Although there is a famous tax quote by Justice Oliver Wendell Holmes, "I like to pay taxes. With them I buy civilization."; there is nothing wrong with taxpayers’ efforts to minimize their tax liability in manners the legislative body deems permissible. Such “tax minimization” is legally permissible and distinguished from “tax evasion,” which is the illegal nonpayment or underpayment of taxes. Then, what about the gray area between tax minimization and tax evasion, commonly referred to as “tax avoidance?” Is it permissible to pursue tax avoidance, where taxpayers reduce their tax obligations in a manner that technically complies with the law but violates the spirit of the law?
Eric C. Chaffee's new work, Collaboration Theory and Corporate Tax Avoidance, 76 Wash. & Lee L. Rev. 91 (2019), is an effort to answer this difficult question in the corporate tax context.
Many corporate managers will argue that their fiduciary duties to the corporation and its stockholders require them to engage in tax avoidance as a means of achieving profit maximization. They derive this requirement from the classic corporate law case, Dodge v. Ford Motor Co., where the Supreme Court of Michigan held that "a business corporation is organized and carried on primarily for the profit of the stockholders." Those who justify tax avoidance claim that the so-called "Dodge Mandate" requires them to undertake aggressive tax avoidance.
The Dodge Mandate has been challenged in many corporate law literatures. Chaffee has further challenged the Dodge Mandate's application in justifying corporate managers’ tax avoidance in his previous work with Karie Davis-Nozemack (Georgia Tech), Corporate Tax Avoidance and Honoring the Fiduciary Duties Owed to the Corporation and Its Stockholders, 58 B.C. L. Rev. 1425 (2017). However, even if the Dodge Mandate fails to justify tax avoidance, it only eliminates one answer to the question of whether it is permissible to pursue tax avoidance, but the question still remains.
In his new work, Collaboration Theory and Corporate Tax Avoidance, Chaffee seeks to find an answer to this question by studying the essential nature of the corporate form. He argues that understanding the nature of the corporate form might help determine when and to what extent engaging in tax avoidance is required, permissible, or prohibited. He first introduces three prevailing theories of the corporations and their limitations. First, the artificial entity theory suggests corporations are artificial entities that owe their existence completely to the government. This theory largely ignores the role of the individuals organizing, operating, and owning the corporation. Second, the real entity theory suggests that each corporation has an existence and identity that is separate and apart from the individuals who organize, operate, and own it. This theory largely ignores the role of the government in creating the corporation and the individuals organizing, operating, and owning the entity. Third, the aggregate theory suggests that a corporation is a collection of individuals joined together through the intersection of various obligations. It ignores the role of the government and does little to explain the corporation's separate legal status. Moreover, while each of these theories explains how corporation exists, each fails to explain why corporations exist. Each also provides little or no guidance as to whether corporate managers should engage in tax avoidance activities.
Chaffee has developed a competing theory of the corporation in his previous works (here and here), which he terms “collaboration theory." The collaboration theory posits that the corporation is a collaboration among the government and the individuals organizing, operating, and owning the corporation. He argues that the collaboration theory explains not only how corporations exist but also why corporations exist (i.e. for economic development and economic gain). The goals of the government and the individuals do not perfectly align, because the government seeks social economic development and gain through raising revenue, and the individuals seeks personal economic development and gain. Nonetheless, Chaffee's new work contributes to the discussion by exploring how collaboration theory applies to corporate tax avoidance and concludes that aggressive corporate tax avoidance is impermissible under this theory. If we understand that the essential nature of the corporate form as a collaboration among the government and the individuals organizing, operating, and owning the business ventures, collaborators in business ventures owe each other a duty of good faith. Then, tax avoidance by corporate managers is an affront to the collaboration because it frustrates one of the government's purposes for entering the collaboration, i.e., gaining revenue. As a result, corporate managers are legally required not to engage in aggressive tax avoidance strategies because they violate the spirit of the law and the duties of good faith that undergird the corporation.
Chaffee's collaboration theory is in line with contemporary social science theories emphasizing corporate social responsibility and business ethics. Although Chaffee's series of work should get credit for applying those social science theories to develop a matching theory in legal scholarship, it is fair to ask why tax minimization is permissible, while tax avoidance is not. If depriving the government of revenue as a result of tax avoidance is not permissible, depriving the government of revenue as a result of tax minimization appears to be troubling as well. Furthermore, collaboration theory does not provide a bright-line standard for purposes of helping corporate managers make tax compliance decisions, when tax avoidance has a relatively vague definition. Chaffee sensibly responds to these concerns by choosing the good faith model over the profit seeking model in developing the details of the collaboration theory.