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COMPLIANCE WITH TAX LIMITS ON MUTUAL 

FUND COMMODITY SPECULATION 

HEARING 

BEFORE THE

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS 

OF THE

COMMITTEE ON 

HOMELAND SECURITY AND 

GOVERNMENTAL AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

JANUARY 26, 2012 

Available via the World Wide Web: http://www.fdsys.gov 

Printed for the use of the 

Committee on Homeland Security and Governmental Affairs 

( 
(II) 

COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS 

JOSEPH I. LIEBERMAN, Connecticut, Chairman 

CARL LEVIN, Michigan 

DANIEL K. AKAKA, Hawaii 

THOMAS R. CARPER, Delaware 

MARK L. PRYOR, Arkansas 

MARY L. LANDRIEU, Louisiana 

CLAIRE MCCASKILL, Missouri 

JON TESTER, Montana 

MARK BEGICH, Alaska 

SUSAN M. COLLINS, Maine 

TOM COBURN, Oklahoma 

SCOTT P. BROWN, Massachusetts 

JOHN MCCAIN, Arizona 

RON JOHNSON, Wisconsin 

ROB PORTMAN, Ohio 

RAND PAUL, Kentucky 

JERRY MORAN, Kansas 

MICHAEL L. ALEXANDER, Staff Director 

NICHOLAS A. ROSSI, Minority Staff Director 

TRINA DRIESSNACK TYRER, Chief Clerk 

PATRICIA R. HOGAN, Publications Clerk 

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS 

CARL LEVIN, Michigan, Chairman 

THOMAS R. CARPER, Delaware 

MARY L. LANDRIEU, Louisiana 

CLAIRE MCCASKILL, Missouri 

JON TESTER, Montana 

MARK BEGICH, Alaska 

TOM COBURN, Oklahoma 

SUSAN M. COLLINS, Maine 

SCOTT P. BROWN, Massachusetts 

JOHN MCCAIN, Arizona 

RAND PAUL, Kentucky 

ELISE J. BEAN, Staff Director and Chief Counsel 

DAVID H. KATZ, Counsel 

CHRISTOPHER BARKLEY, Staff Director to the Minority 

MARY D. ROBERTSON, Chief Clerk 
(III) 

C O N T E N T S 

Opening statements: Page 

Senator Levin .................................................................................................... 1 

Senator Coburn ................................................................................................. 6 

Senator Carper ................................................................................................. 16 

Prepared statements: 

Senator Levin .................................................................................................... 29 

Senator Coburn ................................................................................................. 34 

WITNESSES 

THURSDAY, JANUARY 26, 2012 

Hon. Douglas H. Shulman, Commissioner, Internal Revenue Service ................ 7 

Emily S. McMahon, Acting Assistant Secretary for Tax Policy, U.S. Department of the Treasury ........................................................................................... 9 

ALPHABETICAL LIST OF WITNESSES

McMahon, Emily S.: 

Testimony .......................................................................................................... 9 

Prepared statement .......................................................................................... 42 

Shulman, Hon. Douglas H.: 

Testimony .......................................................................................................... 7 

Prepared statement .......................................................................................... 36 

EXHIBIT LIST 

1.a. Increase in Commodity Related Mutual Funds, 2008-2011, chart prepared by the Permanent Subcommittee on Investigations ........................ 44 

b. 72 IRS Private Letters Authorizing Commodity Investments by Mutual 

Funds, 2006-2011, chart prepared by the Permanent Subcommittee 

on Investigations ........................................................................................... 45 

c. IRS Private Letters Authorizing Commodity Investments by Mutual 

Funds, list prepared by the Permanent Subcommittee on Investigations ................................................................................................................ 46 

d. Letter from Senators Levin and Coburn of the Permanent Subcommittee on Investigations to the Internal Revenue Service regarding 

Private Letter Rulings to Mutual Funds Seeking Commodities Exposure, dated December 20, 2011 .................................................................... 51 

2. Examples of Internal Revenue Service (IRS) Private Letter Rulings: 

a. IRS Private Letter Ruling No. 200628001, released 7/14/2006 ................ 57 

b. IRS Private Letter Ruling No. 200647017, released 11/24/2006 .............. 61 

c. IRS Private Letter Ruling No. 200741004, released 10/12/2007 .............. 67 

3. Legislative History of Section 851: 

a. Title 26 U.S.C. § 851 .................................................................................... 71 

b. Letter from J. Roger Mentz, Acting Assistant Secretary (Tax Policy), 

U. S. Department of the Treasury, to Honorable Ronnie G. Flippo, 

U.S. House of Representative, regarding H.R. 3397 amending provisions of the Internal Revenue Code relating to regulated investment 

companies, dated February 5, 1986 ............................................................ 75 
Page

IV 

c. IRS Revenue Ruling 2006-1 regarding Regulated investment company 

(RIC) request related to a derivative contract reliant on a commodity 

index, dated January 9, 2006 ...................................................................... 78 

d. IRS Implicitly Rules on Economic Substance Doctrine and Blockers, 

TAX NOTES, March 21, 2001 ........................................................................ 81 

4. Legislative History of Regulated Investment Company Modernization Act: 

a. Joint Committee on Taxation Report on Regulated Investment Company Modernization Act of 2010 excerpt explaining Section 201 of 

the bill addressing income from commodities ............................................ 86 

b. Congressional Record excerpts regarding House approval of H.R. 4337, 

Regulated Investment Company Modernization Act of 2010 on September 28, 2010 ............................................................................................ 89 

c. Congressional Record excerpts regarding Senate approval of H.R. 4337, 

Regulated Investment Company Modernization Act of 2010 on December 8, 2010 ..................................................................................................... 93 

d. Congressional Record excerpts regarding final House approval and 

enactment into law of H.R. 4337, Regulated Investment Company Modernization Act of 2010 on December 15, 2010 ........................................... 94 

5. Commodity Related Mutual Funds: 

a. Selected Commodity Related Mutual Funds, list prepared by the Permanent Subcommittee on Investigations ................................................... 97 

b. Information related to: 

• Direxion Commodity Trends Strategy Fund ........................................... 98 

• Highbridge Dynamic Commodities Strategy Fund ................................. 102 

• MutualHedge Frontier Legends Fund ..................................................... 104 

• Oppenheimer Commodity Strategy Total Return Fund ......................... 118 

• PIMCO CommodityRealReturn Strategy Fund and ............................... 124 

• PIMCO CommoditiesPLUS Strategy Fund ............................................. 124 

• Rydex/SGI Long Short Commodities Strategy Fund .............................. 129 

• Rydex/SGI Managed Futures Strategy Fund .......................................... 131 

• Van Eck CM Commodity Index Fund ...................................................... 133 

6. The Existence and Consequences of Excessive Speculation: 

a. Executive Summary and Findings and Recommendations from the 

June 2007 Staff Report of the Senate Permanent Subcommittee on 

Investigations entitled, ‘‘Excessive Speculation in the Natural Gas 

Market’’ ......................................................................................................... 135 

b. Executive Summary and Findings and Recommendations from the 

June 2009 Staff Report of the Senate Permanent Subcommittee on 

Investigations entitled, ‘‘Excessive Speculation in the Wheat Market’’ .. 145 

c. Letter from 450 economists to the G20 Finance Ministers regarding 

impact of speculation on food prices, October 11, 2011 ............................. 165 

d. Better Markets press release regarding October 14, 2011 research 

report, New Research Shows That Wall Street Speculators Are Driving 

Up Food and Fuel Prices and That Commodity Index Funds Should 

Be Banned ..................................................................................................... 187 

7. News Analysis: IRS Suspends RIC Commodities Investments Rulings, 

written by Lee A. Sheppard, Tax Analysts, 2011 ........................................... 192 

8. Select Commodity Price Indices. Source: Chart appearing at http:// 

www.indexmundi.com/commodities/, attributing data to International 

Monetary Fund Primary Commodity Price Indices ....................................... 195 

9. Responses to supplemental questions for the record submitted by Senator 

Carl Levin to The Honorable Douglas H. Shulman, Commissioner, Internal Revenue Service ......................................................................................... 196 

10. Responses to supplemental question for the record submitted by Senator 

Carl Levin to Emily McMahon, Acting Assistant Secretary for Tax Policy, 

U.S. Department of the Treasury .................................................................... 199 
(1) 

COMPLIANCE WITH TAX LIMITS ON MUTUAL 

FUND COMMODITY SPECULATION 

THURSDAY, JANUARY 26, 2012 

U.S. SENATE, PERMANENT SUBCOMMITTEE ON INVESTIGATIONS, OF THE COMMITTEE ON HOMELAND SECURITY

AND GOVERNMENTAL AFFAIRS, Washington, DC. 

The Subcommittee met, pursuant to notice, at 10:31 a.m., in 

room SD–342, Dirksen Senate Office Building, Hon. Carl Levin, 

Chairman of the Subcommittee, presiding. 

Present: Senators Levin, Carper, and Coburn. 

Staff Present: Elise J. Bean, Staff Director and Chief Counsel; 

Mary D. Robertson, Chief Clerk; David H. Katz, Counsel; Christopher Barkley, Staff Director to the Minority; Eric Walker, 

Detailee (FDIC); Dennis Bogusz, Congressional Fellow; Courtney 

Cardin, Law Clerk; Michael Wolf, Law Clerk; Arielle Woronoff, 

Law Clerk; Bill Gaertner, Law Clerk; Tamir Haddad, Intern; Julie 

Kovin, Law Clerk; David Smith and Amanda Slater (Senator Carper). 

OPENING STATEMENT OF SENATOR LEVIN 

Senator LEVIN. Good morning, everybody. For 10 years now, this 

Subcommittee has focused attention on the problem of excessive 

speculation in the commodity markets, including the crude oil, natural gas, and wheat markets. Most recently, in last November’s 

hearing, we examined efforts to apply a new position limits rule to 

protect consumers, businesses, and the commodity markets themselves from excessive speculation. For years now, the American 

people have been whipsawed by unpredictable and often escalating 

commodity prices. We have been hurt at the pump, we have been 

hurt at the dinner table, and we have been hurt in our pocketbooks. We are talking about gasoline prices, electricity and heating 

costs, food prices, and industrial raw materials that together affect 

virtually every American family and business budget. 

The fundamental purpose of commodity markets, unlike stock 

markets, is not to attract investors, but to enable producers and 

users of physical commodities to arrive at a fair price for their 

goods and to hedge their price risks over time. Speculators, who 

don’t intend to use or deliver the commodities that they trade or 

hedge commodity prices so that they can have price certainty, seek 

instead to profit from the price changes. A market which was intended to facilitate price discovery and hedging is now dominated 

by speculators who are driving up price volatility, hedging failures, 
2 

1See Exhibit No. 1a which appears in the Appendix on page 44. 

and in many cases, driving up commodity prices. The reality today 

is that commodity prices are more reflective of trading by speculators than fundamental forces of supply and demand. 

At our November hearing, the Commodity Futures Trading Commission told us that 80 percent of the outstanding futures contracts 

for crude oil are now held by speculators. CFTC Commissioner Bart 

Chilton has said: 

‘‘For those who say no evidence exists linking excessive speculation and prices, they just are not looking. Scores of studies and papers,’’ he said, ‘‘exist which document the linkage.’’ 

Now, the unprecedented flood of speculative money in commodity 

markets today comes from index traders, hedge funds, money managers, and exchange-traded products. Our November hearing also 

exposed a new wave of commodity speculation coming from the $11 

trillion mutual fund industry. Exhibit 1a is a chart which shows 

that, since 2008—and that chart is in front of us, to my left—more 

than 40 commodity-related mutual funds have begun pouring speculative funds into the commodities markets and now have accumulated assets of over $50 billion.1

For most of the 70 years they have been in existence, mutual 

funds were not significant participants in U.S. commodity markets. 

Now, some mutual funds have become major commodity speculators, and more want to follow. When we looked at what had 

changed, we discovered that 6 years ago mutual funds began petitioning for and receiving IRS private letter rulings that, for the 

first time, enabled them to invest heavily in commodities, despite 

longstanding provisions in Section 851(b)(2) of the Internal Revenue Code. Those private letter rulings of the IRS essentially 

opened the floodgates to the mutual fund petitioners, allowing 

them to engage in billions of dollars in commodity speculation. 

Section 851(b)(2), which has been in the Tax Code since mutual 

funds got started in the 1930s, restricts the types of income that 

mutual funds are allowed to obtain. That allowance is put on them 

in the law in exchange for favorable tax treatment. If the mutual 

funds abide by this section’s income source restrictions, those mutual funds do not have to pay corporate income taxes like other corporations. This tax break collectively saves the mutual fund industry billions of dollars each year. In simple terms, the statute requires that 90 percent of a mutual fund’s gross income must be derived from securities, interest, or foreign currency investments. 

That means not more than 10 percent of their income can come 

from alternatives like commodities. 

This 90-percent rule has been in place for decades. But in 2006, 

as financial engineering took hold on Wall Street, the mutual fund 

industry began pressing the IRS to permit it to use complex financial transactions that would, in essence, enable mutual funds to get 

around the 90-percent rule and engage in commodity investments 

beyond the 10-percent limit. Dozens of individual mutual funds 

made these requests in petitions for private letter rulings. 

In response, from 2006 to 2010, the IRS issued 72 private letter 

rulings allowing the mutual funds to whom the letters were addressed to use either wholly owned offshore corporations or finan-
3 

cial instruments called ‘‘commodity-linked notes’’ to make unrestricted commodity investments, notwithstanding the 10-percent 

limit in Section 851. The IRS private letter rulings said that the 

mutual funds could treat the income from those sources not as income from a commodities investment but as income from a ‘‘securities’’ investment in the stock of the company that they owned or 

in a note that was designed to avoid the restrictions of Section 851. 

For example, the IRS allowed mutual funds to establish wholly 

owned controlled foreign corporations (CFCs), whose sole function 

is to trade commodities in the futures and swaps markets. In every 

case we have examined, mutual funds have established these CFCs 

as offshore shell corporations in the Cayman Islands, the classic example of a tax haven. The CFCs—these offshore shell corporations—have no offices, no employees of their own, no independent 

business operations; their commodity portfolios are run by employees who work in the United States for the mutual fund that set up 

the offshore arrangement. For example, one mutual fund told us 

that all of the commodity investment decisions for their offshore 

corporation were made by the mutual fund’s employees in Rockville, Maryland. Another told us that all commodity trading decisions were made by their traders in New York. Still another mutual fund told us openly that their offshore commodity fund had no 

‘‘Cayman presence,’’ describing it as ‘‘smoke and mirrors’’ to obtain 

the tax benefit. 

Now, these CFCs are corporate fictions, offshore shams, paper 

exercises whose sole purpose is to make an end run around the 

legal restrictions on commodity investments by mutual funds. At 

the same time, the IRS has issued private letter rulings explicitly 

allowing those offshore schemes. The IRS private letter rulings provide, for example, that if a mutual fund owns the stock of the offshore shell corporation that it established, it can treat income from 

commodity investments made by that offshore shell corporation and 

distributed back to the United States as income from a securities 

investment rather than a commodities investment. 

In addition, the IRS has issued private letter rulings stating that 

mutual funds can use commodity-linked notes to invest in commodities and treat the resulting income as from a securities investment, even though the notes were created for the sole purpose of 

investing in commodities and end-running Section 851. 

Now, by treating this type of income as derived from securities 

rather than from commodities, the IRS has elevated form over substance, enabling mutual funds to use agents as though they were 

independent actors, and to use financial engineering to do indirectly what the law does not let them do directly. The result is 

opening the door to increasing commodity speculation. 

But that is not all. In the past, under the 90-percent rule, mutual funds spent the lion’s share of their money on stocks, bonds, 

and other securities, providing needed capital for economic growth 

and for jobs. They were an engine of investment in America. But 

as the commodity spigot opens, every dollar spent on commodity 

speculation diverts money from their securities investments. So instead of investing in U.S. businesses, mutual funds will spend more 

and more increasing sums making bets on commodity price move-
4 

1See Exhibit No. 1d which appears in the Appendix on page 51. 

ments. Capital investments do our economy a lot more good than 

betting on prices. 

Now, to understand the context of the issues at stake, let us take 

a look at the history of the tax law’s limits on mutual funds. When 

Federal tax breaks for mutual funds were first enacted in 1936, 

Congress adopted limits on what mutual funds could invest in. 

They allowed mutual funds to utilize income from interest, stock 

dividends, and stock sales. Commodities were not on the list of allowed investments. That was the same year, by the way, that Congress enacted the Commodities Exchange Act of 1936, the first Federal law to control excessive speculation in commodity markets. So 

Congress was well aware of U.S. commodity markets and did not 

make commodities an allowable investment for mutual funds in 

1936. 

In 1954, Congress enacted Subchapter M of the Internal Revenue 

Code to reform taxation of mutual funds. Subchapter M again listed the types of income that mutual funds were allowed to earn in 

exchange for favorable tax treatment. That list was unchanged 

from 1936, and commodities were not on the list. 

In 1986, 50 years after the first mutual funds got started, Congress slightly expanded the types of income that a mutual fund 

could earn while retaining its tax advantages, adding investments 

in foreign currencies to investments in securities. Commodities 

were not added by Congress. The Treasury Department issued a 

letter at the time noting that it ‘‘would generally not treat as qualifying income gains from trading commodities.’’ 

In 2010, the mutual fund industry supported an unsuccessful legislative attempt to change the Tax Code to allow mutual funds to 

make unrestricted commodity investments. As introduced in 2009, 

and passed by the House in 2010, the Regulated Investment Company Modernization Act would have explicitly permitted mutual 

funds to utilize income from ‘‘commodities’’ under Section 851. But 

the Senate did not accept that provision. It was removed from the 

bill which only then was approved by the Senate. Removal of the 

commodities provision was, in fact, the only change made in the 

House-passed bill. The bill was sent back to the House which 

agreed to the bill as amended by the Senate. So the short story is 

that Congress did not agree to adding commodities to the list of acceptable income for mutual funds under the 90-percent rule. If the 

industry wants to try again to change the law to allow more commodity investments by mutual funds, the change needs to be considered not by private letter rulings or regulation, but by Congress 

after a full debate of the pros and cons. 

Six months after Congress made its decision in that Modernization Act, in June 2011, the IRS suspended its issuance of new private letter rulings in this area so it could review the underlying 

policy issues. Later in the year, Senator Coburn and I sent a joint 

letter to the Treasury and the IRS asking the IRS ‘‘to permanently 

halt the further issuance of [the] private letter rulings.’’ And our 

letter is Hearing Exhibit 1d.1

Now, some have suggested that the IRS ought to allow mutual 

funds to use offshore corporations to make commodity investments 
5 

1See Exhibit No. 3d which appears in the Appendix on page 81. 

based on the court case known as Moline Properties, which required the IRS to recognize a certain corporate structure. But in 

Moline Properties, the Supreme Court stated that, ‘‘in matters relating to the revenue, the corporate form may be disregarded where 

it is a sham or unreal.’’ The Cayman corporations being used for 

mutual fund commodity investments have no employees, no place 

of business, no profits of their own, and no obvious nontax purpose. 

There is no office, other than mailboxes. They are exactly the type 

of sham corporations that the Supreme Court said that the IRS can 

disregard. 

Now, another relevant event is the 2010 congressional codification of the economic substance doctrine which permits the IRS to 

disregard transactions that have no substantial nontax purpose. 

Mutual funds have not offered any substantial business or economic purpose for considering these offshore CFCs or constructing 

commodity-linked notes. Their only purpose is to serve the mutual 

funds’ effort to recharacterize the resulting income as derived from 

‘‘securities’’ so that they can make unlimited commodity investments while retaining their privileged tax status. A Tax Notes 

analysis by two tax practitioners, Hearing Exhibit 3d,1 observed 

that ‘‘it is hard to imagine that there could be a nontax purpose 

outweighing the tax purpose on the facts of the rulings.’’ 

Now, finally, there is a long line of cases and private letter rulings in which Federal courts have upheld the IRS’ efforts to go 

after sham corporations or transactions which have no purpose 

other than tax avoidance or which serve only as conduits for parties seeking to avoid taxation. They include cases like Gregory v. 

Helvering, Aldon Homes, Aiken Industries, and the recent case of 

Southgate Master Fund. In Southgate, the Fifth Circuit, citing numerous precedents, wrote the following: 

‘‘The starting point for our analysis is the cardinal principle of 

income taxation: a transaction’s tax consequences depend on its 

substance, not its form. This principle ‘is no schoolboy’s rule; it is 

the cornerstone of sound taxation[.]’ ’’ The court wrote: ‘‘This 

foundational principle finds its voice in the judicial anti-abuse doctrines, which ‘prevent taxpayers from subverting the legislative 

purpose of the tax code by engaging in transactions that are fictitious or lack economic reality simply to reap a tax benefit.’ ’’ 

One of the issues we are going to explore today is why the IRS 

did not follow that approach when analyzing requests by the mutual funds to use offshore corporations and structured notes to 

make their commodity investments. By issuing the private letter 

rulings that it has issued in the mutual fund area, the IRS is undermining its own longstanding efforts to go after sham corporations and transactions that are used to avoid paying a tax. 

These are not arcane issues; they raise fundamental issues affecting our economic future, the functioning of our Tax Code, and 

the use of offshore schemes and financial engineering to avoid our 

tax laws. The IRS private letter rulings have unleashed a new flood 

of speculative commodity investments that are damaging to American families, businesses, and our economy. Commodity speculation 

that contributes to $4-a-gallon gasoline is no joke, and neither is 
6 

a tax policy that threatens to fuel a new explosion in speculation 

in commodities. The IRS letter rulings enable U.S. firms to use offshore shell corporations and financially engineered notes to make 

commodity investments, despite longstanding Tax Code restrictions, and it sets precedents that eat away at the integrity of our 

Tax Code. We should not just stand by and let that happen. 

Today’s oversight hearing is intended to address these concerns. 

We will be hearing from IRS Commissioner Douglas Shulman and 

Emily McMahon, who is the Acting Assistant Secretary of the 

Treasury for the Office of Tax Policy, two of the most senior tax 

officials in the Administration. We thank them for their presence. 

We are grateful that you were able to be here with us today. 

I now invite our Ranking Member, Dr. Coburn, to share his 

views. 

OPENING STATEMENT OF SENATOR COBURN 

Senator COBURN. Thank you, Mr. Chairman, and thank you all 

for being here. Some points. 

There is no definition of ‘‘excessive speculation.’’ We live in global 

markets. The price of oil does not have anything to do with what 

the speculation on the Chicago Board of Exchange is right now because there is a worldwide market for oil, and with the click of a 

computer button, you can trade that—whether you trade here or 

you trade in London or you trade in Paris or you trade in Abu 

Dhabi. 

The fact is we have seen what we think is something that goes 

around the intention of what Congress has created in terms of mutual funds and the greater risk that is associated with commodity 

speculation. And with that, Mr. Chairman, I agree. 

The second point is tax avoidance is not illegal. Tax evasion is, 

and we need to keep that in mind as we look at it. I do not know 

what the answer is to the questions that have been raised today 

and the ultimate answer in terms of the letters that you have 

granted. But I know a couple things are true. One is that we need 

to continue to have the freest and fairest and open markets we can 

have to have the best price discovery, and speculation is a significant component of that. I have asked multiple panels before me 

what excessive speculation is, and I have never been able to get an 

answer to that. The fact is that worldwide demand is growing for 

almost everything that is listed on our commodity exchanges and 

some of the commodity exchanges throughout the world. But the 

fact is we do not price just in our country commodities. They are 

priced based on worldwide demand. 

So my hope is as we go through this—I agree with the Chairman. If our intent is not to allow a mutual fund to speculate in 

commodities, then we should not be allowing the mutual funds so 

that the consumer knows that. That is one. But that will not stop 

speculation in commodities because they will just go somewhere 

else if they are intent on doing that. So I think it is important we 

keep in mind that we are going to have minimal effect, even if we 

come to a conclusion through this hearing, on what is going to be 

the ultimate outcome in terms of speculative behavior in the world 

because we no longer are isolated just in our country. 
7 

1The prepared statement of Mr. Shulman appears in the Appendix on page 36. 

I think it is true that we ought to have much more transparency 

and straightforwardness about what our intent is. And so I thank 

you for being here. My hope is that we can have a better understanding of what has happened, what needs to happen, and what 

we might need to do to achieve that transparency in light of the 

fact that we know we are in a world market and that money is 

going to go where the greatest return is based on what the risk is. 

And where I would agree with the Chairman, is I think we need 

to make sure that people know who are investing in these mutual 

funds that are not speculating commodities what the significant 

risk is. And it is my belief they do know that now, but I think we 

have an obligation to make sure that is the case. 

I yield back. 

Senator LEVIN. Thank you very much, Dr. Coburn, for your work 

and the work of your staff in this matter. It is our joint intent that 

even though there may not be consensus on the effect of speculation, that there is consensus that our laws are intended to be followed, and they cannot be and should not be run around by sham 

transactions. 

I now want to welcome our witnesses for this morning’s hearing: 

Doug Shulman, who is the Commissioner of the Internal Revenue 

Service, and Emily McMahon, the Acting Assistant Secretary for 

Tax Policy for the Department of the Treasury. 

Commissioner Shulman, I want to thank you for being here 

again today. You have testified before this Subcommittee in the 

past. We welcome you back, and we are always pleased to have 

you. 

Ms. McMahon, I think this may be your first appearance, and we 

give you a warm welcome as well. 

Pursuant to Rule VI, all witnesses who testify before the Subcommittee are required to be sworn. At this time I would ask you 

then to please stand and raise your right hand. Do you swear that 

the testimony you are about to give will be the truth, the whole 

truth, and nothing but the truth, so help you, God? 

Mr. SHULMAN. I do. 

Ms. MCMAHON. I do. 

Senator LEVIN. We will use our traditional timing system today, 

and please limit your oral testimony to 10 minutes. At a minute 

before that 10-minute period runs out, you will be given a signal 

by a yellow light a minute before the red light comes on, which will 

give you an opportunity to conclude your remarks. 

Commissioner Shulman, we will have you go first, and after we 

have heard your testimony and Ms. McMahon’s testimony, we will 

then proceed to questions. 

TESTIMONY OF HON. DOUGLAS H. SHULMAN,1

COMMISSIONER, INTERNAL REVENUE SERVICE 

Mr. SHULMAN. Thank you, Chairman Levin and Ranking Member Coburn. I appreciate having the opportunity to testify before 

the SubcCommittee on the issue of regulated investment companies, or RICs, investing in commodities. 
8 

Let me start by explaining that the IRS is involved in this issue 

because it is charged with, as the Chairman said, providing guidance to taxpayers as to whether investments that RICs choose to 

make will produce qualifying RIC income, as defined by the tax 

law. 

In order to maintain its tax status, a RIC must derive 90 percent 

of its income from investments that meet the qualifications of Section 851 of the Code, which generally requires investments be related to stock, securities, or foreign currencies. The term ‘‘securities’’ is specifically defined in the Tax Code in Section 851 by crossreference to the definition of that same term in the Investment 

Company Act of 1940. 

It is the scope of that definition of the word ‘‘security’’—and particularly its application to investments providing indirect exposure 

to commodities—that has been the focus of the 70 or so private letter rulings that are the subject of this hearing. 

Now, while I was not at the agency at the time our position was 

first established and did not participate in any of the decisions 

about our position or the private letter ruling process in the past, 

it may be useful for me to provide a brief explanation of how the 

IRS arrived at the position reflected in the private letter rulings 

and then summarize the IRS’s posture on this issue today. 

In 2005, some RICs started, to guidance from the IRS, as to 

whether certain investments made to achieve exposure to commodity prices would qualify for the 90-percent income test. The IRS 

was unable to find any authoritative guidance on the proper scope 

of the definition of ‘‘security’’ from either the Securities and Exchange Commission or the Commodity Futures Trading Commission. 

This situation resulted in the IRS being asked to issue private 

letter rulings addressing specific proposed RIC commodity-related 

investments based on the IRS’s own best interpretation of the tax 

law, including the cross-references to the 1940 Act. Private letter 

rulings were issued on this subject starting in 2006. As you said, 

they were issued on two basic structures: structured notes and investments in controlled foreign corporations. I have attached details of our counsel’s analysis of this issue to my written testimony 

to give you a better sense of their analysis. 

Last summer, though, as you mentioned, the IRS decided to stop 

issuing private letter rulings until our staff could look at the overall set of issues and consider guidance of broader applicability. 

That is where we are today. 

Mr. Chairman, I want to just close by stating that I am confident 

that our staff did its best to interpret a difficult set of tax law provisions. And while I believe that their conclusions were reasonable 

in the context of an unclear statute, at the agency we have an open 

mind on this issue. The fact that we suspended private letter rulings last summer allows the opportunity for us to take a fresh look 

at this issue. 

You have raised important policy and legal questions that I assure you will be fully considered as we determine the appropriate 

next steps. 

So with that, that ends my testimony, and I will obviously be 

happy to answer questions when the time comes. 
9 

1The prepared statement of Ms. McMahon appears in the Appendix on page 42. 

Senator LEVIN. Thank you very much, Commissioner. Secretary 

McMahon. 

TESTIMONY OF EMILY S. MCMAHON,1 ACTING ASSISTANT 

SECRETARY FOR TAX POLICY, U.S. DEPARTMENT OF THE 

TREASURY 

Ms. MCMAHON. Thank you, Chairman Levin and Ranking Member Coburn. I appreciate the opportunity to testify today on the 

issue of investments in commodities by regulated investment companies. 

Commissioner Shulman’s testimony describes a series of private 

letter rulings issued by the Internal Revenue Service on this subject. I would like to begin by describing the role of the Treasury 

Department in the private letter ruling and published guidance 

process. 

A private letter ruling is a determination issued by the IRS to 

a particular taxpayer that interprets and applies the tax laws to 

the taxpayer’s particular set of facts. As a matter of policy and 

practice, the Treasury Department does not participate in the consideration or issuance of private letter rulings by the IRS. Moreover, other than in highly unusual circumstances, Treasury Department personnel do not know which taxpayers have requested or received private letter rulings. Treasury Department personnel become aware of the issuance of a private letter ruling only when 

that ruling is eventually issued to the public by the IRS in redacted 

form. Consistent with that policy and practice, the Treasury Department did not participate in the formulation, or review or oversee the issuance, of any of the private letter rulings addressing 

commodity-related investments by RICs. Nor has the Treasury Department studied the effect of the private letter rulings on the mutual fund industry. 

The Office of Tax Policy is actively involved, however, in the development of published guidance, including both tax regulations 

and other administrative guidance published in the Internal Revenue Bulletin. In this capacity, Treasury personnel participate in 

the development of the substantive law that private letter rulings 

reflect. 

Thus, in 2005 and 2006, Treasury Department personnel did participate in the development of two published revenue rulings that 

address commodity-related investments by a RIC. These revenue 

rulings, 2006–1 and 2006–31, are described in more detail in Commissioner Shulman’s written testimony. Subsequent to those revenue rulings, the IRS and Treasury Department periodically discussed the possibility of additional guidance in this area as a potential candidate for the Priority Guidance Plan. 

As stated in Commissioner Shulman’s testimony, the IRS has 

suspended the issuance of private letter rulings addressing commodity-related investments by RICs. Treasury Department personnel were not involved in that decision. 

Subsequent to the suspension, the Investment Company Institute 

(ICI) called several members of the staff of the Office of Tax Policy 

to ask why the IRS issuance of rulings had been suspended and 
10 

what the future might hold. Treasury staff could not, and did not, 

provide answers to those questions. On September 28, 2011, at the 

ICI’s request, ICI representatives met with Treasury and IRS personnel to discuss ICI proposals for published guidance that would 

permit commodity-related investments by RICs. 

The Treasury Department and IRS are currently considering the 

possibility of issuing published guidance on this subject. 

The Subcommittee’s letter inviting me to testify at this hearing 

stated that the Regulated Investment Company Modernization Act 

of 2010 ‘‘reaffirmed [Congress’] intent to exclude commodities from 

mutual funds’ qualifying income under Section 851.’’ The House 

version of the bill, H.R. 4337, would have expanded the definition 

of qualifying income to include income derived from direct or indirect exposure to commodities. However, that amendment to the 

definition was removed from the bill before enactment, leaving unchanged the statutory provisions upon which the IRS revenue rulings and private letter rulings were based. Under those provisions, 

the definition of qualifying income is linked to the 1940 Act definition of ‘‘security,’’ and income derived from such securities is not 

explicitly excluded from qualifying income merely because it reflects exposure to commodity prices. 

Under Section 7701 of the Internal Revenue Code, whenever the 

economic substance doctrine is relevant to a transaction, the transaction is treated as having economic substance only if, as a factual 

matter, the transaction changes in a meaningful way the taxpayer’s economic position and the taxpayer has a substantial 

nontax purpose for entering into the transaction. These questions 

are inherently factual. The private letter rulings issued by the IRS 

do not address the potential application of the economic substance 

doctrine, and the Treasury Department does not have independent 

knowledge of the facts underlying the rulings. Therefore, we cannot 

express a view on the application of Section 7701(o) to the transactions described in the private letter rulings. 

Finally, I would note that the extent to which investors should 

be able to obtain exposure to commodity price fluctuations through 

investments in RICs is not fundamentally a tax policy issue. The 

Code provisions in question do raise, however, the issue of whether 

the Treasury Department and the IRS should be required to interpret a nontax statute—in this case, the 1940 Act—that does not 

otherwise fall within their jurisdiction in order to determine the 

availability of favorable tax treatment under the Code. The Securities and Exchange Commission has not issued any guidance of 

which we are aware that addresses the financial instruments described in the IRS private letter rulings, whether those financial 

instruments are securities for 1940 Act purposes, as required to 

produce qualifying income. At the same time, we are not aware of 

any action the SEC has taken to preclude RICs from making those 

investments. Administering the relevant Code provisions under 

these circumstances is challenging from both a practical and a policy perspective. 

Thank you, and I look forward to taking your questions. 

Senator LEVIN. Thank you, Ms. McMahon. 

First, a short bit on the impact of speculation in commodities on 

our cost of gasoline, and then I am going to get to really what is 
11 

1See Exhibit No. 8 which appears in the Appendix on page 195. 

the part of this where I think that Senator Coburn and I agree. We 

obviously do not agree on the question of whether or not speculation has an impact on commodity prices. We have different points 

of view on it. Fair enough. We have had hearings on the subject. 

People have different opinions of the subject. But where we do not 

have different opinions is on the question of whether or not we can 

tolerate sham corporations in the Caymans being used to avoid the 

tax laws of this country. But first just a bit on commodity prices. 

Take a look at Exhibit 8,1 if you both would. We are going to put 

it up for you as well, but it is in your book. It is a chart reflecting 

commodity index prices for fuel, food, and metals going back 20 

years. You can see on this chart that until about 2002, the prices 

were relatively stable. But beginning in 2002, about 10 years ago, 

prices began to get more volatile and started to climb. The year 

2002 is also about the time when investments in commodity index 

funds started to become popular. The chart shows a crash in prices 

in 2008 during the financial crisis, but you can see that the prices 

never fall back to the pre-2002 level, and since May 2009, prices 

have again increased dramatically, approaching record levels. 

Now, this chart, by the way, was put together by a data analysis 

firm called Index Mundi using IMF data, and it is, again, part of 

the exhibits here and will be made part of the record. 

Now, the real question that we need to confront and you folks 

needs to confront, and I very much welcome your testimony, Commissioner, that you are willing to take a fresh look at this despite 

those letters that have been issued, is the moratorium, which you 

issued in June 2010, which was good news. That is the status quo, 

a moratorium, and our request in a letter that we have written 

you, a joint letter from Dr. Coburn and myself, asked that you 

make that moratorium permanent. 

Are there nontax purposes for these transactions that the offshore tax havens are making and then transferring the proceeds to 

their parent corporation? 

What your letters do is state that mutual funds can set up a foreign corporation it controls whose sole purpose is to invest in commodities. If the mutual funds own that stock, which they do, they 

can treat the distribution of income from that wholly owned offshore shell corporation as income derived with respect to a mutual 

fund’s ‘‘business of investing in securities’’ rather than as a commodities investment. 

Now, that means that the mutual fund can treat the offshore 

shell company’s income as meeting the 90-percent test in Section 

851 and outside of the 10-percent limit on alternative investments. 

Now, here is what we have learned. We have learned that these 

offshore shell corporations, these wholly owned subsidiaries established by the mutual funds, are in every case wholly owned Cayman Island corporations. They are shells. No physical offices, no 

employees of their own, no independent operations. The mutual 

fund’s U.S. employees run their commodities portfolios from their 

U.S. offices. There are no offices in the Cayman Islands with people 

that are making decisions on what these CFCs do. 
12 

One mutual fund told us that all of the commodity investment 

decisions come from their Rockville, Maryland, office, as I said. And 

another one acknowledged that there is no Cayman presence; it is 

just ‘‘smoke and mirrors,’’ in their words, to obtain the tax benefit. 

All of the profits and losses by their offshore shells are returned 

to the mutual funds that own them here in the United States. No 

income is kept offshore, no U.S. taxes are evaded. That is not the 

issue here. The income is returned, and when we say no taxes are 

evaded here, of course, there is a tax which would apply to mutual 

funds if they violate the 90-percent rule, so that is really the question here. It is not an evasion issue, as Senator Coburn points out. 

It is an avoidance issue by use of shell corporations which have no 

purpose, no business purpose, no nontax purpose at all. 

Now, clearly—and I think, Commissioner, you will agree with 

this—if the offshore shell corporation did not return the income, 

the mutual fund would lose its favored tax status. So the mutual 

funds try to ensure that that income is returned to the United 

States, which is further proof that it is nothing but a shell corporation. 

Now, the facts indicate—and the mutual funds acknowledge this, 

by the way—that these shell corporations are paper exercises, 

which the mutual funds use to make commodity investments. They 

characterize the resulting income as being derived from the business of investing in securities, however, instead of commodities investments. 

Now, issuing these letters and then approving of this offshore 

gimmick means that the IRS is elevating form over substance. Mutual funds are not investing in their offshore shells. They are running them. They are using a sham or a conduit to do indirectly 

what they cannot do directly by law. 

Now, you have a line of cases where the courts have supported 

the IRS when you have refused to recognize sham corporations. 

You have a number of private letter rulings where you have not 

recognized sham corporations. In one private letter ruling in 

2001—citing the Moline case, by the way—the IRS advises taxpayers that ‘‘a parent corporation and its subsidiary are separate 

taxable entities unless the subsidiary is a sham or acts as a mere 

agent of the parent.’’ For 80 years you have been fighting to be able 

to disregard sham corporations. The IRS has tried to disregard 

them where there is no nontax purpose in their creation. 

So here we have wholly owned corporate shells, no employees, no 

place of business, no independent operations, no income that is not 

turned over to the U.S. parent. The shell is typically run by the 

mutual fund’s own employees here in the United States who control the commodity portfolio. 

In Gregory v. Helvering, the Supreme Court warns against exalting artifice above reality. 

In Southgate, the Fifth Circuit says the tax consequences of a 

transaction are determined based on the underlying substance of 

the transaction rather than its legal form. 

The issue here is not whether or not the offshore corporation’s 

stock is a security. That is not the issue here. Whatever definition 

of ‘‘security’’ you want to take, whether or not it has been defined 

by the SEC, whether it is defined by the CFTC, that is not the 
13 

issue. Of course, it is a security. It is stock. The issue is whether 

or not the offshore corporation which issues that security and 

transfers it to its parent is a sham corporation with no substantial 

nontax purpose. The issue is whether the offshore shell is a conduit 

that the IRS can and should disregard to ensure compliance with 

Section 851. So we do not have to debate what constitutes a security here. That is stock. That is not the issue. 

Now, Commissioner, let me ask you this question: If a mutual 

fund were to violate the income restrictions of Section 851, the tax 

consequences would be, would they not, that the fund would have 

to pay up to 35 percent in corporate income taxes on its income. 

Mr. SHULMAN. Yes, I think that is correct. I think, generally, 

that is correct. The way you get not taxed at the entity level is by 

meeting the restrictions. I think in practice mutual funds all meet 

it, or else they would not be a mutual fund, and they would set up 

a structure another way. So there is generally not taxes coming in 

from these things as they blow through their 90 percent. They either set it up this way or they do not, unless the allocation shifts 

unexpectedly during the year. 

Senator LEVIN. But you do agree that if they violated those income restrictions in that Tax Code Section 851, they would then 

have to pay the corporate income tax? 

Mr. SHULMAN. Yes. 

Senator LEVIN. Now, do you both agree that if a mutual fund 

bought and sold commodity futures or a commodity swap—in other 

words, if a mutual fund made a direct investment in commodities, 

the income from those investments would not qualify as income 

from securities or interest or foreign currencies under the 90-percent income in Section 851? 

Ms. MCMAHON. Yes, I would agree with that. Yes. 

Senator LEVIN. All right. So now the question is whether or not 

they can avoid that impact by creating a shell corporation, which 

everyone agrees is a paper corporation with no business purpose, 

no economic purpose down in the Caymans. The question is whether or not by creating that corporation and just having the stock of 

that corporation transfer to them that converts it somehow magically into a securities transaction. 

Now, why do you think mutual funds are setting up these corporations offshore rather than here in the United States? Commissioner Shulman. 

Mr. SHULMAN. Well, I think they are setting up these structures 

to get some commodity exposure. 

Senator LEVIN. To be able to invest in commodities, which they 

are restricted from doing in Section 851? 

Mr. SHULMAN. Well, they are setting them up to get some exposure to commodities and trying to do in a way that meets the test 

in the tax law. 

Senator LEVIN. And avoids any Section 851 violation. 

Mr. SHULMAN. Sure, it would. 

Senator LEVIN. OK. Now, if they used a wholly owned U.S. corporation to do the commodity investing, would that corporation’s 

profits then be subject to U.S. tax? 

Mr. SHULMAN. I assume so, depending on the structures. 
14 

1See Exhibit No. 9 which appears in the Appendix on page 196. 

Senator LEVIN. So a Cayman corporation is not subject to U.S. 

tax or any other corporate income tax, so they can accumulate and 

invest money more quickly than corporations which do pay taxes. 

So as you say, the reason that they are doing this is so that they 

can avoid a conflict with Section 851. If they directly invested in 

commodities, they would then be subject to the limitations of Section 851. 

Now, the question that then raises is: Did the IRS ask the mutual funds who created the shell corporations in the Caymans 

whether there was a business purpose other than tax avoidance? 

Was that asked of them when they requested the letter? 

Mr. SHULMAN. As I said, I was not involved in the private letter 

rulings. Actually, I did not focus on this issue until after we suspended them. So I do not know what was asked. 

Senator LEVIN. Can you look back and check that? 

Mr. SHULMAN. Yes.1

Senator LEVIN. OK. 

Senator LEVIN. Now, does the IRS care about people circumventing our tax laws through the use of shell/sham corporations offshore? 

Mr. SHULMAN. The answer is yes, let me just give you a little further analysis on that. You had asked about economic substance and 

why we didn’t attack this under the economic substance rule, and 

you quoted some of the cases we have been involved in. 

One, as I think you rightly pointed out, this agency has been 

very aggressive attacking sham corporations that are trying to use 

the Code in ways that are not permissible to lower taxes in the 

United States. We typically raise this doctrine for structures designed to lower tax, such as phony losses, inflated bases, and that 

is where we have gone to court, and that is where most of the common law comes from. 

In this case, I would argue that we should have the debate that 

you have put on the table. Does the Code allow investment in controlled foreign corporations that then invest in some sort of a commodity-related investment, which is very different because there is 

no tax being avoided. There is tax paid on those investments in the 

United States by the mutual fund’s shareholders, just as if those 

mutual fund’s shareholders were not in a mutual fund and were investing directly in commodities. 

Senator LEVIN. Well, isn’t the tax that is being avoided the corporate tax which would be triggered if it was not qualified income 

under Section 851? 

Mr. SHULMAN. As I said before, the activity would not happen, 

and that is legitimate. 

Senator LEVIN. Now, that is a different point. If the IRS said 

that activity that you just have engaged in, creating a shell corporation with no nontax purpose, that sham business, that income 

is going to count under Section 851. If you told them that and they 

still did it, they would have to pay a corporate tax in the United 

States, right? 

Mr. SHULMAN. Sure, but I guess what I am saying is—— 

Senator LEVIN. You do not think they will do it. 
15 

Mr. SHULMAN. My guess is they would not do it. 

Senator LEVIN. That proves that tax avoidance is their purpose, 

which is exactly our point. That is the proof of it, that they would 

not engage in that transaction if, in fact, it had the result under 

the law. So avoiding that tax is their goal, and the question is: Can 

they use a sham corporation, a shell corporation in the Caymans 

that has no business purpose, no economic purpose, can they use 

it to achieve that goal? And your letter says, ‘‘Yes, you can use’’— 

or, ‘‘We are not even going to ask. We are not going to ask you 

whether or not that shell corporation has any business purpose.’’ 

I do not know that. You are going to check that out for me as to 

whether or not you asked the question. 

But, my heavens, if the IRS is fighting against these offshore 

shell corporations, how do we look the other way? How do we give 

a green light to the use of them to qualify this kind of investment 

under our Tax Code? It so totally runs contrary to what you are 

fighting for, which is do not use these shell corporations offshore 

for any nontax purpose; we are going to pierce this veil. That is 

what you fight for. And yet you write a letter—not you but your 

predecessors—that says either, ‘‘We are not going to ask you if 

there is any business purpose to this,’’ or, ‘‘We know there is no 

business purpose to it, but technically that can be considered a security, the stock which is issued by your wholly owned corporation, 

with no people down there, no presence down there. We are going 

to count that as a security for the purpose of Section 851, even 

though it is based on a totally shell/sham corporation.’’ That runs 

inconsistent with your effort to pierce those shell corporations. 

Mr. SHULMAN. Yes, what I am trying to do is distinguish—I will 

repeat, we have suspended the private letter rulings, we are open 

to this, and there are a whole bunch of points you have made that 

you have written to us that we are going to take very seriously as 

we figure out where to go forward. So that is the state of play. 

What I am trying to distinguish is that a very specific issue with 

people who came forward and asked about the technical reading of 

the law. There are lots of places where the corporate form is respected in the tax law, and what we try to do is analyze what is 

the right reading of the law, would it be sustained in the courts, 

etc. 

I think I am just trying to move away from a broad generalization about our approach. We have been very aggressive with sham 

corporations that are designed to lower taxes, and keep this as a 

narrow discussion about corporations and mutual funds trying to 

get commodity exposure, which I think was their purpose, not to 

avoid tax because the tax flows through. 

Senator LEVIN. Well, it is designed to avoid triggering a tax. 

Mr. SHULMAN. I do not want to insult you by repeating it, but 

as I have said, those taxes are never triggered. They either would 

have set up this thing or not. 

Senator LEVIN. They want to avoid triggering the taxes, right? 

Mr. SHULMAN. That is not how I would look at it. 

Senator LEVIN. They want to avoid triggering a tax? You do not 

think that is the whole purpose here, they want to avoid triggering 

a tax? 

Mr. SHULMAN. Well, they just want to set up—— 
16 

Senator LEVIN. They want to have their cake, which is investing 

in commodities, and eat it, too, by not paying what the tax would 

be if they did that directly in the United States. 

Mr. SHULMAN. They want to invest in commodities—— 

Senator LEVIN. That is their open goal, for heaven’s sake. They 

acknowledge that is what their goal is. The question is whether the 

IRS is going to tolerate the use of those shell corporations to 

achieve that goal or whether or not they ought to come to Congress 

and change the law. That is the question. 

Mr. SHULMAN. Right. 

Senator LEVIN. When you put your imprimatur on that, it does 

not undermine your efforts, your important efforts, sometimes heroic efforts, sometimes against great odds, to pierce the veil of 

these phony shell corporations in the Caymans and other offshore 

tax havens. That is what is created here for you. That is the headache you are creating for yourself. It may be slightly different. It 

is not where they are trying to get a tax reduction. It may be where 

they are trying to avoid triggering a tax. But the outcome is exactly 

the same. You are putting your stamp of approval in these letters. 

Thank God now there is a moratorium, but you put your stamp of 

approval on a mechanism which is inconsistent with what you are 

arguing in so many cases, very properly, that you are not going to 

be deterred from the use of sham transactions. That is what the 

stakes are here. 

Do you want to comment? I am going to call on my colleagues. 

Mr. SHULMAN. No, I mean, my comment would be similar to 

what I said before, which is as Commissioner of the IRS, an agency 

that has been very aggressive attacking a lot of corporations 

around issues of economic substance. I want to be very clear for the 

record that the private letter rulings that we issued that only pertain and can only be relied on by the one company that we issue 

it to, not broad applicability, are not precedent and in no way 

speak about the other attacks that we have around the economic 

substance doctrine. So that is what I am trying to say. 

Senator LEVIN. Thank you, Commissioner. Senator Carper. 

OPENING STATEMENT OF SENATOR CARPER 

Senator CARPER. Thanks, Mr. Chairman. 

Ms. McMahon, I sort of join this in mid-flight. Just explain to me 

what do you think the Chairman is up to here. What is he driving 

at? How would you describe it? 

Ms. MCMAHON. As I understand it, the Chairman has several 

concerns: generally the question of whether mutual funds, RICs, 

should be allowed to have commodity exposure. I think our view on 

that broader question is that that is not a tax policy question per 

se, and we are not experts on that topic. 

However, there is a second question as to whether the tax law 

as it currently exists should be interpreted in a manner that would 

facilitate or permit mutual funds to have indirect commodity exposure, and I understand that Chairman Levin is concerned that our 

interpretation, the IRS interpretation, of the existing law has inappropriately facilitated commodity exposure, RICs’ obtaining commodity exposure. 
17 

I think the statutory language that we are looking at is not very 

clear on this question, and because of that the IRS has been placed 

in a difficult position of trying to determine what the limits may 

or may not be on these investments. I think their interpretation so 

far has been a reasonable one under the circumstances, but I would 

echo Commissioner Shulman’s statement that we have an open 

mind on this question, and we are thinking very hard about the 

points that have been raised here today. 

Senator CARPER. Mr. Shulman, is that a fair characterization of 

what Senator Levin is aiming at here? 

Mr. SHULMAN. It sounded good, but I generally do not characterize Chairmen’s statements and thoughts. 

Ms. MCMAHON. I would not have done so either if I had not been 

asked to do so. [Laughter.] 

Mr. SHULMAN. It was a good job. 

Senator CARPER. My next question is of the Chairman: How did 

she do? What do you think? 

Senator LEVIN. Well, she was pretty close on number two. Number one really is something this Subcommittee has looked into, the 

first issue she raised about the impact of speculation on commodity 

prices. But you can agree—and Dr. Coburn does not have the same 

view I do on that issue. But where Dr. Coburn and I have agreed 

and sent a letter to the IRS is that the moratorium on these letters 

which they have sent, which gives the green light to specific mutual funds to proceed in this area, runs right into a number of doctrines. One is the law which specifies what the mutual funds can 

use for interest and income. But, second, it runs head on into what 

the IRS is fighting for, which is to pierce these phony corporations 

offshore who have no nontax purpose, and that is what the issue 

is here. There is a moratorium on these, which we are grateful for, 

from about a year and a half ago I guess now. Our letter requests 

that it be made permanent. 

You can argue the first issue. People will disagree on commodities and whether or not speculation in commodities has an effect 

on price, and what the effect is. The Commodity Futures Trading 

Commission Commissioner says, sure, there is an effect on price. 

We put charts up showing the effect. But whether that is true or 

not, I think we all agree—and the Commissioner and the Secretary 

agree here—that we cannot permit sham transactions to lead to tax 

avoidance. That is the issue here. 

Senator CARPER. Do you concur with that, Mr. Shulman? 

Mr. SHULMAN. Yes, we have been aggressive, using the economic 

substance doctrine for corporations that we think do not meet the 

test of the doctrine, and would be sustained in the courts, are used 

to lower taxes. 

Senator CARPER. All right. What advice do you have for us? This 

is a question for both of you. 

Mr. SHULMAN. I think the simplest advice is I would agree, the 

IRS does not like being in a position where the law is unclear and 

it has to go and make interpretations. The best thing that could 

happen with this debate is if the outcome desired is the outcome 

that this Subcommittee has been discussing in the letter, is to get 

clarity in the law and have Congress pass the law and get clear 

one way or the other. Absent that, we are going to be forced to be 
18 

in this uncomfortable position of doing what we do all the time 

with a grossly complex law. This is having to make interpretations 

about what is the best reading of the law, what will be sustained 

in the courts, that is what we will do. 

As the Chairman noted, we stopped issuing these private letter 

rulings, and we think there needs to be either law, preferably, but 

in the absence of law, guidance of general applicability that can be 

relied on across the industry and stop taking these one-off with 

very specific fact patterns and moving forward in that direction. 

Senator CARPER. In my old job as governor of Delaware, from 

time to time we would suggest to the legislature what tax law 

changes we thought should be made to provide clarity in areas like 

this. Has this Administration provided similar guidance to us in 

the form of recommended legislation to address these issues? 

Ms. MCMAHON. Senator, I do not believe that we have recommended a particular clarification one way or another on this 

point. 

Senator CARPER. Could I just ask if that is the case, then why 

not? 

Ms. MCMAHON. Well, I think that, as I said earlier, there is a 

fundamental question, which is not a tax question, as to whether 

RICs should or should not be permitted to have commodity exposure. That is not something that we as tax experts can answer. I 

think once that question has been answered one way or another, 

it would be very helpful to have the tax law clarified to be consistent with the conclusion on that question. But we, the Treasury 

Department, have not so far expressed a view, I believe, on the—— 

Senator CARPER. Has some other part of the Administration that 

owns that issued—have they said—— 

Ms. MCMAHON. Well, I think that question is fundamentally the 

responsibility of the CFTC or SEC. 

Senator CARPER. All right. Do any other tax-exempt entities use 

controlled foreign corporations to gain exposure to certain investments? 

Ms. MCMAHON. Yes, Senator. 

Senator CARPER. Could you talk about that just for a little bit, 

please? 

Ms. MCMAHON. Well, it is fairly common for tax-exempt entities 

that invest in various types of private equity or other investment 

funds to invest in those funds through offshore corporations in 

order to avoid possible taxation under the unrelated business income tax rules. 

Senator CARPER. OK. A second but related line of questions is: 

Can mutual funds only gain access to commodities through these 

controlled foreign corporations or commodity-linked notes? Is that 

pretty much it? 

Ms. MCMAHON. I am not aware of other ways in which they 

might. 

Senator CARPER. Mr. Shulman, are you? 

Mr. SHULMAN. I think there is a variety of ways that I am aware 

of, and let me just clarify for you. This is an issue that I studied 

up on as part of this hearing. It is not one I was involved with. I 

am just moving into it. But I think there are controlled foreign corporations, there are the structured notes. I think mutual funds can 
19 

invest in partnerships if they wish to, but all these things get complicated with tax structuring. There are qualified publicly traded 

partnerships that are available to invest in. So there is a variety 

of vehicles, but from my understanding, the predominant way is 

through these two—the structured notes and the controlled foreign 

corporations, which were the subject of the private letter rulings. 

Senator CARPER. Let me see if I understand this. We have these 

mutual funds that are, if you will, investing in commodities. They 

are not doing it here through corporations in the United States, so 

States that are interested in—and all States are interested in having corporations register in them, including Delaware. But what we 

have is a situation where instead of these mutual funds establishing or investing in corporations here in America, registered in 

one of our 50 States, and presumably taxes being paid to the Federal Government for those investments, we encourage that activity 

to take place outside of this country in places like the Cayman Islands, and corporations from which States derive no value, no income, and from which the Federal Government derives no taxes. Is 

that the situation we are in? 

Mr. SHULMAN. I would not characterize it that way. First of all, 

the IRS is not in the business in the way that our lawyers who look 

when private letter rulings come in, they do not look at what they 

are encouraging or not. They are trying to say what is allowed 

under the statute. 

Senator CARPER. I am not suggesting it is what you encourage. 

I am not suggesting this is what the IRS is encouraging. But we 

as a Federal Government, is this what we are encouraging? 

Mr. SHULMAN. Sure. I mentioned earlier, and I think the Chairman mentioned as well, the basic tax of mutual funds is being paid 

in these entities. There is not tax not being paid because the way 

mutual funds are taxed is the underlying activity flows through to 

the investors and they pay. So someone who lives in Delaware 

would be paying their Delaware taxes and their Federal taxes 

based on whatever the income was there. But that is a whole different discussion which is obviously a legitimate one. 

Senator CARPER. All right. Can I change the subject just for a 

second, Mr. Chairman? One of the things that the Chairman, Dr. 

Coburn, and I are very much focused on is deficit reduction. I am 

sure everybody in the room cares about it, and there are different 

ways to do that: grow the economy, curtail spending, look for 

wasteful spending in the Federal Government. Another way is the 

maximize the income that we are trying to bring into the treasury 

by making sure that folks are paying their fair share, whether they 

happen to be an individual or a business. So we focus a lot on forgone taxes, but you have an opportunity, I presume, to look at the 

revenue flow coming into the treasury. I do not know if you look 

at it every week or every month. In my role as governor, I drilled 

down every month, the beginning of every month, when we got the 

revenue report from the Division of Revenue. We looked at literally 

every category to see what was happening month by month by 

month, and I tried to stay on it. I do not do that so much as a Senator, but I presume you do that in your role. We are about 3 

months into this fiscal year. I do not know if we have numbers 

through the end of December. But if you would just give us like a 
20 

quick snapshot of what does the revenue picture look like for the 

first 3 months of this fiscal year. Are we doing a little better than 

we might have anticipated, better than budget or not? And is 

growth better or worse than might otherwise have been expected? 

I know that is not what you prepared or were asked to testify 

on, but it would be of great interest to me as we try to maximize 

revenues here. 

Mr. SHULMAN. Yes, I do not have this off the top of my head because, as you said, it was not exactly what I was prepared for, let 

us come back to you, and we would be happy to give you details 

of the revenue—— 

Senator CARPER. I would like you to answer that for the record, 

if you would. 

Mr. SHULMAN. Yes, for the record I will come back and give you 

revenue flows. We track it closely at the Treasury Department. It’s 

mostly the folks who do economics at Treasury, and I do not want 

to give you a wrong answer. 

Senator CARPER. What we are hearing anecdotally is the deficit 

number continues to drop, down from 1.5 to 1.3. Now we are down 

to under a trillion, only $980 billion. That is still a lot of money. 

That is encouraging. I just wondered if we could sort of get you to 

pinpoint where the growth is. 

Mr. Chairman, as usual, you raise intriguing and important 

issues. This is one that is certainly intriguing. Thank you for letting me participate. 

Senator LEVIN. Thank you so much for your participation. 

Just one quick question, perhaps, while Senator Carper is here. 

You made reference, I think, to certain rulings relative to charities 

or nonprofits. Is that correct, Ms. McMahon? 

Ms. MCMAHON. Well, I think I was intending to say that—— 

Senator LEVIN. The UBIT reference you made. 

Ms. MCMAHON. Right, that there were structures commonly used 

that employ—— 

Senator LEVIN. By the nonprofits and charities? 

Ms. MCMAHON. Right. 

Senator LEVIN. Are mutual funds a charity? 

Ms. MCMAHON. No. 

Senator LEVIN. And one other thing that I mentioned before you 

got here, Senator Carper, was that there was an effort made to add 

the investments or speculation in commodities a year and a half 

ago, and the House said it is OK, but we said we would not pass 

the bill with that provision in it. So the Senate did not accept that 

amendment which the House passed, so that is part of the legislative history. I assume that is relevant history, is it, Commissioner 

Shulman? That is relevant history that the Senate did not adopt 

that specific language? 

Mr. SHULMAN. Well, it is something that you raised, and we will 

obviously—— 

Senator LEVIN. Is it relevant legislative history is my question. 

Mr. SHULMAN. To answer directly, we generally do not view 

things that are moved into a statute and pulled out in the middle 

of the process before it is passed into law as definitive guidance. 

Senator LEVIN. How about relevant? I did not use ‘‘definitive.’’ 

Nothing is definitive here. But how about relevant? 
21 

Mr. SHULMAN. Generally, tax provisions that are put in and 

pulled out before the law is ever passed, unless—— 

Senator LEVIN. It does not show anything about congressional intent? That is not relevant to what the congressional intent is, if it 

is not a—— 

Mr. SHULMAN. I do not think it is definitive. 

Senator LEVIN. OK. Let us try relevant. Is it relevant? Try it 

again. 

Mr. SHULMAN. I think it could send a variety of signals, but I am 

not prepared to say every time there is a provision in legislation 

and it moves out between the Houses that we are going to view 

that as congressional intent. 

Senator LEVIN. I guess I am asking you, is it relevant to the 

question of congressional intent? Just relevant. 

Mr. SHULMAN. Sure. It is a piece of information in the whole 

analysis, yes. 

Senator LEVIN. That is all I was asking. We have gone over economic substance and sham doctrines. There is another well-established tax doctrine, too, which relates to conduits. In 1972, I guess, 

the principles were set out in a case called Aiken Industries and 

subsequent regulations of the IRS that the IRS is allowed to disregard any entity which functions as an intermediary for a taxpayer and to treat its income as income attributable to the taxpayer itself. One ruling in 2002 explains, ‘‘Where the parent corporation so controls the affairs of the subsidiary that it is merely 

an instrumentality of the parent, the corporate entity of the subsidiary may be disregarded.’’ 

Are you familiar with that doctrine, the conduit doctrine? 

Mr. SHULMAN. Yes, I am familiar at a high level. 

Senator LEVIN. OK. Will you look into the facts that exist about 

these shell corporations and in your review of this whole matter 

take a look as to whether or not they are simply conduits, and in 

the case of those notes whether or not the banks that enter into 

those notes are simply agents or instrumentalities for the mutual 

funds? Will you check out that doctrine? 

Mr. SHULMAN. Absolutely. 

Senator LEVIN. Do you know, Commissioner, how many private 

letter ruling requests are pending relative to these 72 rulings 

which have been issued? 

Mr. SHULMAN. Yes, 72 issued. There are 28 that have requested 

private letter rulings since we stopped issuing them. 

Senator LEVIN. OK, and those are the ones that there is a moratorium on? 

Mr. SHULMAN. Correct. 

Senator LEVIN. Commissioner, you said that a private letter ruling can be relied on by only one taxpayer, and I think that is, in 

fact, your policy. However, we know of two mutual funds that have 

set up offshore corporations to trade in commodities without any 

private letter ruling. They told us they thought that they were allowed to do so based on other letters, so I think your statement 

here today is very important and hopefully will be relied upon and 

counted on as being factually accurate that the letters which are 

issued only relate to those particular companies or mutual funds 

which requested those letters. That is the status. But I did want 
22 

you to know that there are a couple mutual funds who did not get 

those letters who are operating those offshore tax shelters or tax 

structures. I am just informing you of that, and if you are interested as to the names of those, my staff can give those to you. 

Perfect. That was my next question. We are all set for you. Are 

you ready? 

Senator COBURN. Thank you. You probably asked all the questions. 

Senator LEVIN. I hope so, yes. 

Senator COBURN. Thank you. 

I know Senator Levin has asked this question, but my most important thought about this issue is: Is the purpose for setting up 

an offshore commodities trading firm to avoid taxes? Is there another reason to do that other than to avoid taxes? 

Mr. SHULMAN. We had some discussion about this. Generally, 

people came in for private letter rulings, which we have suspended, 

but they come in to say, ‘‘If we set it up with these detailed facts, 

does the IRS interpret that that is allowable under the law?’’ In the 

past we said yes. Now we are going to take a look and see what 

we think. 

Generally they would not set it up. They would use some other 

structure. They would make another investment. They would go 

into another business if they did not do it. So taxes at the entity 

level is very rare. I know of one circumstance in all of mutual 

funds where a mutual fund decided to be taxable, so it is very rare 

for a mutual fund to pay taxes. That is what the Registered Investment Company Act and Section 851 allows them to do. 

I think the other point I made was that I want to be clear that 

the activity that happens in the controlled foreign corporation flows 

through and taxes are paid ultimately by the mutual fund’s shareholders. So there is no loss of revenue to the Federal Government 

in these transactions, but there is the whole question of does the 

law even allow them to be set up in the first place, which I think 

is the question that was put on the table. 

Senator COBURN. Well, actually, I think there is lost revenue because if, in fact, a mutual fund is going to invest in a company that 

does commodity trading and does not do it in a tax-sheltered location, they are going to pay taxes on that, trading profits before they 

share with the stockholders of the fund. In other words, if I set up 

a corporation, ABC Corporation, and I am going to trade commodities, and I am going to make money, and you are going to be a 

shareholder in that, and I do that onshore, then I am exposed to 

corporate income taxes in this country, if I do it onshore, correct? 

Mr. SHULMAN. I think so. 

Senator COBURN. Yes. So, therefore, I am going to pay taxes 

there, and then I am going to give a distribution to the stockholders of what is left. And then they are going to pay taxes on 

whatever that distribution is if it is above their investment in it 

or if it is a dividend for it. So the point is the reason they are set 

up in offshore is to eliminate that corporate tax on those trades, 

correct? 

Ms. MCMAHON. If I could answer that briefly, the income that is 

generated by the controlled foreign corporations through commodities activities is actually treated as Subpart F income which flows 
23 

up for U.S. tax purposes to the RIC, and ultimately the shareholders, so that there is actually U.S. tax in this particular structure. 

Senator COBURN. But at the shareholder level. 

Ms. MCMAHON. Well, technically the income is includable in the 

income of the RIC. 

Senator COBURN. Right. 

Ms. MCMAHON. And then as long as the RIC complies with the 

requirements that apply for it to have passthrough treatment, it 

would not be taxed at the RIC level. But it is included—— 

Senator COBURN. Right, so it gets taxed by the shareholder. 

Ms. MCMAHON. And it is taxed by the shareholder. But that is 

no different than any other income that they—— 

Senator COBURN. OK. Well, let us take GE for a minute. GE pays 

a dividend, which you pay income tax on, but GE also—GE is a terrible example. They have not paid any income tax in a number of 

years. As a matter of fact, you have been paying them. 

Let us take John Deere. They make earnings. They pay a corporate income tax. They distribute those earnings in terms of dividends, and then those earnings, which have already been taxed 

once, are then going to be taxed again by whoever receives that 

dividend. Correct? 

Ms. MCMAHON. Yes. 

Senator COBURN. So no matter how you base it, the reason for 

putting that account offshore is to lessen the tax that could be acceptable if you did the exact same thing onshore. 

Mr. SHULMAN. First of all, the hypothetical you gave I think is 

accurate. I think if they decide to do the exact same activity onshore, it will be taxed at the corporate level. Before, Senator Carper asked are there other ways that mutual funds can gain access 

to commodities. There is a variety of questions in the law around 

partnerships, around qualified publicly traded partnerships. So the 

chances of a corporation setting up in the United States for the sole 

purpose of doing the kind of direct investment in commodities and 

then moving—being fully owned by a mutual fund, the chances of 

that hypothetical actually occurring are pretty slim. 

The real question is—which I want to be clear, I think it is a legitimate question that is being put on the table here. Can these 

things be set up to invest in commodities or not? 

Senator COBURN. Well, I think the Chairman’s and my reading 

of the law is we do not think so. 

Senator LEVIN. Well, we do not think so, but I am amazed at 

your reluctance to say yes to the most obvious question—you said 

yes to me finally about an hour ago—to Dr. Coburn’s question. The 

reason that these are set up in these offshore locations is so that 

they can avoid that impact of that section of the Tax Code. The answer is—they acknowledge that, for God’s sake. Why can’t the IRS 

look that square in the face and say, ‘‘Of course, that is the reason 

they are doing it.’’ You did it an hour ago. I am amazed at your 

reluctance to simply say yes to Dr. Coburn’s question. Of course, 

that is the reason. They acknowledge that is the reason. And you 

say, ‘‘Well, they are not going to do something which would lead 

to their paying taxes.’’ Of course, that is true. So the other side of 

that coin is the reason they are putting it in the Caymans is to 
24 

avoid that problem. Why not just say yes and then go on from 

there? I mean, why is there any reluctance? That is what I do not 

understand here. 

Mr. SHULMAN. Why do I have reluctance? 

Senator LEVIN. Yes, to say that is the reason that they are in the 

Caymans. 

Mr. SHULMAN. Because having responsibility for the whole U.S. 

tax system, some of the things that have been asked implicate 

some of the other cases we have and other things that are happening outside. And so to make blanket generalizations about our 

views on controlled foreign corporations, when we will attack them, 

when we will not and when they are tax avoidance and when they 

are not has other implications beyond the issue at hand. 

My reluctance is that I am trying to be respectful, and I am very 

clear what this hearing is about. It is the private letter rulings and 

you believing that they were issued contrary to the intent of the 

law and that our lawyers’ interpretation was wrong. I have told 

you we have stopped the private letter rulings, and we are going 

to take a broad look at that. So my goal would be on the record 

to leave it at that and not say things that are going to implicate 

us continuing our aggressive push around things like offshore tax 

evasion and around aggressive corporate structures to avoid paying 

taxes. 

The question on the table, which is a legitimate one, is: Should 

through the Code there be the ability to invest indirectly in commodities through structured notes or through controlled foreign 

corporations? And we are going to take a hard look at that. 

Senator COBURN. Nobody that has applied for one of these private letter rulings and has gotten it has done anything wrong. 

Their motivation is to make money. You have granted a private letter ruling, and they have taken advantage of that. So this is not 

to implicate anybody that has been there. 

But in terms of transparency of markets, my main concern in visiting with the Chairman on this is that people are going to invest 

in speculative things if that is where they think they can get the 

most return, and they think they can. The thing that ought to be 

there is transparency so that they know what the risk is as they 

go into this, and when you have a mutual fund that is doing this, 

a large amount of money can be lost. Or at least the risk for a large 

amount of money is out there; otherwise, they would not be speculating in commodities in the first place. 

As I said earlier, I do not know what too much speculation is, 

but I know we cannot do anything in the long term in this country 

that is going to affect that because we are in a world market. The 

only way we are going to do that is through international agreements if we think that is justifiable. 

So I do not have any criticism with what you have done. The fact 

that you are looking at it I think is great, and I think we ought 

to continue to do that, and we ought to be maybe more clear in how 

we write laws and to give you more guidance, and once of our worst 

habits in Congress is we say we write a law and this is the intent. 

We will let the Administration or the bureaucracy decide what the 

rulings on it are. I think we need to know a little bit more about 

that before we put it out to give you the rulings to write. In other 
25 

words, you would not be sitting here today if we were much more 

clear about what the intent was in 2010. 

Thank you. 

Senator LEVIN. Thank you, Dr. Coburn. 

Do you know of any nontax purpose that mutual funds have for 

opening up these corporations in the Caymans? 

Mr. SHULMAN. Well, the CFCs in the private letter rulings I 

think were set up specifically so that they could invest in commodities. 

Senator LEVIN. And be consistent with the Tax Code? And comply with—— 

Mr. SHULMAN. And income definitions. 

Senator LEVIN. And hope that they are complying with the Tax 

Code and Section 851. 

Mr. SHULMAN. Yes. 

Senator LEVIN. I happen to agree with Dr. Coburn, by the way. 

This is not a question of mutual funds taking advantage of what 

they are trying to take advantage of. I think the investment in 

commodities has the impact we have talked about, but we do not 

have to agree on that. What seems to me is so clear is the purpose 

of their investment or their creation of these shell corporations. 

There is no doubt about it. They do not deny it. Just ask them. 

They will tell you. They are trying to avoid the implications of not 

being eligible for nontax treatment under Section 851. They are not 

hiding that. What troubles me is that if you allow that, if you allow 

the shell corporations to be used for that purpose, there is only a 

tax avoidance purpose that they want to comply with—they have 

to comply with Section 851, as you point out. They do not want to 

pay taxes at a corporate level. That is what Dr. Coburn’s question 

is. What troubles me is why there is any doubt in your mind as 

to what the purpose is. They acknowledge it. But then when the 

IRS says they are going to allow that to be used, allow a shell/sham 

corporation to be used for that purpose, it undermines all the efforts we are making to put those shell/sham corporations out of 

business, frankly. They have no purpose other than tax avoidance. 

By the way, I agree with Dr. Coburn. We are not talking illegality here. We are talking tax avoidance. 

So I am going to end this on a positive note even though I have 

expressed my dismay at the reluctance to acknowledge what is 

open. Ask the mutual funds. I am sure there are many representatives here. And as you point out, they do not want to pay taxes. 

And they would not go there if they had to pay taxes. Of course, 

that is the point. That is why they are going there. But you cannot 

quite say that, and that is what troubles me because if you cannot 

say that, then I wonder about how much you are really going to 

go after these conduits, these shell corporations, however they are 

used, by the way. That is the part that leaves me with uncertainty. 

But what is certain is what you have said here, and that is that 

you are going to take a look at this from that perspective, can the 

IRS resume accurately put its blessing on the use of what are openly shell corporations with no nontax purpose? Can you put your imprimatur on that anymore? And what are the implications of your 

doing that for all the other areas where you are trying to prevent 

that from happening? And if there are other ways that mutual 
26 

funds can speculate consistent with the law, that is one thing. I 

mean, I am not going to start giving tax advice. I do not think 

there are because I think the law is clear, by the way. It has been 

clear for 80 years. We listed what can be done and what that 

means, unless those things are what you are doing, you do not get 

tax freedom at the corporate level. 

The economic substance doctrine has been codified by Congress, 

by the way. This is not any uncertainty or ambiguity. In 2010, we 

codified the economic substance doctrine. It says that you can disregard transactions or entities that create no meaningful change in 

the economic position of the taxpayer and have no substantial purpose other than—and this is the word of the law—‘‘to achieve a tax 

effect.’’ The effect here is to avoid violating or being inconsistent 

with a section of the Tax Code, which would trigger a tax at the 

corporate level. That is the purpose. That is the effect. 

And so would you finally agree, to end on a positive note, that 

in 2010 that economic substance doctrine applies to the transactions that are analyzed in the private letter rulings? Would you 

agree that the law saying that you may apply an economic substance doctrine to transactions, that is applicable, should you decide to apply it, to these transactions? 

Mr. SHULMAN. So while I like the idea of ending on a positive 

note, I am not sure I can agree to that. I think that economic substance is very fact intensive. We typically raise this in other circumstances. We typically do not raise economic substance with specific taxpayers that we have granted private letter rulings. 

Senator LEVIN. I am talking about in the policy that you are 

going to look at, the overall generic policy. 

Mr. SHULMAN. I just think it is something different. I do not 

think we need to raise that in the policy. I think we could decide 

to allow this or disallow this without implicating economic substance. It is really about a reading of the law, and I think it is not 

necessary and, frankly, all of our court cases where we have been 

successful with economic substance have very different sets of fact 

patterns than these. 

Senator LEVIN. Well, we passed a law in 2010 talking about economic substance saying that something has got to be real, it cannot 

be fake, and we are going after these totally phony transactions, 

which is what this is acknowledged to be. It is a shell. It is a sham. 

And for you to say that it might not be even relevant to your decision here—is it at least relevant? Is it something you would want 

to look at? 

Mr. SHULMAN. You have brought up the point about it, and I 

gave you my commitment that all of our points we are going to look 

at closely. I will tell you, though, the economic substance doctrine 

is a very specific tool, and we have a lot of tools. We have private 

letter rulings. We have suspended those. We have regulation or 

guidance. We have said we are going to look at that. And then obviously Congress could get very clear with the law, which would be 

our preference to all this. And so I do not want to implicate the 

economic substance doctrine where we do not have to, and I am not 

sure it is necessary here because we want to continue to win in 

court. Congress codified a judicial doctrine based on common law 

principles that we have been very aggressive and very careful 
27 

about developing our positions, and that is why we have been so 

successful. And I do not want to generalize about the kinds of 

transactions where that could win. When we see an issue that we 

want to attack on economic substance, we will. Our lawyers will 

look at that. We have had a good record with that, and we plan 

to continue that. 

Senator LEVIN. Finally, if there is no economic substance to the 

creation of these corporations other than tax avoidance issues, if 

there is no nontax purpose, to use your words, to create these corporations, is that relevant? 

Mr. SHULMAN. Sure, I mean, the prongs of the economic substance doctrine we would look at, and to the extent that any position was changed going forward and people violated those prongs, 

everything is fair game. I am just saying right now we do not need 

to go attack these economic substance. We can actually put guidance out or have the law changed. 

Senator LEVIN. Thank you both. We have a vote that is on now, 

and apparently there is only 5 minutes left. To end on a positive 

note, we appreciate your reassurance that you are going to take a 

fresh look at this and you are going to apply doctrines in ways 

hopefully that are not going to create precedents that are negative 

in terms of going after sham transactions, we are going to leave on 

that positive note. Again, we are grateful for your appearance here 

today. 

[Whereupon, at 12:10 p.m., the Subcommittee was adjourned.] 

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