don't know the exact standards, but I think it's a lot less and a lot easier for Exam agents to raise it. So you're talking about now kind of, sort of coinciding with audits that you're seeing going to trial on ESD, coupled with the IRS having some success in this space, like Liberty Global. I would expect that agents are going to be more forceful in asserting ESD, if they come across tax planning that they just simply don't like, because it is a — Again, for now, they've got some strong law on their side, and it is a very strong hammer to hang over a taxpayer's head, if you say, "I don't like what you did, and we're going to argue economic substance. And not only do we think you're going to lose on it, you're going to have this pretty severe penalty provision." So I do expect that that will continue to develop in the controversy space.

There have been some comments made by government officials that they are looking at this from a guidance perspective, but no real indication on what they might issue, when they might issue, if they might do anything. It’s a really hard area, I think, to write guidance in, just because it touches so many areas of the income tax law. Just getting any kind of uniform view as to what you do with this would be very, very difficult.

David D. Stewart: So what is your sense of how the court came down on Liberty Global? Did they thread the needle correctly, or did it leave too much open?

Brian Reed: The problem I have with the Liberty Global case is that, well, twofold really. One is they took what I think was a butchered relevancy analysis from the district court, and they just kind of said, "Close enough." And then the other thing that when you read the case that I find to be a little bit troubling is, one, they say that the result that Liberty Global got was clearly not what Congress had intended. And on one hand, you could see how somebody could reach that conclusion pretty quickly. You can say, "Well, wait a minute. Do you think Congress really thought you could snap your fingers and do a couple of steps and make $2+ billion of gain evaporate?" Maybe, because Congress did enact this dividends received deduction.

And the point of this dividends received deduction was that before the TCJA, there was this massive lockout effect on foreign earnings. That companies were keeping foreign earnings parked offshore and they weren't bringing it back, and they wanted to end that practice. And the district court really bought into the IRS's description of the TCJA was this well-coordinated patchwork of rules that were all intended to work in a very specific ordering way. And if you did something that didn't align with that, that that was contrary to Congress's purpose. I'm just not so sure that that is totally correct or, at a minimum, that it's a solid enough basis that a [section] 245A deduction should be denied on the basis of how the earnings and profits were created.

Because if you zoom out, it's one of those cases where I think a lot of people might say, "This was two cute by half. They took advantage of some loopholes. And if Congress had thought through all of this, they probably would've written the rules differently." And maybe they would've. But is it the court's job to close every barn door Congress leaves open? I don't know. But you can imagine another scenario. So imagine instead of Liberty Global selling this CFC stock up to the parent, imagine that they were selling it to a third party. So they had a real business deal on the table, somebody was showing up and they said, "I want to buy this CFC." And they said, "Great." And then Liberty Global had this idea, "Oh, if we just sell the stock, we're going to pay 21 percent tax on the gain and the shares. But if we do this check-the-box transaction before we sell it, now all of a sudden we can convert the gain on the stock into a dividend and not pay any tax." Would the court have come out the same way, or would suddenly interposing a third-party sale have changed their analysis? I don't know. Even in the [section] 245A regs that Treasury has put out since then, I think they've even acknowledged that it's possible that taxpayers could create earnings and profits solely for the purpose of availing themselves of a [section] 245A dividends received deduction.

I mean, I think at the end of the day, what Liberty Global did really was they accelerated income. These were economic gains and assets, and they accelerated the recognition of that income to a beneficial period in time. And again, maybe it was two cute by half, but you can certainly imagine other scenarios. Well, what if they had had expiring attributes and they wanted to accelerate income before they had NOLs (net operating losses) that expired or tax credits that expired? Would that have similarly been subject to an economic substance disallowance, or is that a permissible type of income acceleration? And it's just the line is just very, very unclear, unfortunately.

David D. Stewart: Does this lead to increased uncertainty as you — It seems that courts are now divining both congressional intent on the tax matters at hand, plus congressional intent on the economic substance doctrine at the same time. So how does that play out?

Brian Reed: Yeah. I have to imagine that — Well, I guess this could go one of two ways. You could maybe say it was very clear that Treasury hated a lot of planning that taxpayers were doing, that were done specifically to exploit inconsistencies in the way TCJA was rolled out. So there were other cases where there was mismatches and effective dates, where, for example, the dividends received deductions started applying basically January 1 of 2018. But maybe the GILTI regime didn't apply until later, if you didn't have a calendar-year CFC, cases like Liberty Global. And so, they really didn't like the planning the taxpayers were doing either leading up to TCJA or post-TCJA, that were trying to take advantage of that. And so, maybe a lot of this activity will be confined to just those specific things. If you did something to try and take advantage of this limited window that TCJA afforded you of and you just did it for tax reasons, they're going to come after you very hard. But they're not going to continue to expand in other areas of maybe more run-of-the-mill tax planning.

That's one way it could go. Another way it could go would be, no, that the IRS is going to see this as a very valuable enforcement tool. And they are going to be more inclined to raise it, because they've been successful in raising it. And I think that could have a couple of impacts. I think one would be it's going to require taxpayers to be very, very focused on having robust documentation. I think before this case came out, people would probably have been nervous just hanging their hat on if they had a tax planning transaction and just saying, "Well, ESD isn't relevant," but I think they'd be much more nervous now. And so, I think taxpayers are going to have to focus even more on documenting their nontax business reasons for doing things, what the economic effect of their transactions were, because you're probably not going to be in a position where you're going to just be able to convince the IRS that "ESD is just not relevant. Leave me alone."

So you're going to have to kind of document and show why you actually do satisfy that two-pronged test. I think it'll be interesting to see if taxpayers start disclosing transactions that they are worried about lacking ESD for that penalty point I made earlier, that the penalty rate goes from 40 percent to 20 percent. It's a little bit of a two-edged sword there, because if you disclose it, obviously you're drawing attention to it and probably asking for closer scrutiny on it, but you're giving yourself a little bit of protection. I think it'll be interesting to see whether things like tax insurance, which have been growing in popularity anyway, whether that in any way steps in to fill some void here where taxpayers are more interested in getting tax insurance because now the risk around tax planning and tax-motivated transactions has gone up significantly in light of this case.

David D. Stewart: Do you see this narrowing the window of the amount of tax planning that companies will be willing to do?

Brian Reed: I think it might. I think it might. I mean, I think it would be naive to think that taxpayers are not going to continue to seek ways to minimize their tax burden. I mean, it's a competitive environment. So if you're a large corporation and your competitor is taking advantage of something or they're structuring their affairs in a particular way and you're not, you're putting yourself at a competitive advantage. So there's always puts and takes on risk tolerance and how folks will think about tax planning. But I could certainly imagine this having a chilling effect on a lot of folks that might say, "This is more than we want to bite off." Because the risk of losing now, the probability of losing maybe has gone up or the probability of at least the IRS being willing to litigate these cases has gone up and the cost of doing so has gone up.

David D. Stewart: Well, it certainly should be interesting to see how this develops as we go forward. Brian, thank you so much for being here.

Brian Reed: Thanks for having me. I enjoyed it.

David D. Stewart: That's it for this week. You can follow me online at @TaxStew, that's S-T-E-W, and be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

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