Abstract

Traditionally, appellate review hinged on the distinction between law and fact with appellate courts reviewing legal conclusions under a de novo standard of review while factual findings are reviewed under a clearly erroneous standard. The systemic difficulty with the fact/law distinction is defining fact and defining law. While appellate courts often create sound bites and offer elaborate musings on the definition of each, they maintain the mistaken illusion that a trial court determination is either a question of law or a question of fact. In essence, an appellate court uses the fact/law distinction and the attendant standard of review to promote its view of the correct result. The result in economic substance cases is that the jurisprudence in the appellate courts is confused and inconsistent in the application of the appropriate standard of review. Instead of focusing on misleading labels, courts should focus on the structure of decision making within an institution, placing primary emphasis on the meting out of responsibility among decision makers. Using judicial responsibility as a benchmark, appellate courts should focus on developing the law in a particular area as guidance for future cases and rectifying egregious errors in particular cases even if unrelated to developing the law. In the economic substance context, a clearly erroneous standard of review accomplishes both purposes. Economic substance is a fluid concept that eliminates the pretenses of manufactured transactions and gives the Internal Revenue Service the ability to challenge technical tax results based on subjective standards that overlay the objective rules prescribed by the Internal Revenue Code. A transaction has economic substance if the transaction is rationally related to a useful non-tax business purpose and/or if the transaction results in a meaningful and appreciable enhancement in the net economic position of the taxpayer other than the reduction of taxes. Under both tests, a decision of a trial court, while likely to be significant in terms of dollars at issue, is unlikely to have any appreciable impact on the development of the law in the economic substance area because both questions focus on factually intensive, case specific questions. Factually specific decisions do not create predictable results in future cases and do not advance uniformity in the law. In such cases, judicial responsibility dictates the adoption of a clearly erroneous standard of review.