Question

How business-purpose doctrines affect taxpayer behavior

Answer 1

Tax avoidance "by means which the law permits" traditionally has been viewed as a legal right.' The Commissioner of Internal Revenue (Commissioner) has probed taxpayers' business motives which has led to the development of the business purpose doctrine, which permits the Commissioner to ignore tax benefits for certain transactions motivated by tax avoidance or non-business purposes.

The business purpose doctrines lay down the requirement to drive a transaction by some business consideration other than tax avoidance or non business purpose. To determine the intent of the taxpayer, many factors have been considered by the courts, including:

1) whether the taxpayer had profit potential,

2) whether the taxpayer cited a non-tax business reason for entering into the transaction,

3) whether the taxpayer funded the transaction with its own capital,

4) whether the entities involved in the transaction were entities separate and apart from the taxpayer,

5) whether the transactions entered into were at arms-length.

A transaction does not trigger the application of business purpose doctrines merely because it was entered into with a desire to avoid tax. However, in addition to a tax avoidance motivation, business owners must also have a business motivation and the transaction must have some economic impact on the taxpayer.

More recently, the Commissioner has argued that business purpose is necessary or motive determinative in transactions involving the distribution of corporate dividends, interest deductions, the prepayment of feed, gifts and leaseback.

However, the burden is on the taxpayer to find the opportunities, interpret the Code, adapt his or her behavior accordingly and finally file the appropriate forms with the IRS