A walk through the step-transaction doctrine

Substance over form is the concept that the financial statements and accompanying disclosures of a business should reflect the underlying realities of accounting transactions. Conversely, the information appearing in the financial statements should not merely comply with the legal form in which they appear. In short, the recordation of a transaction should not hide its true intent, which would mislead the readers of a company’s financial statements. “Substance over form” is a traditional accounting maxim that has also influenced legal thinking and has its roots in classical philosophy.

To accountants, the basic legal requirement that accounts must give a ‘true and fair view’ (discussed in chapter 3 at pp. 26–7) means that they must reflect the economic substance of a transaction and not just its legal form. Substance over form is an accounting principle which recognizes that business transactions should be accounted in accordance with their (economic) substance instead of their (legal) form. Economic substance refers to the underlying economic or commercial purpose of a business transaction apart from its legal or tax considerations.

In 1932, the Board of Tax Appeals (which preceded the U.S. Tax Court) ruled in favor of Ms. Gregory, but its decision was reversed by the U.S. The U.S. Supreme Court also ruled in favor of Commissioner Helvering, stating that the Revenue Act did not support reorganizations simply for the purpose of avoiding taxes. Caligula posted the tax laws in such fine print and so high that his subjects could not read them. And how can anyone assess the tax collector’s exercise of power in that setting?

Financial statements drawn up under the Companies Act 1985 are in many ways legal documents. In a literal sense they are required to be produced by law, and to be filed at Companies House. In another sense, too, they must comply with the many detailed requirements of the Act. In earlier, simpler, times, following the legal form of a transaction generally gave an appropriate accounting result.

1. The principle is to make sure that financial information true and faithful representation so the reader will fully understand.
2. Accountants must comply with accounting rule, thus they can manage to hide real intention by preparing a barely meet financial report.
3. The substance over form doctrine is a well settled principle that federal courts apply when interpreting tax rules, as the Court of Appeals acknowledged in Mazzei.
4. After taking ownership of the Monitor stock, she sold them for over $133,000, claiming a cost of over $57,000 and a capital net gain of $76,000.
5. The doctrine of substance-over-form is one of the IRS’s weapons of choice in attacking such transactions.

These statements measure and report the economic impact of a transaction instead of its legal form, which could conceivably mislead people on its true intent. In some circumstances, the lessee might nevertheless be required to record the leased item as an asset if the lessee intends to use the asset for a major portion of its useful life, or where the present value of the future lease payments is nearly equal to the fair value of the asset. Although the lessee is not the owner, the lessee may be required to record the asset as being owned by the lessee, based on the underlying economics of the transaction.

Is “Form” “Substance” When it Comes to Law? The Future of the Doctrines of Economic Substance and Substance Over Form

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Although it is highly unlikely that Congress intended to create a system where taxpayers like the Mazzeis could avoid almost all tax on foreign trade income from export businesses they owned, the applicable statutes as written literally allow them to do so. Since Congress had not enacted any such provision, the Ninth Circuit, citing Russello, 464 U.S. 16, 23 (1983), stated that it “must be deemed to have chosen not to do so.” The IRS issued notices of deficiency based on its theory for the years in question, assessing tax, interest, and penalties against the Mazzeis. While the IRS had asked the court to recharacterize the entire scheme under the substance-over-form doctrine, the court declined to do so. It instead only recharacterized one part of the scheme, the purchase of the FSC shares by the Roth IRAs. If the IRS audits you and makes a claim of https://www.wave-accounting.net/ for any of your financial transactions, you need an experienced tax attorney who understands the law thoroughly enough to refute the government position and prevent you from benefiting from a legitimate tax advantage.

It is particularly relevant while accounting for revenues, sale and purchase agreements, leases etc. The principle of Substance over legal form is central to the faithful representation and reliability of information contained in the financial statements. However, the principle of substance over form has so far not been recognized by IASB or FASB as a distinct principle in their respective frameworks due to the difficulty of defining it separately from other accounting principles particularly reliability and faithful representation. Substance over form is an accounting concept which means that the economic substance of transactions and events must be recorded in the financial statements rather than just their legal form in order to present a true and fair view of the affairs of the entity. The Tax Court had also found that Congress had negated the application of the substance-over-form doctrine with respect to the FSC statute but construed Congress’s limitation of the doctrine very narrowly.

Court says statutory language precludes substance-over-form analysis

Article I of the Constitution gives Congress the authority to lay and collect taxes. This concept seems simple, but may be complicated by courts’ interpretations of the laws Congress has enacted. The judicially-created substance over form doctrine is an excellent example of this type of complication. A transaction is an instance of an event that could alter the financial status of a business entity.

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Substance Over Form

Company A’s financial statements do not include the balance lend to company B and liability from a loan shark. Company A’s owner has taken the cash to help company B which almost goes bankrupt. At the year-end, company B still not doing well, so the owner decides to borrow cash from a loan shark and put it back into the bank account. Based on the form, it just a movement of cash from bank to vault to support operation and so on. And it was put back into the bank at year-end, external auditor can check bank statement or send bank confirmation to ensure if the balance is correct or not. For example, Company A withdraws a large amount of cash at bank to keep in the vault, and they record the movement of cash from bank to cash on hand.

Carbon sequestration payments are qualifying REIT income

Legal form refers to interpretation of a business transaction in accordance with the applicable business laws. It signs a contract to lease a building in Aldgate for 30 years, where the economic components of shareholders equity useful life of the building is estimated to be 35 years. In this instance, the company itself will be called the ‘lessee’ and the other party leasing its building to them as the ‘lessor’.

– Substance over form

The purpose of Financial Reporting Standard 5, Reporting the Substance of Transactions, was to give more strength to the substance aspect as well as guidance in specific transactions. However, its provisions are complex and apply only to a small number of transactions, typically involving very large amounts. The principle of substance over form is explicitly set out in the revised International Accounting Standard 8. Substance over form in accounting refers to a concept that transactions recorded in the financial statements and accompanying disclosures of a company must reflect their economic substance rather than their legal form. The Ninth Circuit observed that the case would be an easy one to apply substance over form principles to if it involved ordinary business entities. In accordance with the terms of the lease agreement, the jets remain in ownership of DEF, Inc. throughout the lease term so the legal form of the contract/agreement dictates that ABC, Inc. should not record them as asset on its balance sheet.