Reversal of Fortune: Did PPL Get a Foreign Tax Credit from the Wrong Government?

Reversal of Fortune: Did PPL Get a Foreign Tax Credit from the Wrong Government?

In PPL Corp. v. Comm'r, 133 S. Ct. 1897 (U.S. 2013), the Supreme Court reminded us that a foreign government's characterization of its own tax is not dispositive in deciding whether the tax ought to be creditable in the United States. [The ruling reversed the judgment of the Third Circuit (665 F3d 60 (3d Cir 2011)), and settled a split with the Fifth Circuit in Entergy Corp v Commr, 683 F3d 233 (5th Cir 2012).] This dismissal accords with the established doctrine around the creditability of a tax, which determines whether something is a tax at all, and, if so, whether it is an income tax, according to U.S. principles. [Treas Reg § 1.901-2(a)(2) ("A foreign levy is a tax if it requires a compulsory payment pursuant to the authority of a foreign country to levy taxes. . . . [which] is determined by principles of U.S. law and not by principles of law of the foreign country."), Biddle v Commr, 302 US 573 (1938).] But something important seems to have been lost in this approach; namely, that the tax in this case seems, in the words of Third Circuit Court Judge Ambros, "a bridge too far" 3 from the kind of income tax that the foreign tax credit was designed to alleviate. The tax in question appears instead to force a disgorgement of profits in order to, in effect, re-price a preexisting sale of a company using the benefit of hindsight to determine the then-fair market value.

The doctrine surrounding the creditability of a tax—which now, due to the PPL Corp. decision, expressly allows a re-configuration of a foreign tax to accord with U.S. income tax principles—does not seem to have a means of dealing with the distinction between an income tax qua income tax and an income tax qua disgorgement of profits. That is troubling because the end result in PPL Corp. is that the U.S. fisc bore the brunt of not one, but two foreign taxes imposed on the same income stream by the same foreign government. Instead, the U.S. could have borne no cost at all to the extent the second tax in effect wiped out profits that had been subject to the foreign income tax in the first place...

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... [A] reflection on the U.K. government's intentions in adopting the tax reveals that any entitlement PPL Corp. had to a tax credit should have been against the government that imposed the forced disgorgement, and not against the United States. That is because an extraction that is a forced disgorgement of profits—which clearly seems to have been the purpose of the U.K. windfall tax—represents an undoing of an "error," which in this case was carried out by the former U.K. government in its sale of the energy companies at a below-market price.

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Various aspects of the U.K. tax legislation suggest that this tax was not designed to consider ability to pay as a fundamental matter. For example, the tax was a one-time levy; it applied only to the specified taxpayers, and could not and would not ever apply to any taxpayer other than those named specifically as a class; it was retroactive; it was specifically designed and formulated to raise a pre-determined amount of revenue, and it did raise that amount of revenue; and finally, its form was specifically chosen to ensure it would not be viewed as a tax on profits. [PPL Corp. & Subsidiaries v. Comm'r, 135 T.C. 304 (T.C. 2010).]

The various U.S. courts dismissed each of these factors as non-dispositive to the question of whether the "predominate character" of the tax was of an income tax in the U.S. sense, per U.S. regulations. Yet together, the factors paint a picture of a tax that is not, in qualitative terms, an income tax.

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In this case the foreign tax was, according to its own designers, not meant to be an iteration of a domestic income tax but rather was intended to perform a distinct and independent function; namely, the disgorgement of profits. If it nevertheless catches the same base as an income tax would in the United States, should the foreign tax credit really apply?

The Supreme Court suggests that the answer is yes, under current law. But the result invites us to reconsider what the foreign tax credit is meant to accomplish as a policy matter, and whether these goals are in fact served when we dismiss evidence that the foreign government expressly intended the tax in question to accomplish a very different result than that normally sought through income taxation.

(Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.)

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