The U.S. Court of Appeals for the Sixth Circuit today reversed a decision of the U.S. Tax Court that had upheld a deficiency determination based on application of the “substance-over-form doctrine” by the IRS. The Sixth Circuit found that the IRS had no basis for recharacterizing the transactions at issue because the point of the Code provisions allowing taxpayers to establish domestic international sales corporation (DISC) and Roth IRAs “…is tax avoidance.”
The case is: Summa Holdings, Inc. v. Commissioner, No. 16-1712 (6th Cir. February 16, 2017). Read the Sixth Circuit’s decision [PDF 101 KB]
The taxpayers used a DISC to transfer money from their family-owned company to their sons’ Roth IRAs. Through a series of transactions, the taxpayers transferred over $5 million from the company to the Roth IRAs.
In 2012, the IRS issued notices of deficiency to the taxpayers, and informed the taxpayers that the substance-over-form doctrine would be applied to reclassify the payments (even though it was agreed that the taxpayers had complied with the relevant provisions of the Code). The Tax Court upheld the deficiency determination, and this appeal followed.
The Sixth Circuit today reversed, finding that the IRS had no basis for recharacterizing the transactions because the taxpayers had used the DISC and Roth IRA provisions “…for their congressionally sanctioned purposes—tax avoidance.” As the appeals court noted, the Code allows the taxpayers to do what they did.
It’s one thing to permit the Commissioner to recharacterize the economic substance of a transaction—to honor the fiscal realities of what taxpayers have done over the form in which they have done it. But it’s quite another to permit the Commissioner to recharacterize the meaning of statutes—to ignore their form, their words, in favor of his perception of their substance.
The Sixth Circuit stated that application by the IRS of the substance-over-form doctrine makes sense when the taxpayer’s formal characterization of a transaction fails to capture economic reality, and would distort the meaning of the Code. However, the court concluded that the Code authorizes DISC commissions and dividends (regardless of whether they have economic substance) in order to reduce the tax burden of exports, and authorizes investors to avoid significant taxes on capital gains and dividends by using their Roth IRAs “in all manners of tax-avoiding ways.”
© 2017 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.