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Codification of Economic Substance Doctrine in Federal Law Raises Questions About Potential Impact on State, Taxpayers

July 8, 2010

In a recent interview, Tax Partner Jeffrey A. Friedman discussed the new federal tax law provision that codifies the common law doctrine of economic substance. The new Internal Revenue Code Section 7701(o) "codifies" a common law concept, economic substance, and establishes a two-part test: A transaction has economic substance only if there has been a "meaningful change" for the taxpayer (as opposed to mere tax benefits), and only if there is a "substantial" non-tax purpose for the transaction. When asked how this test differs from the common law test, Jeff noted the following: "There has been substantial debate—and inconsistent decisions from courts—as to the common law business purpose and economic substance doctrine. For instance, courts have come to different conclusions as to whether these two principles are independent separate tests or are an integrated single test. The new federal statute not only addresses the independence of the tests, but puts in place standards that are used to apply the tests."

July 8, 2010 BNA

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