The Supreme Judicial Court recently ruled against the Commissioner of Revenue in a highly publicized decision, William I. Koch v. Commissioner of Revenue, 416 Mass. 540 (1993). For the reasons explained in this Technical Information Release, the Commissioner intends to treat the decision as confined to its particular facts, and will continue to assess tax and litigate cases where the taxpayer changes the form of a transaction for tax avoidance purposes without any change of substance.
II. Koch Decision
A. ATB Fact-finding
In Koch, the taxpayer, a Massachusetts resident, entered into a binding purchase and sale agreement for the redemption of his shares of stock in a Kansas corporation. After the execution of the agreement, the taxpayer transferred his shares of stock to an escrow agent and the Kansas corporation deposited $200 million with the escrow agent. In the next two days, the taxpayer arranged to amend the purchase and sale agreement to allow him to assign his shares of stock to twenty-five Delaware S corporations of which he was the sole shareholder. He remained personally liable, however, to deliver the stock on redemption. The next day, the Kansas corporation completed the sale transaction.
The Appellate Tax Board ruled that the gain realized from the sale of the stock was the income of the Delaware corporations which were doing no business in Massachusetts. Thus, it ruled that there was no tax owed to Massachusetts by Mr. Koch. The ruling was based upon the Board's conclusion that at the time of the taxpayer's assignment of shares to his Delaware corporations, the transaction was sufficiently uncertain to prevent the application of the substance-over-form rule. The Appellate Tax Board also found as a "fact" that the taxpayer had a valid business reason for transferring the stock to the Delaware corporations.
B. Appellate Action
The Commissioner appealed the Board's decision to the Massachusetts Court of Appeals. Applying a strict standard in favor of upholding the Board's fact-finding, the Court of Appeals nevertheless held as a matter of law that the record demonstrated the presence of a step transaction. The Court of Appeals therefore disregarded the form of the taxpayer's transaction and found his income taxable in Massachusetts. The Supreme Judicial Court reversed the decision of the Court of Appeals, however, and reinstated the Board's decision. The Supreme Judicial Court concluded that, given the deference due to the Board's fact-finding, the evidence before the Board was adequate to support its decision.
III. Future Application of Substance-Over-Form Doctrine
At the heart of any fair system of taxation is the principle that substance and not form is controlling. See, e.g., Commissioner v. P.G. Lake, Inc., 356 U.S. 260 (1958); Helvering v. Horst, 311 U.S. 112 (1940); Minnesota Tea Co. v. Helvering, 302 U.S. 609 (1938); Gregory v. Helvering, 293 U.S. 465 (1935); Brown, Rudnick, Freed & Gesmer v. Assessors of Boston, 389 Mass. 298 (1983). The result of the Koch case notwithstanding, the Commissioner remains committed to the application of the rule of substance over form and to the evenhanded administration and enforcement of all the tax laws of the Commonwealth.
The Commissioner views the Koch case as fact-intensive and will limit the case to its facts. The Supreme Judicial Court did not repudiate substance-over-form analysis in Koch, and the Department of Revenue still considers that doctrine applicable to Massachusetts tax cases in all of its variations: anticipatory assignment of income, conduit theory, step transaction, etc. When the Commissioner determines that a taxpayer is attempting to avoid tax liability, he will look to the substance of the transaction in assessing the correct amount of tax. In fact, Koch reaffirms the position that the Commissioner's determination is presumed to be correct, and that the taxpayer has the burden to prove otherwise. Moreover, in evaluating the facts of a particular case, the Commissioner remains committed to the position that subjective views of the substance of a transaction must be fairly weighed against the objective evidence.
/s/ Mitchell Adams
Commissioner of Revenue
May 3, 1994