On May 20, 2013, the Supreme Court decided PPL Corp. v. Commissioner, No. 12-43, holding that a United Kingdom "windfall tax" imposed on privatized UK companies has the predominant character of an excess profits tax and is therefore creditable under Internal Revenue Code § 901(b)(1) ("§ 901").
In 1997, the U.K. imposed a one-time "windfall tax" on 32 UK companies privatized between 1984 and 1996. During privatization, companies were required to continue providing services at the same rates they had offered under government control, but they were able to increase profits by operating more efficiently. In 1997, when the UK's governing party changed from the Conservative Party to the Labour Party, these additional profits were taxed by Parliament.
PPL Corporation was an owner through subsidiaries of 25 percent of one of the privatized companies. In its 1997 U.S. federal income tax return it claimed a credit under Code § 901 for its share of the U.K. windfall tax bill. The Commissioner of Internal Revenue rejected the claim, but the U.S. Tax Court held that the UK windfall tax was creditable. The Third Circuit reversed.
The Supreme Court granted certiorari to resolve a circuit split regarding the windfall tax's creditability under Code § 901. Section 901 provides that "income, war profits, and excess profit taxes paid or accrued during the taxable year…to any foreign country" shall be creditable against U.S. federal income tax. Under relevant Treasury regulations, "[a] foreign levy is an income tax if and only if …[t]he predominant character of the tax is that of an income tax in the U.S. sense." The way a foreign government characterizes its tax is not dispositive with respect to U.S. creditability analysis; instead, the crucial inquiry is the tax's substantive economic effect. A foreign tax that reaches net gain as an income, war profits or excess profits tax is creditable.
At issue here was whether the windfall tax was a tax on an artificial valuation based upon Parliament's tax formula, or whether in substance it was an "income tax" in the U.S. sense. After identifying that Parliament's formula relied on a fictitious value calculated using an imputed profit-to-earnings ratio, the Court ruled unanimously that the windfall tax in question is really an "excess profits" tax, a category of income tax in the U.S. sense. Here, the tax was viewed by the Court as economically equivalent to the difference between what that taxpayer companies actually earned and the amount the UK government believed they should have earned given their respective floatation values. Those actual "excess profits" above the threshold were taxed at the prescribed UK tax rate of 51.71 percent.
As such, the Court determined to follow "substance over form," rejected the Commissioner's characterization of the tax as not creditable, and further rejected the Commissioner's other arguments regarding the proper calculation of the tax.
Justice Thomas delivered the opinion for a unanimous Court. Justice Sotomayor filed a concurring opinion.