Foreign Tax Credit Generators

Suppose that you are a bank or other financial institution in New York, and that you have funds you can make available to creditworthy businesses in Europe. You advance $1 billion to an internationally known European retailer that needs financing to expand its operations to new countries around the world, or perhaps $2 billion to a top-tanked European bank in need of an influx of Tier 1 Capital. You eventually get your money back,with a healthy rate of return. What transaction could possibly have a more legitimate business purpose?

Or suppose that you are a European financial institution with funds available for deployment into the United States. You advance $1 billion or perhaps $2 billion to a multinational manufacturer based in the United States and get your money back right on time and, once more, with a healthy rate of return. Can anyone possibly say that this transaction lacks profit motive?

But suppose now that before you entered into either of these transactions, you first talked to your accountant or your tax lawyer and they explained that, under current U.S. and European tax rules, you can structure a transaction that will give you a better return at a lower cost to the borrower? Why wouldn't you want to know more? Why wouldn't you heed your advisor's sage advice?

That, of course, is what many lenders did in the 1990s and early 2000s, and the result was a variety of transactions the IRS has disparagingly called "foreign tax credit generators." The IRS has had little success in challenging these transactions on technical grounds; the simple fact is that, by and large, they actually work under the Byzantine rules of the Code and regulations.SO the IRS has resorted to challenging these transactions on the generic grounds of "no business purpose" and "no profit motive"--terms that must be stretched pretty far to describe genuine transactions between unrelated parties that involve real movements of billions of dollars and substantial economic benefits to all concerned.

This article was written by Stafford Smiley and Michael Lloyd. Stafford Smiley is Professor, Graduate Tax Program, at the Georgetown University Law Center. Michael Lloyd is an associate with, and Professor Smiley is Senior Counsel to, the law firm of Caplin & Drysdale, Chartered, Washington, D.C.

This article was published in the May/June issue of Corporate Taxation, © 2012 Thomson Reuters/WG&L.
 

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