Economic Substance and Installment Sales

Public companies have deferred several billion dollars in taxes through the use of monetized installment sales in connection with the sale of their appreciated assets.  An IRS letter ruling, as well as several other authorities, have supported these transactions as detailed on our website at

These transactions have all been based on very technical readings of the Tax Code.  They were all implemented as prearranged plans, marketed by outside advisors, in consequence of the taxpayers’ desire to sale the asset, but substantively there were no other ‘non tax’ reason for structuring them as an installment sale.  In substance, the asset buyers transferred the purchase price to a third party while giving a note receivable to the seller, with another third party providing a loan to the seller.  Nevertheless, the authorities deemed the need for liquidity as sufficient justification for the highly technical structuring of the deferral transactions.

However, some taxpayers and advisors do not like transactions that merely comply with the ‘letter of the law’.  Instead, unlike the public companies’ transactions, they prefer a transaction that complies with both the letter and the spirit of the law.

Consequently, we also offer ‘value added dealer’ services designed to comply with both the letter and the spirit of the law by providing contingency services with greater profit potential than a sellers’ potential tax savings.  In fact, Liquid Capital’s driving objective of offering a ‘better exit strategy’ to sellers preceded our installment sale structures and substantive, non tax related services including an industry rollup syndication ($50mm in private equity committed), ‘venture building’ services on a contingency fee basis and management services allowing owner/operators to phase out of day to day operations.  A partial summary of our previous work can be found at

Below is a partial summary of the legal validity of transactions based only on the ‘letter of the law’ as well as the unassailability of transactions that provide significant non tax related profits coupled with tax advantages.

1. Letter of the Law - Technical Compliance

A. In the case of a public company that provided seller financing which was coupled with a loan, the IRS Office of Chief Counsel Memorandum No. 20123401F stated, “Substantively, the steps of the Transaction matched their form: an installment sale coupled with a monetization loan. The Transaction allowed Taxpayer to take advantage of tax deferral on the Asset sale, which is a permitted result under I.R.C. §§ 453 and 453A.”)

B. Similarly, in Summa Holdings, Inc. v. Comm’r, T.C. Memo 2015-119, the 6th Circuit Appellate court has partially put a leash on the IRS Commissioner to argue that a transaction, if done solely for income tax purposes may be set aside, on substance-over-form arguments, if the transaction clearly follows the Tax Code!

There is no “patriotic duty to increase one’s taxes,” as Judge Learned Hand memorably told us in the case that gave rise to the economic-substance doctrine. Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934). “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.” Id. If the Code authorizes the “formal” transactions the taxpayer entered, then “it is of no consequence that it was all an elaborate scheme to get rid of income taxes.” Id.; See also, David P. Hariton, Sorting Out the Tangle of Economic Substance, 52 Tax Law. 235, 236-41 (1999).

The court further addressed the complexity of the Tax Code and that the substance-over-form doctrine does not authorize the Commissioner to undo a transaction just because taxpayers undertook it to reduce their tax bills. Thus, lowering one’s tax bills is an acceptable form of planning.

The Court in Summa further added that many provisions of the Code owe their existence solely to tax-reducing purposes, to lower current taxes or to shelter income from taxes over time. Many areas the IRS is attacking currently, particularly listed transactions or reportable transactions, may, in theory, be perfectly allowable transactions. As such,
as long as each component of the transaction is compliant with the expressed language in the Code and properly characterized, income tax can be reduced without regard to questions concerning the “substance” of the resultant structure.

The court noted “the substance-over-form doctrine does not give the Commissioner a warrant to search through the Internal Revenue Code and correct whatever oversights Congress happens to make or redo any policy missteps the legislature happens to take.”  
So, tax benefits when correctly following the Code, even if the consequences may have been unintended do not by themselves allow the imposition of the substance-over-form doctrine.  

2. Letter and Spirit of the Law - and Codification of Economic Substance

It is important to note that the sale of an asset is already driven by economics (and the tax optimized structuring thereof merely is a result of that business objective - in contrast to classic ‘tax shelters’’ where the transaction is driven by a desire to shelter income, rather than in consequence of another specific business goal.  Nevertheless, we offer additional ‘value added’ services to supplement a seller’s future business operations that are designed

The legal value of offering these additional services, begins with the recent codification of the Economic Substance Doctrine of IRC 7701.

The Economic Substance Doctrine contains three tests all of which apply in order for a taxpayer's tax position to be denied -

The tests require:

1. A determination be made that the economic substance doctrine is relevant, AND

2. The transaction must change, in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, AND


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

Following is a brief analysis of these three requirements.

1. Determine that transaction to which the economic substance doctrine is relevant

The IRS has left uncertainty remain open by stating that the economic substance doctrine only applies in instances that apply at common law. In Notice 2010-62 IRS stated that determining what transactions will continue to analyze when the economic substance doctrine will apply in the same fashion as it did prior to the enactment of section 7701(o).1  If authorities, prior to the enactment of section 7701(o), provided that the economic substance doctrine was not relevant to whether certain tax benefits are allowable, the IRS will continue to take the position that the economic substance doctrine is not relevant to whether those tax benefits are allowable. Moreover,  they announced that they will not issue private letter rulings or determination letters on the issue of relevancy.

However, the IRS has issued an internal guide which can help taxpayers understand whether the IRS likely believes that a transaction must have economic substance in order to be respected.  This manual is the “Guidance for Examiners and Managers on the Codified Economic Substance Doctrine and Related Penalties”, by the IRS Commissioner for the Large Business and International Division, LB&I Control No: LB&I- 4-0711-015, July 15, 2011.

The guide highlights 18 factors that are indicative of a transaction where the economic substance doctrine does not need to be considered -

The Guidance document lists the following items:

2. The transaction must change, in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and


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

In determining whether the taxpayer meets the conjunctive two-prong test, the transaction's potential for profit is taken into account only if the expected pre-tax profits substantially exceed the expected net tax benefits that would be allowed if the transaction were respected (the "profit potential test").

Note that factors other than profit potential may demonstrate that a transaction results in a meaningful change in the taxpayer's economic position or that the taxpayer has a substantial non-Federal tax purpose for entering into such transaction. The provision does not require or establish a specified minimum return that will satisfy the profit potential test.

However, IRS has stated that it will take into account the taxpayer’s profit motive only if the present value of the reasonably expected pre-tax profit is substantial in relation to the present value of the expected net tax benefits that would be allowed if the transaction were respected for Federal income tax purposes. In performing this calculation, the IRS will apply existing
relevant case law and other published guidance.


Our Preferred Equity Investment transaction structure is designed to generate more profits over the term of the relationship (i.e. over 30 years) than the current tax savings, thereby placing this transaction outside of potential attack based on any and all three of the requirements set forth in the recently codified Economic Substance Doctrine.


Following is a summary of case rulings the codified Economic Substance Doctrine states should be referred to in making a determination as to when the doctrine should apply.