US Supreme Court Sides with Taxpayer in $39M Foreign Tax Credit Dispute

For the Internal Revenue Service, the current scandal it faces regarding the handling of 501(c)(4) non-profit organization applications is not the only piece of very bad news. In a stinging defeat, the U.S. Supreme Court ruled in PPL Corp. v. Commissioner that the tax code permitted a Pennsylvania energy company to claim $39 million in foreign energy tax credits in relation to a British windfall tax. The ruling paves the way for several other energy companies, hit with similar taxes by British authorities, to similarly avail themselves to the credit.

In the 1990s, PPL Corporation, along with Entergy Corporation and American Electric Power Co., acquired several British utility companies. The British government had once owned the entities, but they were privatized in the 1980s and 1990s. In 1997, the British government introduced a 23 percent “windfall” tax on “excess profits” of privatized utility companies. Britain based its new tax on a utility’s average annual profit multiplied by an imputed price-to-earnings ratio.

The taxes imposed on the American companies were substantial. In PPL’s case, it paid the equivalent of approximately 39 million in US dollars. Entergy paid substantially more, at $234 million. The American companies, in turn, claimed a foreign tax credit for the full amount of British windfall taxes. The IRS denied the claims in 2007, asserting that the new British windfall tax was not creditable under the tax code section governing foreign income taxes. Because the British law stated that the tax applied to a utility’s “profit- making value,” not income or receipts, the tax was not predominately an income tax in character, the agency claimed. The US Tax Court concluded that the credits were allowable, but a split emerged on appeal, as the 3d Circuit ruled against PPL, but the 5th Circuit agreed with Entergy. A unanimous Supreme Court agreed with the companies. Justice Clarence Thomas, writing the court’s opinion, explained that the British windfall tax was predominately an excess profits tax, which qualifies as a category of income tax under US law. Because the British tax authorities arrived at the amount of windfall tax using an unrecognized method of “backward-looking analysis of historical profit” to arrive at “a fictitious value,” the court looked past the face of the British tax to reach its fundamental character, which was “a tax on actual profits above a threshold.” The IRS’s characterization could not “be squared with the black-letter principle that ‘tax law deals in economic realities, not legal abstractions,” like the artificial method of calculation Britain employed with its windfall tax, Justice Thomas wrote.

The outcome benefits not only PPL and Entergy, but also American Electric, whose similar dispute with the IRS is still pending, it stated in a brief filed in the PPL case.

The cases of these energy companies highlight the profound need to work with capable advisors when dealing with overseas assets, to ensure your business has the best possible plan in place to minimize potential negative tax impacts. For advice regarding your overseas holdings, consult the experienced tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C., who have years of experience formulating tax plans for businesses throughout New York and New Jersey whose assets stretch beyond the US’s borders. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.

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