Combining Businesses And Their Ownership: The Case For Uniform Nonrecognition Under The Internal Revenue Code

Anthony P. Polito (Suffolk), Combining Businesses and Their Ownership: The Case for Uniform Nonrecognition under the Internal Revenue Code:

If a juridical entity that conducts a bona fide business is absorbed entirely into another juridical entity that also conducts a bona fide business, and the equity holders of the absorbed business receive nothing but equity in the absorbing entity in the transaction, and the equity holders of the absorbing entity retain in form exactly the same legal entitlements as before the transaction, no tax consequences should be triggered with respect to the gain or loss accrued with respect to either the business assets or the equity interests involved.

An individual conversant with practice under the existing U.S. tax law might well be inclined to say that the Proposition holds but not always under existing law. This Article, however, takes a step back to reexamine the Proposition more broadly than that, beginning with first principles of taxation. What principles of taxation would justify such a broad Proposition? To what extent does the existing Internal Revenue Code (“Code”) fulfill the Proposition? To the extent that it does not, on what legitimate considerations is that result predicated? In those cases, are there better options for satisfying those legitimate considerations?

This Article addresses each of these questions in turn. Elsewhere, in an article entitled Advancing to Corporate Tax Integration: A Laissez-Faire Approach, I advanced the proposition that double taxation is sufficiently problematic, because of the distortions to allocative efficiency and distributive equity that it generates, that integrationism should be regarded as normative (“Integrationist Norm”), and, therefore, self-help and partial integration initiatives should be pursued as a second-best solution to the question of appropriate business taxation. At the outset of the analysis, it is important to be clear that this is the perspective from which this Article addresses the questions presented.

The Integrationist Norm calls ideally for the exact elimination of the excess burden of double taxation and the economic and distributive distortions that double taxation entails. In practice, there are circumstances in which circumstances in which it is impossible to eliminate double taxation of business profits without exempting them entirely from taxation. In those circumstances, some pragmatic deviation from the Integrationist Norm is unavoidable, and the question is what deviation must be, or is at least most wisely, accepted.

Before proceeding, is it important to note that this Article confines itself purely to businesses conducted in entities that are domestic. Allowing for foreign business entities raises complications that are beyond its scope. Most notably when is it appropriate to tax a transaction that should not otherwise trigger an income tax solely because it would allow gain to escape U.S. taxing jurisdiction.