WASHINGTON--The Supreme Court on Wednesday appeared split on Wednesday whether utilities that paid a windfall tax in the United Kingdom can claim a foreign-tax credit on their U.S. tax returns.
The case stems from a U.K. decision beginning in 1997 to impose a tax on what it deemed some of the excess value earned by certain utilities. The U.K. had privatized a number of utilities starting in the 1980s, and later decided it had charged too little and was entitled to more money. The U.K. imposed a one-time tax.
A legal battle ensued in the U.S., as American companies with stakes in the U.K. utilities tangled with the Internal Revenue Service over whether the overseas tax qualified for a foreign-tax credit. Two U.S. appeals courts reached different conclusions. The result was that PPL Corp. PPL was denied a tax credit. Entergy Corp. ETR was permitted to take the credit.
Foreign-tax credits are available to U.S. companies if the tax has the characteristics of a U.S. income tax. The question: Did the U.K. windfall tax resemble an income tax--a tax on profits? Or was it a tax on value?
The U.S. government, which risks losing billions in revenue from a broad definition of foreign-tax credit, said the U.K. tax was tied to the value of the companies. PPL Corp. PPL , which had to take a $39 million tax expense in the 2011 fourth quarter after the Philadelphia-based Third U.S. Circuit Court of Appeals denied the credit, said the tax was tied to profits. PPL and companies in other industries stand to lose out on tax credits from a narrow definition of foreign-tax credit.
Justice Sonia Sotomayor was the first to question PPL's rationale, saying that the utility was going too far. "I have a problem with this argument," she told PPL attorney Paul Clement. She said that PPL was in effect asking the Supreme Court to rule that any time profits were an element of a formula for calculating a foreign tax, companies should receive a foreign-tax credit.
Mr. Clement pushed back, saying that a key difference in this case was that the U.K. tax was calculated based on profits that had already been earned. He said that if the U.K. had intended to impose a tax on the value of the company, the government would have factored in future estimated profits, or would have looked to the stock price. By looking to past profits, Mr. Clement argued, the U.K. was in effect taxing income.
Justice Elena Kagan took exception, saying that profits were just one element of the U.K. formula. Because the tax formula was more complex than a simple share of profits, she said, "it's taxing profitability, not profits." Justice Sotomayor lined up with Justice Kagan, saying the tax was based on profitability as "a mechanism" to tax value.
Chief Justice John Roberts jumped in, cautioning against relying on arguments that the government itself had not made. Justice Stephen Breyer said that the U.S. Tax Court had tax expertise, not judges on an appeals court. The U.S. Tax Court ruled against the IRS when the tax authority sought to disqualify both PPL and Entergy from receiving the foreign-tax credit.
"I tend to be tempted to say, well, the tax courts deserve something," Mr. Breyer said. He added that the "heart of the equation" involved a tax on average income.
The outcome of the case will not be known for months and remained uncertain because some justices did not speak and others were inscrutable. Still, the ruling could have implications for a range of other businesses, from oil companies to drug companies, that pay taxes in foreign jurisdictions.
Justice Ruth Bader Ginsburg piped up with a question about whether the U.S. government could come up with new restrictions on foreign-tax credits after the Supreme Court has ruled, asking whether the regulation could be changed if the high court sides with the New Orleans-based Fifth Circuit, which allowed Entergy to take the tax credit. "Could the regulation be changed so it wouldn't happen again?," she wondered.
Ann O'Connell, who represented the U.S. government, said that there was room to make the regulation clearer if the Supreme Court concluded that the windfall tax is an income tax. "If so, then I--I think it should be changed," she said.
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