The Supreme Court on May 20 ruled in PPL Corp. v. Commissioner that the one-time "windfall tax" imposed by the United Kingdom in 1997 had a predominant character of a "classic excess profits tax" and thus could be used in computing the foreign tax credit under Section 901.
Background
Between 1984 and 1996, the UK parliament began privatizing government-owned companies and sold shares in them in an initial offering. PPL Corporation became a 25% owner of one of those companies, South Western Electricity plc. In 1997, a new political party came to power and imposed a 23% windfall tax on the privatized companies, which by then had become wildly profitable. The tax was based on a formulary approach designed to capture excess profits resulting from the privatization.
South Western Electricity's windfall tax burden was £90.4 million. In its 1997 federal income tax return, PPL claimed a credit under Section 901 for its portion of the tax. The IRS rejected the claim.
The Tax Court held that the windfall tax was creditable and had the predominant character of a U.S. income tax in that it passed the realization, gross receipts and net income requirements of reg. section 1.901-2(b)(1).
The IRS appealed to the Third Circuit Court of Appeals and won, with the court holding that the windfall tax did not pass the gross receipts requirement. Around the same time, however, the Fifth Circuit heard an appeal in a companion case and sided with the taxpayer, setting up a Supreme Court challenge.
Supreme Court's reasoning
The Supreme Court, in a unanimous opinion authored by Justice Clarence Thomas, analyzed the nature of the tax under reg. section 1.901-2 and held that the windfall tax met the requirements for creditability, because the tax essentially functioned as an excess profits tax. Under Section 901(b)(1), taxes paid to a foreign country by a domestic corporation on income, war profits and excess profits is creditable.
The Court ruled that was substantively a 51.71% tax on profits above a certain threshold and that the predominant nature of the tax was based on the net income.
The Court reiterated that the correct analysis in determining creditability under Section 901 is to evaluate the economic effect of the tax, not its characterization by the foreign government.
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