Economic Substance, Corporate Tax Shelters, and the Compaq Case

Posted: 14 Aug 2000

See all articles by Daniel Shaviro

Daniel Shaviro

New York University School of Law


This paper analyzes the broad tax policy issues raised by the use of an economic substance approach (whether through rules or standards) to deter corporate tax shelters, with particular reference to the recent Tax Court decision in Compaq Computer Corp. v. Commissioner. It argues that the basic rationale for an economic substance requirement is that it may reduce the social harm caused by taxpayer responses to undesirable incentives created by our tax rules, whether these incentives reflect deliberate enactments such as accelerated depreciation, or the unanticipated exploitation of tax arbitrage opportunities. The approach operates by burdening optimal tax planning through the creation of business frictions would otherwise be as senseless as, say, requiring taxpayers' CFOs to execute back-somersaults in the IRS National Office as a precondition of tax benefit.

With respect to corporate tax shelters generally, it argues that at least some use of an economic substance approach is likely to be desirable in many cases, given (1) taxpayers' apparently high aversion to initial increments of economic risk in tax deals, and (2) the fact that corporate tax sheltering may tend to create preferential tax rates for whatever economic activities can be stuffed into C corporations (rather than, say, accomplishing homemade corporate integration). With respect to Compaq, the report argues that the Tax Court's decision both was legally sound and is likely to have good policy effects, since (along with section 901(k) and IRS Notice 98-5) it deters the creation of what would effectively be an exemption system for the foreign passive income of American multinationals with sufficient capital gains.

Keywords: Corporate tax shelters, foreign tax credits, economic substance

JEL Classification: H21, H23

Suggested Citation

Shaviro, Daniel, Economic Substance, Corporate Tax Shelters, and the Compaq Case. Available at SSRN:

Daniel Shaviro (Contact Author)

New York University School of Law ( email )

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