Corporations have become very concerned about “best practices” and “risk management” in the wake of the Enron scandal and enhanced enforcement rules of government agencies and auditing rules of accountants. One way to address those concerns is for corporate boards to adopt guidelines for employees. One area in which such guidelines can be useful is in application of the economic substance doctrine.

Fortunately, LB&I has issued a directive providing substantial guidance, albeit non binding, on the substantive issues and potential safe harbors in auditing for the economic substance doctrine. Corporate tax departments should incorporate these guidelines into their standard review policy. But on the procedural side, the following can serve as a template for a Corporate Tax Department Economic Substance Doctrine Ethics Policy.

Corporate Tax Department Economic Substance Doctrine Ethics Policy

  1. Identify the events that trigger the process. This identification entails several potential limits: will state taxes be considered where states may assert positions like the doctrine but wholly independent of it? will there be a dollar threshold, and to what will it apply?
  2. Identify who in the company is responsible for triggering the process and carrying it out; establish any review and reporting levels involved.
  3. Establish the time period in which the analysis should occur; ideally it should occur prior to the company decision to engage in the transaction, which distinguishes this process from decisions that will be made later in regards to the Schedule UTP and other disclosure rules for tax and non tax purposes.
  4. Establish best practices for dealing with third parties who may have proposed transactions to the company or who are employed to analyze them.
  5. Establish guidelines for analysis of the proposed transactions to be applied by company employees.
  6. Establish guidelines for when outside professional input is needed.
  7. Establish record keeping guidelines.
  8. Determine how this process will relate to the process that should already exist to create the Schedule UTP and also the process for identifying tax reserves for accounting purposes.
  9. Establish guidelines for discussing economic substance doctrine issues with examining agents.
  10. Establish process for insuring that project plans and purposes are carried out and that underlying assumptions are reality, which will almost always involve parts of the company beyond the Tax Department.
  11. Establish a process to redefine the process when needed
  12. Assess whether there are systemic processes in the company not directly related to any particular transaction that tend to raise concerns under the doctrine (such as handling of subsidiaries and their funds).

Record Keeping

In addition, the company should create documentation of the process. There may be concern about maintaining documentation of such process and analyses, given that the penalties are no fault and the company's due diligence cannot protect it from penalties once the doctrine is applied, and the existence of such analyses could tend to indicate that the company thought the transactions were problematic and might be discovered in the course of disputes with the IRS. This concern should be outweighed by the facts listed below.

The best approach for the company is to create and preserve the analysis that must be made:

  • Because the company properly understands its obligations to various constituencies and is acting to fulfill those obligations;
  • For the protection of the company personnel involved, both internally and as to professional responsibility concerns and criminal law concerns;
  • For preservation of facts that the company would intend to rely upon in defense of an attack on the transaction under the doctrine, and to avoid the appearance of creating such documentation after the fact;
  • To avoid the aura of conscious disregard of the doctrine, which might be a negative factor in itself;
  • To provide penalty protection if tax is found to be due but not on account of the doctrine;
  • To make the best effort that can be made to fill what right now is a vacuum of guidance about the doctrine.