Liberty Global Inc. (“LGI”) avoided tax from the sale of a Belgian subsidiary by claiming a dividends received deduction for the entire amount of $2.6 billion in gain. The government challenged this result on economic substance and step transaction grounds.  In cross motions for summary judgment, previously covered here, LGI and the government presented contradicting interpretations of the application of those doctrines. On October 31, 2023, the District Court for the District of Colorado granted the government’s motion for summary judgment, holding that LGI “has not created a genuine issue as to whether the entire multi-step transaction took place for any substantial reason other than tax evasion.”

The court rejected LGI’s various arguments regarding the application of the economic substance doctrine.

• Relevance: LGI argued that the court should first conduct a threshold inquiry into whether the economic substance doctrine is “relevant” prior to applying the two-pronged inquiry in the statute. The court held that there is no separate threshold inquiry into the relevance of the doctrine because “the doctrine’s relevance is coextensive with the statute’s test for economic substance.” The court stated rather simply that “the economic substance doctrine applies when a transaction lacks economic substance.”
• Unit of analysis: LGI sought to isolate a key step in the transaction, the entity conversion that actually triggered the gain, arguing that since this step was permissible on its own the entire transaction was therefore permissible tax planning. The court rejected this argument, stating that it may use its authority to “aggregate interrelated transactions to...avoid frustrating the doctrine’s purpose” and consider all steps of a transaction in its “necessarily flexible analyses.”
• Exemptions: LGI argued that some tax-motivated transactions are permissible, analogizing its transaction to a married couple’s decision to file a joint or separate tax return to receive the lowest aggregate tax liability. The court rejected that analogy on the basis that the economic substance doctrine applies to “transactions”, and that the decision to file joint or separate returns is not a transaction, and further that such a decision lies within the plain intent of the tax code. LGI made a related argument that its transaction should be exempted as a “basic business transaction.”  The court acknowledged that such exemption for basic transactions exists, but virtually scoffed at LGI’s argument that this highly structured transaction effected with the assistance of high-priced tax advisors should be treated as a basic transaction that is exempted from the economic substance doctrine. Rather, it was exactly the type of transaction to which the doctrine should be applied to “prevent business organizations from entering schemes to evade taxes.”
• Application of the two-prong test: The court then applied the two-prong test of the economic substance doctrine, which requires a transaction to both meaningfully change a taxpayer’s non-tax economic position and have a substantial non-tax purpose. The court concluded that “the only substantial purpose of the transaction was tax evasion.”

This case should be a warning to taxpayers and practitioners that the economic substance doctrine is alive and relevant to transactions that principally or exclusively produce tax benefits.  LGI immediately expressed its intention to appeal.