Kim Presents Taxing Litigation Finance Today At Toronto

Young Ran (Christine) Kim (Cardozo; Google Scholar) presents Taxing Litigation Finance, 93 Geo. Wash. L. Rev. __ (2024), at Toronto today as part of its James Hausman Tax Law and Policy Workshop Series hosted by Ben Alarie: 

The emerging litigation financing industry has the capacity to expand access to justice but also raises important legal and ethical questions. While much has been said about the potential to increase frivolous lawsuits and permit improper control over a claim by the funders, scholarly discussion on the proper tax treatment of the parties involved has fallen by the wayside. Aside from a largely unhelpful 2015 memorandum, the tax authority has chosen to remain silent on the topic.

The problem arises in classifying litigation financing contracts as either a nonrecourse loan, immediate sale of a claim, or a variable prepaid forward contract, all of which have a discrete impact on the timing and character of income. Unfortunately, courts have traditionally found it difficult to draw clear distinctions between these three categories for tax purposes, and the opaque nature of the industry combined with the complexity of the transaction enhances the confusion. The consequences are tax uncertainty and an opportunity for taxpayers to engage in aggressive tax planning by structuring transactions to obtain favorable tax treatment without altering their economic position.

This paper proposes a customized multi-factor analysis to identify the true nature of litigation financing transactions and impose proper tax treatment. The bedrock of this approach is the concept of tax ownership, which, in the context of litigation financing, can be streamlined into two key factors: economic risk and legal control of the claim. By emphasizing the legal control factor, this proposal has the potential to combat the agency problems inherent in litigation finance without hindering market growth. As the industry continues to develop, this paper calls on tax policymakers and other regulatory bodies to reduce the current tax uncertainty by integrating the factors discussed herein when issuing future guidance and imposing disclosure obligations.