The Many Faces of the Economic Substance\u27s Two-Prong Test: Time for Reconciliation?

The fall of 2004 saw the occurrence of several important developments in relation to the ongoing debate on the application of the economic substance doctrine. It started with the issuance of the opinion in Long Term Capital Holding v. United States in the end of August, a case in which a District Court held that a transaction involving the contribution of stock with a built-in loss to a partnership lacked economic substance and had been entered into without any business purpose other than tax avoidance. The court upheld penalties assessed by the IRS despite the taxpayer’s argument that it obtained and relied on two should level opinions supporting its position. During the fall, the Jobs Act of 2004 was finalized and finally signed by the president on October 22, 2004, leaving out the proposed codification of the economic substance doctrine. Subsequent to the Government’s victory in Long Term Capital Holding v. United States, three District Courts have held for the taxpayers in cases involving an economic substance analysis. First, in Black & Decker Corp. v. United States a U.S. District Court has granted Black & Decker Corp.\u27s motion for summary judgment in its refund suit for over $57 million in federal taxes arising from a contingent liability transaction, on the grounds that the transaction had economic substance. Second, in TIFD III-E Inc. v. United States a U.S. District Court (in the Second Circuit) has ordered the IRS to refund$ 62 million to TIFD, the tax matters partner of Castle Harbour-I LLC, applying the economic substance doctrine and finding that the LLC\u27s creation was not a sham designed solely to avoid taxes) Finally, in Coltec Industries Inc. v. United States a U.S. Court of Federal Claims has ordered the IRS to refund to Coltec Industries Inc. $ 82.8 million in federal taxes arising from a contingent liability transaction, almost similar to the one in Black & Decker, on the grounds that the transaction satisfied the statutory language and requirements and, only as a backstop, applying the economic substance doctrine to conclude that the transaction had both business purpose and economic substance. These events have emphasized the controversial application of the doctrine, and how divided are courts, the Government and taxpayers in their interpretation of the doctrine. In a previous article, this author has explored the profit potential issue, an ongoing debatable issue in relation to the doctrine. This article focuses on another unsettled issue, namely the application of the two-prong test. Frank Lyon v. United States has been construed to establish a two-prong standard for examining if a transaction lacks economic substance. Under the general two-prong test described in greater detail herein, the economic substance doctrine is based on an objective and subjective determination of whether a transaction has real, nontax economic benefit. Nevertheless, since Frank Lyon v. United States, the United States Supreme Court has not issued an important decision involving economic substance analysis, and interpretations of the doctrine subsequent to Frank Lyon v. United States was left to the circuits. As a result, circuits and courts are divided with respect to the application of the two-prong test, and several variations have emerged, each of which may result in a different way. This article presents the competing views regarding the application of the two prong test, and suggest a practical solution to reconcile these differences. The conclusions advanced are that the two-prong test ought to be collapsed into a single objective test, which would generally consist of the current objective prong

The impact of a management company’s scale on hotel market value

The choice of management structure is growing in importance for hotel owners. Most owners’ investment theses are based on an attractive acquisition basis, focusing on net cash flow and the sales exit. Depending on the market, transaction price may be influenced by asset level performance which is highly influenced by daily revenue and expense decisions. Hotel brands quantify their value via measures that include market share and loyalty of a customer base. While much research has been conducted on the impact of brands on market value, the influence of hotel management on resale value has not been well investigated. This study seeks to ascertain whether management companies that have a larger reach also have a proportional impact on the sales price, enjoying the economy of scale. The current study isolated the value of a brand to identify the impact of the size of the management company on hotel sales price. Transaction data included U.S. hotel sales over a 19-year timeframe (2001-2019). The impact of management size on hotel sales value is investigated by answering: (1) if there is an economies of scale effect between management size and sale price, (2) if the size of the hotel influences the impact of management, and (3) if such effect differs by location. The results point to a relationship between management size and hotel sales price, which varies by geography and property size. The findings will enable hotel owners to consider an additional investment variable when buying or selling hotels

The Tax Hedging Rules Revisited

As more and more taxpayers (businesses and individuals) are exposed to market risks (including but not limited to fluctuations in interest rates, foreign currency exchange rates and prices), management of such risks has become more and more important for a growing number of taxpayers. To mitigate the potential impact of such market risks, taxpayers enter into hedging transactions (mostly derivatives) to manage such risks. Typically, to manage the risk effectively, the hedging transactions would involve offsetting (i.e., long and short) positions with respect to the same or similar property, so that normally, when one position appreciates the other depreciates (and vice versa). In addition, hedging transactions frequently involve periodic payments (for example, periodic swap payments) either made or received by the taxpayer, depending on movement in market prices or interest rates. Furthermore, a termination payment (again, either made or received by the taxpayer) is typically made when the transaction matures or terminated earlier. From a tax perspective, taxpayers seek effective matching of character and timing of income and deductions from the hedging transaction (both periodic and termination payments) and the hedged item; otherwise, the economic benefit of the risk management strategy will be offset (and perhaps completely negated) by the tax inefficiency created as a result of the mismatch. As I argue in this article, our government should encourage taxpayers to exercise risk management and therefore, should accommodate tax efficiency by reducing the potential for character and timing mismatches. As of now, however, the U.S. federal income tax regime pertaining to hedging transactions limits the availability of the matching principle in certain ways, the result of which is that many transactions with a purpose of risk management remain outside the scope of the tax hedging rules. The current U.S. tax hedging rules suffer from several flaws and are not accommodating enough to many taxpayers. An immediate reform of the tax hedging rules is necessary

High burden of private mutations due to explosive human population growth and purifying selection

Recent studies have shown that human populations have experienced a complex demographic history, including a recent epoch of rapid population growth that led to an excess in the proportion of rare genetic variants in humans today. This excess can impact the burden of private mutations for each individual, defined here as the proportion of heterozygous variants in each newly sequenced individual that are novel compared to another large sample of sequenced individuals. We calculated the burden of private mutations predicted by different demographic models, and compared with empirical estimates based on data from the NHLBI Exome Sequencing Project and data from the Neutral Regions (NR) dataset. We observed a significant excess in the proportion of private mutations in the empirical data compared with models of demographic history without a recent epoch of population growth. Incorporating recent growth into the model provides a much improved fit to empirical observations. This phenomenon becomes more marked for larger sample sizes. The proportion of private mutations is additionally increased by purifying selection, which differentially affect mutations of different functional annotations. These results have important implications to the design and analysis of sequencing-based association studies of complex human disease as they pertain to private and very rare variants.Comment: 23 pages, 2 figure