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• W320421949 abstract "There's an adage that if a tax-saving idea sounds too good to be true, it probably is. A number of corporations that participated in a Merrill Lynch tax plan discovered this when the ruling in a 67-year-old case proved to be their downfall. Gregory v. Helvering, 293 U.S. 465 (1935) was a landmark case--the first of its kind to come before the courts on the question of whether a reorganization took place where the taxpayer had no intent to carry on the existing corporate business, only a desire to minimize taxes. Previously, the courts had always applied a literal interpretation of the law when deciding tax cases. In 1935 the Second Circuit Court of Appeals (in an opinion by Judge Learned Hand) rejected the literal interpretation of the lower court, which had ruled in Mrs. Gregory's favor because she had complied with the letter of the law in seeking to minimize her tax liability. Hand held that the statute presupposed a continuation of business and this intent was absent in Gregory. He ruled that what had occurred was not a reorganization as Congress intended because the taxpayer had not met the law's unwritten requirements. The business purpose test originated with Gregory. It was the first time a literal interpretation of the tax law did not prevail. The U.S. Supreme Court affirmed the ruling. Other concepts that evolved from Gregory, in addition to the business purpose test, include continuity of business, the taxpayer's right to minimize tax liability, substance over form and the step transaction doctrine. The IRS and the courts still apply many of these tests today. What follows is a discussion of three cases in which the courts applied both the doctrine of substance over form and the business purpose test to expose elaborate tax-avoidance schemes as sham transactions. The warning to CPAs and the taxpayers they represent is that the government can still use the simple concepts in Gregory as major weapons against tax shelters. THE MERRILL LYNCH PLAN Merrill Lynch was involved in all three cases. In 1989 and 1990 the brokerage firm marketed an investment plan to several U.S. companies that had as its primary purpose generating huge capital losses the companies could use to offset existing (or expected) capital gains. The plan required the U.S. company to form a partnership (based outside the United States) with a foreign entity that paid no U.S. income tax. In the beginning, the foreign entity would have an overwhelming majority partnership interest. The scheme relied on applying the installment sale (see Installment Sales on page 67) and contingency sale rules to sales of foreign currency for cash or London interbank offered rate (Libor) notes (see Security Definitions on page 68). The plan was for the partnership to trade securities and ultimately purchase private placement notes (PPNs). Merrill Lynch marketed this plan to several large corporations. Although there were slight variations, in general it involved these steps: * The U.S. company would enter into a foreign-based partnership with a foreign entity that was not subject to U.S. income tax. * The foreign entity would have the overwhelming majority partnership interest while the U.S. company would own a distinct minority interest. * The partnership would purchase short-term PPNs eligible for the installment method of accounting. It then would sell them for a large cash down payment with the balance made up of a comparatively small amount of debt instruments (five-year Libor notes) whose yield over a fixed period of time was not ascertainable. One-sixth of the basis would be applied to the down payment. The gain from the down payment would be allocated according to the partnership interests. Therefore, the foreign partner would receive the majority of the gain. * The partnership would claim a large basis (five-sixths of the basis of the PPNs) in the Libor notes. …" @default.
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• W320421949 date "2002-07-01" @default.
• W320421949 modified "2023-09-23" @default.
• W320421949 title "A Weapon from the Past: A 67-Year-Old Case Proves the Downfall of Corporate Tax Shelters" @default.
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