Supreme Court Upholds U.K. Windfall Tax

The Supreme Court, in a PPL Corporation v. Commissioner (Feb. 20, 2013), unanimously held a tax imposed by the U.K. could generate a foreign tax credit under I.R.C. § 901(b)(1). Section 901 permits a foreign tax credit for foreign taxes imposed on income. At issue in PPL was whether the British “windfall profits” tax, which was an excise on the excise profits of privatized utilities in the U.K., was sufficiently similar to an income tax to generate a credit.
The British tax came about in 1997 in response to a domestic outcry against what were perceived to be overly-generous deals made with utility companies when the British Government allowed privatization. The amount of the tax was based upon the difference between the company’s profits, and the sale price of the utility to the private owner. The tax itself related to the profits, and thus the income, of the taxpayer, but the I.R.S. disputed that the arithmetic link made the tax have the “predominant character” of an income tax, as defined in § 901(b)(1) and associated Treasury Regulation § 1.901-2. The calculation of the windfall profits tax amount itself utilized a formula in which net income was a component.
PPL. Corp. claimed foreign tax credits based upon payments made by a British subsidiary under the windfall profits tax. The I.R.S. argued that the windfall profits tax was more akin to a value-added tax, rather than an income tax, and thus not creditable under § 901(b)(1), and denied PPL’s claim. The Tax court had originally ruled that the windfall profits tax was creditable, but that decision was reversed by the Third Circuit Court of Appeals.
Justice Thomas, writing for the unanimous Court, found that the fundamental question was whether the tax had the “predominant character” of an income tax – specifically, whether it approximated a tax on the income of the company, rather than another value. The Court determined, by reviewing the substance of the tax calculation, that it was “economically equivalent to the difference between the profits each company actually earned and the amount the Labor government believed it should have earned given its flotation value. . . . the algebraic reformulations illustrate the economic substance of the tax and its interrelationship with net income. . . . Given the artificiality of the U.K.’s method of calculating purported ‘value,’ we follow substance over form and recognize that the windfall tax is nothing more than a tax on profits above a threshold.” In so holding, the Court permitted the foreign tax credits for the taxpayer.