Court Opinion

ID: 4484013
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:27.247859+00
Date Added: 2024-06-11T08:49:14.210478
License: Public Domain

Tannenwald, J., concurring in the result: Initially, I confess that I find myself on the horns of a dilemma due to two factors: (a) respondent’s concession that the test of principal purpose of tax avoidance or evasion, contained in section 704(b)(2), does not apply, and (b) the fact that the ultimate decision herein is founded upon the evaluation of the record, including extensive oral testimony, by the trier of the facts, Judge Dawson. As I view the majority opinion, it appears to me to articulate an inadequate standard for decision. In essence, the opinion seems to say that “economic substance” or “economic effect” is to be measured against an evaluation of whether the transaction involved herein is founded upon tax avoidance or evasion. To me, such a standard of measurement simply pushes section 704(b)(2) out the front door (because of respondent’s concession) only to bring it back through the side door. The application of the form-vs.-substance doctrine has usually occurred in the course of judicial determination of whether there was an economic basis for a particular transaction aside from the tax benefit. Or, to put it another way, the key element has been whether the transaction was constructed entirely for the tax advantage. Knetsck v. United States, 172 Ct. Cl. 378, 384-385, 348 F.2d 932, 936-937 (1965); McLane v. Commissioner, 46 T.C. 140, 145 (1966), affd. per curiam 377 F.2d 557 (9th Cir. 1967). See also Owens v. Commissioner, 64 T.C. 1, 14 (1975), affd. on the issue involved 568 F.2d 1233 (6th Cir. 1977); Starr v. Commissioner, 46 T.C. 450, 460 (1966). Admittedly, in applying that standard, the tax purpose underpinnings of a transaction have been an influencing factor. In the instant case, however, the presence of section 704(b)(2) and respondent’s concession, in my opinion, severely limit, and, indeed, seem to eliminate, such a consideration. Given these circumstances, I believe that respondent can prevail only if the claimed lack of economic substance is so pervasive that the arrangement in question should properly be characterized as “sham.” I do not believe that the majority opinion has observed the line between purpose of avoidance or evasion of tax (the legislative test embodied in section 704(b)(2), which, by hypothesis, does not apply herein) and the proper application to this case of the form-vs.-substance doctrine, which I am prepared to concede provides an overall judicial gloss to the Internal Revenue Code.1 On the contrary, the majority opinion seems to do no more than say that the divergence between the allocation of “bottom-line” profits and losses2 and the actual division of funds during the taxable years in question is, in and of itself, sufficient to sustain respondent’s position. But, as I have already stated, this appears simply to make the test of “economic substance” or “economic effect” the same as that embodied in section 704(b)(2). If such were the case, the extensive discussions by the commentators as to whether section 704(b)(2), in its original form, applied to “bottom-line” allocations and the enactment of the amendment of that section by section 213(d) of the Tax Reform Act of 1976, Pub. L. 94r-455,90 Stat. 1548, were exercises in futility. The mere application of an improper standard does not, however, afford me a sufficient basis for necessarily disagreeing with the result reached herein. See my dissenting opinion in Estate of Gilman v. Commissioner, 65 T.C. 296, 323 (1975).3 Granted that, if I had been the trier of the facts, I might have reached the opposite result, I think it would be inappropriate for me to assume that Judge Dawson would have so concluded had he applied the standard I espouse. In short, I return to my dilemma and conclude that, although I disagree with the standard which the majority appears to have adopted, I do not believe it lies within my province to make an independent evaluation of the record and perhaps reach a contrary result. Hence my concurrence. Simpson, J., concurring: I agree with the conclusion of the majority, but I have somewhat different reasons for reaching that conclusion. As I understand the provisions of section 704 as they were enacted in 1954, it was contemplated that partners were to have broad authority in allocating the consequences of a partnership enterprise; the only limitation was that if the principal purpose of the allocation was tax evasion or avoidance, the allocation would not be recognized for tax purposes, and that limitation was set forth in section 704(b)(2). See S. Rept. 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. 379 (1954); Rodman v. Commissioner, 542 F.2d 845, 857-858 (2d Cir. 1976); Smith v. Commissioner, 331 F.2d 298 (7th Cir. 1964), affg. a Memorandum Opinion of this Court; Moore v. Commissioner, 70 T.C. 1024, 1033 (1978); Harris v. Commissioner, 61 T.C. 770, 785 (1974); Orrisch v. Commissioner, 55 T.C. 395, 400-401 (1970), affd. per curiam in an unpublished opinion (9th Cir. 1973). Therefore, if the slate were clean, I would have held that section 704(b)(2) is the only applicable limitation in this case. Although there is a question as to whether section 704(b)(2) was intended to apply to the “bottom-line” allocations, I would have held that despite the use of the word “item,” an examination of subchap-ter K and its legislative history indicates that section 704(b)(2) should be applied to all allocations. Yet, since the Commissioner has conceded that section 704(b)(2) does not apply in this case, the result would have been to decide the case in favor of the petitioners. In ,fact, the slate is not clean, and in my opinion, Kresser v. Commissioner, 54 T.C. 1621 (1970), has established a precedent for holding that there is another limitation on a partnership’s authority to allocate tax consequences. In effect, it holds that when the allocation is made for tax purposes and lacks economic reality, the allocation is not to be recognized. Despite my own views of section 704,1 recognize that there is a question as to the scope of section 704(b)(2), and therefore, I am not prepared to argue that Kresser should not be followed. Accordingly, I reach the conclusion that it constitutes precedent for the holding in this case. In my view, there is some question as to what were the real terms of the bargain between the partners in this case. Nevertheless, Judge Dawson heard the case, and he has concluded that the petitioners have failed to prove that the allocation did have economic reality; I accept his conclusion on this matter. In 1976, Congress amended section 704(b) to make clear that it applies to the allocation of bottom-line income and losses and to provide that any such allocation is ineffective if it “does not have substantial economic effect.” For years subject to the 1976 amendment, a question might arise as to whether the “judicial gloss” enunciated and applied by Judge Dawson is in addition to and different from the “substantial economic effect” standard now set forth in section 704(b)(2). Such issue is not presented by this case, and the Court’s opinion should not be understood as taking a position on it.   Whatever may be the “thrust” of Kresser v. Commissioner, 54 T.C. 1621 (1970), the fact is that the record in that case was obscure in many respects and, as a consequence, I do not think it controls our decision herein.    The Apr. 15, 1971, amendment to the agreement provided that profits would also be allocated to petitioner, retroactive to Jan. 1, 1970, but it seems clear that the partners were certain that there would be no profits at least through 1975.    The Court’s decision was affirmed per curiam, 547 F.2d 33 (2d Cir. 1976).