Chemtech: A Showcase for Common Law Partnership Doctrines

Tax Notes


In this article, Andrew Howlett and Lisandra Ortiz analyze Chemtech Royalty Associates LP v. United States, the September 2014 Fifth Circuit decision that gave the government a win in a years-long battle against allegedly abusive tax shelters. According to the authors, Chemtech is significant due to the courts' use of common law doctrines to disregard two partnerships formed by the Dow Chemical Company. Howlett and Ortiz compare the lower court's broad decision disregarding the partnerships at issue using three separate common law doctrines with the Fifth Circuit's narrow opinion. "The court of appeals addressed only the sham partnership holding, which it affirmed. It did not consider whether the district court erred in determining that the transactions lacked economic substance or in classifying the transactions as debt," the authors said.

"The district court's decision is nonetheless relevant to practitioners as an example of how a judicial fact-finder may invoke the sham partnership, economic substance, and bona fide partner doctrines to disregard a partnership arrangement, particularly when it is a marketed transaction. Perhaps most significant to practitioners is the district court's application of its own judgment regarding whether the taxpayer's asserted business purpose in entering into the transaction could have been attained by 'cheaper and less complex alternatives,'" they said.

The authors conclude that case law will evolve in this area as the Internal Revenue Service continues to challenge partnerships it believes are motivated primarily by federal tax benefits, regardless of whether those structures are the product of marketed transactions. "Practitioners should carefully consider the concepts and framework of the Chemtech decisions in evaluating potential judicial challenges to partnership structures," the authors said, adding that Chemtech "gives practitioners an indication of the factors that the Fifth Circuit considers significant."