Cadwalader Logo BrassTax Logo
Liberty Global and DOJ Go Head to Head on Economic Substance Doctrine

Liberty Global Inc. ("LGI") and the Department of Justice are in fierce litigation over the application of the economic substance and step transaction doctrines to a transaction for which LGI claimed a dividends received deduction for $2.4 billion in gain from the sale of its Belgian subsidiary Telenet Group Holding ("TGH"). The government seeks to disregard certain steps of the transaction.

In the first step of the transaction, a disregarded entity owned by TGH converted to an entity which was a corporation for US tax purposes, causing TGH to recognize gain and so increase its earnings and profits. Subsequently, LGI sold its interest in TGH and asserted that the entire amount of its gain was a dividend for which a dividends received deduction could be claimed.

Under the economic substance doctrine, a common-law doctrine that was subsequently codified, a transaction has economic substance only if it meaningfully changes a taxpayer’s non-tax economic position and the taxpayer has a substantial non-tax purpose for entering into the transaction. The codification explicitly preserves pre-existing case law. The step transaction doctrine is a common-law doctrine that combines or disregards steps taken as part of a series of related transactions rather than respecting each step separately.

The government seeks to disregard the entity conversion and so the earning and profits it generated, arguing that these “highly-engineered inter-company transactions” are the type of tax-motivated transactions that Congress intended to be subject to the economic substance doctrine.

LGI contends that Congress intended to exempt the decision to organize as a corporation, citing a House Report to claim that the economic substance doctrine does not apply to “basic business transactions that, under longstanding judicial and administrative practice are respected, merely because the choice between meaningful economic alternatives is largely or entirely based on comparative tax advantages.”

The government asserts that there is no exemption or significant limitation to the economic substance doctrine, noting that when Congress codified the doctrine, it did not intend to exempt corporate reorganizations that are part of a larger scheme designed to generate unintended tax benefits.

The government also invokes the step transaction doctrine to disregard the entity conversion, using the same rationale, asserting that the steps of the transaction are interdependent and would not have been undertaken separately. LGI argues that the step transaction doctrine does not apply because no step was transitory; rather, each step was permanent.

As LGI points out, the consequences of applying the economic substance doctrine—disregarding transactions that comply with all applicable tax rules—would be “extreme.”  The outcome of this case will provide valuable insight into whether the economic substance and step transaction doctrines limit taxpayers’ freedom to choose their form of organization even if solely or primarily motivated by tax considerations.

Key Contacts

Adam Blakemore
T. +44 (0) 20 7170 8697

Linda Z. Swartz
T. +1 212 504 6062

Jon Brose
T. +1 212 504 6376

Andrew Carlon
T. +1 212 504 6378

Mark P. Howe
T. +1 202 862 2236

© 2024 | Notices