RESPONDENT:Commissioner of Internal Revenue
LOCATION: Internal Revenue Service
DOCKET NO.: 12-43
DECIDED BY: Roberts Court (2010-2016)
LOWER COURT: United States Court of Appeals for the Third Circuit
CITATION: 569 US (2013)
GRANTED: Oct 29, 2012
ARGUED: Feb 20, 2013
DECIDED: May 20, 2013
Ann O’Connell – Assistant to the Solicitor General, Department of Justice, for the respondent
Paul D. Clement – for the petitioner
Facts of the case
PPL Corporation held a 25 percent stake in South Western Electricity Board, a utility in England subject to a onetime windfall tax. After PPL paid the tax, it claimed a foreign tax credit under I.R.C. §901 on its U.S. tax return. §901 allows a credit for foreign taxes on “income, war, profits, [or] excess profits.” The Internal Revenue Service (IRS) denied the tax credit and issued a notice of deficiency. PPL then filed a petition in Tax Court to challenge the IRS’s determination. The Tax Court agreed with PPL and the Commissioner of Internal Revenue (CIR) appealed to the U.S. Court of Appeals for the Third Circuit, arguing that §901 does not cover the windfall tax because it is a tax on the company’s value, not its profits. PPL argued that, looking beyond the face of the statute, the windfall tax was intended to act as a tax on excess profits. The Third Circuit ruled in favor of the CIR, holding that the windfall tax is not eligible for credit.
Should courts use a formalistic approach or a substance-based approach that takes into account how the tax actually operates when determining the creditability of a foreign tax?
Media for PPL Corporation v. Commissioner of Internal Revenue
Audio Transcription for Opinion Announcement – May 20, 2013 in PPL Corporation v. Commissioner of Internal Revenue
John G. Roberts, Jr.:
Justice Thomas has our opinion this morning in case 12-43, PPL Corporation versus the Commissioner of Internal Revenue.
This case comes to us on a writ of certiorari to the United States Court of Appeals for the Third Circuit.
Between 1984 and 1996, the United Kingdom privatized 32 owned — state-owned companies.
Many of these companies became dramatically more efficient under private ownership and earned substantial profits.
In 1997, parliament imposed a one-time “windfall tax” on the 32 companies.
The tax was based on the difference between the actual price at which each company was privatized and a theoretical value arrived at by multiplying the company’s historic profits by the number nine.
Parliament labeled this a “price-to-earnings ratio.”
Petitioner, PPL Corporation, owned 25% of the U.K. companies that was subject — one of the U.K. companies that was subject to the tax.
It claimed the credit for it shared bill on its 1997 federal income-tax return, relying on Internal Revenue Code Section 901(b)(1) which provides that any income, war profits, and excess profits taxes paid overseas are creditable against U.S. income taxes.
Treasury Regulations interpret this section to mean that a foreign tax is creditable if its predominant character is that of an income tax in the U.S. sense.
The Commissioner of Internal Revenue rejected PPLs claim, but the Tax Court held that the U.K. windfall tax was creditable.
The Third Circuit reversed.
In an opinion filed with the clerk today, we reversed the judgment of the Third Circuit.
Treasury Regulation Section 1.901-2 sets forth the relevant principles.
First, a tax’s predominant character or the normal manner in which it applies is controlling.
Thus, a foreign tax that operates as an income, war profits, or excess profits tax for most taxpayers is creditable.
Second, the creditability of a foreign tax does not depend on the way a foreign government characterizes its tax.
Instead, it depends on whether the tax would be an income, war profits, or excess profits tax if the U.S. had enacted it.
Other Treasury Regulations expand upon these principles, explaining that a foreign tax’s predominant character is that of a U.S. income-tax if the foreign tax is likely to reach net gain in the normal circumstances in which it applies.
Net gain, also referred to as net income consist of realized gross receipts reduced by significant cost and expense attributable to such gross receipts.
Any foreign tax that reaches net gain or profits is creditable.
Applying these guidelines, we conclude that the U.K. windfall tax’s predominant character is that of an excess profits tax, the category of income tax in the U.S. sense.
The Commissioner argues that the windfall tax is a tax on the difference between two values, but it is, in fact, the tax on the realized net income.
The substance of the windfall tax confirms this conclusion.
When algebraically rearranged, the UK’s formula demonstrates that the windfall tax is economically equivalent to the difference between the profits each company actually earned and the amount the government believed that should have earned during the relevant period.
For most of the companies subject to the tax, the formula effectively imposed a 51% tax on all profits above a threshold, a classic excess profit — profits tax.
The Commissioner also argues that any algebraic rearrangement is improper because U.S. courts must take the foreign tax rate as — as written and accept whatever tax base the foreign tax purports to adopt, but such a rigid construction cannot be squared with the black-letter principle that tax law deals and economic reality is not legal abstractions.
We, accordingly, follow substance over form and hold that the windfall tax is a tax on actual profits above a threshold and is therefore creditable.
The judgment of the Court of Appeals for the Third Circuit is reversed.
The opinion of the Court is unanimous.
Justice Sotomayor has filed a concurring opinion.