In ongoing litigation between the government and Liberty Global Inc. (“Liberty Global”), Liberty Global has appealed a district court’s decision that ruled in favor of the government to the Tenth Circuit. We have previously discussed the district court’s decision pursuant to the economic substance doctrine (the “ESD”) to disregard certain steps of Liberty Global’s transactions and deny Liberty Global’s claim of a $2.4 billion dividends received deduction here.  The appeal has now been fully briefed.

Liberty Global appealed on the grounds that the district court incorrectly applied the ESD, ignoring Congress’ choice to allow taxpayers to claim deductions for foreign dividends. Liberty Global’s brief reiterates its initial argument that the ESD requires a threshold inquiry into its relevance to the transactions in question. Liberty Global explains that the ESD is only relevant to a transaction or transactions when the application of the tax code and regulations is unclear. Liberty Global argues that the ESD is not relevant to its transactions because the tax code clearly permits Liberty Global to claim a deduction even though the transactions giving rise to the deduction were purely motivated by tax considerations. In essence, Liberty Global argues that transactions explicitly permitted by the tax code, such as converting a subsidiary to an entity taxable as a corporation, are not subject to the ESD regardless of motivation.

In response, the government maintains that the district court correctly interpreted and applied the ESD. The government reiterates that the ESD does not require a threshold inquiry into its relevance. Instead, the government explains that the ESD is presumed to be relevant to all transactions, unless Congress explicitly provides otherwise. The government argues that Liberty Global’s transactions have no economic substance because the transactions produce tax benefits that are unintended by Congress even if they mechanically comply with the tax rules. The government urges the Tenth Circuit to uphold the district court’s decision and protect the ESD.

Liberty Global’s reply to the government again claims that the district court inappropriately applied the ESD because the statutory text and legislative history of the ESD requires a threshold inquiry into the ESD’s relevance. Liberty Global stresses that the government cannot use the ESD to nullify tax choices that are expressly allowed by the tax code without any guardrails.

The district court’s decision clearly indicates to taxpayers that the ESD remains relevant to transactions that principally or exclusively produce tax benefits. It remains to be seen whether the Tenth Circuit will agree under de novo review.