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Why Did the IRS Win? A Remarkable Year in Tax Litigation, Part 2

Posted on Jan. 15, 2024
Reuven S. Avi-Yonah
Reuven S. Avi-Yonah

Reuven S. Avi-Yonah ( is the Irwin I. Cohn Professor of Law at the University of Michigan Law School.

In this installment of Reflections With Reuven Avi-Yonah, part 2 of a two-part series, Avi-Yonah continues his examination of 2023 legal victories for the government with a look at an offshore hedge fund case and a Tax Cuts and Jobs Act tax planning case.

In my previous column,1 I pointed out that 2023 was a remarkably good year for government litigators in tax cases. That column focused on two transfer pricing cases (3M2 and Coca-Cola3). This column will focus on two other government victories (YA Global4 and Liberty Global5).6

YA Global

On November 15, 2023, the Tax Court decided YA Global.7 The issue was whether a Caymans-based hedge fund should be treated as engaged in a U.S. trade or business through the activities of its U.S.-based investment manager.8 The hedge fund, YA Global, engaged in originating and managing loans to U.S. persons, and the investment manager, Yorkville Advisors, oversaw the investments. The taxpayer argued that YA Global was simply an investor, but the court held that Yorkville Advisors was acting as the agent of YA Global because its activities on YA Global’s behalf were continuous, regular, and engaged in for the primary purpose of income or profit. The court then held that because Yorkville Advisors was YA Global’s agent, and because the activities of Yorkville Advisors were meaningfully distinguishable from those of a typical investor, YA Global was engaged in a U.S. trade or business.

Before 1997, this case would have been governed by the so-called ten commandments, provisions in the regulations that prescribed the activities that an entity must conduct offshore to avoid being designated as a U.S. trade or business. The problem was that no matter what their tax lawyers said, taxpayers would often violate the commandments in practice. Congress thereupon revoked the commandments. But now that the rule has been replaced by a standard, even though taxpayers may carefully draw formal distinctions between an offshore hedge fund and an onshore investment manager, the courts may follow YA Global in treating the latter as an agent of the former. It helps that the hedge funds are typically partnerships located in tax havens, and therefore the stricter permanent establishment standard of the tax treaties is inapplicable.

The problem is that, like any standard, the application is uncertain, and it can be expected that hedge funds try to avoid the result reached in YA Global. This issue could be resolved if the IRS changed its definitions of domestic partnership and foreign partnership, which it can do by regulation.9 Under current law, the definition generally hinges on where the partnership was formed, like the definition of corporate residency. But if the IRS adopted a “managed and controlled” standard for partnership residency, and if all the actual activities of an investment manager were performed as usual in the United States, it would not be necessary to show that the investment manager was an agent of a foreign partnership.

I would also adopt this definition for corporate taxpayers, as suggested by Treasury in the context of inversions, but that change requires legislation, which is unlikely to be enacted because tax exempt entities and foreign investors rely heavily on so-called blockers — shell corporations in tax havens — to avoid unrelated business income and effectively connected income.10

Liberty Global

In October 2023 the U.S. District Court for the District of Colorado granted summary judgment to the government in Liberty Global Inc.’s suit for a $2 billion tax refund.11 The court applied the codified economic substance doctrine (section 7701(o)) to deny the taxpayer the section 245A deduction for a dividend from foreign earnings.

The transaction was a tax shelter devised by Deloitte that relied on a mistake in the Tax Cuts and Jobs Act. The TCJA provided that the section 245A deduction was available to any U.S. corporate shareholder of a controlled foreign corporation, but that the global intangible low-taxed income inclusion depended on there being a U.S. shareholder of the CFC at the end of the CFC’s tax year. The transaction involved converting a disregarded entity into a CFC and generating earnings and profits that were not taxable under the GILTI regime, and thereafter selling the CFC and claiming the deduction for the resulting dividend.

Treasury had attempted to eliminate this planning opportunity through issuing a regulation (reg. section 1.245A-5T), but the district court held in 2022 that this regulation did not comply with the Administrative Procedure Act and was therefore invalid.12

In the 2023 decision, the court held that in undertaking the analysis under the objective and subjective prongs of the economic substance doctrine, the question was whether the tax results from the transaction were consistent with congressional intent. According to the district court, the core purpose of the doctrine is to prevent taxpayers from avoiding taxes by interpreting tax provisions in ways that Congress did not intend. The court held that the transaction at issue violated the economic substance doctrine because the mistake in the TCJA was clearly not intended by Congress. Liberty Global has appealed the decision to the Tenth Circuit.13

Liberty Global is remarkable because it reverses many years of textualism in relying on congressional (and not taxpayer) purpose in interpreting the economic substance doctrine. To understand its significance, it is important to lay out the history of the economic substance doctrine.14

To discuss the problem of economic substance, one must begin with the classic Supreme Court opinion in Gregory,15 still the most frequently cited tax opinion of all time. Gregory involved the straightforward application of what is now a D reorganization. At the Second Circuit, Judge Learned Hand admitted that the transaction complied with the code as written, but he held that it was nevertheless invalid because this was not what Congress meant:

We agree with the Board and the taxpayer that a transaction, otherwise within an exception of the tax law, does not lose its immunity, because it is actuated by a desire to avoid, or, if one choose, to evade, taxation. Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes. Therefore, if what was done here, was what was intended by section 112(i)(1)(B), it is of no consequence that it was all an elaborate scheme to get rid of income taxes, as it certainly was. Nevertheless, it does not follow that Congress meant to cover such a transaction, not even though the facts answer the dictionary definitions of each term used in the statutory definition. It is quite true, as the Board has very well said, that as the articulation of a statute increases, the room for interpretation must contract; but the meaning of a sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create. The purpose of the section is plain enough; men engaged in enterprises industrial, commercial, financial, or any other might wish to consolidate, or divide, to add to, or subtract from, their holdings. Such transactions were not to be considered as “realizing” any profit, because the collective interests still remained in solution. But the underlying presupposition is plain that the readjustment shall be undertaken for reasons germane to the conduct of the venture in hand, not as an ephemeral incident, egregious to its prosecution. To dodge the shareholders’ taxes is not one of the transactions contemplated as corporate “reorganizations.”16 [Emphasis added; internal citations omitted.]

The Supreme Court affirmed with the same reliance on congressional purpose:

It is earnestly contended on behalf of the taxpayer that, since every element required by the foregoing subdivision (B) is to be found in what was done, a statutory reorganization was effected, and that the motive of the taxpayer thereby to escape payment of a tax will not alter the result or make unlawful what the statute allows. It is quite true that, if a reorganization in reality was effected within the meaning of subdivision (B), the ulterior purpose mentioned will be disregarded. The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. But the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended. The reasoning of the court below in justification of a negative answer leaves little to be said. . . .

The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction, upon its face, lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.17 [Emphasis added; internal citations omitted.]

From 1935 to 1978, this decision guided the interpretation of tax statutes, culminating in the classic Supreme Court opinion in Knetsch,18 a case that likewise involved a straightforward application of the statutory text to reach an absurd and unintended result. But in Frank Lyon,19 the Court shifted the emphasis to a different question: not what Congress intended, but what the taxpayer intended. As the Court stated:

In so concluding, we emphasize that we are not condoning manipulation by a taxpayer through arbitrary labels and dealings that have no economic significance. Such, however, has not happened in this case.

In short, we hold that where, as here, there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax avoidance features that have meaningless labels attached, the Government should honor the allocation of rights and duties effectuated by the parties.20 [Emphasis added.]

This emphasis on the taxpayer’s purpose led to the development of the economic substance doctrine with its two prongs: the objective prong (Did the transaction have a nontax purpose?) and the subjective prong (Did the taxpayer have a nontax purpose?). In 2010 the doctrine was codified as section 7701(o), but Congress stated explicitly that “the determination of whether the economic substance doctrine is relevant to a transaction shall be made in the same manner as if this subsection had never been enacted.”21

The district court in Liberty Global reverts to the pre-Frank Lyon state of affairs, relying not on taxpayer purpose but on congressional purpose. This type of purposivism is now the minority view, and it seems inconsistent with Supreme Court precedents like Gitlitz,22 in which the Court held that:

Courts have discussed the policy concern that, if shareholders were permitted to pass through the discharge of indebtedness before reducing any tax attributes, the shareholders would wrongly experience a “double windfall”: They would be exempted from paying taxes on the full amount of the discharge of indebtedness, and they would be able to increase basis and deduct their previously suspended losses. Because the Code’s plain text permits the taxpayers here to receive these benefits, we need not address this policy concern.23 [Emphasis in original; internal citation omitted.]

But it should also be noted that Gitlitz (with its holding that was promptly reversed by Congress) and other textualist tax cases were decided before the codification of economic substance. Section 7701(o) now states that:

(1) In the case of any transaction to which the economic substance doctrine is relevant, such transaction shall be treated as having economic substance only if —

(A) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and

(B) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction. . . .

(5)(C) The determination of whether the economic substance doctrine is relevant to a transaction shall be made in the same manner as if this subsection had never been enacted.

Arguably, even though the two prongs of economic substance focus on taxpayer purpose, the determination whether the doctrine is “relevant” can be based on congressional purpose, especially because the reference to pre-enactment case law includes a lot of purposivist cases from Gregory onward. It remains to be seen how this case will fare at the appellate level.


1 Reuven S. Avi-Yonah, “ Why Did the IRS Win? A Remarkable Year in Tax Litigation,” Tax Notes Int’l, Jan. 8, 2024, p. 231.

2 3M Co. v. Commissioner, 160 T.C. No. 3 (2023).

3 Coca-Cola Co. v. Commissioner, T.C. Memo. 2023-135.

4 YA Global Investments LP v. Commissioner, 161 T.C. No. 11 (2023).

5 Liberty Global Inc. v. United States, No. 1:20-cv-03501 (D. Colo. 2023).

6 See the discussion of YA Global and Liberty Global in Mindy Herzfeld, “2023: The Judiciary Takes Center Stage,” Tax Notes Int’l, Dec. 18, 2023, p. 1675.

7 YA Global, 161 T.C. No. 11. See also Herzfeld, supra note 6.

8 See 2014 IRS chief counsel advice ILM 201501013, which addresses these facts.

9 See section 7701(a)(4) and (5), defining domestic and foreign.

10 See Avi-Yonah, “Beyond Territoriality and Deferral: The Promise of ‘Managed and Controlled,’Tax Notes Int’l, Aug. 29, 2011, p. 667.

11 Liberty Global, No. 1:20-cv-03501. For a discussion of the case, see Herzfeld, supra note 6.

12 Liberty Global Inc. v. United States, No. 1:20-cv-03501-RBJ (D. Colo. 2022).

13 Amanda Athanasiou, “ Liberty Global Appeals Economic Substance Loss to Tenth Circuit,” Tax Notes Federal, Jan. 8, 2024, p. 360.

14 The following discussion is based in part on Avi-Yonah, “Rodriguez, Tucker, and the Dangers of Textualism,” Tax Notes Federal, Apr. 6, 2020, p. 87.

15 Gregory v. Helvering, 293 U.S. 465 (1935), aff’g 69 F.2d 809 (2d Cir. 1934).

16 Gregory, 69 F.2d at 810-811.

17 Gregory, 293 U.S. at 468-470.

18 Knetsch v. United States, 364 U.S. 361 (1960).

19 Frank Lyon Co. v. United States, 435 U.S. 561 (1978).

20 Id. at 583-584.

21 Section 7701(o)(5)(C).

22 Gitlitz v. Commissioner, 531 U.S. 206 (2001).

23 Id. at 219-220.


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