The IRS is expected to begin asserting economic substance arguments more aggressively after winning two recent court cases, but lingering uncertainty over the relevancy threshold will complicate the analysis of the doctrine’s application to transactions.
The Tenth Circuit Court of Appeals recently affirmed a district court decision in Liberty Global Inc. v. United States, No. 23-1410 (10th Cir. 2026), denying a $110 million refund claim after concluding the transactions at issue lacked economic substance. The transactions sought to exploit a mismatch between the effective dates of the dividends received deduction and the mandatory transition tax enacted under the Tax Cuts and Jobs Act of 2017.
Liberty Global argued that the economic substance doctrine should apply only after a relevancy determination and therefore should not apply to what it characterized as the basic business transactions forming the initial steps of its strategy.
The economic substance doctrine was codified in 2010 and its definition under Section 7701(o)(1) is prefaced by the phrase “in the case of any transaction to which the economic substance doctrine is relevant.” Section 7701(o)(5)(C) further provides that the “determination of whether the economic substance doctrine is relevant to a transaction shall be made in the same manner as if this subsection had never been enacted,” referring to its application as a long-standing common law doctrine. The legislative history also indicates in a Joint Committee on Taxation (JCT) explanation (JCX-18-10) that the rules are “not intended to alter the tax treatment of certain basic business transactions” when the “choice between meaningful economic alternatives is largely or entirely based on comparative tax advantages.” The JCT description offers several examples.
The 2-1 majority opinion rejected Liberty Global’s argument, characterizing the debate over a separate relevancy inquiry a “red herring.” The Tenth Circuit agreed with the district court that economic substance was relevant because Liberty Global’s transactions “mechanically utilize the provisions of the tax code to obtain a benefit not intended by Congress.” The court said Liberty Global cannot escape the economic substance doctrine “by including within its integrated structure steps that might, if standing alone, be considered basic business transactions.”
The Tenth Circuit’s conclusion is partially at odds with the Tax Court’s decision in Patel v. Commissioner, 165 T.C. No. 10 (2025), which held that “Congress could not have been clearer” that a determination on relevancy is required separately and before the economic substance doctrine is applied. The Tax Court, however, ultimately found that the economic substance doctrine was relevant in Patel using that threshold, and the IRS prevailed in the case.
BDO Takeaway
Different courts might now apply different relevancy thresholds for the application of the economic substance doctrine, and the Tax Court could even apply different tests for different taxpayers. Under the Golson rule, the Tax Court will generally follow the precedent of the court of appeals to which the taxpayer would appeal. Because the Tax Court held that the relevancy determination should be based on the common law application of the economic substance doctrine, it focused on cases from the Sixth Circuit, which was the court to which the taxpayer in Patel would appeal. Taxpayers in other circuits could find the Tax Court relying on other cases.
Liberty Global might seek a rehearing or appeal, but ultimately, the differences in relevancy thresholds could be overstated. Patel prevailed on the nature of the relevancy determination, but the Tax Court still found the doctrine relevant. The majority in the Tenth Circuit also appeared inclined to find the doctrine relevant for Liberty Global regardless of when and how the determination was made.
Next Steps
Taxpayers should expect the IRS to assert economic substance arguments more aggressively despite the lingering uncertainty over the relevancy threshold. Companies with mergers and acquisitions activity that involve complex or multistep transactions that generate favorable tax results should evaluate the potential application of the economic substance doctrine to their fact patterns.
Please visit BDO’s Corporate Tax Services page for more information on how BDO can help.