Abusive Offshore Tax Avoidance Schemes -
Law and Arguments (Section IV)
From: http://www.irs.gov/businesses/small/article/0,,id=106566,00.html

IV. Argument Responses

• Substance -- Not Form -- Controls Taxation

  The Supreme Court of the United States has consistently stated that the substance rather than the form of a transaction is controlling for tax purposes.

  Gregory v. Helvering, 293 U.S. 465 (1935), XIV-1 C.B. 193; Helvering v. Clifford, 309 U.S. 331 (1940), 1940-1 C.B. 105 - The court determined abusive trust arrangements may be viewed as sham transactions, and the IRS may ignore the trust and its transactions for federal tax purposes.

  Markosian v. Commissioner, 73 T.C. 1235 (1980) - Held that the trust was a sham because the parties did not comply with the terms of the trust and the supporting documents and the relationship of the grantors to the property transferred did not differ in any material aspect after the creation of the trust.

  Zmuda v. Commissioner, 731 F.2d 1417 (9th Cir. 1984) - The income and assets of the business trust, the equipment in the equipment trust, the residence in the family residence trust, and the assets in the foreign trust were all determined to belong directly to the owner.

• Special Rules Apply To Foreign Trusts

  A trust is a foreign trust unless a US court is able to exercise primary supervision over the trust's administration and a US trustee has the authority to control all substantial decisions of the trust (IRC §§ 7701(a)(30)(E) and 7701(a)(31)(B)). IRC § 6048 imposes various obligations on foreign.trusts and persons creating, transferring to, or receiving distribution from. A failure to report such transactions could result in substantial penalties being assessed under IRC § 6677. (See IRC §§ 671 through 679 for grantor trust rules and IRC §§ 641 through 685 for non-grantor trust rules).

• Placing Business Activity In A Trust Does Not Avoid Tax

  A trust is an arrangement where a trustee takes title to property for the purpose of protecting or conserving it for beneficiaries.

  There are other arrangements which are known as trust, but which are not classified as trusts for purposes of the Internal Revenue Code, These trusts, which are often known as business or commercial trusts, generally are created by the beneficiaries as a devise to carry on a profit-making business which normally would have been carried on through business organizations that are classified as corporations or partnerships. Therefore, these business or commercial trusts if foreign, are taxed as either a partnership or association, or if domestic, are taxed as either a partnership or disregarded entity (Treas. Reg. § 301.7701-4).

• Multiple Entities Do Not Change The Character Of Income

Generally the "character" and "source" of income are not changed by shifting income items through one or more additional entities (domestic or foreign).

For example:

1. If a foreign trust is not treated as a grantor trust, distribution of its income are taxable to US beneficiaries when made. Distributions of trust corpus are not taxable. IRC § 652 (simple trusts) and IRC § 661 (complex trusts) specify that distributions have the same character in the hands of the beneficiaries that the income had in the hands of the trustee.

2. A capital gain from a US partnership remains a capital gain in the hands of the partners to that US partnership, and to any persons receiving the income in additional tiers below the initial recipient.

Note: This page contains one or more references to Internal Revenue Code (IRC) sections. A link to the Internal Revenue Code is included for the convenience of those who would like to read the technical reference material. To access the applicable Internal Revenue Code sections visit the Tax Code, Regulations, and Official Guidance page.

Return to Table of Contents