Chemoil: Economic Substance, Tax Credits, and Unprofitable Ventures

Abstract

The Chemoil tax dispute provides an opportunity to explore the relationship between the economic substance doctrine and unprofitable transactions that are rendered economically viable by tax credits. Chemoil raises a particularly interesting point of contention. Transactions that generate specific excise tax credits (which are designed to encourage otherwise unprofitable activities) may appear to run afoul of the economic substance doctrine, which considers whether transactions have independent economic significance setting aside the tax benefits derived from the transactions. Thus, there is a tension between the congressional intent to provide an incentive for otherwise unprofitable activities and the congressional intent behind the economic substance doctrine, which, by its nature, denies tax benefits that arise out of transactions with no economic effects apart from their federal tax implications. Moreover, if a taxpayer cannot avoid application of the economic substance doctrine to the relevant transactions, the dispute raises the further question of whether transactions whose profitability is derived solely from excise tax credits should still be considered as having economic substance because of the nature of how these tax credits operate to encourage otherwise economically unviable yet ostensibly congressionally endorsed activities.

Keywords: economic substance, tax, tax credits