ECONOMIC SUBSTANCE Definition

Bookmark and Share

ECONOMIC SUBSTANCE refers to the application of income tax laws, i.e., the substance of the transaction, rather than its form, determines the tax consequences, with few exceptions. The "form" of a transaction is only the label the interested parties attach to their arrangement. For instance, an arrangement might be called a compensation agreement, loan, lease or sale. Documents may support the form, but the courts are not concerned with these labels or papers that purport to govern the transaction -- they focus on its substance. The "substance over form" analysis is used to dissect self-serving transactions between parties, including loans and payments to family members; transactions between related corporations and their shareholders, partnerships and their partners; and between trusts and their beneficiaries. For instance, sale of a home by a parent to a child may be re-characterized by the court as a gift, if the child never pays for it. Related-party transactions provide fertile territory for self-dealing, with the tax benefit as the real motivating purpose, disguised by the form of the transaction. In contrast, arms-length transactions with independent third parties are far less vulnerable.

Learn new Accounting Terms

CONTINGENT WORKERS is a provisional group of workers who work for an organization on a non-permanent basis, also known as freelancers, independent professionals, temporary contract workers, independent contractors or consultants.

ETHICAL STANDARDS, in accounting, is a written document containing basic principles and essential procedures together with related guidance in the form of explanatory and other material.

Suggest a Term

Enter Search Term

Enter a term, then click the entry you would like to view.