I chose this court case because the decision will have effects on many businesses in the United States who own foreign companies. A holding for the Commissioner of Internal Revenue may subject taxpayers in PPL’s position to double taxation. However, a holding for PPL threatens to undermine the consistency and uniformity of the U. S. tax code as well as curtailing the power of the Commissioner of Internal Revenue to interpret the law. The main issue in the case is whether or not a U. S. company receives a U. S. tax credit for paying the United Kingdom’s windfall tax.
Along with the issue comes the question on whether or not the courts should employ a formalistic approach that looks solely at the form of the foreign tax statue and ignores how the tax actually operates, or should employ a substance based approach that considers factors such as the practical operation and intended effect of the foreign tax. Section 901 of the Internal Revenue Code allows U. S. Corporations a tax credit for income, war profits, and excess profits taxes paid to another country to avoid double taxation.
This case involves the application of section 901 to a “winfall tax” (a one-time twenty three percent tax imposed by the United Kingdom on privatized companies). Petitioner PPL Corporation is an energy company in Allentown, Pennsylvania that provides electricity and natural gas to consumers in the United States and the United Kingdom. PPL Corporation owned a 25% share in South Western Electricity Board that the Government privatized in the 1980’s. In 1997, the U. K. Government imposed a windfall tax on companies based on the difference between a company’s value and the “flotation value”, or the amount at which the U. K. Government sold the company. After paying the tax, PPL then filed a tax claim with the IRS asserting PPL was eligible for a foreign tax credit under section 901 of the Internal Revenue Code.
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After being denied by the IRS in 2007, PPL argued that the windfall tax targets income and that the calculation of the tax involves the value of the company’s net gain. The Commissioner denied these laims however, stating that the tax is not a tax on income but rather a tax on the value of a company. The Commissioner adds that the calculation of the tax measures the ability of a company to generate income. The decision on the petition filed by PPL in the United States Tax Court was that PPL was entitled to a foreign tax credit because the windfall tax was essentially a tax on excess profits and this fell within the requirements of section 901. The Commissioner then appealed the decision to the United States Court of Appeals for the Third Circuit.
There, the decision was reversed in favor of the Commissioner holding that the windfall tax did not entitle PPL to a foreign tax credit because the tax was a tax not solely on South Western Electricity Board’s profits but instead on the difference between its profits and sale value. On July 9, 2012 PPL contested the decision of the Third Circuit and filed a writ of certiorari to the Supreme Court of the United States which was granted review on October 9, 2012. As I stated before, one of more important discussions about this particular case is what approach the courts should take when deciding.
PPL argues the Supreme Court should adopt an approach that considers the actual as well as the planned function of the foreign tax, a substance based approach. PPL argues that U. S. tax laws have always looked beyond the label or name of the tax imposed by the foreign country and instead focused on how the tax operates- the substance of the tax. Furthermore, the PPL notes that the Treasury Regulations, section 901-2, suggest that a substance-based approach should be used. The Treasury Regulations state that “income” includes any income that has already been earned, is revenue based on gross receipts, or is net income.
Congress intended, as shown in section 901, that in such situations, the substance of the tax trumps its form because tax law aims to reach the realities of economic transactions and dealings. The Commissioner argues that PPL’s reliance on the substance-based approach incorrectly assumes that any tax that depends on net profits is an income tax. Thus, the Commissioner rejects the substance-based approach and argues that the foreign tax paid by PPL was not an income tax and therefore does not qualify under section 901.
The Commissioner argues that the substance of the U. K. windfall is the same as the form or labels that the British tax authorities have provided. The Commissioner stated that the U. K. windfall tax is a tax on the value of a company in relation to how much the U. K. government would receive for the company if it were sold. In response to PPL’s argument on double taxation, the Commissioner believes that because the windfall tax is not an income tax, PPL’s profits are not actually taxed twice.
The Supreme Court’s decision in this case will determine whether a windfall tax involving gross receipts and excess profit constitutes the equivalent of a United States income tax and thus is eligible for a foreign tax credit under the Internal Revenue Code. I think PPL has a strong case against the Commissioner and I believe the Supreme Court will rule in the companies favor. I do believe that the windfall taxation on these businesses along with the U. S. taxation would mean double taxation for these companies.
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