Castle Harbour: Economic Substance and the Overall Tax-Effect Test
12 Pages Posted: 19 Aug 2008
Date Written: August 19, 2008
The taxpayer victory in Castle Harbour v. Commissioner has been heralded as a watershed in tax shelter litigation. The district court rejected the government's arguments that the partnership was a sham and that the partnership's allocations violated the overall-tax-effect test. This article explores the relationship between the economic substance doctrine and limitations on flexible allocations under Subchapter K. Although the section 704(c) regulations now provide an anti-abuse rule that should make it impossible to replicate the Castle Harbour transaction, the government also maintained that the partnership's allocations lacked substantial economic effect under the section 704(b) regulations. The article argues that the district court's circular interpretation of the overall test threatens to undermine the ability of the section 704(b) regulations to deter tax-driven allocations. Although the government's relative ownership test was defective, the article suggests alternative methods for reallocating the partnership's book items to reflect the partners' economic interests.
Keywords: Castle Harbour, tax shelter, substantiality, 704(c), 704(b), abuse, partnership, partners' interest, reallocation
JEL Classification: K34
Suggested Citation: Suggested Citation