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Substance Over Form Doctrine

Updated on July 18, 2023

The Doctrine of Substance over Form empowers tax authorities to disregard the legal form of a transaction or arrangement and instead focus on its true substance or economic reality. Its purpose is to prevent taxpayers from employing artificial or contrived structures solely for the purpose of avoiding or minimizing taxes. Under the substance over form doctrine, tax authorities have the authority to recharacterize or reclassify a transaction if they believe that the form adopted by the taxpayer does not reflect the underlying economic substance. This means that even if a transaction is structured in a certain way to obtain tax benefits or exploit loopholes, the tax authorities can look beyond the legal form and assess the transaction based on its true economic nature.

Tax authorities may consider various factors to assess the substance of a transaction, such as the purpose, intent, commercial rationale, economic consequences, and the rights and obligations of the parties involved. If the tax authorities determine that the transaction’s substance differs from its form, they have the power to adjust the tax consequences accordingly. Similarly, if a transaction is found to be improperly structured or lacks economic substance, tax authorities also have the authority to impose penalties and interest on the tax liability associated with the recharacterized transaction. This serves as a deterrent to discourage taxpayers from engaging in tax avoidance schemes.