Mazzei v. Commissioner of Internal Revenue, No. 18-72451 (9th Cir. 2021)
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The Ninth Circuit joined its sister circuits in concluding that, when Congress expressly departs from substance-over-form principles, the Commissioner may not invoke those principles in a way that would directly reverse that congressional judgment.
The panel reversed the tax court's decision in favor of the Commissioner on a petition for redetermination of federal excise tax deficiency where petitioners established a Foreign Sales Corporation to reduce the tax paid on income that was then distributed as dividends to Roth Individual Retirement Accounts (IRAs). The panel concluded that the unusual statutory provisions at issue here expressly elevated form over substance in the relevant respects, and thus the tax court erred by invoking substance-over-form principles to effectively reverse that congressional judgment and to disallow what the statute plainly allowed.
Court Description: Tax. The panel reversed a decision by the full Tax Court in favor of the Commissioner on a petition for redetermination of federal excise tax deficiency, in a case involving the use of a Foreign Sales Corporation to reduce the tax paid on income that was then distributed as dividends to Roth Individual Retirement Accounts. Appellants established a FSC under since-repealed provisions of Internal Revenue Code §§ 921–927 (the FSC statute). Under the FSC statute, a corporation with foreign trade income could establish a related FSC as a shell corporation and then effectively cycle a portion of that income through the FSC where it would be taxed at lower rates. As a result, the FSC’s taxable income was generated through related-party transactions that lacked meaningful economic substance. The FSC taxation rules thus reflected a departure from the normal principle that taxation is based on economic substance rather than on legal form. Appellants made their Roth IRAs formal shareholders of their FSC. Appellants’ export corporation paid commissions into the FSC, and the FSC’s after-tax income was returned as dividends and distributed to appellants’ IRAs rather than to their export corporation. As a result, no tax was paid when the money was received into the Roth IRAs, and no tax would be paid on qualified withdrawals from the Roth IRAs. MAZZEI V. CIR 3 The Commissioner challenged this scheme, asking the Tax Court to recharacterize the entire scheme under the doctrine of substance over form. The Tax Court held that, under substance-over-form principles, appellants—not the Roth IRAs—were the real owners of the FSC. This meant that appellants should be deemed to have received the dividends, their contributions to the Roth IRAs exceeded the statutory limits for such contributions, and appellants were consequently liable for excise taxes on the excess contributions. The panel concluded that, due to the unusual statutory provisions at issue here, the Tax Court erred by invoking substance-over-form principles to effectively reverse congressional judgment and to disallow what the statute plainly allowed. The panel joined three other circuits that have similarly disallowed the invocation of substance-over- form principles to undo the congressionally authorized separation of substance and form that is involved in an entity similar to the FSC at issue here.
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