Case Study: PPL Corp. et al. v. Commissioner of Internal Revenue
In PPL Corp. et al. v. Commissioner of Internal Revenue, Docket No. 12-43 (Opinion May 20, 2013), a circuit split regarding an issue of international taxation was resolved. The specific question at issue was whether a U.K. “windfall tax” paid by a U.S. company was creditable on a U.S. tax return. Unfortunately for the Internal Revenue Service, the Supreme Court held that it was, reasoning that the tax was in the nature of an income tax, and therefore qualified as a creditable foreign tax payment within the meaning of the Tax Code.
For those who don’t know, a tax credit is a “below-the-line” subtraction that reduces tax liability after it has been calculated. For example, if net income is $100,000 and the applicable tax rate is 20%, the total tax payable will be $20,000. If a $15,000 tax credit is available, however, total tax payable will be reduced to only $5,000.
This is in contrast to a deduction, which is an “above-the-line” subtraction. In our example, if the $15,000 were available as a deduction (instead of as a credit), it would reduce net income to $85,000, and leave our taxpayer with a total tax bill of $17,000.
Accordingly, tax credits provide extraordinarily valuable tax savings, and taxpayers will fight hard if there is a chance that a payment made could be characterized as such.
In this case, PPL Corporation, a U.S. energy company, had an ownership of a U.K. energy company. When it paid certain “windfall” taxes in connection with privatization of that U.K. entity, it later claimed a tax credit for the amount of those taxes under 26 CFR § 1.901-2 (a). That subsection states that a tax paid to a foreign government is creditable if, “The predominant character of that tax is that of an income tax in the U.S. sense.”
The IRS disagreed, mainly arguing that because the formula by which the tax was calculated was tied to valuation of the company, and did not expressly focus on income or profits, it could not qualify as an “income tax.” Because of that, the IRS reasoned, the tax paid by PPL could not be creditable.
The Supreme Court was not persuaded by the technical nature of the IRS’s arguments, focusing on precedent that states that, “[T]ax law deals in economic realities, not legal abstractions.” The tax in question was, in essence, based on the company’s out-earning profit projections prepared in connection with privatization. Seeing through to this underlying character of the tax, the court held that it indeed was a creditable income tax.
The Court also dealt with an argument that the tax could not be creditable because it would have been assessed differently against different entities, in such a way that, for some taxpayers, it might not be characterized as an income tax. That is, it was argued that if a tax is not in the character of an income tax for all taxpayers, it cannot satisfy § 1.901-2 (a). The Court disagreed with this argument, but did not base its holding thereon, as the reasoning was not raised by a party in interest.
The decision of the court below was accordingly reversed.
If you are interested in learning more, the @WashULaw online LL.M. in U.S. Law program offers a course entitled International Business Transactions that can help expand your understanding of certain issues that may be relevant to cases like these.