Leveraged FTC Generators : did the Davis Committee give them too much credit?
Date | 01 September 2018 |
Author | Ed Liptak |
Published date | 01 September 2018 |
Pages | 1-13 |
DOI | 10.10520/EJC-1110db1534 |
Record Number | btclq_v9_n3_a2 |
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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.
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