Economic Substance Test

The Economic Substance Test is a legal standard used to determine whether a transaction has real economic significance beyond just being a tax-saving strategy. It assesses if the transaction genuinely affects the business's financial situation, rather than being solely for tax benefits. In essence, it ensures that companies engage in transactions that have actual purpose and value, avoiding schemes that artificially reduce tax liabilities. If a transaction fails this test, it may not be recognized for tax purposes, meaning the intended tax benefits won't apply.