Last week, the Tenth Circuit affirmed the district court judgment in the case, Liberty Global, Inc. v. United States, siding with the government in a dispute over whether the complex series of transactions that Liberty Global used to accomplish a restructuring without incurring U.S. tax liability would be respected. The case represents an interesting example of the tension between the anti-abuse doctrines, particularly the economic substance doctrine, and the ability of taxpayers to rely on the written language of the Code.

The transaction at issue was designed to solve a problem that many a tax practitioner has faced—how to move a foreign subsidiary of a U.S. corporation out from under the U.S. chain without incurring tax. Liberty Global, Inc. (LGI), the ultimate parent of which, Liberty Global plc, is domiciled in the United Kingdom, came up with a series of transaction steps that would allow LGI to move its indirect interest in a Belgian cable broadband business (Telenet) up the chain of ownership such that it would be directly held by Liberty Global plc. 

From a tax planning perspective, the solution, code-named Project Soy, was an ingenious application of some of the provisions in the 2017 tax bill. Broadly speaking, the transaction comprised four steps (for the visually inclined—and perhaps anyone who gets lost with the dizzying array of entity names—the internal steps plan outlining Project Soy was filed as an attachment in the litigation and can be viewed here), which was intended to work roughly as follows:

Step 1. Telenet Group BVBA, a Belgian entity disregarded for U.S. tax purposes and wholly owned by its Belgian parent, Telenet Group Holding (TGH) (in which LGI indirectly had a controlling interest), engaged in a transaction that effectively converted much of TGH’s equity value in Telenet Group BVBA into a large monetary claim. (It may be helpful to think of that claim as similar in effect to a short-term note.) Because Telenet Group was disregarded, this had no U.S. income tax impact.

Step 2. Telenet Group transferred all of its equity interests in Telenet Financing, a U.S. entity wholly owned by Telenet Group and disregarded for U.S. tax purposes, to TGH (its parent), for the nominal amount of $4. As with Step 1, because Telenet Group and Telenet Financing were both disregarded, this had no U.S. income tax impact.

Step 3. Under Belgian law, Telenet Group converted from being a BVBA to being an NV/SA, which is a per se corporation under Treas. Reg. § 301.7701-2(b)(8)(i). For U.S. tax purposes, the incorporation of a disregarded entity by a single owner is treated as a transaction to which section 351 applies. However, in the deemed section 351 exchange, TGH was treated as receiving not only stock of the newly regarded Telenet Group, but also nonstock property—principally profit-certificate-like interests reflecting the large monetary claim generated in Step 1.

That nonstock property was treated as boot to TGH. This boot constituted income for U.S. tax purposes up to the amount of built-in gain in the assets of Telenet Group (roughly $4.6 billion). This was gain recognized by a foreign corporation in a deemed incorporation transaction involving non-U.S. assets, and so it was not directly taxable to TGH by the United States. Section 951A, however, would capture that gain indirectly as GILTI in the hands of LGI, a U.S. shareholder with respect to TGH, if TGH had an actual U.S. shareholder on the last day of TGH’s taxable year.¹ The solution, then, was to ensure that TGH no longer had an actual U.S. shareholder by year-end. 

Step 4. That led to Step 4, under which TGH’s parent company, Liberty Global Broadband, a U.K. limited company treated as a corporation for U.S. tax purposes,² sold its interest in TGH to Liberty Global plc (the ultimate parent) in exchange for an intercompany note—and by doing so on December 28, 2018, it ensured that LGI had no GILTI inclusion for the year on account of the boot deemed received by TGH. Under section 964(e)(1), when a CFC sells stock in another foreign corporation, section 1248 principles can recharacterize the gain as a dividend to the extent of E&P. Accordingly, for LGI, this meant that the sale produced a deemed dividend—but that’s where section 245A came into play. Under section 245A (and the coordinating rule in section 964(e)(4)), certain dividends received by certain domestic corporations from specified foreign corporations are eligible for a 100% dividends-received deduction, offsetting the income inclusion resulting from the sale-recharacterized-as-a-dividend.

To summarize, then, LGI combined section 1248 and section 245A to have a sale transaction characterized as a dividend. But in order to have enough E&P, it needed to engage in a set of transactions that would produce E&P for U.S. tax purposes. That was the role of Steps 1 through 3—to generate E&P for U.S. tax purposes without generating a corresponding foreign-tax cost. By ensuring that LGI’s interest was terminated before year-end, that E&P ultimately was intended to escape U.S. taxation as well. 

Suffice it to say this did not work. (Moreover, Treasury regulations—promulgated after Project Soy was completed and later finalized—generally disallow the availability of the section 245A deduction in transactions similar to the ones engaged in by Liberty Global.) In the majority opinion, the Tenth Circuit held as follows:

The economic substance doctrine codified in § 7701(o) is relevant to attempts by taxpayers to mechanically utilize the provisions of the Tax Code to obtain a benefit not intended by Congress. That is exactly what LGI did with Project Soy. And, as LGI admitted, the first three steps of the Project lack economic substance under the test set out in § 7701(o).

In her dissent, Judge Eid argued that in order for the economic substance doctrine to apply in the first instance, the doctrine must be “relevant.” And in her view, the test for relevance is as follows:

In essence, the doctrine adds a substance requirement to provisions dealing with economic realities. But for the doctrine to apply, the statutory language must explicitly incorporate a term related to economic reality or the taxpayer’s economic motive. This definition of relevance precludes the application of the economic substance doctrine to certain basic business transactions where Congress sanctioned choices for administrability purposes or to transactions that take advantage of noneconomic incentive provisions enacted by Congress.

Applying this test to Liberty Global, Judge Eid argued that the provision at issue (selling a CFC so as to take advantage of the last-day rule) did not implicate an “economic reality” that would make the economic substance doctrine relevant. Accordingly, while acknowledging “that Congress did not intend for LGI to take advantage of the statutory gap exploited by Project Soy,” “it is not our province ‘to rescue Congress from its drafting errors, and to provide for what [we] might think . . . is the preferred result,’ by applying a doctrine that is not relevant to the transaction at issue.” (quoting Lamie v. U.S. Trustee, 540 U.S. 526, 542 (2004)). 

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At its core, the majority opinion and the dissent emphasize a real issue in the tax law—the way in which “errors” in the tax law ought to be fixed. There seems to be little doubt that when the massive tax bill passed in the winter of 2017 that overhauled the international tax system, members of Congress did not anticipate the provisions to be combined in such a way as to achieve the result that was intended by Project Soy. And to be sure, the executive branch stepped in to plug the holes exposed by Project Soy with the (now-finalized) regulations under section 245A. 

But divining Congress’ “intent” (as opposed to a statute’s purpose) in such legislation is often a fool’s errand. The purpose of section 245A was to allow certain foreign earnings to be repatriated without residual U.S. dividend taxation, and, at a sufficiently high level of generality, Project Soy can be described as doing just that. The fact that the “earnings” were generated under U.S. tax law (and only U.S. tax laws) also reflects a separate legislative purpose—to recognize gain on contributed property when nonstock property is received in a section 351 transaction. The Code frequently treats deemed or formal transactions as producing real tax consequences—section 351 boot and section 338 elections (particularly section 338(g) elections on foreign target corporations) are obvious examples—and the mere fact that LGI used such rules to generate U.S. tax consequences should not, by itself, make the planning abusive.

Project Soy also included a real economic transaction—moving the TGH interest out from under the U.S. chain—and it did so in a tax-efficient manner. The fact that it was a tax-efficient structure is hardly objectionable, either. After all, taxpayers regularly plan into the Code’s reorganization and nonrecognition provisions to avoid recognition on dispositions or restructurings that otherwise might be taxable. It is likely that many reorganizations and nonrecognition transactions today go far beyond whatever was “intended” by the Congresses that passed the provisions. To the extent that is true, however, we should consider carefully whether aggressive application of anti-abuse doctrines is the best way to combat unintended tax avoidance or whether we should defer to Congress for that.

There are no easy answers. The anti-abuse doctrines are powerful and important tools in the hands of the IRS, especially because sophisticated taxpayers and their advisers can often move faster than Congress or Treasury in exploiting fissures in the tax system. In that respect, the majority’s concern is not hard to understand: LGI conceded that the E&P-generating steps were undertaken without non-tax substance, and their only apparent function was to detach section 245A from the anti-deferral rules enacted alongside it. But those anti-abuse doctrines should be used carefully, because ultimately it is the responsibility of Congress to ensure that undesirable side-effects of the tax provisions it enacts are appropriately cabined. 

1. A similar last-day rule applies for subpart F income, which would be relevant to the extent the gain were attributable to property of a kind that gives rise to foreign personal holding company income, such as passive-income-producing property. ↩︎
2. As a technical matter, Liberty Global Broadband indirectly owned TGH through disregarded entities, and the legal transferor was one of Liberty Global Broadband’s disregarded subsidiaries. While relevant for the formal transfer of ownership under relevant U.K. and Belgian law, those ultimately are not relevant for U.S. tax purposes. ↩︎