Step-transaction and substance-over-form in financial transactions


Authored by RSM US LLP


In a recent decision, GSS Holdings (Liberty) Inc. v. United States, the Court of Federal Claims applied the step-transaction and the substance-over-form doctrines in the context of the related party rules in a manner that should put taxpayers on alert as they structure their financial transactions. This case demonstrates that the IRS and the courts look to all relevant agreements between related parties in evaluating the substance of a transaction, including whether there was a related party sale generating a disallowed capital loss.

Key Takeaways 

Taxpayers need to understand the implications of the aforementioned doctrines as they relate to financial agreements, each of which has independent economic substance and legitimate business purposes, but are intended to function in tandem. More so, taxpayers need to pay particular attention when dealing with financial agreements between related parties as the court will scrutinize all outstanding agreements as they pertain to a substance over form analysis. 

In GSS Holdings, the court was less concerned with ‘why’ the Taxpayer entered into a series of financial transactions as opposed to ‘how’ the transactions were intended to function. The Taxpayer was unable to show that their independent economic transactions were not functionally linked, and therefore the court collapsed the transactions into a single transaction for tax purposes.

GSS Holdings (Liberty) Inc.


GSS Holdings Inc. (“Taxpayer”) was a regarded corporation for U.S. federal income tax purposes and was the sole legal owner of Liberty Street Funding LLC (“Liberty”).2 For U.S. federal income tax purposes, Liberty was taxed as a partnership in which Taxpayer and Scotiabank (Ireland) Limited (“Scotiabank”), were partners for tax purposes. Scotiabank was a subsidiary of the Bank of Nova Scotia (“BNS”) which, as administrator, controlled the operations of Liberty and absorbed most of the benefit and risk of the operation.3

This case looked at two distinct financial transactions (the exercise of a put contract, and a payment under a note) both of which were separately executed at different times; however, were intended to work in coordination to provide an economic hedge. This case dealt with a loss sustained by the Taxpayer, the deductibility of which, depended on whether or not the two transactions (as discussed below) were appropriately stepped-together by the IRS.

Relevant Transactions

Exercise of Put

The first relevant transaction alluded to above, was the exercise by Liberty of a Liquidity Asset Purchase Agreement (“Put”) which required BNS to purchase certain distressed financial assets from Liberty at a par value equal to Liberty’s basis in the assets. In other words, Liberty exercised a put right that required BNS to purchase the distressed financial assets from Liberty at a preset value equal to Liberty’s tax basis in the assets, regardless of their market value.4


In conjunction with the exercise of the Put, Liberty was required, under the terms of a separately executed note (“First Loss Note”), to transfer cash to BNS. This payment was from an account the funds of which originated from a loan to Liberty from Scotiabank and was held for the benefit of the first party (either Liberty or BNS) to suffer a loss upon the exercise of the Put. 

When Liberty exercised the Put there was a substantial loss on the sale, thereby triggering the contractually required transfer of cash. Simultaneous with this transfer, Liberty received related insurance proceeds, which netted against the amount paid to BNS, resulted in the reported loss which was at dispute.


The IRS argued that the payment under the First Loss Note was “inextricably linked” to the exercise of the Put and, as such, the two events must be viewed collectively under the step-transaction doctrine.5 The Taxpayer argued that the independent business purposes for each agreement preclude the application of the step transaction doctrine and that the two could not be collapsed because at the time of the creation of the Put, the First Loss Note was not yet in place. The Taxpayer further argued that the “end results” test, shouldn’t apply because they could never have intended to make the payment required under the First Loss Note since, Liberty never intended to invest in assets that would become financially distressed. 

The court broadened the step-transaction doctrine approach that the IRS used, and instead applied the general substance over form doctrine. In quoting the United States Court of Appeals for the Federal Circuit, the court pointed out that when applying the substance over form doctrine the transaction scrutinized is “the one that gave rise to the alleged tax benefit.”6 The court in GSS Holdings reasoned that “[t]he focus of analysis thus needs to be on the sale in question, not the underlying business purposes that created the framework that enabled the transaction.” Thus, even with legitimate independent business purposes for each step, the substance over form doctrine can still be applied.

Specifically regarding the application of the step-transaction doctrine, the court used the end-results test and noted that the intent of the First Loss Note was to “compensate the first party to experience losses” as a result of the exercise of the Put. The court paid no attention to the Taxpayer’s arguments and addressed the point that the Taxpayer focused on the wrong transaction entirely, mentioning that the creation of the First Loss Note and the intention behind such was irrelevant to the analysis. The event that was relevant for purposes of the end-results test was the ultimate payment out of Liberty to BNS as a result of the exercise of the Put.


The court held that, regardless of the timing of the necessary steps and independent legitimate business purposes for each step, the fact that the payment under the First Loss Note was always intended to be made in coordination with the Put made the steps “inextricably linked.” The court further stated that “[w]hether we consider the two transactions ‘stepped together’ or if we analyze the substance (purpose) of the transactions as a unified whole, the result is the same.” Ultimately, the Taxpayer’s claim of independent business purpose was to no avail, because unlike the case7 they relied on, their independent business purpose was not regulatory compliance.8


1GSS Holdings (Liberty) Inc. v. United States, No. 19-728T (Fed. Cl. 2021).

2Taxpayer is the legal owner of Liberty however, their equity is “nominal,” totaling only $25,000; so it requires additional financial support to operate. Furthermore, the Taxpayer does not have any decision-making ability, nor is it required to absorb any expected losses or receive any expected residual returns. 

3Much of the history around the transactions have to do with shifting credit risk and consolidation concerns, however these points are beyond the scope of this article.

4Important to note, Liberty was a commercial paper conduit, which as described in the case, is a financial vehicle that makes investments funded by the issuance of short-term notes. It then reinvests the proceeds in longer term investments and makes profits off the spread, or the rate of return on its investments that are in excess of the interest rate paid on the commercial paper that it issues. To hedge against the liquidity risk, Liberty attained a put right for each package of longer-term investments it purchased. These puts guaranteed liquidity by giving Liberty the ability to sell the investment package to BNS at a preset price, regardless of the investments’ market value. In exchange for this put, Liberty paid a fee to BNS.

5The IRS also argued that since, Liberty originally reported the payment under the First Loss Note netted together with the Put, the Danielson rule would preclude the Taxpayer from later re-characterizing the transactions. However, this issue is beyond the scope of this article.

6Coltec Indus. v. United States, 454 F.3d 1340, 1356 (Fed. Cir. 2006).

7Falconwood Corp. v. United States, 422 F.3d 1339 (Fed. Cir. 2005).

8Unlike the Taxpayer, in Falconwood the independent business purpose of the questioned transactions that drove them, was compliance with regulatory requirements.

Let's Talk!

Call us at +1 213.873.1700, email us at or fill out the form below and we'll contact you to discuss your specific situation.

  • Topic Name:
  • Should be Empty:

This article was written by Mark Schneider, Nate Meyers and originally appeared on 2021-08-13.
2021 RSM US LLP. All rights reserved.

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

​Vasquez & Company LLP is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.

For more information on how ​Vasquez & Company LLP can assist you, please call +1 213.873.1700.

Subscribe to receive important updates from our Insights and Resources.

  • Should be Empty: