Leveraged FTC Generators : did the Davis Committee give them too much credit?

• Jurisdiction: South Africa
• Author: Ed Liptak
• DOI: 10.10520/EJC-1110db1534
• Published date: 01 September 2018
• Date: 01 September 2018
• Record Number: btclq_v9_n3_a2
• Pages: 1-13
• Published By: Siber Ink

1

© Siber ink

Leveraged FTC Generators:

DID THE DAVIS COMMITTEE GIVE THEM TOO

MUCH CREDIT?

ED LIPTAK

ABSTRACT

As Lord Templeman once observed, every tax avoidance scheme involves

a trick and a pretence. In practice, the extraordinary legal complexity of

these schemes, particularly those designed to exploit international tax arbi-

trage opportunities, often makes identifying those tricks and pretences an

almost overwhelming task. So-called Foreign Tax Credit Generators (‘FTC

Generators’), which were one subject of the Report on Base Erosion and Profit

Shifting by the Davis Tax Committee, are a case in point.

In these situations, an analysis of the actual cash flows in these schemes —

a ‘follow the money’ approach, so to speak — can often be an effective way

to find the cracks in even the most imposing legal facades and to see through

them to the tricks and pretences behind them. The first part of this article

applies this approach to the hypothetical FTC Generator that was used as an

example by the Davis Tax Committee in its Report. It reveals that the numbers

in that example do not, and cannot, add up without something more, namely,

a ‘tax gross up’ trick that ensures that the South African investor is completely

insulated from the economic burden of the foreign tax in respect of which it

would claim a credit.

The second part of this article applies this approach to one of the actual FTC

Generators at issue in a leading case from New Zealand, BNZ international Ltd

v CIR. It shows that the purported borrowing ostensibly used to finance the

taxpayer’s investment in the scheme was a pretence involving circular flows of

cash through a tax indifferent party that eliminated any economic risk to the

parties and reduced the scheme to nothing more than the purchase and sale

of potential foreign tax credits for a fee. It also shows that the real payoff for

the scheme was a domestic tax arbitrage opportunity involving the mismatch

of deductible interest expense and an effectively tax-free income stream.

Introduction

The Davis Tax Committee (‘DTC’) published its final Report on Base Erosion

and Profit Shifting (‘BEPS Report’) on 13 November 2017.1 Amongst other

things, the Report discusses so-called foreign tax credit generators (‘FTC

Generators’).2 As their name implies, these schemes involve cross-border

arrangements that seek to give South African taxpayers the opportunity to

claim credits for foreign income taxes paid by their foreign counterparties.

1

Available online at http://www.taxcom.org.za/library.html.

2

BEPS Report at 51–53.